4-1
Slide
4-1
Slide
4-2
Comprehensive Income
Proponents argue
that certain
changes in equity
should be included
in the
determination of
net income.
Chapter Four
The Income Statement
and Statement of Cash Flows
© 2004 The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
Slide
4-3
© 2004 The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
Slide
4-4
Comprehensive Income
Income
Income from
from Continuing
Continuing Operations
Operations
Statement
Statement of
of Financial
Financial Accounting
Accounting Standards
Standards No.
No. 130
130
Comprehensive
Comprehensive income
income includes
includes traditional
traditional net
net
income
income and
and changes
changes in
in equity
equityfrom
from nonowner
nonowner
transactions.
transactions.
Examples
Examples of
of nonowner
nonowner transactions:
transactions:
•Foreign
•Foreign currency
currencytranslation
translation adjustment,
adjustment, net
net of
of tax
tax
•Unrealized
•Unrealized gains(losses)
gains(losses) on
oninvestment
investmentsecurities,
securities, net
net of
of tax
tax
•Minimum
•Minimum pension
pension liability
liabilityadjustment,
adjustment, net
net of
of tax
tax
© 2004 The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
Slide
4-5
Revenues
Expenses
Inflows of
resources
resulting
from
providing
goods or
services to
customers.
Outflows of
resources
incurred in
generating
revenues.
Gains and
Losses
Income Tax
Expense
Increases or
decreases in
equity from
peripheral or
incidental
transactions
of an entity.
Because of
its
importance
and size,
income tax
expense is a
separate
item.
© 2004 The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
Slide
4-6
Income Statement (Single-Step)
Income Statement
{
Proper Heading
Revenues
& Gains
Expenses
& Losses
Operating
Income
McGraw-Hill/Irwin
vs.
Nonoperating
Income
© 2004 The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
{
{
Central Company
Income Statement
For the Year Ended 12/31/03
Revenues and gains:
Sales, net
Interest income
Gain on sale of plant assets
Total revenues and gains
Expenses and losses:
Cost of goods sold
Selling expenses
General and admin. exp.
Depreciation expense
Interest expense
Income taxes
Loss on sale of investment
Total expenses & losses
Net income
$
$
785,250
62,187
24,600
872,037
351,800
197,350
78,500
17,500
27,000
62,500
9,000
$
743,650
128,387
© 2004 The McGraw-Hill Companies, Inc.
4-2
Slide
4-7
Slide
4-8
Income Statement (Multiple-Step)
{
Proper Heading
Gross
Margin
Operating
Expenses
Nonoperating
Items
{
{
{
Sales, net
Cost of goods sold
Gross margin
Operating expenses:
Selling expenses
General & admin. Expense
Depreciation expense
Income from operations
Other revenues & gains:
Interest income
Gain on sale of plant assets
Other expenses:
Interest expense
Loss on sale of investments
Income before taxes
Income taxes
Net income
McGraw-Hill/Irwin
Slide
4-9
Earnings Quality
Central Company
Income Statement
For the Year Ended 12/31/03
$
$
$
$
197,350
78,500
17,500
785,250
351,800
433,450
293,350
140,100
62,187
24,600
86,787
27,000
9,000
$
(36,000)
190,887
62,500
128,387
© 2004 The McGraw-Hill Companies, Inc.
Manipulating Income and Income
Smoothing
“Most managers prefer to report earnings that follow a
smooth, regular, upward path.”
Earnings quality refers to
the ability of reported
earnings to predict a
company’s future.
The relevance of any
historical-based financial
statement hinges on its
predictive value.
Slide
4-10
Separately Reported Items
Three types of events are reported separately,
net of taxes:
Two ways to manipulate income:
Income from continuing operations
1. Discontinued operations (net of tax
effect)
2. Extraordinary items (net of tax effect)
3. Cumulative effect of a change in
accounting principle (net of tax effect)
Net Income
1. Income shifting
2. Income statement
classification
McGraw-Hill/Irwin
Slide
4-11
© 2004 The McGraw-Hill Companies, Inc.
