Professional Documents
Culture Documents
Chapter 3
Chapter 3
Email: tiendt@ftu.edu.vn
CONTENT
Components of the income statement
Net
Revenue Expense
Income
Investors examine a firm’s income statement for valuation purposes while lenders
examine the income statement for information about the firm’s ability to make the
promised interest and principle payments on its debt.
COMPONENTS OF THE INCOME STATEMENT
Revenues (sales, turnover): Amounts reported from the sale of goods and services in the normal
course of business.
Net revenue: Revenue less adjustments for estimated returns and allowances (e.g. for estimated
Expenses: Amounts incurred to generate revenue and include cost of goods sold, operating
Gains and losses: assets inflows and outflows not directly related to the ordinary activities of the
business.
For example, a company sell surplus land, the cost of land is subtracted from the sales price
Operating profit: gross profit minus operating expense (selling, general and administrative
expenses)
Net profit (net income, earning, bottom line): operating profit minus interest expense and
income taxes
Minority owners’ interest: the pro-rata share of the subsidiary’s income for the portion of the
Notes: In Vietnam, interest expense is classified as operating expense and therefore operating
profit is equal to gross profit minus S&A expense and interest expense.
COMPONENTS OF THE INCOME STATEMENT
PRINCIPLES OF REVENUE RECOGNITION
Revenue recognition can occur independently of cash movements—for example, in the case of
Consequently, firms can manipulate net income by recognizing revenue earlier or later, or by
Long-term contract
• Percentage-of-completion method
• Completed contract method
Installment sales
• Installment method
• Cost recovery method
REVENUE RECOGNITION APPLICATIONS
Example: Builder Co.’s contract with Customer Co. to construct the commercial
building specifies consideration of $5,000,000. Builder Co.’s expected total costs to
complete are $4,000,000. The Builder incurs $3,000,000 in costs in the first year.
Assuming that costs incurred provide an appropriate measure of progress toward
completing the contract, how much revenue and costs should Builder Co. recognize
for the first year?
Suppose that on the second year, job is completed with costs of $1,250,000 (a cost
overrun). how much revenue and costs should Builder Co. recognize for this year?
REVENUE RECOGNITION APPLICATIONS
A long-term contract is one that spans a
number of accounting periods (e.g., a
construction contract)
As with revenue recognition, expense recognition can occur independently of cash movements.
When a company sells its products or services on credit, it is likely that some
customers will ultimately default on their obligations (i.e., fail to pay).
Under the matching principle, at the time revenue is recognized on a sale, a
company is required to record an estimate of how much of the revenue will
ultimately be uncollectible. Companies make such estimates based on previous
experience with uncollectible accounts. Such estimates may be expressed as a
proportion of the overall amount of sales, the overall amount of receivables, or the
amount of receivables overdue by a specific amount of time. The company records
its estimate of uncollectible amounts as an expense on the income statement, not as
a direct reduction of revenues.
PRINCIPLES OF EXPENSE RECOGNITION
Warranties
At times, companies offer warranties on the products they sell. If the product proves
deficient in some respect that is covered under the terms of the warranty, the company
will incur an expense to repair or replace the product. At the time of sale, the company
does not know the amount of future expenses it will incur in connection with its
warranties.
Under the matching principle, a company is required to estimate the amount of future
expenses resulting from its warranties, to recognize an estimated warranty expense in
the period of the sale, and to update the expense as indicated by experience over the
life of the warranty.
PRINCIPLES OF EXPENSE RECOGNITION
Depreciation and Amortisation
Depreciation: term commonly applied for physical long-lived assets, such as plant and
equipment (NOT land)
Amortization: Term commonly applied to this process for intangible long-lived assets with
a finite useful life
NONRECURRING ITEMS &
CHANGES IN ACCOUNTING STANDARDS
Separating nonrecurring from recurring items of income and expense can help an
analyst assess a company’s future earnings.
Nonrecurring items:
discontinued operations
When a company has issued any financial instruments that are potentially
convertible into common stock, it is said to have a complex capital
structure.
Example: For the year ended 31 December 2018, Shopalot Company had net income of
$1,950,000. The company had 1,500,000 shares of common stock outstanding, no
preferred stock, and no convertible financial instruments. What is Shopalot’s basic EPS?
EARNINGS PER SHARE
Example:
Calculate
(1) the weighted average number of shares outstanding
(2) the company’s basic EPS
Assume the following:
Company had net income of $2,500,000 for the year and paid $200,000 of preferred dividends.
1,000,000 Shares outstanding on 1 January 2020
200,000 Shares issued on 1 April 2020
(100,000) Shares repurchased on 1 October 2020
1,100,000 Shares outstanding on 31 December 2020
EARNINGS PER SHARE
Solution:
Weighted average number of shares outstanding
1,000,000 × (3 months/12 months) Jan, Feb, Mar
+ 1,200,000 × (6 months/12 months) April–Oct
+ 1,100,000 × (3 months/12 months) Oct, Nov, Dec
= 1,125,000 Weighted average number of shares outstanding
Basic EPS
= (Net income – Preferred dividends)/Weighted average number of shares outstanding
= ($2,500,000 – $200,000)/1,125,000
= $2.04
EARNINGS PER SHARE
Effect of stock dividend and stock split:
A stock dividend is the distribution of additional shares to each shareholder in an
amount proportional to their current number of shares.
A stock split refers to the division of each “old” share into a specific number of
“new” (post-split) shares.
Each shareholder’s proportional ownership in the company is unchanged by either of
these events. Each shareholder has more shares but the same percentage of the total
share outstanding.
Example: Assume the same facts as Example 7 except that on 1 December 2018, a
previously declared 2-for-1 stock split took effect. Each shareholder of record receives
two shares in exchange for each current share that he or she owns. What is the
company’s basic EPS?
EARNINGS PER SHARE
Example: During the past year, R&J Inc. had net income of $100,000, paid dividends
of $50,000 to its preferred stockholders, and paid $30,000 in dividends to its common
shareholders. R&J’s common stock account showed the following: