FSA - Ch04 - Income Statement

Chapter
Income Statement
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The Income Statement
• Summarizes revenues and expenses, and gains
and losses
• Ends with the net income for a specific period
• Multiple-step format—presents separately
– Gross profit
– Operating income
– Income before taxes
– Net income
© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain
product or service or otherwise on a password-protected website for classroom use.
The Income Statement—Continued
• Single-step format
– Totals all revenues and gains
– Deducts total expenses and losses
Multiple-Step Single-step
Multiple-step Income statement
Single-step Income statement
For the year ended December 31, N
Net revenue 37,586
Net revenue 37,586
Cost of sales 16,742
Interest income 488
Gross margin 20,844
Other income -
Operating expenses:
38,074
General & administrative 5,458
Costs & expenses
Research and development 5,722
Cost of sales 16,742
Restructuring charges 710 11,890
General & administrative 5,458
Operating income 8,954
Research and development 5,722
Interest income (expense) 488
Other losses 1,756
Other gains (losses) (1,756) (1,268)
Restructuring charges 710 11,890
Income before taxes 7,686
Income before taxes 7,686
Provision for taxes 2,394
Provision for taxes 2,394
Net income $ 5,292
Net income $ 5,292
Basic Elements of the Income
Statement
• Net Sales (Revenues)
• Cost of Goods Sold (Cost of Sales)
• Other Operating Revenue
• Operating Expenses
• Other Income or Expense
Net Sales (Revenues)
• Represents revenue from the sale of principal
goods or services sold to customers
• Shown net of
– Discounts
– Returns
– Allowances
Cost of Goods Sold (Cost of Sales)
• The cost of goods that were sold to produce
revenue
Retailer Manufacturer
Beginning Inventory Beginning Inventory
+ Purchases + Cost of Goods Manufactured
− Ending Inventory − Ending Inventory
Cost of Goods Sold Cost of Goods Sold
• A service firm will not have cost of goods sold,

but it will often have cost of services
Other Operating Revenue
• Depends on the operations of the business
• Examples
– Lease revenue
– Royalties
Operating Expenses
• Consist of two types
– Selling expenses
• Result from a company’s effort to create sales
• Advertising. Sales commissions, and Sales supplies used
– Administrative expenses
• Relate to the general administration of a company’s
operation
• Salaries, Insurance, and Bad debt expense
Other Income or Expense
• Secondary activities not directly related to
operations
• Dividend income, Interest income, Gains
(losses) from sale of assets, and Interest
expense
Special Income Statement Items
G and F Company
Consolidated Income Statement (multiple-step format)
Net sales $XXX
Cost of goods sold (XXX)
Gross profit XXX

Other operating revenue XXX
Operating expenses:
Selling expenses $(XXX)
General expenses (XXX) (XXX)
Operating income XXX

Other income (includes interest income) XXX
Other expenses (includes interest expense) (XXX)
[A] Unusual or infrequent item disclosed separately (loss) (XXX)
[B] Equity in earnings of nonconsolidated subsidiaries (loss) XXX
G and F Company
Consolidated Income Statement (multiple-step format)
For the year ended December 31, N (Continued)
Income before taxes XXX
Income taxes related to operations (XXX)
Net income from operations XXX

