Chapter 5
Income Statement & Related
Information
Income Statement
• Revenues: inflows from major operations
• Expenses: outflows from major operations
• Gains & Losses: changes in equity from
peripheral activities
• Non-recurring items
• Net income: bottom line all operating
activities recorded on the income statement
• Comprehensive income: Changes in equity
from all non-owner sources (note: usually not
reported on the income statement
Income Statement Usefulness
Evaluate past performance.
Predicting future performance.
Help assess the risk or uncertainty of
achieving future cash flows.
Income Statement Limitations
Companies omit items that cannot be
measured reliably.
Income is affected by the accounting
methods employed.
Income measurement involves judgment.
Earnings Quality
•
Companies have incentives to manage income to
meet or beat Wall Street expectations, so that
the market price of stock increases and
the value of stock options increase.
• Quality of earnings is reduced if earnings
management results in information that is
less useful for predicting future earnings
and cash flows.
Revenue
• Revenues – Inflows or other
enhancements of assets or settlements of
its liabilities that constitute the entity’s
ongoing major or central operations.
Sales
Fee Revenue (services, etc.)
Interest Revenue
Dividend Revenue
Rent Revenue
Expenses
• Outflows or other using-up of assets or
incurrences of liabilities that constitute
the entity’s ongoing major or central
operations.
Expenses by Category
• Cost of goods sold (manufacturing, retail)
• Cost of sales (services or services included)
• Operating expenses (selling, general &
administrative, research & development,
other)
• Interest income & expenses
• Provision for tax
Gains & Losses
•Gains – Increases in equity (net assets)
from peripheral or incidental transactions.
•Losses - Decreases in equity (net assets)
from peripheral or incidental transactions.
•
Gains and losses can result from
sale of investments or plant assets,
settlement of liabilities,
write-offs of assets.
Non-recurring Items
• Extraordinary items
• Discontinued operations
• Accounting changes
Change in accounting principle
Change in accounting estimate
Correction of an error
Single Step Income Statement
Income Statement (in thousands)
Revenues:
Sales
Interest revenue
Total revenue
####
17,000
####
Expenses:
Cost of goods sold 149,000
Advertising expense 10,000
Depreciation expense 43,000
Interest expense
21,000
Income tax expense 24,000
Total expenses
####
Net income
Earnings per share
####
$
0.75
Multiple Step Income Statement
Separates operating transactions from
non-operating transactions.
Matches costs and expenses with
related revenues.
Highlights certain intermediate
components of income that analysts use.
Multiple Step Income Statement
Income Statement (in thousands)
Sales
Cost of goods sold
Gross profit
####
149,000
136,000
Operating expenses:
Advertising expense
10,000
Depreciation expense
43,000
Total operating expense53,000
Income from operations 83,000
Other revenue (expense):
Interest revenue
Interest expense
Total other
Income before taxes
Income tax expense
17,000
(21,000)
(4,000)
79,000
24,000
Net income
Earnings per share
####
$
0.75
Non-recurring & Other Irregular Items
• Companies are required to report irregular items in
the financial statements so users can
determine the long-run earning power
of the company. (Irregular items for 600 companies, 1
Year.)
Discontinued Operations
•
Discontinued Operations occur when,
– (a)
company eliminates the
results of operations and
cash flows of a component.
(b)there
is no significant continuing involvement in
that component.
•
Amount reported “net of tax” (intra-period tax
allocation).
Extraordinary Items
•
Extraordinary items are nonrecurring material items
that differ significantly from a company’s typical
business activities. With SFAS #145-relatively rare.
•
Extraordinary Item must be both of an
Unusual nature and
Occur infrequently
• Company must consider the environment in which it
operates.
•
Amount reported “net of tax.”
Unusual Gains & Losses
•
Material items that are unusual or infrequent, but not
both, should be reported in a separate section just
above “Income from continuing operations before
income taxes.” These are not non-recurring items.
•
Examples can include:
Write-downs of inventories
Foreign exchange transaction gains and losses
•
The Board prohibits net-of-tax treatment for these
items.
Changes in Accounting Principle
Retrospective adjustment
Cumulative effect adjustment to beginning
retained earnings
Approach preserves comparability
Examples include:
 change from FIFO to average cost
 change from the percentage-of-completion to the
completed-contract method
Changes in Estimate
Accounted for in the period of change and future
periods
Not handled retrospectively
Not considered errors or extraordinary items
Examples include:
 Useful lives and salvage values of depreciable assets
 Allowance for uncollectible receivables
 Inventory obsolescence
Correction of an Error
Result 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 retained
earnings
Tax Allocation
Tax Allocation Result 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 retained
earnings
Tax affect is reported within the line item.
Inter-period Tax Allocation is the timing difference
between GAAP and tax accounting; for example, most
companies use straight-line depreciation for financial
reporting and accelerated for tax purposes
Earnings Per Share (EPS)
• Calculation:
– Net income - Preferred dividends
Weighted average number of shares outstanding
An important business indicator.
Measures the dollars earned by each
share of common stock.
Must be disclosed on the income
statement.
Changes in Retained Earnings
Increases:
Net income
Change in accounting principle
Error corrections
Decreases:
Net loss
Dividends
Change in accounting principles
Error corrections
All-Inclusive Income
• Net income is considered “modified” allinclusive income
• All-inclusive is Comprehensive Income
• Some companies report comprehensive
income as part of the income statement
• For most companies, comprehensive income
has to be calculated.
Other Comprehensive Income
Gains & losses not reported on the income
statement (also called “dirty surplus):
Unrealized gains and losses on availablefor-sale securities.
Translation gains and losses on foreign
currency.
Pension & derivatives gains & losses
Other
Comprehensive Income
• Usually reported at part of the statement of
stockholders’ equity.
Comprehensive Income
• Balance Sheet presentation (part of
stockholders’ equity):
Earnings Measures
•
•
•
•
•
•
•
Gross profit
Operating income
Income before tax
Earnings before income & taxes (EBIT)
Income from continuing operations
Net income
Comprehensive income