1. UNDERSTANDING FINANCIAL STATEMENTS
THE INCOME STATEMENT and THE STATEMENT OF STOCKHOLDERS’ EQUITY
Chapter 3
Fraser/Ormiston: Understanding Financial Statements, 6th ed. (C) 2001 Prentice Hall Business Publishing

2. The Income Statement Revenues Expenses Net Income Earnings Per Share
Also called the Statement of Earnings
Fraser/Ormiston: Understanding Financial Statements, 6th ed. (C) 2001 Prentice Hall Business Publishing

3. Statement of Shareholders’ Equity
Documents changes in balance sheet equity accounts from one accounting period to the next
Provides an important link between the balance sheet and the income statement
Company may report info in note or supplementary schedule rather than formal statement if desired….(many do!)
Fraser/Ormiston: Understanding Financial Statements, 6th ed. (C) 2001 Prentice Hall Business Publishing

4. Income Statement
Earnings reported on income statement DO NOT EQUAL cash generated during accounting period (no, we are not ignoring cash…stay tuned for Chapter 4 in due time)
Income Statement may take multi-step or single step form, but regardless of form, “outline” is as follows……………...
Fraser/Ormiston: Understanding Financial Statements, 6th ed. (C) 2001 Prentice Hall Business Publishing

5. “Outline” of Income Statement
Income from Continuing Operations
“Below the line” Items (reported net of tax):
Income from Discontinued Operations
Extraordinary Gains and Losses
Cumulative Effect of a Change in Accounting Principle
Fraser/Ormiston: Understanding Financial Statements, 6th ed. (C) 2001 Prentice Hall Business Publishing

6. “Comprehensive” Income
Beginning in 1998, companies required to report COMPREHENSIVE INCOME
Comprehensive income includes ALL changes in equity during a period except those resulting from investments by owners and distributions to owners
Fraser/Ormiston: Understanding Financial Statements, 6th ed. (C) 2001 Prentice Hall Business Publishing

7. Where do I find it?
Comprehensive Income may be reported in one of three ways:
on the face of the income statement
in a separate statement of comprehensive income
in a statement of stockholders’ equity
We’ll look at this a bit later, but first let’s take a look at the MAJOR CATEGORIES of an income statement
Fraser/Ormiston: Understanding Financial Statements, 6th ed. (C) 2001 Prentice Hall Business Publishing

8. Major Categories
Focus on MULTIPLE-STEP Statement (it has more detail and is more useful…)
NET SALES: A firm’s sales are usually reported as Sales less Sales Returns less Sales Allowances
the major source of revenue for most companies
trends are important
Fraser/Ormiston: Understanding Financial Statements, 6th ed. (C) 2001 Prentice Hall Business Publishing

9. Major Categories (continued)
Cost of Goods Sold (CGS)
cost to seller of products sold to customers
relationship between CGS and sales is an important one
Gross Profit (first step of profit determination)
difference between net sales and CGS
key analytical tool in analyzing firm’s operating performance
Fraser/Ormiston: Understanding Financial Statements, 6th ed. (C) 2001 Prentice Hall Business Publishing

10. Major Categories (continued)
Operating Expenses
Include such things as selling expenses, administrative expenses, advertising, lease payments, depreciation, amortization, repairs and maintenance
Important to track carefully -- trends, absolute amounts, relationship to sales, relationship to industry competitors
Fraser/Ormiston: Understanding Financial Statements, 6th ed. (C) 2001 Prentice Hall Business Publishing

11. Major Categories (continued)
Operating Profit (second step of profit determination) -- also called EBIT
measures overall performance of company’s operations: sales revenue less expenses associated with generating sales
Other Income/Expense
includes revenues/expenses other than from operations, e.g. interest
Fraser/Ormiston: Understanding Financial Statements, 6th ed. (C) 2001 Prentice Hall Business Publishing

12. Major Categories (continued)
Earnings before income taxes
profit recognized before deduction of income tax expense
remember, income taxes paid may differ from income tax expense (deferred taxes)
Net Earnings
“bottom line” -- firm’s profit after consideration of ALL revenues & expenses
Fraser/Ormiston: Understanding Financial Statements, 6th ed. (C) 2001 Prentice Hall Business Publishing

13. Major Categories (continued)
Earnings per Common Share
Determined by dividing earnings available to common shareholders (earnings less any preferred dividend requirements) by average number of common shares outstanding during the period
If firm has “complex” capital structure, it will report basic and diluted EPS
Extensively used by analysts in evaluating a firm
Fraser/Ormiston: Understanding Financial Statements, 6th ed. (C) 2001 Prentice Hall Business Publishing

14. Last but not least….
SOMEWHERE, the firm must report Comprehensive Income
May be on the face of the income statement, may be in the statement of stockholders’ equity, may be in a separate financial statement
Wherever it is -- let’s take a look at what it includes
Fraser/Ormiston: Understanding Financial Statements, 6th ed. (C) 2001 Prentice Hall Business Publishing

15. Comprehensive Income Includes Net Earnings computed as illustrated
Also includes foreign currency translation adjustments, unrealized gains/losses on available-for-sale securities, additional pension liabilities and changes in fair market value of cash flow hedges (beyond the scope of this text…count your blessings!)
Fraser/Ormiston: Understanding Financial Statements, 6th ed. (C) 2001 Prentice Hall Business Publishing

16. Statement of S/E
Details transactions that affected the balance sheet equity accounts during an accounting period
In a nutshell, it simply explains how each account got from the balance at the beginning of the period to the balance at the end of the period and describes “events” that caused the balances to change
Fraser/Ormiston: Understanding Financial Statements, 6th ed. (C) 2001 Prentice Hall Business Publishing

17. Retained Earnings
Changes in R/E account are primarily result of net income/loss and dividends
Balance can also be affected by prior period adjustments and some changes in accounting principles
Changes in R/E are watched by analysts and the details on what caused the changes are documented in the Statement of Stockholders’ Equity
Fraser/Ormiston: Understanding Financial Statements, 6th ed. (C) 2001 Prentice Hall Business Publishing

18. Complications: Cost vs Equity
Two methods may be used to account for investments in other companies -- can make evaluation of a company’s financial condition more complicated
If “significant influence” exists, the EQUITY METHOD is used
If equity method is used, the income of the investee is recognized when earned instead of when received as dividends
Fraser/Ormiston: Understanding Financial Statements, 6th ed. (C) 2001 Prentice Hall Business Publishing

19. SUMMARY
Income Statement is important, but it is not the “be all and end all” statement
Statement of Stockholders’ Equity can provide useful information for analysis
Income Statement provides “fertile ground” for the savvy analyst to till!
All in all, earnings are important!!!
Fraser/Ormiston: Understanding Financial Statements, 6th ed. (C) 2001 Prentice Hall Business Publishing

20. STATEMENT OF CASH FLOWS
“Coming Attractions”
NEXT ON THE AGENDA
STATEMENT OF CASH FLOWS
Fraser/Ormiston: Understanding Financial Statements, 6th ed. (C) 2001 Prentice Hall Business Publishing