Chapter 9
The Corporate Income Statement and
Financial Statement Analysis
Chapter 9: Objectives
•Account for investments in stocks and bonds.
•Identify the key elements of the corporate income statement.
•Compute earnings per share.
•
•Account for corporate income taxes.
•Discuss the objectives of and sources for information for financial statement
analysis for different types of decision makers.
•Prepare trend analyses of financial statement data.
•Prepare common-sized financial statements.
•Compute key financial ratios including liquidity, leverage, activity, profitability,
and market strength ratios.
•Assess earnings quality.
Chapter 9
2
The Income Statement
Income From Operations = Revenue – COGS- General Expenses
Other Items include:
Interest Income/Expense
Earnings (or losses) from stock or bond investments
Discontinued operations
Extraordinary items
Cumulative effects of accounting changes
Deferred income taxes
Chapter 9
3
Investments in Stocks
•Cost Method
•Equity Method
Chapter 9
4
Equity Terms
•Parent
•Subsidiary
•Consolidation
•Minority Interest
Chapter 9
5
Visual Recap 9.1
Accounting Methods for Long-term Investment in Other Companies
Method
Cost
Equity
Ownership
< 20%
Initial
Investment
Investment
Cash
Investment
Cash
Investment
Cash
Receipt of
Dividends
Cash
Dividend Revenue
Cash
Investment
Cash
Investment
Year-End
Procedures
Debit or credit the
Investment
account to adjust it
to FMV. The other
debit or credit will
be to
Stockholders’
Equity
Investment
Income from
Unconsolidated
Affiliates
Consolidate the
financial statements
of both companies;
remove the effects of
transactions between
the two companies.
Subtract minority
interest.
20%–80%
Chapter 9
>80%
6
Investments in Bonds
EXHIBIT 9.2
Journal Entries for a Bond Investment Purchased at a Discount
Date
Description
Debit
2003
Apr. 1Investment in Bonds Payable 96,231
Cash
To record purchase of $100,000,
10%, 5-year bonds at a market
rate of 11%.
Sept.
30
Cash
5,000
Investment in Bonds Payable 377
Interest Revenue
To record receipt of semiannual
interest and amortization of
discount to the investment
account.
Chapter 9
Credit
96,231
5,377
7
Dec. 31
Interest Receivable
Investment in Bonds Payable
2,500
189
Interest Payable
2,689
5,000
188
Interest Revenue
Interest Receivable
2,688
2,500
To record accrual of 3 month's
of interest and amortization of
discount to the investment
account.
2004
Mar. 31
Cash
Investment in Bonds Payable
To record receipt of semiannual
interest and amortization of
discount to the investment
account.
Chapter 9
8
Corporate Income Taxes
Taxable income over
$
0
50,000
75,000
100,000
335,000
10,000,000
15,000,000
$
Not over
Tax rate
50,000
15%
75,000
25%
100,000
34%
335,000
39%
10,000,000
34%
15,000,000
35%
18,333,333
38%
Chapter 9
9
Two Sets of Books?
•Temporary Differences
• Permanent Differences
•Deferred Tax Liability
•Deferred Tax Asset
Chapter 9
10
Income From Noncontinuing
Items
•Discontinued Operations
•Extraordinary Items
•Cumulative Effect of a change in
Accounting Principle
Chapter 9
11
Discontinued Operations
Income Statement will contain:
(1) the operating income (or loss) for that
business segment
(2) the gain (or loss) resulting from the
disposal of the segment.
Chapter 9
12
Extraordinary Items
Unusual in nature: The event should be
highly abnormal, taking into account the
environment in which the entity operates
AND
Infrequent in occurrence: The event should
not reasonably be expected to recur in the
foreseeable future, taking into account the
environment in which the entity operates.
Chapter 9
13
Cumulative Effect of a Change in
Accounting Principle
Defined as: the impact on the company's prior
years' net incomes had the newly adopted
accounting principle been used during those
years.
Cumulative effect components of an income
statement are shown "net of tax" after
extraordinary items.
Chapter 9
14
Analytical Techniques
• trend analysis
• common-sized financial statements
• ratio analysis
Trend Analysis: Shows percentage changes from year to year.
Common Size Financials: each line item is expressed as a
percentage of a major financial statement component within the
year.
Ratio Analysis: study of relationships between two financial
statement items.
Chapter 9
15
Ratio Analysis
Liquidity
Current Ratio
Quick Ratio
Leverage
Debt to Total Assets
Long-term Debt to Equity
Times Interest Earned
Acti vity
Ag e of R ec.
AR Tur nover
Age of Inventory
Chapter 9
Inventory Turnover
Asset Turnover
16
Ratio Analysis
Profitability
Gross Margin %
Profit Margin %
Return on Assets
Return on Equity
Market Strength
Price - Earnings
Chapter 9
Market to Book
17