5-1

5
Merchandising Operations and
the Multiple-Step Income
Statement

Kimmel ● Weygandt ● Kieso

Financial Accounting, Eighth Edition
5-2
 CHAPTER OUTLINE
LEARNING OBJECTIVES

1 Describe merchandising operations and inventory systems.

2 Record purchases under a perpetual inventory system.

3 Record sales under a perpetual inventory system.

Prepare a multiple-step income statement and a

4 comprehensive income statement.

Determine cost of goods sold under a periodic inventory

5 system.

6 Compute and analyze gross profit rate and profit margin.

5-3
 Describe merchandising operations and
LEARNING
OBJECTIVE 1 inventory systems.

Merchandising Companies
Buy and Sell Goods
Retailer

Wholesaler Consumer

The primary source of revenues is referred to as

sales revenue or sales.
5-4 LO 1
 Merchandising Company

Income Measurement

Not used in a
Sales Less
ILLUSTRATION 5-1
Service business.
Revenue Income measurement process for a
merchandising company

Equals
Cost of Gross Less
Goods Sold Profit

Operating Equals Net

Cost of goods sold is the total Income
Expenses
cost of merchandise sold (Loss)
during the period.

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 OPERATING CYCLES ILLUSTRATION 5-2
Operating cycles for a
service company and a
merchandising company

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 FLOW OF COSTS
ILLUSTRATION 5-3
Flow of costs

Companies use either a perpetual inventory system or a

periodic inventory system to account for inventory.
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 FLOW OF COSTS

Perpetual System
 Maintain detailed records of the cost of each inventory
purchase and sale.
 Records continuously show inventory that should be
on hand for every item.
 Company determines cost of goods sold each time a
sale occurs.

5-8 LO 1
 FLOW OF COSTS

Periodic System
 Do not keep detailed records of the goods on hand.
 Cost of goods sold determined by count at the end of
the accounting period.
 Calculation of Cost of Goods Sold:

Beginning inventory $ 100,000

Add: Purchases, net 800,000
Goods available for sale900,000
Less: Ending inventory 125,000
Cost of goods sold $ 775,000

5-9 LO 1
 FLOW OF COSTS

Advantages of the Perpetual System

 Traditionally used for merchandise with high unit
values.
 Shows the quantity and cost of the inventory that
should be on hand at any time.
 Provides better control over inventories than a
periodic system.

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 INVESTOR INSIGHT Morrow Snowboards, Inc.

Improve Stock Appeal

Investors are often eager to invest in a company that has a hot
new product. However, when snowboard maker Morrow
Snowboards, Inc. issued shares of stock to the public for the
first time, some investors expressed reluctance to invest in
Morrow because of a number of accounting control problems. To
reduce investor concerns, Morrow implemented a perpetual
inventory system to improve its control over inventory. In
addition, it stated that it would perform a physical inventory count
every quarter until it felt that its perpetual inventory system was
reliable.

5-11 LO 1
 Merchandising Operations and
DO IT! 1 Inventory Systems

Indicate whether the following statements are true or false. If false,

indicate how to correct the statement.
1. The primary source of revenue for a False
merchandising company results from performing (service
services for customers. company)

2. The operating cycle of a service company is

usually shorter than that of a merchandising True
company.
3. Sales revenue less cost of goods sold equals
True
gross profit.
4. Ending inventory plus the cost of goods False
purchased equals cost of goods available for sale. (Beg. Inventory
+ COGS)

5-12
LO 1
 Record purchases under a perpetual
LEARNING
OBJECTIVE 2 inventory system.

 Made using cash or

credit (on account).

 Normally record when

goods are received
from the seller.

 Purchase invoice
should support each
credit purchase.
ILLUSTRATION 5-5
Sales invoice used as
Purchase invoice by Sauk Stereo
5-13 LO 2
 Record Purchase of Merchandise
ILLUSTRATION 5-5

Illustration: Sauk Stereo (the

buyer) uses as a purchase
invoice the sales invoice
prepared by PW Audio Supply,
Inc. (the seller). Prepare the
journal entry for Sauk Stereo
for the invoice from PW Audio
Supply.

