Accounting and Finance Virtual Internship Series – Part 3 The General Ledger Accounting / Financial Accounting or Reporting unit - Continuation

The last wo elements of a Financial statement, Income and Expenses are found on the Statement of Comprehensive Income or Statement of Profit or Loss and other Comprehensive Income.

INCOME

The International Financial Reporting Standard 15 - Revenue from Contracts with Customers, defines Income as ‘increase in economic benefit during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in an increase in equity other than those relating to contributions from equity participants.’

A significant portion of a Business’s income is from its Revenue. Revenue is income from the normal operations of a Business. The income from normal operations is usually from sales of goods and services.

The Source and nature of what is classified as Revenue is dependent on the principal activities of the Company. For a trading company, Revenue is sales of its merchandise. Whereas, for a Service company, Revenue is income from services performed for customers. Similarly, for a company whose primary activity is rental of properties, its Revenue will be rental income from its tenants. Revenue and Turnover are sometimes used interchangeably.

Income that are not from the normal operations of the business are usually classified as other income in the statement of profit and Loss and other comprehensive income. As an example, for a trading company, any income from subletting part of its office space will not be treated as Revenue but as other income. For a Company that sells Cars, sales of cars that are part of its inventories will be regarded as Revenue, this will not be the case when a Company that sells Infant Clothing dispose of one of its delivery vans.

Revenue is an important element in any financial statement. A credit entry is usually passed in the book when Revenue is earned. It is also a key performance measure for evaluating the performance of a business entity.

Prior to accounting period commencing from 1st January 2018, there were several accounting standards and interpretations on the recognition of Revenue. IAS 11 dealt with Revenue from Construction contracts, IAS 18 with Revenue from Sales of goods, rendering of services, and for interest, royalties and Dividend, IFRIC 13 dealt with customer loyalty programmes, IFRIC 15 with Agreements for Construction of Real Estate, IFRIC 18 with Transfer of Assets from Customers and SIC 31 with Revenue – Barter transactions involving advertising services. IFRS 15 became effective from accounting period beginning or after 1st January 2018. It replaced and superseded the other standards and interpretations listed above.

IFRS 15 outlines the principles that a business entity should apply to report information relating to the nature, timing, uncertainty and cash flow arising from contracts with customers.

The Revenue standard, IFRS15 introduced what is known as the five-step model for Revenue recognition. The five steps which are outlined below must be fulfilled before Revenue is recognized;

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

The first four steps are usually fulfilled by other departments other than Finance. To have a proper understanding of Revenue, it is essential to have a thorough understanding of the sales cycle or order to cash process.

Typically, an enquiry or a request for quotation is received from a customer (or potential customer) stating the items or services (performance obligations) that the customer requires. The sales team then prepare a quotation or service proposal for the request stating the price for fulfilling the request. The customer reviews this and after possible negotiations, an agreement is reached. The customer confirms the stated obligations and prices on the quotation by issuing a purchase order to the supplier or service provider. The purchase order which is a confirmation of the final quotation clearly state the performance obligations and the determined transaction price.

In the sales quotations or proposals, milestones are usually agreed, and the total purchase consideration allocated to these milestones (performance obligations).

After the sales contract, performance obligations and transaction price are agreed, the service execution or delivery of the requested goods are usually carried out by collaborations between the operations, sales, direct procurement and supply chain (logistics) teams. It is only after the performance obligations are fulfilled that invoicing or billing is done by the Finance team.

Clearly from the above explanation, there must be clear offer and acceptance of the sales terms for the first step to be deemed to have been fulfilled. For step 2, the performance obligation must be a distinct good or service (or bundle of goods and services) or a series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customers. step 3 is the agreed sales price excluding all trade discounts. It is the agreed amount receivable from fulfilling the sales contract. Allocation of the transaction price usually occur where there are multiple performance obligations. The stand-alone selling price is allocated to each performance obligation. Where the stand-alone prices are not available, an estimate is permissible. Step 5 is fulfilled when control is passed, and the customer can enjoy substantially all the benefits from the assets. Passing of control is usually evidenced by a signed job completion card or service report or an acknowledged proof of delivery.

Invoicing is usually done on the business entity’s ERP after a confirmation by the Finance team that control has been passed to the customer. Typically, it is expected that there is a control stage where the amount to be invoiced is compared against the purchase order from the customer, the items delivered to the customer and the invoice from supplier of the item that were sold.

Effective Finance Business partnering involves having a clear understanding of the entire OTC process and providing support to operations in these other processes as much as possible. Accounting and Finance has gone beyond just posting and reporting the figures. Accounting and Finance professionals should be an integral support system for the business.

Revenue is key as it is an indication of customer acceptance of the product or services of a business. All other things being equal, an increase in Revenue should result in an increase in profit.

Revenue is also a key element in the calculations of several accounting ratios.

EXPENSES

The International Accounting Standard Board framework defines Expenses as decreases in economic benefits during the accounting period in the form of outflows or depreciation of assets or incurrences of liabilities that result in decreases in equity, other than those from relating to distributions to equity participants.

In a typical financial statement, expenses are usually shown as either direct expenses (cost of sales) or as indirect expenses (Administrative expenses, Marketing and selling expenses). Deduction of all the expenses from the Income for the year will give the Profit for the year (Revenue less cost of sales gives gross profit. Addition of other income to the gross profit and deduction of indirect expenses and losses will result in the net profit of the business).

Expenses usually have a debit entry except for reversals that will have credit entries.

In the General ledger, there are usually several ledger accounts for posting expenses depending on their nature. There could be ledger for raw material cost, direct labour cost, factory expenses, personnel expenses, travel expenses, rent and rate, insurance expenses, consulting fees, depreciation, bank charges, interest expense, legal fees, audit fee, IT and telephone expenses etc. The expense ledgers in use are dependent on the nature of business of the entity.

Control of Expenses is a key management responsibility to ensure that the business entity is profitable.

The below is also a brief explanation on the other elements in the proposed new chapter by the FASB: Gains; Losses; Investments by Owner; Distributions to Owners and Comprehensive Income

Gains are economic benefits that are outside the normal business operations of an entity typically from the increased value of an assets. Examples of gains include foreign exchange gains, asset revaluations gains, gains from disposal of fixed assets. Gains could be realized (from actual sales or occurrence) or unrealized (potential gain).

Losses are decrease in a business resources or assets. Losses can occur when cost produce no benefits, excess of expenditure over Revenue, excess of cost over net proceeds. Losses are usually reported net of related income

Gains and Losses are shown in the statement of comprehensive income.

Investments by owners are increase in Equity.

Distributions to owners are payments of the retained earnings of a company to its owners or shareholders in form of dividend payments or distribution of assets of the company or issue of Bonus shares from share premium account

Investments by Owners and distributions to owners are usually shown in the statement of Financial position under Equity and in the statement of changes in Equity.

Comprehensive income are all the changes in equity during a period except those resulting from investments by owners and distributions to owners.

In conclusion, to have a more detailed understanding of financial statements and their elements, you can pick up any financial statement and go through noting each statement and the contents. There are several copies of financial statements submitted by publicly listed companies from various sectors on the website of the Nigerian stock exchange. You can visit their website and download these financial statements for further review.