Chapter 17

The income statement

17.1

Extraordinary items were previously defined in AASB 1018 (AASB 1018 was replaced by
AASB 101 in 2005) as items of revenue and expense that are attributable to transactions or
events of a type that are outside the ordinary activities of the business, and are not of a
recurring nature. The commentary to AASB 1018 noted that an item must both be outside the
ordinary activities of the business and be of a non-recurring nature before it could be
classified and disclosed as an extraordinary item.
Because extraordinary items, by definition, are not expected to recur, it does seem logical
that they be separately identified given that they might not be terribly relevant when trying to
assess the future performance of an entity. Arguably, banning the separate disclosure of
extraordinary items does seem a retrograde step (what do the students think about this
view?). It should be remembered that there is a very broad requirement in AASB 101 that
requires the separate disclosure of material items of income and expenses. The AASB
Framework also suggests that income and expenses that arise in the course of ordinary
activities of the entity be separately disclosed from those items that do not arise in the course
of ordinary activities.

17.2

There is a general requirement that unless a specific accounting standard requires an item of
income or expense to be recorded directly in equity, the expense or income amount is to be
included in the income statement. Specifically, paragraph 78 of AASB 101 states:
all items of income and expense recognised in a period shall be included in profit or
loss unless an Australian Accounting Standard requires otherwise.
Items to be directly adjusted against equity would include prior period errors. Other items to
be adjusted directly against equity (rather than being included within the income statement)
would also include those items identified at paragraph 99 of AASB 101 such as gains or
losses on revaluation, exchange differences on translation of foreign entities financial
statements, and gains or losses on remeasuring available-for-sale financial assets.

17.3

In the authors opinion it is very difficult to support the new approach whereby prior period
errors must be adjusted directly to retained earnings rather than taking them to the income
statement in the period in which the errors were identified. Hence, arguments AGAINST the
approach required by AASB 108 are provided. These arguments are as follows:

Firstly, if the item was directly debited to retained earnings then it would never appear in
reported profits. This may lead to inappropriate judgements as to the profitability of the
entity.

Secondly, as it is now permissible to debit such omissions directly to retained earnings,

there may be an incentive for management to forget to include expenses in particular
periods, given that they would then be debited to the opening retained earnings in the
next period. If management was rewarded on the basis of accounting profits the
incentive to employ such practices may be high.

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Lastly, there arguably will be some confusion caused when opening retained earnings do
not equal the closing retained earnings of the previous period. Of course, such confusion
may be alleviated to some extent by appropriate note disclosure.

17.4

Profit is the difference between income and expenses. As the Framework for the Preparation
and Presentation of Financial Statements defines both income and expenses, there is no need
to provide a definition of profit.

17.5

Most Accounting Standards have a section devoted to disclosures, many of which relate to
expenses and revenues. Most of these disclosure requirements, nevertheless, are subject to
materiality considerations. However, not all types of expenses and revenues are covered by
the various Accounting Standards and, hence, there are not specific disclosure requirements
in relation to all types of expenses and revenues: from a practical perspective, this would be
too difficult.
Preparers of accounts nevertheless are required to provide all information that is likely to be
material to the users of financial statements. This obviously relies upon much professional
judgement. If an item of expense or revenue is not the subject of an Accounting Standard, but
the preparers of the financial statements make the judgement that knowledge of the item may
influence particular resource allocation decisions, then the preparers should disclose the
particular item, typically by way of a note to the financial statements.

17.6

Students should refer to AASB 101. AASB 101 identifies a number of disclosures that must
be presented on the face of the income statement. It also notes a number of items that must
be disclosed either on the face of the income statement or in the notes to the financial
statements. It should also be noted that a number of expenses and items of income might be
recorded directly in equity. In this regard, AASB 101 requires that the statement of changes
in equity show on the face of the statement each item of income and expense for the period
that, as required by other Australian Accounting Standards, is recognised directly in equity,
and the total of these items. It should also be noted that a number of other accounting
standards stipulate items of income and expense that must be disclosed in the financial
statements.
In relation to AASB 101, the disclosures pertaining to the income statement are as follows:
Information to be Presented on the Face of the Income Statement
81.
As a minimum, the face of the income statement shall include line items that present
the following amounts for the period:
(a) revenue;
(b) finance costs;
(c) share of the profit or loss of associates and joint ventures accounted for using the
equity method;
(d) tax expense;
(e) a single amount comprising (i) the post-tax profit or loss of discontinued
operations and (ii) the post-tax gain or loss recognised on the measurement to
fair value less costs to sell or on the disposal of the assets or disposal group(s)
constituting the discontinued operation; and
(f) profit or loss.
82.

The following items shall be disclosed on the face of the income statement as
allocations of profit or loss for the period:
(a) profit or loss attributable to minority interest; and

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(b) profit or loss attributable to equity holders of the parent.

