Accounting Business Reporting for Decision Making

CHAPTER 6 Statement of profit or loss and statement of changes in equity 223

The preceding illustrative examples have used timing differences to distinguish between the accrual

and cash concepts of profit or loss that arise under the accrual and cash systems of accounting respec-

tively. If an entity reported its profit or loss at the end of its life rather than periodically throughout

its life, there would be no difference between the accrual and cash concepts of profit. For example,

assume that ATC’s business described in the illustrative examples had a life of two years. As illustrated

in table 6.1, the income and expenses recognised over the two-year life would be identical despite the

accrual and cash profit figures being different in the reporting periods ended 31 December 2016 and

31 December 2017. This is because timing transactions reverse over the life of the entity.

TA BLE  6.1

Accrual and cash profits compared between reporting periods ended

December 2016 and December 2017

Reporting period

ended December 2016

Reporting period

ended December 2017

Over the

two years

Accrual-based profit

Income recognised $8 000 for coaching fees $12 000 for coaching fees $20 000

Expenses recognised $500 mobile phone

$200 insurance

$2 200 insurance $ 2 900

Accrual profit (loss) for period

(income less expenses)

$7 300 $9 800 $17 100

Cash-based profit

Income recognised $12 000 coaching fees

received in advance

$8 000 received for

coaching fees provided

in 2016

$20 000

Expenses recognised $2 400 insurance

premium paid

$500 mobile phone

account paid

$ 2 900

Cash profit (loss) for period $9 600 $7 500 $17 100

Depreciation

There are other expenses recognised under accrual accounting that do not involve cash flows. For example,

depreciation and amortisation are expenses recognised in the statement of profit or loss that do not involve

any outflow of cash. All property, plant and equipment assets must be depreciated and certain intangible assets

must be amortised. Depreciation (amortisation) is the systematic allocation of the cost of a tangible (intangible)

asset over its useful life. Depreciation (amortisation) expense recognises that the asset’s future economic ben-

efits have been used up in the reporting period. Depreciation and amortisation do not represent the reduction

in the asset’s market value from the start to the end of the reporting period. This is another reason why profit or

loss does not represent the change in an entity’s value from the start to the end of the reporting period.

Consider the following example of how depreciation can be calculated. An entity purchases a car

for $40 000, with an estimated useful life of four years and expected residual value of $8000. If we

assume that the benefits of using the car will be derived evenly over its useful life, then the straight-line

depreciation method is used. Other depreciation methods are discussed later in this chapter. Straight-line

depreciation results in the same depreciation expense being recorded each year for the asset’s useful life.

Straight-line depreciation is calculated using the equation below.

Annual depreciation expense=

Cost of asset − Expected residual value

Asset’s expected useful life (years)

=

$40 000 − $8 000

4 years

=$8 000