1. CHAPTER 6 – Part 2
THE INCOME STATEMENT 15 15

2. SFAS No 130 - Reporting Comprehensive Income
Original issues:
Should comprehensive income be reported?
Should cumulative accounting adjustments be included in comprehensive income?
How should the components of comprehensive income be classified for disclosure?
How should comprehensive income be disclosed in the financial statements?
Should the components of other comprehensive income be disclosed before or after their related tax effects? 37

3. Should Comprehensive Income Be Reported?
SFAS No 130
Requires the disclosure of comprehensive income and
Discusses how to report and disclose comprehensive income and its components, including net income.
Does not specify when to recognize or how to measure components 38 38

4. Should Cumulative Accounting Adjustments Be Included?
As Part Of
Cumulative Accounting Adjustments
Comprehensive Income
Cumulative Accounting Adjustments 39 39

5. How Should the Components of Comprehensive Income Be Classified for Disclosure?
Requirement:
Companies must disclose an amount for net income
That amount must be accorded equal prominence with the amount disclosed for comprehensive income
Items of other comprehensive income are classified based on their nature 40 40

6. Allows for the disclosure of comprehensive income
How Should Comprehensive Income be Disclosed in the Financial Statements?
Requires a gross disclosure technique for items of other comprehensive income
Allows for the disclosure of comprehensive income
On income statement
On a separate statement
On the statement of stockholders’ equity 41 41

7. Should Components of Other Comprehensive Income Be Displayed Before or After Their Related Tax Effects.
Allows the components of other comprehensive income to be disclosed either
Net of related tax effects or
Before related tax effects with one amount shown for the aggregate income tax expense or benefit related to the total amount of other comprehensive income
Other comprehensive income is transferred to a separate component of stockholders’ equity
Best Buy discloses changes in other comprehensive income in its consolidated statement of shareholder's equity.
Circuit City does not disclose any items of other comprehensive income in its financial statements. 42 42

8. Prior Period Adjustments
An adjustment to beginning retained earnings balance
Original criteria in APB No. 9
Examples were income tax disputes and litigation
SEC Staff Bulletin No. 8 and APB Opinion No. 16
Correction of an error
Adjustments from realization of operating loss carryforward of purchased subsidiary 23 23

9. Financial Performance Reporting by Business Enterprises
In 2001 FASB initiated a project to redesign the income statement.
This project termed Financial Performance Reporting by Business Enterprises has two main objectives:
To improve the quality of information disclosed in financial statements to that investors, creditors and other interested parties are able to better evaluate an enterprise’s financial performance
To ascertain that the financial statements provide sufficient information to permit the calculation of key financial performance measures.

10. Financial Performance Reporting by Business Enterprises
While no final conclusions had been drawn when this book was published, some tentative decisions have been offered:
A single statement of comprehensive income should be prepared that reports all items of revenue, expense, gains and losses.
The statement of comprehensive income should report three major categories
Business activities
Financing
Other
Income tax expense should be reported separately after the categories.
Income from continuing operations should be disclosed as a subtotal
Discontinued operations are to be presented as a separate classification net of their tax effects after income tax expense.
Other comprehensive income is also presented
The cumulative effect of a change in accounting principle is included in other comprehensive income.
Extraordinary items will be reported in the appropriate major category before tax and will not be labels as extraordinary.

11. The Value of Corporate Earnings
The financial analysis of a company’s income statement focuses on a company’s operating performance by focusing on such questions as:
What are the company’s major sources of revenue?
What is the persistence of a company’s revenues?
What is the company’s gross profit ratio?
What is the company’s operating profit margin?
What is the relationship between earnings and the market price of the company’s stock?

12. Sources of Revenue
The financial analysis of a diversified company requires a review of the impact of various business segments on the company as a whole.
Best Buy reports segmental information for two segments in its financial statements
domestic
international
Circuit City does not disclose any segmental information.
Neither company discloses any information about major customers.

13. Persistence of Revenues

14. Management’s Discussion and Analysis
The MD&A section of a company’s annual report can provide valuable information on the persistence of a company’s earnings and its related costs.
SEC requires companies to disclose any changes or potential changes in revenues and expenses to assist in the evaluation of period-to-period deviations.
Examples of these disclosures include
unusual events
expected future changes in revenues and expenses
the factors that caused current revenues and expenses to increase or decrease
trends not otherwise apparent from a review of the company’s financial statements
An expanded discussion of the MD&A section of the annual report is contained in Chapter 17.

15. Gross Profit Percentage = Gross profit ÷ net sales
Gross Profit Analysis
Gross Profit Percentage = Gross profit ÷ net sales
25%
23.6%
22.7%
18%

16. Net Profit Analysis
2.1%
1.3%
1.0%
.5%

17. The Value of Corporate Earnings
The relationship between corporate earnings and stock prices
Measured by price earnings ratio
Current market price per share
Earnings per share
Best Buy = 13.54
Circuit City = 22.25

18. International Accounting Standards
International Accounting Standards Committee has:
Defined the concepts of performance and income in “Framework for the Preparation and Presentation of Financial Statements”
Discussed the content and format of the income statement in IAS No. 1, “ Presentation of financial Statements”
Discussed some components of the income statement in an amended IAS No. 8, now titled "Accounting Policies, Changes in Accounting Estimates and Errors"
Defined the concept of revenue in IAS No. 18, “Revenue”
Amended IAS No. 33
Discussed the required presentation and disclosure of a discontinued operation in IFRS No. 5, “Non-Current Assets Held for Sale and Discontinued Operations” 46

