Comprehensive income

The net income

The net income provides details about how the net assets (also called: equity) of a company has changed as a result of transactions or events other than those related to the owners (investments and distributions). These changes are represented by the elements:

1. revenue
2. expenses
3. gains
4. losses

The amounts in the income statement should be read and analyzed with the period in mind since the elements of the income statement are presented for “a period of time”.

For example, the net income can be presented for a 12-month period (this means that the revenues presented are the ones earned for the 12-month period covered by the statement) or quarterly basis (this means the revenues presented are only for a specified three-month period). Understanding this will help users of the financial statements better compare results to other companies or to previous periods.

Generally the elements of the income statement are recorded using the accrual method which means that:

• Revenues and income are recorded when they are earned regardless of when cash was received; and
• Expenses and losses are recorded when they are incurred regardless of when cash was paid.

Further details about revenue and expense recognition are explained below for each element.

1. Revenues

These are inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities. These include routine transactions as well as “other activities” - such as permitting others to use the entity’s resources - that result in interest, rent, royalties, and fees.

According to the GAAP revenue recognition principles, revenues are earned and recognized in the period when the performance obligation is satisfied.

2. Expenses

These are outflows or other using up of assets of an entity or incurrences of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities. These include routine transactions as well as “other activities” - such as the entity using the resources of others - that result in interest, rent, royalties, and fees paid.

The expense recognition principle, or the matching principle, states that recognition of expenses is related to net changes in assets and the earning of revenues. Expenses should be recognized when the work or product contributes to revenue.

3. Gains

These are increases in equity (net assets) from transactions and other events and circumstances affecting an entity except those that result from revenues or investments by owners.

4. Losses

These are decreases in equity (net assets) from transactions and other events and circumstances affecting an entity except those that result from expenses or distributions to owners.

Distinguishing between revenue, expenses, gains, or losses

The primary purpose of distinguishing revenues from gains, and expenses from losses is to make the information in the statement of comprehensive income as useful as possible.

In particular, the users should know the differences between items resulting from routine transactions (revenues and expenses) and from other events (gains and losses) to assess the amount, timing and uncertainty of potential future cash flows.

Although these classifications are ultimately covered by the standards (or codifications), they always consider the objective of financial reporting discussed in the Concept statements.

While revenues and expenses typically result from delivering or producing goods, rendering services or carrying out other activities, gains and losses typically result from one of the following three circumstances:

1. Nonreciprocal transactions or events such as natural catastrophes - Nonreciprocal transactions or events are generally distinguishable from revenues and expenses.

2. Exchange transactions - Distinctions between revenues and gains and expenses and losses from exchange transactions of an entity depend to a significant extent on the nature of the entity and the activity with which an item is associated. An identical item can be used by entities differently. As a result, the proceeds from the sale of an asset may be revenue for one entity and may be a factor in determining gain or loss for another. For example, the proceeds from the sale of a machine displayed as inventory would be considered revenue, and the cost of that machine would be considered an expense. However, the proceeds from the sale of a machine used by an entity in a productive capacity would not be considered revenue - the entity would report a gain or a loss upon disposition of that machine.

3. Holding gains and losses - Holding gains and losses can be a result of a contractual change in value of an asset or a liability from a passage of time, as is the case of interest, or a change in the value of the asset or liability. Those value changes would be distinguished between those that are classified as revenues and expenses or those that are classified as gains and losses.

Example: Gain or loss on equipment disposal

A company sells a piece of equipment for $18,000. The equipment originally cost $25,000 and has accumulated depreciation of $10,000, giving a net book value of $15,000.

• Net book value: $25,000 − $10,000 = $15,000
• Sale proceeds: $18,000
• Gain on disposal: $18,000 − $15,000 = $3,000

Because the equipment was used in a productive capacity (not held for sale as inventory), the $3,000 is reported as a gain on the income statement, not as revenue.