CHAPTER 4
Income Statement and Related Information
ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)
Topics
Questions
Brief
Exercises
Exercises
Problems
1.
Income measurement
concepts.
2.
Computation of net
income.
3.
Single-step income
statements.
11, 19
1, 2
3, 4, 5, 7
2, 4, 5
1, 4, 5
4.
Multiple-step income
statements.
11, 12, 13,
15, 17, 19,
20, 22
3, 4, 5, 6
3, 4, 5, 6, 7,
8, 9, 10, 17
1, 3, 4, 5, 7
1, 4, 5, 6
1, 3, 6, 7
5, 6
5.
1, 2, 3, 4, 5,
6, 7, 8, 9, 10,
18, 33, 34,
35
Concepts
for Analysis
1, 2, 3
1, 4, 7
Discontinued
operations.
15, 16, 22,
31, 35, 37
6.
Intraperiod tax
allocation.
21, 24, 27,
28
12, 13, 14,
15, 16, 17
3, 5, 7
7.
Extraordinary items.
15, 16, 29
6
3, 7
8.
Noncontrolling
interest.
22, 23
9.
Earnings per share.
22, 25, 26
10.
Accounting changes,
prior period
adjustments.
11.
12.
4, 5, 6
6
8, 9, 10, 13
1, 2, 3, 4
6
4, 14, 15, 16 6, 7
11, 12, 14
5, 6
6
Retained earnings
statement and
statement of
stockholders’ equity
16, 30, 32
9, 10
9, 11, 12,
15, 16, 17
1, 2, 4, 5, 6
Comprehensive
income.
36
11
2, 3, 15, 16,
17
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4-1
ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Learning Objectives
Brief
Exercises
Exercises
Problems
1.
Understand the uses and limitations
of an income statement.
2.
Describe the content and format of an income
statement.
4, 5
4, 5, 6, 7
2
3.
Prepare an income statement.
1, 2, 3, 4
1, 2, 3, 4, 5,
6, 7, 8, 9, 11,
15, 16, 17
1, 2, 3, 4,
5, 7
4.
Explain how to report various income items.
4, 5
8, 9, 11, 14,
17
1, 3, 4,
5, 6, 7
5.
Identify where to report earnings per share
information.
8
6, 7, 8, 9, 10,
11, 13, 17
1, 2, 3, 4,
5, 6, 7
6.
Understand the reporting of accounting
changes and errors.
6, 7, 10
14
6, 7
7.
Prepare a retained earnings statement.
9, 10
8, 9, 11, 12,
17
1, 2, 5, 6
8.
Explain how to report other comprehensive
income.
8
2, 3, 8, 15,
16, 17
4-2
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ASSIGNMENT CHARACTERISTICS TABLE
Level of
Difficulty
Time
(minutes)
Simple
Simple
Simple
Moderate
Simple
Moderate
Moderate
Simple
Simple
Simple
Moderate
18–20
15-20
15–20
20–25
30–35
30–35
30–40
15–20
30–35
20–25
20–25
E4-12
E4-13
E4-14
E4-15
E4-16
E4-17
Computation of net income.
Compute income measures.
Income statement items.
Single-step income statement.
Multiple-step and single-step.
Multiple-step and extraordinary items.
Multiple-step and single-step.
Income statement, EPS.
Multiple-step statement with retained earnings.
Earnings per share.
Condensed income statement—periodic inventory
method.
Retained earnings statement.
Earnings per share.
Change in accounting principle.
Comprehensive income.
Comprehensive income.
Various reporting formats.
Simple
Moderate
Moderate
Simple
Moderate
Moderate
20–25
15–20
15–20
15–20
15–20
30–35
P4-1
P4-2
P4-3
P4-4
P4-5
P4-6
P4-7
Multiple-step income, retained earnings.
Single-step income, retained earnings, periodic inventory.
Irregular items.
Multiple- and single-step income, retained earnings.
Irregular items.
Retained earnings statement, prior period adjustment.
