Chapter 4
Income Statement
and Related Information
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Income Statement
Usefulness: evaluate past performance;
predict future performance; assess future
cash flows.
 Limitations: different numbers from
different methods; affected by estimation
and judgement; asymmetry in the
measurement of losses and gains.
 Quality of Earnings: earnings management
limits earnings quality through “cookie jar”
reserves and “big bath” write-offs and writedowns.

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1. Format of the I/S
Multiple Step Income Statement (condensed)
Sales
COGS
Gross margin
Operating expenses
Income from operations
Other revenues and gains
Other expenses and losses
Income from continuing operations (IFCO)
Discontinued operations
Extraordinary items
Net income
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1. Format of the I/S
Single Step Income Statement (condensed)
Revenues
Sales revenue
Other revenues and gains
Expenses
COGS
Operating expenses
Other expenses and losses
Income from continuing operations (IFCO)
Discontinued operations
Extraordinary items
Net income
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Content of the I/S
Research and development expenses  Prior to SFAS 2 (1974), all R&D costs were
capitalized, then amortized when products
“came on line” and generated revenues
(matching).
 SFAS 2 required companies to expense all
costs relating to R&D, unless they related to
fixed assets with multiple project uses (ex:
buildings and some equipment).
 Rationale: too difficult to identify and match
costs incurred to specific product revenues.
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Content of the I/S
Restructuring expenses  Include charges for employee severance
and relocation.
 Include charges for write-down of assets
retained in the business and write-off of
assets sold or disposed of.
 Disclosure of components of restructuring
charges now required by SEC.
 Companies historically used this account to
“dump” a number of costs, including those
not related to restructuring, in a “big bath”
year.
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Content - Discontinued Operations

Discontinued operations (DO) relate to the disposal of
a component of a company. Separate disclosures are
required so that investors can distinguish between
ongoing activity and nonrecurring activity.
 A component contains operating activities and cash
flows that can be distinguished from other activities of
the company.
 To be considered a discontinued operation, two
criteria must be met: (1) the results of operations and
cash flows of the component are eliminated from its
ongoing operations, and (2) there is no significant
continuing involvement in the component after the
discontinuance.
 Financial statement presentation includes any
operating income or loss to the measurement date, as
well as any gain or loss on the disposal of the assets.
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Content - Extraordinary Items

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Extraordinary items are defined as those activities
that are material in amount, unusual in nature, and
infrequent in occurrence.
To determine, consider the natural, political, and
economic environment of the firm.
Examples of EI include natural disasters,
nationalization or expropriation of assets by a foreign
government, and one-time major economic
transactions.
If unusual or infrequent, but not both, report in “other
gains/losses”, as part of IFCO. Examples include
material write-down of receivables, and loss from
employee strike.
FASB ruled “9/11 events not extraordinary”
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I/S Classification - Class Problem
1.Loss in Florida from hurricane:
2.Loss from sale of a component:
3.Property loss from terrorist activity on U.S.
soil:
4.Material write-off of accounts receivable:
5.Normal write-off of accounts receivable:
6.Loss from flood (in a 500-year flood plain):
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Content – Changes and Errors
(more in Chapter 22)
 Change in Accounting Principle: includes
changes in accounting methods for such topics
as inventory, depreciation, construction costs
treated by retrospective adjustment of the
financial statements (restate prior years).
 Change in Estimate: like changes in depreciation
life or salvage value; change is treated
prospectively – affects only current and future
periods.
 Correction of Errors: include errors in calculation
and mistakes in the application of accounting
principles; treated as a prior period adjustment to
beginning retained earnings.
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Intraperiod Tax Allocation

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
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The first level of tax allocation is at Income from
Continuing Operations (IFCO).
After that calculation, each item presented below
(discontinued operations and extraordinary items)
is presented net of tax.
Each of these items is presented “net of tax.” This
is necessary because income tax expense has
already been calculated on IFCO. Therefore,
each level below IFCO must present the tax effect
for that component.
This is called “intraperiod” tax allocation allocation of income tax expense to different parts
of the income statement.
A “partial” income statement is presented on the
next slide (and assumes a 25% tax rate).
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Partial Income StatementSample Company
(assuming a 25% tax rate)
Income from continuing operations
Income tax expense
Income from continuing operations - net of tax
Discontinued operations
Income from operations of discontinued segment
(less tax effect of $25)
Loss on disposal of discontinued segment
(less tax effect of $10)
Extraordinary item
Loss from flood damage
(less tax effect of $9)
$120
(30)
90
Net income
$108
75
(30)
(27)
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Earnings Per Share (EPS)

