Income Statement

Two most common formats:

Single-Step Format

Multiple-Step Format

Income Statement

Single-step format:

Earnings Per Share (Common) $0.605*

*assume 1,000,000 shares of common outstanding

Cost of Goods Sold $725,000Selling Exps $115,000Admin Exps $45,000Income Tax Expense $35,000

Total Exps $920,000

then subtract all expenses

Net Income $605,000

to arrive at net income.

Net Sales $1,000,000Rental Revenue $525,000

Total Revs $1,525,000

classify all revenues

Income Statement

Multiple-step format

• Compute Operating Income

• Add other income and gains.

- Operating Revenue – Operating Expenses

•Subtract other expenses and losses to arrive at net income.

Allows a better picture of whether operations provided sufficient net income, since income from operations is directly computed.

Multi-step Income Statement

Less Income Tax (30%) $99,600Net Income $232,400

Sales (Operating Revenue) $2,000,000Less COGS $1,150,000

Gross Margin $850,000Less Operating Expenses $350,000Less Administration Expenses $175,000

Operating Income $325,000

Operating Revenues –Operating Expenses

Other Revenues and Gains $55,000Less Other Expenses $48,000

Net Income (before tax) $332,000

Other Revenues –Other Expenses

Income StatementMost common general format

Salesminus COGSequals Gross Marginminus Selling Expensesminus Administrative and General Expensesequals Operating Incomeplus Other Revenues and Gainsplus Unusual Gainsminus Unusual Lossesequals Net Income Before Taxes, Disc. Operations, & Extraord. Items

minus Discontinued Operations (net of tax)minus Extraordinary Items (net of tax)plus/min Cumulative Effect of Change in Accounting Principle (net of tax)equals Net Income

Earnings Per Share

minus Income Taxesequals Net Income Before Disc. Operations & Extraord. Items (net of tax)

Note: from this point forward, all additions and subtractions need to be made in after-tax

dollars (i.e. net of tax).

Income Statement

Major income statement “highlights”

• Called “highlighting” because each of the following categories must be represented in its own line on the income statement.

- Discontinued Operations- Extraordinary Items- Unusual Gains and Losses- Changes in Accounting Principle- Changes in Estimates

Income Statement

Discontinued Operations

Gains or losses from

disposal of a segment of a business

are reported separately from the normal operating income of the parent.

This is reported net of tax since it comes after taxes have been subtracted.

Normal disposal of assets, partial segment disposal, phasing out a product line do not qualify for this treatment.

These are considered normal operating disposals and are reported as operating gains

and losses.

Income Statement

Extraordinary Items

Material, non-normal, non-recurring gains or losses.

The following cannot be considered extraordinary:

• Write down of receivables, inventory, intangible assets• Foreign currency exchange gains or losses• Effects of a labor strike• Adjustments of accruals on long-term contracts

Must meet two criteria:• Unusual in nature• Infrequent occurrence

• Major, unusual natural disasters• Terrorism (assuming it’s not frequent, like Israel)

Income Statement

Extraordinary Items

Material, non-normal, non-recurring gains or losses.

The following might be considered extraordinary:

Report net of tax

Must meet two criteria:• Unusual in nature• Infrequent occurrence

Income Statement

Unusual Gains and Losses

Items that are considered unusual but generally occur frequently and therefore cannot be called extraordinary.

• Restructuring charges• Layoffs• Plant Closings • Asset write-offs

The following might be considered unusual:

Note that these are not discontinued operations, because they do not pertain to an entire business segment.Report in before-tax

dollars (since this is highlighted before taxes

are deducted).

Income Statement

Changes in Accounting Principle

• If there is a change in GAAP • If the company changes its reporting choice for a particular item (LIFO for FIFO, for example)

Reported net of tax.

the retroactive cumulative (all prior years) effect of the change is reported as a separate item.

Income Statement

Changes in Accounting Principle

Example: Inventory was purchased in 2000:

1/10 100 units @ $4.001/25 400 units @ $5.002/10 200 units @ $6.00

Inventory sold (and method chosen):

Year 2000: 300 units (LIFO)Year 2001: 350 units (switch to FIFO)

The switch to FIFO requires us to report 2001 income under FIFO

and fix 2000 income as if it were reported under FIFO.

This is done using a cumulative adjustment on the new year’s income statement (2001).

Income StatementChanges in Accounting Principle

2000: 300 units (LIFO)2001: 350 units (switch to FIFO)

PurchasesSales

First, compute the 2000 adjustment for change in principle:

1/10/00 100 units @ $4.001/25/00 400 units @ $5.002/10/00 200 units @ $6.00

COGS under old system (LIFO): COGS under new system (FIFO):

100 x $4.00 $400200 x $5.00 $1000Total $1400

200 x $6.00 $1200100 x $5.00 $500Total $1700

If the tax rate is 30%, this results in a $210, net of tax, cumulative increase to income to be reported on the 2001 income statement.

The difference is a $300 reduction in 2000 COGS

Income StatementChanges in Accounting Principle

2000: 300 units (LIFO) (now FIFO)2001: 350 units (switch to FIFO)

PurchasesSales

Next, compute the 2001 COGS:

1/10/00 100 units @ $4.001/25/00 400 units @ $5.002/10/00 200 units @ $6.00

now 200 are left here

200 x $5.00 $1000150 x $6.00 $900Total $1900

Income StatementChanges in Accounting Principle

This will be reflected in the 2001 (current year’s) income statement as follows:

Sales $3,875COGS $1,900Gross Margin $1,975Selling Exps $350Admin Exps $200Operating Income $1,425Taxes Paid (30%) $427.50Net Income bef. Cumulative effect of acctg change $997.50Cumulative effect of accounting change (net of tax) $210Net Income $1207.50

Income Statement

Changes in Estimates

Covered in Chapter 23.Not retroactively applied.

Examples:

• Changes in bad debt allowance estimate• Changes in expected useful life for an asset

Income StatementEarnings Per Share

• Required to be reported in Income Statement

• Must be reported for discontinued operations, extraordinary items, and cumulative effect of accounting changes (see example, bottom of illustration 4-17 on pg. 148)

Net Income – Preferred DividendsWeighted Average # of Shares Outstanding

Income StatementRetained Earnings

RetainedEarnings

Revenues ExpensesDividends

Income StatementRetained Earnings

RetainedEarnings

Revenues –Expenses =Net Income

ExpensesDividends

Alternatively,

Income StatementStatement of Retained Earnings

Reconciles activities in the Retained Earnings account

Income StatementStatement of Retained Earnings

Reconciles activities in the Retained Earnings account

Beginning Balance $1,000,000

Income StatementStatement of Retained Earnings

Reconciles activities in the Retained Earnings account

Beginning Balance $1,000,000Correction for understatement of income error, prior year $100,000

Any prior year net income errors are adjusted directly to the Retained Earnings account.

Income StatementStatement of Retained Earnings

Reconciles activities in the Retained Earnings account

Beginning Balance $1,000,000Correction for understatement of income error, prior year $100,000Adjusted Beginning Balance $1,100,000Add: Net Income $450,000Less: Dividends Paid $350,000Ending Balance $1,200,000