Income statement, irregular items.
Moderate
Simple
Moderate
Moderate
Moderate
Moderate
Moderate
30–35
25–30
30–40
45–55
20–25
25–35
25–35
CA4-1
CA4-2
CA4-3
CA4-4
CA4-5
CA4-6
CA4-7
Identification of income statement deficiencies.
Earnings management.
Earnings management.
Income reporting items.
Identification of income statement weaknesses.
Classification of income statement items.
Comprehensive income.
Simple
Moderate
Simple
Moderate
Moderate
Moderate
Simple
20–25
20–25
15–20
30–35
30–40
20–25
10–15
Item
Description
E4-1
E4-2
E4-3
E4-4
E4-5
E4-6
E4-7
E4-8
E4-9
E4-10
E4-11
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4-3
LEARNING OBJECTIVES
1.
2.
3.
4.
5.
6.
7.
8.
4-4
Understand the uses and limitations of an income statement.
Describe the content and format of the income statement.
Prepare an income statement.
Explain how to report various income items.
Explain where to report earnings per share information
Understand the reporting of accounting changes and errors.
Prepare a retained earnings statement.
Explain how to report other comprehensive income.
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CHAPTER REVIEW
1. Chapter 4 presents a detailed discussion of the concepts and techniques that underlie the
preparation of the income statement and retained earnings statement and the reporting of
other comprehensive income. The requirements for adequate presentation of reported net
income are described and illustrated throughout the chapter.
2. (L.O. 1) The income statement helps users of financial statements (1) evaluate the past
performance of the company, (2) provide a basis for predicting future performance, and
(3) help assess the risk or uncertainty of achieving future cash flows. The limitations of
the income statement include (1) companies omit items from the income statement that
they cannot measure, (2) income numbers are affected by the accounting methods
employed, and (3) income measurement involves judgment.
3. Quality of earnings is important because markets are based on trust and it is imperative
that investors have faith in the numbers reported. If that trust is damaged, capital markets
will be damaged.
Elements of the Income Statement
4. (L.O. 2) The major elements of net income are: revenues, expenses, gains, and losses.
The distinction between revenues and gains and the distinction between expenses and
losses depend to a great extent on the typical activities of a business enterprise. When
inflows or enhancements of assets result from typical business activities (generally the
activities the entity is in business to perform), revenues result. Likewise, outflows or the
using up of assets resulting from typical business activities will generate expenses.
Nontypical business activities resulting in inflows or outflows of assets will normally
generate transactions classified as gains or losses.
Income Statement Formats
5. (L.O. 3) The income statement may be presented in the single-step format or the
multiple-step format. Single-step income statements derive their name from the fact that
total costs and expenses are subtracted from total revenues in a “single step” to arrive at net
income. Income taxes are normally shown as a separate item among the expenses (usually
last) to indicate their relationship to income before taxes. The multiple-step format separates
results achieved by regular operations of the entity from those obtained by nonoperating
activities. Expenses are also classified by function such as cost of sales, selling, and
administrative. The multiple-step format provides more information to financial statement
users than does the single-step format; however, both are found in actual practice.
6. An income statement is composed of various sections that relate to different aspects of
the earning process. The seven sections identified in the chapter, in the general order of
their appearance in the income statement, are:
(1) Operating Section. Revenues and expenses from the entity’s principal operations.
a. Sales or revenue section.
b. Cost of goods sold section.
c. Selling expenses.
d. Administrative or general expenses.
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(2) Nonoperating Section. Revenues and expenses resulting from secondary or auxiliary
activities of the company.
a. Other revenues and gains.
b. Other expenses and losses.
(3) Income Tax. All taxes levied on income from continuing operations.
(4) Discontinued Operations. Material gains and losses resulting from disposal of
a segment of the business.
(5) Extraordinary Items. Unusual and infrequent material gains and losses.
(6) Noncontrollable Interest.
(7) Earnings per Share.
