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Measurement of Profit & Reporting
Comprehensive Income
Week 11 Lecture
ACCT2011
Financial Accounting A
Dr Eagle Zhang
Week 11
Text Readings:
- Chapter 16: section 16.1 16.3.1 (to p.510)
- Chapter 19: section 19.5
Handbook Readings:
- AASB 101
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Week 11
Learning objectives
1. Understand different approaches to profit
measurement and the approach adopted in Australia
(Ch 16 LO 1 - 2)
2. Understand the requirements for the preparation of a
statement of comprehensive income in AASB 101 (Ch
16 LO 3)
3. Understand the requirements of AASB 108 in terms of
accounting for changes in accounting policies,
estimates and errors (Ch 19 LO 7, 8 & 9)
4. Understand some of the social implications of the
financial reporting for comprehensive income
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Objective 1
Understand different approaches to profit
measurement and the approach
adopted in Australia
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Measurement of profit
Traditionally, profit has been the process of:
- Matching revenues for a period with expenses incurred in
generating those revenues
The traditional profit measurement has changed due
to:
- Changes in the categorisation and labelling of financial
statement elements.
- Reduced emphasis on matching.
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Measurement of profit (Contd)
- Operating-profit approach:
- Profit is measured as income from operations minus
expenses from operations.
- All-inclusive approach:
- Profit is measured as the result of ordinary operations plus
income and expenses relating to prior periods, the effects
of some accounting policy changes and the result of
extraordinary transactions and events.
- Comprehensive income approach:
- Profit includes all income and expenses as defined in the
Framework.
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Measurement of profit (contd)
Approach adopted in AASB 101:
- The Statement of Comprehensive Income:
identifies total comprehensive income as all changes in
equity other than contributions from or distributions to equity
holders (shareholders).
Profit or Loss is the total of income less expenses,
excluding the components of other comprehensive income.
(AASB101:7)
Other comprehensive income comprises items of income
and expense (including reclassification adjustments) that
are not recognised in profit or loss as required or permitted
by other Australian Accounting Standards. (AASB101:7)
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Measurement of profit (contd)
Measurement of comprehensive income:
Statement of comprehensive income
Income
Less: Expenses
= Profit or loss for the period
+/- Items of other comprehensive income
=Total comprehensive income for the period
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Objective 2
Understand the requirements for the
preparation of a statement of comprehensive
income in AASB 101
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AASB 101
The approach in AASB101 is similar to the comprehensive
income approach.
AASB 101.7:
Total comprehensive income is the change in equity
during a period resulting from transactions and other
events, other than those changes resulting from
transactions with owners in their capacity as owners.
Total comprehensive income comprises all components
of profit or loss and of other comprehensive income.
Owners are holders of instruments classified as equity.
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AASB 101
Other comprehensive income comprises items of income and
expense (including reclassification adjustments) that are not
recognised in profit or loss as required or permitted by other
Australian Accounting Standards.
The components (101.7) of other comprehensive income include:
(a) changes in revaluation surplus (see AASB 116 Property, Plant and
Equipment and AASB 138 Intangible Assets);
(b) actuarial gains and losses on defined benefit plans recognised in
accordance with paragraph 93A of AASB 119 Employee Benefits;
(c) gains and losses arising from translating the financial statements of a
foreign operation (see AASB 121 The Effects of Changes in Foreign
Exchange Rates);
(d) gains and losses on remeasuring available-for-sale financial assets (see
AASB 139 Financial Instruments: Recognition and Measurement); and
(e) the effective portion of gains and losses on hedging instruments in a cash
flow hedge (see AASB 139).
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AASB 101
IASB/FASB convergence project
Framework, released in September 2010
ED IAS 1 The Presentation of Items of Other
Comprehensive Income, released in May 2010.
Statement of Comprehensive Income (current
requirement)
- Option of one inclusive statement, or
- Two related statements ie, Income Statement and
Statement of Other Comprehensive Income
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AASB 101
Profit or Loss for the Period:
An entity shall recognise all items of income and expense in a
period in profit or loss unless an Australian Accounting
Standard requires or permits otherwise. (AASB101:88)
Some Australian Accounting Standards specify circumstances
when an entity recognises particular items outside profit or
loss in the current period. AASB 108 specifies two such
circumstances: the correction of errors and the effect of
changes in accounting policies. (AASB101:89)
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AASB101
Other Comprehensive Income for the Period:
An entity shall disclose the amount of income tax relating to
each item of other comprehensive income, including
reclassification adjustments, either in the statement of profit or
loss and other comprehensive income or in the notes.
(AASB101:90)
An entity shall disclose reclassification adjustments relating to
components of other comprehensive income. (AASB101:92)
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Reclassification adjustments disclosure
AASB 101.90-96
AASB 101 defines a reclassification adjustment as amounts
reclassified to profit or loss in the current period that were
recognised in other comprehensive income in the current or
previous periods
Individual accounting standards specify whether and when
amounts previously recognised in other comprehensive
income are reclassified to profit or loss (e.g. the disposal of
available-for-sale financial instruments)
A reclassification adjustment is included with the related
component of other comprehensive income in the period that
the adjustment is reclassified to profit or loss.
