Financial Reports: Statement of Income, Compre- Compre-hensive Income and Changes in Equity
Chapter 3 Learning Objectives
3.4 Statement of Income and Comprehensive Income
3.3.1 Financial Statement Differences Between IFRS and ASPE
The core financial statements shown above illustrate the types of statements required for IFRS companies. They are the following:
• a statement of income
• a statement of comprehensive income
• a worksheet-style statement of changes in equity with all the equity accounts included
• a statement of financial position
• a statement of cash flows
• notes to the financial statements
IFRS requires the comparative previous year amounts be reported as well as disclosure of the earnings per share. ASPE does not require these disclosures. IFRS requires the statement of comprehensive income (or a combined statement of income and comprehensive income), whereas ASPE only requires a statement of income because comprehensive income does not exist. The statement of changes in equity required by IFRS shown in the Wellbourn example above now becomes a more simplified statement of retained earnings for ASPE, where only the details for retained earnings are reported (though any changes in shareholder equity accounts must be disclosed in the notes to the financial statements). The remaining equity accounts such as common shares and contributed surplus are reported as ending balances directly in the balance sheet for ASPE (called the statement of financial position for IFRS companies).
3.4. Statement of Income and Comprehensive Income 49
Some of these estimates have more measurement uncertainty than others, and some esti-mates are inherently more conservative than others. This in turn affects the quality of earnings reported in an income statement.
Quality of earnings– the amount of earnings attributable to sustainable ongoing core business activities rather than to “artificial profits” arising from:
• differences in earnings due to applying the various accounting policy choices such as FIFO or weighted average cost for inventory valuation or straight-line, declining-balance, or units-of-production depreciation methods
• the use of estimates such as those for estimating bad debt or warranty provisions
• the presence of significant amounts of non-operating gains and losses compared to income from continuing operations
• the inclusion of unreliable items such as inappropriate contingent gains
• management bias and reported amounts not objectively determined
• differences due to IFRS or ASPE application of standards
• information that is not concise or clearly presented and is poorly understood, resulting in potential misstatement
Lower quality earnings will include significant amounts of the items listed. If the quality of earnings is low, more risk is associated with the financial statements, and investors and creditors will place less reliance on them.
Single-step and Multiple-step Statement of Income
Single-step, multiple-step, or any condensed formats used in a statement of income are not specified GAAP requirements. Companies can choose whichever format best suits their reporting needs. Smaller privately held companies tend to use the simpler single-step for-mat, while publicly traded companies tend to use the multiple-step format. When condensed formats are used, they are supplemented by extensive disclosures in the notes to the financial statements and cross-referenced to the respective line items in the statement of income.
The Wellbourn Services Ltd. statement of income, shown earlier, is an example of a typical single-step income statement. For this type of statement, revenue and expenses are each reported in the two sections for continuing operations. Discontinued operations are separately reported below the continuing operations. The separate disclosure and format for the discon-tinued operations section is a reporting requirement and is discussed and illustrated below.
The condensed or single-step formats make the statement simple to complete and keeps
sensitive information out of the hands of competitive companies, but provides little in the way of analytical detail.
Themultiple-step income statement format provides much more detail. Below is an example of a multiple-step statement of income for Toulon Ltd., an IFRS company, for the year ended December 31, 2020.
3.4. Statement of Income and Comprehensive Income 51
Toulon Ltd.