7. Condensed income statements. Includes only totals of expense groups. Supplementary
schedules support the totals.
Reporting Various Income Items
8. (L.O. 4) For the most part, accountants tend to agree on the composition of items included
on the income statement. However, certain unusual items (irregular gains/losses) have
stirred controversy in regard to the effect they should have on the presentation of net
income. Some accountants favor reporting the unusual items directly in the income
statement. Those who support the current operating performance concept to income
measurement believe that the unusual items should be closed directly to retained
earnings (not included in computing net income). The accounting profession adopted a
modified all-inclusive concept and requires application of this approach in practice.
9. In an attempt to provide financial statement users with the ability to better determine the
long-range earning power of an enterprise, certain professional pronouncements require
that the following irregular items be highlighted in the financial statements.
a. Discontinued operations.
b. Extraordinary items.
c. Unusual gains and losses.
d. Changes in estimates.
e. Corrections of errors.
4-6
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Unusual Gains and Losses
10. Material gains and losses that are either unusual or occur infrequently, but not both, are
excluded from the extraordinary item classification. These items are presented with the
normal, recurring revenues, costs, and expenses. If material, these items are disclosed
separately; if immaterial, they may be combined with other items in the income statement.
Discontinued Operations
11. A discontinued operation occurs when (a) a company eliminates the results of
operations of a component of the business, and (b) there is no significant continuing
involvement in that component after the disposal transaction. When an entity decides to
dispose of a component of its business, certain classification and disclosure requirements
must be met. A separate income statement category for gain or loss from disposal of a
component of a business must be provided. In addition, the results of operations of a
component that has been or will be disposed of are also reported separately from
continuing operations.
Intraperiod Tax Allocation
12. Intraperiod tax allocation is the process of relating the income tax effect of an unusual
item to that item when it appears on the income statement. Income tax expense related to
continuing operations is shown on the income statement at its appropriately computed
amount. All other items included in the determination of net income should be shown net
of their related tax effect. The tax amount may be disclosed in the income statement or in
a footnote.
Extraordinary Items
13. Extraordinary items are defined as material items that are unusual in nature and occur
infrequently. Both characteristics must exist for an item to be classified as an
extraordinary item on the income statement. Only rarely does an event or transaction
clearly meet both criteria and thus give rise to an extraordinary gain or loss. If an event or
transaction meets both tests, it is shown net of taxes in a separate section of the income
statement usually just above net income.
Noncontrolling Interest
14. Noncontrolling interest is the portion of equity (net assets) interest in a subsidiary not
attributable to the parent company.
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Earnings per Share
15. (L.O. 5) In general, earnings per share represents the ratio of net income minus preferred
dividends (income available to common shareholders) divided by the weighted average
number of common shares outstanding. It is considered by many financial statement users
to be the most significant statistic presented in the financial statements, and must be
disclosed on the face of the income statement. Per share amounts for gain or loss on
discontinued operations and gain or loss on extraordinary items must be disclosed on the
face of the income statement or in the notes to the financial statements.
Changes in Accounting Principles
16. (L.O. 6) A change in accounting principle results when a company adopts a new
accounting principle that is different from the one previously used. A company recognizes a
change in accounting principle by making a retrospective adjustment to the financial
statements. Such an adjustment recasts the prior years’ statements on a basis consistent
with the newly adopted principle. The company records the cumulative effect of the change
for prior periods as an adjustment to beginning retained earnings of the earliest year
presented.
Changes in Estimates
17. Accountants make extensive use of estimates in preparing financial statements. Adjustments
that grow out of the use of estimates in accounting are used in the determination of
income for the current period and future periods and are not charged or credited directly
to Retained Earnings. It should be noted that changes in estimates are not considered
errors (prior period adjustments) nor extraordinary items.