Intraperiod Income Tax
Allocation
Income
Income Tax
Tax Expense
Expense must
must be
be associated
associated with
with
each
each component
component of
of income
income that
that causes
causes it.
it.
© 2004 The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
McGraw-Hill/Irwin
xx
$ xxx
Slide
4-12
Discontinued Operations
Sale or disposal of a component
of an entity.
A component includes:
Report
Report effects
effects of
of Discontinued
Discontinued
Operations,
Operations, Extraordinary
Extraordinary
Items,
Items, and
andCumulative
CumulativeEffect
Effect of
of
Accounting
Accounting Changes
Changes NET
NET OF
OF
INCOME
TAXES.
INCOME TAXES.
© 2004 The McGraw-Hill Companies, Inc.
xx
xx
© 2004 The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
n
Show
Show Income
Income Tax
Tax
Expense
Expense related
related to
to
Income
Income from
from
Continuing
Continuing
Operations.
Operations.
$ xxx
n
n
n
n
McGraw-Hill/Irwin
Reportable segments
Operating segments
Reporting units
Subsidiaries
Asset groups
© 2004 The McGraw-Hill Companies, Inc.
4-3
Slide
4-13
Slide
4-14
Discontinued Operations
Discontinued Operations
Report results of operations
separately if two conditions are met:
1.
2.
Results of operations
include two items:
The operations and cash flows of the
component have been (or will be)
eliminated from the ongoing
operations.
The entity will not have any
significant continuing involvement in
the operations of the component after
the disposal transaction.
1.
2.
© 2004 The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
Slide
4-15
McGraw-Hill/Irwin
Slide
4-16
Discontinued Operations
Results of operations
include two items:
The income or loss stream for
the period from the identifiable
discontinued operation.
2. The actual gain or loss from
Carrying Valuedisposal
of Assets
< (Fair
Value of Assets - Cost to Sell)
of the
component
or
an “impairment loss” if the
component is held for resale.
1.
McGraw-Hill/Irwin
Slide
4-17
© 2004 The McGraw-Hill Companies, Inc.
Computation of Loss from Discontinued Operations
(Net of Tax Effect):
Loss from discontinued operations
Less: Tax benefit ($150,000 × 30%)
Net loss
$
Loss on disposal of assets
Less: Tax benefit ($100,000 × 30%)
Net loss
$
McGraw-Hill/Irwin
$
$
(150,000)
45,000
(105,000)
(100,000)
30,000
(70,000)
© 2004 The McGraw-Hill Companies, Inc.
© 2004 The McGraw-Hill Companies, Inc.
Discontinued Operations
Example
During the year, Apex Co. sold an
unprofitable component of the company.
The component had a net loss from
operations during the period of $150,000 and
its assets sold at a loss of $100,000. Apex
reported income from continuing operations
of $128,387. All items are taxed at 30%.
How will this appear on the income
statement?
McGraw-Hill/Irwin
Slide
4-18
Discontinued Operations
Example
The income or loss stream for
the period from the identifiable
discontinued operation.
The actual gain or loss from
disposal of the component
or
an “impairment loss” if the
component is held for resale.
© 2004 The McGraw-Hill Companies, Inc.
Discontinued Operations
Example
Income Statement Presentation:
Income from continuing operations
Discontinued operations:
Loss on operations (net of
tax benefit of $45,000)
Loss on disposal of assets (net
of tax benefit of $30,000)
Net loss
McGraw-Hill/Irwin
$ 128,387
(105,000)
(70,000)
$ (46,613)
© 2004 The McGraw-Hill Companies, Inc.
4-4
Slide
4-19
Slide
4-20
Extraordinary Items
Example
Extraordinary Items
During the year, Apex Co. experienced a
loss of $75,000 due to an earthquake at one
of its manufacturing plants in Nashville.
This was considered an extraordinary item.
The company reported income before
extraordinary item of $128,387. All gains
and losses are subject to a 30% tax rate.
Material in amount
Gains or losses that are
Πunusual
in nature and
in occurrence.
Ž required by GAAP.
• infrequent
Reported net of related
taxes
How would this item appear on the
income statement?
© 2004 The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
Slide
4-21
© 2004 The McGraw-Hill Companies, Inc.
