Concepts, Rules, and Examples | WILEY IAS 2003: Interpretation and Application of International Accounting Standards

Concepts of Income

Economists have generally adopted a wealth maintenance concept of income. Under this concept, income is the maximum amount that can be consumed during a period and still leave the enterprise with the same amount of wealth at the end of the period as existed at the beginning. Wealth is determined with reference to the current market values of the net productive assets at the beginning and end of the period. Therefore, the economists' definition of income would fully incorporate market value changes (both increases and decreases in wealth) in the determination of periodic income.

Accountants, on the other hand, have generally defined income by reference to specific events that give rise to recognizable elements of revenue and expense during a reporting period. The events that produce reportable items of revenue and expense comprise a subset of economic events that determine economic income. Many changes in the market values of wealth components are deliberately excluded from the measurement of accounting income but are included in the measurement of economic income.

The discrepancy between the accounting and economic measures of income are the result of a preference on the part of accountants and financial statement users for information that is reliable. Since many fluctuations in the market values of assets are matters of conjecture, accountants have retained the historical cost model, which generally precludes the recognition of market value changes until realized by a transaction. Similarly, both accountants and economists understand that the earnings process occurs throughout the various stages of production, sales, and final delivery of the product. However, the difficulty in measuring the precise rate at which this earnings process is taking place has led accountants to conclude that income should normally be recognized only when it is fully realized. Realization generally implies that the enterprise producing the item has completed all of its obligations relating to the product and that collection of the resulting receivable is assured beyond reasonable doubt. For very sound reasons, accountants have developed a reliable system of income recognition that is based on generally accepted accounting principles applied consistently from period to period. The interplay between recognition and realization generally means that values on the balance sheet are recognized only when realized through an income statement transaction.

A separate but equally important reason for the disparity between the accounting and economic measures of income relates to the need for periodic reporting. The economic measure of income would be relatively simple to apply on a life cycle basis. Economic income would be measured by the difference between its wealth at the termination point and its wealth at the origination date, plus withdrawals or other distributions and minus additional investments over the course of its life. However, applying the same measurement strategy to discrete fiscal periods as accountants apply is much more difficult. The continual earnings process in which the earnings of a business occur throughout the various stages of production and delivery of a product is conceptually straightforward. Allocating those earnings to individual years, quarters, or months is substantially more difficult, requiring both estimates and judgment. Consequently, accountants have concluded that there must be unambiguous guidelines for revenue recognition. These have required recognition only at the completion of the earnings cycle.

The appropriate measurement of income is partially dependent on the vantage point of the party doing the measuring. From the perspective of outside investors taken as a whole, income might be defined as earnings before any payments to those investors, including bondholders and preferred stockholders, as well as common shareholders. On the other hand, from the viewpoint of the common shareholders, income might better be defined as earnings after payments to other investors, including creditors and preferred shareholders. Currently, net income is defined as earnings available for the preferred and common stockholders. However, in various statistics and special reports, a variety of these concepts are employed.

Recognition and Measurement

Recognition involves the depiction of an item in words and by a monetary amount, and the inclusion of that amount in the balance sheet or the income statement. For recognition of an item on financial statements, it should meet the definition of an element as prescribed by the IASC's Framework and satisfy the criteria for recognition as set out in that document. The criteria are needed to assist accountants in determining which economic events are in the domain of items included in the measurement of income. The IASC's Framework has identified the following recognition criteria, which remain in force:

Item must meet the definition of an element. To be recognized, an item must meet one of the definitions of an element of the financial statements. For instance, a resource must meet the definition of an asset, an obligation must meet the definition of a liability, and so on. It is interesting to note that sometimes the interrelationship between the elements requires that an item that meets the definition and recognition criteria for a particular element, for instance, an asset, automatically requires the recognition of another element, for example, income or a liability.
Assessment of degree of uncertainty regarding future economic benefits. This refers to the degree of uncertainty that the future economic benefits associated with an item will flow to or from the enterprise. The assessment of this uncertainty is made on the basis of evidence available at the time of preparation of the financial statements. This concept can be illustrated through the following example: At year-end while valuing inventory, if it is uncertain whether or not the full cost of the inventory could be recovered in the future when part of the inventory is damaged, recognition is given to this uncertainty and the inventory is written down to its net realizable value.
Item's cost or value can be measured with reliability. An item must possess a relevant attribute, such as cost or value, which can be quantified in monetary units with sufficient reliability. Measurability must be considered in terms of both relevance and reliability, the two primary qualitative characteristics of accounting information.
Relevance. An item is relevant if the information about it has the capacity to make a difference in investors', creditors', or other users' decisions. The relevance of information is affected by its nature and materiality.
Reliability. An item is reliable if the information about it is representationally faithful, free of material errors, and is neutral or free from bias. Further, to possess the quality of reliability, two more features should be present.
1. The transactions and other events the information purports to represent should be accounted for and presented in accordance with their substance and economic reality and not merely their legal form.
2. The preparers of financial statements, while dealing with and recognizing uncertainties, should exercise judgment or a degree of caution: in other words, prudence.

To be given accounting recognition, an asset, liability, or item of income or expense would have to meet the above-mentioned five criteria.

Income.

According to the IASC's Framework

Income is 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 equity participants. The definition of income encompasses both revenue and gains, and revenue arises in the course of ordinary activities of an enterprise and is referred to by different names, such as sales, fees, interest, dividends, royalties, and rent

IAS 18 is the standard that deals with the accounting for revenue. It sets forth the following characteristics of the term revenue:

Inflows of economic benefits arise in the course of ordinary activities of an enterprise.
Inflows are to be reported gross.
Inflows result in increases in equity, other than increases relating to contributions from equity participants.

The measurement concept requires that revenue be measured at the fair value of the consideration received or receivable. Fair value is defined as

the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's-length transaction.

The realization concept stipulates that revenue is recognized only when the following occur:

The earnings process is complete or virtually complete.
Revenue is evidenced by the existence of an exchange transaction that has taken place.

The existence of an exchange transaction is critical to the accounting recognition of revenue. Generally, it means that a sale to an outside party has occurred, resulting in the receipt of cash or the obligation by the purchaser to make future payment for the item received. However, an exchange transaction is viewed in a broader sense than the legal concept of a sale. Whenever an exchange of rights and privileges takes place, an exchange transaction is deemed to have occurred. For example, interest revenue and interest expense are earned or incurred ratably over a period without a discrete transaction taking place. Accruals are recorded periodically to reflect the interest realized by the passage of time. Similarly, the percentage-of-completion method recognizes revenue based on the measure of progress on a long-term construction project. The earnings process is considered to occur simultaneously with the measure of progress (e.g., the incurrence of costs).

