218 Accounting: Business Reporting for Decision Making
A financial objective of an entity is to create value for its owners. For a company listed on a
securities exchange, such as the Australian Securities Exchange or the Shanghai Stock Exchange, the
value creation (or lack thereof) is generally evidenced by movements in the company’s share price.
For business entities with no observable share price, value creation is realised when the business is
sold. The two aspects that determine value creation are return and risk, with higher risk being synon-
ymous with higher return. The statement of profit or loss reflects the accounting return for an entity
for a specified time period. The accounting return is formally referred to as the profit or loss of the
entity.
While the focus of this chapter is on the statement of profit or loss and the reporting of profits, the
importance of sustainable business practices must be understood. Sustainability considerations often
factor into the risk and return analysis. While many entities aim for profit maximisation, the impor-
tance of sustainable business practices means that decisions may be made that are not necessarily profit
maximising, but are beneficial for the environment or the community. Entities often articulate their gov-
ernance, environmental and social policies and report on their environmental and social performance in
addition to their financial performance. This is referred to as triple bottom line reporting or environ-
mental, social and governance (ESG) reporting. More recently, the concept of integrated reporting
has emerged. Integrated reporting conveys information on how an entity’s strategy, governance, perfor-
mance and prospects lead to the creation of value. Refer to chapter 2 for a discussion of sustainability
reporting.
For example, JB Hi-Fi Ltd’s 2015 annual report includes governance, environmental and social state-
ments and notes that the company recognises the importance of all these matters to its shareholders,
suppliers and customers. Putting this into practice, JB Hi-Fi Ltd discusses its governance policies and
procedures, details its initiatives to reduce the impact of its business on the environment, and lists its
programs designed to ‘give back’ to the community.
It must also be remembered that a profit objective is not relevant for all entities. Many entities are not-
for-profit entities. For example, the mission of the Bill and Melinda Gates Foundation is to help all people
lead healthy, productive lives. As we will see in this chapter, the profit or loss figure is not a measure of
the change in an entity’s value from the start of the reporting period to the end of the reporting period.
This is because profit or loss is determined as income less expenses and, for accounting purposes, not
all value changes result in income or expenses that are recognised in the statement of profit or loss. The
reported profit figure is also not a measure of the cash that the entity has accumulated during the period,
as income and expense recognition is not contingent upon cash being received or paid. The definition of
‘income’ encompasses both:
- revenue arising in the ordinary course of activities (e.g. sales, fees and dividends)
- gains (e.g. gains on disposal of non-current assets, and unrealised gains on revaluing assets).
While some gains are recognised in the statement of profit or loss, other gains are taken directly
to equity, depending on the prescribed accounting treatment stated in various accounting standards.
For example, property, plant and equipment (PPE) assets can be measured at their fair value. In
electing to measure such assets at fair value, any value increase is an unrealised gain and increases
the revaluation surplus in the equity section of the balance sheet, rather than being included as
income in the measurement of profit or loss for the reporting period. Other gains, such as the gain on
disposal of PPE, are required to be recognised as income and included in the determination of profit
or loss.
Given that revenue is a subset of income, the terms ‘revenue’ and ‘income’ will both appear throughout
the discussions. Do not let this confuse you. Remember that revenue is the term that applies to income
arising in the ordinary course of an entity’s activities.
Periodic determination of an entity’s profit or loss is necessary because users need to assess the profit-
ability of an entity throughout its life. Users rely on periodic profit or loss figures to evaluate past
decisions, revise predictions and make future decisions. An entity cannot remain viable in the long term
if it continually generates losses. Without producing a periodic statement of profit or loss, management