83.

Additional line items, headings and subtotals shall be presented on the face of the
income statement when such presentation is relevant to an understanding of the
entitys financial performance.

Information to be Presented either on the Face of the Income Statement or in the Notes
86.
When items of income and expense are material, their nature and amount shall be
disclosed separately.
93.
Entities classifying expenses by function shall disclose additional information on the
nature of expenses, including depreciation and amortisation expense and employee
benefits expense.
95.
An entity shall disclose, either on the face of the income statement or the statement of
changes in equity, or in the notes, the amount of dividends recognised as distributions
to equity holders during the period, and the related amount per share.
Interestingly, AASB 101 specifically excludes particular disclosuresand these relate to
extraordinary items. As paragraph 85 of AASB 101 states:
An entity shall not present any items of income and expense as extraordinary items,
either on the face of the income statement or in the notes.
That is, extraordinary items as we used to call them are no longer allowed to be
separately identified as extraordinary they are nevertheless still to be included in
determining profit and can be separately disclosed if a particular accounting standard requires
the specific type of expense or income to be separately disclosed, but they cannot be
identified as being extraordinary.
It should also be noted that issues of materiality need to be considered when disclosing the
various expense and revenue items. If an item of expense or revenue is not deemed to be
material then it typically does not need to be separately disclosed.
17.7

At one time in Australia the income statement did provide a reconciliation of opening and
closing retained earnings. This is not the case at the present time. Pursuant to AASB 101 the
income statement shows the profit or loss for the period. A reconciliation of opening and
closing retained earnings is to be provided either on the face of the statement of changes in
equity, or in the notes thereto. Specifically, paragraph 97(b) of AASB 101 requires:
An entity shall also present, either on the face of the statement of changes in equity or
in the notes:
(b)
the balance of retained earnings (i.e. accumulated profit or loss) at the
beginning of the period and at the reporting date, and the changes during the
period.

17.8

AASB 108 requires all errors that relate to prior reporting periods to be corrected by
adjusting the opening balance of retained earnings and restating the comparative information.
There is also a general requirement stipulated in AASB 108 that when an entity applies an
accounting standard for the first time, any retrospective adjustment is to be made to retained
earnings and not through the income statement. Specifically, paragraphs 19, 22 and 23 of
AASB 108 state:
19.

Subject to paragraph 23:

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(a)

an entity shall account for a change in accounting policy resulting from the
initial application of an Australian Accounting Standard in accordance with
the specific transitional provisions, if any, in that Australian Accounting
Standard; and

Retrospective application
22. Subject to paragraph 23, when a change in accounting policy is applied
retrospectively in accordance with paragraph 19(a) or (b), the entity shall adjust
the opening balance of each affected component of equity for the earliest prior
period presented and the other comparative amounts disclosed for each prior
period presented as if the new accounting policy had always been applied.
Limitations on retrospective application
23. When retrospective application is required by paragraph 19(a) or (b), a change in
accounting policy shall be applied retrospectively except to the extent that it is
impracticable to determine either the period specific effects or the cumulative
effect of the change.
17.9

The statement of changes in equity discloses those items of income and expense that are
adjusted directly against equity rather than being recognised in the income statement. The
statement of changes in equity also shows the profit for the period (from the income
statement). It adds the net income recognised directly in equity to the profit for the period
(from the income statement) to provide a total of the recognised income and expense for the
period.
The statement of changes in equity, or the accompanying notes, also provides a reconciliation
of opening and closing share capital, reserves, and retained earnings.

17.10 This is an interesting issue that is useful in stimulating debate amongst students. Traditional
financial accounting is based on providing measures of performance that are of an economic
or financial nature. It is based on notions of property rights and market transactions and
ignores many social costs and benefits that are generated by reporting entities. For example,
traditional definitions of assets and expenses are tied to determinations about whether
particular expenditure is likely to generate future economic benefits. At issue here is whether
the reported performance of government departments should be focused upon generating
future economic benefits or some other less tangible (perhaps social) benefits. Many
researchers have argued that switching to conventional financial accounting practices has
caused many government institutions such as hospitals, galleries, etc., to lose focus or sight
of the reason for their existence (to provide social services/benefits) and, rather, to cause
them to focus on issues pertaining to economic efficiencies. Students should be encouraged
to consider whether changing the accounting practices to be adopted by an entity can actually
change the culture of the entity, or the expectations about an entitys performance.
17.11 Lost profits would not be recognised by conventional financial accounting practices.
Opportunity costs are typically ignored. The recognition of expenses would be restricted to
the costs necessary to repair the conveyor system and other items damaged by the fire. If the
expenditure improves the assets performance over and above how they performed prior to
the fire then some of the expenditure might be capitalised. To the extent that the fire caused a
material impact on financial performance then some disclosure of the incident in the notes to
the financial statements would be warranted.
17.12 (a)

