1. Income Statement Two most common formats: Single-Step Format Multiple-Step Format

2. Income Statement Single-step format: Earnings Per Share (Common)$0.605* *assume 1,000,000 shares of common outstanding Cost of Goods Sold$725,000 Selling Exps$115,000 Admin Exps$45,000 Income Tax Expense$35,000 Total Exps$920,000 then subtract all expenses Net Income$605,000 to arrive at net income. Net Sales$1,000,000 Rental Revenue$525,000 Total Revs$1,525,000 classify all revenues

3. Income Statement Multiple-step format Compute Operating Income Add other income and gains. - Operating Revenue – Operating Expenses Subtract other expenses and losses to arrive at net income. Allows a better picture of whether operations provided sufficient net income, since income from operations is directly computed.

4. Multi-step Income Statement Less Income Tax (30%)$99,600 Net Income$232,400 Sales (Operating Revenue)$2,000,000 Less COGS$1,150,000 Gross Margin $850,000 Less Operating Expenses$350,000 Less Administration Expenses$175,000 Operating Income$325,000 Operating Revenues – Operating Expenses Other Revenues and Gains$55,000 Less Other Expenses$48,000 Net Income (before tax)$332,000 Other Revenues – Other Expenses

5. Income Statement Most common general format Sales minusCOGS equalsGross Margin minusSelling Expenses minusAdministrative and General Expenses equals Operating Income plusOther Revenues and Gains plusUnusual Gains minus Unusual Losses equalsNet Income Before Taxes, Disc. Operations, & Extraord. Items minusDiscontinued Operations (net of tax) minusExtraordinary Items (net of tax) plus/minCumulative Effect of Change in Accounting Principle (net of tax) equalsNet Income Earnings Per Share minusIncome Taxes equalsNet Income Before Disc. Operations & Extraord. Items (net of tax) Note: from this point forward, all additions and subtractions need to be made in after-tax dollars (i.e. net of tax).

6. Income Statement Major income statement “highlights” Called “highlighting” because each of the following categories must be represented in its own line on the income statement. - Discontinued Operations - Extraordinary Items - Unusual Gains and Losses - Changes in Accounting Principle - Changes in Estimates

7. Income Statement Discontinued Operations Gains or losses from disposal of a segment of a business are reported separately from the normal operating income of the parent. This is reported net of tax since it comes after taxes have been subtracted. Normal disposal of assets, partial segment disposal, phasing out a product line do not qualify for this treatment. These are considered normal operating disposals and are reported as operating gains and losses.

8. Income Statement Extraordinary Items Material, non-normal, non-recurring gains or losses. The following cannot be considered extraordinary: Write down of receivables, inventory, intangible assets Foreign currency exchange gains or losses Effects of a labor strike Adjustments of accruals on long-term contracts Must meet two criteria: Unusual in nature Infrequent occurrence

9. Major, unusual natural disasters Terrorism (assuming it’s not frequent, like Israel) Income Statement Extraordinary Items Material, non-normal, non-recurring gains or losses. The following might be considered extraordinary: Report net of tax Must meet two criteria: Unusual in nature Infrequent occurrence

10. Income Statement Unusual Gains and Losses Items that are considered unusual but generally occur frequently and therefore cannot be called extraordinary. Restructuring charges Layoffs Plant Closings Asset write-offs The following might be considered unusual: Note that these are not discontinued operations, because they do not pertain to an entire business segment. Report in before-tax dollars (since this is highlighted before taxes are deducted).

11. Income Statement Changes in Accounting Principle If there is a change in GAAP If the company changes its reporting choice for a particular item (LIFO for FIFO, for example) Reported net of tax. the retroactive cumulative (all prior years) effect of the change is reported as a separate item.

12. Income Statement Changes in Accounting Principle Example: Inventory was purchased in 2000: 1/10100 units @ $4.00 1/25400 units @ $5.00 2/10200 units @ $6.00 Inventory sold (and method chosen): Year 2000:300 units (LIFO) Year 2001:350 units (switch to FIFO) The switch to FIFO requires us to report 2001 income under FIFO and fix 2000 income as if it were reported under FIFO. This is done using a cumulative adjustment on the new year’s income statement (2001).

13. Income Statement Changes in Accounting Principle 2000:300 units (LIFO) 2001:350 units (switch to FIFO) Purchases Sales First, compute the 2000 adjustment for change in principle: 1/10/00100 units @ $4.00 1/25/00400 units @ $5.00 2/10/00200 units @ $6.00 COGS under old system (LIFO): COGS under new system (FIFO): 100 x $4.00$400 200 x $5.00$1000 Total$1400 200 x $6.00$1200 100 x $5.00$500 Total$1700 If the tax rate is 30%, this results in a $210, net of tax, cumulative increase to income to be reported on the 2001 income statement. The difference is a $300 reduction in 2000 COGS

14. Income Statement Changes in Accounting Principle 2000:300 units (LIFO) (now FIFO) 2001:350 units (switch to FIFO) Purchases Sales Next, compute the 2001 COGS: 1/10/00100 units @ $4.00 1/25/00400 units @ $5.00 2/10/00200 units @ $6.00 now 200 are left here 200 x $5.00$1000 150 x $6.00$900 Total$1900

15. Income Statement Changes in Accounting Principle This will be reflected in the 2001 (current year’s) income statement as follows: Sales$3,875 COGS$1,900 Gross Margin$1,975 Selling Exps$350 Admin Exps$200 Operating Income$1,425 Taxes Paid (30%)$427.50 Net Income bef. Cumulative effect of acctg change$997.50 Cumulative effect of accounting change (net of tax)$210 Net Income$1207.50

16. Income Statement Changes in Estimates Covered in Chapter 23. Not retroactively applied. Examples: Changes in bad debt allowance estimate Changes in expected useful life for an asset

17. Income Statement Earnings Per Share Required to be reported in Income Statement Must be reported for discontinued operations, extraordinary items, and cumulative effect of accounting changes (see example, bottom of illustration 4-17 on pg. 148) Net Income – Preferred Dividends Weighted Average # of Shares Outstanding

18. Income Statement Retained Earnings Retained Earnings RevenuesExpenses Dividends

19. Income Statement Retained Earnings Retained Earnings Revenues – Expenses = Net Income Expenses Dividends Alternatively,

20. Income Statement Statement of Retained Earnings Reconciles activities in the Retained Earnings account

21. Income Statement Statement of Retained Earnings Reconciles activities in the Retained Earnings account Beginning Balance$1,000,000

22. Income Statement Statement of Retained Earnings Reconciles activities in the Retained Earnings account Beginning Balance$1,000,000 Correction for understatement of income error, prior year$100,000 Any prior year net income errors are adjusted directly to the Retained Earnings account.

23. Income Statement Statement of Retained Earnings Reconciles activities in the Retained Earnings account Beginning Balance$1,000,000 Correction for understatement of income error, prior year$100,000 Adjusted Beginning Balance$1,100,000 Add: Net Income$450,000 Less: Dividends Paid$350,000 Ending Balance$1,200,000