Chapter 5
The Income Statement
and Statement of Cash
Flows
Intermediate Accounting
10th edition
Nikolai Bazley Jones
An electronic presentation
by Norman Sunderman
Angelo State University
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation.
Thomson, the Star logo, and South-Western are trademarks used herein under license.
2
Concepts of Income
Capital Maintenance Concept
Under this concept, corporate income for a
period of time is the amount that may be
paid to stockholders during that period
and still enable the corporation to be as
well off at the end of the period as it was at
the beginning.
3
Concepts of Income
Capital Maintenance Concept
Assume a corporation has net assets of $45,000 at
the beginning and $80,000 at the end of the year,
and that no additional investments or withdrawals
were made.
Ending net assets
The corporation could
Less: Additional
payinvestment
out $35,000 to
Ending net assets
excludingand
investment
stockholders
still
Less: Beginning
net
assets
be as
well
off at yearTotal income for the year
end.
$80,000
0
$80,000
(45,000 )
$35,000
4
Concepts of Income
Capital Maintenance Concept
Assume a corporation has net assets of $45,000 at the
beginning and $80,000 at the end of the year.
Stockholders made additional capital investments of
$10,000.
Ending net assets
$80,000
Less: Additional investment
(10,000 )
Ending net assets excluding investment
$70,000
Less: Beginning net assets
(45,000 )
Total income for the year
$25,000
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Concepts of Income
Transactional Approach
The transactional approach
to income measurement is
Under this concept, a company records its
used in accounting today.
net assets at their historical cost, and it
does not record changes in the asset and
liabilities unless a transaction, event, or
circumstance has occurred that provides
reliable evidence of a change in value.
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Concepts of Income
Transactional Approach
A corporation’s net income for an accounting
period currently is measured as follows:
Net income = Revenues – Expenses + Gains Losses
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Conceptual Reporting
Guidelines
Providing information about its operating
performance separately from other aspects
of performance.
2. Presenting the results of particularly
significant activities or events that predict
the amounts, timing, and uncertainty of its
future income and cash flows.
3. Providing information useful for assessing
the return on investment.
1.
The FASB suggests that a company’s
Continued
income statement can be improved by--
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Conceptual Reporting
Guidelines
Providing feedback that enables users to
assess their previous predictions of income
and its components.
5. Providing information to help assess the
cost of maintaining its operating capability.
6. Presenting information about how
effectively management has discharged its
stewardship responsibilities regarding the
company’s resources.
4.
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Specific Conceptual
Guidelines
1. Those items that are judged to be unusual
in amount based on past experience should
be reported separately.
2. Revenues, expenses, gains, and losses that
are affected in different ways by changes
in economic conditions should be
distinguished from one another.
3. Sufficient detail should be given to aid in
understanding the primary relationships
among revenues, expenses, gains, and
losses.
Guidelines about how to report revenues, expenses,
Continued
gains, and losses.
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Specific Conceptual
Guidelines
When the measurements of
revenues, expenses, gains, or
losses are subject to
different levels of reliability,
they should be reported
separately.
5. Items whose amounts must
be known for the calculation
of summary indicators (e.g.,
rate of return) should be
reported separately.
4.
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Revenues
Revenues are inflows (or increases) of
assets of a company or settlement of
its liabilities during a period . . .
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Revenues
…from delivering or producing goods,
rendering services, or other activities
that are the company’s ongoing major
or central operations.
13
Revenue Recognition
Recognition is the process of
formally recording and reporting
an item in a company’s financial
statements when they are earned.
14
Revenues
A company usually recognizes
revenue at the time goods are
sold or services are rendered.
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Expenses
…rendering
services,
or carrying
Expenses are
outflows
of assets
out
activities
that are the
of aother
company
or incurrences
of
company’s
ongoing
majorfrom
or
liabilities
during
a period
central
operations.goods,...
delivering
or producing
16
Expenses
Expenses are assets that have
expired or been sold, consumed
or used up during the period
and have no future benefit to
the business. Expenses are from
the company’s ongoing major
or central operations.
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Expense Recognition
Expenses should be matched or
recognized in the same period as the
revenues they help generate.
1. Cause and effect
(cost of goods sold and commissions)
2. Systematic and rational
(depreciation)
3. Immediate recognition (period costs)
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Cost: Asset or Expense
Transaction
If a cost results in an
economic resource
providing future
benefits, record it as
an...
Cost
Asset
Continue
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Cost: Asset or Expense
Transaction
Cost
If a cost is a result of
providing goods or
services in a time
period, record it as
an...
Expense
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Cost: Asset or Expense
If the benefits have been
used up, the asset is
charged off to an expense.
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Income Statement Content
1. Income from continuing operations








Sales revenue (net)
Cost of goods sold
Gross profit
Operating expenses
Income from operations
Other items
Income from continuing operations before tax
Income tax expense related to continued
operations
 Income from continuing operations
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Income Statement Content
2. Results from discontinued operations
a. Income (loss) from operations of
discontinued significant
components (net of income taxes).
b. Gain (loss) from disposals of
discontinued significant
components (net of income taxes).
