ACTG 3110 Chapter 4 The Income Statement and Related Information

What is an Income Statement? Information covered Time period covered Usefulness of the income statement –Evaluate past performance –Provide basis for predicting future performance –Help assess risk of future cash flows Limitations –The items that cannot be measured reliably are not included –Numbers affected by accounting methods employed –Income measurement involves judgment. Quality of Earnings – earnings management

Elements of the Income Statement Income Measurement –Net Assets approach –Transactions approach Revenues Expenses Gains Losses

Income From Continuing Operations All items must be expected to continue in the future Often lists income tax expense separately Operating income Nonoperating income

Single-step Format All income sources grouped together All expense sources grouped together No separate cost of goods sold section No gross margin No separation of other income and expenses

Multiple-Step Format Separate cost of goods sold section Gross margin subtotal Separate other income and expenses from operating income and expenses Separate income tax expense Both single step and multiple step format agree with GAAP Formats are the same below the income from continuing operations

Irregular Information on the Income Statement Discontinued operations (net of tax) Extraordinary items (net of tax) Earnings per share Intraperiod Tax Allocation –Taxes for operating items –Taxes for irregular information separate

Discontinued Operations SFAS 144 Disposal of a separate component of the entity which has operations and cash flows that can be clearly distinguished Two components to report: 1.Operating results of the discontinued segment from beginning of year to the disposal date 2.Gain/loss on disposal Gain/loss on sale of net assets –Reported net of tax –Can be combined or reported separately –In comparative statements, the income from the discontinued component must be separated from income from continuing operations

Extraordinary Items MATERIAL IN AMOUNT AND BOTH INFREQUENT AND UNUSUAL Requires judgment in that this event is not likely to occur again Reported net of tax Unusual or infrequent items are NOT extraordinary items and cannot be reported net of tax Restructuring charges are not extraordinary items International Practices

Accounting Changes Change in accounting principle –Accounted for retrospectively, meaning past financial statements must be restated –Examples include changing from FIFO to LIFO Change in estimates – prospective adjustments (do not have to restate) –Changes in depreciation methods –Changes in useful lives –Changes in bad debt estimates Change in reporting entity (mergers and acquisitions) –Restate financial statements as if the new entity existed in the past years if possible

Prior Period Adjustments Material errors discovered in subsequent years Adjust beginning retained earnings and correct other accounts Restate past financial statements Disclose nature of error in footnotes

Earnings Per Share Ratio of income available to common shareholders Presented for income from continuing operations, income from discontinuing operations, extraordinary items and net income (Net income – preferred dividends) weighted average number of common shares outstanding Basic EPS and Diluted EPS reported

Retained Earnings Statement Beginning balance Prior period adjustments Adjusted beginning balance Add net income or subtract net loss Subtract dividends declared Ending balance Some retained earnings is restricted (must classify as such)

Comprehensive Income Statement No. 130 Change in equity due to everything except investments by owners and distributions to owners. Presentation –One statement (continue on with net income) –Two statement (separate comprehensive income statement) –Part of stockholders’ equity statement Shows foreign currency translation gains/losses, unrealized gains/losses on investments in debt and equity securities available for sale, and minimum liabilities of pension obligations, and many other adjustments Accumulated balance is reported in stockholders’ equity