Accounting Business Reporting for Decision Making

240 Accounting: Business Reporting for Decision Making

charges). If the entity is a net lender (i.e. a bank) with interest income exceeding interest expense, it will

be necessary to subtract the net interest from the profit before tax figure to derive EBIT. If the entity is a

net borrower, with interest expense exceeding interest income, it will be necessary to add the net interest

to the profit before tax figure to derive EBIT. The 2015 EBIT figure for JB Hi-Fi Ltd is not disclosed in

its 2015 statement of profit or loss. Some entities do disclose EBIT. The steps involved in calculating

EBIT are shown in figure 6.6. Applying these steps, the EBIT for JB Hi-Fi Ltd is $201 459 000. This is

JB Hi-Fi Ltd’s profit before tax of $195 532 000 with finance costs of $5 927 000 added back.

Step 1: Identify the entity’s profit from continuing operations before income tax but after interest.

Step 2: Calculate the entity’s net finance income (cost):

Finance income − Finance costs = Net finance income (costs)

Step 3: If the entity has net finance income, deduct the net finance income from profit from continuing

operations before tax to give EBIT. If the entity has net finance costs, add the net finance

costs to profit before tax to give EBIT.

FIGURE 6.6 Calculation of EBIT

Profit pre- and post-depreciation and amortisation

Depreciation and amortisation are non-cash expenses included in the statement of profit or loss.

Earnings before interest, tax, depreciation and amortisation (EBITDA) refers to the profit before net

interest, taxation and depreciation/amortisation expense. It is a measure of the raw operating earnings of

an entity, as it excludes asset diminution in addition to tax and financing charges. EBITDA is used for a

number of purposes, including financial statement analysis and credit analysis. It was used traditionally

as a substitute for a cash-based profit measure. Because cash flows associated with operating activities

are available in the statement of cash flows, the need to approximate cash flows from operations via

EBITDA is no longer necessary.

Profit pre- and post-material items

Items of income and expense can be labelled as material (or significant) on the basis of their size or

nature. Many users of financial statements are interested in an entity’s maintainable earnings. Often

this is taken to be the income less expenses from ‘ordinary’ activities, excluding the material items. It

is argued that the exclusion of material items from profit provides a better reflection of the trend and

sustainability of profit. This does not mean that users should ignore material items. Due consideration

should still be given to these items, as interesting trends in relation to them may emerge.

Profit from continuing and discontinued operations

If an entity has sold or plans to sell a part of its business during the reporting period, information must be

disclosed that enables users of the financial statements to evaluate the financial effects of the discontinued

operations. The entity must disclose separately the profit or loss after tax associated with the discontinued

operations from that of the continuing operations. This assists users to better predict future profits.

Pro forma earnings

It has become popular for entities to refer to pro forma earnings in addition to GAAP determined earn-

ings. Pro forma earnings refer to earnings that are not in accordance with GAAP earnings. The inclu-

sion of pro forma earnings is often regarded as selective reporting by entities, because it allows them

to include items of their choosing in the determination of profit. Consequently, it is usual for pro forma

earnings to be higher than GAAP reported earnings. Entities reporting pro forma earnings justify the pro

forma figure by claiming that it is useful to decision makers as it ‘normalises’ earnings. Unusual items

(particularly expense items) tend to be excluded in the calculation of pro forma earnings.