1. The Income Statement & The Statement of Stockholders’ Equity
Chapter 11
The Income Statement & The Statement of Stockholders’ Equity

2. Learning Objectives Analyze a complex income statement
Account for a corporation’s income tax
Analyze a statement of stockholders’ equity
Understand managers’ and auditors’ responsibilities for the financial statements

3. Income Statement
Periodically Prepared to report Financial Consequences of Activities Undertaken
By Accounting Entity
Within a Certain Period of Time
Profit
More resources available at end-of-period then beginning-of-period
Loss
Consumed more resources by the end-of-period then it generated

4. Income Statement Summary of Revenues and Expenses
For a Specific Period of Time
Grouped by Class
Sales
Returns and Allowances
Discounts
Cost of Goods Sold
Gross Margin/Profit
Operating Expenses
Selling Expenses
Salaries
Advertising
Travel
Telephone
Supplies
Depreciation
Administrative
Salaries
Telephone
Legal & Professional
Supplies
Depreciation – Bldg & Equip
Misc.
Net Income from Operations
Other
Interest Expense
Interest Income
Discontinued Operations
Extraordinary Events
Cumulative Effect of Change
Net Income
Earnings Per Share

5. Accounting Principles
Matching
Revenue Realization

6. Income Statement - Continuing Operations
Allied Electronics Corporation
Income Statement
Year Ended December 31, 20x5
Sales revenue $500,000
Cost of goods sold –240,000
Gross margin $260,000
Operating expenses ,000
Operating income $ 79,000

7. Income Statement - Continuing Operations
Operating income $79,000
Other gains (losses):
Loss on restructuring operations ( 8,000)
Gain on sale of machinery ,000
Income from continuing operations
before income tax $90,000
Income tax expense ,000
Income from continuing operations $54,000

8. Income Statement - Special Items
Discontinued operations: $35,000,
less income tax of $14, ,000
Income before extraordinary items
and cumulative effect of change
in depreciation method $75,000
Extraordinary flood loss, $20,000,
less income tax savings of $8,000 (12,000)
Cumulative effect of change in
depreciation method, $10,000,
less income tax of $4, ,000
Net income $69,000

9. Income from Continuing Operations
A measure of the part of the business expected to be ongoing.
Used to predict future income.

10. Predicting Future Profits
Estimated annual
income in the future
Estimated value of
Common Stock =
Investment
capitalization rate
If estimated value of the company:
Decision
Exceeds
Current market
Value of the
Company
Buy the stock
Equals
Hold the stock
Is less than
Sell the stock

11. Estimated Value of Common Stock

12. Continuing Operations
The company restructured operations at a loss of $8,000.
Report as “Other” item – part of continuing operations, but falls outside of main business endeavor

13. Other Income Statement Items
Discontinued Operations
Extraordinary Gains and Losses (Extraordinary Items)
Must be both infrequent
seldom happening or occurring
and Unusual
not ordinarily encountered
Cumulative Effect of a Change in Accounting Method

14. Discontinued Operations
Segment – identifiable division of a company
Sold or
Closed

15. Extraordinary Items Unusual for the company and infrequent
Losses due to natural disasters
Expropriations
the action of the state in taking or modifying the property rights of an individual in the exercise of its sovereignty
An Exception
Material gains/losses from extinguishment of debt (to be reported as extraordinary item)

16. Cumulative Effect of a Change in Accounting Principle
From double-declining-balance (DBB) to straight-line depreciation
From first-in, first-out (FIFO) to weighted-average cost for inventory
Report in a special section of the income statement after extraordinary items

17. Average number of shares of common outstanding
Earnings Per Share
Net Income -
Preferred dividends
Earnings per share =
Average number of shares of common outstanding
Earnings per share is disclosed separately for:
continuing operations
discontinued operations (do not subtract pfd)
Extraordinary items (don not subtract pfd)
Cumulative effect of change in accounting method (do not subtract pfd)

