Wiley - Chapter 4: Income Statement and Related Information
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Chapter 4-1
Income Statement and Income Statement and Related InformationRelated Information
Income Statement and Income Statement and Related InformationRelated Information
ChapteChapter r
44
Chapter 4-2
Relevance
Evaluate past performance (feedback).
Predicting future performance.
Help assess the risk or uncertainty of achieving future cash flows. (conceptual framework objective)
Income Statement UsefulnessIncome Statement UsefulnessIncome Statement UsefulnessIncome Statement Usefulness
Chapter 4-3
Faithful Representation
Companies omit items that cannot be measured reliably.
Allowing choice/discretion can help but is not always good
Income is affected by the accounting methods employed and judgments of managers.
Income Statement LimitationsIncome Statement LimitationsIncome Statement LimitationsIncome Statement Limitations
Chapter 4-4
Income Statement LimitationsIncome Statement LimitationsIncome Statement LimitationsIncome Statement Limitations
Quality of Earnings may be reduced when CEO’s have incentives to manage income for personal gain which may not align with providing most decision useful information.
Potential misalignment due to:Stock options.
Beating earnings expectations is positively related to market value of stock price
Bonuses for reaching earnings levels set by company boards
Chapter 4-5
Elements of the Income StatementElements of the Income StatementElements of the Income StatementElements of the Income Statement
Revenues – Inflows or other enhancements of – Inflows or other enhancements of assets or settlements of its liabilities that assets or settlements of its liabilities that constitute the entity’s ongoing major or central constitute the entity’s ongoing major or central operations.operations.
SalesSales
Fee revenueFee revenue
Interest revenueInterest revenue
Dividend Dividend revenuerevenue
Rent revenueRent revenue
Examples of Revenue Accounts
Chapter 4-6
Elements of the Income StatementElements of the Income StatementElements of the Income StatementElements of the Income Statement
Expenses – Outflows or other using-up of assets – Outflows or other using-up of assets or incurrences of liabilities that constitute the or incurrences of liabilities that constitute the entity’s ongoing major or central operations.entity’s ongoing major or central operations.
Cost of goods soldCost of goods sold
Depreciation Depreciation expenseexpense
Interest expenseInterest expense
Rent expenseRent expense
Salary expenseSalary expense
Examples of Expense Accounts
Chapter 4-7
Elements of the Income StatementElements of the Income StatementElements of the Income StatementElements of the Income Statement
Gains – Increases in equity (net assets) from – Increases in equity (net assets) from peripheral or incidental transactions.peripheral or incidental transactions.
Losses - Decreases in equity (net assets) - Decreases in equity (net assets) from peripheral or incidental transactions.from peripheral or incidental transactions.
Gains and losses can result fromGains and losses can result from
sale of investments or plant assets, sale of investments or plant assets,
settlement of liabilities, settlement of liabilities,
write-offs of assets.write-offs of assets.
Chapter 4-8
Single-Step Income StatementSingle-Step Income StatementSingle-Step Income StatementSingle-Step Income Statement
The single-step The single-step statement consists of statement consists of just two groupings:just two groupings:
I ncome Statement (in thousands)
Revenues:
Sales 285,000$
I nterest revenue 17,000
Total revenue 302,000
Expenses:
Cost of goods sold 149,000
Advertising expense 10,000
Depreciation expense 43,000
I nterest expense 21,000
I ncome tax expense 23,700
Total expenses 246,700
Net income 55,300$
Earnings per share 0.75$
RevenuesRevenues
ExpensesExpenses
Net IncomeNet Income
Single- Single- StepStep
Single- Single- StepStep
No distinction between No distinction between OperatingOperating and and Non-Non-operatingoperating categories. categories.
Chapter 4-9
Single-Step Single-Step FormatFormat
Single-Step Single-Step FormatFormat
Administrative expense: Revenues:
Offi cers' salaries 4,900$ Sales 96,500$
Depreciation 3,960 Rental revenue 17,230
Cost of goods sold 63,570 Total revenues 113,730
Rental revenue 17,230 Expenses:
Selling expense: Cost of goods sold 63,570
Transportation- out 2,690 Selling expense 17,150
Sales commissions 7,980 Administrative exense 8,860
Depreciation 6,480 I nterest expense 1,860
Sales 96,500 I ncome tax expense 7,580
I ncome tax expense 7,580 Total expenses 99,020
I nterest expense 1,860 Net income 14,710$
I ncome Statement
For the year ended Dec. 31, 2011
E4-4: Prepare an income statement from the data below.
Chapter 4-10
Multiple-Step Income StatementMultiple-Step Income StatementMultiple-Step Income StatementMultiple-Step Income Statement
The presentation The presentation divides information divides information into major into major sections. sections.
The presentation The presentation divides information divides information into major into major sections. sections.
I ncome Statement (in thousands)
Sales 285,000$
Cost of goods sold 149,000
Gross profi t 136,000
Operating expenses:
Advertising expense 10,000
Depreciation expense 43,000
Total operating expense 53,000
I ncome from operations 83,000
Other revenue (expense):
I nterest revenue 17,000
I nterest expense (21,000)
Total other (4,000)
I ncome before taxes 79,000
I ncome tax expense 23,700
Net income 55,300$
Earnings per share 0.75$
1. Operating 1. Operating Section Section
1. Operating 1. Operating Section Section
2. Nonoperating 2. Nonoperating Section Section
2. Nonoperating 2. Nonoperating Section Section
3. Income tax 3. Income tax 3. Income tax 3. Income tax
Chapter 4-11
Multiple-Step Multiple-Step FormatFormat
Multiple-Step Multiple-Step FormatFormat
Administrative expense: Sales 96,500$
Offi cers' salaries 4,900$ Cost of goods sold 63,750
Depreciation 3,960 Gross profit 32,750
Cost of goods sold 63,750 Operating Expenses:
Rental revenue 17,230 Selling expense 17,150
Selling expense: Administrative exense 8,860
Transportation- out 2,690 Total operating expenses 26,010
Sales commissions 7,980 I ncome from operations 6,740
Depreciation 6,480 Other revenue (expense):
Sales 96,500 Rental revenue 17,230
I ncome tax expense 7,580 I nterest expense (1,860)
I nterest expense 1,860 Total other 15,370
I ncome before tax 22,110
I ncome tax expense 7,580
Net income 14,530$
I ncome Statement
For the year ended Dec. 31, 2011
Illustration (E4-4): Prepare an income statement from the data below.
Chapter 4-12
Single Step
Used mainly by service firms, banks, utilities
Multiple Step
Used mainly by merchandising and manufacturing firms
Income Statement FormatsIncome Statement FormatsIncome Statement FormatsIncome Statement Formats
Chapter 4-13
Diluted EPS – takes account of potential dilution from options, convertible debt or preferred stock
EPS to be reported for continuing operations, each of the non-continuing operations account, and net income.
Earnings Per ShareEarnings Per ShareEarnings Per ShareEarnings Per Share
Net income - Preferred dividends
Weighted average number of shares outstanding
Basic EPS Calculation
Chapter 4-14
Exercise In 2007, Kirby Puckett Corporation reported net income of $1,200,000. It declared and paid preferred stock dividends of $250,000. Puckett had 280,000 common shares outstanding at 2007 year end (500,000 shares authorized) of which 100,000 common shares were outstanding the whole year and 180,000 outstanding since June 30. Compute Puckett’s 2007 earnings per share.
Exercise In 2007, Kirby Puckett Corporation reported net income of $1,200,000. It declared and paid preferred stock dividends of $250,000. Puckett had 280,000 common shares outstanding at 2007 year end (500,000 shares authorized) of which 100,000 common shares were outstanding the whole year and 180,000 outstanding since June 30. Compute Puckett’s 2007 earnings per share.
Earnings Per ShareEarnings Per ShareEarnings Per ShareEarnings Per Share
Chapter 4-15
Special Reporting IssuesSpecial Reporting IssuesSpecial Reporting IssuesSpecial Reporting Issues
EPS Info
Present EPS information for
Continuing, Discontinued,
and Extraordinary
Sections.
(Note: Preferred dividends are deducted
from Income from continuing operations)
Chapter 4-16
Reporting Irregular (non-continuing) Reporting Irregular (non-continuing) ItemsItems
Reporting Irregular (non-continuing) Reporting Irregular (non-continuing) ItemsItems
Companies are required to report irregular items Companies are required to report irregular items in the financial statements so users can better in the financial statements so users can better understand the long-run earnings power of the understand the long-run earnings power of the company.company.
Chapter 4-17
Irregular items fall into six categories
Discontinued operations.
Extraordinary items.
Unusual gains and losses.
Changes in accounting principle.
Changes in estimates.
Corrections of errors.
