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Chapter4-1

C H A P T E R 4

INCOME STATEMENT AND RELATED

INFORMATION

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Chapter4-2

Evaluate past performance.

Income Statement

Help assess the risk or uncertaintyof achieving future cash flows.

Predicting future performance.

Usefulness

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Chapter4-3

Companies omit items that cannotbe measured reliably.

Income Statement

Limitations

Income measurement involvesjudgment.

Income is affected by theaccounting methods employed.

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Chapter4-4

Earnings Management

Companies have incentives to manage incometomeet or beat Wall Street expectations, so that

market price of stock increases and

value of stock options increase.

Income Statement

Quality of earningsis reduced if earningsmanagement results in information that is lessuseful for predicting future earnings and cashflows.

Quality of Earnings

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Chapter4-5

Format of the Income Statement

Revenues Inflows or other enhancements of assets orsettlements of its liabilities that constitute the entitys

ongoing major or central operations.

Sales

Fee revenue

Interest revenue

Dividend revenue

Rent revenue

Examples of Revenue Accounts

Elements of the Income Statement

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Chapter4-6


ExpensesOutflows or other using-up of assets orincurrences of liabilities that constitute the entitys ongoing

major or central operations.

Cost of goods sold

Depreciation expense

Interest expense

Rent expense

Salary expense

Examples of Expense Accounts


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Chapter4-7


Gains Increases in equity (net assets) fromperipheral or incidental transactions.

Losses - Decreases in equity (net assets) fromperipheral or incidental transactions.

Gains and losses can result from

sale of investments or plant assets,settlement of liabilities,

write-offs of assets.


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Chapter4-8

Single-Step Format

The single-step statementconsists of just twogroupings:

Income Statement (in thousands)Revenues:

Sales 285,000$

Interest revenue 17,000

Total revenue 302,000

Expenses:Cost of goods sold 149,000

Selling expense 10,000

Administrative expense 43,000

Interest expense 21,000

Income tax expense 24,000

Total expenses 247,000Net income 55,000$

Earnings per share 0.75$

RevenuesExpenses

Net Income

Single-Step

No distinction betweenOperatingand Non-operatingcategories.

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Chapter4-9

Separates operating transactions fromnonoperating transactions.

Matches costs and expenses with relatedrevenues.

Highlights certain intermediate components of

income that analysts use.

Multiple-Step Format

Background

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Chapter4-10

1. Operating section

2. Nonoperating section

3. Income tax

4. Discontinued operations

5. Extraordinary items

6. Earnings per share


Income Statement Sections

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Chapter4-11


The presentationdivides informationinto major sections.

Income Statement (in thousands)

Sales 285,000$Cost of goods sold 149,000

Gross profit 136,000

Operating expenses:

Selling expenses 10,000

Administrative expenses 43,000Total operating expense 53,000

Income from operations 83,000

Other revenue (expense):


Interest expense (21,000)

Total other (4,000)

Income before taxes 79,000


Net income 55,000$

Earnings per share 0.75$

1. Operating Section

2. NonoperatingSection

3. Income tax

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Chapter4-12

Irregular items fall into six categories1. Discontinued operations.

2. Extraordinary items.

3. Unusual gains and losses.

4. Changes in accounting principle.

5. Changes in estimates.

6. Corrections of errors.

Reporting Irregular Items

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Chapter4-13

Discontinued Operations occurs when,

(a) company eliminates the

results of operations and

cash flows of a component.

(b) there is no significant continuing involvementin that component.

Amount reported net of tax.


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Chapter4-14

Reporting Discontinued Operations



Interest expense (21,000)Total other (4,000)



Income from continuing operations 55,000

Discontinued operations:Loss from operations, net of tax 315

Loss on disposal, net of tax 189

Total loss on discontinued operations 504

Net income 54,496$

Discontinued Operationsare reported after

Income from continuingoperations.

Previously labeled asNet Income.

Moved to


Sales 285,000$

Cost of goods sold 149,000

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Chapter4-15

Extraordinary items are nonrecurring materialitems that differ significantly from a companystypical business activities.