Journal entry at 30 June 2009

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At the beginning of the current reporting period the carrying amount of the asset was
$1,280,000 (which is $2 million x 16/25 that is, at the beginning of the year the asset would
have been depreciated for 9 years of the expected life of 25 years). Based on the revised
useful life of the asset, the remaining useful life is six years from the beginning of the financial
period and not 16 years. The carrying amount of $1,280,000 is to be depreciated over a sixyear period so that the remaining depreciation is charged over the useful life of the asset.
Dr
Cr

Depreciation
Accumulated depreciation - buildings

213 333
213 333

(b) Supporting note - change in accounting estimate

2009
($)

2008
($)

Profit before tax has been arrived at after taking into account:
Depreciation
Original
80 000
Change in accounting estimate
133 333
213 333

80 000
25 000

As a result of the revision during the year of the remaining estimated useful life of a building
from 16 to 6 years the depreciation charge will increase by $133 333 for the following 6
years.
17.13(a)

Journal entry at 30 June 2009

At the beginning of the current reporting period the carrying amount of the asset was
$2,250,000 (which is $3 million x 6/8 that is, at the beginning of the year the asset would
have been depreciated for 2 years of the expected life of 8 years). Based on the revised useful
life of the asset, the remaining useful life is ten years from the beginning of the financial
period and not six years. The carrying amount of $2,250,000 is to be depreciated over a tenyear period so that the remaining depreciation is charged over the useful life of the asset.
Dr
Cr

Depreciation
225 000
Accumulated depreciation - plant and equipment

225 000

(b) Supporting note - change in accounting estimate

2009

2008

($)

($)

Profit before tax has been arrived at after taking into account:
Depreciation
Original
Change in accounting estimate

375 000
(150 000)
225 000

375 000
375 000

As a result of the revision during the year of the remaining estimated useful life of plant and
equipment from 6 to 10 years the depreciation charge will decrease by $150 000 for the
following 6 years.
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17.14 Scenario 1 is a change in accounting estimate. The decision to reduce the expected useful life
of factory buildings involves the application of judgment based on the latest information
available to management. As the expected useful life of a non-current asset at balance date
cannot be predicted with certainty, changes in the expected useful life is a change in an
accounting estimate.
Scenario 2 is a prior period error. It arose from a material amount not being included when
the 2008 financial statements were prepared.
The increase in depreciation expense results from a change in an accounting estimate. The
estimate is the amount to be expensed by the organisation for depreciation. The new
information available to the company will result in it being in a position to make an improved
judgment of the amount to be depreciated at year end. However, the amount that related to
the flood loss of inventory was not recognised in the financial statements ending 30 June
2008 was clearly an oversight or omission on the part of the company and, as such, meets the
definition of a prior period error.
Material prior period errors are corrected retrospectively in the first set of financial
statements authorised for issue after their discovery. In other words the current years
financial statements are presented as if the error never occurred. Any adjustments are
excluded from profit or loss for the period in which the error was discovered. This is
achieved by adjusting the opening balance of retained earnings and restating the comparative
amounts for the prior periods presented. If the error occurred in a period prior to the present
period presented, the opening balance of assets, liabilities and equity should be restated for
the earliest period presented. Where historical summaries are provided, the amounts relating
to prior periods should be restated and this restatement disclosed where practicable.
Using a tax rate of 30 per cent, the following journal entry would be necessary to correct the
financial statements:
30 June 2009
Dr Retained earnings
Dr Tax payable
Cr Inventory raw materials

52 500
22 500
75 000

17.15 BHP would need to consider the amount of the fines (a possible total of at least $8 million)
and the probability that the amounts will need to be paid. If the amounts can be measured
reliably, and if the payments are considered probable, then some expenses and associated
liabilities should be recorded. If the amounts cannot be measured reliably or the probability of
ultimate payment is not clear, then some disclosure within the notes to the financial
statements would be warranted (perhaps to the extent the fines are considered material).
The incident would obviously impact on BHPs reputation, and might act to undermine any
further statements about operating standards made by the management of the organisation.
Costs associated with such implications, however, will not be recorded by the financial
accounting system. Also, the damage caused to the fish habitats would not be recognised by
BHP: only the fines would be recognised. The reason for this is that the fish habitats are not
controlled by BHP and, hence, any damage caused to them is not an expense of the entity
(as they were not recognised as the entitys assets).
It should be noted that given the massive size of BHP and the relatively insignificant dollar
amount of the fines, BHP might decide in the absence of specific disclosure requirements to
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make no disclosures about the fines (see Deegan and Rankin 1996 for research that shows
how companies typically elected to make no disclosures about environmental fines on the
basis of the materiality of the amounts involvedChapter 37 provides the reference).
Because many organisations did not provide any information in their annual report about
environmental prosecutions, a section was added to the Corporations Act in 1998 which
requires companies to provide information within the Directors Report about environmental
prosecutions.
17.16 (a)

The amount of the additional expense would not be of sufficient magnitude to warrant
it being separately disclosed. Income tax expense would be shown separately on the
face of the income statement.

