ACC1001 · Accounting Fundamentals
Income Statements & Changes in Equity
Income Statements & Changes in Equity measures performance over a period: Income − Expenses = Profit, the difference between a trading entity (with cost of sales and gross profit) and a service entity (without), and depreciation as the unit's worked case of accounting-policy choice. The statement of changes in equity is the link statement that carries profit into the balance sheet. It is examined by interpreting and explaining — including why a method choice changes reported profit even though the asset is identical.
What this chapter covers
- 011. The income statement (profit or loss): measuring performance over a period on the accrual basis
- 022. Income − Expenses = Profit (Loss); uses two of the five elements
- 033. Trading vs service entity: gross profit = Sales − Cost of sales; service has no COGS
- 044. Expense groupings: selling, administrative/general, financial (interest), income tax
- 055. Depreciation as accounting-policy choice: straight-line, reducing balance, units of production
- 066. How a policy choice shifts reported profit (an example of accounting discretion)
- 077. The statement of changes in equity (SOCE): the link between income statement and balance sheet
- 088. SOCE roll-forward: opening equity + profit + capital − drawings/dividends = closing equity
Depreciation policy choice — three methods, year 1
- +1(a) Straight-line = (Cost − Residual) ÷ Useful life = (48,000 − 0) ÷ 6 = $8,000 per year.
- +1(b) Reducing balance = Carrying amount × rate = 48,000 × 25% = $12,000 in year 1 (more expense early).
- +2(c) Units of production = Cost × (units this period ÷ total expected units) = 48,000 × (120,000 ÷ 400,000) = 48,000 × 0.30 = $14,400.
- +1Units of production reports the highest year-1 expense ($14,400) here, ahead of reducing balance ($12,000) and straight-line ($8,000).
- +1Explain why it matters: the asset is identical, yet the policy choice changes reported profit — higher depreciation means lower profit this year. This is the discretion that makes depreciation a textbook example of accounting-policy choice (and a lever for earnings management).
Key terms
- Income statement (profit or loss)
- A statement measuring performance over a period on the accrual basis: Income − Expenses = Profit (Loss). It uses two of the five elements — income and expenses.
- Gross profit
- For a trading entity, Sales revenue − Cost of sales. It shows the margin left after the cost of the goods sold, before operating expenses. A service entity has no cost of sales, so it reports no gross profit line.
- Accounting-policy choice
- Where standards permit more than one acceptable treatment, management chooses a policy — depreciation method being the unit's main example. Because the choice changes reported profit for an identical asset, it is a source of discretion and potential earnings management.
- Depreciation methods
- Straight-line = (Cost − Residual) ÷ Useful life, equal each period. Reducing (diminishing) balance = Carrying amount × rate, more expense early. Units of production = Cost × (units this period ÷ total expected units). They apply to buildings, plant and equipment — not land.
- Statement of changes in equity (SOCE)
- The link statement between the income statement and the balance sheet: Closing equity = Opening equity + Profit (− Loss) + Additional capital − Drawings/Dividends (± revaluations).
- Trading vs service entity
- A trading entity sells goods, so its income statement shows Sales − Cost of sales = Gross profit, then operating expenses. A service entity sells services and has no cost of sales, so it goes straight from income to expenses to profit.
Income Statements & Changes in Equity FAQ
What is the difference between a trading and a service income statement?
A trading entity sells goods, so its income statement first shows Sales revenue minus Cost of sales to get gross profit, then deducts operating expenses to reach profit. A service entity sells services and has no cost of sales, so there is no gross-profit line — it simply deducts all expenses from income. Knowing which form to use is a common exam check.
Why is depreciation called an accounting-policy choice?
Because more than one method is acceptable — straight-line, reducing balance and units of production — and each gives a different expense, and therefore a different reported profit, for exactly the same asset. Management's choice of method is a genuine policy decision, which is why depreciation is the unit's standard illustration of accounting discretion and the scope for earnings management. Monash does not ask you to calculate it; it asks you to explain the effect.
What does the statement of changes in equity do?
It is the link statement that connects the income statement to the balance sheet. It takes opening owner's equity, adds the profit from the income statement (or subtracts a loss), adds any additional capital the owner contributed, subtracts drawings or dividends (and adjusts for any revaluations), and arrives at closing equity — which is the equity figure that appears on the balance sheet.
Does depreciation apply to land?
No. Depreciation spreads the cost of an asset over its useful life, and land is treated as having an indefinite life, so it is not depreciated. Depreciation applies to assets such as buildings, plant and equipment, and land improvements. This is a frequent classification trap — remember that land itself is the exception.
Exam move
Separate the two statements in your mind: the income statement measures performance over a period, while the SOCE rolls equity forward and links that profit into the balance sheet. Practise both the trading layout (Sales − Cost of sales = Gross profit, then operating expenses) and the service layout (no COGS) so you instantly pick the right form. For depreciation, focus on the argument rather than the arithmetic — the same asset gives different profit under different methods, which is why it is the unit's accounting-policy-choice example; just be able to set up each method and explain the earnings-management angle. Memorise the SOCE roll-forward line. Because Monash says you will not calculate depreciation, rehearse explaining its effect, not crunching it, and take wording from the lecture slides.
