50 Financial Reporting

Multiple-step format -
Minimum Line Item
typical sections and
Disclosures:
subtotals: Toulon Ltd.
Consolidated Statement of Income and Comprehensive Income Heading
Heading
for the year ended December 31, 2015
In $000’s except per share amounts 2015 2014 Comparative years (IFRS)

Sales $6,260 $5,008 Revenue – separated into major

Gross profit section categories (IFRS & ASPE)
with subtotal Cost of goods sold 2,500 1,750 Inventory charged to expense
Gross profit 3,760 3,258 (IFRS & ASPE)

Operating expenses Employee benefits expense in-

cluding salaries and wages, pay-
Salaries and benefits expense 650 520 roll taxes, health care costs, and
post-retirement benefits (IFRS)

Depreciation expense 35 20 Depreciation and amortization

(IFRS & ASPE)
Travel and entertainment expense 150 120
Operating expenses Advertising expense 55 45
with subtotal
Freight-out expenses 10 8
The remaining expenses by na-
Supplies and postage expense 5 4 ture (IFRS)
Telephone and internet expense 15 12
Legal and professional expenses 8 6
Insurance expense 6 5
934 740
Income from operations 2,826 2,518
Other revenue and expense This section is for non-operating
Dividend revenue 3 3 items. Finance costs such as
interest income & expense, for-
Non-operationing Interest income from investments 2 2 eign exchange, gain/loss from
section with subtotal Gain from sale of trade investments 4 0 sale or impairment of assets and
Interest expense (2) (3) interest (IFRS & ASPE)
7 2
Income from continuing operations 2,833 2,520
before income tax Income tax expense on continu-
Income tax expense Income tax expense 850 680 ing operations (IFRS & ASPE)

Subtotal from
continuing operatings Income from continuing operations 1,983 1,840 Same as Income before discon-
Discontinued operations tinued operations (ASPE)
Loss from operation of discontinued division
(net of tax of $45,000) (105) 0 Discontinued operations, net-of-
Discontinued tax with tax amounts disclosed
Loss from disposal of division (IFRS & ASPE)
(net of tax of $18,000) (42) 0
(147) 0
Net income (profit or
Net income (note 1) 1,836 1,840 Net income (profit or loss)
loss)
Other comprehensive income:
Items that may be reclassified subsequently
to net income or loss: Other comprehensive income by
Comprehensive nature (IFRS)
Unrealized gain from available for sale investments
income (IFRS)
(net of tax of $6,000 for 2015 and $3,000
for 2014 respectively) 14 9
Total comprehensive income 1,850 1,849 Total comprehensive income
separated into attributable to
Non-controlling interests (minority interests) (11) (12)
parent and non-controlling
Attributable to the equity holders of Toulon $1,839 $1,837 interests (IFRS)
 3.4. Statement of Income and Comprehensive Income 51

Earnings per share, attributable to

the equity holders of Toulon:
Basic EPS from continuing and
Basic earnings per share
discontinued operations (IFRS)
Earnings per share Continuing operations $ 16.32 $13.25
Basic and diluted EPS Discontinued operations (1.23) 0
(IFRS)
Diluted earnings per share
Continuing operations 12.86 13.75 Diluted EPS from continuing and
Discontinued operations (1.03) 0 discontinued operations (IFRS)

Note 1: Net income 1,836 1,840 Net income (profit or loss) sepa-
rated into attributable to the par-
Non-controlling interests (minority interests) (10) (11)
ent and non-controlling interests
Attributable to the equity holders of Toulon $1,826 $1,829 (IFRS & ASPE)

For Toulon, the consolidated statement of income and comprehensive income separates
the statement into individual sections, which includes a blend of mandatory reporting
requirements and minimum reporting items and subtotals:

Typical sections for the state- Minimum reporting require- Minimum reporting require-
ment of income and compre- ments for IFRS companies. ments for ASPE companies.
hensive income.
(A mix of line item reporting re- (Some of these can be either (Some of these can be either
quirements and optional report- reported on the face of the state- reported on the face of the state-
ing.) ment or in the notes to the finan- ment or in the notes to the finan-
cial statements.) cial statements.)

• revenue, sales and net sales, • revenue separated into income • revenue separated into income
COGS, and gross profit sources such as sales and sources such as sales and
revenue (for services, etc.) revenue (for services, etc.)
• inventory expensed • inventory expensed

• operating expenses by nature • amortization and depreciation • amortization and depreciation

(by function is optional)
• employee benefits such as • share-based compensation
salaries, wages, payroll taxes,
health care costs, and post-
retirement benefits
• all other operating expenses
by nature
52 Financial Reporting

