1. The Income Statement and the Statement of Cash Flows C hapter 5 COPYRIGHT © 2010 South-Western/Cengage Learning Intermediate Accounting 11th edition Nikolai Bazley Jones An electronic presentation By Norman Sunderman and Kenneth Buchanan Angelo State University

2. 2 1.Understand the concepts of income. 2.Explain the conceptual guidelines for reporting income. 3.Define the elements of an income statement. 4.Describe the major components of an income statement. 5.Compute income from continuing operations. Objectives

3. 3 6.Report results from discontinued operations. 7.Identify extraordinary items. 8.Prepare a statement of retained earnings. 9.Report comprehensive income. 10.Explain the statement of cash flows. 11.Classify cash flows as operating, investing, or financing. Objectives

4. 4 Capital Maintenance Concept Under this concept, corporate income for a period of time is the amount that may be paid to stockholders during that period and still enable the corporation to be as well off at the end of the period as it was at the beginning. Concepts of Income

5. 5 Assume that a corporation has beginning net assets of $45,000 and ending net assets of $80,000. Stockholders made an additional capital investment of $10,000 during the year. Ending net assets$ 80,000 Less: Additional investment (10,000) Ending net assets excluding investment$ 70,000 Less: Beginning net assets (45,000) Total income for the year$ 25,000 Capital Maintenance Concept Concepts of Income

6. 6 Transactional Approach A corporation’s net income for an accounting period currently is measured as follows: Net income = Revenues – Expenses + Gains – Losses Concepts of Income

7. 7 Purposes of the Income Statement 1.To help evaluate management's past performance. 2.To help predict the company’s future income and cash flows. 3.To help assess the company’s “creditworthiness.” 4.To help in comparisons with other companies.

8. 8 Revenues are inflows of (increases in) assets of a company or settlement of its liabilities during a period… Revenues

9. 9 …from delivering or producing goods, rendering services, or other activities that are the company’s ongoing major or central operations. Revenues

10. 10 Recognition is the process of formally recording and reporting an item in a company’s financial statements when they are earned. Revenue Recognition

11. 11 Expenses are outflows of (decreases in) assets of a company or incurrences of liabilities during a period from delivering or producing goods,… …rendering services, or carrying out other activities that are the company’s ongoing major or central operations. Expenses

12. 12 Expense Recognition 1.Association of Cause and Effect (cost of products sold and sales commissions) 2.Systematic and Rational Allocation (depreciation) 3.Immediate Recognition (period costs) The FASB has identified three expense recognition principles to properly match expenses against revenues:

13. 13 Cost: Asset or Expense Transaction Cost ContinuedContinued If a cost results in an economic resource providing future benefits, record it as an... AssetAsset

14. 14 If a cost is a result of providing goods or services in a time period, record it as an... ExpenseExpense Transaction Cost Cost: Asset or Expense

15. 15 If the benefits have been used up, the asset is charged off to an expense. Cost: Asset or Expense

16. 16 Gains and Losses Gains and losses relate to peripheral or incidental activities or to the effects of other events and circumstances. They are reported “net” (not net of tax) in contrast to revenues and expenses, which are reported “gross.”

17. 17 1.Income from continuing operations a.Sales revenue (net) b.Cost of goods sold c.Gross profit d.Operating expenses e.Income from operations f.Other items g.Income from continuing operations before tax h.Income tax expense related to continued operations i.Income from continuing operations Income Statement Content

18. 18 2.Results from discontinued operations a.Income (loss) from operations of discontinued components (net of income taxes) b.Gain (loss) from disposals of discontinued components (net of income taxes. a.Income (loss) from operations of discontinued components (net of income taxes) b.Gain (loss) from disposals of discontinued components (net of income taxes. Income Statement Content

19. 19 3.Extraordinary items (net of income taxes) 4.Net income 5.Earnings per share Income Statement Content That’s it!

20. 20 Multiple-Step Income Statement

21. 21 Cost of Goods Sold—Periodic

22. 22 Operating Expenses Operating expenses are those primary recurring costs (other than cost of goods sold) incurred to generate sales revenue.

23. 23 Operating Expenses

24. 24 Other Items Other items includes those significant recurring items of revenue and expense that are not directly related to the primary operations of the company.

25. 25 Single- Step Income Statement

26. 26 Discontinued Operations A company may decide to “discontinue” some of its operations and sell a component of these operations. What is a component?

27. 27 Discontinued Operations A component of a company involves operations and cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the company. A component may be a subsidiary, an operating segment, or an asset group.

