3- Statement of Profit and Loss Flashcards
What does Statement of Profit and Loss Show?
- Income of a firm- revenue earned by firms minus its expenses.
3 types of payment methods
- Cash on delivery
- Paid in arrears
- Paid in advance
Cash on delivery
Services and goods paid at the time the services are consumed or goods received.
Examples of cash on delivery
Goods from supermarket, takeaway food.
Paid in arrears
Services consumed and goods delivered and paid for at a later time.
May be invoiced at the time of delivery (typical for goods) or at a later time (common for services).
Examples of payments in arrears
Goods sold by one firm to another (invoiced at the time), electricity consumed (invoiced at a later date).
Paid in advance
Services and goods ordered and paid for in advance.
Examples of payments in advance
Rent on commercial premises, tickets for a flight.
Why Can’t We Use Cash Flows for Profit?
The timing mismatch between payments for sales and payments for their related costs makes it impossible to produce a meaningful value profit for an accounting period based on cash flows.
The Accrual Principle
Revenue should be recognised when earned regardless of when paid for. Expenses should be recognised when incurred regardless of when paid for.
IFRS Revenue Recognition Requirements
- the rights to all economic benefits from a product or a service, and responsibilities for any risks, have been transferred from the seller to the buyer without recourse (or returns can be reliably estimated)
- and the amount of revenue and associated costs can be measured reliably.
Different expenses
- Product costs
- Costs of running the business
- Selling and distribution costs
Problem with reporting expenses
- IFRS is not very proscriptive in terms of reporting
- US GAAP/ SEC Reporting
- Wide variation in terms of level of reporting and presentation
- Creates comparability problems
Product costs
Comprise all of the costs expended on a goods or service that are needed to generate the revenue from selling the goods or service.
Examples of product costs
- Direct costs such as raw materials and labour
- Fair share of the manufacturing overheads.
Matching Principle
Costs associated with revenues should be recognised in the same periods in which the revenues are recognised.
Reason for the matching principle
Needed to report meaningful value for profit
Gross/ Trading Profit
Revenue minus cost-of-sales
Period costs
Costs that cannot be easily be matched with revenues.
Corporate overheads
The costs of running the business
Manufacturing overheads
Transformed into product costs
Application of the Accrual Principle to Period Costs
Costs incurred for services received or things consumed that cannot be directly associated with revenues should be recognized in the same periods in which the benefits from the service were received or consumption took place.
Examples of corporate overheads
- Head office itself (building, staff)
- Marketing
- Data centres, call centres and IT network
- May include selling and distribution costs- Reported as “Other operating expenses” or “Selling, General and Administrative (SG&A) expenses”
Core Operating Profit
Gross profit - other operating expenses
