FM202

Understanding
Income Statement
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Income Statement Format
Item Details
Revenue Income generated from day-to-day (core) activities of the company
Cost of good sold Direct cost related to the revenue
Gross profit Profit after deducting all direct costs from the revenue
Operating expenses Other cost related to operations
EBITDA Profit after deducting all operating costs from the revenue
Depreciation and amortization Charge related to the fixed assets used in the business
EBIT Profit after deducting all costs except for interest and tax
Interest Cost for the borrowed funds
EBT Profit before tax
Tax Corporate tax
PAT Profit After tax

Revenue
1 2 3 4 5
Identify the Identify the Determine the Allocate the Recognize revenue
contract(s) with a performance transaction price transaction price to when (or as) the
customer obligations in the the performance entity satisfies a
contract obligations in the performance
contract obligation.

Revenue
LENOV Ltd got into a contract to supply 50 computers to IMS Proschool on 31st March 2021. Under the terms of
contract, the company will provide computers for Rs 36,000/- each with 3 years onsite maintenance contract.
The computers were delivered on 15th April 2021. When should LENOV recognise revenue?

Revenue
Contract signed by 2 performance Rs 36,000/ each or Rs 9,000/ allocated Rs 27,000/

the companies on obligation: Rs 1,800,000 in total to 3-yr maintenance recognized on 15 th
31 st March 2021 Deliver computers and Rs 27,000/ for April 2021 and
Provide 3-yr service the computers Rs 3,000/ each year
for services
1 2 3 4 5
Identify the Identify the Determine the Allocate the Recognize revenue
contract(s) with a performance transaction price transaction price to when (or as) the
customer obligations in the the performance entity satisfies a
contract obligations in the performance
contract obligation.

Revenue
On 31st March, an automobile company sold 50 cars to the distributor with a condition that the automobile
company can change the price of the car any time before it is sold to the ultimate customer. The dealer has
made partial payment and the balance will be paid once the car is sold to the ultimate customer. Can the
automobile company record revenue on 31st March or should wait until it is sold to ultimate customer?

Revenue
Revenue is recognized as control is passed, either over time or at a point in time. Factors that may indicate the
point in time at which control passes include, but are not limited to: [IFRS 15:38]
• the entity has a present right to payment for the asset;
• the customer has legal title to the asset;
• the entity has transferred physical possession of the asset;
• the customer has the significant risks and rewards related to the ownership of the asset;
• the customer has accepted the asset.

Revenue
A seller sold goods worth Rs. 100,000 using the Flipcart platform on 31st March. The goods will be delivered on
10th of April to the buyer. Flipcart charges 10% commission on the transaction and pays to the seller after one
month of sale. Questions: Should the seller record revenue on 31st March or 10th April or wait till they receive
money? When should Flipcart recognise revenue and how much (Rs.100,000 or Rs. 10,000)?

Revenue

Revenue
If you sell goods with a condition that it can be returned with 1 month, should you record the revenue
immediately or wait for one month to get over?

Revenue

Revenue
If you have taken a contract to construct roads (50 kms) for Rs. 1500 million and estimate that it will take 5 years
to complete the project. Should you recognise all the revenue immediately or should you wait for 5 years or
something else?

Revenue
An entity recognizes revenue over time if one of the following criteria is met:
• the customer simultaneously receives and consumes all the benefits provided by the entity as the entity
performs;
• the entity’s performance creates or enhances an asset that the customer controls as the asset is created; or
• the entity’s performance does not create an asset with an alternative use to the entity and the entity has an
enforceable right to payment for performance completed to date.

Expense Recognition
Matching Principle
üMatch expenses with associated revenues

ü The matching principle requires that the company matches the COGS with the revenues of the period
Period Costs
üExpenses that less directly matching the timing of revenues

ü Administrative Expenses

Expense Recognition
Matching Principle
üMatch expenses with associated revenues

ü The matching principle requires that the company matches the COGS with the revenues of the period
Period Costs
üExpenses that less directly matching the timing of revenues

ü Administrative Expenses
Sometimes we must estimate expenses

For example:
1. Provision for warranties
2. Provision for doubtful debt

Depreciation & Amortization
üDepreciation is a process of systematically allocating costs of long-lived assets over the period during which the assets are
,-./0123 5.6/3 7819:1;3 :19-3
expected to provide economic benefits 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 =
<6=3 >= ?03 1223?
ü Various methods of depreciation, such as straight line, WDV and units of production
ü Owned land is never depreciated
üDepreciation of intangible assets (patents, copyrights etc) is called amortization
Goodwill is an intangible asset.