19. IASC Definitions of Performance and Income
Profit is used
to measure performance
or as the basis for other measures
Measurement of income is dependent on
the concept of capital maintenance used by the enterprise
Physical capital maintenance
Financial capital maintenance 47

20. IASC Definitions of Performance and Income
The IASC definition of income encompasses both revenue and expenses
The IASC has not made the distinction between ordinary and nonordinary operations contained in SFAC No. 6
A proposed standard would require a “Statement of Non-owner Movements in Equity”
Encourages an analysis of income and expenses based on their nature or function in the enterprise 48

21. IAS No. 1: Presentation of Financial Statements
Requires an operating/non operating separation and disclosure of the following components of income:
Revenue
Results of operating activities
Finance costs
Income from associates and joint ventures
Taxes
Profit or loss from ordinary activities
Extraordinary items
Minority interest
Net profit or loss
FASB Staff Reaction

22. IAS No. 8: Accounting Policies, Changes in Accounting Estimates and Errors
Originally, IAS No. 8
defined the concepts of
net profit or loss from ordinary activities
extraordinary items
accounting changes
fundamental errors
Each of these income statement items was defined and reported in a manner similar to U.S. GAAP
with the exception of fundamental errors
The revised IAS No. 8
does not distinguish between ordinary and extraordinary items
eliminates the concept of fundamental errors 49

23. IAS No. 8: Accounting Policies, Changes in Accounting Estimates and Errors
A GAAP hierarchy indicates that the following sources must be applied in descending order of authoritativeness:
International Financial Reporting Standard, including any appendices that form part of the Standard
Interpretations
Appendices to an IFRS that do not form part of the Standard
Implementation guidance issued by IASB in respect of the Standard

24. IAS No. 8: Accounting Policies, Changes in Accounting Estimates and Errors
Now defined as newly discovered omissions or misstatements of prior period financial statements based on information that was available when the prior financial statements were prepared
All material errors will be accounted for retrospectively
by restating all prior periods presented
and adjusting the opening balance of retained earnings of the earliest prior period presented
Cumulative effect recognition in income is prohibited
FASB Staff Reaction

25. IAS No. 18 - Revenue Revenue should be recognized when:
The enterprise has transferred to the buyer the significant risks and rewards of ownership of goods
The enterprise doesn’t retain managerial involvement or control over the goods sold
The amount can be measured reliably
It is probable that economic benefits associated with the transaction will flow to the enterprise
The costs associated with the transaction can be measured reliably 50

26. IAS No. 18 - Revenue FASB Staff Reaction
U. S. GAAP does not specifically address the issue of revenue
If it did, there would probably be a difference because of the IASC use of the term probable future economic benefit
FASB Staff Reaction 50

27. IAS No. 35 Discontinued Operations
The amended IAS No. 33 incorporated the following additional disclosures and guidelines:
Basic and diluted EPS must be presented for
(a) profit or loss from continuing operations and
(b) net profit or loss
…on the face of the income statement for each class of ordinary shares, for each period presented.
Potential ordinary shares are dilutive only when their conversion to ordinary shares would decrease EPS from continuing operations
(IAS 33 previously used net income as the benchmark).

28. IAS No. 35 Discontinued Operations
For contracts that may be settled in cash or shares, now includes a rebuttable presumption that the contract will be settled in shares.
If an entity purchases (for cancellation) its own preference shares for more than their carrying amount, the excess (premium) should be treated as a preferred dividend in calculating basic EPS (deducted from the numerator of the EPS computation).
Guidance is provided on how to calculate the effects of contingently issuable shares; potential ordinary shares of subsidiaries, joint ventures, or associates: participating securities; written put options; and purchased put and call options.

29. - + SFRS No. 5 replaces IAS No. 35. Discontinued operations
IFRS No. 5: Non-Current Assets Held for Sale and Discontinued Operations
SFRS No. 5 replaces IAS No. 35.
Discontinued operations
Post-tax profit or loss of the discontinued operation
Post-tax gain or loss recognized on the measurement to fair value
Cost to sell or fair value adjustments on the disposal of the assets (or disposal group) - +
Should be presented as a single amount on the face of the income statement

30. IFRS No. 5: Non-Current Assets Held for Sale and Discontinued Operations
Detailed disclosure of revenue, expenses, pre-tax profit or loss, and related income taxes is required
either in the notes or on the face of the income statement in a section distinct from continuing operations.
Such detailed disclosures must cover both the current and all prior periods presented in the financial statements.
IFRS No 5 prohibits the retroactive classification as a discontinued operation, when the discontinued criteria are met after the balance sheet date.

31. Prepared by Richard Schroeder, PhD Kathryn Yarbrough, MBA
End of Chapter 6 - Part 2
Prepared by Richard Schroeder, PhD Kathryn Yarbrough, MBA
Copyright © 2005 John Wiley & Sons, Inc.  All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written consent of the copyright owner is unlawful.  Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc.  The purchaser may make back-up copies for his/her own use only and not for distribution or resale.  The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.