© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 12-1 INCOME AND CHANGES IN RETAINED EARNINGS Chapter 12

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 12-2 Information about net income can be divided into two major categories Income from continuing operations. 1. Results of discontinued operations. 2. Impact of extraordinary items. 3. Effects of changes in accounting principles. Normal, recurring revenue and expense transactions. Unusual, nonrecurring events that affect net income. Reporting the Results of Operations

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 12-3 This tax expense does not include effects of unusual, nonrecurring items. These unusual, nonrecurring items are each reported net of taxes.

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 12-4 Discontinued Operations: When a company has a discontinued operation, it must report the income or loss from operating a segment that has been discontinued, and the gain or loss on the sale of the segment net of taxes. Extraordinary items are gains and losses that are both unusual and infrequent in occurrence. Some examples include losses from natural disasters and expropriation of property by a foreign government. Extraordinary items are also reported net of taxes.

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 12-5 During 2007, Matrix, Inc. sold an unprofitable segment of the company. The segment had a net loss from operations during the period of $150,000 and a loss on the sale of its assets of $100,000. Matrix reported income from continuing operations of $1,750,000. All items are taxed at 30%. How will this appear on the income statement? During 2007, Matrix, Inc. sold an unprofitable segment of the company. The segment had a net loss from operations during the period of $150,000 and a loss on the sale of its assets of $100,000. Matrix reported income from continuing operations of $1,750,000. All items are taxed at 30%. How will this appear on the income statement? Discontinued Operations

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 12-6 Discontinued Operations

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 12-7 Income Statement Presentation: Discontinued Operations

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 12-8 During 2007, Matrix, Inc. experienced a loss of $75,000 due to an earthquake at one of its manufacturing plants in Nashville. This was considered an extraordinary item. The company reported income before extraordinary item of $1,575,000. All gains and losses are subject to a 30% tax rate. How would this item appear on the 2007 income statement? During 2007, Matrix, Inc. experienced a loss of $75,000 due to an earthquake at one of its manufacturing plants in Nashville. This was considered an extraordinary item. The company reported income before extraordinary item of $1,575,000. All gains and losses are subject to a 30% tax rate. How would this item appear on the 2007 income statement? Extraordinary Items

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 12-9 Income Statement Presentation: Extraordinary Items - Example

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin A measure of the company’s profitability and earning power for the period. Based on the number of shares issued and the length of time that number remained unchanged. Earnings Per Share (EPS)

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Remember that Matrix, Inc. has income from continuing operations of $1,750,000. The after- tax loss from discontinued operations was $175,000 and the extraordinary loss was $52,500. Assume that Matrix has 156,250 weighted average shares outstanding. Prepare a partial income statement showing the EPS for income from continuing operations and for the other special items. Prepare a partial income statement showing the EPS for income from continuing operations and for the other special items. Remember that Matrix, Inc. has income from continuing operations of $1,750,000. The after- tax loss from discontinued operations was $175,000 and the extraordinary loss was $52,500. Assume that Matrix has 156,250 weighted average shares outstanding. Prepare a partial income statement showing the EPS for income from continuing operations and for the other special items. Prepare a partial income statement showing the EPS for income from continuing operations and for the other special items. Earnings Per Share (EPS)

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin * Rounded. Earnings Per Share (EPS)

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin If preferred stock is present, subtract preferred dividends from net income prior to computing EPS. EPS is required to be reported in the income statement. Earnings Per Share (EPS) Net Income -Preferred Dividends Weighted Average Number of Common Shares Outstanding Earnings Per Share =

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Basic and Diluted Earnings per Share If a company has convertible securities, like convertible preferred stock outstanding, the conversion of these securities to common stock may dilute (reduce) earnings per share. Diluted earnings per share reflect the impact of the assumed conversion of the securities on earnings.

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Often, the Price-Earnings Ratio is used to evaluate the reasonableness of a company’s stock price. Price-earnings Ratio (P/E) Let’s examine this further.

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Declared by Board of Directors. Not legally required. Not legally required. Creates liability at declaration. Requires sufficient Retained Earnings and Cash. Accounting for Cash Dividends

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Date of Declaration Board of Directors declares the dividend. Record a liability. Date of Declaration Board of Directors declares the dividend. Record a liability. Dividend Dates On March 1, 2007, the Board of Directors of Matrix, Inc. declares a $1.00 per share cash dividend on its 500,000 common shares outstanding. The dividend is payable to stockholders of record on April 1, and paid on May 1.

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Ex-Dividend Date The day which serves as the ownership cut-off point for the receipt of the most recently declared dividend. Ex-Dividend Date The day which serves as the ownership cut-off point for the receipt of the most recently declared dividend. NO ENTRY Dividend Dates

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Date of Record Stockholders holding shares on this date will receive the dividend. (No entry ) Date of Record Stockholders holding shares on this date will receive the dividend. (No entry ) Dividend Dates X April 2007

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Date of Payment Record the payment of the dividend to stockholders. Date of Payment Record the payment of the dividend to stockholders. Dividend Dates

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin All stockholders retain same percentage ownership. No change in total stockholders’ equity. No change in par values. Accounting for Stock Dividends Distribution of additional shares of stock to stockholders.

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Summary of Effects of Stock Dividends and Stock Splits

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Adjust retained earnings retroactively. The adjustment should be disclosed net of any taxes. The correction of an error identified as affecting net income in a prior period. Prior Period Adjustments

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Statement of Retained Earnings with Prior Period Adjustment