Consolidated Statement of Income and Comprehensive Income for the year ended December 31, 2020
In $000’s except per share amounts 2020 2019
Sales $6,260 $5,008
Cost of goods sold 2,500 1,750
Gross profit 3,760 3,258
Operating expenses
Salaries and benefits expense 650 520
Depreciation expense 35 20
Travel and entertainment expense 150 120
Advertising expense 55 45
Freight-out expenses 10 8
Supplies and postage expense 5 4
Telephone and internet expense 15 12
Legal and professional expenses 8 6
Insurance expense 6 5
934 740
Income from operations 2,826 2,518
Other revenue and expense
Dividend revenue 3 3
Interest income from investments 2 2
Gain from sale of trade investments 4 0
Interest expense (2) (3)
7 2
Income from continuing operations 2,833 2,520
before income tax
Income tax expense 850 680
Income from continuing operations 1,983 1,840
Discontinued operations
Loss from operation of discontinued division
(net of tax of $45,000) (105) 0
Loss from disposal of division
(net of tax of $18,000) (42) 0
(147) 0
Net income (note 1) 1,836 1,840
Other comprehensive income:
Items that may be reclassified subsequently to net income or loss:
Unrealized gain from FVOCI investments (net of tax of $6,000 for 2020 and $3,000
for 2019 respectively) 14 9
Total comprehensive income 1,850 1,849
Non-controlling interests (minority interests) (11) (12) Attributable to the equity holders of Toulon $1,839 $1,837 Multiplestep format
-typical sections and subtotals:
Minimum Line Item Disclosures:
Heading Heading
Comparative years (IFRS)
Gross profit section with subtotal
Revenue – separated into major categories (IFRS & ASPE)
Inventory charged to expense (IFRS & ASPE)
Employee benefits expense in-cluding salaries and wages, pay-roll taxes, health care costs, and post-retirement benefits (IFRS)
Depreciation and amortization (IFRS & ASPE)
The remaining expenses by na-ture (IFRS)
Operating expenses with subtotal
Non-operating section with subtotal
This section is for non-operating items. Finance costs such as in-terest income & expense, foreign exchange, gain/loss from sale or impairment of assets and interest (IFRS & ASPE)
Income tax expense
Income tax expense on continuing operations (IFRS & ASPE) Subtotal from
continuing operations Same as Income before
discontin-ued operations (ASPE)
Discontinued operations
Discontinued operations, net-of-tax with net-of-tax amounts disclosed (IFRS & ASPE)
Net income (profit or loss) Net income (profit or
loss)
Comprehensive income (IFRS)
Other comprehensive income by nature (IFRS)
Total comprehensive income sep-arated into attributable to par-ent and non-controlling interests (IFRS)
Earnings per share, attributable to the equity holders of Toulon:
Basic earnings per share
Continuing operations $ 16.32 $13.25
Discontinued operations (1.23) 0
Diluted earnings per share
Continuing operations 12.86 13.75
Discontinued operations (1.03) 0
Net income 1,836 1,840
Non-controlling interests (minority interests) (10) (11) Attributable to the equity holders of Toulon $ 1,826 $1,829 Earnings per share
Basic and diluted EPS (IFRS)
Basic EPS from continuing and discontinued operations (IFRS)
Diluted EPS from continuing and discontinued operations (IFRS)
Net income (profit or loss) sepa-rated into attributable to the par-ent and non-controlling interests (IFRS & ASPE)
Note 1:
Other revenue and expenses section is to report non-operating transactions not due to typical daily business activities. For example, if a company sells retail goods, any interest expense incurred is a finance cost, and is not due to being in the retail business.
Toulon reported four non-operating items:
• Dividend revenue would be for dividends received from an investment in shares of another company
• Interest income from investments would likely be from an investment in bonds of another company
• Gain from the sale of trading investments would be for the profit made when the invest-ment was sold. In this case, the investinvest-ment is classified as fair value through net income (FVNI), which means any changes in the investment’s fair value at each reporting date, or profit upon sale, are reported as a gain/loss in net income
• Interest expense would be any interest paid on amounts owed to various creditors.
This is considered to be a financing expense and not an operating expense, unless the company is a finance company.
Other examples of non-operating items are listed below:
• write-down of inventory
• impairment losses and reversals of impairment losses on PPE, intangible assets, and goodwill
• foreign currency exchange gains or losses
• gain or loss from asset disposal or from long-lived assets reclassified as held for sale
• interest expense by current liabilities, long-term liabilities, and capital lease obligations
3.4. Statement of Income and Comprehensive Income 53
• unusual items (not typical and infrequent)
The multiple-step format with its section subtotals makes performance analysis and ratio calculations such as gross profit margins easier to complete and makes it easier to assess the company’s future earnings potential. The multiple-step format also enables investors and creditors to evaluate company performance results from continuing and ongoing operations having a high predictive value compared to non-operating or unusual items having little pre-dictive value.
Operating Expenses
Expenses from operations must be reported by their nature and, optionally, by function (IFRS).
Expenses by nature relate to the type of expense or the source of expense such as salaries, insurance, advertising, travel and entertainment, supplies expense, depreciation and amorti-zation, and utilities expense, to name a few. The statement for Toulon Ltd. is an example of reporting expenses by nature. Reporting expenses by nature is mandatory for IFRS compa-nies; therefore, if the statement of income reports expenses by function, expenses by nature would also have to be reported either as a breakdown within each function in the statement of income itself or in the notes to the financial statements.
Expenses by function relate to how various expenses are incurred within the various de-partments and activities of a company. Expenses by function include activities such as the following:
• sales and marketing
• production
• office and administration
• research and development
Common costs such as utilities, supplies, insurance, and property tax expenses would have to be allocated between the various functions using a reasonable basis such as square footage or each department’s proportional share of overall expenses. This allocation process can be cumbersome and will require more time, effort, and professional judgement.
The sum of all the revenues, expenses, gains, and losses to this point represents theincome or loss from continuing operations. This is a key component used in performance analysis and will be discussed later in this chapter.
Income Tax Allocations
Intra-period tax allocation is the process of allocating income tax expense to various cate-gories within the statement of income, comprehensive income, and retained earnings.
