11111 Intermediate Accounting, Ninth Edition Kieso and Weygandt Prepared by Catherine Katagiri, CPA The College of Saint Rose Albany, New York John Wiley & Sons, Inc.

Chapter 4: Income Statement and Related Information After studying this chapter you should be able to: Identify the uses and limitations of an income statement. Prepare a single-step income statement. Prepare a multi-step income statement. Explain how irregular items are reported. Explain intraperiod tax allocation. Explain where earnings per share information is reported. Prepare a retained earnings statement. Explain how other comprehensive income is reported.

333 Income Statement Income StatementIncome Statement –This statement is also known as the results of operations. –Used to predict amount, time and certainty of future cash flows. –Used to help users determine the risk of NOT achieving particular cash flows. –Used to evaluate routine performance.

44 Income Statement Income statementIncome statement –Used to assess likelihood of repayment to creditors. –Accrual based. –Limitations: »Historically based information. »Only quantifiable information included. »Quality of earnings must be assessed. Manipulation of income is possible (GAAP, intentions). Use of liberal (aggressive) accounting policies report higher income numbers in the short run. Quality of earnings would be low.

55 Income Statement Capital maintenance approachCapital maintenance approach to net income: –Assets less liabilities equals owners’ equity (residual). –Change in the assets less the change in the liabilities equals the change in the owners’ equity. If you add dividends to this change and subtract investments you have the concept of comprehensive income. –Detailed information on the calculation of net income is not present.

66 Transactions approachTransactions approach to net income calculation (GAAP). –Net income = Revenues less Expenses –Please see page 149, test, for elements of the income statement. Income Statement Revenues Gains Expenses Losses

77 Income Statement Income from operations is very important! It would be expected that this item would be the “heart” of the business-normal, routine- and would continue to occur from one period to the next.

88 Income Statement Format Single-step statement (page 150, text) –Income is calculated in one step, little detail provided. –No gross profit figure is calculated. –Revenues and gains are reported as a group. –Expenses and losses are reported as a group. –Simple; no indication of priorities. –Often provided for those who do not wish a great amount of detail but want just the “bottom line”. –Same presentation (as the multi-step format) of extraordinary items, discontinued operations and changes in accounting principles.

99 Multi-step statement (page 153) –Greater detail. –Gross Profit figure is calculated (most indicative of the multi-step format). –Revenues and gains are presented separately by source (operations, other). –Expenses and losses are presented separately by source (operations, other). –Manufacturers use the cost of goods manufactured to replace the purchases figure within the cost of goods sold calculation. Income Statement Format

10 Income Statement Format Single-step and multi-step statements: The presentation of extraordinary items, discontinued operations or accounting principle changes is the same. Condensed statements of income are found which follow the multi-step format with detail contained in supporting schedules (page 154, text). Both Single and Multi-step formats are GAAP. Both yield the same net income figure. It is a matter of form not substance.

11 What should be included on the current period’s income statement? There are 3 schools of thought: Income Statement Format Current operating performance. Current operating performance. This school would have all usual items that affect income and have their origins this period included in the income calculation. Items from prior periods or unusual items would be excluded from the current income calculation. All-inclusive. All-inclusive. This school would have all items that effect income included in current net income regardless if they had their origins in prior periods or were unusual in nature.

12 Income Statement Format Modified all-inclusive. Modified all-inclusive. Adopted by APB #9. States all income items should be reported on the income statement, current operations, except for the following items: Prior period adjustments (PPA). These flow directly to the statement of retained earnings, net of tax, as an adjustment to the beginning balance. Disposal of a segment of a business (Discontinued operations--Appendix). Extraordinary items. Cumulative effect of a change in accounting principle.

13 The specified items, excluding Prior Period Adjustments, are to be presented on the current period income statement after income from continuing operations (net of tax). The specified exceptions are each given their own line and are presented net of their tax effect. The order is (if present) –Disposal of a segment –Extraordinary items –Cumulative Effect of a Change in Accounting Principle Income Statement Format

14 Reporting Irregular Items Extraordinary items: APB #30 –For events that affect income to be considered extraordinary items the following criteria must be met (BOTH) »Unusual in nature »Infrequent in occurrence –The APB gave specific examples (page 157) of those items which were NOT extraordinary items. The definition of an extraordinary item was meant to be very restrictive!

15 –What non-extraordinary items have in common is that they are to to some degree under management control: Reporting Irregular Items Foreign currency transactions. Write-down of inventory, receivables. Asset exchanges. Labor strikes. Change in long-term accruals. Disposal of a segment.

16 Reporting Irregular Items –If items are unusual in nature or infrequent in occurrence but not both they should be listed in the “other” section of revenues or expenses. –Specific items which have been designated extraordinary items are: »Gain or loss on the extinguishment of debt (issuer). »Expropriation by a foreign government. »Acts of God.