For accounting purpose goodwill arises only in a purchase transaction.
It is excess of purchase price over the net assets acquired. So, if X Ltd acquired Y Ltd for $120 million when its net assets (A - L =
E = Net Asset = Net Worth) was $100 million, the $20 million access paid will be reported as goodwill in X Ltd books of accounts.
Goodwill is never amortized but is tested for impairment.

Non-Recurring Items
üA company needs to separate revenues and expenses into items that are likely to continue in the future and items that are not
üHelps analysts to predict future earnings of the company
üItems that are not likely to continue can be classified as:
ü Discontinued operations:
ü An operation that the company has disposed in the current period or is planning to dispose in future.
ü Discontinued operations are shown as a separate line item, net of tax, after net income from continuing operations.
ü Unusual or infrequent items:
ü These are either unusual in nature or infrequent in occurrence
ü For example, gains or losses from selling an equipment.
ü they are shown as a separate line item, but before tax, and are included in the income from continuing operations.

Non-Recurring Items
ü Change in accounting policy
ü Refers to change from one accounting method to another. For example, changing inventory valuation from LIFO to FIFO
ü It requires retrospective application, i.e. all prior period financial statements need to be restated
ü Retrospective application, helps maintain comparability of the statements across periods
ü Changes in accounting estimate
ü This refers to change in the management’s estimate. For example, changing the useful life of a depreciable asset.
ü It requires prospective application, i.e. no need to restate prior period financial statements
ü Correction of prior-period error
ü This refers to an adjustment done to correct a prior period accounting error. All prior period statements should be restated
ü In addition, disclosure of the nature of the adjustment is required in footnotes

Non-Operating Items
üNon-operating items are portion of income or expenses that relates to activities not core to business operations
ü For a non-financial services company, interest income and expenses are non-operating in nature
ü For a financial services company, interest income and expenses are operating in nature

EPS
,.>=6? 1??.6C-?1C93 ?> >.D6E1.F 201.3

Earnings per share (EPS) is the profit or loss attributable to each share. 𝐸𝑃𝑆 =
G> >= 201.32
Profit attributable to the equity is the Net profit less any dividend to be paid to preference shareholders
No of shares in the denominator refers to the weighted average number of shares (weights given based on number of months)
G3? 5.>=6? 7 ,.3=3.3D J6:6D3ED

𝐵𝑎𝑠𝑖𝑐 𝐸𝑃𝑆 =
K36;0?3D 1:3.1;3 E> >= 201.32
number of shares is calculated by adjusting

also known as a common share or a share which entitles the holder to a fixed
the shares at the beginning of the period
common stock. An equity instrument dividend, whose payment takes priority
by the number of shares bought back or
that is subordinate to all other classes of over that of ordinary share dividends.
issued, multiplied by a time-weighting
equity instruments .
factor.
Ordinary Shares Preference Shares Weighted Average

Basic EPS - Example
Y Ltd has 10,000 shares outstanding at the beginning of the year. On April 1, the company issues 4,000 new
shares. On September 1, it repurchases 3,000 shares. Calculate weighted average number of shares outstanding
for the year, for its reporting of basic earnings per share.

Basic EPS - Example
Date No. Sh Weight Wt Sh
1-Ja n 10,000.0 12/12 10,000.0
1-Apr 4,000.0 9/12 3,000.0
1-Sep (3,000.0) 4/12 (1,000.0)
Weighted average 12,000.0

Basic EPS - Example
Y Ltd has 10,000 shares outstanding at the beginning of the year. On April 1, the company issues 4,000 new
shares. On July 1, distributes a 10% stock dividend. On September 1, it repurchases 3,000 shares. Calculate
weighted average number of shares outstanding for the year, for its reporting of basic earnings per share.