[C] Discontinued operations:
Income (loss) from operations of discontinued segment (less applicable income $(XXX)
taxes of $XXX)
Income (loss) on disposal of division X (less applicable income taxes of $XXX) (XXX) (XXX)
[D] Cumulative effect of change in accounting principle (loss) (less applicable $XXX
income taxes of $XXX)
Net income-before noncontrolling interest XXX
[E] Net income-noncontrolling interest $(XXX)
Net income $XXX
Earnings per share $XXX
• Unusual or Infrequent Item Disclosed Separately
– Shown with normal recurring revenues and expenses
– If material, disclosed separately, before tax
– Treatment for analysis
• Included in primary analysis as they relate to operations
• In supplementary analysis, it should be removed net after tax
Special Income Statement Items—
Continued
• Equity Earnings of Nonconsolidated Subsidiaries
– The investor’s proportionate share of the investee’s
net income
– Does not represent cash flow to the investor
• Cash dividends received represent cash flow
– Analysis issues
• Investor’s net income includes revenue of other entity
• May distort ratios
• Presented before tax; tax consequences typically immaterial
Continued
• Income Taxes Related to Operations
– Federal, state, and local taxes
– Includes both paid and deferred taxes
Continued
• Discontinued Operations
– Disclosed separately in the income statement
– Earnings from discontinued operations are presented
net of tax, after net earnings from continuing operations
– Analysis of the single amount of net earnings from
discontinued operations can be presented in the notes
or on the face of the income statement
– Profitability analysis issues
• Inadequate disclosure of associated assets
• Lack of historical profit and loss information on the
discontinued operations
Special Income Statement Items —
Continued
• Extraordinary Items
– Discussion of “Extraordinary items” is of historical
nature
– Prohibited under IFRS and US GAAP
– These items were characterized by the following:
• Unusual and infrequent
• Reported net of income tax
• Earnings per share reported before and after extraordinary
items
Continued
• Change in Accounting Principles
– Current GAAP requires retrospective approach,
unless it is impracticable
• Cumulative effect on prior years reported is reflected in
beginning retained earnings in the year of change
– If impracticable
• Determine the difference to the opening balances in the
accounts
– Prior to current GAAP, changes were presented using
the prospective method
Continued
• Net Income—Noncontrolling Interest (prior to
Dec. 31, 2009 it was called minority share of
earnings)
– Earnings of a partially-owned consolidated subsidiary
that would accrue to the minority owners
– Presented net-of-tax
Earnings per Share
• Earnings divided by the number of shares of
outstanding common stock
• When the entity discloses profit or loss from
continuing operations, EPS must be presented
in respect of continuing operations.
• If an entity reports a discontinued operation, it
must also present EPS for the discontinued
operation.
Net income
EPS =
Outstanding shares of common stock
Retained Earnings
• The accumulated undistributed earnings of the
corporation reported on the balance sheet
• Appropriated
– Restricted by law, contract, or management decision
– Not available for dividends
– Does not represent cash or any other asset
• Unappropriated
– Available for dividends
Reconciliation of Retained Earnings
• Reported as part of the statement of
stockholders’ equity or combined with the
income statement
Beginning balance of retained earnings
+ Prior period adjustments (net of tax)
Cumulative effect of a change in accounting principle
±
(net of tax)
= Beginning balance as adjusted
+ Net income
– Dividends
= End-of-year balance of retained earnings
Dividends
• Dividends return profits to the owners of a
corporation
• Date of declaration
– Creates liability and reduces retained earnings
• Date of payment
– Eliminates liability and reduces cash
Stock Dividends
• Issuing a percentage of outstanding stock as
new shares to existing shareholders
– Assuming a small distribution (less then 25%)
• Removing the fair market value of the stock from retained
earnings and transferring it to paid-in capital
– If the stock dividend is material
• The amount transferred to paid-in capital is determined by
multiplying the par value by the number of additional shares
• Total equity is unaffected by a stock dividend
– Restate share quantities to reflect stock dividend
activity
Stock Dividend—Example
• 100,000 shares outstanding; $1 par; $5 market
• 10% stock dividend on 100,000 shares, issue
10,000 additional shares recorded at $5 per
share
10% stock dividend
Before Effect of dividend After
Common stock par value $1.00 $1.00
Shares outstanding 100,000 issue 10,000 shares 110,000
Total par value $100,000 10,000 $110,000
Additional paid-in capital 750,000 40,000 790,000
Total paid-in capital 850,000 900,000
Retained earnings 1,000,000 (50,000) 950,000
Total stockholders' equity $1,850,000 $1,850,000
Stock Dividend Example
• 100,000 shares outstanding; $1 par; $5 market
• 40% stock dividend on 100,000 shares, issue
40,000 additional shares recorded at $1 per
share
40% stock dividend
Before Effect of dividend After
Common stock par value $1.00 $1.00
Shares outstanding 100,000 issue 40,000 shares 140,000
Total par value $100,000 40,000 $140,000
Additional paid-in capital 750,000 750,000
Total paid-in capital 850,000 890,000
Retained earnings 1,000,000 (40,000) 960,000
Total stockholders' equity $1,850,000 $1,850,000
Stock Splits
• 2-for-1 split
– Doubles the quantity of stock
– Par or stated value is halved
• No effect on retained earnings, additional paid-in
capital, or capital stock accounts
• Analysis issues
– Restate share quantities to reflect split activity
Legality of Distributions to Shareholders
• As per various state laws