Slide
4-22
Extraordinary Items
Example
Extraordinary Loss
Less: Tax Benefits
($75,000 × 30%)
Net Loss
McGraw-Hill/Irwin
Unusual or Infrequent Items
$ (75,000)
Items that are material and are either
unusual or infrequent—but not both—
are included as a separate item in
continuing operations.
22,500
$ (52,500)
Income Statement Presentation:
Income before extraordinary item
Extraordinary Loss:
Earthquake loss
(net of tax benefit of $22,500)
Net income
$ 128,387
(52,500)
$ 75,887
© 2004 The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
Slide
4-23
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
4-24
Accounting Changes
Type of Accounting
Change
Change in Accounting
Estimate
Change in Accounting
Principle
Change in Reporting
Entity
McGraw-Hill/Irwin
Change in Accounting Principle
Definition
Revision of an estimate
because of new
information or new
experience
Retrospectively recast
prior years' financial
statements when they are
reported.
Change from reporting as
one type of entity to
another type of entity
© 2004 The McGraw-Hill Companies, Inc.
Occurs when
n
n
Changing from one GAAP method to another
GAAP method, or
Changing the method of application of an existing
principle.
Make a retrospective recast of prior years’
financial statements when those statements
are reporting along with the current period
statement.
Changes in depreciation, depletion and
amortization methods are accounted for as
changes in estimates.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
4-5
Slide
4-25
Slide
4-26
Change in Estimates
On January 1, 2000, we purchased
equipment costing $30,000, with a useful
life of 10 years and no salvage value.
During 2003, we determine that the
remaining useful is 5 years (8-year total
life). We use straight-line depreciation.
Revision of a previous
accounting estimate.
The new estimate should be
used in the current and future
periods.
The prior accounting results
should not be be restated.
Slide
4-27
Compute the revised depreciation
expense for 2003.
© 2004 The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Change in Reporting Entity
$
30,000
$
(9,000)
21,000
÷ 5 years
4,200
Financial
statements
are prepared
for separate
entities.
Record depreciation expense of $4,200 for
2003 and subsequent years.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
4-28
Change in Estimates
Example
Asset cost
Accumulated depreciation
12/31/02 - ($3,000 × 3 years)
Remaining to be depreciated
Remaining useful life
Revised annual depreciation
Change in Estimates
Example
© 2004 The McGraw-Hill Companies, Inc.
Slide
4-29
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
4-30
Change in Reporting Entity
Change in Reporting Entity
If two entities combine:
If two entities
combine, a single
set of consolidated
financial statements
is generally
required.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
1. Prepare a single set of
consolidated financial
statements.
2. Retroactively restate
financial statements of
prior periods.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
4-6
Slide
4-31
Slide
4-32
Prior Period Adjustments
Example
Prior Period Adjustments
Corrections of errors from a
previous period.
Appear on the Statement of
Retained Earnings as an
adjustment to beginning
retained earnings.
Must show the adjustment net
of income taxes.
Prepare the necessary journal entry in
2004 to correct this prior period error.
© 2004 The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
Slide
4-33
While reviewing the depreciation entries
for 2001-2004, the controller found that
in 2003 depreciation expense was
incorrectly debited for $150,000 when in
fact it should have been debited
$125,000. All items are taxed at 30%.
GENERAL JOURNAL
Date
Slide
4-34
Prior Period Adjustments
Example
Description
PR
12/31/03 Depreciation Expense
Debit
Page: 180
Credit
GENERAL JOURNAL
Date
Description
2004
Accumulated Depreciation
Description
PR
2004
Accumulated Depreciation
Debit
Page: 180
Credit
25,000
Page: 180
Credit
© 2004 The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
Slide
4-36
Prior Period Adjustments
Example
GENERAL JOURNAL
Debit
To
To correct
correct the
the 2003
2003 error
error in
in 2004,
2004, we
we can
can
debit
debit Accumulated
Accumulated Depreciation
Depreciation since
since itit is
is
aa permanent
permanent account.
account.
© 2004 The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
PR
2004 Entry
150,000
IfIf this
this was
was the
the original
original entry,
entry,
how
how do
do we
we correct
correct it?
it?
