ACC/ACF1100

Introduction to Financial Accounting

Lecture 11:
Equity, income, and expenses

Dr Chris Adrian - Department of Accounting

Reference:
Required readings: Financial Accounting - Reporting, Analysis and Decision Making (7th
Edition)
Chapter 3: section 3.2
Chapter 8: sections 8.10 – 8.11
Chapter 10: sections 10.7 - 10.8
Chapter 13: section 13.7
Week 11
• Define, report on, and account for Equity
• Discuss the definition and recognition criteria appropriate to the
measurement of Income and Expenses
• Identify and understand the tension between the Conceptual Framework
and accounting standards in the context of expenses such as R & D and
Exploration & Evaluation
Equity

3
 Equity
Definition of Equity
Owner’s Equity is a residual interest in the assets of an entity after
deducting its liabilities (Framework, Para. 4.63)
OE = A-L
No recognition criteria for Equity but is dependent on the recognition
and measurement of assets and liabilities

Statement of Changes in Equity

• Reflects the net changes in equity accounts for the period.
• Must show for each equity account a reconciliation between opening
and closing balances.
Statement of Changes in Equity
Statement of Financial Position – Equity
Section
 Equity
Statement of Changes in Equity
In the Statement of Changes in Equity of a corporation we would typically
include reconciliations of the following accounts:
1. Share Capital
shows the amount of assets invested in the company by its owners (shareholders)
2. Retained Earnings/Profits (or Accumulated Losses)
record net profit / losses retained in the business from this year and all prior
years that has not been:

• distributed to shareholders as dividends

• transferred to a reserve account.
3. Reserves
predominantly increases in equity from sources other than contributed capital
from the owners and retained earnings.
can also be transferred from retained earnings to the reserve account to signal
that this amount is not distributable to shareholders as dividends
 Equity
Accounting for Share Capital, Retained Earnings and Reserves
Accounting for Share Capital
Issue shares for cash Issue shares and receive NCA

Dr Cash Dr NCA
Cr Share Capital Cr Share Capital

Accounting for Retained Earnings

1. Records net profit/loss
Consider the implications of company tax
2. Records dividends

Accounting for Reserves

 Equity
Accounting for Retained Earnings
Company Tax
Profit before tax $120,000 reported on 30 June 2022. Company tax rate
is a flat 30%. Income tax is paid on 4th September 2022.

BDA estimating tax expense at year end

30/6/2022
Dr Income Tax Expense $36,000
Cr Income Tax Payable $36,000

$120,000 x 0.3
Closing entry for income tax expense
30/6/2022
Dr Profit or Loss Summary $36,000
Cr Income Tax Expense $36,000
 Equity
Accounting for Retained Earnings
Profit before tax $120,000 reported on 30 June 2022. Company tax rate
is a flat 30%. Income tax is paid on 4th September 2022.

Transfer of Profit or Loss to Retained Earnings after ALL income and

expense accounts have been closed
30/6/2022
Dr Profit or Loss Summary $84,000
Cr Retained Earnings $84,000

$120,000 - $36,000 tax

Note: following entries are required if a loss is made
30/6/2022
Dr Retained Earnings
Cr Profit or Loss Summary
 Equity
Accounting for Retained Earnings
Profit before tax $120,000 reported on 30 June 2022. Company tax rate
is a flat 30%. Income tax is paid on 4th September 2022.

Journal entry recording payment of tax

4/9/2022
Dr Income Tax Payable $36,000
Cr Cash $36,000

Cash payment to ATO

 Equity
Retained Earnings
Accounting for Dividends
A dividend is a distribution of profit (retained earnings) by a company
to its shareholders.
Forms of dividends:
• cash
• property
• shares

Companies often pay 2 dividends:

• Final dividend determined at end of year and paid in the following
year
• Interim dividend declared and paid during the year
 Equity
Retained Earnings
Accounting for Dividends
Interim Dividend Declared
(promised, proposed, announced) When paid

Dr Interim Dividend Dr Interim Div. Payable

Cr Interim Dividend Payable Cr Cash

Final Dividend declared at YE Interim dividend removal

Dr RE AND Dr RE
Cr Final Dividend Payable That triggers Cr Interim Dividend

Payment of Final Dividend And this reminds you to process

Dr Final Dividend Payable any transfers out of RE
Cr Cash
 Equity
Accounting for Reserves
Transfer of a portion of retained earnings to a reserve account

Dr Retained Earnings
Cr Reserve
 LECTURE ILLUSTRATION 1
The organisation is a company called Express Deliveries Ltd. with share
capital of $200,000. The company had retained earnings at the beginning
of the period of $50,000. The company is subject to Company Tax at a
rate of 30¢ per $ and net profit before tax and taxable income were both
$100,000 for 2022.