The conditions for the timing of revenue recognition would also be varied if the production of certain commodities takes place in environments in which the ultimate realization of revenue is so assured that it can be recognized upon the completion of the production process. At the opposite extreme is the situation in which the exchange transaction has taken place but significant uncertainty exists as to the ultimate collectibility of the amount. For example, in certain sales of real estate, where the down payment percentage is extremely small and the security for the buyer's notes is minimal, revenue is often not recognized until collections are actually received.

Expenses.

According to the IASC's Framework

Expenses are decreases in economic benefits during an accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. Thus the characteristics of expenses include the following:
1. Sacrifices involved in carrying out the earnings process
2. Actual or expected cash outflows resulting from ordinary activities
3. Outflows reported gross

Expenses are expired costs, or items that were assets but are no longer assets because they have no future value. The matching principle requires that all expenses incurred in the generating of revenue be recognized in the same accounting period as the revenues are recognized. The matching principle is broken down into three pervasive measurement principles: associating cause and effect, systematic and rational allocation, and immediate recognition.

Costs such as materials and direct labor consumed in the manufacturing process are relatively easy to identify with the related revenue elements. These cost elements are included in inventory and expensed as cost of sales when the product is sold and revenue from the sale is recognized. This is associating cause and effect.

Some costs are more closely associated with specific accounting periods. In the absence of a cause and effect relationship, the asset's cost should be allocated to benefiting accounting periods in a systematic and rational manner. This form of expense recognition involves assumptions about the expected length of benefit and the relationship between benefit and cost of each period. Depreciation of fixed assets, amortization of intangibles, and allocation of rent and insurance are examples of costs that would be recognized by the use of a systematic and rational method.

All other costs are normally expensed in the period in which they are incurred. This would include those costs for which no clear-cut future benefits can be identified, costs that were recorded as assets in prior periods but for which no remaining future benefits can be identified, and those other elements of administrative or general expense for which no rational allocation scheme can be devised. The general approach is first to attempt to match costs with the related revenues. Next, a method of systematic and rational allocation should be attempted. If neither of these measurement principles is beneficial, the cost should be immediately expensed.

As stated in the IASC's Framework, the term expenses is broad enough to include losses as well. Expenses that arise in the course of the ordinary activities of an enterprise include such items as cost of sales, wages, and depreciation. They usually take the form of an outflow of cash or depletion of other assets.

Losses also represent decreases in economic benefits and are similar in nature to expenses. However, there is a subtle difference between the two concepts: losses may or may not arise in the course of ordinary activities, whereas expenses arise from ordinary activities. Thus, a loss from an extraordinary item such as a natural disaster would also qualify as a loss according to this definition. It is to be noted that even unrealized losses are covered here. For example, losses arising from the effects of increases or decreases in the exchange rates for a foreign currency in respect of the borrowings of an enterprise in that currency, which are unrealized losses, are also contemplated by this definition.

It is interesting to note that in the United States, the FASB's conceptual framework project defined expenses as "outflows or other using up of assets or incurrences of liabilities (or a combination of the two) resulting from delivery of goods, rendering of services, or other activities constituting the enterprise's major or central operations." This definition, although crisp and concise, is quite comprehensive; it seems to cover all conceivable ways of incurring expenses. For instance, the expression "a combination of the two" probably was intended to be a catch-all clause but for some reason has not been included in the definition given in IASC's Framework.

Gains and losses.

According to the IASC's Framework

Gains (losses) represent items that meet the definition of income (expenses) and may or may not arise in the course of ordinary activities of an enterprise. Gains (losses) represent increases (decreases) in economic benefits and as such are no different in nature from revenue (expenses). Hence they are not regarded as separate elements in IASC's Framework. Characteristics of gains and losses include the following:
1. Result from peripheral transactions and circumstances that may be beyond entity's control
2. May be classified according to sources or as operating and nonoperating

The recognition of gains and losses should follow the principles stated below.

Gains often result from transactions and other events that involve no earnings process; therefore, in terms of recognition, it is more significant that the gain be realized than earned.
Losses are recognized when it becomes evident that future economic benefits of a previously recognized asset have been reduced or eliminated, or that a liability has been incurred without associated economic benefits. The main difference between expenses and losses is that expenses result from continuing operations, whereas losses result from peripheral transactions that may be beyond the entity's control.

Statement of changes in equity and statement of recognized gains and losses.

IAS 1 prescribes a new component of financial statements (to be presented along with the traditional financial statements). While the IASC had earlier expressed its intent to mandate a new prescribed financial statement, the statement of nonowner movements in equity, opposition resulted in a somewhat modified final standard. Although different in some particulars and offering more options in terms of format, this will nonetheless reveal to financial statement users the full scope of changes in economic position, whether due to traditional items of income and expense, or to such other phenomena as revaluations of plan assets and investments, or the translations of foreign subsidiaries' and affiliates' balance sheets.

IAS 1 offers preparers two principal mechanisms for reporting the changes in enterprise equity for a period. The first of these would have the reporting entity present a new financial statement, to be captioned the statement of changes in equity. This statement should present

An enterprise's total recognized gains or losses for the period, including those that are recognized directly in equity (giving details of each item of income, expense, gain, or loss which are required by other IAS to be shown directly in equity, along with the total of these items, plus net profit or loss for the period and cumulative effect of changes in accounting policy and of correction of fundamental errors if accounted for by the benchmark treatments prescribed by IAS 8); and, in addition,
Other changes in the equity accounts, along with a reconciliation of beginning and ending balances in each of the components of equity (giving details by each class of equity capital) and balances of accumulated profit or loss (giving details of the movements for the period).

An example of the statement of changes in equity is presented in the following section of this chapter.

Under the second of the two permitted approaches, the enterprise would present a statement of recognized gains and losses for the period, which would only include the net effect of income, expense, gain or loss reported in the income statement for the period. That is, net income or loss, including if applicable the cumulative effect of changes in accounting policy and of the correction of any fundamental errors accounted for by the benchmark treatments prescribed by IAS 8, would be added to the other items of income, expense, gain or loss which are carried directly to equity, with the total of these being presented as the final amount in the statement of recognized gains and losses.

If the second approach is utilized, the changes in other capital accounts resulting from transactions with owners, as well as the changes in retained earnings (referred to in IAS 1 as accumulated profit or loss), must be presented elsewhere in the notes to the financial statements. An example of this second approach is also shown in the following section of this chapter.