Can
we
just
reverse
Can we just reverse it?
it?
Why
Why or
or why
why not?
not?
Date
Prior Period Adjustments
Example
150,000
Accumulated Depreciation
Slide
4-35
© 2004 The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
Prior Period Adjustments
Example
GENERAL JOURNAL
Date
Description
2004
Accumulated Depreciation
2004 Entry
PR
Debit
Page: 180
Credit
2004 Entry
25,000
25,000
Income Taxes Payable
Retained Earnings
17,500
We
We can’t
can’t credit
credit Depreciation
Depreciation Expense
Expense
since
since itit was
was closed
closed in
in 2003,
2003, so
so we
we credit
credit
Retained
Earnings.
Retained Earnings.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
7,500
Retained Earnings
17,500
Remember to consider the tax effects:
$25,000 × 30% = $7,500 taxes payable
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
4-7
Slide
4-37
Slide
4-38
Basic Earnings Per Share
Net Income Available
to Common
Shareholders
÷
Earnings Per Share Disclosure
Report EPS data separately for:
Weighted-Average
Number of Common
Shares Outstanding
1. Income from Continuing Operations
2. Discontinued Operations
3. Extraordinary Items
4. Net Income
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
4-39
Slide
4-40
Statement of Cash Flows
future net cash flows
liquidity
n long-term solvency.
ll
ll
Sales
Sales to
to customers.
customers.
Interest
Interest and
and dividends
dividends
received.
received.
ll
Purchase
Purchase of
of goods
goods for
for resale
resale
and
and services.
services.
Salaries
and
wages.
Salaries and wages.
Interest
Interest on
on debt.
debt.
Income
Income taxes.
taxes.
n
+
Outflows
Outflows to:
to:
n
ll
ll
ll
Slide
4-41
Cash Flows from Operating
Activities
Inflows
Inflows from:
from:
Provides relevant information about a
company’s inflows and outflows of cash.
Helps investors and creditors to assess
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Direct and Indirect Methods of
Reporting
_
© 2004 The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
Slide
4-42
Cash
Cash
Flows
Flows
from
from
Operating
Operating
Activities
Activities
Cash Flows from Investing
Activities
Inflows
Inflows from:
from:
Two Formats for Reporting Operating Activities
ll
ll
Direct Method
Indirect Method
Reports the cash
effects of each
operating activity
Starts with
accrual net
income and
converts to cash
basis
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
ll
Sale
Sale of
of property,
property, plant,
plant, and
and
equipment.
equipment.
Sale
Sale or
ormaturity
maturityof
of investment
investment
securities
securities (stocks
(stocks and
andbonds).
bonds).
Collection
of
nontrade
Collection of nontrade
receivables.
receivables.
+
Outflows
Outflows to:
to:
ll
ll
ll
Purchase
Purchase of
of property,
property, plant,
plant, and
and
equipment.
equipment.
Purchase
of
investment
Purchase of investment
securities
securities (stocks
(stocks and
andbonds).
bonds).
Loans
Loans to
to other
otherentities.
entities.
McGraw-Hill/Irwin
_
Cash
Cash
Flows
Flows
from
from
Investing
Investing
Activities
Activities
© 2004 The McGraw-Hill Companies, Inc.
4-8
Slide
4-43
Cash Flows from Financing
Activities
Slide
4-44
End of Chapter 4
Inflows
Inflows from:
from:
ll
ll
Borrowing
Borrowing on
on notes,
notes,
mortgages,
mortgages, bonds,
bonds, etc.
etc. from
from
creditors.
creditors.
Issuing
Issuing stock
stock to
to owners.
owners.
+
Outflows
Outflows to:
to:
ll
ll
ll
Repay
Repayprincipal
principal to
to creditors
creditors
(excluding
(excluding interest).
interest).
Repurchase
Repurchase stock
stock from
from owners.
owners.
Dividends
Dividends to
to owners.
owners.
McGraw-Hill/Irwin
_
Cash
Cash
Flows
Flows
from
from
Financing
Financing
Activities
Activities
© 2004 The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.