The directors of the company have decided (on 30 June 2022) to propose
a dividend of $20,000 and to transfer $15,000 to General Reserve
(current balance $20,000 Cr).

On 15 September 2022, we paid the tax owed and the final dividend.

Required:
1. record all relevant journal entries
2. show statement of changes in owner equity and balance sheet
extracts
 LECTURE ILLUSTRATION 1
BDA estimating tax expense at year end
30/6/2022
Dr Income Tax Expense $30,000
Cr Income Tax Payable $30,000
$100,000 x 0.3
Closing entry for income tax expense
30/6/2022
Dr Profit or Loss Summary $30,000
Cr Income Tax Expense $30,000

Transfer of Profit or Loss to Retained Earnings after ALL income

and expense accounts have been closed
30/6/2022
Dr Profit or Loss Summary $70,000
Cr Retained Earnings $70,000
$100,000 - $30,000 tax
 LECTURE ILLUSTRATION 1
Final Dividend declared at year end
30/6/2022
Dr Retained Earnings $20,000
Cr Final Dividend Payable $20,000

Transfer of a portion of retained earnings to general reserve account

30/6/2022
Dr Retained Earnings $15,000
Cr General Reserve $15,000
When tax is paid on 15/9/2022
Dr Income Tax Payable $30,000
Cr Cash $30,000
When dividend is paid on 15/9/2022
Dr Final Dividend Payable $20,000
Cr Cash $20,000
 LECTURE ILLUSTRATION 1

Extract from the Statement of Changes in Equity

Retained Earnings at beginning 50 000

Plus: Net profit after tax 70 000
profit available for appropriation 120 000

Less: Proposed final dividend 20 000

Transfer to general reserve 15 000 (35 000)

Retained Earnings at end 85,000

 LECTURE ILLUSTRATION 1
Shareholders Equity Section of the Balance Sheet as at 30 June 2022

Current Liabilities

Income Tax Payable 30,000

Final Dividend Payable 20,000 50,000

Shareholders Equity

Share Capital 200,000

General Reserve 35,000
Retained Earnings 85,000 320,000
 LECTURE ILLUSTRATION 2

Trafford Ltd commenced its operations on 1 July 2020. The following transactions occurred in
the financial year 2020/2021.
 On 1 July 2020, the directors issued 300,000 ordinary shares at $1 each.
 On 1 October 2020, in light of a reasonably successful first quarter, the company declared
a interim dividend of $0.10 per share. This interim dividend was paid on 1 November 2020.
 On 1 December 2020, the company issued 200,000 ordinary shares in exchange for land.
The land has a fair value of $200,000 on the day of the transaction.
 The profit before income tax for the financial year 2020/2021 was $300,000. The income
tax expense was $90,000.
 On 30 June 2021, $30,000 was transferred from retained earnings to the general reserve.
 On 30 June 2021, the directors declared a final dividend of 20 cents per share.
 On 1 August 2021, the company paid both the final dividend and tax.

Required:
Prepare general journal entries to record all the above transactions and events. Narrations are
NOT required.
 LECTURE ILLUSTRATION 2
Date Account Name Debit ($) Credit ($)
1 July 2020 Cash 300,000
Share capital 300,000

1 October 2020 Interim dividend 30,000

Interim dividend payable 30,000
300,000 shares x $0.10
1 November Interim dividend payable 30,000
2020
Cash 30,000

1 December Land 200,000

2020
Share capital 200,000
 LECTURE ILLUSTRATION 2
Date Account Name Debit ($) Credit ($)
30 June 2021 Income tax expense 90,000
Income tax payable 90,000

P&L summary 90,000

Income tax expense 90,000

P&L summary 210,000

Retained earnings 210,000

Retained earnings 130,000

Interim dividend 30,000
Final dividend payable 100,000
(500,000
shares x
$0.20)