IAS 1 explains that it is important to take into consideration all income, expenses, gains, and losses (including those not recognized in the income statement) in assessing the overall financial performance of an enterprise. Thus, the revised standard on presentation of financial statements has prescribed this new component of financial statements to capture those items of gains or losses that are not included in the determination of net income or loss for the period. This standard further justifies the need for the presentation of this new component of financial statements by setting forth the following reasoning for its prescription:

Since IAS 8 requires that all items of income and expense in a period be included in the determination of net profit or loss for the period, unless an international accounting standard requires or permits otherwise; and also
Since other standards, such as IAS 16, 25, and 21, require that specified gains and losses, such as revaluation surpluses or deficits and foreign currency translation differences, be recognized directly as changes in equity along with capital transactions with and distributions to the enterprise's owners; thus,
In order to capture all gains or losses that have a bearing on the enterprise's financial position, it is important that a separate component of financial statements be presented along with the traditional components of financial statements.

While the new standard refers to this as "a separate component of the financial statements," what is required is a new financial statement that (depending on which alternative version is adopted) may also require additional footnote materials. This "separate component" is to be presented as an integral part of all complete sets of financial statements. Accordingly, any set of financial statements would be considered incomplete without this new statement.

It is to be noted that the IASC's action is in line with the current thinking in the UK and US. In the US, SFAS 130 prescribes a similar statement to be presented as a separate component of the financial statements, based on the FASB's concept of "comprehensive income." In the UK, which was the first to take this step, the treatment is very similar to that embraced by IAS 1, and the new component of financial statement prescribed under FRS 3 of the UK GAAP is captioned the "statement of total recognized gains and losses," which is similar to that suggested by IAS 1 when the second suggested approach is utilized.

Examples of the new statements alternatively required by IAS 1.

Example 1:

If the statement of changes in equity is to be employed

XYZ Malta Inc. Statement of Changes in Equity For the Year Ended December 31, 2003 *(in thousands of US dollars)*
	Share capital	Share premium	Revaluation reserve	Currency translation	Accumulated profits	Total
Balance at Dec. 31, 2001	$1,000	$100	$200	$200	$100	$1,600
Changes in accounting policy	--	--	--	--	50	50
Opening balances, as restated	1,000	100	200	200	150	1,650
Currency translation difference	--	--	--	(50)	--	(50)
Surplus from revaluation of buildings	--
Surplus from revaluation of buildings	--	--	100	--	--	100
Net gains and losses not recognized in income statement	--	--	100	(50)	--	50
Net profit for the period	--	--	--	--	100	100
Issuance of share capital	100	10	--	--	--	110
Balance at Dec. 31,2002	1,100	110	300	150	250	1,910
Currency translation difference	--	--	--	150	--	150
Deficit on revaluation of investments	--
Deficit on revaluation of investments	--	--	--	--	(50)	(50)
Net gains and losses not recognized in income statement	--	--	--	150	(50)	100
Net profit for the period	--	--	--	--	200	200
Dividends	--	--	--	--	50	(50)
Balance at Dec. 31, 2003	$1,100	$110	$300	$300	$350	$2,160

Example 2:

If the statement of recognized gains and losses is to be presented (see note below)

ABC Barbados Co. Ltd. Statement of Recognized Gains and Losses For the Year Ended December 31, 2003 *(in thousands of US dollars)*
	2003	2002
Surplus on revaluation of buildings	$ 500	$ --
Surplus (deficit) on revaluation of investments	1,000	(1,000)
Exchange differences on translation of the financial statements of a foreign subsidiary	2,000	(2,000)
Net gains (losses) not recognized in the income statement	3,500	(3,000)
Net profit for the year	5,000	2,800
Total recognized gains and losses	8,500	(200)
Effect of changes in accounting policy	$ --	$ 500
NOTE: If this approach is used, then a reconciliation of the opening and closing balances of share capital, reserves, and retained earnings (accumulated profits) as illustrated in the first example, above, should be presented in the footnotes to the financial statements.

Impact of Legal Form on Financial Reporting

Revenues and expenses of a corporation are easily identified and separated from the revenues and expenses of the shareholders. In both the sole proprietorship and partnership form of entity, the identification process can be more difficult. Items such as interest or salaries paid to partners or owners may be thought of as distributions of profits rather than expenses. However, many entities adopt the philosophy that income reporting should be the same regardless of legal form (economic substance takes precedence over legal form). Under the corporate form of business, interest on stockholder loans and salaries paid to stockholders are clearly classified as expenses and not as distributions. Accordingly, under this theory, these items may be treated as expenses for both partnerships and sole proprietorships. However, full disclosure and consistency of financial reporting treatment would be required. Circumstances may involve treating certain payments, such as guaranteed salaries, as expenses while classifying other "salaries" as profit distributions.

Income Statement Classification and Presentation

Statement title.

Income statements measure economic performance for a period of time and, except for this variation, follow the same basic rule for headings and titles as do balance sheets. For instance, the legal name of the entity must be used to identify the financial statements and the title "Income Statement" used to distinguish the statement from other information presented in the annual report. This is important also so that users can identify the information that is presented in accordance with international accounting standards from other information that may not be the subject of accounting requirements.

If another comprehensive basis of accounting is used, as is explicitly contemplated under US GAAP, such as the "cash basis" or "income tax basis," the title of the financial statement should be modified accordingly. "Statement of Revenue and Expenses—Income Tax Basis" or "Statement of Revenue and Expense—Modified Cash Basis" are examples of such titles. However, it should be noted that international accounting standards neither refer to nor contain guidance relating to these other comprehensive bases of accounting. One could interpret this omission to mean that current international accounting standards (i.e., the IASC's Framework and IAS 1) recognize only the accrual basis of accounting.

Reporting period.

The period covered by the income statement must clearly be identified, such as "year ending (ended) December 31, 2003." Such dating informs the user of the financial statements not only about the length of the period covered by the income statement, but also the starting and ending dates. Dating such as "the period ending March 31, 2003" or "through March 31, 2003" would represent a violation of accounting principles because of the lack of precise definition in these titles. Income statements are normally presented annually (i.e., for a period of twelve months or a year). However, in exceptional circumstances, income statements could be presented for periods in excess of one year or for shorter periods as well (e.g., for five months or a quarter of a year). IAS 1 requires that when financial statements are presented for periods other than a year, the following additional disclosures should be made:

The reason for presenting the income statement (and other financial statements, such as the cash flow statement, statement of changes in equity, and notes) for a period other than one year; and
The fact that the comparative information presented (in the income statement, statement of changes in equity, cash flow statement, and notes) is not truly comparable.

Entities whose operations form a natural cycle may have a reporting period end on a specific day (e.g., the last Friday of the month). Certain enterprises (typically retail enterprises) prepare income statements for a fiscal period of fifty-two or fifty-three weeks instead of a year (thus, to always end on a day such as Sunday, on which no business is transacted, so that inventory may be taken). These entities should clearly state that the income statement has been presented, for instance, "for the fifty-two-week period ended March 28, 2003." The new standard on presentation of financial statements specifically addresses enterprises that prefer to report consistently for a fifty-two or fifty-three-week period, and states categorically that it does not preclude this practice since it is unlikely that the financial statements thus presented would be materially different from those that are presented for one full year.