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Income Statement Content
3. Extraordinary items (net of income
taxes)
4. Net income
5. Earnings per share
That’s it!
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Operating Expenses
Operating expenses are
those primary recurring
costs (other than cost of
goods sold) incurred to
generate sales revenue.
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Gains and Losses
Gains and losses are
reported net (not net of tax)
in contrast to revenues and
expenses, which are reported
gross. They appear in the
Other section of a multiple
step income statement.
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Income Tax Expense
Income tax expense is matched against the following:
1. Income from continuing operations
2. Income (loss) from the operations of a
discontinued component
3. Gain (loss) from the disposal of a
discontinued component
4. Extraordinary items
5. Any prior period adjustments
6. Any items of other comprehensive
income
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Income Tax Expense
Interperiod tax allocation involves
allocating a corporation’s income tax
obligation as an expense to various
accounting periods because of temporary
(timing) differences between its taxable
income and pretax financial income.
28
Income Tax Expense
Intraperiod tax allocation involves
allocating a corporation’s total income
tax expense for a period to the various
components of its net income, retained
earnings, and other comprehensive
income.
29
Discontinued Operations
What is a
component?
A company may decide to
“discontinue” some of its
operations and sell a component
of these operations.
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Discontinued Operations
A component may
be a subsidiary, an
operating segment
or an asset group.
A component of a company
involves operations and cash
flows that can be clearly
distinguished, operationally
and for financial purposes,
from the rest of the
company.
31
FASB Statement No. 144 requires that all of the
following criteria be met to qualify for “held for sale”:
1. Management has committed to a plan to sell the
component.
2. The component is available for immediate sale in its
present condition.
3. Management has begun an active program to locate a
buyer.
4. The sale is probable within one year.
5. The component is being marketed for sale at a price that
is reasonable in relation to component’s fair market
value.
6. It is unlikely that management will make significant
changes to the plan.
Held for Sale
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Income Statement: Results
from Discontinued Operations
Examples from APB No. 30
The sale by a diversified
company of a major
division that
represented the
company’s only
activities in the
electronic industry.
33
Income Statement: Results
from Discontinued Operations
Examples from APB No. 30
The sale by a meat
packing company
of its 20% interest
in a professional
football team.
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Income Statement: Results from
Discontinued Operations
Income from continuing operations
$93,000
Results from discontinued operations:
Reported
net
of
taxes
Income from operations of
discontinued Division X (net
of $2,880 income taxes)
$ 6,720
Loss on disposal of Division X
(net of $6,000 income tax credit)
(14,000 ) (7,280 )
Income before extraordinary items
$85,720
Reported net of taxes
35
Income Statement: Results from
Discontinued Operations
Note that discontinued
operations are reported on the
income statement after the
continuing operations, but
before extraordinary items.
36
Income Statement: Results from
Discontinued Operations
Income from continuing operations
$93,000
Results from discontinued operations:
Income from operations of
discontinued Division X (net
of $2,880 income taxes)
$ 6,720
Income before extraordinary items
Element 1: operating income (loss)
$85,720
37
Income Statement: Results from
Discontinued Operations
Income from continuing operations
$93,000
Results from discontinued operations:
Income from operations of
discontinued Division X (net
of $2,880 income taxes)
$ 6,720
Loss on disposal of Division X
(net of $6,000 income tax credit)(14,000 ) (7,280 )
Income before extraordinary items
$85,720
Element 2: gain or loss on disposal
38
Income Statement: Results from
Discontinued Operations
Sale Illustration
On September 30, 2007, Duvall Company sells
Division C (a component of its operations) for
$102,000 and incurs $2,000 of legal fees and
closing costs. At the time of the sale, the book
values of Division C’s assets and liabilities are
$150,000 and $80,000, respectively. Duvall
Company is subject to a 30% income tax rate.
Continued
39
Sale Illustration
Net cash received ($102,000 – $2,000)
$100,000
Book value of net assets of Division C:
Assets
$150,000
Liabilities
Net book value
Pretax gain
Income tax (30%)
After-tax gain
(80,000 )
(70,000 )
$ 30,000
(9,000 )
$ 21,000
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Income Statement: Results from
Discontinued Operations
Held-for-Sale Illustration
Elmo Company classifies Division M as “held for
sale” at the end of 2007. Elmo Company expects to
sell Division M in 2008 and estimates the fair value
of the division is $200,000. At the end of 2007, the
book value of Division M is $240,000. The company
is subject to a 30% income tax rate.
Continued
41
Fair value of Division M
$200,000
Book value of net assets of Division M:
Assets
$330,000
Liabilities
(90,000 )
Net book value
(240,000 )
Pretax loss
$ (40,000 )
End of 2007
Loss on Write-Down of Held-For-Sale
Division M (pretax)
Assets of Division M
40,000
40,000
42
Income Statement: Results from
Discontinued Operations
Disclosures Required by FASB Statement No. 144
 A description of the facts and circumstances
leading up to the sale, and, if held-for-sale, the
expected manner and timing of the sale.
 The revenues and pretax income (loss) of the
component included in its operating income
(loss) reported in the results of discontinued
operations section of the company’s income
statement.