Corrections of Errors
18. Companies must correct errors by making proper entries in the accounts and reporting
corrections in the financial statements. Corrections of errors are treated as prior period
adjustments, similar to changes in accounting principles. Companies record an error in
the year in which it is discovered. They report the effect of the error as an adjustment to
the beginning balance of retained earnings. If a company prepares comparative financial
statements, it should restate the prior statements for the effects of the error.
Retained Earnings
19. (L.O. 7) The retained earnings statement serves to reconcile the balance of the retained
earnings account from the beginning to the end of the year. The important information
communicated by the retained earnings statement includes: (a) prior period adjustments
(income or loss related to corrections of errors in the financial statements of a prior period
net of tax), (b) changes in accounting principle, (c) the relationship of dividend distributions
to net income for the period, and (d) any transfers to and from retained earnings.
4-8
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Comprehensive Income
20. (L.O. 8) Items that bypass the income statement are included under the concept of
comprehensive income. Comprehensive income includes all changes in equity during
a period except those resulting from investments by owners and distributions to owners.
21. The FASB requires that the components of other comprehensive income must be
displayed in one of two ways: (1) a one statement approach, or (2) a two statement
approach. In the one statement approach, the traditional net income is a subtotal, with
total comprehensive income shown as a final total. The combined statement has the
advantage of not requiring the creation of a new financial statement. The two statement
format reports comprehensive income in a separate statement, which indicates that the
gains and losses identified as other comprehensive income have the same status as
traditional gains and losses.
Statement of Stockholders’ Equity
22. This statement reports the changes in each stockholders’ equity account and in total
stockholders’ equity during the year. Both contributions (issuances of shares) and
distributions (dividends) to owners, and a reconciliation of the carrying amount of each
component of stockholders’ equity from the beginning to the end of the period are
disclosed in the statement.
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4-9
LECTURE OUTLINE
The material in this chapter can be covered in two to three class sessions. Most students have
had previous exposure to the concepts presented in the chapter.
The lecture and assigned problems should be directed toward three areas of concentration:
1. An understanding of the concepts underlying the measurement and presentation of income.
These include concepts such as the quality of earnings, the modified all-inclusive approach
versus the current operating performance approach, etc.
2. An understanding of each of the intermediate components of income and other various
income items, including prior period adjustments, extraordinary items, discontinued
operations etc. Students should be able to: (1) recognize these items when encountered in
problem material, and (2) identify the proper accounting and disclosure procedure for each
of them.
3. An understanding of the proper format for income (including comprehensive income) and
retained earnings statements. Given transaction data or account balances, students should
be able to prepare single- and multiple-step income statements, retained earnings statements, comprehensive income statements, combined statements of comprehensive income,
and statements of stockholders’ equity.
A. (L.O. 1) Uses and Limitations of an Income Statement.
1.
The income statement helps investors and creditors predict the amounts, timing, and
uncertainty of future cash flows. Income statement information is useful for:
a.
Evaluating past performance.
b.
Predicting future performance.
c.
Determining the risk (uncertainty) of achieving future cash flows. Information
about the various components of income—revenues, expenses, gains, and
losses—is helpful for assessing the likelihood of achieving a particular level of
cash flows in the future.
B. Limitations of the Income Statement.
1.
2.
Items that cannot be measured reliably are omitted from the income statement.
For example:
a.
Unrealized gains and losses on certain investment securities.
b.
The value of brand recognition, customer service, and product quality.
Income numbers are affected by the accounting methods employed. Discuss the
concept of the quality of earnings.
a.
4-10
Discuss how earnings management can affect the quality of earnings.
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3.
Income measurement involves judgment. Discuss this in terms of bad debt expense
and depreciation expense.
C. Quality of Earnings.
1.
Earnings management is the planned timing of revenues, expenses, gains, and losses
to smooth out bumps in earnings.
2.
Quality of earnings is important because markets rely on trust. Investors losing faith in
the numbers reported in the financial statements will damage U.S. capital markets.
3.
The SEC has taken decisive action to prevent the practice of earnings management.
D. Format of the Income Statement.
1.