In order that the presentation and classification of items in the income statement be consistent from period to period, items of income and expenses should be uniform both with respect to appearance and categories from one time period through the next. That is, if a decision is made to change classification schemes, the comparative prior period financials should be restated to conform and thus to maintain comparability between the two periods being presented together. Disclosure must be made of this reclassification, since the earlier period financial statements being presented currently will differ in appearance from those nominally same statements presented in the earlier year.

Aggregating items.

Aggregation of items should not serve to conceal significant information, such as netting revenues against expenses or combining elements of interest to readers, such as bad debts and depreciation. The categories "other" or "miscellaneous expense" should contain, at maximum, an immaterial total amount of aggregated insignificant elements. Once this total approaches, for example, 10% of total expenses (or any other materiality threshold), some other aggregations with explanatory titles should be selected.

Information is material if its omission or misstatement or nondisclosure could influence the economic decisions of users taken on the basis of the financial statements. Materiality depends on the size of the item judged in the particular circumstances of its omission (IASC's Framework, para 30). But it is often forgotten that materiality is also linked with understandability and the level of precision in which the financial statements are to be presented. For instance, the financial statements are often rendered more understandable by rounding information to the nearest thousand currency units (i.e., US dollars). This obviates the necessity of loading the financial statements with unnecessary detail. However, it should be borne in mind that the use of the level of precision that makes presentation possible in the nearest thousands of currency units is acceptable only as long as the threshold of materiality is not surpassed.

Offsetting items of revenue and expense.

Materiality also plays a role in the matter of allowing or disallowing offsetting of the items of income and expense. IAS 1 addresses this issue and prescribes rules in this area. According to this standard, items of income and expense should be offset when, and only when

An international accounting standard requires or permits it. For example, IAS 30 permits banks and similar financial institutions to offset income and expense items relating to hedging; or
Gains, losses, and related expenses arising from the same or similar transactions and events are not material. Such amounts should be aggregated in such cases.

The standard also states that immaterial amounts should be aggregated with amounts of similar nature or function and need not be presented separately. However, when such gains or losses are individually material, then they should not be offset, but instead should be presented on a gross basis. For example, gain on the sale of a building is $5 million and loss on the sale of land during the same accounting period is $10 million. If both of these amounts are individually material, they should not be offset but be shown on a gross basis.

Usually, losses and gains on disposal of noncurrent assets are seen reported on a net basis, which may be due to the fact that they are not material individually (compared to other items on the income statement). However, if they were material individually, as in the example above, they would need to be disclosed separately according to the requirements of IAS 1. It is the authors' opinion that even under the existing international accounting standards, they would not be required to be offset and shown on a net basis. For instance, IAS 16 stipulates that, "gains or losses arising from the retirement or disposal of an item of property, plant, and equipment...should be recognized as income or expense in the income statement." Read in the light of the guidelines contained in the IASC's Framework, which categorically states that "when gains (losses) are recognized in the income statement, they are usually displayed separately because knowledge of them is useful for the purpose of making economic decisions," it would be unreasonable to interpret that IAS 16 does not require disclosure of gains or losses arising from the retirement or disposal of property, plant, and equipment.

Further, based on the discussion above, it seems unreasonable to read between the lines of IAS 16 in an attempt to reach a conclusion, as some have done, that it does not require the disclosure of gains or losses arising from the retirement or disposal of property, plant, and equipment, and therefore that such gains or losses may be included as an undisclosed net amount within broad expense categories such as "general and administrative expenses." In the authors' opinion, although gains or losses arising from retirement or disposal of property, plant, and equipment are not mentioned in the disclosure section of IAS 16, they are specifically dealt with in an earlier paragraph of that IAS. Thus, reading all the provisions of IAS 16, together with the IASC's Framework (as explained earlier), it would not be unreasonable to interpret that such gains or losses should be disclosed separately in the income statement, if material.

IAS 1 further clarifies that when items of income or expense are offset, the enterprise should nevertheless consider, based on materiality, the need to disclose the gross amounts in the notes to the financial statements. This standard gives the following examples of transactions that are incidental to the main revenue-generating activities of an enterprise and whose results when presented by offsetting or reporting on a net basis, such as netting any gains with related expenses, reflect the substance of the transaction:

Gains or losses on the disposal of noncurrent assets, including investments and operating assets, are reported by deducting from the proceeds on disposal the carrying amounts of the asset and related selling expenses.
Extraordinary items are presented net of related taxation and minority interest.
Expenditure that is reimbursed under a contractual arrangement with a third party may be netted against the related reimbursement.

For example, an enterprise based on a time-share arrangement processes computerized accounting data electronically for its own accounting department as well as for certain other companies in the area and incurs a total expenditure of $5 million for an accounting period. The expenditure it incurs on this data-processing activity should be presented after netting the related reimbursable expenditure, which amounts to $3 million. Thus, the income statement presentation would display the net figure (expense) of $2 million (instead of a gross basis presentation of a $5 million expense and a $3 million income). This financial statement presentation reflects the substance of the transaction. (It should be noted, however, that a disclosure of the gross amounts, if they are material, may need to be made in the notes to the financial statements; this is also a requirement of IAS 1 and was explained earlier in this chapter.)

Major components of the income statement.

IAS 1 stipulates that, at the minimum, the income statement must include line items that present the following items (if they are pertinent to the entity's operations for the period in question):

Revenue
Results of operating activities
Finance costs
Share of profits and losses of associates and joint ventures accounted for by the equity method
Tax expense
Profit or loss from ordinary activities
Extraordinary items
Minority interest
Net profit for the period

The foregoing items represent the barest minimum: Other line items can be included as deemed useful or necessary to fairly communicate the results of the enterprise's operations. It should be carefully noted that this requirement must be satisfied by presentation on the face of the income statement; it cannot be dealt with by incorporating the items into the notes to the financial statements.

While the objectives of the line items are uniform across all reporting entities, the manner of presentation may differ. Specifically, IAS 1 offers preparers two different manners of classifying operating and other expenses: the natural scheme, or the functional one. While entities are encouraged to apply one or the other of these on the face of the income statement, it would be permissible to relegate this information to the notes.

The natural expense classification scheme identifies costs and expenses in terms of their character, such as salaries and wages, raw materials consumed, and depreciation of plant assets. On the other hand, the functional classification scheme (also referred to as the "cost of sales" method) reports on the purpose of the expenditure, such as for manufacturing, distribution, and administration. Note that the minimum line item disclosures mandated by the standard must be met in any case; thus, finance costs must be so identified regardless of which classification scheme is employed.

