In this round of the Accounting 101 series, we will discuss the two elements of financial performance, which are income and expenses. The financial performance of an entity is measured by the performance of its income and expenses and they are presented or disclosed in the statement of profit or loss and other comprehensive income. The recognition of income and expenses in the statement of profit or loss and other comprehensive income relates directly to the movement of assets, liabilities and equity elements of financial position.
Let us now see the relationship between the elements of financial performance and the elements of financial position.
Definition of income and expense
The IFRS Conceptual Framework for Financial Reporting defines income and expense as follows:
- Income is increase in assets or decrease in liabilities, that result in increase in equity, other than those relating to contribution from holders of equity claims.
- Expense is decrease in assets, or increase in liabilities, that result in decreases in equity, other than those relating to distributions to holders of equity claims.
How do we understand these definitions from the non-technical perspective? Below is a table on the relationship between elements of the financial statements.
|1. An additional economic inflow of assets value such as:
– increase in the revalued amount of property, plant and equipment
– increase in the fair value of assets
2. Income from the de-recognition of assets such as:
– gain on disposal of property, plant and equipment
– gain on selling off the financial assets
3. Revenue generated from using the assets or selling the output produced by the assets such as:
– rental income from investment properties
– revenue from the sale of goods and services produced using the property, plant and equipment
|1. A decrease in the carrying amount of an asset for example:
– depreciation of property, plant and equipment
– amortisation of intangible assets
– impairment of financial and non-financial assets
– written down value of inventories
– a decrease in the revalued amount or fair value of an asset
2. Expenses from the de-recognition of assets such as:
– loss on disposal of property, plant and equipment
– loss on disposal of other investments
3. Other expenses arising from the use of assets in the production of revenue such as:
– staff costs
– administrative costs
– selling and distribution costs
|A decrease in the carrying amount of liabilities such as:
– a decrease in interest for floating-rate loans and borrowings
– modification gains for financial liabilities
– reversal of provision
|An increase in the carrying amount of liabilities such as:
– an increase in interest for floating-rate loans and borrowings
– modification loss for financial liabilities
– additional provision made
|The net amount of income minus expenses for the period
|The net amount of income minus expenses for the period
Presentation of income and expense in the statement of profit or loss and other comprehensive income
In our previous article – The structure, content and other disclosures in the financial statements, we have discussed that an entity can either present a statement of profit or loss and other comprehensive income either as a single statement or as a two-separate statement. Income and expense are classified and included in the financial statements either in the statement of profit or loss or outside the statement of profit or loss – i.e., in other comprehensive income statements (two-statement approach) or section (under single statement approach).
Why is there a need for the differentiation between income and expenses in the profit or loss and income and expenses in other comprehensive income? Generally, users of the financial statements focus on the profit or loss in assessing the financial performance of an entity. Profit or loss is the primary source of information and the starting point for the users to determine the performance of an entity for the period presented.
The next question is how do we know which item of income and expenses should go to the profit or loss and which items should go to the other comprehensive income? Because the profit or loss statement or section is the starting point for users to assess the entity’s financial performance, all income and expenses are in principle, included in that statement. However, certain standards require for certain income and expenses to be included in the other comprehensive income if such approach provides a more relevant information or faithful presentation of the entity’s financial performance for that period. This is clearly stated in the standards governing such transactions.
Does this mean income and expenses included in the other comprehensive income will never be included in the profit or loss? The answer is not necessarily. As a general principle, income and expenses in other comprehensive income will be reclassified to the profit or loss in a future period when doing so results in the statement of profit or loss providing more relevant information or a more faithful representation of the entity’s financial performance for that future period. However, there are certain exceptions where income or expenses will never be reclassified from other comprehensive income to profit or loss. These exceptions, if any, will be clearly stated in the respective standards governing such transactions. Because of this, you will be able to see two separate categories for – items to be reclassified or will never be reclassified subsequently to profit or loss in the other comprehensive income statement or section. You can refer to the example provided in the article mentioned earlier. This requirement is also clearly stated in paragraph 82A of IAS 1 Presentation of Financial Statements.
We have now concluded our discussion on the five elements of the financial statements – assets, liabilities, equity, income and expenses. You can refer to our articles below for recap on all these five elements:
- Assets – Accounting for financial assets and Accounting for non-financial assets
- Liabilities and equity.
Stay tuned for our upcoming articles in Accounting 101 series.