The elements of the income statement are revenues, expenses, gains, and losses.
2.
Income statement formats.
a.
(L.O. 2) Single-step format.
TEACHING TIP
Use Illustration 4-1 can be used to describe the single-step format. Make comparisons with
the multiple-step format in Illustration 4-2.
b.
(L.O. 3) Multiple-step format.
TEACHING TIP
Use Illustration 4-2 to describe the sections of the multiple-step income statement format.
Emphasize the intermediate components such as gross profit, income from operations, and
other revenues and expenses.
c.
Point out that the difference between the two formats affects only the presentation
of items before income from continuing operations.
d.
GAAP permits either the multiple-step or single-step format.
e.
Condensed income statements. Used when the amount of expense detail
prevents a conveniently sized income statement. See Illustration 4-3 on page 166
of the text.
3. (L.O. 4) Reporting Irregular Items: Presentation of items after income from continuing
operations.
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TEACHING TIP
Illustration 4-3 can be used to discuss each of the special items after income from
continuing operations. Emphasize that separate disclosures of these items are the result of
pronouncements by the accounting profession.
Developing a framework for reporting irregular items is important to ensure reliable
income information.
a.
The current operating performance approach requires that net income should
include only regular, recurring earnings from normal operations. Irregular gains
and losses should be closed directly to retained earnings.
b.
The accounting profession has adopted a modified all-inclusive concept and
requires application of this approach in practice. This approach requires that
companies record most items, including irregular ones, as part of net income.
E. Unusual Gains and Losses. Items that are unusual or infrequent, but not both.
1.
Companies report unusual items in the “Other revenues and gains” or “Other expenses
and losses” section.
2.
These items may not be presented net of tax.
F. Discontinued Operations. Results from disposal of a component of the business.
1.
A discontinued operation occurs when two things happen: (1) a company eliminates
the results of operations of a component of the business, and (2) there is no significant
involvement in that component after the disposal transaction.
2.
Examples of disposals of a component are:
4-12
a.
A sale by a diversified company of a major division which represents the company’s
only activities in the electronics industry. The assets and results of operations of the
division are clearly segregated for internal financial reporting purposes from the
other assets and results of operations of the company.
b.
A sale by a meat packing company of a 25% interest in a professional football
team which has been accounted for under the equity method. All other activities of
the company are in the meat packing business.
c.
A sale by a communications company of all its radio stations which represent 30% of
gross revenues. The company’s remaining activities are three television stations and
a publishing company. The assets and results of operations of the radio stations are
clearly distinguishable physically, operationally, and for financial reporting purposes.
d.
A food distributor disposes of one of its two divisions. One division sells food
wholesale primarily to supermarket chains and the other division sells food
through its chain of fast food restaurants, some of which are franchised and some
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of which are company-owned. Both divisions are in the business of distribution of
food. However, the nature of selling food through fast food outlets is vastly different
than that of wholesaling food to supermarket chains.
3.
4.
Disposals that do not qualify as disposals of a component are:
a.
The sale of a major foreign subsidiary engaged in silver mining by a mining company
which represents all of the company’s activities in that particular country. Even
though the subsidiary being sold may account for a significant percentage of gross
revenue of the consolidated group and all of its revenues in the particular country,
the fact that the company continues to engage in silver mining activities in other
countries would indicate that there was a sale of only a part of a line of business.
b.
The sale by a petrochemical company of a 25% interest in a petrochemical plant
which is accounted for as an investment in a corporate joint venture under the
equity method. Since the remaining activities of the company are in the same line
of business as the 25% interest which has been sold, there has not been a sale of
a major line of business but rather a sale of part of a line of business.
c.
A manufacturer of children’s wear discontinues all of its operations in Italy which
were composed of designing and selling children’s wear for the Italian market. In
the context of determining a component of a business by class of customer, the
nationality of customers or slight variations in product lines in order to appeal to
particular groups are not determining factors.
d.