IAS 35 governs the presentation and disclosures pertaining to discontinuing operations. This is discussed later in this chapter. Measurement matters relating to discontinuing operation are not covered by this standard; rather, other guidance, particularly IAS 36 dealing with impairment of assets, must be consulted.

IAS 1 furthermore stipulates that if a reporting entity adopts the functional classification scheme, it must also provide information on the nature of its expenses, including depreciation and amortization and staff costs (salaries and wages). The standard does not provide detailed guidance on this requirement, however. Presumably the traditional disclosures (e.g., depreciation expense as defined in IAS 16, etc.) would be sufficient to satisfy this rule.

As a practical matter, most traditionally structured income statements employ a combination of functional and natural classifications, or are effectively supplemented by disclosures made in other financial statements or in the footnotes. For example, even when depreciation is not set forth as a line item on the income statement, it will appear on the cash flow statement (if the popular indirect method is employed). As noted, finance costs must be separately stated on the income statement, whichever classification scheme is primarily used.

Finally, IAS 1 requires that dividends, on a per share basis, be disclosed either on the face of the income statement or in the notes thereto. Dividends include both those paid and those declared but unpaid at year-end.

While IAS does not require the inclusion of subsidiary schedules to support major captions in the income statement, it is commonly found that, for example, detailed schedules of costs of goods manufactured and/or sold are included in full sets of financial statements. These will be illustrated in the following section to provide a more expansive discussion of the meaning of certain major sections of the income statement.

Income from ordinary activities.

This section of the income statement will serve to summarize the revenues and expenses of the company's central operations.

Sales or other operating revenues are charges to customers for the goods and/or services provided to them during the period. This section of the income statement should include information about discounts, allowances, and returns, to determine net sales or net revenues.
Cost of goods sold is the cost of the inventory items sold during the period. In the case of a merchandising firm, net purchases (purchases less discounts, returns, and allowances plus freight-in) are added to beginning inventory to obtain the cost of goods available for sale. From the cost of goods available for sale amount, the ending inventory is deducted to compute cost of goods sold.

Example of schedule of cost of goods sold

ABC Merchandising Company Schedule of Cost of Goods Sold For the Year Ended December 31, 2003
Beginning inventory				$xxx
Add:	Purchases		$xxx
	Freight-in		xxx
Cost of purchases			xxx
Less:	Purchase discounts	$xx
	Purchase R&A	xx	(xxx)
Net purchases				xxx
Cost of goods available for sale				xxx
Less:	Ending inventory			(xxx)
Cost of goods sold				$xxx

A manufacturing enterprise computes the cost of goods sold in a slightly different way. Cost of goods manufactured would be added to the beginning inventory to arrive at cost of goods available for sale. The ending inventory is then deducted from the cost of goods available for sale to determine the cost of goods sold. Cost of goods manufactured is computed by adding to raw (direct) materials on hand at the beginning of the period the raw materials purchases during the period and all other costs of production, such as labor and direct overhead, thereby yielding the cost of goods placed in production during the period. When adjusted for changes in work in process during the period and for raw materials on hand at the end of the period, this results in the calculation of goods produced.

Example of schedules of cost of goods manufactured and sold

XYZ Manufacturing Company Schedule of Cost of Goods Manufactured For the Year Ended December 31, 2003
Direct materials inventory 1/1/03		$xxx
Purchases of materials (including freight-in and deducting purchase discounts)		xxx
Total direct materials available		$xxx
Direct materials inventory 12/31/03		(xxx)
Direct materials used			$xxx
Direct labor			xxx
Factory overhead:
Depreciation of factory equipment		$xxx
Utilities		xxx
Indirect factory labor		xxx
Indirect materials		xxx
Other overhead items		xxx	xxx
Manufacturing cost incurred in 2003			$xxx
Add:	Work in process 1/1/03		xxx
Less:	Work in process 12/31/03		(xxx)
Cost of goods manufactured			$xxx

XYZ Manufacturing Company Schedule of Cost of Goods Sold For the Year Ended December 31, 2003
Finished goods inventory 1/1/03		$xxx
Add:	Cost of goods manufactured	xxx
Cost of goods available for sale		$xxx
Less:	Finished goods inventory 12/31/03	(xxx)
Cost of goods sold		$xxx

Operating expenses are primary recurring costs associated with central operations, other than cost of goods sold, which are incurred to generate sales. Operating expenses are normally classified into the following two categories:
1. Selling expenses
2. General and administrative expenses
Selling expenses are those expenses related directly to the company's efforts to generate sales (e.g., sales salaries, commissions, advertising, delivery expenses, depreciation of store furniture and equipment, and store supplies). General and administrative expenses are expenses related to the general administration of the company's operations (e.g., officers and office salaries, office supplies, depreciation of office furniture and fixtures, telephone, postage, accounting and legal services, and business licenses and fees).
Gains and losses stem from the peripheral transactions of the entity. These items are shown with the normal recurring revenues and expenses. If they are material, they should be disclosed separately and shown above income (loss) from continuing operations before income taxes. Examples are write-downs of inventories and receivables, effects of a strike, and gains and losses from exchange or translation of foreign currencies.
Other revenues and expenses are revenues and expenses not related to the central operations of the company (e.g., gains and losses on the disposal of equipment, interest revenues and expenses, and dividend revenues).
Separate disclosure items are items that are within the profit or loss from the ordinary activities but are of such size, nature, or incidence that their disclosure becomes important in order to explain the performance of the enterprise for the period. They should be reported as a separate component of income from continuing operations. Examples of items that require such disclosure are as follows:
1. Write-down of inventories to net realizable value, or of property, plant, and equipment to recoverable amounts, and subsequent reversals of such writedowns
2. Costs of restructuring the activities of an enterprise and any subsequent reversals of such provisions
3. Gains or losses resulting from disposals of items of property, plant, and equipment
4. Gains or losses from disposals of long-term investments
5. Results of discontinued operations
6. Costs of litigation settlements
7. Other reversals of provisions

Discontinuing operations. In IAS 35, which superseded a portion of IAS 8 (that originally dealt with "discontinued operations"), the requirement is set forth that what are now referred to as "discontinuing operations" must be reported in those circumstances when an enterprise pursuant to a single plan sells, either in its entirety or piecemeal, or terminates through abandonment, a separate major line of business or geographical area of operations, such as a segment (as that term is defined by IAS 14), which can be distinguished operationally and for financial reporting purposes.

Per IAS 35, a "discontinuing operation" is a component of a business that, pursuant to a single plan, is either to be disposed of substantially in its entirety or to be terminated through abandonment or piecemeal sale of assets and settlement of liabilities. In order to qualify as a "discontinuing operation," the operation would need to comprise either a separate major line of business, geographical area of operations, or class of customer, and furthermore be organized such that it could be so distinguished both operationally and for financial reporting purposes.

