From the book:
" Ending retained earnings = Beginning retained earnings + Revenues − Expenses − Dividends "
" As its name suggests, retained earnings represent the earnings (i.e., net income ) that are retained by the company "
Elsewhere in the book:
" Net income = Income – Expenses"
I’m missing something. Is it ‘revenue - expenses’ or ‘income - expenses’?
Thanks for your help :]
Net income is _ revenue less expenses_; it’s probably a bad idea to use income as a synonym for revenue.
Note, too, that the dividends cited in the retained earnings equation are dividends _ declared _, not dividends paid.
Thanks, clear and helpful as always. It should be easier to get clear definitions such basic terminology without asking!
Are these conflicts in the book or just two concepts with the same name?
----- page 47:
" Revenue – Expenses = Net income (loss)"
----- page 17:
" The basic equation underlying the income statement is Revenue + Other income – Expenses = Income – Expenses = Net income. "
" Other income includes gains , which may or may not arise in the ordinary activities of the business "
So gains/losses are or aren’t included in “net income” / “bottom line” ?
On the Danone income statement exmaple (page 151/152) the “Net income” line includes interest income (which isn’t revenue)
That depends on the context. Revenue is usually the biggest component of gross and net income, although these are accounting terms, revenue is an income in any case. Netting out income and expenses gives you the net income, so it’s probably a bad idea to use net income as it’s synonym.
There are no mistakes, income is the realized inflow of monetary value, that includes all forms of income. Other income here may not mean other comprehensive income (OCI) which are non-operating accumluated gains/loses that are either unrealized, or unqualified to take part of net income such as unrealized P&L’s on available for sale securities (only non-financial firms), currency translations, or changes in the NAV of a defined benefit plan. These are usually included as part of comprehensive income, below the income statement, or on a seperate form.
Other income on the other hand, may refer to income that is part of the company’s earnings, but not part of recurring business operation. Like interest income, rent income, income on equity investments, gain on sale of assets or securities, or asset revaluation (up to the point of previous write-down). Note that a line item other income is usually included in many company’s IS, and it usually an aggregate of non-operating gains and loses net together under other income, or other non-operating income, and can be a negative value. While recurring financial income (interest income, deferred taxes) are included below operating income.
Yes, so ‘revenue’ and ‘income’ and not equal. So how can the book say both of these equations:
_ Revenue – Expenses = Net income _
_ Income – Expenses = Net income _
2014 FRA (book 3) pages 47 and 17.
Must be a mistake, right?
The first one is a more simple equation, and still intuitively correct. It assumes that revenue is your only source of inflow, and cost of goods sold and possibly any fixed assets are expenses. It’s a more simple business model than you can find for bigger public companies.
The other equation is also correct, but it assumes that revenue might not be the only source of income, and includes potentially both operating, and non-operating income.
Don’t get caught up on insignficant details. This is just the beginning of the book. An 8 year old would understand clearly that the money you’re left with is the money you get minus the money you spend. That’s what net income means, and I’m sure you clearly understand the concept as well.
Fine, I can accept that. But I wish they weren’t so careless with equations.
So back to the original question, which one of these is correct:
*** Ending retained earnings = Beginning retained earnings + Revenues − Expenses − Dividends
*** Ending retained earnings = Beginning retained earnings + Income - Expenses − Dividends
In other words… to gains go towards retained earnings?
Both are correct.
Assuming clean surplus accounting, retained earnings is the amount of earnings you plough back into your capital after distributing cash to shareholders. So RE = NI - Dividends.
OCI are not included in RE. Only the bottom line of the income statement. The second equation is more correct for a public company, since they generally have more than one type of income besides core operating revenue/sales, like investments in other companies, interest income from excess cash investments, or gains on sale of assets or reverse of asset write downs.
The former equation is more common in small business models like a lemonade stand where revenue is your only source of income.
Thanks
Income is sometime synonymous of revenue.
Net income is when you net out the income by deducting the expenses from all the incomes (Revenue).
Both are correct if you consider Revenues means Income. But the upper one is more likely to be used.
Don’t confuse it with the net ncome. Emphasise on NET. Net is a particular amount at the end of a process. So “Net Income” comes at the end of income statement.
Gains can be different from OCI.
OCI is tranferred directly to equity on the balance sheet and not reflected on the income statement or retained earnings. - includes things like unrealized gains/losess on available for sale securities - actuarial gains/losses on pension obligations
GAINS are transferred through profit/loss on the income statement and through retained earnings. - these are things like gains on sale of fixed assets, or gains - unrealized gains/losses due to foreign currency translation
What?
I think he’s right? currency adjustments for a foreign subsidiary goes to OCI, all else goes to ‘gains’,
Either way… the question of this thread is answered: in the FRA book, the equals sign has a very loose definition of ‘equal’
He wrote currency translations under gains, not OCI.
I was simply highlighting the point that not all ‘income’ is included in RE. And gave examples of instances in which it would flow through RE and instances where it is transferred directly to equity.
How would gains/losses of currency translation flow through retained earnings?
Not sure if I understand your question correctly.
If you are wondering how unrealized gains/losses arise from foreigh currency translation consider this:
You own a multinational company with a local currency of USD and your fiscal year end is Dec.31. You also operate in China, where this use the Renmimbi, RMB. The current exhxanage rate RMB/USD is 10. You purchase manufactured goods from China on Nov 30 on credit for 100 RMB to be paid on Jan 31, and create an accounts payable for 10 USD (100/10=10). When your fiscal year end rolls around, the RMB/USD is 11. Since you are now able to pay back your debt with less USD ((100/11=9.09), you will have recorded an unrealized gain on the income statement. (10 - 9.09 = 0.91). You will also report your accounts payable as 9.09 USD instead of 10 USD due to the currency appreciation.
Well it’s a small point and off topic, but interesting.
From what little I’ve read, in CFA terms, the word ‘translation’ seems to be reserved for reporting currently held assets/liabilities from another currency.
Also is it common to use the word ‘unrealized gains’ in relation to ‘accrued expenses’/‘accounts payable’? I’ve only seen it so far in connection with assets.
Don’t you mean USD/RMB?
I understand all that, my question was if and why unrealized currency translations are recorded on the income statement, and not OCI?