1. ©2008 Pearson Prentice Hall. All rights reserved. 11-1 The Income Statement & the Statement of Stockholders’ Equity Chapter 11

2. ©2008 Pearson Prentice Hall. All rights reserved. 11-2 Learning Objective 1 Analyze a corporate income statement

3. ©2008 Pearson Prentice Hall. All rights reserved. 11-3 Continuing Operations Income from day-to-day normal business activities Includes:  Revenues and operating expenses  Gains and losses  Income tax expense Can help predict future annual income

4. ©2008 Pearson Prentice Hall. All rights reserved. 11-4 Investment Capitalization Rate & Value of Stock Estimated value of common stock Estimated annual future income Investment capitalization rate = Rate used to estimate value of stock The higher the rate, the higher the risk Compared to market value of the company # of common shares Market price per share X

5. ©2008 Pearson Prentice Hall. All rights reserved. 11-5 Investment Decision Rule If the estimated value of the company: Exceeds Equals Is less than Current market value of the company Buy; stock price may increase Hold; stock price steady Sell; stock price may go down

6. ©2008 Pearson Prentice Hall. All rights reserved. 11-6 Discontinued Operations Company sells a segment of the business  Identifiable part of business Reported beneath income from continuing operations  Net of income taxes Not considered in predictions of future earnings

7. ©2008 Pearson Prentice Hall. All rights reserved. 11-7 Extraordinary Items Gains and losses that are both infrequent and unusual Include losses from natural disasters and expropriation of assets by foreign governments Do NOT include gains or losses from lawsuits, restructuring or sale of plant assets Reported after continuing operations net of income taxes

8. ©2008 Pearson Prentice Hall. All rights reserved. 11-8 Cumulative Effect of Change in Accounting Method Change from one accounting method to another  FIFO to LIFO  Straight-line depreciation to double-declining balance Makes difficult to compare year-to-year statements Reported in special section usually after extraordinary items

9. ©2008 Pearson Prentice Hall. All rights reserved. 11-9 Earnings per Share (EPS) Key measure of company’s success: Net Income - Preferred Dividends Average number of common shares outstanding Reported for each element of net income: Preferred dividends only subtracted for continuing operations and net income Discontinued operations, extraordinary items, etc.

10. ©2008 Pearson Prentice Hall. All rights reserved. 11-10 Comprehensive Income Change in stockholders’ equity from all non-owner transactions Net Income plus:  Unrealized gains (losses) on available-for- sale investments  Foreign currency translation adjustments Not included in net income or EPS calculations

11. ©2008 Pearson Prentice Hall. All rights reserved. 11-11 E11-12

12. ©2008 Pearson Prentice Hall. All rights reserved. 11-12 E11-12 Earnings per share (1600 shares) Income from continuing operations 3.19 Extraordinary gain 0.50 Net Income $ _________ Divide net income by # of shares

13. ©2008 Pearson Prentice Hall. All rights reserved. 11-13 Learning Objective 2 Account for a corporation’s income taxes

14. ©2008 Pearson Prentice Hall. All rights reserved. 11-14 Corporate Income Taxes Federal corporate income tax rate = 35% Income tax expense  Reported on income statement  Based on current year earnings Income tax payable  Current liability on the balance sheet  Amount to be paid to government

15. ©2008 Pearson Prentice Hall. All rights reserved. 11-15 Differences Between Accounting Income and Taxable Income Income Statement  Reports results of operations  Based on accrual account Income Tax Return  Filed with IRS to determine taxes owed  Based on tax laws Depreciation common difference  Straight-line for accounting purposes  Accelerated for tax purposes

16. ©2008 Pearson Prentice Hall. All rights reserved. 11-16 Deferred Taxes When corporations use different methods for accounting and taxes:  Income tax expense does not equal income tax payable The result is a deferred tax liability or asset Income tax expense < Income tax payable Income tax expense > Income tax payable Deferred tax liability Deferred tax asset

17. ©2008 Pearson Prentice Hall. All rights reserved. 11-17 Prior Period Adjustments Correction of an accounting error from a previous period Related revenue or expense item has been closed into Retained Earnings Beginning retained earnings is adjusted for the amount of the error

18. ©2008 Pearson Prentice Hall. All rights reserved. 11-18 Learning Objective 3 Analyze a statement of stockholders’ equity

19. ©2008 Pearson Prentice Hall. All rights reserved. 11-19 Statement of Stockholders’ Equity Includes all equity accounts (example on following slide) Show activity in each account:  From beginning balance to ending balance  Increases and decreases Also includes accumulated other comprehensive income:  Unrealized gain or loss on investments  Foreign currency translation adjustment

20. ©2008 Pearson Prentice Hall. All rights reserved. 11-20 Statement of Stockholders' Equity Common stock Add'l Paid- in Capital Retained Earnings Treasury Stock Total Stockholders' Equity Beginning BalanceXXX(X)X Issuance of stockXXX Net incomeX Cash dividends(X) Stock dividendsXX(X) Purchase of treasury stock(X) Sale of treasury stockXXX Ending BalanceXXX(X)X Which account does net income affect? What’s the net effect of a stock dividend on total equity?

21. ©2008 Pearson Prentice Hall. All rights reserved. 11-21 Learning Objective 4 Understand managers’ and auditors’ responsibilities for the financial statements

22. ©2008 Pearson Prentice Hall. All rights reserved. 11-22 Management’s Responsibility Internal controls over financial reporting in accordance with GAAP  Standard for preparing financial statements  Designed to produce relevant and reliable information for investors and creditors

23. ©2008 Pearson Prentice Hall. All rights reserved. 11-23 Auditor’s Report Companies hire Certified Public Accountants (CPAs) to examine financial statements  Examination is called an external audit  CPAs are to independent of the company they are auditing CPA firms issue audit reports  Provide opinion if financial statements are in accordance with GAAP

24. ©2008 Pearson Prentice Hall. All rights reserved. 11-24 Types of Audit Reports Clean opinion; Statements are fairly presented Qualified “Except for” opinion; Statements are reliable except for one or more items Adverse Statements are unreliable and not in accordance with GAAP Disclaimer No opinion; auditor was unable to form an opinion Unqualified

25. ©2008 Pearson Prentice Hall. All rights reserved. 11-25 End of Chapter 11