Accounting Business Reporting for Decision Making

244 Accounting: Business Reporting for Decision Making

6.11 The link between the financial statements

LEARNING OBJECTIVE 6.11 Explain the relationship between the statement of profit or loss, the balance
sheet, the statement of comprehensive income and the statement of changes in equity.

It is important to understand the relationships between the financial statements, rather than viewing each state-

ment in isolation. We have already seen how the income and expense definitions are linked to the asset and lia-

bility definitions. The recognition of income occurs simultaneously with the increase in assets or decrease in

liabilities. Similarly, the recognition of expenses occurs simultaneously with the decrease in assets or increase

in liabilities. The fundamental purpose of the statement of profit or loss is to present the entity’s financial per-

formance for a period of time. The entity’s profit or loss for the reporting period belongs to the entity’s owners.

The profit or loss for the reporting period is added to the undistributed profits from previous periods (retained

earnings, or retained profits or accumulated profits are interchangeable terms used to describe undistributed

profits in the entity). The retained earnings at the end of the reporting period are the retained earnings at the start

of the period, plus the current period’s profits, less any distributions (e.g. dividends or drawings) made to owners

during the reporting period. The retained earnings balance at the end of the reporting period is an equity item in

the balance sheet. Items of income and expense directly recognised in equity, and transactions with owners as

owners (as per the statement of changes in equity), also result in changes in the equity balance from the begin-

ning to the end of the reporting period. This relationship between the statement of profit or loss, the statement of

comprehensive income, the balance sheet and the statement of changes in equity is illustrated in figure 6.10.

Beginning of the reporting

period (t = 0) End of the reporting period (t = 1)

Asset (^) t = 0 — Liabilities (^) t = 0 = Equity (^) t = 0 Assets t = 1 — Liabilities t = 1 = Equity t = 1
Where:
Prot
(– loss)
Transactions that:

1. are recognised
   as income and
   expenses in
   statement of prot
   or loss

Prot

Recognised

directly in

equity

2. are recognised
   as income and
   expenses but go
   directly to equity


3. are with owners
   as owners


4. alter assets and
   liabilities without
   changing equity

During the

reporting period

+ +/−

Transactions

with owners

as owners

(e.g. dividends,

share issues)

Income

(– expenses)

directly

recognised

in equity

Statement of

comprehensive

Statement of income

changes in

equity

Equity t = 1 = Equity t = 0 +

FIGU R E 6.10 Relationship between the statement of profit or loss, statement of comprehensive income,

balance sheet and the statement of changes in equity