– Distributions to stockholders are acceptable as long
as the firm has the ability to pay debts as they come
due in the normal course of business
– Distributions to stockholders are acceptable as long
as the firm is solvent and the distributions do not
exceed the fair value of the assets
– Distributions consist of solvency and balance sheet
test of liquidity and risk
Comprehensive Income
• Total comprehensive income is defined as ‘the
change in equity during a period resulting from
transactions and other events, other than those
changes resulting from transactions with owners
in their capacity as owners’.
Net income
+ The period’s change in accumulated other comprehensive income
= Comprehensive income
• Other comprehensive income (OCI) is defined
as comprising ‘items of income and expense that
are not recognized in profit or loss as required or
permitted by other International Financial
Reporting Standards (IFRS®).
• Foreign currency translation adjustments
• Unrealized holding gains and losses on
investments
• Changes to stockholders’ equity resulting from
additional minimum pension liability adjustments
• Unrealized gains and losses from derivative
instruments
Comprehensive Income—Continued
• Required disclosures
– Comprehensive income
– Each category of other comprehensive income
– Reclassification adjustments for each category of
other comprehensive income
– Tax effects for each category of other comprehensive
income
– Balances for each category of accumulated other
comprehensive income
Comprehensive Income—Continued
• Presentation
– A single income statement reporting net income and
comprehensive income, or
– Report comprehensive income in a separate
statement immediately following the statement of
income
• Analysis issues
– Typically more volatile than net income
• A better indication of long-run profitability
Comprehensive Income—
Combined with Income Statement
XYZ Corporation Statement of Income and Comprehensive income
Sales $230,000
Cost of goods sold 140,000
Gross profit 90,000
Operating expenses 40,000
Operating income 50,000
Other income 4,000
Income before income taxes 54,000
Income taxes 20,000
Net income 34,000
Other comprehensive income
Available for sale security adjustment, net of tax 5,500
Minimum pension liability adjustment, net of tax 3,500
Foreign currency transaction adjustment, net of tax (5,000)
Other comprehensive income 4,000
Comprehensive income $38,000
Earnings per share (for net income only) $2.8
Comprehensive Income—Separate
Statement
XYZ Corporation
Statement of comprehensive income
Net income $34,000
Other comprehensive income

Available for sale security adjustment, net of tax 5,500
Minimum pension liability adjustment, net of tax 3,500
Foreign currency transaction adjustment, net of tax (5,000)
Total other comprehensive income 4,000
Comprehensive income $38,000
Income Statement IFRS vs. GAAP
• IFRS and U.S. GAAP for income statements are
similar, with some presentation differences
– IFRS have no required format of the income
statement
– IFRS classify expenses based on their nature or
function
– IFRS equipment may be revalued which results in the
adjustment of depreciation expenses
– IFRS allow for alternative performance measures to
be presented in income statement

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Chapter

• A service firm will not have cost of goods sold,

Gross profit XXX

General expenses (XXX) (XXX)

Operating income XXX

[A] Unusual or infrequent item disclosed separately (loss) (XXX)

[B] Equity in earnings of nonconsolidated subsidiaries (loss) XXX

Net income from operations XXX

Net income $XXX

Earnings per share $XXX

• As per various state laws

Other comprehensive income

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