Reporting Irregular ItemsReporting Irregular ItemsReporting Irregular ItemsReporting Irregular Items
Chapter 4-18
Discontinued Operations occurs when,
(a) company eliminates the
results of operations and
cash flows of a component.
(b) there is no significant continuing involvement in that component.
Amount reported “net of tax.”
See FASB Codification 205 20
Reporting Irregular ItemsReporting Irregular ItemsReporting Irregular ItemsReporting Irregular Items
Chapter 4-19
Exercise: McCarthy Corporation had after tax income from continuing operations of $55,300,000 in 2007. During 2007, it disposed of its restaurant division at a pretax loss of $270,000. Prior to disposal, the division operated at a pretax loss of $450,000 in 2007. Assume a tax rate of 30%. Prepare a partial income statement for McCarthy.
Exercise: McCarthy Corporation had after tax income from continuing operations of $55,300,000 in 2007. During 2007, it disposed of its restaurant division at a pretax loss of $270,000. Prior to disposal, the division operated at a pretax loss of $450,000 in 2007. Assume a tax rate of 30%. Prepare a partial income statement for McCarthy.
Reporting Discontinued OperationsReporting Discontinued OperationsReporting Discontinued OperationsReporting Discontinued Operations
Income from continuing operations
Discontinued operations:
Loss from operations, net of $________ taxLoss on disposal, net of $_________ tax
Net income
Total loss on discontinued operations
Chapter 4-20
Reporting Discontinued OperationsReporting Discontinued OperationsReporting Discontinued OperationsReporting Discontinued Operations
Other revenue (expense):
I nterest revenue 17,000
I nterest expense (21,000)
Total other (4,000)
I ncome before taxes 79,000
I ncome tax expense 23,700
I ncome from continuing operations 55,300
Discontinued operations:
Loss from operations, net of tax 315
Loss on disposal, net of tax 189
Total loss on discontinued operations 504
Net income 54,796$
I ncome Statement (in thousands)
Sales 285,000$
Cost of goods sold 149,000 Discontinued Discontinued
Operations are Operations are reported after “Income reported after “Income
from continuing from continuing operations.”operations.”
Previously labeled as “Net Income”.
Moved to
Chapter 4-21
Extraordinary items are nonrecurring material items that differ significantly from a company’s typical business activities.
Extraordinary Item must be both of an
Unusual Nature and Occur Infrequently
Company must consider the environment in which it operates.
Amount reported “net of tax.”
Reporting Irregular ItemsReporting Irregular ItemsReporting Irregular ItemsReporting Irregular Items
Chapter 4-22
Are these items Extraordinary? CA 3
Reporting Extraordinary ItemsReporting Extraordinary ItemsReporting Extraordinary ItemsReporting Extraordinary Items
Chapter 4-23
Exercise: McCarthy Corporation had after tax income from continuing operations of $55,300,000 in 2007. In addition, it suffered an unusual and infrequent pretax loss of $770,000 from a volcano eruption. The corporation’s tax rate is 30%. Prepare a partial income statement for McCarthy Corporation beginning with income from continuing operations.
Exercise: McCarthy Corporation had after tax income from continuing operations of $55,300,000 in 2007. In addition, it suffered an unusual and infrequent pretax loss of $770,000 from a volcano eruption. The corporation’s tax rate is 30%. Prepare a partial income statement for McCarthy Corporation beginning with income from continuing operations.
Income from continuing operations
Extraordinary loss, net of$__________tax
Net income
Reporting Extraordinary ItemsReporting Extraordinary ItemsReporting Extraordinary ItemsReporting Extraordinary Items
Chapter 4-24
Other revenue (expense):
I nterest revenue 17,000 I nterest expense (21,000) Total other (4,000)
I ncome bef ore taxes 79,000 I ncome tax expense 23,700 I ncome from continuing operations 55,300
Extraordinary loss, net of tax 539
Net income 54,761$
I ncome Statement (in thousands)
Sales 285,000$
Cost of goods sold 149,000 Extraordinary Items Extraordinary Items
are reported after are reported after “Income from “Income from
continuing continuing operations.”operations.”
Previously labeled as “Net Income”.
