Chapter 11:
The Income Statement
Evolving definitions
Future events
Comprehensive
income
Earnings Per Share
Earnings management
Definitions: Income
Income and profit...results from the
deduction from revenues, or from operating
revenues, of COGS, other expenses, and
losses
Net income...the excess (deficit) of revenue
over expenses for an accounting period
Comprehensive income...
Definitions: Revenues
Results from the sale of goods and
rendering of services...
Gross increases in assets and gross
decreases in liabilities measured in
conformity with GAAP...
Inflows or other enhancements of assets of
an entity or settlements of its liabilities...
Revenues versus Gains
Typically have been displayed separately on
financial statements
Gains are . . . revenues . . . from other than sales of
products, merchandise, or services. . . .
Gains are increases in equity (net assets) from
peripheral or incidental transactions . . . except
those that result from revenues or investments by
owners.
Definitions: Revenue Recognition
Revenue should be identified during the period
during which the major economic activities
necessary to the creation and disposition of goods
and services has been accomplished
Alternative points in time
During production
At completion of production
At time of sale
When the cash is collected
Definitions: Expenses and Losses
Includes all expired costs which are
deductible from revenues
Gross decreases in assets or gross increases
in liabilities recognized and measured in
conformity with GAAP...
Are outflows or other using up of assets or
incurrence of liabilities...
Cost Classifications
Costs directly associated with the revenue
of the period
Costs associated with the period on some
basis other than a direct relationship with
revenue
Costs that cannot, as a practical matter, be
associated with any other period
Future Events
Reporting process is grounded in recording events
that have occurred, but these past events and their
recording are very dependent upon our
interpretation of future events either happening or
not happening
Every accrual and deferral is dependent upon
future events
Treatment of future events in asset, liability,
expense, and revenue recognition has not been
well systematized
Future Events
Trade-off of
qualitative
characteristics such as
relevance and
reliability?
Answer may be
largely qualitative in
nature, which may add
to the ever-burgeoning
role of disclosure
What is
accounting’s future?
Comprehensive Income
Comprehensive income pushes the allinclusive approach toward its logical
conclusion
In addition to net income as presently
defined, comprehensive income includes
those elements of profit and loss that
bypassed the income statement
Reporting Comprehensive Income
1. in a combined statement of financial
performance (income in which the
comprehensive income elements and total would
appear below net income)
2. in a separate statement of comprehensive income
which would begin with net income
3. reported within a statement of changes in equity
Nonoperating Items
Nonoperating section of the income
statement
discontinued operations
extraordinary items
accounting principle changes
Retained earnings statement reports prior
period adjustments
Earnings Per Share (EPS)
SFAS No. 128 , an improvement over APB
Opinion No. 15
increases EPS comparability with other nations
simplifies the computational aspects of EPS
revises disclosure requirements
Calculations have to be shown right on the
income statement itself for both basic and
diluted earnings per share
Earnings Management
....purposeful
intervention in the
external financial
reporting process,
with the intent of
obtaining some
private gain
(Schipper)
Earnings Management
Managing income to affect management
compensation
Income might be managed by manipulating
discretionary accruals
Studies find that managers manage income when bonus
plans are dependent on earnings levels
Income smoothing
Managers smooth income to facilitate better predictions
of future cash flows on which firm value is based
Studies’ tests confirm income-smoothing behavior
Trends
Pre-FASB more time and effort was placed
on refining the income statement to the
detriment of the balance sheet
Since FASB, a shift toward
cleaning up the balance sheet
a movement toward more of an asset-liability
approach to the financial statements consistent
with the conceptual framework project
Chapter 11:
The Income Statement
Evolving definitions
Future events
Comprehensive
income
Earnings Per Share
Earnings management