For example, income taxes are to be allocated to the following four categories:
1. Income from continuing operations before taxes 2. Discontinued operations, net of tax
3. Each item reported as other comprehensive income, net of tax
4. Each item regarding retrospective restatement for changes in accounting policy or cor-rection of prior period errors reported in retained earnings, net of tax, which is also discussed later in this chapter
The purpose of these allocations is to make the information within the statements more in-formative and complete. For example, Toulon’s statement of income for the year ending December 31, 2020, allocates 30% income tax as follows:
• Income from continuing operations of $850,000 ($2,833,000 × 30%)
• Loss from discontinued operations of $45,000 ($150,000 × 30%)
• Loss from disposal of discontinued operations of $18,000 ($60,000 × 30%)
• Comprehensive income gain from FVOCI investments of $6,000 ($20,000 × 30%)
All companies are required to report each of the categories above net of their tax effects. This makes analyses of operating results within the company itself and of its competitors more comparable and meaningful.
Note: if there is a net loss, the income tax reported on the income statement will be “income tax recovery” and shown as a negative (bracketed) amount.
Discontinued operations
Sometimes companies will sell or shut down certain business components or operations be-cause the operating segment or component is no longer profitable, or they may wish to focus their resources on other business components. To be separately reportable as a discontinued operation in the statement of income, the business component being discontinued must have its own clearly distinguishable operations and cash flows, referred to as a cash-generating unit (CGU) for IFRS companies. Examples are a major business line or geographical area.
If the discontinued operation has not yet been sold, there must be a formal plan in place to dispose of the component within one year and to report it as a discontinued operation.
3.4. Statement of Income and Comprehensive Income 55
The items reported in this section of the statement of income are to be separated into two reporting lines:
• Gains or losses in operations prior to disposal of the CGU, net of tax, with tax amount disclosed
• Gains or losses in operations on disposal of the CGU, net of tax, with the tax amounts disclosed
A video is available on the Lyryx site. Click here to watch the video.
Net Income and Comprehensive Income
Note that the statement for Toulon Ltd. combines net income and total comprehensive income.
Two statements would be prepared for IFRS companies that prefer to separate net income from comprehensive income. Thestatement of income, ends at net income (highlighted in yellow).
A second statement, called the statement of comprehensive income, would start with net income and include any other comprehensive income (OCI) items. The Wellbourn financial statement (shown in section 3.3of this chapter) is an example of separating net income and total comprehensive income into two statements.
Another item that is important to disclose in the financial statements is the non-controlling interest (NCI) reported for net income and total comprehensive income. This is the portion of equity ownership in an associate (subsidiary) that is not attributable to the parent company (Toulon, in our example) that has acontrolling interest(greater than 50% but less than 100%
ownership) in the acquired company’s net assets. Toulon must consolidate the associate’s financial data with its own and report as a single entity to comply with IFRS standards. Con-sider that if a company purchases 80% of the net assets of another company, the remaining 20% must therefore be owned by outside investors. This 20% amount must be reported as the non-controlling interest to ensure that investors and creditors of the company holding 80%
(parent) are adequately informed about the true value of the net assets owned by the parent company versus outside investors.
For ASPE companies using a multiple-step format, the statement of income would look virtually the same as the example for Toulon above and would include all the line items up to the net income amount (highlighted in yellow). As previously stated, comprehensive income is an IFRS concept only; it is not applicable to ASPE.
A video is available on the Lyryx site. Click here to watch the video.
Earnings per Share
Basic earnings per share represent the amount of income attributable to each outstanding common share, as shown in the calculation below:
Basic earnings per share (EPS)= Net income − preferred dividends Weighted average number of
common shares outstanding
The earnings per share amounts are not required for ASPE companies. This is because ownership of privately owned companies is often held by only a few investors, compared to publicly-traded IFRS companies where shares are held by many investors.
For IFRS companies, basic earnings per share excludes OCI and any non-controlling interests.
EPS is to be reported on the face of the statement of income as follows:
• Basic and diluted EPS from continuing operations
• Basic and diluted EPS from discontinued operations, if any
The term basic earnings per share refers to IFRS companies with a simple capital structure consisting of common shares and perhaps non-convertible preferred shares or non-convertible bonds. Reporting diluted earnings per share is required when companies hold financial instru-ments such as options or warrants, convertible bonds, or convertible preferred shares, where the holders of these instruments can convert them into common shares at a future date. The impact of these types of financial instruments is the potential future dilution of common shares and the effect this could have on earnings per share to the common shareholders. Details about diluted earnings per share will be covered in the next intermediate accounting course.
A video is available on the Lyryx site. Click here to watch the video.
A video is available on the Lyryx site. Click here to watch the video.