Chapter 5: Income Statement and Related Information Fundamentals of Intermediate Accounting Weygandt, Kieso, and Warfield Prepared by Bonnie Harrison, College of Southern Maryland LaPlata, Maryland

2 Chapter 5 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

3 Chapter 5 Income Statement and Related Information After studying this chapter you should be able to : Explain where earnings per share information is reported. Prepare a retained earnings statement. Explain how other comprehensive income is reported

4 Usefulness of Income Statement 1.Evaluate the past performance of the enterprise. 2.Provide a basis for predicting future performance. 3.Help assess the risk or uncertainty of achieving future cash flows.

5 Limitations of the Income Statement 1.Items that cannot be measured reliably are not reported in the income statement. 2.Income numbers are affected by the accounting methods employed. 3.Income measurement involves judgment.

The Single Step Income Statement This statement presents information in broad categories. Major sections are Revenues and Expenses. The Earnings per Share amount is shown at the bottom of the statement. There is no distinction between operating and non-operating activities.

Single Step Statement Revenues Sales Other Revenues Expenses Cost of Goods Sold Selling & Admn Expenses Interest Expense Income Tax Expense Expenses Earnings per Share NET INCOME - =

The Multiple Step Income Statement The presentation divides information into major sections on the statement. The statement distinguishes operating from non-operating activities. Continuing operations are shown separately from irregular items. The income tax effects are shown separately as well.

Multiple Step Income Statement Operating Section Sales Revenue less: Cost of Goods Sold less: Selling Expenses less: Administrative Expenses 1 Non-Operating Section Add: Other Revenues and Gains Less: Other Expenses and Losses 2 Income Tax3 Irregular Items Discontinued Operations (net of tax) Extraordinary Items (net of tax) Cumulative Effect of a Change in Accounting Principle (net of tax) 4 Earnings per Share 5

Irregular Items: Discontinued Operations

Criteria for Discontinued Operations Discontinued operations refer to the disposal of a segment. To qualify:  The segment must be a distinct line of business  Its assets and operations must be distinguishable from other assets and operations. A distinction is made between:  the segment’s results of operations and  the disposal of the segment’s assets

Reporting Discontinued Operations There are two important dates in reporting discontinued operations: the measurement date andthe measurement date and the disposal datethe disposal date The measurement date is when management commits itself to a plan of segment’s disposal. The disposal date is the date of sale of segment.

Irregular Items: Extraordinary Items

Extraordinary items are: nonrecurring material items that differ significantly from typical activities Extraordinary items must meet two tests : they must be unusual and they must be infrequent The environment in which the business operates is of primary importance

Extraordinary Items: what they are not Losses from write-down or write-off of receivables, inventories, etc. Gains and losses from exchange or translation of foreign currency Gains and losses from the abandonment of property used in business Effects of strike Adjustments or accruals on long term contracts.

Unusual Gains & Losses Items that are unusual OR infrequent, but not both. If material, disclose separately. Do not disclose, net of taxes.

Irregular Items: Cumulative Effect of a Change in Accounting Principle

Change in Accounting Principle An accounting change results when: a new principle, different from the one in use, is adopted. The effect of the change is to be disclosed after extraordinary items. A change in principle is to be distinguished from a change in estimates. A change from FIFO to LIFO method in inventory costing is an example.

Change in Accounting Principle Gilbert company buys and places in service an asset on 1/1/2002. The cost is $100,000. Estimated useful life is 4 years. Ignore salvage value. Tax rate is 30%. The company uses the double-declining method of depreciation in 2002 and It changes to the straight-line method in 2004 (1/1/2004.) Present the effect of the change in accounting principle.

Change in Accounting Principle YearDouble-decliningStraight lineDifference balance depreciationdepreciation 2002$50,000$25,000$25, $25,000$25,000$ -0- Extraordinary Item$XXXX Cumulative Effect on prior years of retroactive application of new depreciation method (net of tax, $7,500)$17,500 Presentation Net difference $25,000 Increases net income

Changes in Accounting Estimates Accounting estimates will changes as new events occur, more experience is acquired or additional information is obtained Changes in accounting estimates are accounted for in period of change and future periods.

Changes in Accounting Estimates: Example On 1/1/2004, Gilbert Company (see preceding example for accounting principle change) revises the useful life of the asset to be 3 more years (2004, 2005 and 2006). The salvage value is estimated to be $5,000. This change involves a revision of initial estimates. The depreciation method remains straight-line.

Changes in Accounting Estimates: Example Book value (1/1/2004):$50,000 Less: Salvage value($5,000) Revised depreciable cost:$45,000 Remaining useful life:3 years Annual straight-line depreciation:$15,000 (years 2004, 2005 and 2006) Note: The changes in useful life and salvage value do not affect prior periods

24 Intraperiod Tax Allocation Tax expense for year related to specific items. Used for: –Income from continuing operations –Discontinued operations –Extraordinary items –Change in accounting principle

Earnings per Share Earnings per share is a significant business indicator figure. It is computed as: Net Income less Preferred Dividends Weighted Average of Common Shares Outstanding Earnings per share is required to be disclosed on the income statement for all the major sections. Earnings per share is subject to dilution (reduction), if issue of additional shares is possible in the future.

Retained Earnings Statement Retained earnings are increased by net income and decreased by net loss and dividends for the year. Corrections of errors in prior period financial statements are shown as prior period adjustments to the beginning balance in retained earnings. Any part of retained earnings, appropriated for a specific purpose, is shown as restricted earnings.

27 Other Comprehensive Income – all changes in equity during a period, except those resulting from investments by or distributions to owners.

28 Other Comprehensive Income must be displayed as: A separate statement of comprehensive income OR Combined income statement and comprehensive income statement OR Part of statement of stockholders equity

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