May 4 Inventory 3,800

Accounts Payable
5-14 3,800 LO 2
 FREIGHT COSTS ILLUSTRATION 5-6
Shipping terms

Ownership of the goods Ownership of the goods

passes to the buyer when the remains with the seller until
public carrier accepts the the goods reach the buyer.
goods from the seller.

Freight costs incurred by the seller are an operating expense.

5-15 LO 2
 FREIGHT COSTS

Illustration: Assume upon delivery of the goods on May 6,

Sauk Stereo pays Public Freight Company $150 for freight
charges, the entry on Sauk Stereo’s books is:
May 6 Inventory 150
Cash

150
Assume the freight terms on the invoice in Illustration 5-5 had
required PW Audio Supply to pay the freight charges, the
entry by PW Audio Supply would be:
May 4 Freight-out 150
Cash
5-16 LO 2
150
 PURCHASE RETURNS AND ALLOWANCES

Purchaser may be dissatisfied because goods are

damaged or defective, of inferior quality, or do not meet
specifications.

Purchase Return Purchase Allowance

Return goods for credit if May choose to keep the
the sale was made on merchandise if the seller
credit, or for a cash refund will grant a reduction of the
if the purchase was for purchase price.
cash.

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 PURCHASE RETURNS AND ALLOWANCES

Illustration: Assume Sauk Stereo returned goods costing

$300 to PW Audio Supply on May 8.

May 8 Accounts Payable 300

Inventory 300

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 PURCHASE RETURNS AND ALLOWANCES

Review Question
In a perpetual inventory system, a return of defective
merchandise by a purchaser is recorded by crediting:

a. Purchases

b. Purchase Returns

c. Purchase Allowance

d. Inventory

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 PURCHASE DISCOUNTS

Credit terms may permit buyer to claim a cash discount

for prompt payment.
Example: Credit terms
Advantages: may read 2/10, n/30.
 Purchaser saves money.
 Seller shortens the operating cycle by converting the
accounts receivable into cash earlier.

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 PURCHASE DISCOUNTS

2/10, n/30 1/10 EOM n/10 EOM

2% discount if 1% discount if Net amount due

paid within 10 paid within first 10 within the first 10
days, otherwise days of next days of the next
net amount due month. month.
within 30 days.

5-21 LO 2
 PURCHASE DISCOUNTS

Illustration: Assume Sauk Stereo pays the balance due of

$3,500 (gross invoice price of $3,800 less purchase returns
and allowances of $300) on May 14, the last day of the
discount period. Prepare the journal entry Sauk Stereo
makes on May 14 to record the payment.

May 14 Accounts Payable 3,500

Inventory 70
Cash 3,430

(Discount = $3,500 x 2% = $70)

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 PURCHASE DISCOUNTS

Illustration: If Sauk Stereo failed to take the discount, and

instead made full payment of $3,500 on June 3, the journal
entry would be:

June 3 Accounts Payable 3,500

Cash 3,500

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 PURCHASE DISCOUNTS

Should discounts be taken when offered?

Discount of 2% on $3,500 $ 70.00

$3,500 invested at 10% for 20 days 19.18
Savings by taking the discount $ 50.82

Example: 2% for 20 days = Annual rate of 36.5%

($3,500 x 36.5% x 20) ÷ 365 = $70

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 PURCHASING TRANSACTIONS

Inventory
Debit Credit

4th - Purchase $3,800 $300 8th - Return

6th – Freight-in 150 70 14th - Discount

Balance $3,580

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 DO IT! 2 Purchase Transactions

On September 5, De La Hoya Company buys merchandise on

account from Junot Diaz Company. The purchase price of the goods
paid by De La Hoya is $1,500. On September 8, De La Hoya returns
defective goods with a selling price of $200. Record the transactions
on the books of De La Hoya Company.

