Explain What Are The Two Types Of Presentation Of Expenses Format Recognized In The Income Statement In Accordance to FRS 101 Presentation of Financial Statements

November 30th, 2009 Comments off
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Under Malaysia FRS 100 an entity shall present an analysis of expenses recognized in profit or loss using a classification based on either 

  • their nature or  
  • their function within the entity, 

whichever provides information that is reliable and more relevant. 

This article looks at the two methods of presenting the expenses format in the Income Statement. 

(1)  Applying the  ‘Nature of expense’ method.  

An entity aggregates expenses within profit or loss according to their nature for example:

  • depreciation, purchases of materials, transport costs, employee benefits and advertising costs)
  • the expenses are not reallocate among functions within the entity.  

The main advantage of using this “nature of expense” method is that it is simple to apply because no allocations of expenses to functional classifications are necessary.

Income Statement Format using  the nature of expense method: 

 

$

$

Revenue

 

X

Other Income

 

X

Changes in inventories of finished goods and work in progress

X

 

Raw materials and consumables used

X

 

Employee benefits expense

X

 

Depreciation and amortization expense

X

 

Other expenses

X

 

Total Expenses

 

(X)

Profit Before tax

 

X

 

(2) Applying the ‘Function of expense’ or ‘Cost of sales’ Method  

An entity classifies expenses according to their function as part of cost of sales or, for example, the costs of distribution or administrative activities. At a minimum, an entity discloses its cost of sales under this method separately from other expenses. 

The advantage of this “function of expense method” is that it can provide more relevant information to users than the classification of expenses by nature, but the disadvantage is that the allocating of costs to functions may require arbitrary allocations which involve considerable judgement. 

Income Statement Format using the function of expense method: 

 

$

Revenue

X

Cost of sales

(X)

Gross Profit

X

Other Income

X

Distribution costs

(X)

Administrative expenses

(X)

Other expenses

(X)

Profit before tax

X

 Note that if an entity classifies its  expenses by function, it should also disclose the following additional information on the nature of expenses, including depreciation and amortisation expense and employee benefits expense.

 Salient points: 

  • The choice between the function of expense method and the nature of expense method depends on historical and industry factors and the nature of the entity. 
  • Both methods provide an indication of those costs that might vary, directly or indirectly, with the level of sales or production of the entity.
  • Because each method of presentation has merit for different types of entities, FRS 101requires management to select the presentation that is reliable and more relevant. However, because information on the nature of expenses is useful in predicting future cash flows, additional disclosure is required when the function of expense classification is used.

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Financial Accounting

 
 

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