The profit and loss statement

Một phần của tài liệu IFRS fair value and corporate governance the impact on budgets balance sheets and management accounts dimitris n chorafas (Trang 357 - 360)

As every manager and every accountant should know, the first step in counting profit and loss is to clarify the meaning of net income, which is the basic item on any income statement. Generally speaking, net income is taken as equal to the difference between revenueand expense. The problem is that there exists no gen- eral agreement on the method of measuring each of them. This leaves room for considerable differences of opinion about the:

● Real meaning of net income, and

● The dependability of the estimate of net income, for an accounting period.

Expert accountants say that dependability of net income estimates depends pri- marily on four factors: the length of accounting period; the extent to which events relating to the current period are separated from events affecting prior or future accounting periods; the amount of longer-term assets owned by the com- pany; and, most evidently, stability of prices.

The fourth of these factors is squarely addressed by IFRS, through the fair value option. The other three largely depend on the jurisdiction – the laws, regula- tions, and supervisors’ opinions prevailing in the country in which a company reports profit and loss. As far as both financial reporting and management accounting are concerned:

● Estimates of net income for a day, week or month are likely to be much less reliable than estimates for a year, and

● Estimates for a year are less reliable than estimates covering a longer period, such as the medium term.

Both bullets should be interpreted on an ‘other things being equal’ basis.

Moreover, no matter what the first bullet states, it becomes increasingly impor- tant (and popular) to compute intraday P&L for management accounting reasons, albeit admitting the possibility of a 3–4% error. (See Chapter 15 on the virtual balance sheet.)

To appreciate the importance of the accounting period, the reader should recall that while the expenses assigned to a period are supposed to relate to revenues realized in that period, more frequently than not it is not practicable to attempt such match- ing. For example, it is usually difficult to estimate the portion of the cost of a long- lived asset applicable to a given accounting period. For these reasons:

● The net income reported on the income statement is unlikely to corre- spond exactly to the true increase in the owners’ equity during an account- ing period, and

● In fact, the true monetaryincome of an entity can be known only after this entity has been completely terminated, its assets disposed of and its liabil- ities paid.

Notice, however, that there is also non-monetaryincome, such as personal satis- faction service rendered to society, but this is not part of regulatory financial reporting requirements. On the other hand, certain of the individual items on a P&L statement may be quite reliable. The sales revenue figures are usually a close approximation to actual sales revenue.

For instance, amounts for many expense items, such as wages, suppliers, and utilities, are close approximations to actual expenses. To the contrary, deprecia- tion is most often only a rough approximation, while some special adjustments reported as non-operating expenses may be little more than guesswork.

Somebody, of course, must be responsible for facts and figures. With or without the Sarbanes–Oxley Act (see Chapter 11), from initial financial planning esti- mates to the master budget, balance sheet, and income (profit and loss) state- ment, the processes which come into play involve managerial responsibility.

● Personal accountability has to be engaged, from lower level to higher level management, and

● This is true not only at the vertex of the organization but at every level of the process of financial reporting.

Not only must the company’s financial plans and reporting requirement adhere to proper accounting principles, they must also be characterized by cost- effectiveness. Attention should be paid to the fact that many costs tend to get out of control, as they accrue continuously and have to be settled by cash payments.

● It is a rare case where bureaucracy and its out-of-control expenditures are deliberately planned.

● Typically, bureaucratic costs grow up and, if they are not curtailed, they run out of control.

Including the reliability of figures and the issue of costs, the managerial respon- sibility involved in the preparation of profit and loss statements calls for a great amount of care and rigorous evaluation. The P&L at year end is a snapshot, whose contents accumulate day after day. Hence the need for a conceptual view of how to derive added value from the resources available to the firm.

These are the dynamics of the computation of income statements. Regarding the mechanics, there is no mystery as to how to prepare a profit and loss report.

Keeping always in mind what has been said about caveats to net income, an easy way to compose the P&L statement is through a few simple equations:

Gross margin Net sales ⫺Cost of goods sold (13.3) Net result Gross margin ⫺Nonrecoverable expenses

⫺Administrative expenses (13.4)

For a manufacturing company, net salesrepresents the revenue on sales. That is the gross sales amount minus all discounts and price reductions. Cost of goods sold is based on current costs of direct materials (DM), direct labour (DL), and overhead (including utilities, rental, depreciation, and so on) at fac- tory level.

Notice that while the budget is the financial plan kept internal to the entity, the P&L statement is not only an instrument reporting to stakeholders, regulators and the public, but also an internal control device. For many leading-edge organ- izations, the procedure of tracking and testing P&L is critical to establishing and maintaining a system of internal controls, enriched with financial analyses which highlight high performersand low performersamong the company’s busi- ness units.

Ifthe financial plans and the internal management accounting system have been established on sound principles, thenP&L will provide a sound basis for evalu- ation of performance. From an internal control perspective, for each department, section, and project, there should be available:

● Projected budget figures

● Authorizations to spend money, and

● Actual results for the given period.

These three sets of figures can form the basis of comparative analysis in per- formance reporting, from cash estimates to expenses, all the way to Plan/Actual (see Chapter 9) and costs versus obtained result. In fact, using high technology, P&L evaluations can be made ad hoc, which is serving the purpose of being in charge of operations. Questions confronting company management are:

● How detailed should the monitoring be?

● How to judge whether subordinates are performing the delegated task in an effective manner?, and

● How to increase or decrease our frequency of monitoring, depending on quality and steadiness of results?

Senior management can answer these queries if it is capable of both quantifying and qualifyingthe tasks under its control. That is precisely the area where finan- cial algorithms, heuristics and scenario writing come into the picture, as a way to clarify what enters into the different chapters, how these chapters relate among themselves, and the notions which exist behind their variation.

In conclusion, the mathematics of P&L statements are simple, but the data com- ing into them are not always reliable. Sometimes hypotheses being made have not been properly tested. Yet, their effect is to alter the P&L information elements, at times misinforming the reader. In other cases such elements are largely guesses.

Một phần của tài liệu IFRS fair value and corporate governance the impact on budgets balance sheets and management accounts dimitris n chorafas (Trang 357 - 360)

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