SFAS 128 (ACS 260) simplified the presentation of
earnings per share to two components:
– basic EPS
– diluted EPS

Calculation of Basic EPS =
Net Income - preferred dividends
Average common shares outstanding
 Concept: to indicate how much each common
shareholder “owns” with respect to earnings.
 Preferred dividends are deducted - if declared or if
cumulative - because they are “owned” by to
preferred shareholders.
 This is a calculation of “what is” - the numerator
and denominator use actual shares outstanding
and actual net income for the year.
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Earnings Per Share (EPS)


Diluted earnings per share examines all the
potentially dilutive securities that a company has
issued, like convertible preferred stock, convertible
bonds, and employee stock options. Although
these securities have not been converted at year
end, the calculation shows the effect that the
shares could have on EPS.
Calculation of Diluted EPS =
Net Income - P.D + adjustment for dilutive shares
Avg. CS outstanding + adjustment for dilutive shares

Concept: to indicate how much each common
shareholder would “own” with respect to earnings
IF all dilutive securities had been exercised at the
beginning of the year.
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EPS Disclosure

Separate EPS disclosure for:
– Net income from continuing operations (after
tax)
– Disposals of business segments
– Extraordinary items
 Calculation
– Separate dollar amount (from above
categories) divided by number of common
shares outstanding
 If diluted EPS exists, the company should also
calculate diluted EPS for each level of
presentation.
 If diluted EPS is antidilutive (the calculation is
actually higher than basic EPS), the company
does not have to present diluted EPS.
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EPS Disclosure - Sample Co.
(Based on 100,000 shares outstanding.)
Basic Earnings Per Share:
Income from continuing operations
$0.90
Discontinued operations
Income from operations of segment 0.75
Loss on disposal
(0.30)
Extraordinary loss
(0.27)
Net income
$1.08
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Statement of Retained Earnings
Expanded Format:
Retained Earnings, Beginning
$ xx
Prior Period Adjustment (net of tax) xx
Retained Earn., Begin adjusted
$ xx
Add: Net Income
xx
Less: Cash Dividends
xx
Less: Stock Dividends
xx
Retained Earnings, Ending
$ xx
Note that an appropriation of retained earnings
might be deducted above, creating two retained
earnings (restricted and unrestricted); the same
effect can be achieved through a footnote
disclosure, to indicate restricted use of RE.
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Comprehensive Income
Definition: change in equity (net assets) of
an entity during a period from transactions
and other events and circumstances from
nonowner sources. It includes all changes
in equity during a period except those
resulting from investments by owners and
distributions to owners (SFAC 6).
 Comprehensive income =
Net Income
+Other Comprehensive Income

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Other Comprehensive Income

Other comprehensive income (OCI) includes a
number of equity changes that are not included
in net income.
 In Ch. 17, we will discuss “Unrealized Gains and
Losses on Available-for-Sale Investments.”
These G/L are excluded from net income
because they are usually noncurrent G/L which
will not be realized until sometime in the future
when the investment is sold. (Other activities
affecting OCI will be discussed in ACCT 3305).
 For the last 20+ years, these changes have
been disclosed in the Statement of Stockholders’
Equity. This has changed, starting in Dec. 2011.
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Comprehensive Income Presentation

Although Comprehensive Income has existed as
a concept even before SFAC 6, it has never
been presented as a component of the
financials, until now.
 The new standard (ASC 220-10) allows 2
alternatives:
– Presentation as a single statement which
includes both the Income Statement
components and the OCI components.
– Presentation of 2 contiguous statements:
(1) Income Statement
(2) Statement of Comprehensive Income
(which shows both Net Income and OCI)
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Statement of Stockholders’ Equity

The Statement of Stockholders’ Equity (SSE)
has been used for many years, instead of the
Statement of Retained Earnings, to explain the
detail changes in all the components of
Stockholders’ Equity. The column for OCI will
no longer present the detail changes in OCI, just
as the Retained Earnings Column does not
show the detail revenues and expenses.
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Example of SSE
CS
PS APIC RE AOCI
$200 $200 $600 $400 20
250
(40)
(200)
Balance 1/1/12
Net income
Cash dividends
Stock dividends
Purchase of TS
Other Comp. Income
Balance, 12/31/12
$200
TS
$(40)
$200
$600 $410
$12
$32 $(40)
Note: CS is Common Stock;
PS is Preferred Stock;
APIC is Additional Paid-in Capital;
RE is Retained Earnings;
AOCI is Accumulated Other Comprehensive Income;
TS is Treasury Stock.
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