SOLUTION

Sept. 5 Inventory 1,500

Accounts Payable 1,500

Sept. 8 Accounts Payable 200

Inventory 200

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 Record sales under a perpetual
LEARNING
OBJECTIVE 3 inventory system.

 Sales may be made on credit or for cash.

ILLUSTRATION 5-5

 Sales revenue, like service

revenue, is recorded when
the performance obligation
is satisfied.
 Performance obligation is
satisfied when the goods
are transferred from the
seller to the buyer.
 Sales invoice should
support each credit sale.
5-27 LO 3
 Recording Sales

Journal Entries to Record a Sale

#1 Accounts Receivable or Cash XXX Selling

Sales Revenue Price
XXX

#2 Cost of Goods Sold XXX

Cost
Inventory
XXX

5-28 LO 3
 Recording Sales

Illustration: PW Audio Supply records the sale of $3,800

on May 4 to Sauk Stereo on account (Illustration 5-5) as
follows (assume the merchandise cost PW Audio Supply
$2,400).

May 4 Accounts Receivable 3,800

Sales Revenue 3,800

4 Cost of Goods Sold 2,400

Inventory 2,400

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5-30
LO 3
 SALES RETURNS AND ALLOWANCES

 “Flip side” of purchase returns and allowances.

 Contra revenue account to Sales Revenue (debit).

 Sales not reduced (debited) because:

► Would obscure importance of sales returns and
allowances as a percentage of sales.

► Could distort comparisons.

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 SALES RETURNS AND ALLOWANCES

Illustration: Prepare the entry PW Audio Supply would

make to record the credit for returned goods that had a
$300 selling price (assume a $140 cost). Assume the
goods were not defective.

May 8 Sales Returns and Allowances 300

Accounts Receivable 300

8 Inventory 140
Cost of Goods Sold 140

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 SALES RETURNS AND ALLOWANCES

Illustration: Assume the returned goods were defective

and had a scrap value of $50, PW Audio would make the
following entries:

May 8 Sales Returns and Allowances 300

Accounts Receivable 300

8 Inventory 50
Cost of Goods Sold 50

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 SALES RETURNS AND ALLOWANCES

Review Question
The cost of goods sold is determined and recorded each
time a sale occurs in:

a. periodic inventory system only.

b. a perpetual inventory system only.

c. both a periodic and perpetual inventory system.

d. neither a periodic nor perpetual inventory system.

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 ACCOUNTING ACROSS THE ORGANIZATION

The Point of No Returns?

In most industries, sales returns are relatively minor. But returns
of consumer electronics can really take a bite out of profits.
Recently, the marketing executives at Costco Wholesale Corp.
faced a difficult decision. Costco has always prided itself on its
generous return policy. Most goods have had an unlimited grace
period for returns. A new policy will require that certain electronics
must be returned within 90 days of their purchase. The reason?
The cost of returned products such as high-definition TVs,
computers, and iPods cut an estimated 8¢ per share off Costco’s
earnings per share, which was $2.30.
Source: Kris Hudson, “Costco Tightens Policy on Returning Electronics,”
Wall Street Journal (February 27, 2007), p. B4.

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 SALES DISCOUNTS

 Offered to customers to promote prompt payment of

the balance due.
 Contra revenue account (debit) to Sales Revenue.

5-36 LO 3
 SALES DISCOUNTS

Illustration: Assume Sauk Stereo pays the balance due of

$3,500 (gross invoice price of $3,800 less purchase returns
and allowances of $300) on May 14, the last day of the
discount period. Prepare the journal entry PW Audio Supply
makes to record the receipt on May 14.

May 14 Cash 3,430 *

Sales Discounts 70
Accounts Receivable 3,500

* [($3,800 – $300) X 2%]

5-37 LO 3
 DO IT! 3 Sales Transactions

On September 5, De La Hoya Company buys merchandise on

account from Junot Diaz Company. The selling price of the goods is
$1,500, and the cost to Diaz Company was $800. On September 8,
De La Hoya returns goods with a selling price of $200 and a cost of
$105. Record the sale on the books of Junot Diaz Company.

