Measuring and Reporting Financial Performance

Overview
Background

Owners, management and other stakeholders of the business would want to know whether the business is earning from its operations. The results of business operations are summarized and reported in the financial statement called Income Statement or Statement of Income or Statement of Profit & Loss or Statement of Financial Performance. The interval covered by the income statement is known as the accounting period, i.e., any period usually of twelve months during which business transactions are recorded and reported upon. When the accounting period ends on December 31, it is called a calendar period. When it ends on any month, it is called a financial period.

Purpose

The purpose of Unit III Measuring and Reporting Financial Performance is to illustrate how an income statement may be prepared and the nature of the different accounts included in the income statement. Income Statement provides financial information regarding the results of business operations for a given period of time. It is a report that shows whether or not the business achieved its primary objective of earning a profit or net income. An income statement is prepared by listing the revenues earned during the period; the expenses incurred in earning the revenue; and subtracting the expenses from the revenue to determine if a net income or a net loss was incurred. On the other hand, the purpose of Unit IV Statement of Changes in Owners Equity is to show how the capital statement may be prepared and how withdrawals of proprietor and the firms financial performance may affect the balance of capital at the end of every accounting period.

In this unit

Forms of Income Statement Income Accounts Expense Accounts Debit and Credit of Income Statement Accounts

Topics

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Forms of Income Statement

Overview

The forms of income statement that a business prepares depend on the nature of the business activity undertaken by the firm. As provided in the revised Philippine Accounting Standard (PAS) 1, (PFRS, 2008), service oriented businesses normally prepare the natural form, formerly known as the single step income statement and trading and manufacturing firms normally use the functional form, formerly known as the multiple-step income statement format.

Natural Form

The income statement presentation under this form arranges all income accounts in one group, all expense accounts in another group and then deducts the total expenses from the total income in a single-step operation of subtraction to arrive at the final result of net income or net loss.

Illustration

Below is an illustration of a natural form income statement:

JOSEPH LABRADOR CONSULTANCY Income Statement For the year ended December 31, 20X1 Revenues: Note Service Income P 650,000 Other Income (1) 50,000 Less: Operating Expenses Employee Costs Travel & Transportation Rent Expense Supplies Expense Utilities Expense Janitorial & Security Depreciation Expense Commission Expense Insurance Representation & entertainment Repairs & maintenance Taxes & Licenses Doubtful Accounts Miscellaneous Expense Net Income

700,000

(2)

(3) (4)

250,000 100,000 80,000 70,000 50,000 32,000 28,000 17,000 14,000 12,000 9,500 4,000 2,000 4,000 P

672,500 27,500

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Notes to the Natural Form

The following are the notes to the natural form income statement:
Note 1 - Other Income Interest income Dividend income Total other income Note 2 - Employee Costs Professional fees Salaries & Employee Benefits Total employee costs Note 3 - Utilities expense Telephone & communication Light & Water Total utilities expense

P P

28,000 22,000 50,000

P P

175,000 75,000 250,000

P P

30,000 20,000 50,000

Note 4 - Depreciation Depreciation - office equipment Depreciation - furniture & fixtures Total depreciation

18,000 10,000 28,000

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Functional Form

The income statement presentation under this form clearly shows specific sections of income, costs and expenses in a series of arithmetic operations. This form requires that cost of goods sold and the expenses be subtracted in steps to arrive at the net income. Merchandising businesses uses this format. Below is an illustration of a functional form income statement: Joseph Labrador Consultancy Income Statement For the year ended December 31, 20X1 Net sales revenue Cost of sales Gross profit Other income Total income Operating expenses: Distribution expenses Administrative expenses Other expenses Finance cost Net income Note 1 2 3 P 193,000 (145,000) P 48,000 3,000 P 51,000 P 14,000 24,000 800 1,200 P

Illustration

4 5 6 7

(40,000) 11,000

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Notes to the Functional Form

The following are the notes to the functional form income statement:

Note 1 - Net sales revenue Gross sales Less: Sales Returns & Allowances Sales Discount Net sales revenue Note 2 - Cost of sales Merchandise Inventory, Jan. 1 Add: Net cost of purchases Purchases Less: Purchase Returns & Allowances Purchase Discounts Net purchase Add: Freight-in Cost of goods available for sale Less: Merchandise Inventory, Dec. 31 Cost of sales Note 3 - Other income Rent Income Dividend Income Interest Income Gain on Sale of Furniture & Fixtures Total other income Note 4 - Distribution expenses Salesperson' Salaries and Commissions s Representation and Entertainment Depreciation - Store Equipment SSS & Philhealth Premiums Expense Freight-out Miscellaneous Selling Expense Total selling expenses

P 200,000 P 5,000 2,000 7,000 P 193,000

P P 175,000 P 3,000 2,000 5,000 P 170,000 1,000 P P

5,000

171,000 176,000 31,000 145,000

1,500 800 500 200 3,000

9,000 1,200 1,000 900 800 1,100 14,000

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Note 5 - Administrative expenses Salaries Expense Light, Water and Telephone Uncollectible Accounts Depreciation Expense SSS & Philhealth Premiums Miscellaneous General Expense Total administrative expenses Note 6 - Other expenses Loss on Sale of Equipment Total other expenses Note 7 Finance Cost Interest Expense Discount Lost Total Finance Cost

15,000 3,500 2,000 1,500 1,300 700 24,000

P P

800 800

P P

1,000 200 1,200

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Income Accounts
Overview

Income is defined as 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 the owner (IASB Framework as cited by Weygant, et. al, 2010). The following are the usual account titles found in a natural form income statement.