In other words, while a "discontinuing operation" would not have to meet the test of being a segment as that term is defined in IAS 14, clearly it would have to be a substantial operation and be readily identifiable both in terms of its actual physical operations (e.g., by having separate factory facilities, etc.) as well as from a financial reporting perspective (e.g., by having divisional financial statements prepared for management use, etc.). The standard points out that even a major part of a segment could qualify as a discontinuing operation, but the question of how significant a part this would have to be, to potentially comprise an operation which could be segregated as described in IAS 35 once a decision to discontinue had been made, is not addressed in the standard. Thus, this will remain in the domain of individual judgments until such time, if ever, when the IASC provides further guidance.

The standard notes that major product lines and portions of segments would often qualify as discontinuing operations, provided that certain conditions were met. If operating assets and liabilities and income could be attributed to the component, and at least a majority of its operating expenses could be attributed to it, then it would likely be valid under the standard to define this operation (if it were being sold or abandoned) as a discontinuing operation.

Furthermore, to qualify as a "discontinuing operation," the act of discontinuing the operation would have to involve a significant management event, such as the sale or abandonment of the entire operation or an organized, even if piecemeal, effort to sell off the assets and settle the obligations of the operation. This limitation suggests that any discontinuation decision will be of sufficient import that it will be clear that it indeed involves a major portion of the enterprise's operations, even if not an entire segment as defined by IAS 14.

It should be noted that under the new standard the term "discontinuing" is used in place of the formerly employed term "discontinued." This change has been made largely to acknowledge that the disclosures are being made while the act of discontinuation is in process, and not merely once it has been fully achieved. Notwithstanding this change, the meaning is intended to be essentially that which was earlier ascribed to the previously employed terminology.

IAS 35 prescribes the following disclosures for a discontinuing operation in the financial statements beginning with the period in which the initial disclosure event occurs:

A description of the discontinuing operation;
The business or geographical segment(s) in which it is reported in accordance with IAS 14;
The date and nature of the initial disclosure event;
The date or period in which the discontinuance is expected to be completed if known or determinable;
The carrying amounts, as of the balance sheet date, of the total assets and the total liabilities to be disposed of;
The amount of revenue, expenses, and pretax profit or loss from ordinary activities attributable to the discontinuing operation during the current financial reporting period, and the income tax expense relating thereto as required by IAS 12; and
The net cash flows attributable to the operating, investing, and financing activities of the discontinuing operation during the current financial reporting period.

The reason that the carrying amount (i.e., book value) of discontinuing operations has been defined to be the reportable amount is that IAS 35 does not address measurement matters as such; rather, it presumes that other IAS deal with these concerns, and that the carrying values of assets (whether to be disposed of or not) have already been adjusted for any impairment (the subject of IAS 36, discussed in Chapter 8). Thus, if the carrying amounts of assets needed to be adjusted upon being declared to be part of a discontinuing operation, this would imply that accounting standards had not previously been complied with. If all existing impairments had been properly recognized, then logically the mere act of declaring an operational segment a discontinuing operation would not, in and of itself, have any further impact on carrying value.

Also since IAS 35 sets forth only disclosure requirements (and not recognition or measurement requirements), the standard is able to take a somewhat different than normal position regarding the relevance of the reporting entity's fiscal year-end. The decision to segregate the results of the discontinuing operation need not be made by the actual year-end in order to present the income statement as required under the standard. Rather, if it is known at the date on which the financial statements are authorized for issue by the board of directors (or similar governing body) that an initial disclosure event has occurred after the end of the enterprise's financial reporting period, the above-noted disclosures should be presented.

The standard categorically states that income and expenses relating to a discontinuing operation should not be presented as extraordinary items. The reason for proscribing extraordinary treatment is as follows: extraordinary items as defined in IAS 8 (discussed in detail below) are events that are clearly distinct from ordinary activities of the enterprise and as contemplated by IAS 8, based on the two examples of extraordinary items given in IAS 8, are events which are not within the control of the management of the enterprise. By contrast, a discontinuing operation, per IAS 35, is a component of the enterprise that is either being disposed of or terminated through abandonment, based on a plan by an enterprise's management. Being thus based on a "plan by an enterprise's management," a discontinuing operation could hardly be considered an event "not within the control of management," and hence, income and expenses relating to a discontinuing operation should not be presented as extraordinary items. The results of discontinuing operations should be included in the profit or loss from ordinary activities.

Under the provisions of IAS 35, an initial disclosure event is that which first causes the enterprise to disclose, in the financial statements, initial information about a planned discontinuance. This event is defined by the earlier of two occurrences: the reporting entity's entering into a binding sale agreement, or both the approval by its governing board (or equivalent) of a detailed formal plan for the discontinuance, and the announcement thereof to the public. IAS 37 (discussed in Chapter 12) offers instructive examples to help in distinguishing situations in which an initial disclosure event has occurred from those in which the event has not occurred. For example, a pre-year-end decision to close a division, which has yet to be communicated to any affected parties (workers, customers, etc.) would not trigger disclosure of a discontinuing operation under IAS 35.

IAS 35 allows such a disclosure to be made either in the notes to the financial statements or on the face of the financial statements. It should be noted, however, that disclosure of the amount of pretax gain or loss recognized on the disposal of assets or settlement of liabilities attributable to the discontinuing operation should be made on the face of the income statement. Also, the standard recommends (i.e., it encourages but does not require) presentation on the face of the statements of income and of cash flows disclosures relating to revenues, expenses, pretax profits or losses, income tax expense, and cash flows attributable to discontinuing operations.

Under the provisions of IAS 35, in reporting periods after that in which the initial disclosure event has occurred, the entity would need to incorporate updated disclosures in the financial statements, until such time as the planned discontinuance has been completed. A discontinuance effected by the sale of a division would be completed once the transaction had taken place; it would not require that payments from the buyer(s) to the seller have been fully collected. If the plan to discontinue is abandoned, this event would also terminate the need to present information about the discontinuing operation.