SOLUTION

Sept. 5 Accounts Receivable 1,500

Sales Revenue 1,500

Sept. 5 Cost of Goods Sold 800

Inventory 800

5-38 LO 3
 DO IT! 3 Sales Transactions

On September 5, De La Hoya Company buys merchandise on

account from Junot Diaz Company. The selling price of the goods is
$1,500, and the cost to Diaz Company was $800. On September 8,
De La Hoya returns goods with a selling price of $200 and a cost of
$105. Record the return on the books of Junot Diaz Company.

SOLUTION

Sept. 8 Sales Returns and Allowances 200

Accounts Receivable 200

Sept. 8 Inventory 105

Cost of Goods Sold 105

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 Prepare a multiple-step income statement
LEARNING
OBJECTIVE 4 and a comprehensive income statement.

SINGLE-STEP INCOME STATEMENT

 Subtract total expenses from total revenues
 Two reasons for using the single-step format:
1. Company does not realize any type of profit or
income until total revenues exceed total
expenses.

2. Form is simple and easy to read.

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 SINGLE-STEP INCOME STATEMENT

Illustration 5-7

ILLUSTRATION 5-7
5-41 Single-step income statements LO 4
 MULTIPLE-STEP INCOME STATEMENT

 Highlights the components of net income.

 Three important line items:
1. gross profit,

2. income from operations, and

3. net income.

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 MULTIPLE-STEP INCOME STATEMENT

Key
Line
Items

ILLUSTRATION 5-8
Multiple-step income
statements

5-43 LO 4
MULTIPLE-
STEP

Key Items:
 Sales

ILLUSTRATION 5-11
5-44 LO 4
MULTIPLE-
STEP

Key Items:
 Sales
 Gross Profit

ILLUSTRATION 5-11
5-45 LO 4
MULTIPLE-
STEP

Key Items:
 Sales
 Gross Profit
 Operating
Expenses

ILLUSTRATION 5-11
5-46 LO 4
MULTIPLE-
STEP

Key Items:
 Sales
 Gross Profit
 Operating
Expenses
 Nonoperating
Activities

ILLUSTRATION 5-11
5-47 LO 4
MULTIPLE-
STEP

Key Items:
 Sales
 Gross Profit
 Operating
Expenses
 Nonoperating
Activities

ILLUSTRATION 5-11
5-48 LO 4
MULTIPLE-
STEP

Key Items:
 Sales
 Gross Profit
 Operating
Expenses
 Nonoperating
Activities
 Net Income

ILLUSTRATION 5-11
5-49 LO 4
 MULTIPLE-STEP INCOME STATEMENT

Review Question
The multiple-step income statement for a merchandiser
shows each of the following features except:

a. gross profit.

b. cost of goods sold.

c. a sales revenue section.

d. investing activities section.

5-50 LO 4
 ETHICS INSIGHT IBM

Disclosing More Details

After Enron, increased investor criticism and regulator scrutiny
forced many companies to improve the clarity of their financial
disclosures. For example, IBM began providing more detail regarding
its “Other gains and losses.” It had previously included these items in
its selling, general, and administrative expenses, with little disclosure.
For example, previously if IBM sold off one of its buildings at a gain, it
included this gain in the selling, general, and administrative expense
line item, thus reducing that expense. This made it appear that the
company had done a better job of controlling operating expenses
than it actually had. As another example, when eBay recently sold
the remainder of its investment in Skype to Microsoft, it reported a
gain in “Other revenues and gains” of $1.7 billion. Since eBay’s total
income from operations was $2.4 billion, it was very important that
the gain from the Skype sale not be buried in operating income.