A diversified company sells a subsidiary which manufactures furniture. The company
has retained its other furniture manufacturing subsidiary. The disposal of the
subsidiary, therefore, is not a disposal of a component of the business but rather a
disposal of part of a line of business.
e.
The sale of all the assets (including the plant) related to the manufacture of men’s
woolen suits by an apparel manufacturer in order to concentrate activities in the
manufacture of men’s suits from synthetic products. This would represent a disposal
of a product line as distinguished from the disposal of a major line of business.
Disposals of a component are reported net of tax in the income statement immediately
below income from continuing operations. Results of the disposal are reported in two
amounts.
a.
Income or loss from operation of the component that has been or will be
disposed of, net of tax.
b.
Gain or loss from disposal of the discontinued component, net of tax.
G. Intraperiod Tax Allocation. The process of associating income tax expense with related
income. The general concept is “let the tax follow the income.”
1.
Intraperiod tax allocation involves a breakdown of total income tax expense into
separate components which are disclosed in different portions of the financial
statements. Intraperiod tax allocation is applied to:
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4-13
2.
a.
Income from continuing operations.
b.
Discontinued operations.
c.
Extraordinary items.
Use the income statement on text page 172 to demonstrate intraperiod tax allocation.
Ask students to compute the total income tax expense for 2014. It is $167,800,
disclosed for accounting purposes as follows:
Tax associated with continuing operations ...................................
Tax on operations of discontinued division ...................................
Reduction of tax due to loss on disposal of
discontinued division .............................................................
Total income tax expense .............................................................
$184,000
24,800
(41,000)
$167,800
Without intraperiod tax allocation, total income tax expense would merely be reported
as $167,800 and financial statement users would not be able to assess the tax consequences of operations or of irregular items.
3.
Point out that the net-of-tax amount of an item is calculated by multiplying the item by
(1 minus the tax rate).
H. Extraordinary Items. Nonrecurring material items that are unusual in nature and
infrequent in occurrence, considering the environment in which the entity operates.
1.
2.
Examples of extraordinary items are:
a.
A large portion of a tobacco manufacturer’s crops is destroyed by a hail storm.
Severe damage from hail storms in the locality where the manufacturer grows
tobacco is rare.
b.
A steel fabricating company sells the only land it owns. The land was acquired ten
years ago for future expansion, but shortly thereafter the company abandoned all
plans for expansion and held the land for appreciation.
c.
A company sells a block of common stock of a publicly traded company. The
block of shares, which represents less than 10% of the publicly-held company, is
the only security investment the company has ever owned.
d.
An earthquake destroys one of the oil refineries owned by a large multi-national oil
company.
Examples of items that are not extraordinary are:
a.
4-14
A citrus grower’s Florida crop is damaged by frost. Frost damage is normally
experienced every three or four years. The criterion of infrequency of occurrence
taking into account the environment in which the company operates would not be
met since the history of losses caused by frost damage provides evidence that
such damage may reasonably be expected to recur in the foreseeable future.
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b.
A company which operates a chain of warehouses sells the excess land surrounding
one of its warehouses. When the company buys property to establish a new
warehouse, it usually buys more land than it expects to use for the warehouse with
the expectation that the land will appreciate in value. In the past five years, there
have been two instances in which the company sold such excess land. The criterion
of infrequency of occurrence has not been met since past experience indicates that
such sales may reasonably be expected to recur in the foreseeable future.
c.
A large diversified company sells a block of shares from its portfolio of securities
which it has acquired for investment purposes. This is the first sale from its portfolio
of securities. Since the company owns several securities for investment purposes,
it should be concluded that sales of such securities are related to its ordinary and
typical activities in the environment in which it operates and thus the criterion of
unusual nature would not be met.
d.
