Unit 2

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Features of the P&L

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1

Features of the P&L

  • Summarizes the revenues, costs and expenses occurred during a specific period

  • Uses accrual accounting methods

  • Ignores when and why cash is received or paid

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2

Three sections of the P&L

  • Operating result

    • Profit before interest and tax (EBIT)

  • Financial result

    • Operating + financial = Profit before tax

  • Net profit

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3

Operating result (P&L)

Results from company’s operating activities, irrespective of their financing, with only operating expenses being accounted for.

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What does EBIT measure

Core operating performance

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Use of EBIT

Comparison of companies in one and different industries

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European way to present expenses

Expenses by nature

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7

Expense by nature

Expenses are accounted by their type (ex: raw material, wages, depreciation)

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Anglo-Saxon way to present operating expenses

Expense by function

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9

Expenses by function

Expenses are accounted by the activity that they were assigned to and bundled into the cost of goods

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Financial result

Interest income - interest expense

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Interest income

Dividend income from investments and cash holdings

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Profit before tax (PBT)

EBIT + financial result

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Use of PBT

Used to compare profitability with companies with similar financings structures, but in different tax jurisdictions

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Net profit

Total revenue - total costs

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Total costs and tax on income

Total costs include tax on income

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Net profit definition

Wealth generated by the company and is available for shareholders, but can also be retained for future investing

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Accruals

Revenues or expenses incurred that have impacted company's net income, even though the cash still has not exchanged hands

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Deferral

Means of recording an expense or an income that was paid in one accounting period, but not accounted for until a later one

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Revenue recognition

Revenue is recognized when it is earned (incurred), which implies a certain degree of performance on the part of supplier

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IFRS 15

Establishes that a company will get its revenue from the goods and services they provided

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IAS 2

Treatment of inventories, including definition of COGS

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Treatment of revenues

Inventories are expensed when the goods are actually sold and the revenue is recognized

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COGS

Opening inventory + purchases during the period - closing inventory

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Gross profit

Sales - Cost of goods sold

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Difference between gross profit and EBIT

Gross profit subtracts only COGS from the sales, while the EBIT also has to account for the operating costs

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Considerations through inventory managment

Inventory managment should not overstate or understate value of the inventory, which is especially a risk, when prices fluctuate rapidly. And some of the value might be there, but not realisable in a realistic situation

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Cost calculation approach allowed by the IFRS

FIFO and Individual costs

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Individual costs

Cost are calculated for the products/services

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The effect of Accruals on statements

Changes in net income on income and the balance sheet, as they involve non-cash assets and liabilities

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In-depth effect of accrual of expenses

Equity goes down, since the expenses are accrued as liability

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In-depth effect of defferal of expenses

Expenses are deferred (+E), as an asset (+A), Equity is increased through profit to “delete the expense” and the expense is seen as an asset, since it will be used in future

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In-depth effect of deferral of revenue

Revenue is accrued (+E), as an Asset (+A), because it will be used in future to earn profit, equity and profit both go up

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In-depth effect of accrual of revenue

Revenue deferred (-E), as a Liability (+L), profit goes down, which leads to lower equity

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Fair value approach

Market-based measurement that is not entity specific

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Principles of a fair value price:

  • It’s an exit price

  • Not a force sale

  • From market-based view

    • Current price at the measurement date

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Difficulty with the fair value approach

There is a need to make assumptions regarding a market even where there is no active market

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IAS 16

Concerned with fixed assets and their valuation principles

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Initial valuation of fixed assets

Historical or acquisition cost, which includes all expenditure to get the asset ready for use

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Addition of subsequent expenditure to the initial costs

Only added to the cost if it will produce economic benefits beyond it’s originally assessed performance

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Depreciable amount of the asset

Acquisition cost minus the residual value of the asset

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Depreciation schedule factors

Depreciable amount of the asset, the useful life of the asset, depreciation methods

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Straight-line depreciation method

Depreciation as a function of time

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Diminishing balance depreciation method

allocates a high proportion of the expense in the early life of the asset

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Units of production depreciation method

Non-current asset is expensed according to physical capacity usage

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Impact of depreciation on the balance sheet

Lowers the net value of the asset (aka: carrying amount/book value) through lowering the gross acquisition costI

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Impact of depreciation on a P&L account

Increase in depreciation expense of the current year

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Asset impairment when does it occur

Occurs if the economic value of the asset drops below its carrying amount (net book value)

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IAS 36

Asset impairment

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How does asset impairment occur

The book value of the asset is adjusted downwards for an impairment loss, reducing profit

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Carrying amount

The book value of an asset

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Bad debts

Specific receivables that are not likely ever to be paid on the available evidence, should be written off quickly

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Doubtful receivables

May or may not be repaid in the future, so possibly becoming bad debt

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Allowance for doubtful receivables

Expensed in P&L and is entered in the balance sheet as credit balance

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Ways to create hidden reserves

Creation of excessive provisions, excessive asset write-down/impairment, adjustments of accrued/differed expenses/revenues

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Capital structure of companies

Mix of equity capital and debt capitalQ

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Equity capital

funds owned by shares and consists of: contributed funds and Internally generated funds

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Contributed funds

Money that shareholders originally invested in the company in exchange for shares

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Internally generated funds

Profits that have not been distributed to shareholders, retained by the company in order to finance future operations and expansion

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Retained earnings

Profits that are eligible to be paid over to shareholders, but have not been distributed

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Reserves

Appropriation of retained profits, such as legal/statutory reserves, directly included in equity

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Debt capital

Borrowed funds

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