Reporting Extraordinary ItemsReporting Extraordinary ItemsReporting Extraordinary ItemsReporting Extraordinary Items
Moved to
Chapter 4-25
Reporting Irregular ItemsReporting Irregular ItemsReporting Irregular ItemsReporting Irregular Items
I nterest expense (21,000)
Total other (4,000)
I ncome before taxes 79,000
I ncome tax expense 23,700
I ncome from continuing operations 55,300
Discontinued operations:
Loss from operations, net of tax 315
Loss on disposal, net of tax 189
Total loss on discontinued operations 504
I ncome before extraordinary item 54,796
Extraordinary loss, net of tax 539
Net income 54,257$
I ncome Statement (in thousands)
Sales 285,000$
Cost of goods sold 149,000
Reporting when both Reporting when both
Discontinued Discontinued
Operations and Operations and
Extraordinary Items Extraordinary Items
are present. are present.
Discontinued OperationsDiscontinued Operations
Extraordinary ItemExtraordinary Item
Chapter 4-26
Relates the income tax expense to the specific items that give rise to the amount of the tax expense.
Income tax is allocated to the following items:(1) Income from continuing operations before tax(2) Discontinued operations(3) Extraordinary items(4) Changes in accounting principle(5) Correction of errors
Intraperiod Tax AllocationIntraperiod Tax AllocationIntraperiod Tax AllocationIntraperiod Tax Allocation
Chapter 4-27
I nterest expense (21,000)
Total other (4,000)
I ncome f rom cont. oper. before taxes 79,000
I ncome tax expense 23,700
I ncome from continuing operations 55,300
Discontinued operations:
Loss on operations, net of $135 tax 315
Loss on disposal, net of $81 tax 189
Total loss on discontinued operations 504
I ncome before extraordinary item 54,796
Extraordinary loss, net of $231 tax 539
Net income 54,257$
I ncome Statement (in thousands)
Sales 285,000$
Cost of goods sold 149,000
Total Tax Total Tax
AllocatedAllocated
Example of Intraperiod Tax Example of Intraperiod Tax AllocationAllocation
Example of Intraperiod Tax Example of Intraperiod Tax AllocationAllocation
$23,700$23,700
(135)(135)(81)(81)
(231)(231)
$23,253$23,253
Note: losses reduce Note: losses reduce
the total taxthe total tax
Chapter 4-28
Unusual Gains and Losses
Material items that are unusual or infrequent, but not both, should be reported in a separate section just above “Income from continuing operations before income taxes.”
Examples can include:
Write-downs of inventoriesForeign exchange transaction gains and losses
The Board prohibits net-of-tax treatment for these items.
Reporting Irregular ItemsReporting Irregular ItemsReporting Irregular ItemsReporting Irregular Items
Chapter 4-29
Changes in Estimate
Accounted for in the period of change and future periods
Not handled retrospectively
Not considered errors or extraordinary items
Examples include: Useful lives and salvage values of
depreciable assets Allowance for uncollectible receivables Inventory obsolescence
Reporting Irregular ItemsReporting Irregular ItemsReporting Irregular ItemsReporting Irregular Items
Chapter 4-30
Arcadia HS, purchased equipment for $510,000 Arcadia HS, purchased equipment for $510,000 which was estimated to have a useful life of 10 years which was estimated to have a useful life of 10 years with a salvage value of $10,000 at the end of that with a salvage value of $10,000 at the end of that time. Depreciation has been recorded for 7 years on time. Depreciation has been recorded for 7 years on a straight-line basis. In 2005 (year 8), it is a straight-line basis. In 2005 (year 8), it is determined that the total estimated life should be 15 determined that the total estimated life should be 15 years with a salvage value of $5,000 at the end of years with a salvage value of $5,000 at the end of that time.that time.
Questions:Questions: What is the journal entry to correct What is the journal entry to correct
the prior years’ depreciation?the prior years’ depreciation? Calculate the depreciation expense Calculate the depreciation expense
for 2005.for 2005.
Change in Estimate ExampleChange in Estimate ExampleChange in Estimate ExampleChange in Estimate Example
Chapter 4-31
Change in Estimate ExampleChange in Estimate ExampleChange in Estimate ExampleChange in Estimate ExampleAfter 7 yearsAfter 7 years
Chapter 4-32
Changes in Accounting Principles
Retrospective adjustment
Cumulative effect adjustment to beginning retained earnings of earliest year presented
Approach preserves comparability
Examples include: change from FIFO to average cost
change from the percentage-of-completion to the completed-contract method
Reporting Irregular ItemsReporting Irregular ItemsReporting Irregular ItemsReporting Irregular Items
Chapter 4-33
Reporting Irregular ItemsReporting Irregular ItemsReporting Irregular ItemsReporting Irregular Items
Change in Accounting Principle: Gaubert Inc. decided in March 2010 to change from FIFO to weighted-average inventory pricing. Gaubert’s income before taxes, using the new weighted-average method in 2010, is $30,000.
