Venus Cellular

Topics: Generally Accepted Accounting Principles, Income statement, Balance sheet Pages: 7 (1843 words) Published: April 22, 2013

Venus Cellular

Question 1: Identify whether the analysis of expenses in profit or loss is presented by nature or function.

In accordance with IFRS, presentation of financial information in the statement of profit or loss requires that expenses be classified based on either their nature or function within the operation. IAS 1.99 states that “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.” IAS 1.101 further explains, “expenses are sub classified to highlight components of financial performance that may differ in terms of frequency, potential for gain or loss and predictability. This analysis is provided in one of two forms.” The first form of analysis, by ‘nature of expense’, is defined in IAS 1.102. Under this method, “an entity aggregates expenses within profit or loss according to their nature, and does not reallocate them among functions within the entity.” Examples of classification by nature include depreciation, purchases of materials, transport costs, employee benefits, and advertising costs. Because there is no allocation of expenses by function, the application of this method tends to be more simplistic. Upon observation, we recognize that this is not the prevailing method utilized in the preparation of the statement of profit or loss by Venus Cellular.

The presence of the ‘cost of sales’ in this statement highlights the distinguishing factor in the presentation of the statement of profit or loss using the ‘function of expense’ or ‘cost of sales’ method of presentation. IAS 1.103 states, “the second form of analysis is the ‘function of expense’ or ‘cost of sales’ method and classifies expenses according to their function as part of cost of sales or, for example, the cost distribution or administrative activities. At a minimum, an entity discloses its cost of sales under this method separately from other expenses.” Due to the provisions for line items including Cost of sales and Administrative and selling expenses provided by Venus Cellular, it is quite clear they have employed an analysis by function in the presentation of expenses. IAS 103 goes on to state, “this method can provide more relevant information to users than the classification of expenses by nature, but allocating costs to functions may require arbitrary allocations and involve considerable judgement.” For instance, consider transportation costs. Shipping costs incurred to transport products to customers or distribution centers would be classified under Distribution costs, while transportation costs incurred by internal auditors traveling to various production facilities or a sales manager’s flight costs to attend a trade show, would be classified in Administrative and selling expense.

IAS 1.103 also provides an example of a classification 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

It’s important to note IAS 104, which states, “an entity classifying expenses by function shall disclose additional information on the nature of expenses, including depreciation and amortization expense and employee benefit expense.” The reason for such disclosures is seen in IAS 105, which explains, “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.” Finally, IAS 105 provides, “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...
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