Retained earnings 30,000

General reserve 30,000

1 August 2021 Final dividend payable 100,000

Cash 100,000

1 August 2021 Income tax payable 90,000

Cash 90,000
Income

23
 Income
Definition
Income is increases in assets, or decreases in liabilities, that result in
increases in equity, other than those relating to contributions from
holders of equity claims. (Conceptual Framework – Para. 4.68)

Components of Income
Include:
 Revenue - arises from ordinary activities
e.g., sales, fees, interest, dividends, royalties and rent

 Gains - other income (realised and unrealised)

e.g., from disposal of NCA  shown on income statement
e.g., asset revaluation surplus  shown on statement of comprehensive
income
 Income
Statement Of Comprehensive Income
AASB 101 states in Para. 81:
An entity shall present all items of income and expenses recognised in a
period:
(a) in a single statement of comprehensive income; or
(b) in two statements: a statement displaying components of profit and
loss (separate income statement) and a second statement beginning with
profit or loss and displaying components of other comprehensive income
(statement of comprehensive income)

The rationale behind these two options of presentation is that it will

allow the users of the financial statements to analyse the changes in the
entity’s equity resulting from transactions with owners in their capacity
as owners (e.g., dividends ) separately from non owner changes (e.g.,
third party transactions)
 Income
Statement of Comprehensive Income
What is Comprehensive Income?
– Reflects economic concept of income

AASB101 defines comprehensive income as a ‘total’

• ‘total comprehensive income’ = “the change in equity during a
period resulting from transactions & other events, other than those
changes resulting from transactions with owners in their capacity as
owners”

Total Comprehensive Income =

“normal profit / loss from income statement”
+ “other comprehensive income”
 Income
Statement of Comprehensive Income
Other Comprehensive Income =
“items of income and expense ….
that are not recognised in the profit and loss as required … by other
Australian Accounting Standards”
Examples of other comprehensive income
 Revaluation Surplus (ARR) adjustments (AASB 116)
 Adjustments from translation of the financial statements of a
foreign subsidiary (AASB 121)
 Gains or losses on re-measuring available-for-sale financial assets
(AASB 139)
 Income - Gains
• No definition in the Conceptual Framework (CF)
• Gains may or may not arise from operating activities
• Usually are incidental to main operations of the business
• Gains are usually determined on a net basis:
 proceeds less the carrying amount
and / or
 proceeds less costs of achieving the proceeds
 e.g., profit on disposal of assets

• Maybe realised or unrealised

 Income - Gains
Unrealised gains
Under the traditional accounting practices, e.g., conservatism, such gains
would not have been recognised as Income because of low probability of
generating economic benefits.

However, unrealised gains can be recognised as (other comprehensive)

income under some standards and the Conceptual Framework
• AASB 116 – permits fair value revaluation of PPE with increments
being recognised in ‘owner’s equity’
 Income
New Revenue Standard
AASB 15 Revenue from Contracts with Customers
Effective from 1 January 2018
It moves away from the older standards which had industry or
transaction specific approaches
eg. replacing standards on Revenue, Construction Contracts, Loyalty
Programs, Barter etc
There is now one standard for revenue recognition.
AASB15 establishes a single and comprehensive approach which sets
out how much revenue is to be recognised, and when.

WILL LEARN IN DETAIL IN YOUR THIRD YEAR FINANCIAL

ACCOUNTING
 Income
New Revenue Standard
AASB 15 Revenue from Contracts with Customers

The core principle is that an entity should recognise revenue from the
transfer of promised goods or services to the customer in an amount that
reflects the consideration to which the entity expects to be entitled in
exchange for those goods or services.

The core principle of the standard is carried out in 5 steps.