Extraordinary Item must be both of anUnusual Nature and

Occur Infrequently

Company must consider the environment in which itoperates.

Amount reported net of tax.


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Chapter4-16

Are these items Extraordinary?(a) A large portion of a tobacco manufacturers

crops are destroyed by a hail storm. Severedamage from hail storms in the locality wherethe manufacturer grows tobacco is rare.

(b) A citrus grower's Florida crop is damaged byfrost.

(c) A company sells a block of common stock of a

publicly traded company. The block of shares,which represents less than 10% of the publicly-held company, is the only security investmentthe company has ever owned.

YES

Reporting Extraordinary Items

NO

YES

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Chapter4-17

Are these items Extraordinary?(d) A large diversified company sells a block of

shares from its portfolio of securities which ithas acquired for investment purposes. This isthe first sale from its portfolio of securities.

(e) An earthquake destroys one of the oil refineriesowned by a large multi-national oil company.Earthquakes are rare in this geographicallocation.

(f) A company experiences a material loss in therepurchase of a large bond issue that has beenoutstanding for 3 years. The company regularlyrepurchases bonds of this nature.

NO


YES

NO

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Chapter4-18

Illustration: KC Corporation had after tax income fromcontinuing operations of $55,000,000 in 2007. In addition, itsuffered an unusual and infrequent pretax loss of $770,000from a volcano eruption. The corporations tax rate is 30%.

Prepare a partial income statement for KC Corporationbeginning with income from continuing operations.

Income from continuing operations $55,000,000

Extraordinary loss, net of $231,000 tax 539,000

Net income $54,461,000


($770,000 x 30% = $231,000 tax)

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Chapter4-19







Extraordinary loss, net of tax 539Net income 54,461$

Extraordinary Itemsare reported after

Income from continuingoperations.

Previously labeled asNet Income.


Moved to


Sales 285,000$


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Chapter4-20



Income before taxes 79,000Income tax expense 24,000


Discontinued operations:

Loss from operations, net of tax 315

Loss on disposal, net of tax 189

Total loss on discontinued operations 504

Income before extraordinary item 54,496

Extraordinary loss, net of tax 539

Net income 53,957$

Reporting when bothDiscontinued Operations

and

Extraordinary Items

are present.

DiscontinuedOperations

Extraordinary Item


Sales 285,000$


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Chapter4-21

Unusual Gains and LossesMaterial items that are unusualor infrequent, but notboth, should be reported in a separate section justabove Income from continuing operations before

income taxes.

Examples can include:

Write-downs of inventories

Foreign exchange transaction gains and lossesThe Board prohibits net-of-tax treatment for theseitems.


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Chapter4-22

Changes in Accounting PrinciplesRetrospective adjustment

Cumulative effect adjustment to beginning

retained earningsApproach preserves comparability

Examples include:

change from FIFO to average cost change from the percentage-of-completion to

the completed-contract method


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Chapter4-23

Changes in EstimateAccounted for in the period of change and futureperiods

Not handled retrospectivelyNot considered errors or extraordinary items

Examples include:

Useful lives and salvage values of depreciable assets

Allowance for uncollectible receivables

Inventory obsolescence


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Chapter4-24

Change in Estimate: Arcadia HS, purchased equipmentfor $510,000 which was estimated to have a useful life of 10years with a salvage value of $10,000 at the end of thattime. Depreciation has been recorded for 7 years on a

straight-line basis. In 2010 (year 8), it is determined thatthe total estimated life should be 15 years with a salvagevalue of $5,000 at the end of that time.

Questions:

What is the journal entry to correctthe prior years depreciation?

Calculate the depreciation expensefor 2010.

No EntryRequired

Change in Estimate Example

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Chapter4-25

Equipment $510,000

Fixed Assets:

Accumulated depreciation 350,000

Net book value (NBV) $160,000

Balance Sheet (Dec. 31, 2009)

Change in Estimate Example After 7 years

Equipment cost $510,000Salvage value - 10,000

Depreciable base 500,000

Useful life (original) 10 years

Annual depreciation $ 50,000 x 7 years = $350,000

First, establishNBV at date of

change in estimate.

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Chapter4-26

Change in Estimate Example After 7 years

Net book value $160,000Salvage value (new) 5,000

Depreciable base 155,000

Useful life remaining 8 years

Annual depreciation $ 19,375

DepreciationExpense calculation

for 2010.

Depreciation expense 19,375

Accumulated depreciation 19,375

Journal entry for 2010

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Chapter4-27

Corrections of ErrorsResult from: mathematical mistakes

mistakes in application of accounting principles oversight or misuse of facts

Corrections treated as prior period adjustments

Adjustment to the beginning balance of retainedearnings


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Chapter

4-28

Corrections of Errors: To illustrate, in 2011, HillsboroCo. determined that it incorrectly overstated its accountsreceivable and sales revenue by $100,000 in 2010. In 2011,Hillboro makes the following entry to correct for this error

(ignore income taxes).


Retained earnings 100,000

Accounts receivable 100,000

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Chapter

4-29

Relates the income tax expense to the specific items thatgive rise to the amount of the tax expense.

Income tax is allocated to the following items:(1) Income from continuing operations before tax(2) Discontinued operations

(3) Extraordinary items

(4) Changes in accounting principle

(5) Correction of errors

Special Reporting Issues

Intraperiod Tax Allocation

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Chapter

4-30

Extraordinary Gain: Schindler Co. has income beforeincome tax and extraordinary item of $250,000. It has anextraordinary gain of $100,000 from a condemnation

settlement received on one its properties. Assuming a 30percent income tax rate.


Intraperiod Tax Allocation

Illustration 4-13

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Chapter

4-31

An important business indicator.

Measures the dollars earned by each share of

common stock.Must be disclosed on the the income statement.


Net income - Preferred dividends

Weighted average number of shares outstanding

Earnings Per Share

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Chapter

4-32

Earnings Per Share (BE4-8): In 2010, Hollis Corporationreported net income of $1,000,000. It declared and paidpreferred stock dividends of $250,000. During 2010, Hollishad a weighted average of 190,000 common shares

outstanding. Compute Holliss 2010 earnings per share.


- $250,000$1,000,000

190,000= $3.95per share

Net income - Preferred dividends

Weighted average number of shares outstanding

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Chapter

4-33


LO 6

EPS

Divide byweighted-average

sharesoutstanding

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Chapter

4-34

Increase

Net incomeChange in accountingprinciple

Error corrections

Decrease

Net lossDividends

Change in accounting

principlesError corrections

Retained Earnings Statement


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Chapter

4-35

Woods, Inc.Statement of Retained Earnings

For the Year Ended December 31, 2011

Balance, January 1 1,050,000$

Net income 360,000Dividends (300,000)

Balance, December 31 1,110,000$

Before issuing the report for the year ended December 31, 2011, you

discover a $50,000 error (net of tax) that caused 2010 inventory to beoverstated (overstated inventory caused COGS to be lower and thus netincome to be higher in 2010). Would this discovery have any impact onthe reporting of the Statement of Retained Earnings for 2011?


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Chapter

4-36

Restricted Retained EarningsDisclosed

In notes to the financial statements

As Appropriated Retained Earnings


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Chapter

4-37

Comprehensive IncomeAll changes in equity during a period except those

resulting from investments by owners and

distributions to owners.Includes:

all revenues and gains, expenses and losses

reported in net income, and all gains and losses that bypass net income but

affect stockholders equity.


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Chapter

4 38



Sales 285,000$


Gross profit 136,000

Operating expenses:Selling expenses 10,000

Administrative expenses 43,000

Total operating expense 53,000

Income from operations 83,000



Interest expense (21,000)

Total other (4,000)



Net income 55,000$

Other ComprehensiveIncome

Unrealized gains and

losses on available-for-sale securities.

Translation gains andlosses on foreigncurrency.

Plus others

+

Reported inStockholders Equity

Comprehensive Income

ch04

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