Basic EPS - Example
Date No. Sh Weight Adj Wt Sh
1-Jan 10,000.0 12/12 1.1 11,000.0
1-Apr 4,000.0 9/12 1.1 3,300.0
1-Sep (3,000.0) 4/12 (1,000.0)
Weighted average 13,300.0

Basic EPS - Example
Y Ltd has net income of $150,000, paid $10,000 cash dividends to its preferred shareholders, and paid $14,750
cash dividends to its common shareholders. Calculate basic EPS using 14,000 as weighted average number of
shares.

Basic EPS - Example
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 − 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑

𝑊𝑒𝑖𝑔ℎ𝑡𝑒𝑑 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑆ℎ𝑎𝑟𝑒𝑠
150,000 − 10,000
14000
𝐵𝑎𝑠𝑖𝑐 𝐸𝑃𝑆 = 10

Basic EPS
üIn case of stock splits:

ü 2 for 1 stock split increases the shares outstanding by 100%
ü For EPS calculation purposes, a stock split is treated as if it occurred at the beginning of the year
üIn case of dividends:

ü The weighted average outstanding shares increases with the dividend
ü 10% dividend results in a 10% increase in the shares outstanding

number of shares is calculated by adjusting
also known as a common share or a share which entitles the holder to a fixed
the shares at the beginning of the period
common stock. An equity instrument dividend, whose payment takes priority
by the number of shares bought back or
that is subordinate to all other classes of over that of ordinary share dividends.
issued, multiplied by a time-weighting
equity instruments .
factor.

Diluted EPS
Diluted earnings per share (DEPS) is the EPS considering all convertible securities have been converted to ordinary shares.
G3? 5.>=6? 7 ,.3=3.3D J6:6D3ED ^ ,.3=3..3D J6:6D3ED ^_E?3.32? ∗(b7c1d .1?3)

𝐷𝐸𝑃𝑆 =
K? 1:; E> >= 201.32^ Shares from conversion of convertible Pref Stock ^ Shares from conversion of convertible debt + Shares issuable for warrants and option
üWe assume that the convertible securities are convert to ordinary shares (even though they will convert in future)
üIf DEPS > EPS than while reporting DEPS, we make it equal to EPS
üIn such case the securities are call antidilutive

Diluted EPS - Example
Net Income for the year is $500,000,000
Common Stock of $10 each 20000000
Tax Rate 40%
Preferred stock outstanding ($10 each) = $ 7,500,000
Preferred Dividend Rate = 6%
One preferred stock is converted into 1.25 common shares
Calculate fully diluted EPS34

Particulars Calculation Output

Net Income 500,000,000
Less Preference Dividend
34 6% * 7,500,000 450,000
Divided by Wt No of Shares 20,000,000
BEPS 24.98
Number of Preference Shares 7,500,000 / 10 750,000

New Shares Post Conversion 750,000 *1.25 937,500
Total Shares 20,000,000 + 937,500 20,937,500
Diluted EPS 500,000,000 / 20,937,500 23.88

Net Income for the year is $500,000,000
Common Stock of $10 each 20000000
Tax Rate 40%
Convertible Debt outstanding ($1000 each) = $ 25,000,000
Bond Rate = 5%
One bond is converted into 125 common shares
Calculate fully diluted EPS


Divided by Wt
34 No of Shares 20,000,000
BEPS 25
Number of Convertible Bonds 25,000,000 / 1,000 25,000

New Shares Post Conversion 25,000 *125 3,125,000
Total Shares 20,000,000 + 937,500 23,125,000
Interest on the Bond 25,000,000*5% 1,250,000
Diluted EPS [500,000,000 + 1,250,000*(1-40%) / 21.64
23,125,000

Net Income $500,000,000
Common Stock of $10 each 20,000,000 Number of Shares
Average Price of stock $20.00
Exercise Price $15.00
Number of Options outstanding 1000000
Basic EPS $25.00

Proceed from Warrants Conversion 1,000,000* 15 15,000,000

34
No of shares that can be purchased 15,000,000 / 20 750,000
from above proceed at average price
Number of shares issued 1,000,000
Number of shares issued at no cost 1,000,000 – 750,000 250,000
Diluted EPS 500,000,000/ (20,000,000 + 250,000) 24.69

Net income = $2,500,000
600,000 common stock outstanding
20,000 shares of convertible preferred
Preferred dividend per share of $10, each preferred share is convertible into 2 shares of common stock

34
Less Preference Dividend 10 * 20,000 200,000
Divided by Wt No of Shares 600,000
BEPS 3.83
New Shares Post Conversion 20,000 *2 40,000
Total Shares 600,000 + 40,000 640,000
Diluted EPS 2,500,000 / 640,000 3.91
Since DEPS > BEPS, we report 3.83 as BEPS and DEPS. Here convertible preference shares are anti-dilutive

Comprehensive Income
Comprehensive income is the change in equity of a business enterprise during a period from transactions and other events and
circumstances from non-owner sources.

