The comprehensive income is a statement inclusive of all income and expenses including revenue, profit and loss, profit share, finance costs, operational costs, investment costs, tax expenses, discontinued operations and others recognized during that specific period – i. E. For the Year Ended 31st December 2013. It displays the change in equity (net assets) of a business operation during a period from transactions and other events as well as circumstances from non-owners sources. This statement also illustrates the financial performance and outcomes of operations of a particular company or entity for an accounting period.
The purpose of the statement of comprehensive income is to provide the basic measures of performance of an entity over a specific accounting period. It reports all changes in equity (except those resulting from investments by owners and distributions to owners) of an entity that resulted from recognized transactions and other economic operations with owners in their capacity as owners. The statement of comprehensive income is drawn up for owners and users who are concerned with the business operations’ financial performance.
For instance, from the income statements, he users are able to monitor the change in sales revenue over periods, change in gross, operating and net profit margin over periods as well as the increase or decrease in gross, operating and net profit and compare against industry growth. The users may also use these data to compare the entity’s profitability with other organizations operating in the similar industries. This statement is an essential reference for users as the data reported can also be used to assess potential transformations in its economic resources and its capacity to generate cash from its resources.
Additionally, users would require this information to manically evaluate how effectively any additional resources might be utilized to enhance financial performance. As defined by the Conceptual Framework for Financial Reporting, income is derived from increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity apart from those relating to contributions from equity contributors.
Whereas, expenses are derived from decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or liabilities that result in decreases in equity apart from those relating to distributions to equity contributors. Income comprises of revenue earned from events of an entity – i. E. Sales, interest, dividend, royalties, others and gains which arise from other events of income generated.
Gain is of the same nature as revenue and represents increases in economic benefits however it may or may not arise from events of an entity hence is not regarded as a separate element under the Conceptual Framework. Income by definition also includes unrealized gains so when gains are recognized in the income statements, they would usually be displayed strictly as knowledge of them is useful for the purpose of making economic decisions and are often reported net of related expenses.
Expenses comprise of losses and expenses incurred from events of an entity – i. E. Cost of sales and depreciation which typically are in the form of cash outflows or depletions of assets. Losses are of the same nature as expenses and represent decreases in economic benefits however it may or may not arise from events of an entity hence is not regarded as a separate element under the Conceptual Framework. Losses include those resulting from natural disasters and disposal of non-current sets.
Losses by definition also include unrealized losses like effects of increases in the exchange rate for a foreign currency from borrowings so when losses are recognized in the income statements, they would usually be displayed distinctly as knowledge of them is useful for purpose of making economic decisions and are often reported net of related income. B) Describe the general purpose of the statement of financial position.
In addition, explain the terms asset, liability and equity as defined by the Conceptual Framework for Financial Reporting. The financial position is a tenement also known as balance sheet, presents the financial position of an entity at a given date – i. E. As at 31st December 2013. It consists of three main components; assets, liabilities and equity. The statement of financial position facilitates users in assessing the financial soundness of an entity in terms of liquidity risk, financial risk, credit risk and business risk.
When used in conjunction with other financial statements of the entity and its competitors, balance sheet may help to identify relationships and trends which are indicative of potential problems or areas for further improvements. Analysis of the tenement of financial position could therefore assist the users of financial statements to predict the amount, timing and volatility of entity’s future earnings. These users range from internal users i. E. The management to external users i. E. The investors/shareholder.
The management, requires the financial position to gauge the performance of the company as a result of their past decisions, ability to generate wealth for their shareholders, increase in share price which in terms causes public perception to improve and hence causing earnings to increase and lastly it gives the management an overall look of their performance bonus and bob’s security. The financial position provide the investors/shareholder with an outlook on the performance, liquidity, debt level, direction, dividend payout of the company before they decide to buy/sell their current shares of the company.
As defined by the Conceptual Framework for Financial Reporting, the elements of financial statements directly relate to the measurement of financial positions are assets, liabilities and equity. Asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. It is something which a business owns or has control over to benefit from its use in some way (e. G. A machine). It is worth noting that the framework defines asset in terms of control rather than ownership.
Therefore an asset may be recognized in the financial statement of the entity even if ownership does not belong to them. For instance the machine was rented by the entity for the entire duration over it useful life, the machine could be recognized in the entity s statement of financial position since the entity has control over the economic benefits that would be derived from the use of the asset. Since assets are only recognized when the entity has control over it useful life, it would imply that certain assets would not be recognized in the statement of financial position.
For instance a good attitude and hardworking worker would be the most valuable assets of the company but the company has no control over its workers simply because they could quit the company any day and join the rival firm at the disadvantage of the company. Hence such asset may not be recognized in the statement of financial position. Assets can be classified as current or non-current depending on the duration hat the entity plans to derive from the economic benefit of its use.
