5 Objectives Financial Statements “to provide information that is useful to users of assessing the financial position …… and the performance and cash flows of an enterprise ……”(HKSA Stm. 2.01)
6 Objectives Income Statement “…… while information about performance is primarily provided in a profit and lossaccount ……”(HKSA Stm. 2.01)“The financial statement of a firm thatsummarizes revenues and expenses over aspecified time period.”(The 'Lectric Law Library's Lexicon)
8 Main Items in I/S Turnover Cost of sales Gross profit Other revenue Distribution / Administrative / Other operating expensesP/L from operationFinance costShare of P/L of associates / joint venturesTax expensesP/L from ordinary activitiesExtraordinary itemsMinority interestNet P/L for the period
16 Creditors are …… Trade creditors : - Supplier of goods & service Non-trade creditors :- Customers & employees with claims- Lending institutions & individuals;- Debt security holders.
17 Creditors need …...information that enables them to determine whether amounts owing to them will be paid when duei.e. Solvencyinterested in an enterprise continuation of the enterprise as a major customer.
18 Solvency If enterprise can meet short-term & long-term obligation - Finance costs e.g. interest expense- operating profits
19 Going-concern The continuousness of the company by comparative figures Profit / Loss ?
20 Separate Items Impairment Items Finance costs Operating profits Balance Sheet as a supplementary tool
22 Mangers are ……Managers are basically those who run the firm on behalf of the shareholders. They are expected to act in the best interest of the shareholders.For the managers, income statements are published as a compliance of the Accounting Standards and the law.
23 ProfitabilityThey are concerned about the profitability and the company’s performance.Income StatementPredict Future Growth, Profits Share Price
24 Channel of Communication Income statements also serve as their channel of communication with the investors and to attract more investors.
25 Channel of Communication According to George Staubus, Professor of University of California, Berkeley in the ‘Investor Theory’ – “accounting/financial statements is to provide information to the firm’s suppliers of capital…..help them ascertain the firm’s willingness to pay investors.”Attractinvestors
26 Ability AssessmentIncome statements very often also serve as a means to assess managerial ability and their remunerations are tied to the current year earnings.“Famous scholars Paton & Littleton says in their definition of income: ‘…. It reflects managerial effectiveness and is of particular significance to those who furnish the capital and take the ultimate responsibility.”
27 Planning and ControlIncome statements (published accounts) can be used for internal control but normally managers mainly rely on the management accounts.Act as a monitoring tool with the support of budgeted I/S and comparison between actual and planned performance.
29 Limitations Information asymmetry Due to adverse selection, not all information are available to the investors in the income statements.Hence, income statements may not be able to reflect the full picture.
30 Limitations Earnings management & Income smoothing manipulation of accountsintentional dampening of fluctuations about some level of earnings that it currently considered to be normal for a firm e.g. by classification, recognition, allocation of time, etc. (Ronald D Picur; JBFA)MAY NOT BE THE TRUE PICTURE !
31 Limitations Agency relationship Results in agency costs Stockholders/investorsExist whenever a principal hire somebody else to act on its behalf as an agentAgency relationshipResults in agency costsIncome statements may not be able to reflect the firm’s real stability or potential to make profit.e.g. consume perquisitesCreditors(Michael C. Jensen)e.g. increase level of debt or take high risk projectswhich are unanticipated by creditors
33 Comprehensive Income Theory all-inclusive incomeAccording to Financial Accounting Standards Board (FASB) SFAS 130:‘Comprehensive income is the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. It includes net income and other comprehensive income such as foreign currency translation adjustments, unrealized gains and losses, etc.
34 Comprehensive Income Theory Advantages: (Stan Clark, University of Southern Mississippi)Net income of the firm for the life of the firm should be equal to the sum of the annual report net incomesIncome smoothing may be checked by the inclusion of all income changes and creditsA better picture of the total performance of the firm is conveyed, especially when both recurring and unusual, infrequently occurring items are displayed separately in the income statement.
35 Value-added income statement Evaluate the firm in terms of its contribution to the society and the cooperative effort between the employees, suppliers of fund, & the government.Basis of theory: The above mentioned parties should cooperate together in order for a firm to survive and to make profit.
36 Value-added income statement (Waino Suojanen, Accounting Review)Performance measure of wealth creation by the firm, reflect more information e.g. social change (Michael Morley, The Value Added Statement, London)