Example of disclosure of discontinuing operations under IAS 35

Alternative I—Columnar presentation

Taj Mahal Enterprises Statement of Income For the Years Ended December 31, 2003 and 2002 *(In 1,000 UAE Dirhams)*
	Continuing Operations (Segments X & Y)		Discontinuing Operation (Segment Z)		Enterprise as a Whole
	2003	2002	2003	2002	2003	2002
Revenue	10,000	5,000	3,000	2,000	13,000	7,000
Operating expenses	(7,000)	(3,500)	(1,800)	(1,400)	(8,800)	(4,900)
Impairment loss	--	--	(500)	(400)	(500)	(400)
Provision for employee end-of-service benefits	--	--	(900)	--	(900)	--
Pretax profit (loss) from operating activities	3,000	1,500	(200)	200	2,800	1,700
Interest expenses	(300)	(200)	(100)	(100)	(400)	(300)
Profit (loss) before tax	2,700	1,300	(300)	100	2,400	1,400
Income tax expense (@ 20%)	(540)	(260)	60	(20)	(480)	(280)
Profit (loss) from operating activities after tax	2,160	1,040	(240)	80	1,920	1,120

Alternative II—Tabular presentation

Taj Mahal Enterprises Statement of Income For the Years Ended December 31, 2003 and 2002 *(In UAE Dirhams)*
	2003		2002
Continuing Operations (Segments X & Y):
Revenue	10,000		5,000
Operating expenses	(7,000)		(3,500)
Pretax profit from operating activities	3,000		1,500
Interest expense	(300)		(200)
Profit before tax	2,700		1,300
Income tax expense	(540)		(260)
Profit after taxes (@ 20%)		2,160		1,040
Discontinuing operation (Segment Z):
Revenue	3,000		2,000
Operating expenses	(1,800)		(1,400)
Impairment loss	(500)		(400)
Provision for employee end-of-service benefits	(900)		--
Pretax profit (loss) from operating activities	(200)		200
Interest expense	(100)		(100)
Profit (loss) before tax	(300)		100
Income tax expense (@ 20%)	60		(20)
Profit (loss) after taxes		(240)		80
Total enterprise:
Profit (loss) from ordinary activities		1,920		1,120

Alternative III—Not presented in the body of the income statement

As an alternative to the foregoing income statement presentations, disclosure by means of footnotes is allowed. A range of methods is potentially useful, from full pro forma presentation in the notes to a narration of the nature of the operations which are being discontinued, including relevant amounts.

Income tax expense related to ordinary activities is that portion of the total income tax expense applicable to continuing operations.

Extraordinary items are income or expenses that arise from events or transactions that are clearly distinct from ordinary activities of an enterprise.

Only on rare occasions does an event or a transaction give rise to an extraordinary item. The nature of the event in relation to the business ordinarily carried out by the enterprise determines whether or not an event is clearly distinct from the ordinary activities of the enterprise and hence should be classified as an extraordinary event. Thus an event may be extraordinary for one enterprise but may not be extraordinary for another enterprise. For instance, losses sustained from a hurricane would be an extraordinary event for most enterprises but claims resulting from such a natural disaster by an insurance company do not qualify for such treatment (since such claims are part of the ordinary activities of an insurance company's business).

Examples of events or transactions that generally qualify as extraordinary items, as included in IAS 8, are the following:

Losses resulting from the expropriation of assets
Losses sustained from natural disasters such as an earthquake

The nature and the amount of each extraordinary item should be disclosed separately. Disclosures may be made either on the face of the income statement or in footnotes to the financial statements.

Example of presentation of extraordinary item

XYX Malta, Ltd. Income Statement For the Year Ended December 31, 2003
	2003	2002
Sales	$1,000,000	$ 800,000
Cost of sales	(700,000)	(600,000)
Gross profit	300,000	200,000
Distribution costs	(50,000)	(40,000)
Administrative expenses	(30,000)	(40,000)
Net financing costs	(20,000)	(20,000)
Loss from sale of scooter division (Note 1)	(50,000)	--
Profit from ordinary activities, before taxes	150,000	100,000
Income tax expense	(60,000)	(40,000)
Extraordinary item
Loss on expropriation of Suzukiyo moped manufacturing operations in India (net of income taxes of $30,000) (Note 2)	--	(30,000)
Net profit for the year	$ 90,000	$ 30,000

Note 1: On September 1, 2003, the company sold its scooter division. The results of this operation had previously been reported in the scooter industry segment and the domestic geographic segment. The loss on the sale was computed based on the sale proceeds and the net carrying amounts of assets and liabilities of the operation at the date of the sale. The revenues recognized relating to this operation from January 1, 2003, until the date of sale, September 1, 2003, were $100,000 (the comparable 2002 amount was $150,000), and the profits before income taxes were $30,000 ($40,000 in 2002).
Note 2: On July 1, 2002, the company's Suzukiyo moped manufacturing operations were expropriated in India, without compensation, by government decree. The results of this operation had previously been reported in the moped industry segment and the Far East geographic segment. The extraordinary loss from this operation was computed using the carrying amounts of assets and liabilities at the date of expropriation. The revenues recognized relating to this operation from January 1, 2002, to July 1, 2002, were $50,000, and the profits before tax were $22,000.

Development Stage Enterprises

A recurring concern among newly established enterprises is that, given what is often a multiyear process of achieving a normal level of operations and absorbing the typically heavy start-up costs needed to achieve this, the income statements prepared and presented under generally accepted accounting principles may be insufficient to provide the user with meaningful insights into the operations and potential of the entity. In years gone by, a commonly employed solution was to defer many costs that normally are deemed to be period costs, and then to amortize these over what was often an arbitrary period (e.g., five years). The logic was that these costs were incurred to benefit operations after the entity began to operate in a normal fashion, and to expense these upon incurrence would most commonly result in reportable losses that would imply that future successful operations would not be achieved.

The obvious flaw in the deferral of start-up costs from a financial reporting perspective is that these deferred costs would necessarily be presented as assets on the enterprise's balance sheet, when in fact these sunk costs would have no demonstrable value for the future, particularly if the entity's strategies proved unsuccessful. Thus, there is an inherent conflict among some of accounting's most fundamental concepts: the going concern assumption, realization, and conservatism. Ultimately, the US and other accounting standard setters had to rule that costs must be accounted for by development stage enterprises no differently than by operating enterprises: If the cost represents an asset, it is accounted for as such, but if a sunk cost does not meet the definition of an asset, it must be expensed when incurred.

In recognition of the not unreasonable argument that strict application of the foregoing rule would result in income statements for development stage enterprises which might not be as meaningful as would be hoped, the salient US accounting standard provides that cumulative statements of income be presented for development stage enterprises, so that users can better understand the full scope of the activities undertaken preparatory to achieving normal operations. Although there is currently no corresponding standard under IAS, there is also no prohibition against the presentation of such statements (at least on a supplementary basis). The following discussion is offered to those who may choose to report on this basis.

Development stage enterprises defined.

Under the applicable US GAAP standard, SFAS 7, a development stage enterprise is defined as one that is devoting substantially all of its efforts to establishing a new business, and either of the following conditions exists:

Planned principal operations have not begun.
Planned principal operations have begun but there has been no significant revenue.