18. Income Statement - Earnings per Share
Earnings per share of common stock
(20,000 shares outstanding):
Income from continuous operations
(54000)/ $2.70
Income from discontinued operations
(21000/20000)
Income before extraordinary item
and cumulative effect of change
in depreciation method
(75000/20000) $3.75
Extraordinary loss
(12000/20000) (0.60)
Cumulative effect of change in
depreciation method
(6000/20000)
Net income
(69000/20000) $3.45

19. Earnings Per Share Effect of preferred stock Dilution
preferred dividends must be paid before distributions of earnings to common stockholders.
Dilution
Convertible items could result in diluted eps.
Diluted EPS is disclosed on the income statement.

20. Comprehensive Income
Change in total stockholders’ equity from all sources other than from the owners of the business.
Unrealized gains (losses) on available-for-sale investments
Foreign-currency translation adjustments

21. Corporate Income Taxes
Must measure
Income tax expense
Income tax payable
Income
tax
expense =
Income before income tax (from the
income statement) X
Tax Rate
Income
tax
payable =
Taxable income from the income tax return
filed with the IRS X
Tax Rate

22. Corporate Income Taxes
Difference between income tax expense and income tax payable is a deferred tax liability or deferred tax asset.

23. Accounting for Corporate Income Taxes
Suppose for 20x5, Nike, Inc., has pretax accounting income of $900 million on the income statement.
Taxable income is $800 million on the company’s income tax return.
The tax rate is 40%.

24. Accounting for Corporate Income Taxes
Dec 31 Income Tax Expense ($900 x .40) 360
Income Tax Payable ($800 x .40) 320
Deferred Tax Liability 40
Recorded income tax for the year
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

25. Accounting for Corporate Income Taxes
Income statement
Income before income tax $900
Income tax expense
Net income $540
Balance sheet
Current Liabilities:
Income tax payable $320
Long-term liabilities:
Deferred tax liability *
Total $360
*Assumes beginning tax liability was zero.

26. Retained Earnings Prior period adjustments
corrections of errors that occurred in prior periods.
Since the temporary accounts have been closed to retained earnings, errors from prior periods must be made to retained earnings.

27. Reporting a Prior-Period Adjustment
CNN Corporation
Statement of Retained Earnings
Year Ended December 31, 2005
Retained Earnings, Dec. 31, 2004 (original) $390,000
Prior-period adjustment – debit to correct error
in recording income tax expense of ( 10,000)
Retained earnings, Dec. 31, 2004, adjusted $380,000
Net income for ,000
Total $494,000
Deduct: Dividends for ( 41,000)
Retained earnings balance, Dec. 31, $453,000
©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

28. Restrictions on Retained Earnings
Dividends and purchases of treasury stock require payments by the corporation to its stockholders
Creditors may restrict a corporation’s dividend payments and treasury stock purchases
Companies report any retained earnings restrictions in notes to the financial statements

29. Statement of Stockholders’ Equity
Reports all changes in equity for the period.
Issuance of stock
Net income
Cash dividends
Stock dividends
Treasury stock transactions
Accumulated other comprehensive income

30. Statement of Stockholders’ Equity

31. Responsibility for the Financial Statements
Management
issues a statement of responsibility with financial statements
declares responsibility for financial statements and states that they conform to GAAP

32. Auditor Report Typically contains three paragraphs:
Identifies the audited financial statements
Describes how the audit was performed
States the auditor’s opinion -financial statements conform to GAAP and people can rely on them for decision making

33. Auditor Report Unqualified (Clean) Qualified Adverse Disclaimer
the financial statements presented are free of material misstatements and are in accordance with GAAP
Qualified
the financial statements are fairly presented with a certain exception which is otherwise misstated
Adverse
the information contained is materially incorrect, unreliable, and inaccurate in order to assess the auditee’s financial position and results of operations
Disclaimer
the auditor could not form, and consequently refuses to present, an opinion on the financial statements