34
Total Comprehensive Income =
Net Income
+Foreign Currency Translation Adjustment
+Unrealized gains or losses on derivatives contracts accounted for as hedges
+Unrealized gains and losses on available for sale securities
+Pension Adjustment to funded status

Common Size Income Statement
34

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Understanding

FINANCE | ACCOUNTS | DIGITAL www.proschoolonline.com

Revenue Income generated from day-to-day (core) activities of the company

Cost of good sold Direct cost related to the revenue

Operating expenses Other cost related to operations

Interest Cost for the borrowed funds

EBT Profit before tax

Tax Corporate tax

PAT Profit After tax

FINANCE | ACCOUNTS | DIGITAL www.proschoolonline.com

FINANCE | ACCOUNTS | DIGITAL www.proschoolonline.com

FINANCE | ACCOUNTS | DIGITAL www.proschoolonline.com

Contract signed by 2 performance Rs 36,000/ each or Rs 9,000/ allocated Rs 27,000/

FINANCE | ACCOUNTS | DIGITAL www.proschoolonline.com

FINANCE | ACCOUNTS | DIGITAL www.proschoolonline.com

• the entity has a present right to payment for the asset;

• the customer has legal title to the asset;

• the entity has transferred physical possession of the asset;

• the customer has accepted the asset.

FINANCE | ACCOUNTS | DIGITAL www.proschoolonline.com

FINANCE | ACCOUNTS | DIGITAL www.proschoolonline.com

• the entity has a present right to payment for the asset;

• the customer has legal title to the asset;

• the entity has transferred physical possession of the asset;

• the customer has accepted the asset.

FINANCE | ACCOUNTS | DIGITAL www.proschoolonline.com

immediately or wait for one month to get over?

FINANCE | ACCOUNTS | DIGITAL www.proschoolonline.com

• the entity has a present right to payment for the asset;

• the customer has legal title to the asset;

• the entity has transferred physical possession of the asset;

• the customer has accepted the asset.

FINANCE | ACCOUNTS | DIGITAL www.proschoolonline.com

FINANCE | ACCOUNTS | DIGITAL www.proschoolonline.com

enforceable right to payment for performance completed to date.

FINANCE | ACCOUNTS | DIGITAL www.proschoolonline.com

üMatch expenses with associated revenues

üExpenses that less directly matching the timing of revenues

FINANCE | ACCOUNTS | DIGITAL www.proschoolonline.com

üMatch expenses with associated revenues

üExpenses that less directly matching the timing of revenues

Sometimes we must estimate expenses

FINANCE | ACCOUNTS | DIGITAL www.proschoolonline.com

ü Owned land is never depreciated

üDepreciation of intangible assets (patents, copyrights etc) is called amortization

Goodwill is an intangible asset.

FINANCE | ACCOUNTS | DIGITAL www.proschoolonline.com

ü Unusual or infrequent items:

ü These are either unusual in nature or infrequent in occurrence

ü For example, gains or losses from selling an equipment.

FINANCE | ACCOUNTS | DIGITAL www.proschoolonline.com

ü Change in accounting policy

ü Retrospective application, helps maintain comparability of the statements across periods

ü Changes in accounting estimate

ü Correction of prior-period error

ü In addition, disclosure of the nature of the adjustment is required in footnotes

FINANCE | ACCOUNTS | DIGITAL www.proschoolonline.com

FINANCE | ACCOUNTS | DIGITAL www.proschoolonline.com

,.>=6? 1??.6C-?1C93 ?> >.D6E1.F 201.3

G3? 5.>=6? 7 ,.3=3.3D J6:6D3ED

number of shares is calculated by adjusting

Ordinary Shares Preference Shares Weighted Average

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FINANCE | ACCOUNTS | DIGITAL www.proschoolonline.com