Chapter 4
Income Statement
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The Income Statement
• Dated for a period of time
– For the Year Ended...
• Multiple-step format
–
–
–
–
Gross profit
Operating income
Income before taxes
Net income
• Single-step format
– Total of all revenues and gains
– Less the total of all expenses and losses
Chapter 4, Slide #2
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Multiple-Step
Multiple-Step Company
Income Statement
For the Year Ended December 31, 20XX
Sales
Cost of Goods Sold
Gross Profit
Operating Expenses:
General & Administrative
Advertising
Uncollectible Accounts
Operating Income
Interest Income
Other Revenue
Income Before Taxes
Income Taxes
Net Income
$ 496,120
234,972
261,148
Single Step
Single-Step Company
Income Statement
For the Year Ended December 31, 20XX
Sales
Interest Income
Other Income
$ 496,120
122,757
44,715
663,592
$ 131,409
128,325
22,664
282,398
(21,250)
122,757
44,715
167,472
146,222
8,498
$ 137,724
Costs and Expenses:
Cost of Goods Sold
General & Administrative
Advertising
Uncollectible Accounts
Income Before Taxes
Income Taxes
Net Income
Chapter 4, Slide #3
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
$ 234,972
131,409
128,325
22,664
517,370
146,222
8,498
$ 137,724
Basic Elements of the Income Statement
•
•
•
•
•
Net Sales (Revenues)
Cost of Goods Sold
Other Operating Revenue
Operating Expenses
Other Income or Expense
Chapter 4, Slide #4
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Net Sales
• Revenue from the sale of principal goods or
services sold to customers
• Shown net of
– Discounts
– Returns
– Allowances
Chapter 4, Slide #5
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Cost of Goods Sold
• The cost of goods that were sold to produce
revenue
Retailer
Beginning Inventory
+ Purchases
– Ending Inventory
= Cost of Goods Sold
Manufacturer
Beginning Inventory
+ Cost of Goods
Manufactured
– Ending Inventory
= Cost of Goods Sold
Chapter 4, Slide #6
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Other Operating Revenue
• Reflects the nature of the business
• Examples
–
–
–
–
Lease revenue
Royalty revenue
Finance charges
Commission revenue
Chapter 4, Slide #7
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Operating Expenses
• Selling expenses
– Result from the company’s effort to create sales
– Examples
• Advertising
• Sales commissions
• Sales supplies used
• Administrative expenses
– Relate to the general administration of the
company’s operation
– Examples
• Salaries
• Insurance
• Bad debt expense
Chapter 4, Slide #8
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Other Income or Expense
• Secondary activities not directly related to
operations
–
–
–
–
Dividend income
Interest income
Gains (losses) from sale of assets
Interest expense
Chapter 4, Slide #9
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Special Income Statement Items
• Unusual or Infrequent Items Disclosed
Separately
– Included with normal recurring revenues and
expenses
– If material, disclosed separately, before income
taxes
– Relate to operations
– Treatment for analysis
• Primary analysis: include
• Supplementary analysis: exclude
Chapter 4, Slide #10
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Special Income Statement Items (cont’d)
• Equity in Earnings of Nonconsolidated
Subsidiaries
– The investor’s proportional share of the investee’s
net income
– Does not represent cash flow to the investor
• Cash dividends received represent cash flow
– Analysis issues:
• Investor’s net income includes revenue of other entity
• May distort ratios
• Presented before tax; tax consequences typically
immaterial
Chapter 4, Slide #11
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Special Income Statement Items (cont’d)
• Income Taxes Related to Operations
– Federal, state, and local
– Includes both paid and deferred taxes
• Discontinued Operations
– Reported net of income tax
– Analysis issues:
• Inadequate disclosure of associated assets
• Lack of historical profit and loss information on the
discontinued operations
Chapter 4, Slide #12
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Special Income Statement Items (cont’d)
• Extraordinary Items
– Unusual and infrequent
– Reported net of income tax
– Analysis issues:
• Exclude from primary analysis
• Include for supplementary analysis
Chapter 4, Slide #13
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Special Income Statement Items (cont’d)
• Cumulative Effect of a Change in Accounting
Principle
– For fiscal years beginning before 12/15/05
• Cumulative effect of the change shown net of tax on the
income statement of the period in which change was
made
• Earlier statements not restated to reflect application of the
new principle
– Effective for fiscal years beginning after 12/15/05
• All comparative statements are retrospectively restated to
reflect application of the new accounting principle
• The cumulative effect on income of earlier years is shown
as a net-of-tax adjustment to the beginning Retained
Earnings balance of the earliest period presented
Chapter 4, Slide #14
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Special Income Statement Items (cont’d)
• Minority Share of Earnings
– Earnings of a partially-owned consolidated
subsidiary that would accrue to the minority owners
– Presentation may be either pre-tax or net-of-tax
• Earnings per Share
Net income ÷ Number of shares outstanding
Chapter 4, Slide #15
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Reconciliation of Retained Earnings
Reported as part of the Statement of Stockholders’
Equity or combined with the Income Statement
+
±
=
+
–
=
Beginning of year balance of retained earnings
Prior period adjustments
Cumulative effect of a change in accounting
principle
Beginning balance as adjusted
Net income
Dividends
End-of-year balance of retained earnings
Chapter 4, Slide #16
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Retained Earnings
• The accumulated undistributed earnings of the
corporation reported on the balance sheet
• Appropriated
– Restricted by law, contract, or management
decision
– Not available for dividends
• Unappropriated
– Available for dividends
– Does not represent cash or any other asset
Chapter 4, Slide #17
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Stock Dividends
• Cash dividends
– Date of declaration: create liability and reduce
retained earnings
– Date of payment: reduce liability and cash
• Stock dividends
– Small (less then 25%): capitalize the market value
of the stock
– Material: capitalize the par value of the stock
– Total equity is unaffected by a stock dividend
– Analysis issues:
• Restate share quantities to reflect stock dividend activity
Chapter 4, Slide #18
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Stock Dividend Example
100,000 shares outstanding; $1 par; $5 market
Common stock par value
Shares outstanding
Total par value
Additional paid-in capital
Total paid-in capital
Retained earnings
Total stockholders' equity
Before
$1.00
100,000
$100,000
750,000
850,000
1,000,000
$1,850,000
5% stock dividend
30% stock dividend
effect of dividend balance after effect of dividend balance after
$1.00
$1.00
issue 5,000 sh
105,000 issue 30,000 sh
130,000
5,000
$105,000
30,000
$130,000
20,000
770,000
750,000
875,000
880,000
(25,000)
975,000
(30,000)
970,000
$1,850,000
$1,850,000
5% stock dividend on
100,000 shares: issue
5,000 additional
shares recorded at $5
per share
Chapter 4, Slide #19
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30% stock dividend
on 100,000 shares:
issue 30,000
additional shares
recorded at $1 per
share
Stock Splits
• 2-for-1 split
– Doubles the quantity of stock
– Par or stated value is halved
• No effect on retained earnings, additional paidin capital, or capital stock accounts
• Analysis issues:
– Restate share quantities to reflect split activity
Chapter 4, Slide #20
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Legality of Distributions to Shareholders
• Per various state laws
– Distributions are acceptable as long as the firm has
the ability to pay debts as they come due in the
normal course of business
– Distributions to stockholders are acceptable as long
as the firm is solvent and the distributions do not
exceed the fair value of the assets
– Distributions consist of solvency and balance sheet
test of liquidity and risk
Chapter 4, Slide #21
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Comprehensive Income
Net income
+ The period’s change in accumulated other comprehensive income
= Comprehensive income
• Foreign currency translation adjustments
• Unrealized holding gains and losses on
available-for-sale marketable securities
• Changes to stockholders’ equity resulting from
additional minimum pension liability
adjustments
• Unrealized gains and losses from derivative
instruments
Chapter 4, Slide #22
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Comprehensive Income (cont’d)
• Required disclosures
– Comprehensive income
– Other comprehensive income from each category
– Reclassification adjustments for each category of
other comprehensive income
– Tax effects for each category of other
comprehensive income
– Balances for each category of other comprehensive
income
Chapter 4, Slide #23
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Comprehensive Income (cont’d)
• Presentation
– In a separate financial statement
– Combined with the income statement
– As part of the schedule of changes in stockholders’
equity
Chapter 4, Slide #24
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Comprehensive Income –
Separate Statement
XYZ Corporation
Statement of Comprehensive Income
For the Year Ended December 31, 20XX
Net income
Other comprehensive income
Available-for-sale security adjustment, net of tax
Minimum pension liability adjustment, net of tax
Foreign currency transaction adjustment, net of tax
Total other comprehensive income
Comprehensive income
Chapter 4, Slide #25
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
$ 34,000
5,500
3,500
(5,000)
4,000
$ 38,000
Comprehensive Income –
Combined with Income Statement
XYZ Corporation
Statement of Income and Comprehensive Income
For the Year Ended December 31, 20XX
Sales
Cost of goods sold
$ 230,000
140,000
Gross profit
Operating expenses
370,000
40,000
Operating income
330,000
Other income
4,000
Income before income taxes
326,000
Income taxes
20,000
Net income
Other comprehensive income
Available-for-sale security adjustment, net of tax
Minimum pension liability adjustment, net of tax
Foreign currency transaction adjustment, net of tax
306,000
5,500
3,500
(5,000)
Other comprehensive income
4,000
Comprehensive income
$ 310,000
Earnings per share (for net income only)
$
Chapter 4, Slide #26
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
2.80
Comprehensive Income – As Part of the
Statement of Stockholders’ Equity
XYZ Corporation
Statement of Changes in Stockholders' Equity
For the Year Ended December 31, 20XX
Beginning Balance
Net Income
Available-for-sale
security adjustment,
net of tax
Minimum pension
liability adjustment, net
of tax
Foreign currency
transaction adjustment,
net of tax
Comprehensive income
Ending Balance
Retained
Total
Earnings
$180,000
$60,000
34,000
34,000
Accumulated
Other
Comprehensive
Common Stock
Income
Amount Shares
$10,000 $110,000 55,000
5,500
5,500
3,500
3,500
(5,000)
38,000
(5,000)
$218,000
$94,000
$14,000 $110,000
Chapter 4, Slide #27
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
55,000
Comprehensive Income (cont’d)
• Analysis issues:
– Typically more volatile than net income
– A better indication of long-run profitability
Chapter 4, Slide #28
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.