Chapter 4 Income Statement

Front 1

3 useful ways to use the Income Statement

Back 1

1. Evaluate Past Performance
2. Provide a basis for predicting future performance.
3. Help assess the risk or uncertainty of achieving future cash flows.

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3 limitations of the Income Statement

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1. Companies omit items from the income statement that they cannot measure reliably.
ex. company may not record unrealized gains and losses on certain investment securities in income when there is uncertainty.

2. Income numbers are affected by the accounting methods employed.
ex.
so one company may depreciate using an accelerated method, and the second might use straight line. if all other factors were equal, then the first company would have a lower income.

3. income measurement involes judgement.

ex. you can make optimistic estimates and get it wrong.

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The motivation to meet earnings may incline businesses to

Back 3

override good busines practices

Front 4

Earnings management?

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the planned timing of revenues, expenses, gains and losses to smooth out bumps in earnings.

companies use this to increase income in the current year at the expense of income in future years.

Example: Recognizing sales before earned to boost earnings. or vice versa.

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Cookie jar reseres

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using unrealistic assumptions to estimate liabilities for items such as

loan loss, restructuring charges and warranty returns. the companies then reduce these reserves in the future to increase reported income in the future.

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quality of earnings.

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useful ness for predicting future earnings and cash flow. markets rely on trust.

Front 7

Transaction approach .

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Focuses on income-related activities that have occured during the period.

can classify income by customer, product line or function, or by operating and non-operating, continued and discontinued, regular or irregualr.

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revenues

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inflows or other enhancements of assets of an entity or settlements of its liabilities during a period.

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expenses

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outflows or other using up of assets or incurrences of liabilities during a period .

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Capital maintenance approach

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a company determines income for the period based on the the change in equity, after adjusting for capital contributions or distributions.

The components of income are not evident in its measurement.

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Gains

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increases in equity(netassets) from peripheral or incidental transactions except those that result from revenues or investment by owners

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Losses

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Decreases in equity (net assets) from peripheral or incidental transactions of an entity except those that result from expenses or distributions to owners

Front 13

When Mcdonalds sells a hamburger it records the selling price as_____

when they sell land it recods any excess of the selling price over book value as a ________

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Revnue

Gain

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SIngle Step Income satement

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2 groupings: Revenues and Expenses. Expenses are deduced from revues to arrive at net income or loss.

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Advantage of a single step format

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simple presentation and the absense of any implaction that one type of revenue or expense has priority

Front 16

Multiple step income statement

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Separation of operating and non operating activities of the company.

A classification of expenses by functions, such as merchandising (cogs) selling, and administration.

you can compare with years past.

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Operating Section of income statement

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A Sales or Revenue section
B Cost of Goods Sold Section
C Selling Expenses
D Administrative or general Expenses

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Non-Operating Section

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A report of revnues resulting from secondary or auxiliary activities of the company.
(A) Other revenues and Gains
(B) Other Expenses and Losses

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Other Revenues and Gains

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Non Operating Section:

a list of the revenues earned or gains incurred, generally net of related expenses, from nonoperating transactions

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Other Expenses and Losses.

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A list of the expenses or lossses incurred, generally net of any related incomes, from nonoperating transactions.

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Income Tax

Back 21

a short section reporting federal and state taxes levied on income from continuing operations

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discontineued operations

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material gains or losses reluting from the dispostition of a segment of the business.

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Extraordinary Items

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Unusla and infrequent material gains and losses

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natural expense classification

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the content of the operating section is always the same, the organization of the material can differ.

wholesale trade

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functional expense classification

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administrative, occupancy, publicity, buying, and sellin expenses

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Multiple step income statement presents three subtotals of note:

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1. Net sales revenue
2.Gross Profit
3. Income from operations.

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Why is the disclosure of net sales revenue useful?

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Because regular revenue is a seperate item. Now you can work with irregualr or incidental revenues elsewhere in the income statement

Front 28

Why do you disclose gross profit?

Back 28

it is provides useful numbers for evaluating performance and predicting future earnings.

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why do you disclose income from operations?

Back 29

highlights the difference between regular and irregular or incidental activities. it helps users recognize that incidental or regular activities are unlikely to continue at the same level.

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Condensed income statement

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it is a condensed version of the multiple step statement.

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discontinued operation

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when 2 things happen
1. a company eliminates the result of operations and cash flows of a component from its ongoing operations,
2. there is no significant continuing involvement in that component after the disposal transaction.

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Irregular items fall into 6 categories

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1. Discontinued operations
2. extraordinary items
3.unusual gains and losses
4. Changes in accounting principle
5. Changes in estimates
6. corrections of errors

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extraordinary items

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1. unusual nature
2. infrequency of occurrence

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Not extraordinary items

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they are are usual in nature and may be expected to recur as a consequence of customary and continuing business activites.

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criteria for an extraordinary item is met

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if it resulted directly from a major casuality, an expropriation, or a prohibition undera newly enacted law or regulation.

