CHAPTER 6 Statement of profit or loss and statement of changes in equity 2396.9 Financial performance measures
LEARNING OBJECTIVE 6.9 Differentiate alternative financial performance measures.
We saw earlier that the statement of profit or loss complying with accounting standards must disclose a
number of required profit figures such as profit before and after tax. There are additional profit figures
that may be referenced in the financial statements or referred to in the financial press. The following sec-
tions introduce these profit figures.
Gross profit
Gross profit refers to revenue less the cost of sales, and is applicable to manufacturing and retail oper-
ations. The gross profit measures the revenue remaining after deducting the cost of sales. An entity
cannot be sustainable unless it has a positive gross profit, meaning that it is selling its goods at a price
exceeding their cost. Gross profit reflects the percentage by which an entity marks up the cost of its
products to sell to its customers. It also reflects an entity’s relationship with suppliers and its purchasing
power. Both of these are intrinsically linked to the competitiveness of the industry in which it operates.
For example, the 2015 statement of profit or loss of JB Hi-Fi Ltd shows a gross profit of $798 253 000,
calculated as revenue ($3 652 136 000) less the cost of sales ($2 853 883 000). This represents a gross
profit margin (gross profit divided by revenue) of 22 per cent. This is a relatively low mark-up reflecting
the high-volume nature and competitiveness of the industry in which JB Hi-Fi Ltd operates.
Profit
Profit is the term commonly given to the gross profit less all other expenses incurred in operating the
business. Effectively, it is the entity’s income less expenses for the reporting period.
Profit pre- and post-tax
Profit performance measures can be referred to on a pre- and/or post-tax basis. Taxation is an expense of
a company, because a company has an obligation to pay tax on business activities. The tax that a com-
pany pays is based on taxable income as calculated by applying taxation rules. In contrast, the profit
reported in the statement of profit or loss is measured by applying accounting rules. To the extent that
the taxation and accounting rules differ, the tax expense of a company will not be simply the pre-tax
accounting profit multiplied by the applicable tax rate. Taxation and accounting rules can diverge due to:
- income not being assessable for taxation purposes
- expenses not being deductible for taxation purposes.
Consider a company that sold a building in the current reporting period for a $100 000 gain. The
building was purchased prior to the introduction of the capital gains tax so, although the $100 000 will
be included in the determination of accounting profit for the period, it is not assessable income for tax-
ation purposes. As we will see in chapter 8, profit before and after tax is used to assess the profitability
of an entity. An owner is more interested in the profit after tax, because tax obligations must be satisfied
before profits can be distributed as dividends. Conversely, a financial analyst would be interested in the
profit before tax, because this reflects the outcomes of the entity’s investing and financing activities
without the effect of a variable (taxation) that is determined by forces outside the control of the entity,
namely by the government.
Profit pre- and post-interest
As previously noted, profit reflects the effects of an entity’s investing and financing decisions and the
taxation consequences thereof. To isolate the returns associated with the investment decision only, profit
before interest and tax is the relevant figure. This is more commonly referred to as earnings before
interest and taxation (EBIT). The interest figure refers to the net effect of finance-related income and
expenses. Net finance costs are defined as interest income less interest expense (including finance lease