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Reclassification adjustments disclosure
Why disclose reclassification adjustments?
The purpose is to provide users with information to assess the
effect of suchreclassifications on profit or loss.
For example, gains realised on the disposal of available-for-sale
financial assets are included in profit or loss of the current
period. These amounts may have been recognised in other
comprehensive income as unrealised gains in the current or
previous periods. Those unrealised gains must be deducted
from other comprehensive income in the period in which the
realised gains are reclassified to profit or loss to avoid including
themin total comprehensive income twice.
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Example (Reclassification)
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Objective 3
Apply the requirements of AASB 108 Accounting Policies,
Changes in Accounting Estimates and Errors to the selection,
application and modification of accounting policies in the
preparation of financial statements
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Revising accounting estimates
Revisions made to the numbers or disclosures do not
constitute a change in accounting policy.
A revision of an accounting estimate must be accounted for
prospectively (para. 36): this means it must be corrected in
the current and/or future periods, not revised in a prior period.
A material change in an accounting estimate must be
disclosed, with details of the nature and amount of the change
(para.39).
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Correcting errors
A material error made in a prior period, you must correct it
retrospectively by (AASB108.42):
Restating the comparative amounts for the prior period(s) presented in
which the error occurred; or
If the error occurred before the earliest prior period presented, restating
the opening balances of assets, liabilities and equity for the earliest prior
period presented.
Disclosure requirements para.49.
Example
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Objective 4
Understand some of the social
implications of the financial reporting for
comprehensive income
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The concept of income
What are we trying to measure and how can we measure
it?
Income is 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, other than those relating to contributions from equity
participants (Framework para. 70)
Why does this matter?
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The concept of income
Start of the 2014 End of the 2014
3-year-old Toyota 4-year-old Toyota
5 shirts The same 5 shirts
A keyboard The same keyboard
4 pairs of jeans 6 pairs of jeans
$1,000 cash $1,800 cash
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The competing ideas of income realisation
The central issue*:
Pre-double entry bookkeeping period (Resources rather than
profits, no clear distinction b/w income and capital)
Pacioli times (15
th
16
th
century) (income calculation replaced
accountability as the major bookkeeping problem)
Matching costs with revenues (19
th
century)
Early 20
th
century (business income still was a core issue).
Stewardship perspective vs. Predictability argument
* Chatfield (1977) A History of the Accounting Thought
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Historical debates
Financial nature of organisation that could be quantified into
monetary numbers were highlighted.
Accounting has been defined as a measurement where
numbers are assigned to quantities of something deemed
important.
Users need current price information.
Owners of capitals with unquestioned significance attached.
Competing ideas:
the importance of measuring the capitalised value of the enterprise and
changes therein.
profits exist only when the increase in wealth is realised rather than
assets appreciated in value.
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An economic concept of income: Increases in asset values
when they accrue but not when they are realised through sale
Patons (1922) Accounting Theory with special reference to the
corporate enterprise: Ensure we accounted for inflation and maintain
capital at an appropriate level to continue operating.
Alexander (1950): the importance of measuring the capitalised value of the
enterprise and changes therein.
Moonitz (1961): measuring the changes in enterprise wealth, using the
present value of future cash flows.
Chambers (1966): asset measurement on the basis of current cash
equivalents (realisable values)
Edwards and Bell (1961): capital maintenance (Current Value Accounting)
The concept of income
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More competing ideas:
Dicksee (1921): long-term assets are recorded at
historical costs and income is recognised only when they
are sold
Hatfield (1927): profits exist only when the increase in
wealth is realised rather than assets appreciated in
value.
Canning (1920)/Gilman (1939)
The concept of income
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What do you think
Income as a measure of performance: arising only from
purposeful activities, particularly the recurring usage of
physical non-current (or fixed) capital;
Or as an enhancement of investors wealth.
Asset and Liability View vs Revenue and Expense
View of income.
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Financialised global economic system
A systematic transition of profit making from traditional
production to the financial sector
Proliferation of complex financial instruments and derivatives,
and a powerful incentive to pursue high-risk, high-leverage
strategies
Change managerial behaviour in non-financial companies
with greater emphases on short-term financial market-based
performance.
Corporate performance =financial performance (as reflected
in the balance sheets)
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Financialised global economic system
Financial innovations =market efficiency improvements
Finance sector attracts significant resources away from other
productive sectors.
Financial speculation offers unprecedented risks/returns, but
contributes little to the real economy.
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Implications for accounting
Refocus accounting towards the needs of speculators in
capital markets.
reliability vs faithful representation
Instead of providing information that allows an
assessment of risk, the focus (OCI/FVA) obscures and/or
normalises the systemic risks associated with
financialisedearnings.
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Implications for accounting
Mispricing and misrepresenting the systemic risks of
financialisation
Speculation and instability introduced into the valuation
process.
- Zhang Y and Andrew J 2014 'Financialisation and the
Conceptual Framework', Critical Perspectives on Accounting
(Special Issue on Critical Perspectives on Financialization),
vol.25, iss.1, pp. 17-26