Other non-operating revenues Other non-operating revenues Other non-operating revenues

and expenses such as: and expenses such as: and expenses such as:
• other revenues, expenses, • finance costs such as interest • income from investments sep-
gains and losses not incurred income and interest expense, arated into income from in-
in the normal course of income from associates vestment for non-consolidated
business subsidiaries, investments us-
• write-down of inventory
ing equity method, at cost or at
fair value
• write-down of inventory
• impairment losses and rever-
sals of impairment losses on
PPE, intangible assets, and
goodwill
• exchange gains or losses
• gain or loss from asset dis-
posal or from long-lived assets
reclassified as held for sale
• interest expense by current
liabilities, long-term liabilities,
and capital lease obligations
• unusual items (not typical and
infrequent)

• income tax expense • income tax expense (from con- • income tax expense (from con-
tinuing operations) tinuing operations)

• Income from continuing opera- • Income from continuing opera- • Income/loss before discontin-
tions subtotal tions subtotal ued operations subtotal (same
as income from continuing op-
erations IFRS)

• discontinued operations net of • discontinued operations, if any, • discontinued operations, if any,

tax with tax amounts disclosed net of tax with tax amounts net of tax with tax amounts
and subtotal disclosed and subtotal disclosed and subtotal

• net income (profit or loss) • net income (profit or loss) • net income

• other comprehensive income, • other comprehensive income, • N/A

if any if any

• total comprehensive income • total comprehensive income • N/A

(net income + OCI) (net income + OCI)
 3.4. Statement of Income and Comprehensive Income 53

• basic and diluted earnings per • basic and diluted earnings per • not required
share by continuing and dis- share by continuing and dis-
continued operations continued operations

The multiple-step format with its section subtotals makes performance analysis and ratio
calculations such as gross profit margins easier to complete and makes it easier to
assess the company’s future earnings potential. The multiple-step format also enables
investors and creditors to evaluate company performance results from continuing and on-
going operations having a high predictive value separately, compared to non-operating or
unusual items having little predictive value. The following are examples of non-operating
revenue, expenses, gains, and losses for a typical company not normally involved in rental
properties or finance:

• rent revenue (e.g., for unused space)

• interest income (e.g., for investing idle cash)
• interest expense on debts payable
• write-down of inventory
• gain or loss from the sale of assets
• foreign exchange gain or loss

These non-operating items are usually reported as separate line items in the non-operating
revenue and expenses section, but there is some flexibility regarding how these items can
be reported.

Operating Expenses

Expenses from operations must be reported by their nature and, optionally, by function
(IFRS). Expenses by nature relate to the type of expense or the source of expense
such as salaries, insurance, advertising, travel and entertainment, supplies expense,
depreciation and amortization, and utilities expense, to name a few. The statement for
Toulon Ltd. is an example of reporting expenses by nature. Reporting expenses by
nature is mandatory for IFRS companies; therefore, if the statement of income reports
expenses by function, then expenses by nature would also have to be reported either as
a breakdown within each function in the statement of income itself or in the notes to the
financial statements.

Expenses by function relate to how various expenses are incurred within the various
departments and activities of a company. Expenses by function include activities such as
the following:
54 Financial Reporting

• sales and marketing

• production

• office and administration

• research and development

Common costs such as utilities, supplies, insurance, and property tax expenses would
have to be allocated between the various functions using a reasonable basis such as
square footage or each department’s proportional share of overall expenses. This allo-
cation process can be cumbersome and will require more time, effort, and professional
judgement.

The sum of all the revenues, expenses, gains, and losses to this point represents the
income or loss from continuing operations. This is a key component used in perfor-
mance analysis and will be discussed later in this chapter.

Income Tax Allocations

Intra-period tax allocation is the process of allocating income tax expense to various
categories within the statement of income, comprehensive income, and retained earnings.

For example, income taxes are to be allocated to the following four categories:

1. Income from continuing operations before taxes (statement of income)

2. Discontinued operations gains or losses, and gain or loss from disposal of discon-
tinued operations (statement of income)

3. Each item reported in other comprehensive income (statement of comprehensive

income)

4. Each retrospective restatement for changes in accounting policy or correction of

prior period errors (statement of changes in equity or retained earnings statement),
which is also discussed later in this chapter

The purpose of these allocations is to make the information within the statements more
informative and complete. For example, Toulon’s statement of income for the year ending
December 31, 2015, allocates tax at a rate of 30% to the following:

• Income from continuing operations of $850,000 ($2,833,000 × 30%)

• Loss from discontinued operations of $45,000 ($150,000 × 30%)

 3.4. Statement of Income and Comprehensive Income 55

• Loss from disposal of discontinued operations of $18,000 ($60,000 × 30%)

• Comprehensive income gain from available-for-sale investments of $6,000 ($20,000×

30%)

When reporting requirements are standardized, all companies are required to report each
of the categories above net of their tax effects. This makes analyses of operating results
within the company itself and of its competitors more comparable and meaningful.

Discontinued operations

Sometimes companies will sell or shut down certain business components or operations
because the operating segment or component is no longer profitable, or they may wish to
focus their resources on other business components. In order to be separately reportable
as a discontinued operation in the statement of income, the business component being
discontinued must have its own clearly distinguishable operations and cash flows, referred
to as a cash-generating unit (CGU) for IFRS companies. Examples are a major business
line or geographical area. If the discontinued operation has not yet been sold, then there
must be a formal plan in place to dispose of the component within one year and to report
it as a discontinued operation.