Service Income

Different businesses have different ways of earning income. The term that is generally used to refer to any kind of income from services rendered is service income. This represents the inflow of cash or non-cash assets arising from services rendered. Other account names that may be used to refer to income from services describes the specific nature of the service rendered: (Pefianco and Mercado, 1983) Professional Fees. These indicate income from rendering professional services without specifying the particular nature of professional service rendered. Medical Fees. This refers to income received from rendering medical services. Legal Fees. This refers to income received from rendering legal services. Dental Fees. This refers to income received from rendering dental services. Accounting Fees. This refers to income received from rendering accounting services. Management Fees. This refers to income received from rendering various management consultancy services. This refers to income from sources other than the principal line of activity of the business. The examples of other income are:

Other Income

Interest Income. The revenue to the payee for loaning out a principal amount to a borrower. This may also refer to income earned from money deposited in a bank. Dividend Income. Income earned in investing cash in stocks of other businesses.

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Expense Accounts
Overview

Expenses are the cost of goods or services that are used or consumed in the operations of a particular business activity. In service businesses, the following are the common expenses.

Salaries

This is the cost of services rendered by the employees and/or laborers of a business firm. This account may be used to include the cost of all emergency allowances, 13th month pay, and other employee fringe benefits.

Rent

The rental cost of office space, equipment, etc.

Office Supplies

This refers to the cost of office stationery; coupon bond, carbon paper, typewriter or computer ribbons, envelopes, pencils, ball pens, and office supply items that are consumed in business operations.

Utilities

This refers to the cost of light and water consumed as well as the cost of using telephone facilities.

Taxes and Licenses

This refers to all payments required to be made to the Bureau of Internal Revenue and the Municipal Treasurer for privilege taxes, mayors permits, municipal taxes and licenses, business taxes and others.

Transportation

This is the cost incurred by office employees when commuting from the office to the place of business of clients, e.g., jeepney fares, taxi fares, and bus fares. Also included are transportation fares from the office to any place on official business. Travelling Expense is used when business trips are made out of town, the cost of transportation fares by plane, by boat, or by bus.

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Gas and oil

This refers to the cost of gas and oil consumed whenever transportation vehicles or company cars are used in official business trips.

Representation

The cost incurred when entertaining clients or prospective clients. Included are the costs incurred when office employees represent the firm in some official functions.

Depreciation

This refers to the expense associated with the use of the companys plant assets, i.e., spreading (allocating) the cost of a plant asset over its useful life.

Bad Debts or Doubtful Account

Selling or rendering services on credit create both a benefit and a cost. Credit customers who fail to pay their liabilities will create an expense in the company. The allocation or provision for this future uncollectibility of some of the accounts of credit customers is called bad debts expense or doubtful accounts expense or uncollectible account expense.

Subscriptions or Communications Expense Donations and Contributions

This account may be used for the cost of internet subscriptions or other related telecommunication expenses.

This refers to contributions made to charitable institutions or any other worthwhile projects.

Miscellaneous

Any other costs of operations that may not be sufficiently big in amount to be classified separately are charged to this account.

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Debit and Credit of Income Statement Accounts

Overview

A business transaction is an activity that involves the exchange of values. This exchange would result to a situation or receiving a value equal to the value given away. In this part, we would learn the simple mechanics of these activities which bring about changes in the income statement.

Revenues

The purpose of a business, other than to render service to the community, is to increase assets and owners equity through revenues, which are amounts, earned by delivering goods or services to customer. Revenues increase owners equity because they increase the businesss assets but not its liabilities. As a result, the owners interest in the assets of the business increases.

Example: Jose Labrador earns service income by providing professional accounting service for his clients. Assume he earns P10,000 and collects this amount in cash. The effect on the accounting equation is an increase in the asset cash and an increase in Labrador Capital due to the income generated. Assets - Cash 10,000 increase = Liabilities + Labrador, Capital 10,000 increase - Service income

Expenses

In earning revenue, a business incurs expenses. Expenses are decreases in owners equity that occur in the course of delivering goods and service to clients. Expenses decrease owners equity because they use up the business assets.

Example: During the month, Labrador paid the salary of the company secretary for P5,000. The effect on the accounting equation is a decrease in the asset, cash and a decrease in capital due to the expense incurred. Asset - Cash 5,000 decrease = Liabilities + Labrador, Capital 5,000 decrease - Salaries expense

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Normal Balance

Upon analyzing the effects of income and expense accounts in the owners equity, one may conclude that, since owners equity or capital has a normal credit balance, it must follow that all income accounts will also have normal credit balances since they cause an increase in the capital account. On the contrary, since expenses have a decreasing effect in the capital account, the normal balance of all expense accounts would be debit. The illustration presents two main sources of owners equity, namely: investments and revenues. On the other hand, withdrawals and expenses decrease the owners equity. INCREASES
Owner investments in the business

DECREASES
Owner withdrawals from the business

Owner s Equity

Revenues

Expenses

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