Illustration 4-10Illustration 4-10Calculation of a Change inAccounting Principle
Illustration 4-11Illustration 4-11Income StatementPresentation of a Changein Accounting Principle (Based on 30% tax rate)
Pretax Income Data
Chapter 4-34
Corrections of Errors
Result from: mathematical mistakes mistakes in application of accounting
principles oversight or misuse of facts
Corrections treated as prior period adjustments
restate all prior financial statements presented
Reporting Irregular ItemsReporting Irregular ItemsReporting Irregular ItemsReporting Irregular Items
Chapter 4-35
Retained EarningsRetained EarningsRetained EarningsRetained Earnings
IncreaseIncrease
Net incomeNet income
Change in accounting principle
Error corrections
DecreaseDecrease
Net lossNet loss
Dividends
Change in accounting principles
Error corrections
Changes in Retained Earnings
Chapter 4-36
Exercise 4-11 (assume no Exercise 4-11 (assume no comparative financial statements)comparative financial statements)
Exercise 4-11 (assume no Exercise 4-11 (assume no comparative financial statements)comparative financial statements)
Chapter 4-37
All changes in equity during a period except those All changes in equity during a period except those resulting from investments by owners and resulting from investments by owners and distributions to owners.distributions to owners.
Comprehensive IncomeComprehensive IncomeComprehensive IncomeComprehensive Income
I ncome Statement (in thousands)
Sales 285,000$
Cost of goods sold 149,000 Gross profi t 136,000
Operating expenses:
Advertising expense 10,000 Depreciation expense 43,000
Total operating expense 53,000 I ncome from operations 83,000
Other revenue (expense):
I nterest revenue 17,000 I nterest expense (21,000)
Total other (4,000) I ncome bef ore taxes 79,000 I ncome tax expense 24,000 Net income 55,000$
Other Comprehensive Other Comprehensive IncomeIncome
Unrealized gains and losses on available-for-sale securities.
Translation gains and losses on foreign currency.
Plus others
+
Reported in Stockholders’ Equity
Chapter 4-38
OCI presented as net of tax.OCI presented as net of tax. OCI is also reported in the Stockholder’s Equity OCI is also reported in the Stockholder’s Equity
section in the balance sheetsection in the balance sheet
Other Comprehensive IncomeOther Comprehensive IncomeOther Comprehensive IncomeOther Comprehensive Income
Chapter 4-39
Reporting Comprehensive IncomeReporting Comprehensive IncomeReporting Comprehensive IncomeReporting Comprehensive Income
FASB’s new guidance requires companies to present OCI in one of two ways:•Present OCI in a single continuous statement of comprehensive income that lists the components of net income and total net income, the components of OCI and total OCI, and the total of CI.• Take a two-statement approach:
• An income statement presenting the components of net income and total net income, and
• A statement of OCI (immediately following the income statement) must present the components of OCI, a total for OCI and a total for CI. • The second statement may begin with net income.
Chapter 4-40
Comprehensive IncomeComprehensive IncomeComprehensive IncomeComprehensive Income
Balance Sheet PresentationBalance Sheet Presentation
Regardless of the display format used, the Regardless of the display format used, the accumulated accumulated other comprehensive income other comprehensive income of $90,000 is reported in the of $90,000 is reported in the stockholders’ equity section of the balance sheet.stockholders’ equity section of the balance sheet.
Chapter 4-41
Under iGAAP, companies must classify expenses by either nature or function. If a company uses the functional expense method on the income statement, disclosure by nature is required in the notes to the financial statements. (SEC requires functional expense method)
Presentation of the income statement under U.S. GAAP follows either a single-step or multiple-step format. iGAAP does not mention a single-step or multiple-step approach. In addition, under U.S. GAAP, companies must report an item as extraordinary if it is unusual in nature and infrequent in occurrence. Extraordinary items are prohibited under iGAAP.
Chapter 4-42
Both iGAAP and U.S. GAAP have items that are recognized in equity as part of comprehensive income but do not affect net income. U.S. GAAP provides two possible formats for presenting this information. iGAAP provides the statement of recognized income and expense (SoRIE) format.
Under iGAAP revaluation of land, buildings, and intangible assets is permitted (shown as an other comprehensive income adjustment).
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