28. 28 Income from continuing operations$93,000 Results from discontinued operations Income from operations of discontinued Division X (net of $2,880 income taxes)$ 6,720 Income before extraordinary items$85,720 Element 1: Operating income (loss) Income Statement: Results from Discontinued Operations Reported net of taxes

29. 29 Income from continuing operations$93,000 Results from discontinued operations Income from operations of discontinued Division X (net of $2,880 income taxes)$ 6,720 Loss on sale of Division X (net of $6,000 income tax credit) (14,000) (7,280) Income before extraordinary items$85,720 Element 2: Gain or loss on sale Income Statement: Results from Discontinued Operations Reported net of taxes

30. 30 Disclosures Required by GAAP  A description of the facts and circumstances leading up to the sale, and, if held for sale, the expected manner and timing of the sale  The revenues and pretax income (loss) of the component included in its operating income (loss) reported in the results from discontinued operations section of the company’s income statement ContinuedContinued Disclosures

31. 31  If not separately reported on its income statement, the gain (loss) on the sale and the caption on the income statement that includes the gain (loss)  If not separately reported on its balance sheet, the book value of the major classes of assets and liabilities Disclosures Required by GAAP Disclosures

32. 32 Extraordinary Items Unusual nature— the underlying event or transaction possesses a high degree of abnormality and is of a type clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the company. An extraordinary item is an event or transaction that is both unusual in nature and infrequent in occurrence.

33. 33 Extraordinary Items Infrequency of occurrence— the underlying event or transaction is of a type that is not reasonably expected to recur in the foreseeable future. An extraordinary item is an event or transaction that is both unusual in nature and infrequent in occurrence.

34. 34 Extraordinary Items An extraordinary item is an event or transaction that is both unusual in nature and infrequent in occurrence. Unusual nature— the unusual nature criterion depends upon the environment in which a company operates. An event may be unusual in nature for one company but not another.

35. 35 One other item is required to be reported as an extraordinary item. As prescribed by GAAP, when a company purchases another company and pays less than the fair value of the net assets of the other company, it reports the difference as an extraordinary gain. Extraordinary Items

36. 36 Change in Accounting Estimate When a company changes an accounting estimate, it accounts for the change in the current year, and in future years if the change affects both. Because companies present financial information on a periodic basis, accounting estimates are necessary, and changes in these estimates frequently occur.

37. 37 IFRS vs. U.S. GAAP  IFRS require a company to use accrual accounting under the historical cost framework, considering economic substance instead of legal form.  In addition, much of a company’s income statement content is similar in that IFRS require disclosure of revenues, operating expenses, finance costs, tax expense, net income (loss), results of discontinued operations, and earnings per share. A company is also required to disclose comprehensive income in either a single statement of comprehensive income or in two separate statements.

38. 38 IFRS vs. U.S. GAAP  While the presentation of discontinued operations is similar to U.S. GAAP, IFRS differ in what qualifies as a component that has been disposed of or held for sale. Under IFRS, a component is a separate major line of business or geographical area. U.S. GAAP allows for a much broader definition in which a discontinued operation may be only a portion of a separate line of business.  IFRS prohibit the reporting of items that are unusual in nature and infrequent in occurrence as extraordinary items.

39. 39 Statement of Cash Flows 1.The company’s ability to generate positive future cash flows 2.The company’s ability to meet its obligations and pay dividends 3.The company’s need for external financing 4.The reasons for differences between the company’s net income and associated cash receipts and payments 5.Both the cash and noncash aspects of the company’s investing and financing transactions during the accounting period The statement of cash flows helps external users assess:

40. 40 The statement of cash flows includes three major sections. 1.Net cash flow from operating activities 2.Cash flows from investing activities 3.Cash flows from financing activities Statement of Cash Flows

41. 41 Statement of Cash Flows 1.To eliminate certain amounts that were included in net income but that did not involve a cash inflow or cash outflow for operating activities 2.To include any changes in the current assets (other than cash) and current liabilities involved in the company’s operating cycle that affect cash flow differently than net income In the Net Cash Flows from Operating Activities section, net income is listed first and then adjustments are made to net income (indirect method):

42. 42 Operating activities include all the transactions and other events related to the earnings process. Investing activities include transactions involving buying and selling long-term investments; buying and selling property, plant, and equipment; and lending money and collecting on the loans. Financing activities include transactions involved in obtaining and disbursing resources from and to owners and repaying the amounts borrowed. Statement of Cash Flows

43. 43 Statement of Cash Flows 1.Receipts from selling property, plant, and equipment 2.Receipts from selling investments in stocks and debt securities 3.Payments for purchases of property, plant, and equipment 4.Payments for investments in stocks and debt securities The Cash Flows from Investing Activities section includes all the cash inflows and outflows involved in investing activities transactions of the company. Common investing activities are:

44. 44 Statement of Cash Flows 1.Receipts from the issuance of debt securities 2.Receipts from the issuance of stocks 3.Payment of dividends 4.Payments to retire debt securities 5.Payments to reacquire stock The Cash Flows from Financing Activities section includes all the cash inflows and outflows involved in the financing activities transactions of the company. Common financing activities are:

45. 45 C hapter 5 Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.