228 Accounting: Business Reporting for Decision Making
6.4 Measuring financial performance
LEARNING OBJECTIVE 6.4 Describe the measurement of financial performance.
Recall that the Conceptual Framework discussed in chapter 5 identifies the objective of financial
reporting, assumptions underlying financial statements and the qualitative characteristics of finan-
cial statements, and defines the elements of financial statements (assets, liabilities, equity, income and
expenses) and the recognition criteria applied to the elements. In the next sections, we will discuss the
definition and recognition criteria applicable to income and expenses.
‘Profit or loss’ is not formally defined in the Conceptual Framework, but instead is identified as being
measured as the difference between income and expenses in a reporting period. To measure the profit or
loss of an entity, it is therefore necessary to identify and measure all income and expense items attribut-
able to the reporting period. This necessitates an understanding of what attributes a transaction requires
in order to be classified as an item of income or expense.
The Conceptual Framework specifies definition criteria for income and expenses. It also discusses the
recognition process that applies to these elements. A transaction must satisfy the definition and recog-
nition criteria to be included in the statement of profit or loss. We will see that the definitions of income
and expenses are integrally linked with assets and liabilities.
6.5 Income
LEARNING OBJECTIVE 6.5 Discuss the definition and classification of income.
To be recorded as income in a particular reporting period, the income definition criteria must be satis-
fied. These criteria are examined in the following sections.
Income definition
Income is defined in the proposed Conceptual Framework (para. 4.48) as:
increases in assets or decreases in liabilities that result in increases in equity, other than those
relating to contributions from holders of equity claims.Recall that income comprises both revenue and gains, with revenue arising in the ordinary course of
an entity’s activities. Gains also represent increases in economic benefits, but they may or may not arise
in the ordinary course of an entity’s activities.
Income must be associated with an increase in assets or decrease in liabilities. When deciding if the income
definition criteria are satisfied, it is necessary to ascertain whether a new asset exists or an existing asset has
increased, or whether an existing liability has been reduced. Recalling the duality principle, an increase in an
asset or a reduction in a liability must be accompanied by an increase in equity. Thus, income increases equity.
Consider a retail operation that is making credit and cash sales. A cash sale would satisfy the defi-
nition of income, as it results in an inflow or increase of economic benefits — the entity has increased its
cash at bank. Similarly, a credit sale also satisfies the income definition criteria, as it results in the cre-
ation of an accounts receivable — representing a present economic resource. The transaction in which
the customer settles the account by paying cash to the business does not satisfy the income definition.
While the retail operation has more cash, due to the customer paying, assets have not increased in total
because another asset — accounts receivable — has been extinguished and therefore offsets the increase
in cash. Thus, there is no increase in assets as a result of this latter transaction.
If a transaction involves a contribution by owners or contributed capital (such as a cash injection to the
business from the owner’s personal account), the income definition criteria is not satisfied. For example,
the owners of a retail business contribute $100 000 to the business to fund a store refurbishment. The
receipt of the $100 000 will not be recorded as income by the business (to be reported in the statement
of profit or loss), because it results from a transaction with the owners of the business. Instead, cash (an
asset) will increase and capital contributions (an equity item) will increase.