17 Reporting Irregular Items Prior Period Adjustments: FASB #16 –Treatment is to adjust the beginning balance of Retained Earnings rather than have the item reflected on the income statement of any period (unless comparative statements are presented). –Prior Period Adjustments are »The correction of errors (mistakes, omissions) »To account for the effect of operating loss tax carryforwards of purchased subsidiaries. »Reported net-of-tax. »We will deal with the correction of errors

18 –For example: You “forgot” to depreciate a building last period ($20,000, tax rate is 20%) To adjust: Reporting Irregular Items Adjustment Account 20,000 Accum. Deprec. Building 20,000 RE 16,000 Tax Asset (refund) 4,000 Adjustment Account 20,000

19 Occurs when an entity discontinues clearly separable operations, not just a disposal of assets incident to operations. –You must define the segment, assets, method of disposal, time periods involved, estimates of income between dates available, estimated salvage value of assets, etc. –Measurement date-Date the contract signed. –Disposal date-Date operations close and assets sold. Discontinued Operations

20 Discontinued Operations Case #1 Measurement and disposal date the same day: –All figures are known and are within the same accounting period. Presentation: Income from continuing operations, after taxesXX Discontinued Operations: Gain/Loss from operations, less taxesXX Gain/Loss on disposal, less taxesXXXX Net IncomeXX

21 Case #2 Measurement date and disposal date are different days but within the same accounting period. –All facts are known by the end of the accounting period. –You must separate the results of operations from the beginning of the period to the measurement date from the results of operations between the measurement and disposal dates. Discontinued Operations

22 Discontinued Operations Presentation Case #2: Income from continuing operations, after taxesXX Discontinued Operations: Gain/Loss from operations, less taxesXX Gain/Loss on disposal, including operating G/L and G/L on disposal of assets, less taxesXXXX Net IncomeXX

23 Case #3 Measurement date and disposal date are different and not in the same accounting period –Use of estimates is required as all is not known by the end of the accounting period. Any changes are treated as changes in estimates. –If losses are expected recognize immediately. Expected gains may be recognized to the extent of anticipated losses but no further. Realized gains are recorded in the period they occur. Follow conservatism! Discontinued Operations

24 Discontinued Operations Presentation Case #3: Income from continuing operations, after taxesXX Discontinued Operations: Gain/Loss from operations, less taxesXX Gain/Loss on disposal, including estimated operating G/L and estimated G/L on disposal of assets, less taxesXXXX Net IncomeXX

25 Cumulative Effect of a Change in Accounting PrincipleCumulative Effect of a Change in Accounting Principle –Covered in Chapter 23 so we will be brief here! –Two types: »“Usual” or “common” type Report using the new principle in the year of change. Any effect on income of changing the principle on prior years is reported in the current year, net of tax after extraordinary items. For example, changing from Straight-Line depreciation to Declining Balance for your assets. Enhances consistency over comparability. Change in Accounting Principle

26 Change in Accounting Principle »“Unusual” or “specified exception” Restate financial statements of all periods presented. For periods not presented that the change affects, restate the beginning balance of RE for the first year presented. Enhances comparability over consistency. For example: Changes in accounting method for long- term construction contracts.

27 Intraperiod Tax Allocation Intraperiod Tax AllocationIntraperiod Tax Allocation –The concept that items are presented on financial statements with their related tax effects attached to them. –Tax expense is allocated within the period to the items that helped give rise to it. – We have seen this with the tax attached to: Operations Discontinued operations Prior period adjustments Extraordinary items Changes in Accounting Principles

28 Earnings per share (EPS) Chapter 17Earnings per share (EPS) Chapter 17 –Very wide-spread financial calculation (book not cash). –Only required financial ratio calculation. –To Put it SIMPLY now Net income to common stockholders Weighted average number of shares –Area of recent change by Financial Accounting Standards Board. The new standard has simplified the required calculation of earnings per share. Earnings Per Share

29 Statement of Retained Earnings Statement of Retained EarningsStatement of Retained Earnings –May be separately presented or appended to the Income Statement. –Of great interest to shareholders. –Appropriations: »The earmarkings of retained earnings for a future purpose. »It is really a statement of management intention. »Appropriations of retained earnings in NO WAY provides funds for the intention. –See Statement of Retained Earnings, page 165, text.

30 Comprehensive Income Comprehensive incomeComprehensive income includes all changes in equity during the period except those resulting from investments by owners and distributions to owners. –Components of comprehensive income are to be displayed in one of three ways: »A separate income statement. »A combined income statement of comprehensive income. »As a part of stockholder’s equity. –Regardless of format comprehensive income will be presented in the stockholders’ equity section of the balance sheet. Please see Illustration 4-23, page 19, our text.