SFAS 7 indicated that these enterprises should prepare their financial statements in accordance with the same GAAP applicable to established operating entities. SFAS 7 indicated that specialized accounting practices are unacceptable and that development stage enterprises were to follow the same generally accepted accounting principles as those that applied to an established operating entity. SFAS 7 also provided that a development stage enterprise should disclose certain additional information that would alert readers to the fact that the company is in the development stage. Disclosure requirements include

All disclosures applicable to operating entities
Identification of the statements as those of a development stage enterprise
Disclosure of the nature of development stage activities
A balance sheet that includes the cumulative net losses since inception in the equity section
An income statement showing current period revenue and expense, as well as the cumulative amount from the inception of the entity
A statement of cash flows showing cash flows for the period, as well as those from inception
A statement of stockholders' equity showing the following from the enterprise's inception:
1. For each issuance, the date and number of equity securities issued for cash or other consideration
2. For each issuance, the dollar amounts per share assigned to the consideration received for equity securities
3. For each issuance involving noncash consideration, the nature of the consideration and the basis used in assigning the valuation
For the first period in which an enterprise is no longer a development stage enterprise, it shall be disclosed that in prior periods the entity was a development stage enterprise. If comparative statements are presented, the foregoing disclosure presentations (2 through 7) need not be shown.

Given the absence of guidance under IAS regarding the possible utility of presenting cumulative operating statements for enterprises which have yet to begin normal scale operations, the insights offered by the relevant US standard could be employed by those seeking expanded financial statement disclosures to accomplish a similar goal.

IASB Projects Affecting the Income Statement

Improvements project.

The Improvements Project, which as of mid-2002 was responsible for proposed amendments to twelve outstanding IAS, promises significant changes to IAS 1 and IAS 8, both of which are important guides to the presentation of the income statement.

Regarding changes to IAS 1, the proposed amendments would alter the current exemption from having to disclose particular items of comparative information from "impracticability" to "causing undue cost or effort." It would also absorb the guidance regarding the presentation requirements for the net profit or loss for the period, which is currently found in IAS 8. The caption "results of operating activities" would be banned from the income statement, since that term is not defined under IAS 1. Finally, and most importantly, IAS 1 would be amended to ban the use of the caption "extraordinary items," both in the body of the financial statements and in the notes thereto.

IAS 8 would also be significantly revised, to remove the distinction between fundamental errors and other material errors, and add a new definition of errors. Thus, the concept of a fundamental error would be eliminated. The current choice of accounting for corrections of errors—as either prior period adjustments (affecting opening retained earnings and all comparative statements presented) or as cumulative effects included in current earnings (with no restatement of comparative financials)—would be eliminated, with only retrospective (prior period adjustment) method remaining for use. This method involves either restating the comparative amounts for the prior period(s) in which the error occurred, or when the error occurred before the earliest prior period presented, restating the opening balance of retained earnings for that period. Thus, prior period statements being presented currently are to be shown as if the error had not occurred.

Currently, a restatement of prior periods' financials (for comparative purposes) when an error is being corrected is accepted when not practical to accomplish. Under revised IAS 8, this will be allowed only if not achievable without "undue cost or effort." Also, the exemption would apply only to the particular prior period for which restating comparative information would cause undue cost or effort.

In another important change, the revised IAS 8 will remove the allowed alternative treatment of voluntary changes in accounting policies, meaning that a reporting entity would no longer be permitted to include the adjustment resulting from retrospective application of changes in accounting policies in income for the current period, while presenting comparative information as it had been originally reported in the financial statements of prior periods. Instead, the adjustment resulting from retrospective application of changes in accounting policies will have to be made to the opening balance of retained earnings for the earliest prior period presented, and the other comparative amounts disclosed for each prior period presented, where applicable, as if the new accounting policy had always been in use. Only "undue cost or effort," not mere "impracticality," could be used to exempt the entity from this requirement.

In addition to the changes to be wrought by the Improvements Project noted above, the IASB has proposed a new standard to govern the presentation of the financial statements at the time IAS (IFRS) is first adopted. These proposed changes are discussed in Chapter 2.

Reporting performance.

Yet another critical project of the IASB is that on Reporting Performance, which is being conducted in concert with the UK's Accounting Standards Board, which has been pursuing this program for several years and has already issued a draft on this subject. (Note that the US's FASB also has this project on its agenda.)

This project is intended to broadly address the issues related to the display and presentation, in the financial statements, of all recognized changes in assets and liabilities arising from transactions or other events, with the exception of those related to transactions with owners as owners. Put differently, the project is concerned with the reporting of comprehensive income. Thus, consideration is to be given to all items that are at present reported in the income statement, the cash flow statement, and the statement of changes in equity. The project is concerned with, among other things, distinguishing revenues and expenses from other sources of comprehensive income or expense, the reporting of holding gains and losses, and distinguishing operating and nonoperating items.

Changes to the financial statements that present "flows," as currently set forth in IAS 1, are the most likely outcome of this project. The project is not concerned with balance sheet presentation. Likewise, it is not intended to identify or develop any new or alternative performance measures, such as EBITDA, operating cash flow, free cash flow, and various measures of pro forma results. Nonfinancial performance measures—such as performance ratios—and the form and content of management's discussion and analysis of financial position and results of operations (operating and financial review) are not subject of the project, either.

IASB decided that this project should define where and how an entity should report those transactions and events recognized during the reporting period, not how they should be measured. Individual IFRS provide detailed recognition, measurement, and disclosure requirements; this project will not revisit those matters.

Certain decisions were taken by a predecessor committee, which may (or may not) be subscribed to by those involved in the current phase of this project. Those decisions were that

There should be a single statement of "recognized income and expenses" which should report all increases or decreases in net assets of the enterprise, other than those increases or decreases arising from capital transactions. This would eliminate separate reporting of other items of comprehensive income, excluded from net income.
Recycling between categories in the performance statement, and between the performance statement and the statement of shareholders' equity, would be prohibited. Thus, an item of income or expense would be recognized only once.
Capital transactions would be reported in a separate statement of shareholders' equity, which would be revised and made mandatory (i.e., mere footnote disclosure of movements, in lieu of financial statement presentation, would not be permitted).
IAS 7 would be amended to align, where necessary, with the statement of recognized income and expenses. Capital transactions would be reported as a separate category.

Early thinking is to have the performance statement track the cash flow statement; that is, to have the principal category of the statement be the business activities category, with other categories being financing activities and investing activities (or, under an alternative being explored, these activities might be combined as treasury activities). There would possibly be differentiation within the categories between changes in items that are measured at fair value and those on a basis of other than fair value.

Certain items would be reported separately in the statement of recognized income and expenses, including income taxes (IAS 12), discontinuing operations (IAS 35) and the cumulative foreign exchange translation account (IAS 21). IAS 8 would be amended to abolish the concept of an extraordinary item (this has already been absorbed into the Improvements Project, discussed above).