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dcomapnies must show extraordinary items net of taxes in a separate section which one.

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before net income.

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Unusual Gains and Losses

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shown with normal recurring revenues and expenses.

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restructuring change

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a major reorganization of company affairs, such as costs associated iwth employee layoffs, plant closing costs, write-offs of assets, and so on.

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where do companies tend to report unusual items?

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in a seperate section just above income from operations before income taxes, and extraordinary items.

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when perparing a multiple step income statement, you should report unusual items in

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other revenues and gains, or other expenses and losses.

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changes in accounting principles include

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a change in the method of inventory pring from fiffo to average cost, or a change in accounting for construction contracts fro mthe percentage-of-completion to the completed contract method.

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retrospective adjustment

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recasting the prior years statements on a basis consistent with the newly adopted principle. the company re

Front 43

where do companies tend to report unusual items?

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in a seperate section just above income from operations before income taxes, and extraordinary items.

Front 44

when perparing a multiple step income statement, you should report unusual items in

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other revenues and gains, or other expenses and losses.

Front 45

changes in accounting principles include

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a change in the method of inventory pring from fiffo to average cost, or a change in accounting for construction contracts fro mthe percentage-of-completion to the completed contract method.

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retrospective adjustment

Back 46

recasting the prior years statements on a basis consistent with the newly adopted principle. the company re

Front 47

Not extraordinary items

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they are are usual in nature and may be expected to recur as a consequence of customary and continuing business activites.

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criteria for an extraordinary item is met

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if it resulted directly from a major casuality, an expropriation, or a prohibition undera newly enacted law or regulation.

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dcomapnies must show extraordinary items net of taxes in a separate section which one.

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before net income.

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Unusual Gains and Losses

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shown with normal recurring revenues and expenses.

Front 51

restructuring change

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a major reorganization of company affairs, such as costs associated iwth employee layoffs, plant closing costs, write-offs of assets, and so on.

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Not extraordinary items

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they are are usual in nature and may be expected to recur as a consequence of customary and continuing business activites.

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criteria for an extraordinary item is met

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if it resulted directly from a major casuality, an expropriation, or a prohibition undera newly enacted law or regulation.

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dcomapnies must show extraordinary items net of taxes in a separate section which one.

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before net income.

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Unusual Gains and Losses

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shown with normal recurring revenues and expenses.

Front 56

restructuring change

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a major reorganization of company affairs, such as costs associated iwth employee layoffs, plant closing costs, write-offs of assets, and so on.

Front 57

where do companies tend to report unusual items?

Back 57

in a seperate section just above income from operations before income taxes, and extraordinary items.

Front 58

when perparing a multiple step income statement, you should report unusual items in

Back 58

other revenues and gains, or other expenses and losses.

Front 59

changes in accounting principles include

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a change in the method of inventory pring from fiffo to average cost, or a change in accounting for construction contracts fro mthe percentage-of-completion to the completed contract method.

Front 60

retrospective adjustment

Back 60

recasting the prior years statements on a basis consistent with the newly adopted principle. the company re

Front 61

Changes in estimates

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a company a ccounts for such changes in estimates in the period of change if they affect only that period. or that period and the future if it affects both.

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True/False

Companies handle changes in estimate retrospectively

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False

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Is changes in estimate considered an Extraordinary item?

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NO! they are not!

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correction of errors are treated as

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Prior period adjustments. treated like a change in estimate it is made in the year it was discovered.

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intraperiod tax allocation

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allocation within a period. it relates incoe tax expense, of the fiscal period to specific items that give rise to the amount of the tax provision.

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companies use intraperiod tax allocation on the income statement for the following items:

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1. Income from continuing operations, 2. discounted operations,
3. extraordinary items.

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earnings per share

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Net income - Preferred dividends
/
Weighted average number of shares outstanding
An important business indicator.

Measures the dollars earned by each share of common stock.

Must be disclosed on the the income statement

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What increases retained earnings?

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Net income
Change in accounting principle
Error corrections

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What decreases retained earnings?

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Net loss
Dividends
Change in accounting principles
Error corrections

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Restricted Retained earnings are disclosed

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In notes to the financial statements
As Appropriated Retained Earnings

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Comprehensive Income must be displayed in one of three ways.

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1. a second income statement
2. a combined statement of comprehensive income
3. as a part of the staement of stockholders' equity.

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Comprehensive income

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All changes in equity during a period except those resulting from investments by owners and distributions to owners

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Comprehensive income includes

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all revenues and gains, expenses and losses reported in net income, and
all gains and losses that bypass net income but affect stockholders’ equity.

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other comprehensive income

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Gains and losses that bypass net income but affect stockholders' equity are referred to as

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Three approaches to reporting Comprehensive Income (SFAS No. 130, June 1997):

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A second separate income statement;
A combined income statement of comprehensive income; or
As part of the statement of stockholders’ equity