A textile manufacturer with only one plant moves to another location. It has not
relocated a plant in twenty years and has no plans to do so in the foreseeable
future. Notwithstanding the infrequency of occurrence of the event as it relates to
this particular company, moving from one location to another is an occurrence
which is a consequence of customary and continuing business activities, some of
which are finding more favorable labor markets, more modern facilities, and
proximity to customers or suppliers. Therefore, the criterion of unusual nature has
not been met and the moving expenses (and related gains and losses) should not
be reported as an extraordinary item. Another example of an event which is
a consequence of customary and typical business activities (namely financing) is
an unsuccessful public registration, the cost of which should not be reported as an
extraordinary item.
3.
Some items are given extraordinary item treatment by pronouncement, and not
necessarily because they are unusual and infrequent. An example is gains or losses
from a prohibition under a newly enacted law or regulation.
4.
Extraordinary items are presented net of tax in the income statement, below discontinued
operations.
I. Noncontrolling interest is the portion of equity (net assets) interest in a subsidiary not
attributable to the parent company.
TEACHING TIP
The treatment of the unusual items impacting the income statement are summarized in
Illustration 4-4.
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J. (L.O. 6) Earnings Per Share. A widely used measure of business performance.
1.
Discuss the importance of earnings per share (EPS) in the financial press using
examples from The Wall Street Journal.
2.
EPS is equal to:
Net Income – Preferred Dividends
Weighted Average of Common Shares Outstanding
3.
Per share amounts must be disclosed on the face of the income statement for the
following amounts:
a.
Income from continuing operations.
b.
Discontinued operations.
c.
Income before extraordinary items.
d.
Extraordinary items.
e.
Net income.
K. Changes in Accounting Principle. Adoption of an accounting method that is different
from the one previously used.
1.
Examples:
a.
Change from FIFO to average cost.
b.
Change from percentage-of-completion to the completed-contract method for
construction contracts.
2.
Discuss the distinction between a change in accounting principle and a change in
accounting estimate.
3.
Recast prior years’ statements to reflect new principle.
4.
Point out that it is the cumulative effect of the change on prior years’ income that is
disclosed as an adjustment to beginning retained earnings of the earliest year presented.
L. Changes in Estimates. Adjustments that result from periodic revisions in estimates.
1.
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Examples.
a.
Changes in the estimated lives or salvage values of depreciable assets.
b.
Changes in estimated collectibility of receivables.
c.
Adjustment of inventory costs or estimated realizability.
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2.
These adjustments are not considered errors or extraordinary items. Students frequently misunderstand this. They erroneously believe that special journal entries or
separate disclosures must be made.
M. Correction of errors.
1.
2.
Examples.
a.
Mathematical mistakes.
b.
Mistakes in the application of accounting principles.
c.
Oversight or misuse of facts that existed at the time financial statements were
prepared.
Reported as a prior period adjustment net of income taxes.
TEACHING TIP
The treatment of accounting changes and errors is summarized in Illustration 4-5.
N. (L.O. 7) Retained Earnings Statement. A summary disclosure of the changes in the
balance of the Retained Earnings account from the beginning to the end of the year. The
following items are disclosed in the retained earnings statement:
1.
Prior period adjustments. Adjustments (net of tax) to the opening balance of retained
earnings.
a.
Transactions that are accounted for as prior period adjustments:
(1) Correction of errors in financial statements of prior periods.
(2) Changes in accounting principle.
b.
The entry to record a prior period adjustment usually involves the following types
of accounts:
(1) The Retained Earnings account.
(2) A balance sheet account (e.g., Accumulated Depreciation, Inventory, etc.).
2.
Dividends and net income.
3.
Restrictions of retained earnings.
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O. (L.O. 8) Comprehensive Income. Includes all changes in equity during a period except
those resulting from investments by owners and distributions to owners.
1.
Other comprehensive income. Includes those gains and losses that bypass net
income but affect stockholders’ equity (i.e., unrealized gains and losses on availablefor-sale securities).
2.
The FASB requires that the components of other comprehensive income be reported
in one of two ways.
a.
A one statement approach.
b.
A two statement approach.
TEACHING TIP
Illustrations 4-6 can be used to discuss the presentation of accumulated other
comprehensive income in the financial statements.