 Income
New Revenue Standard
AASB 15 Revenue from Contracts with Customers
AASB 15 par 9 defines a contract as:
“An agreement between two or more parties that creates enforceable rights
and obligations”.
AASB 15 gives conditions that need to be passed to qualify as a contract:
• The contract has been approved by all parties
• Each parties rights can be identified
• The payment terms can be identified
• The contract has commercial substance
• It is probable that payment will be collected
 Income
New Revenue Standard
AASB 15 Revenue from Contracts with Customers
In Step 2 we need to identify the different goods and services under the
contract which should be accounted for separately.
• referred to as unbundling the contract.
These separate goods or services are known as distinct performance
obligations  distinct if:
• the customer can benefit from the good or service either on its own or
together with other resources that are readily available to the
customer; and
• the promise to transfer the good or service to the customer is
separately identifiable from other promises in the contract.
Examples: Software – purchase of software with a contract for post-
delivery service support?
 Income
New Revenue Standard
AASB 15 Revenue from Contracts with Customers
AASB 15 para 47 defines the transaction price as:
“The amount of consideration (fixed, variable, non-cash) an entity expects
to be entitled to for the goods or services in the contract.”
ie. The amount it will actually bill

What is variable consideration?

Such as discounts, rebates, refunds, rights of return, credit, price
concessions, incentives
AASB 15 para 50
If the consideration promised in a contract includes a variable
element, then the entity estimates the amount of consideration to
which it expects to be entitled.
 Income
New Revenue Standard
AASB 15 Revenue from Contracts with Customers

The total transaction price is allocated between the different performance

obligations based on their stand alone selling prices.
Example:
Software – allocate transaction price between purchase of software and
post-delivery service support.

AASB 15 para 79 suggests three approaches to estimating a standalone

selling price if it’s not known.
1. Adjusted market assessment approach
2. Expected cost plus a margin approach
3. Residual approach
 Income
New Revenue Standard
AASB 15 Revenue from Contracts with Customers
When do you recognise the revenue ?
1. over a period of time or
2. at a particular point in time

An entity recognises revenue OVER TIME when any of the following

three are satisfied (AASB15.35):
• When the customer simultaneously receives and consumes the benefit
• The entity’s performance enhances an asset e.g. work in progress
• Asset has no alternative use and has to be paid for
 Income
New Revenue Standard
AASB 15 Revenue from Contracts with Customers
If not recognized over time, then revenue will be recognized at a Point in
time
Which point in time ?
We recognize revenue at the point in time when control has passed
Factors that would indicate control has passed include:
• right to payment
• customer has legal title to the asset
• entity has transferred physical possession
• the customer has the significant risks and rewards of ownership
• the customer has accepted the asset
 Lecture Illustration 3 - AASB 15

King Traders is a company that provides mobile phone sales and

services. The company gives customers the following option. A King
Mate 10 (list selling price $900) provided free with a three-year contract
of $55 per month for phone services

Required

Apply the five stages of the criteria of the AASB 15 Revenue from
Contracts with Customers to determine how this may be recognised as
Income.
 Lecture Illustration 3 - AASB 15

Five stages of the criteria Explanation

Identify the contract(s)

Identify the performance obligation

Determine the transaction price

Allocate the transaction price

Recognise revenue when the

performance obligation is satisfied
 Lecture Illustration 3 - AASB 15

Revenue allocation Contracts Per month

Phone: immediate
recognition
Phone services
Total Revenue
 Lecture Illustration 3 - AASB 15
Five stages of the Explanation
criteria
Identify the There are two contracts: one for the mobile phone, and the
contract(s) other for the provision of phone services
Identify the There are two distinct obligations from the phone company.
performance The sale of the phone and the provision of the monthly
obligation phone services for three years
Determine the The total is $1,980 = 36 X $55
transaction price
Allocate the The standalone price for the phone of $900 and the
transaction price balance for the 36 months of phone services of $1,080
Recognise revenue The $900 price for the phone is likely to be recognised
when the immediately as income at the point of sale. It will likely not
performance have on going service obligations.
The 36 months of phone services is likely to be recognised
obligation is satisfied
over time as phone services provided by King Traders are
delivered.
This income would likely be recognised on a monthly basis,
that is, $30 per month (i.e., $1,080 / 36).
 Lecture Illustration 3 - AASB 15

Revenue allocation Contracts Per month

Phone: immediate recognition 900
Phone services 1,080 $30
Total Revenue 1,980
Expenses

45
 Expenses
Definition
Expenses are decreases in assets, or increases in liabilities, that result in
decreases in equity, other than those relating to distributions to holders
of equity claims (Conceptual Framework – Para. 4.69).

