5676.0 - Business Indicators, Australia, Sep 2012  
ARCHIVED ISSUE Released at 11:30 AM (CANBERRA TIME) 03/12/2012   
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FEATURE ARTICLE: BUSINESS INDICATORS SURVEY - PROFIT MEASURES


INTRODUCTION

This feature article presents a summary of profit measures published in Business Indicators, Australia (ABS cat. no. 5676.0). The estimates are of use in their own right, by assisting the Australian community monitor business profitability over time, and are also used to compile the income account of quarterly Gross Domestic Product (GDP).


BUSINESS INDICATORS SURVEY - PROFIT MEASURES

Company gross operating profits

Company gross operating profits (CGOP) is an accounting concept used to measure the profitability of a company's production process (of goods and services), excluding the effects of financing activities and income tax. CGOP data is not collected directly by the ABS from survey respondents. The Business Indicators Survey collects total income and expense data directly and then removes the components that are not part of the production process. CGOP is derived as:

Company Gross Operating Profit

= (total income - interest income - gains from variations in foreign exchange rates- unrealised gains from revaluation of assets - profit on the sale of assets - dividend income)

less (total expenses - interest expense - depreciation/amortisation)

plus (change in book value of inventories)

CGOP is published in its own right as well as used to compile Private non-financial corporations Gross Operating Surplus (GOS) in the income account of quarterly Gross Domestic Product (GDP). Quarterly GDP is published in Australian National Accounts: National Income, Expenditure and Product (ABS cat. no. 5206.0). CGOP data for a selection of industries from the Business Indicators Survey is used to compile the GOS estimates. Financial and Insurance Services, Education and Training, and Health Care & Social Assistance industries are all excluded.

GOS is an economic concept and represents the surplus accruing to businesses from their production of goods and services. While both CGOP and GOS are the operating surplus remaining after the costs of production are deducted from the income earned, there is one important difference. This difference relates to the Inventory Valuation Adjustment (IVA).


Inventory Valuation Adjustment

CGOP is defined as income less a number of expenses as well as the change in the book value of inventories. The book value is the value of inventories recorded in the business' financial accounts, often using historical prices of products (i.e. at a price when the product entered inventory).

When prices of products change within an accounting period, this can result in a holding gain/loss on inventories held. For instance, in a period where prices rise, the change in book value will include both the value of the physical increase or decrease in inventories and an increase in value due to the effect of rising prices on the value of inventories held. A holding gain will occur when the volume of inventories has increased or is unchanged and prices have increased (and vice versa).

For national accounting purposes, holding gains/losses are not included in GOS. This is because the holding gain/loss is not a result of the production process (economic activity). The holding gain/loss recorded for inventories is deducted from CGOP via the IVA to derive GOS. The IVA is measured as a dollar value.

IVA is calculated as the difference between the book value change in inventories and the physical change in inventories, valued at average current prices. Change in inventories is calculated separately for three sectors: 1) private non-farm; 2) farm; and 3) public authorities.

Example: The relationship between company gross operating profits and gross operating surplus

A hypothetical company is now used to illustrate how CGOP is used to compile GOS.

Consider a private non-financial company operating within the Australian economy. In a particular quarter, it earns income of $1,000,000 from its production of goods and services. Income not earned from its production process is excluded, such as financing activities. During the quarter, the company also incurs expenses as a result of its production process. It pays $300,000 in wages and salaries and employer's contribution to superannuation, incurs $200,000 in expenses as a result of the production process, including the change in book value of inventories. Expenses not related to the normal production process are excluded.

CGOP is the sum of these flows, which is $500,000. IVA is $4,150. GOS is the sum of these flows less the IVA, which is $495,850. Table 1 displays the derivation of company gross operating profit and GOS.

TABLE1


Income from production of goods & servicesplus

Income unrelated to production of goods & services

less

Compensation of Employees (including wages and superannuation)
less

Production expenses (including change in book value of inventories)
less

Non-production expenses

less

Inventory Valuation Adjustment (IVA)
equals

“Profit”

GOS1,000,000*N/A300,000200,000N/A4,150495,850

CGOP1,000,000N/A300,000200,000N/AN/A500,000

*Simplified definition abstracting from several minor conceptual differences.

The company's production expenses of $200,000 include the change in book value of inventories. Deriving the IVA from book value data is described below.