An asset that allows the entity over a usage of a long period of time is deemed as non-current whereas assets that are expected to be realized within one year are deemed as current assets. Assets are further classified in the statement of financial position on the basis of their nature under tangible & intangible, inventory, trade receivables, cash and cash equivalents. Liability is an obligation that an entity owes to someone and its payment involves the transfer of cash or other resource.
Liability could for instance be a bank loan, which obligates the entity to pay loan installments over the duration of the loan to the bank along with loan interest. Alternatively it could be a trade payable arising from the purchase of supplies from a supplier on credit. For a liability to be recognized in the financial statements, it must be a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.
Conversely, a liability may not be recognized in anticipation of a future obligation for instance a bank loan expected to be taken in near future. The obligation to transfer economic benefits may not only be a legal one. For instance liability in respect of a constructive obligation may also be recognized where an entity, on the basis of its past practices has created a socially responsible image in the minds of concerned public that it will fulfill such obligation in the future.
For example, a company that encourages its customer to use recycle bag when shopping with them in spite of no legal obligation in promoting being an environmental friendly user , and it advertise itself as an environment friendly organization, then this give rise to a constructive liability and must therefore be recognized in the financial statements of the company. This is because a valid expectation has been created that the company will promote a green environment by using recycle bag when shopping with them.
Liabilities can be classified under current or non-current depending on the duration of which the entity intends to settle the liability. A liability which will be settled over a long term is classified as non-current whereas liabilities which will be settled within one year from the reporting date are classified as current abilities. Liabilities are further classified in the statement of financial position on the basis of their nature under trade and other payable, short term borrowing, long term borrowing and current tax payable.
Equity is the residual interest in the assets on the entity after deduction all the liabilities. It is what the business owes to the owners. Equity therefore includes shared capital contributed by shareholders along with any profits retained in the business. Therefore in the event when the business is being liquidated, equity is what the owners can take home. Unlike assets and liabilities, equity has no recognition criteria. As defined by the framework, equity is the residual interest in the asset of the entity after deducting all its liabilities. Simply put in words equation; capital= assets – liabilities.
From this we can understand that if only recognition criteria of assets and liabilities are provided that is enough to cover the equity element as well as this is just a residual. Examples of equity being recognized in the statement of financial position are the following, share capital, retained earnings and revaluation reserve. C) Explain the accrual axis of accounting by defining the principles involved. Illustrate your answer by taking the example of the cost of sales adjustment in the statement of comprehensive income. Under accrual basis of accounting, income must be recorded in the accounting period that it was earned.
Therefore, accrued income must be realized in the accounting period which it was earned rather than in the subsequent period which it will be received. In contrast, prepaid income must not be recorded as income in the accounting period which it is received but instead it should only be recorded as income in the subsequent accounting erred in which the service has been rendered. Expenses, on the other hand, must be recorded in the accounting period in which they are incurred. Therefore, accrued expense must be recorded in the accounting period in which it occurs rather than in the subsequent period in which it will be paid.
In contrast, prepaid expenses must not be shown as expenses in the accounting period in which it is paid but instead it must only be presented in the subsequent accounting period in which the services in respect of the prepaid expenses have been performed. Accrual basis of accounting ensures that expenses are “matched” tit the revenues earned in an accounting period and that we should report both activities at the same time. This principle is known as the matching concept that exists only in accrual accounting.
This simply means that if you owned a store and spent money on purchases of stocks, you wouldn’t record the expense until you sold the items for revenue. Even so, you would record only the portion of the expense attributable to each individual item as it got sold. Matching principle is further enhanced by developing the use of depreciation in accounting for non-current assets. Depreciation indicates how much of an assets value has been used up over several accounting period. Depreciation is used in accounting to match the expense of an asset to the income that the asset helps the company earn.
Matching principle therefore results in the presentation of a more balanced and consistent view of the financial performance of an entity as compare to the use of cash basis accounting. Under accrual concept accounting, revenue is recognized by the seller when it is earned regardless of whether cash from the transaction has been received. This is known as realization concept. Application of the realization principle ensures that the reported performance of an entity reflects the true extent of revenue earned during an accounting period rather than the cash inflows generated during the accounting period.
To better understand the concept of accrual accounting we look into an example of the cost of sales with adjustment made in the income statement. For example, in a financial year, Hays limited purchased one thousand tables at $100 each and sold eight hundred tables at $300 each. Under cash basis accounting, the profit he earned would have been using the sales income deducting the cost of items which is: ($300 x 800 tables) – ($100 x 1000 tables) = $140,000.
But under accrual basis of accounting, it states that expenses are “matched” with the revenues earned in an accounting period and that we should report both activities at the same time. Hence he should make an adjustment by crediting the expense account to match that of the revenue i. E. He should use sales ($300 x 800 tables) – cost of sales ($1 00 x 800 tables) = $160,000. In this case, expenses are directly matched to revenues they produced. However in many small businesses, where sole proprietorship is concerned, they practice cash accounting instead.