Components of Expenses
Include:
• Expenses – arising in the course of the ordinary activities
e.g., cost of sales, wages and depreciation.
• Losses – meet the expense definition but may or may not arise in the
course of the ordinary activities
• often reported on a net basis
e.g., from disposal of NCA  shown on income statement
 Expenses - Losses
Losses – can be both realised and unrealised
• Realised losses e.g., losses from disasters such as flood and fire; losses
from disposal of Non-Current Assets

• Unrealised losses arising for example:

• from adverse changes in foreign exchange rates
• application of AASB 102 lower of cost & NRV rule
• AASB 116 and 136 (impairment and revaluation decrements)
• numerous provisions refer to AASB 137

• Unrealised losses (in contrast to unrealised gains) have an established

history of being recognised as expenses on income statement
 Expenses - Issues
Similarities with the definition of income are evident and expected,
reflecting:
• Asset / Liability model
• Symmetrical attributes – revenues / gains and expenses / losses

One significant difference being:

• There is NO standard specifically devoted to expenses

• Issues arising in relation to expenses therefore will be based on a range

of varying standards, the Conceptual Framework, and GAAP.

Capitalisation of expenditure as asset vs. expense, focus on

• Research & Development AASB 138
• Exploration & Evaluation of Mineral resources AASB 6
• Consistent with each other?
• Consistent the conceptual framework?
 Expenses - Issues
Research & Development AASB 138

• Research Phase
original and planned investigation undertaken with the prospect of
gaining new scientific or technical knowledge and understanding
 Expense all
• Development Phase
application of research findings or other knowledge to a plan or
design … (Para. 8)
 Can be capitalised as asset if the definition and recognition criteria
of asset, all 6 conditions (para 57) are met and not prohibited under
para 63 (see lecture 9)
 Expenses - Issues
Research & Development AASB 138 vs.
The Conceptual Framework
• Research Phase
 Expense all
In theory, the “expense all research” requirement is in conflict with the
CF which would argue that if it passes the asset definition and
recognition criteria, it should be recognised as an asset.
In practical terms, the expensing of research expenditure would appear to
be consistent with relevance (one of the recognition criteria). At that
stage, the probability of inflows of future benefits is low (para 5.12(b)).
 Expenses - Issues
Research & Development AASB 138 vs.
The Conceptual Framework
• Development Phase
 Can be capitalised as Asset if
1. The definition and recognition criteria are met
2. All 6 conditions (para 57) are met, and
3. Not prohibited under para 63 (see lecture 9)

Much stringent than the definition and recognition criteria of asset under
the Conceptual Framework
 inconsistent?
 Expenses - Issues
Exploration & Evaluation of Mineral resources AASB 6
• Exploration
Includes the topographical, geological, geochemical and geophysical
studies that are usually made over a wide area
• Evaluation
Work is undertaken to determine the technical feasibility and
commercial viability of the prospect

 Expense as incurred OR
 Can recognise as an Asset if :
• a) such expenditure is expected to be recouped through successful
development and exploitation OR
• b) exploration has not reached a stage which permits a reasonable
assessment of economical potential (para Aus7.2).
 Expenses - Issues
Exploration & Evaluation of Mineral resources AASB 6 vs.
The Conceptual Framework
1. E&E – Expense as incurred or
This is clearly inconsistent with the Conceptual Framework which
would argue that if it passes the asset definition and recognition
criteria, it must be recognised as an asset. Although in practical terms?

2. E&E – Recognise as an Asset if :

• a) such expenditure is expected to be recouped through successful
development and exploitation or
– Expected = probable FEB?
• b) exploration has not reached a stage which permits a reasonable
assessment of economical potential.
– Record as an asset if you have no idea of whether a mining site
can generate inflows of economic benefits
 Expenses - Issues
Research & Development AASB 138 vs.
Exploration & Evaluation of Mineral resources AASB 6
Research phase vs. Exploration & Evaluation
(note: development phase is excluded in the comparison)
• Same issue: spend money now, questionable success.
• Should we record as Asset or Expense?
• Given same issue, you would expect similar accounting treatment
Research phase AASB 138
No capitalisation of assets at all, even if research can lead to
successful development
Exploration & Evaluation AASB 6
 Can be capitalised as asset if 1) expected to be recouped or 2)
unknown outcomes
 Why does AASB 6 Exploration &
Evaluation Offer Multiple Options?
Conservatism
• And yet the “capitalise when unclear” option
is NOT conservative

Political Pressure
• Mining industry powerful in Australia