(1) Change in book value
  • deflators for the opening and closing book values are constructed based on assumptions as to how businesses value their inventories

    Book value of inventories at end of quarter t
    105,000
    Book value of inventories at end of quarter t+1
    148,800
    Change in book value of inventories
    43,800
    Base of price index
    100
    Price index at end of quarter t
    120
    Price index at end of quarter t+1
    124
    Average price index for quarter t+1
    122



(2) Revaluation to constant prices
  • the opening and closing book values are expressed in constant prices (only closing levels are available, so the opening level of one period is set equal to the closing level of the previous period)
  • the values are differenced to obtain changes in inventories at constant prices

    Constant price level   = book value ÷ price index × 100
    Constant price value of inventories at end of quarter t = 105,000 ÷ 120 × 100
    = 87,500
    Constant price value of inventories at end of quarter t+1 = 148,800 ÷ 124 × 100
    =120,000
    Constant price change in inventories = 120,000 - 87,500
    = 32,500



(3) Revaluation to current quarter prices
  • the values at constant prices are inflated to obtain current price changes in inventories

    Current price change in inventories = change in inventories at constant prices × average price index for current quarter ÷ 100
    = 32,500 × 122 ÷ 100
    = 39,650



(4) Derivation of the IVA
  • the IVA is the difference between the changes in inventories calculated using book values and those calculated at current prices

    IVA = change in book value - physical change at current quarter prices
    = 43,800
    = change in book value - current price change in inventories (IVA adjusted)
    = 9,650
    = 4,150




Unincorporated gross operating profits

Unincorporated gross operating profits (UGOP) reflect profits for unincorporated businesses. An unincorporated business is an entity created to produce goods or services, and is entirely owned by one or more members of the same household. It is treated as a part of that household and not as a separate legal institutional unit, that is, a corporation . UGOP is used to compile quarterly Gross Mixed Income (GMI) estimates in Australian National Accounts: National Income, Expenditure and Product (ABS cat. no. 5206.0).

GMI is the operating surplus accruing to owners of unincorporated businesses from the production of goods and services. The term 'mixed income' is used because the surplus arising from the production process for unincorporated businesses can comprise returns to the capital of the household and returns to the labour of the household. In other words, it is a combination of compensation of employees and operating surplus accruing to the owners of unincorporated businesses.

UGOP contribute to Non-farm GMI in the quarterly national accounts. All industries included in the Business Indicators Survey contribute to Non-farm GMI, excluding Financial & Insurance Services.


Business gross operating profits

Business gross operating profit (BGOP) is the sum of unincorporated gross operating profits and company gross operating profits. The term 'business' is used to include both corporations and unincorporated businesses.


Company profits before income tax

Company profits before income tax is equivalent to the accounting term 'earnings before taxes' (EBT). This measure is often used to monitor company profits without the impact of changes in tax rates or differences between tax jurisdictions. Company profits before income tax is measured as net operating profit or loss before income tax and extraordinary items and is net of capital profits or losses arising from the sale of businesses' own capital goods and dividends received. Extraordinary items are gains or losses from events that are infrequent and unusual in nature. For example, losses sustained as a result of a natural disaster may qualify as an extraordinary loss for entities that do not operate in a region subject to such events .

Data on company profits before income tax is not collected directly from survey businesses. It is derived from a range of data items that are directly collected.

Company profits before income tax

= (total income - profit on the sale of assets - dividend income)

less (total expenses)

plus (change in book value of inventories)


SUMMARY

Profit measures are essential to understand Australia's economic performance. This article provides a summary of the various measures of profit published in Business Indicators, Australia and describes how profits data are used to compile the income components of GDP.


REFERENCES

Australian System of National Accounts: Concepts, Sources and Methods, Edition 1 2012 (cat. no. 5216.0).

Australian National Accounts: National Income, Expenditure and Product (cat. no. 5206.0).

Australian Accounting Standard Board, AASB 1018 Statement of Financial Performance, Melbourne, Victoria, Australia, June 2002.

Business Indicators, Australia (cat. no. 5676.0).

United Nations, International Monetary Fund, Organisation for Economic Co-operation and Development, World Bank and Commission of the European Communities, System of National Accounts 2008, Brussels/Luxembourg, New York, Paris, Washington D.C., 2008..