Continued
43
Income Statement: Results from
Discontinued Operations
Disclosures Required by FASB Statement No. 144
 If not reported separately on its income
statement, the gain (loss) on the sale and the
caption on the income statement that includes
the gain (loss).
 If not separately reported on its balance sheet,
the book value of the major classes of assets and
liabilities.
44
Sale in a Later
Accounting Period
When a company classifies a significant
component as held for sale, it records and
reports the component at the lower of (1) its
book value (book value of assets minus book
value of liabilities) or (2) its fair value (the
amount at which the assets and liabilities as
a whole could be sold in a current single
transaction) less any cost to sell.
45
Sale in a Later
Accounting Period
Elmo Company classifies Division M (a
significant component of its operations) as “held
for sale” at the end of 2007. Elmo Company
expects to sell Division M in 2008 at its fair value
of $200,0000 (consisting of assets with a fair
value of $300,000 and liabilities with a fair value
of $100,000). At the end of 2007, the book value
of Division M is $240,000 (assets book value,
$330,000; liabilities book value, $90,000). The
company is subject to a 30% income tax rate.
Continued
46
Fair value of Division M
$200,000
Book value of net assets of Division M:
Assets
$330,000
Liabilities
(90,000 )
Net book value
(240,000 )
Pretax loss
$ (40,000 )
End of 2007
Loss on Write-Down of Held-For-Sale
Division M (pretax)
Liabilities of Division M
Assets of Division M
40,000
10,000
30,000
47
Extraordinary Items
An extraordinary
item is an event or
transaction that is
both unusual in
nature and
infrequent in
occurrence.
Unusual nature--the
underlying event or
transaction possesses a high
degree of abnormality and is
of a type clearly unrelated
to, or only incidentally
related to, the ordinary and
typical activities of the
company.
Infrequency of
occurrence--the underlying
event or transaction is of a
type that is not reasonably
expected to recur in the
foreseeable future.
48
Extraordinary Items
Events that the APB Opinion No. 30 identified as not
qualifying as extraordinary:
The write-down or write-off of receivables,
inventories, equipment leased to others, or
intangible assets.
2. Gains or losses from exchanges or
transactions of foreign currency.
3. Gains or losses from the disposals of a
business component.
1.
Continued
49
Extraordinary Items
Events that the APB Opinion No. 30 identified as not
qualifying as extraordinary:
Other gains or losses from the sale or
abandonment of property, plant, or
equipment.
5. The effects of a strike.
6. The adjustment of accruals on long-term
contracts.
7. The effect of a terrorist attack.
4.
50
Extraordinary Items
One other item is required to be reported as
an extraordinary item. As prescribed by
FASB Statement No. 141, when a company
purchases another company and pays less
than the fair value of the other company, it
reports the difference as an extraordinary
gain.
51
Extraordinary Items
Event
No
Report Gain (Loss) As
Unusual?
or
No
Infrequent?
Income from Continuing
Operation (Other Items
section)
52
Extraordinary Items
Event
No
Unusual?
Yes
and
Infrequent?
Yes
or
No
Report Gain (Loss) As
Extraordinary
Item
53
Change in Accounting
Estimate
Because companies present financial
information on a periodic basis,
accounting estimates are necessary,
and changes in these estimates
frequently occur.
When a company changes an
accounting estimate, it accounts for
the change in the current year, and in
future years if the change affects both.
54
Statement of Retained
Earnings
Retained earnings is the
link between a
corporation’s balance sheet
and its income statement.
55
Statement of Retained
Earnings
Beginning retained earnings
Plus (minus): Prior period adjustment
(net of $2,400 income taxes)
Adjusted beginning retained earnings
Plus (minus): Net income (loss)
Minus: Dividends (specifically identified,
including per share amounts)
Ending retained earnings
$59,200
5,600
$64,800
22,300
$87,100
(9,400)
$77,700
56
Comprehensive Income
Recall that the FASB now requires companies
to report their comprehensive income (or loss)
for the accounting period.
A company’s comprehensive income consists of
two parts: net income and other
comprehensive net income. Currently, there
are four items of a company’s other
comprehensive income:
Continued
57
Comprehensive Income
1. Any unrealized increases (gains) or decreases
(losses) in the market value of investments in
available-for-sale securities.
2. Any change in the excess of its additional
pension liability over unrecognized prior
service costs.
3. Certain gains and losses on “derivative”
financial instruments.
4. Any transaction adjustment from converting
the financial statements of a company’s
foreign operations into U. S. dollars.
58
Comprehensive Income
The FASB allows a company to report its
comprehensive income under three alternatives:
On the face of its income statement.
In a separate statement of comprehensive
income.
In its statement of changes in stockholders’
equity.
The company must display the statement
containing the comprehensive income as a major
financial statement in its annual report.
59
Comprehensive Income
In reporting its
comprehensive income,
a company must add its
other comprehensive
income to net income.
The other
comprehensive income
items may be reported
at their gross amounts
or net of tax.
If each item is reported
at its gross amount, then
the total pretax amount
of other comprehensive
income must be reduced
by the related income
tax expense.
A company is not
required to report
earnings per share on
its comprehensive
income.
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Chapter 5
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