P. (L. O. 8) Statement of Stockholders’ Equity. This statement reports the changes in each
stockholders’ equity account and in total stockholders’ equity during the year. It discloses:
1.
Contributions (issuances of shares) and distributions (dividends) to owners.
2.
A reconciliation of the carrying amount of each component of stockholders’ equity from
the beginning to the end of the period.
TEACHING TIP
Illustration 4-7 can be used to discuss the presentation of the statement of stockholders’
equity.
4-18
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*Q. (L.O. 9) IFRS Insights. As in GAAP, the income statement is a required statement for
IFRS. In addition, the content and presentation of an IFRS income statement is similar to
the one used for GAAP.
1.
IAS 1, “Presentation of Financial Statements,” provides general guidelines for the
reporting of income statement information. Subsequently, a number of international
standards have been issued that provide additional guidance to issues related to
income statement presentation.
2.
Relevant Facts.
a. Similarities.
(1)
Both GAAP and IFRS require companies to indicate the amount of net
income attributable to noncontrolling interest.
(2)
Both GAAP and IFRS follow the same presentation guidelines for
discontinued operations, but IFRS defines a discontinued operation more
narrowly.
(3)
Both GAAP and IFRS have items that are recognized in equity as part of
comprehensive income but do not affect net income. Both GAAP and IFRS
allow a separate statement of comprehensive income or a combined
statement.
b. Differences.
(1)
Presentation of the income statement under GAAP follows either a singlestep or multiple-step format. IFRS does not mention a single-step or multiplestep approach. Under GAAP, companies must report an item as extraordinary
if it is unusual in nature and infrequent in occurrence. Extraordinary items are
prohibited under IFRS.
(2)
Under IFRS, companies must classify expenses by either nature or function.
GAAP does not have that requirement, but the SEC requires a functional
presentation.
(3)
IFRS identifies certain minimum items that should be presented on the
income statement. GAAP has no minimum information requirements.
However, the SEC rules have more rigorous presentation requirements.
(4)
IFRS does not define key measures like income from operations. SEC
regulations define many key measures and provide requirements and
limitations on companies reporting non-GAAP/IFRS information.
(5)
Under IFRS, revaluation of property, plant, and equipment, and intangible
assets is permitted and is reported as other comprehensive income. The
effect of this difference is that application of IFRS results in more transactions
affecting equity but not net income.
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ILLUSTRATION 4-1
SINGLE-STEP INCOME STATEMENT
4-20
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ILLUSTRATION 4-2
MULTIPLE-STEP INCOME STATEMENT
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ILLUSTRATION 4-3
REPORTING SPECIAL ITEMS
4-22
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ILLUSTRATION 4-4
SUMMARY OF IRREGULAR ITEMS
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ILLUSTRATION 4-5
SUMMARY OF ACCOUNTING CHANGES AND ERRORS
4-24
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ILLUSTRATION 4-6
REPORTING ACCUMULATED OTHER COMPREHENSIVE INCOME
(a) One Statement Approach
ABC Company
Statement of Comprehensive Income
For the Year Ended December 31, 2014
Sales revenue
Cost of goods sold
Gross profit
Operating expenses
Net income
Other comprehensive income
Unrealized holding gain (loss), net of taxes
Comprehensive income
$ xx
xx
xx
xx
xx
xx
$ xx
(b) Two Statement Approach
ABC Company
Income Statement
For the Year Ended December 31, 2014
Sales revenue
Cost of goods sold
Gross profit
Operating expenses
Net income
$ xx
xx
xx
xx
$ xx
ABC Company
Comprehensive Income Statement
For the Year Ended December 31, 2014
Net income
Other comprehensive income
Unrealized holding gain (loss), net of taxes
Comprehensive income
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xx
xx
$ xx
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4-25
ILLUSTRATION 4-7
STOCKHOLDERS’ EQUITY STATEMENT
4-26
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