Income Statement
measures the success of company operations for a given time period
Used to determine profitability, investment value, and creditworthiness
Predict: amounts, timing, and uncertainty of future cash flows
Usefulness of the Income statement
Evaluate the past performance of the company (compare)
Provide a basis for predicting future performance
Help assess the risk of uncertainty of achieving future cash flows
Relationships among revenues, expenses, gains, and losses
Limitations of the income statement
Net income=estimate and reflects a number of assumptions
(1) Companies omit items from the income statement that they cannot measure reliability
Ex: do not record unrealized gains or losses
(2) Income numbers are affected by the accounting methods employe
Quality of earnings-Want to beat wall street predictions
SEC thinks this may take away from good business practices
Stop earning management
Stop earning management
planned timing of revenues, expenses, gains, and losses to smooth out bumps in earnings
Ex: increase income of current year at the expense of income in future years
Increase current earnings to increase income in the future-cookie jar
Use of quality of earnings
useful in predicting future earnings and cash flow
Elements of the income statement
Net income results from revenue, expense, gain, and loss
Transaction approach
Revenues=sales, fees, interest, dividends, rent
Expenses=COGS, depreciation, interest, rent, salary, tax
Gain/loss=investment, plant assets, settle liabilities, write offs
Transaction approach
focus on income-related activities that have occurred during the period
Multiple step income statement
Operating section
Non operating section
Income tax
Discounted operations
Noncontorlling interest
Earnings per share
Operating section
revenues and expenses of principal operations
Purpose: arrive at the net amount of sales revenue
Sales or revenue-sales, discounts, allowances, returns
COGS=cost of goods that were sold to purchase the sales
Selling expense=lists expenses resulting from e
nonoperating expenses
eport of rev and exp resulting from secondary activities
Other revenues and gains=revenues recognized or gains incurred from nonoperating transactions
Other expenses and losses=expenses and losses incurred from nonoperating operations
income tax
report federal and state taxes levied on income from continuing operations
Discontinued Operations
material gains and losses resulting from the disposition of a component of the business
Net of tax
After income from continuing operations
Non-controlling interest
allocation of income to non controlling shareholders
Earnings per share
a measure of performance over the reporting period
Disclosure
Net sales=regular revenues are a separate item
Gross profit=evaluate performance and predict future
Income from operations-differences between regular and non-recurring or incidental activities
Condensed Income Statement
include only the totals of expense groups in the statement of income
Then prepares supplementary schedules to support totals
single-step income statement
Revenues and expenses
Expenses are deducted from revenues to get net income
Advantage=simple presentation
Revenue-expenses=net income
No distinguishing between operating and nonoperating
current operating performance approach
most useful income measure reflects only regular and recurring revenue and expense elements
Does not recognize gains or losses
Requires judgement on what is operational
modified all inclusive concept
incluse most items as part of net income
(1) Unusual and infrequent gains and losses
(2) Discontinued operations
(3) Noncontrolling interest
(4) earnings per share
Unusual and infrequent gains and losses
Unusual=high degree of abnormality and of a type clearly unrelated to the ordinary and typical activities of the company, taking into account the environment in which it operates
Infrequency of occurrence-type of transaction that is not reasonable expecte
Discontinued Operations
Needs to be a major line
(1) company eliminates the results of the operations of a component of the business (operations and cash flows that can be clearly distinguished)
(2) Strategic shift=disposal of a major line of business, major geographical area, m
intraperiod tax allocation
allocation within the income statement of a period
Relates to income tax expense of the fiscal period
Helps understand the impact of income taxes on the various components of net income
(1) income from continuing operations
(2) Discontinued operations
noncontrolling interest
the portion of equity (net assets) interest in a subsidiary not attributable to the parent company
(1) majority interest represented by stockholders who own the contorlling interest
(2) Noncontrolling interest represented by stockholders who are not part
Earnings per share
EPS=(net income-preferred dividends)/Weighted average common shares outstanding
Easily relatable to stock price
Measures dollars earned on each share of common stock
After tax
Other reporting issues
(1) Accounting changes and errors
(2) Retained earnings statement
(3) Comprehensive income
Accounting changes and errors
Changes in accounting principles
Changes in accounting estimates
Corrections of errors
changes in accounting principle
Change in the method of inventory pricing from FIFO to average-cost, or a change in accounting for construction contracts from the percentage of completion to the completed contract method
Retrospective adjustment
Retrospective adjustment
recasts the prior years statement on a basis consistent with the newly adopted principle
Changes in accounting estimates
Useful life, salvages values of depreciable assets,uncollectible receivables,
Account for changes in estimates in the period of change if they affected only that period
Companies do not handle changes in estimate retrospectively
Not considered errors
Corrections of errors
Math mistake, application of accounting principles mistake, misuse of facts
Correct errors by making proper entries in the accounts and reporting the corrections in the financial statements
Prior period adjustments
Prior period adjustment
record correction of an error in the year it was discovered
Adjust beginning of retained earnings
Retained earnings statement
Net income increases retained earnings
Net loss decreases retained earnings
Cash and stock dividends decrease retained earnings
Changes in accounting principles can increase or decrease
Companies charge or credit these adjustments (net of tax) to the open
Restrictions on Retained Earnings
to comply with contractual requirements, board of directors, or current necessary
Disclosed in financial statements
Appropriated retained earnings-(1) retained earnings free (unrestricted) (2) retained earnings appropriated (restricted)
Total of those is
Comprehensive income
all changes in equity during a period except those resulting from investments by owners and distribution to owners
all revenues and gains, expenses and losses reported in net income, and all gains and losses that bypass net income but affect stockholders'
Fair value=misleading
FASB agrees-limites # of transactions under other comprehensive income
The aggregate amount of the other comprehensive income item is reported in stockholders' equity as
Accumulated Other Comprehensive Income.
Ex: available-for-sale debt investments
Other comprehensive income
non-owner changes in equity that bypass the income statement
Unrealized gains or losses on available for sale securities
Translation gains and losses on foreign currency
Statement of SE
1.Contributions (issuances of shares) and distributions (dividends) to owners.
2.Reconciliation of the carrying amount of each component of stockholders' equity from the beginning to the end of the period.
reports the changes in each stockholders' equity
Non-controlling interest
allocation of income to non controlling shareholders
Own more than 50% of a company-put in the consolidated income statement
Report at 100%
This area subtracts the part you do not own out
After net income
Limitations of income statement
Omit items that cannot be measured reliably
Income measurement involves judgment
Income is affected by the accounting methods employed.
Income statement usefulness
Help assess the risk or uncertainty of future cash flows.
Predicting future performance
Evaluate past performance.
quality of earnings
Infscome that will continue in the future
EPS and discontinued operations
Need to report in 3 ways if there is discontinued operations
Continuing operations
Discontinuing operations
Net
Preferred stock
Preferred dividends must be paid if there are available funds
No voting rights
Priority over common stockholder
Changes in estimate
Accounted for in the period of change or the period of change and future periods if the change affects both
Not retrospective
No not correct prior year comparative numbers
Not an error or extraordinary item
Error
Math mistake
Mistake in application of principles
Oversight or misuse of facts
Corrections treated as prior period adjustments
Must correct prior year comparative numbers
Adjust beginning retained earnings