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 COMPREHENSIVE INCOME STATEMENT

Comprehensive income statement presents items that are

not included in the determination of net income.
Items excluded from net income but included in
comprehensive income are either reported in a combined
statement of net income and comprehensive income, or in a
separate comprehensive income statement. ILLUSTRATION 5-12
Combined statement of net
income and comprehensive
income

5-52 LO 4
 DO IT! 4 Multiple-Step Income Statement

The following information is available for Art Center Corp. for the year
ended December 31, 2017.
Other revenues and gains $ 8,000 Sales revenue $462,000
Other expenses and losses 3,000 Operating expenses 187,000
Cost of goods sold 147,000 Sales discounts 20,000
Other comprehensive
income 10,000
Prepare a multiple-step income statement and comprehensive income
statement for Art Center Corp. The company has a tax rate of 25%. This
rate also applies to other comprehensive income.

5-53 LO 4
 Prepare a multiple-step income statement and comprehensive
income statement for Art Center Corp. (statement heading omitted).

5-54 LO 4
 Prepare a multiple-step income statement and comprehensive income
statement for Art Center Corp.

5-55 LO 4
 Determine cost of goods sold under a
LEARNING
OBJECTIVE 5 periodic inventory system.

Periodic Inventory System

 No running account of changes in inventory.
 Ending inventory determined by physical count.
 Cost of goods sold not determined until the end of the
period.
ILLUSTRATION 5-13
Basic formula for cost of goods
sold using the periodic system

5-56 LO 5
 Periodic Inventory System

ILLUSTRATION 5-14
Cost of goods sold for a merchandiser
5-57 using a periodic inventory system LO 5
 DO IT! 5 COGS—Periodic System
Aerosmith Company’s accounting records show the following at the yearend
December 31, 2017.
Purchase Discounts $ 3,400 Freight-In 6,100
Purchases 162,500 Beginning Inventory 18,000
Ending Inventory 20,000 Purchase Returns and Allowances 5,200
Assuming that Aerosmith Company uses the periodic system, compute (a) cost of
goods purchased and (b) cost of goods sold.

SOLUTION
Beginning Inventory $ 18,000
Purchases $ 162,500
Purchase Returns and Allowances - 5,200
Purchase Discounts - 3,400
Freight-In + 6,100 160,000 (a)
Goods Available for Sale 178,000
Ending Inventory - 20,000
Cost of Goods Sold $ 158,000 (b)
5-58 LO 5
 Compute and analyze gross profit rate
LEARNING
OBJECTIVE 6 and profit margin.

GROSS PROFIT RATE

May be expressed as a percentage by dividing the
amount of gross profit by net sales.
A decline in the gross profit rate might have several causes.
► Selling products with a lower “markup.”
► Increased competition may result in a lower selling price.
► Company forced to pay higher prices to its suppliers
without being able to pass these costs on to its customers.

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 GROSS PROFIT RATE

ILLUSTRATION 5-16
Gross profit rate
Why does REI’s gross profit rate differ so
much from that of Dick’s Sporting Goods and
the industry average?
5-60 LO 6
 PROFIT MARGIN

The profit margin measures the percentage of each

dollar of sales that results in net income.

How do the gross profit rate and profit margin ratio differ?
► Gross profit rate measures the margin by which
selling price exceeds cost of goods sold.
► Profit margin ratio measures the extent by which
selling price covers all expenses (including cost of
goods sold).

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 PROFIT MARGIN

ILLUSTRATION 5-18
Profit margin
How does REI compare to its competitors? Its
profit margin was lower than Dick’s in 2014 and
was less than the industry average. Thus, its profit
margin does not suggest exceptional profitability.
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 PEOPLE, PLANET, AND PROFIT INSIGHT
Selling Green
Here is a question an executive of PepsiCo Inc. was asked: Should
PepsiCo market green? The executive indicated that the company
should, as he believes it’s the No. 1 thing consumers all over the
world care about. Here are some of his thoughts on this issue:
“Sun Chips are part of the food business I run. It’s a ’healthy
snack.’ We decided that Sun Chips, if it’s a healthy snack, should be
made in facilities that have a net-zero footprint. In other words, I want
off the electric grid everywhere we make Sun Chips. We did that. Sun
Chips should be made in a facility that puts back more water than it
uses. It does that. And we partnered with our suppliers and came out
with the world’s first compostable chip package.
Now, there was an issue with this package: It was louder than the
(continued)
5-63 LO 6
 PEOPLE, PLANET, AND PROFIT INSIGHT
Selling Green
New York subway, louder than jet engines taking off. What would a
company that’s committed to green do: walk away or stay
committed? If your people are passionate, they’re going to fix it for
you as long as you stay committed. Six months later, the
compostable bag has half the noise of our current package.
So the view today is: we should market green, we should be
proud to do it . . . it has to be a 360 process, both internal and
external. And if you do that, you can monetize environmental
sustainability for the shareholders.”
Source: “Four Problems—and Solutions,” Wall Street Journal (March 7,
2011), p. R2.

