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10.1 Financial statements

Syllabus
9609–2026–2027
Topic
10.1
Level
A2

Learning objectives

10.1.1Statement of profit or loss• Statement of profit or loss- the meaning and purpose of the statement of profit or loss- the contents of a statement of profit or loss: revenue, cost of sales, gross profit, expenses, profit from operations (operating profit), taxation, profit for the year, dividends, retained earnings- amendment of a statement of profit or loss- the impact on the statement of profit or loss of a given change10.1.2Statement of financial position• Statement of financial position- the meaning and purpose of statement of financial position- the contents of a statement of financial position including non-current assets, current assets, current liabilities, net current assets, net assets, non-current liabilities, reserves and equity- amendment of a statement of financial position- the relationships between items in the statement of profit or loss and the statement of financial position10.1.3Inventory valuation• Inventory valuation- the difficulties of valuing inventory- the net realisable value method10.1.4Depreciation• Depreciation- the role of depreciation in the accounts- the impact of depreciation (straight-line method only) on the statement of financial position and the statement of profit or loss

The statement of profit or loss explains period income, costs and retained earnings

A statement of profit or loss reports financial performance over a period: revenue earned, costs/expenses charged and resulting profit. It supports trend/target/competitor analysis and decisions, but accounting profit is not the same as cash flow.

Line/cascade Meaning
Revenue Income from ordinary sales before deducting costs
less Cost of sales Direct cost of goods/services sold (often opening inventory + purchases/production cost − closing inventory)
= Gross profit Amount available to cover operating expenses and profit
less Expenses Operating costs not included in cost of sales
= Profit from operations / operating profit Profit generated by core operations
less Taxation Tax charge on profit
= Profit for the year Profit attributable after tax for the period
less Dividends Distribution to shareholders from profit (not an operating expense)
= Retained earnings for the period Profit kept in business, added to retained-earnings reserve subject to other changes
Given change, other things equal Statement impact
Revenue increases 20kwithcostofsalesunchanged∣Revenue,gross/operating/profitbeforetaxrise20k with cost of sales unchanged | Revenue, gross/operating/profit before tax rise20k; tax may rise
Cost of sales increases 8k∣Grossprofitanddownstreamprofitfall8k | Gross profit and downstream profit fall8k
Operating expense/depreciation increases 5k∣Operatingprofitanddownstreamprofitfall5k | Operating profit and downstream profit fall5k; gross profit unchanged
Tax charge increases 2k∣Profitforyearfalls2k | Profit for year falls2k; operating/gross profit unchanged
Dividend increases $3k Retained amount/equity/cash falls; profit for year and operating profit unchanged

For an amendment: identify amount and classification → change that line once → recalculate every downstream subtotal → apply any stated tax/dividend effect → trace linked statement-of-financial-position item. Do not change unrelated upstream subtotals.

Interpret with accounting policy/estimates, one-off items, inflation, seasonality, scale/product mix and cash/balance-sheet evidence. Revenue/profit can rise while receivables, inventory or borrowing create liquidity risk.

Profit is a period measure based on accruals and non-cash charges. Dividends distribute profit; they do not reduce operating profit. A single line change must flow only through the appropriate downstream totals.

The statement of financial position balances resources with financing claims

A statement of financial position is a snapshot at one date of assets/resources controlled, liabilities/obligations and equity/residual owner financing. It indicates asset structure, liquidity, long-term debt and accumulated financing—not market value or cash performance by itself.

Section Meaning/examples
Non-current assets Longer-term operating resources such as property/equipment at carrying amount
Current assets Expected to turn into cash/use within operating cycle: inventory, trade receivables, cash
less Current liabilities Due within short term: trade payables, overdraft/accrual/tax due
= Net current assets Current assets − current liabilities (working-capital position)
Non-current assets + net current assets = net assets before long-term claims Resource amount after short-term obligations
less Non-current liabilities Longer-term loans/obligations
= Net assets Residual funded by equity/reserves
Equity and reserves Share capital plus retained/other reserves; equals net assets

Assets=Liabilities+Equity;Netcurrentassets=Currentassets−Currentliabilities;Netassets=EquityandreservesAssets = Liabilities + Equity; Net current assets = Current assets - Current liabilities; Net assets = Equity and reserves

Profit/loss item/change Financial-position relationship
Credit revenue Raises profit and trade receivables until cash collected
Expense incurred but unpaid Lowers profit and raises current liability
Profit retained Adds to retained-earnings reserve/equity; corresponding assets/liabilities reflect underlying transactions
Dividend paid Reduces cash and retained earnings/equity; does not reduce operating profit
Closing inventory Current asset and deduction in cost of sales; higher valid value raises profit/equity
Depreciation Expense lowers profit/retained equity and accumulated depreciation lowers non-current asset carrying amount
Tax charge unpaid Lowers profit and raises tax/current liability until paid

Amend by identifying at least two linked effects and preserving the equation. Buying equipment for cash swaps current asset for non-current asset; buying with a long-term loan raises asset and non-current liability; collecting receivable swaps receivable for cash and creates no new revenue/profit.