The items reported in this section of the statement of income are to be separated into two
reporting lines:

• Gains or losses in operations prior to disposal of the CGU, net of tax, with tax
amount disclosed

• Gains or losses in operations on disposal of the CGU, net of tax, with the tax
amounts disclosed

Net Income and Comprehensive Income

Note that the statement for Toulon Ltd. combines net income and total comprehensive
income. Two statements would be prepared for IFRS companies that prefer to separate
net income from comprehensive income. The first, the statement of income, ends
at net income (highlighted in yellow). A second statement, called the statement of
comprehensive income, would immediately follow the statement of income, beginning
with net income and include any other comprehensive income items. The Wellbourn
financial statement (shown in section 3.3 of this chapter) is an example of separating net
income and total comprehensive income into two statements.

Another item that is important to disclose in the financial statements is the non-controlling
interest (NCI) reported for net income and total comprehensive income. This is the
56 Financial Reporting

portion of equity ownership in an associate (subsidiary) that is not attributable to the

parent company (Toulon, in our example) that has a controlling interest (greater than
50% but less than 100% ownership) in the acquired company’s net assets. Toulon must
consolidate the associate’s financial data with its own and report as a single entity to
comply with IFRS standards. Consider that if a company purchases 80% of the net assets
of another company, the remaining 20% must therefore be owned by outside investors.
This 20% amount must be reported as the non-controlling interest to ensure that investors
and creditors of the company holding 80% (parent) are adequately informed about the true
value of the net assets owned by the parent company. This will be discussed again in the
chapter on intercorporate investments. How non-controlling interest is reported on the
statement of income and comprehensive income is the relevant point for this chapter.

For ASPE companies using a multiple-step format, the statement of income would look
virtually the same as the example for Toulon above and would include all the line items
up to the net income amount (highlighted in yellow). As previously stated, comprehensive
income is an IFRS concept only; it is not applicable to ASPE.

Earnings per Share

Basic earnings per share represent the amount of income attributable to each outstanding
common share, as shown in the calculation below:

Net income − preferred dividends

Basic earnings per share (EPS) =
Weighted average number of
common shares outstanding

The earnings per share amounts are not required for ASPE companies. This is because
ownership of privately owned companies is often held by only a few investors, compared
to publically-traded IFRS companies where shares are held by many investors.

For IFRS companies, basic earnings per share (excluding Other comprehensive income
(OCI) and non-controlling interests) are to be reported on the face of the statement of
income as follows:

• Basic and diluted EPS from continuing operations

• Basic and diluted EPS from discontinued operations, if any

The term basic earnings per share refers to IFRS companies with a simple capital struc-
ture consisting of common shares and perhaps non-convertible preferred shares or non-
convertible bonds. Reporting diluted earnings per share is also required when companies
hold financial instruments such as options or warrants, convertible bonds, or convertible
 3.5. Statement of Changes in Equity (IFRS) and Statement of Retained Earnings (ASPE) 57

preferred shares where the holders of these instruments can convert them into common
shares at a future date. The impact of these types of financial instruments is the potential
future dilution of common shares and the effect this could have on earnings per share to
the common shareholders. Details about diluted earnings per share will be covered in the
next intermediate accounting course.

3.5 Statement of Changes in Equity (IFRS) and

Statement of Retained Earnings (ASPE)

Recall that net income or loss is closed to retained earnings. For ASPE companies, there
is no comprehensive income (OCI) and therefore no AOCI account in equity. With this
simpler reporting requirement, ASPE companies report retained earnings in the balance
sheet and detail any changes in retained earnings that took place during the reporting
period in the statement of retained earnings. An example of a statement of retained
earnings is that of Arctic Services Ltd., for the year ended December 31, 2015.

Arctic Services Ltd.

Statement of Retained Earnings
for the year ended December 31, 2015

Balance, January 1, as reported $ 250,000

Cumulative effect on prior years of retrospective application
of changing inventory costing method from FIFO
to moving weighted average
(net of taxes for $5,400) 12,600
Correction for an overstatement of net income from a prior period
due to an ending inventory error (net of $3,000 tax recovery) (7,000)
Balance, January 1, as adjusted 255,600
Net income 80,500
336,100
Cash dividends declared $(75,000)
Stock dividends declared (60,000) (135,000)
Balance, December 31 $ 201,100

As discussed at the beginning of this chapter, any error corrections from prior periods or
allowable changes in accounting policies will result in a reporting requirement to restate
the opening retained earnings balance for the current period. Each error and change in
accounting policy item is reported, net of tax, with the tax amount disclosed. The retained
earnings balance is restated and a detailed description is included in the notes to the
financial statements. The journal entry for the two restatement items for Arctic Services
would be: