the income statement and statement of cash flows

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The Income Statement and Statement of Cash Flows. Objectives of the Chapter. 1. Study the content of an income statement . 2. Study the reporting of comprehensive income. 3. Prepare a retained earnings statement. - PowerPoint PPT Presentation

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  • *Objectives of the Chapter1. Study the content of an income statement.2. Study the reporting of comprehensive income.3. Prepare a retained earnings statement.4. Discuss the quality of earnings, earnings management and limitations of the income statement.5. Study the content of a statement of cash flows.

  • *Income Measurementa. Capital Maintenance ApproachIncome = Net assets changes adjusting for additional investments from owners and dividends.b. Accounting Measurement of Income (transaction approach) = Revenues- Expenses + Gains - Losses

  • *Definition of Elements of Accounting Income Measurement1.Revenues: inflows or increases of assets or decreases of liabilities from activities related to the major operation of a business entity; will eventually increase stockholders equity (i.e., sales revenue). .

  • Income Measurement And Profit Analysis*Revenue Recognition Principle (SFAS No. 5) (-An Accrual Basis)Revenue is recognized when it is earned and realized or realizable (SFAC 5, par. 83).Earned : the entity has substantially accomplished what it must do to be entitled to compensation.Realized: goods are exchanged for cash or claims.Realizable: assets received as compensation are readily convertible into cash or claims to cash.In general, these conditions are met at time of sale (delivery) or when services are rendered (SFAC 5, par. 84). .

    Income Measurement And Profit Analysis

  • *Revenue Recognition PrincipleOther conditions for revenue recognition (Staff Accounting Bulletin No. 101(1999)):Persuasive evidence of a sale.Price is fixed or determinable.Collectibility is reasonably assured.Delivery has occurred or services have been rendered.

  • *Definition of Elements of Accounting Income Measurement (contd.)2. Expenses: outflows or decreases of assets or increases of liabilities of a business entity from activities related to the major operation of a business entity; will eventually decrease stockholders equity.Recognition Principle: Expense recognition (or matching) principle.

  • Accrual Accounting and the Financial Statements*The Expense Recognition (Matching) Principle If revenues are recognized in a period, all related expenses should be recognized in the same period regardless whether expenses are paid or not.The related expenses include traceable costs (e.g. product costs), period costs, (e.g. interest and rent expenses) and estimated expenses (e.g. depreciation expense and bad debt expense).

    Accrual Accounting and the Financial Statements

  • *Definition of Elements of Accounting Income Measurement (contd.)3.Gains: increase in assets from incidental transactions (not related to the major operation of a business entity).4.Losses: decrease in assets from incidental transactions.(i.e., Losses from sale of equipment, inventory write-off, unrealized losses of marketable security valuation)

  • *What Should Be Included (Reported) in The Income Statement?Two conceptsItems under debate

  • *Two Conceptsa. Current Operating Performance Concept: I/S should only include normal, ordinary, recurring results of operations from the current period.b. All-Inclusive Concept:All transactions should be reported in I/S (except for dividends distribution and capital transactions).

  • *Irregular Items under Debate1. Results from Discontinued Operations.2. Extraordinary Items.3. Unusual Gains or Losses (i.e., losses from inventory write-off, losses or gains from disposal of PPE, foreign currency translation gains or losses etc.). 4. Corrections of errors of prior years (Prior Period Adjustments).5. Accounting Changes (i.e., changes in estimates and changes in accounting principles).

  • Numbers of Irregular Items Reported in Recent Years by 500 Large Companies (Source: Kieso, etc., 14th e, illustration 4-5)*

  • *Irregular Items under DebateAPB opinion No. 9 (effective 12/31/66) adopts the all inclusive concept except for the prior period adjustment , dividends and capital adjustments (thus, a modified all inclusive concept).SFAS No. 154 further excludes the reporting of the cumulated effect from changes of accounting principles from the income statement.

  • *BANNER CORPORATIONIncome StatementFor Year Ended December 31, 20x2Sales revenue$150,000Less:Sales returns and allow.$4,000Sales discounts taken$2,300 (6,300)Net sales$143,700Cost of goods sold (Note A) (86,000)Gross profit$57,700Operating expensesSelling expenses (Note B)$10,200General and administrative exp. (Note C)16,000Depreciation expense 7,800Exhibit 4-1 Multiple-Step Income Statement*

  • *Depreciation expense 7,800 Total operating expenses(34,000)Operating income $23,700 Other revenues and expensesInterest revenue$1,800 Dividend revenue600 Interest expense(2,100)Loss on sale of equipment (4,000) (3,700)Pretax income from continuing operations$20,000 Income tax expense (6,000)Income from continuing operations$14,000 Exhibit 4-1 (contd.)*

  • *Income from continuing operations$14,000Results from discontinued operationsIncome from operations of discontinued component A (net of $1,950 I/T)$4,550Loss on disposal of component A (net of $3,150 I/T credit) (7,350) (2,800)Income bef. extraordinary items$11,200 Extraordinary loss from explosion(net of $750 I/T credit)(1,750)

    Net income$9,450 Exhibit 4-1 (contd.)*

  • *Exhibit 4-1 (contd.)

    Earnings Per Share* Components of Income (5,000 shares) Income from continuing operations$2.80 Results from discontinued operations(0.56)Extraordinary loss from explosion(0.35)Net income$1.89

    * Basic and Diluted EPS

    *

  • *Note A: Cost of Goods SoldInventory, 1/1/x2$40,000Purchases$120,000Less: Purchase discounts(5,000)Freight-In 10,000Net purchases125,000Total inv. available for sale165,000Less: inventory, 12/31/x2(79,000)Cost of goods sold$86,000

  • *Note B: Selling ExpensesSales salaries and commissions$3,000Sales office salaries2,000Travel and entertainment1,000Advertising expenses1,000Freight-out800Shipping supplies and expenses1,700Postage and stationery 400Telephone & telegraph expenses$10,200

  • *Note C: General and Administrative ExpensesOffices salaries$10,000Legal and professional services2,000Utility expense2,000Insurance expense1,000Stationery, supplies and postage500Miscellaneous office expense 500$16,000

  • *BANNER CORPORATIONIncome StatementFor Year Ended December 31, 20x2RevenuesSales rev. (net of $2,300 discounts and $4,000 returns and allow.)$143,700Interest revenue1,800Dividend revenue 600Total revenues$146,100ExpensesCost of goods sold (Note A)$86,000Selling expenses (Note B)10,200General and administrative expenses. (Note C)16,000Exhibit 4-2 Single-Step Income Statement*

  • *General and administrative expenses. (Note C)16,000Depreciation expense7,800Loss on sale of equipment4,000Interest expense2,100Income tax expense 6,000Total expenses(132,100)Income from continuing operations $14,000Results form discontinued operationsIncome from operations of discontinued component A (net of $1,950 I/T)$4,550Loss on disposal of component A (net of $3,150 I/T credit) (7,350) (2,800)

    Exhibit 4-2 (contd.)*

  • *Loss on disposal of component A (net of $3,150 I/T credit) (7,350) (2,800)Income bef. extraordinary items$11,200Extraordinary loss from explosion(net of $750 I/T credit)(1,750)Net income$9,450

    Exhibit 4-2 (contd.)*

  • *Exhibit 4-2 (contd.)

    Earnings Per Share* Components of Income (5,000 shares) Income from continuing operations$2.80 Results from discontinued operations(0.56)Extraordinary loss from explosion(0.35)Net income$1.89

    * Basic and Diluted EPS

    *

  • Another Example of An Income Statement(Kieso, etc.,illustration 4-17) ssss *

  • *Four Parts of the Income StatementI. Income from continuing operations.a. Net sales.b. CGS.c. Operating expensesd. Other revenue and expenses (including unusual gains & losses).e. Income taxes for the continuing operations.

  • *Four Parts of the Income Statement (contd.)II.Results from discontinued operations (net of I/T).a.Income (Losses) from operations of discontinued components.b.Gains (Losses) from disposal of discontinued components.III. Extraordinary items (net of I/T).

  • *Four Parts of the Income Statement (contd.)IV.Earnings per share (by components). *Prior period adjustments are reported in the statement of retained earnings at the net of I/T effect.

  • *I. Income From Continuing Operations Detailsa.Net sales =Sales -Sales R&A - sales Discountsb. C.G.S.: (see Note A)Perpetual Inventory system.Periodic Inventory system.CGS = Beginning Inventory + Net Purchases - Ending InventoryNet Purchases = Purchases - Purchases R&A - Purchases Discounts + Freight-In

  • *I. Income From Continuing Operations (contd.)c. Operating expenses (see Ciena Corp. annual report of 2008): Cost incurred to generate operations includingResearch and Development Selling Expense (see Note B) Administrative Expense (see Note C) Depreciation and amortization Exp.Restructuring costsGoodwill and long-lived asset impairments

  • *I. Income From Continuing Operations (contd.)d. Other revenues and expenses (including unusual gains and losses) :Revenues and expenses of recurring items that are not related to major operations (i.e. interest revenue and expense, etc.)Gains and losses that are unusual but not infrequent: loss from inventory write-off, gains or losses from disposals of PPE or sale of investments, gains or losses from foreign currency translation.

  • *I. Income From Continuing Operations (contd.)e.Income taxes relat

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