Equity is the residual claim, not a cash account available to spend. 'Current' concerns operating-cycle/short-term classification, not importance. A balanced statement can still contain poor estimates or weak liquidity.

Inventory is reported at the lower of cost and net realisable value

Inventory valuation is difficult when purchase/production costs vary, units are interchangeable or partly completed, overhead allocation is uncertain, and goods become damaged, obsolete, seasonal or slow-moving. Quantity/cut-off and expected selling/completion/disposal costs also require evidence.

Netrealisablevalue(NRV)=estimatedsellingprice−estimatedcoststocomplete−estimatedcoststosellNet realisable value (NRV) = estimated selling price - estimated costs to complete - estimated costs to sell

Value each relevant inventory item/group at the lower of its cost and NRV. Cost represents attributable acquisition/conversion cost; NRV represents expected recoverable amount from sale. The lower-value rule prevents recognising profit before sale and avoids overstating assets/profit when recovery has fallen.

Item cost = 72.Expectedsellingprice=72. Expected selling price =80, completion cost = 7andsellingcost=7 and selling cost =4, so NRV = 69.Reportinventoryat69. Report inventory at69 and recognise a 3reduction/expense.IfNRVwere3 reduction/expense. If NRV were76, report at cost $72—not at the higher expected gain.

Valid closing-inventory valuation change, other things equal Impact
Closing inventory reduced/write-down Cost of sales rises; gross/operating/profit for year and retained equity fall; current assets/net assets fall
Closing inventory increases because more valid units/cost Cost of sales falls and reported profit/current assets rise, but cash may be tied up and obsolescence risk may worsen

Support estimates with count/cut-off, purchase/production records, age/condition, post-period selling prices, return/discount history and completion/disposal plans. Apply consistent classifications and update NRV when evidence changes.

NRV is not selling price: completion and selling costs are deducted. Inventory is not written up above cost for expected profit, and higher reported inventory/profit is not automatically stronger cash or performance.

Straight-line depreciation allocates asset cost and reduces carrying value

Depreciation systematically allocates the depreciable amount of a non-current asset over its estimated useful life as it helps generate activity/revenue. It matches expense to periods and prevents non-current assets/profit from remaining overstated; it is not a valuation forecast or replacement cash fund.

Annualstraight−linedepreciation=(assetcost−estimatedresidualvalue)/estimatedusefullifeAnnual straight-line depreciation = (asset cost - estimated residual value) / estimated useful life

Machine cost 110,000,residualvalue110,000, residual value10,000, useful life 5 years: annual depreciation = (110,000−110,000 −10,000) ÷ 5 = 20,000.After3fullyears,accumulateddepreciation=20,000. After 3 full years, accumulated depreciation =60,000 and carrying amount = 110,000−110,000 −60,000 = $50,000.

Statement Straight-line impact for the period
Profit or loss Depreciation expense increases; operating profit, profit for year and retained amount fall, other things equal
Financial position Non-current asset carrying amount falls through accumulated depreciation; retained earnings/equity/net assets fall through lower profit
Cash No current cash outflow from recording depreciation; cash was affected when asset was bought/financed, though lower taxable profit may affect tax

For an amendment, calculate period charge from stated cost, residual value and useful life; add it to expenses; recalculate profit and retained earnings; increase accumulated depreciation/reduce carrying amount by the same pre-tax charge, applying any stated tax effect separately. Review useful-life/residual estimates when evidence changes.

Straight line is simple and gives equal annual charge, suitable when benefits are consumed evenly. Actual usage, maintenance, technology/obsolescence and market value may change unevenly, so carrying amount does not claim to equal resale value.

Depreciation is a non-cash expense allocation, not money placed aside and not necessarily market-value decline. Land or assets with no depreciable amount are not automatically treated like finite-life equipment.