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 KEEPING AN EYE ON CASH

Earnings have high quality if they provide a full and

transparent depiction of how a company performed.

► A measure significantly less than 1 suggests that a

company may be using more aggressive accounting
techniques in order to accelerate income recognition.
► A measure significantly greater than 1 suggests that a
company is using conservative accounting techniques
which cause it to delay the recognition of income.
5-65 LO 6
 DO IT! 6 Gross Profit Rate and Profit Margin

Rachel Rose, Inc. reported the following in its 2017 and 2016 income
statements.
2017 2016
Net sales $80,000 $120,000
Cost of goods sold 40,000 60,000
Operating expenses 14,000 28,000
Income tax expense 8,000 12,000
Net income $18,000 $ 20,000

Determine the company’s gross profit rate and profit margin.

2017 2016
($80,000 − $40,000) ($120,000 − $60,000)
= 50% = 50%
$80,000 $120,000

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 DO IT! 6 Gross Profit Rate and Profit Margin

Rachel Rose, Inc. reported the following in its 2017 and 2016 income
statements.
2017 2016
Net sales $80,000 $120,000
Cost of goods sold 40,000 60,000
Operating expenses 14,000 28,000
Income tax expense 8,000 12,000
Net income $18,000 $ 20,000

Determine the company’s gross profit rate and profit margin.

2017 2016
$18,000 ÷ $80,000 = 22.5% $20,000 ÷ $120,000 = 16.7%

5-67 LO 6
 APPENDIX 5A: Record purchases and sales of
LEARNING
OBJECTIVE *7 inventory under a periodic inventory system.

RECORDING MERCHANDISE TRANSACTIONS

 Record revenues when sales are made.
 Do not record cost of merchandise sold on the date of sale.
 Physical inventory count determines:
► Cost of merchandise on hand and
► Cost of merchandise sold during the period.

 Record purchases in Purchases account.

 Purchase returns and allowances, Purchase discounts, and
Freight costs are recorded in separate accounts.
5-68 LO 7
 RECORDING PURCHASE OF
MERCHANDISE

Illustration: On the basis of the sales invoice (Illustration 5-5)

and receipt of the merchandise ordered from PW Audio
Supply, Sauk Stereo records the $3,800 purchase as follows.

May 4 Purchases 3,800

Accounts Payable
3,800

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 FREIGHT COSTS

Illustration: If Sauk pays Public Freight Company $150

for freight charges on its purchase from PW Audio Supply
on May 6, the entry on Sauk’s books is:

May 6 Freight-in (Transportation-in) 150

Cash
150

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 Purchase Returns and Allowances

Illustration: Sauk Stereo returns $300 of goods to PW Audio

Supply and prepares the following entry to recognize the
return.

May 8 Accounts Payable 300

Purchase Returns and Allowances 300

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 Purchase Discounts

Illustration: On May 14 Sauk Stereo pays the balance due

on account to PW Audio Supply, taking the 2% cash
discount allowed by PW Audio for payment within 10 days.
Sauk Stereo records the payment and discount as follows.

May 14 Accounts Payable 3,500

Purchase Discounts
70
Cash
3,430

5-72 LO 7
 RECORDING SALES OF MERCHANDISE

Illustration: PW Audio Supply, records the sale of $3,800 of

merchandise to Sauk Stereo on May 4 (sales invoice No.
731, Illustration 5-5) as follows.

