1. BSAD 221 Introductory Financial Accounting Donna Gunn, CA

2. Income Statement Elements Revenues Less: Operating Expenses Subtotal: Operating Income Less: Income Tax Expenses Total: Net Income Non-operating Items Subtotal: Earnings before income tax

3. Income Statement Elements Revenues are transactions that result in an increase in a company’s assets from the selling of goods or services Revenues

4. Income Statement Elements Costs of good sold The direct cost of the products sold to customers Other operating expenses The usual expenses that make up business operations, other than costs of goods sold Less: Operating Expenses

5. Income Statement Elements Earnings from ongoing operations Subtotal: Operating Income

6. Income Statement Elements Gains or losses that result from items outside of normal operating activities Non-operating items

7. Income Statement Elements Equal to revenues minus ALL expenses except for income tax expenses Earnings before income taxes

8. Income Statement Elements Income taxes for the year required for the federal and provincial governments Difference between revenues and expenses times the tax rate Income tax expense

9. Income Statement Elements Total of ALL revenues and expense for the period Total: Net Income

10. Income Statement Elements Results of continuing operations can be presented in one of the two formats Single step format: Revenues (All Operating Expenses) Operating income Multiple step format: Sales (Cost of Goods Sold) Gross Margin (Other Operating Expenses) Operating income

11. Single-Step Income Statement Presents only two groupings for operating income: 1.Revenues (includes gains) 2.Expenses (includes losses) Advantages: Simplicity Eliminates classification problems for revenues/ expenses Disadvantage: Operating and non-operating activities reported together

12. Multiple-Step Income Statement 12 Operating and non-operating activities are separated Advantages: Greater predictive value and feedback value Provides better detail to compare companies Allows for ratio analysis used to assess performance Disadvantage: More work due to increased complexity

13. Other Comprehensive Income 13 Largely other comprehensive income is a separate section that reports unrealized gains and losses not included on the income statement.

14. Comprehensive Income Statement Example of a combined income and comprehensive I/S: Sales800,000 Cost of goods sold600,000 Gross profit200,000 Operating expenses 90,000 Net income110,000 Other comprehensive income Unrealized gain 30,000 Comprehensive income140,000

15. Uses and Limitations of the Income Statement Uses: Evaluate past performance and profitability Assist in predicting future performance Assess potential risk or uncertainty in achieving future cash flows

16. Uses and Limitations of the Income Statement Limitations: Items are excluded if they cannot be measured reliably Amounts reported are affected by accounting methods used Use of estimates in measuring income

17. Quality of Earnings Nature of Content Free from bias Represents economic reality Reflects earnings from ongoing operations Can be correlated with cash flows from operations Presentation Does not disguise or mislead (transparent) Information presented is understandable Information is clear and concise

18. Research has shown that about half of all financial statement fraud over the past two decades has involved improper revenue recognition – such as: 1.Recognizing revenue before it is earned 2.Providing incentives for customers to buy more inventory than needed 3.Reporting revenue when significant services/goods are still to be delivered 4.Reporting sales to fictitious or nonexistent customers Evaluating the Quality of Earnings

19. Earnings per Share Earnings per share (EPS) is considered one of the most significant business indicators Indicates dollars earned per common share; it does not report the dollars paid (or to be paid) per common share

20. 20 Weighted Average of Common Shares Outstanding Net Income – Preferred Dividends Calculated as: Earnings per Share

21. Value of a Company Income from continuing operations can be used in estimating the value of common shares. To do this we use a capitalization rate.

22. Assume an interest rate of 12% to value Westmount. Estimated value of Westmount’s common shares Estimated annual income in the future = Investment capitalization rate ÷ $54,000 ÷ 0.12 = $450,000 = Earnings Valuation of a Company

23. Current market value of the company Number of common shares outstanding Current market price per share =× $513,000 12,500$41.04 =× Market Value of a Company

24. Continuing Operations: Investment Decision The investment decision rule may take this form: Estimated Value > Market Value …… BUY Estimated Value = Market Value ……. HOLD Estimated Value < Market Value ……. SELL

25. Continuing Operations: Investment Decision In the case of Westmount… Estimated Value = $450,000 Market Value = $513,000 Estimated Value < Market Value, therefore sell

26. Statement of Shareholders Equity Common Shares Retained EarningsAOCI Total Shareholder's Equity Balance, Jan 1 $180,000 $136,000 $(4,000) $312,000 Net income 54,400 Cash dividends (21,000) Issuance of shares 6,000 Balance, Dec 31 $186,000 $169,400 $(4,000) $351,400

27. Suppose for 2011, Red Lake Outfitters Ltd. has pretax accounting income of $10 million on the income statement. Taxable income is $9.2 million on the company’s income tax return. The tax rate is 30%. Accounting for Corporate Income Taxes

28. Dr. Income Tax Expense (1)3M Cr. Income Tax Payable (2)2.76M Cr. Future Income Tax Liability (3)0.24M Recorded income tax for the year (1)$10M x 30% (2)$9.2M x 30% (3)$3M - $2.76M Accounting for Corporate Income Taxes

29. Income statement Income before income tax$10.00 Income tax expense (3.00) Net income$ 7.00 Balance sheet Current Liabilities: Income tax payable$2.76 Long-term liabilities: Future income tax liability 0.24* *Assumes beginning tax liability was zero. Accounting for Corporate Income Taxes