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  • Hi, Else here.

  • And in this video, we'll be learning

  • about how to report expenses on the statement

  • of income/comprehensive income.

  • As noted in my previous video, expenses

  • are not a required line item under Canadian IFRS.

  • However, one of the required line items

  • is profit or loss from all operations.

  • This can only be calculated when expenses,

  • such as cost of goods sold or depreciation, are included.

  • It is, therefore, clear that the line item expenses must

  • be presented in the statement.

  • In addition, IAS I, in paragraph 99,

  • recommends that the statement of income/comprehensive income

  • include an analysis of the expenses classified

  • in one of two ways--

  • by nature or by function.

  • What does this mean?

  • By nature means that expenses are grouped based

  • on the source of the expense.

  • All similar sources are grouped together.

  • By function means that expenses are

  • grouped based on what the business used the expenses for.

  • This can also be viewed as grouping cost by activity.

  • Often the whole concept of by nature versus by function

  • confuses students, so let's do an example

  • to clarify what by nature and by function actually means.

  • Assume you work for Greene Inc. The business

  • has three departments-- production,

  • sales and marketing, and administration.

  • Each of these departments have the following costs--

  • the cost of raw materials consumed during production,

  • employee benefit costs, including wages, payroll taxes,

  • health care costs, et cetera, depreciation and amortization

  • costs with regards to long-lived assets, utility

  • costs for communication, water, and electricity, and finally,

  • other expenses, which would include all other costs

  • incurred to generate revenue.

  • You can quickly see that total costs for this business

  • are 3,205,000.

  • What would show on the face of the statement

  • of income/comprehensive income if Greene Inc was reporting

  • their expenses by function?

  • Cost of goods sold of 2,616,00 to represent the costs

  • incurred by the production department,

  • selling expenses of 366,000 to represent the costs incurred

  • by the sales and marketing departments,

  • administration expenses of 223,000 to represent

  • the costs due to the administration department,

  • and finally, interest expense of 54,000.

  • Remember from my previous video that IFRS requires financing

  • costs to be shown separately.

  • Total expenses for Greene Inc would be 3,259,000.

  • These expenses are on the face of the statement

  • of income/comprehensive income.

  • However, if a business chose a condensed format

  • they would likely list only two lines

  • on the face of the statement--

  • operating costs of 3,205,000 with a reference

  • to a note and interest expense of 54,000

  • because this line must always be shown

  • on the face of the statement.

  • The breakdown of the operating expenses

  • would be provided in the nose to the financial statements,

  • likely in the form of a schedule.

  • If a condensed format is used, information

  • must be provided in the notes to the financial statements.

  • As you can see, expenses by function

  • can be thought of as expenses by departments

  • within the business.

  • For example, cost of goods sold is made up

  • of all the expenses used or consumed

  • by the production department when they are producing goods.

  • Are there any drawbacks to providing expenses by function?

  • Actually, there is.

  • When we provide expenses by function,

  • we have to divide all costs into multiple departments.

  • For example, amortization or utility costs

  • may have to be allocated.

  • This requires professional judgment

  • because costs are sometimes allocated using cost drivers.

  • As you may remember from managerial accounting,

  • the cost drivers used to allocate

  • costs between departments may not

  • represent 100% of the costs in the cost pool.

  • Allocations are, by their very nature, estimations.

  • This must be understood when you see an income

  • statement with costs presented by function.

  • What about presenting expenses by nature?

  • Let's go back to our example.

  • If Greene Inc reports their expenses by nature,

  • they would group expenses that have a similar source together.

  • For example, employee benefit costs

  • may be divided by department, but all of these expenses

  • are from the same source--

  • employees working for the company.

  • Depreciation and amortization can also

  • be divided by department, but all of these expenses

  • are from the same source, which is

  • using long-lived assets in the operation of the business.

  • Expenses by nature means that all expenses

  • with a similar source are grouped together

  • on the statement of income/comprehensive income.

  • Therefore, for Greene Inc, the statement

  • would present raw materials consumed would be 1,246,000.

  • Employee benefit costs from all departments would be 1,149,150.

  • Depreciation and amortization expense for the whole company

  • would be 529,650.

  • Utility costs would be 48,200.

  • And other costs would be 232,000.

  • Finally, interest expense would be 54,000.

  • Notice that the total of 3,259,000

  • is exactly the same as the total expenses by function.

  • The expenses are simply categorized

  • using a different method.

  • By function or by nature, what does IFRS say?

  • Actually, IFRS states that when an entity chooses

  • to report their expenses by function,

  • they must also provide the same information by nature.

  • At a minimum, businesses reporting their expenses

  • by function must also disclose the following,

  • either on the face of the statement

  • or as a note to the statement--

  • cost of inventory charge to expenses, employee benefit

  • costs, depreciation and amortization costs.

  • This means that information by nature

  • is required, while information by function is optional.

  • Note that ASPE does not require expenses

  • by either function or nature.

  • Entities using ASPE can choose to disclose what they feel

  • is relevant to their stakeholders.

  • So which method is better for the stakeholders?

  • It depends on what the stakeholders need

  • to make an informed decision.

  • For instance, a retailer, such as Walmart reports

  • by function on the face of their income statement,

  • because for manufacturers, wholesalers, and retailers,

  • the focus is on the cost of goods sold and gross profit.

  • Analysis of gross profit provides important information

  • with regards to inventory prices and costs.

  • Other businesses may also prefer by function.

  • Pfizer Inc. reports by function, because they

  • have huge expenses related to research and development.

  • If Pfizer reported by nature, those costs

  • would be largely hidden within the employee benefit costs.

  • This is because a large portion of research and development

  • costs are attributed to payroll costs.

  • Other businesses provide expenses

  • by nature on the face of their statement,

  • because their business model supports this type of grouping.

  • For instance, Royal Bank of Canada

  • reports their expenses by nature.

  • This makes sense, since their business does not

  • have a cost of goods sold.

  • Expenses group by nature is more informative

  • to their stakeholders.

  • How does all this translate into a question

  • you may see on a test or exam?

  • Well, you may get a statement of income/comprehensive income

  • and be asked, is this by nature or by function?

  • You may get a listing of accounts which includes both

  • and then be asked to produce a statement by either function

  • or nature.

  • If you include all the expenses on your statement,

  • then the expenses will be double what they actually are.

  • The key here is to be able to differentiate

  • the expenses by function from the expenses by nature.

  • That way, you can produce the statement requested.

  • Let's just check your understanding

  • with regards to these concepts.

  • Remember to pause the video before I

  • answer the question for you.

  • If the line item called distribution costs was included

  • on an income statement, are expenses

  • presented by function or by nature?

  • The answer is B, by function.

  • Distribution or delivery costs are the costs

  • incurred by the sales department and are, therefore, considered

  • a by function presentation.

  • That's it for the presentation of expenses on the statement

  • of income/comprehensive income.

  • Thank you for watching this video.

  • I hope you found it useful for your learning.

Hi, Else here.

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B2 US statement nature income comprehensive income cost greene

Expenses - By Nature or By Function

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    陳虹如 posted on 2017/06/23
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