May 4 Accounts Receivable 3,800

Sales Revenue
3,800

No entry is recorded for cost of goods sold at the time of the

sale under a periodic system.

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 Sales Returns and Allowances

Illustration: To record the returned goods received from

Sauk Stereo on May 8, PW Audio Supply records the $300
sales return as follows.

May 8 Sales Returns and Allowances 300

Accounts Receivable
300

5-74 LO 7
 Sales Discounts

Illustration: On May 14, PW Audio Supply receives

payment of $3,430 on account from Sauk Stereo. PW Audio
honors the 2% cash discount and records the payment of
Sauk’s account receivable in full as follows.

May 14 Cash 3,430

Sales Discounts 70
Accounts Receivable 3,500

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 COMPARISON OF ENTRIES—
PERPETUAL VS. PERIODIC

5-76 LO 7
 COMPARISON OF ENTRIES—
PERPETUAL VS. PERIODIC

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 A Look at IFRS

LEARNING Compare the accounting for

OBJECTIVE 8 merchandising under GAAP and IFRS.

KEY POINTS
Similarities
 Under both GAAP and IFRS, a company can choose to use
either a perpetual or a periodic inventory system.
 The definition of inventories is basically the same under GAAP
and IFRS.

5-78 LO 8
 A Look at IFRS

KEY POINTS
Similarities
 As indicated above, the basic accounting entries for
merchandising are the same under both GAAP and IFRS.
 Both GAAP and IFRS require that income statement information
be presented for multiple years. For example, IFRS requires that
2 years of income statement information be presented, whereas
GAAP requires 3 years.

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 A Look at IFRS

KEY POINTS
Differences
 Under GAAP, companies generally classify income statement
items by function. Classification by function leads to descriptions
like administration, distribution, and manufacturing. Under IFRS,
companies must classify expenses either by nature or by
function. Classification by nature leads to descriptions such as
the following: salaries, depreciation expense, and utilities
expense. If a company uses the functional-expense method on
the income statement, disclosure by nature is required in the
notes to the financial statements.

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 A Look at IFRS

KEY POINTS
Differences
 Presentation of the income statement under GAAP follows
either a single-step or multiple-step format. IFRS does not
mention a single-step or multiple-step approach.
 Under IFRS, revaluation of land, buildings, and intangible assets
is permitted. The initial gains and losses resulting from this
revaluation are reported as adjustments to equity, often referred
to as other comprehensive income. The effect of this
difference is that the use of IFRS result in more transactions
affecting equity (other comprehensive income) but not net
income.
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 A Look at IFRS

LOOKING TO THE FUTURE

The IASB and FASB are working on a project that would rework the
structure of financial statements. A main goal of this new approach is
to provide information that better represents how businesses are run.
This approach draws attention away from just one number—net
income. It will adopt major groupings similar to those currently used by
the statement of cash flows (operating, investing, and financing), so
that numbers can be more readily traced across statements. For
example, the amount of income that is generated by operations would
be traceable to the assets and liabilities used to generate the income.
Finally, this approach would also provide detail, beyond that currently
seen in most statements (either GAAP or IFRS), by requiring that line
items be presented both by function and by nature.
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 A Look at IFRS

IFRS Practice
Which of the following would not be included in the definition of
inventory under IFRS?
a) Photocopy paper held for sale by an office-supply store.
b) Stereo equipment held for sale by an electronics store.
c) Used office equipment held for sale by the human relations
department of a plastics company.
d) All of the above would meet the definition.

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 A Look at IFRS

IFRS Practice
Which of the following would not be a line item of a company
reporting costs by nature?
a) Depreciation expense.
b) Salaries expense.
c) Interest expense.
d) Manufacturing expense.

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 A Look at IFRS

IFRS Practice
Which of the following would not be a line item of a company
reporting costs by function?
a) Administration.
b) Manufacturing.
c) Utilities expense.
d) Distribution.

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