(b)

Noosa Ltd manufactures surf clothing, so such expenditure would be incurred from
time-to-time. The development expenditure had been deferred to future periods as an
asset. As there is no likelihood that the expenditure will now lead to any economic
benefits, the full amount of $400 000 should be written off as an impairment loss.
Because of the materiality of the item, separate disclosure of the amount in the
income statement or in the notes would be expected.

(c)

Where there is a sale of a division then this would constitute a restructuring of the
entity, and if the sale of the division occurred in the 2009 financial year then separate
disclosure would be required. The amount involved would also be material, therefore
warranting separate disclosure. See paragraphs 86 and 87 of AASB 101. In this
situation, however, the sale will not occur until after balance sheet date, but before
the completion of the 2009 financial statements. It is therefore considered to be a
non-adjusting event after the balance sheet date and therefore under the ambit of
AASB 110. The event refers to something that will occur after balance sheet date
(rather than providing details of an event or transaction that occurred before balance
sheet date). Even though the 2009 financial statements would not be adjusted, note
disclosure would be required. Paragraph 21 of AASB 110 states:
If non-adjusting events after the reporting date are material, nondisclosure
could influence the economic decisions of users taken on the basis of the
financial report. Accordingly, an entity shall disclose the following for each
material category of non-adjusting event after the reporting date:
(a) the nature of the event; and
(b) an estimate of its financial effect, or a statement that such an estimate
cannot be made.

(d)

Prima facie, the increase in wage costs would not seem to warrant separate
disclosure. How the total amount of wage costs would be disclosed would depend
upon the presentation format chosen for the income statement. If a presentation
format based on the nature of expenses is chosen then employee benefit costs might
be separately disclosed within the income statement. If a disclosure approach based
on function of expenses is adopted then costs of sales would be separately disclosed
and this would incorporate wage costs relating to the production of goods and
services.

(e)

Given the amount involved is probably not deemed to be material (6.45% of after tax
profit), separate disclosure would not be warranted.

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17.17 It should be noted that although not provided in the solution to this question (due to
insufficient data), prior year comparatives would be required to be disclosed. Notes are
provided here although the question does not ask for them.
Fergie Limited
Income Statement for the financial year ended 30 June 2009
Note
Sales revenue
Cost of goods sold
Gross profit
Other income interest revenue
Administrative expenses
Borrowing costs
Other expenses
Profit before income tax
Income tax expense
Profit for the period

2009
$000
1 600
(550)
1 050
200
(240)
(25)
(175)
810
(150)
660

Fergie Limited
Statement of changes in equity for the financial year ended 30 June 2009
Gain on revaluation of properties
Expense recognised directly in equity as a
result of applying new accounting standard
(Note: We would typically provide details of
the specific adjustment and accounting
standard involved.)
Net income recognised directly in equity
Profit for the period
Total recognised income and expense for the
period

80

(50)
30
660
690

Notes in the Financial Report

Note 2: Profit for the period
Profit for the period has been derived after charging the following items:
Damage occurring to property, plant and equipment as a result of spacejunk re-entering atmosphere
Expense pertaining to the insolvency of a customer
Note 3 Movements in equity
Share capital
Ordinary shares balance at start of period (assumed from question)
Movements
Balance at end of period
Revaluation reserve
Balance at start of year (assumed)
Gain on revaluation
Balance at the end of the year

65
110
175

60

60

80
80

Retained earnings

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Balance at start of period

Changes in accounting policy
Restated balance
Profit for the period
Total for the period
Dividends
Balance at end of period

17.18 (a)

(b)

140
50
90
660
750
100
650

The results of the company appeared to be particularly impacted by two events, both
of which related to loans advanced to group entities. In predicting future
performance it would seem necessary that specific knowledge of these write-offs be
held by interested parties as, on the balance of probabilities, such write-offs will not
occur again and hence might not be relevant in predicting future performance. It is
the authors opinion that the removal of extraordinary items as a disclosure option
has not benefited financial statement users. Students should be encouraged to think
of pros and cons in respect of the prohibition of the disclosure of extraordinary
items.
There is a general requirement at paragraph 86 of AASB 101 which states:
When items of income and expense are material, their nature and amount
shall be disclosed separately.
As the amounts involved are clearly material, it would seem that there is a strong
argument that separate disclosure of the write-offs is required, either on the face of
the income statement, or in the notes.

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