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CHAPTER 4
INCOME STATEMENT AND
RELATED INFORMATION
Sommers – ACCT 3311
Discussion Question
Q4-1 What kinds of questions about future cash flows do investors
and creditors attempt to answer with information in the income
statement?
Income Statement
Usefulness

Evaluate past performance.


Predicting future performance.
Help assess the risk or uncertainty of
achieving future cash flows.
Income Statement
Limitations

Companies omit items that cannot be
measured reliably.


Income is affected by the accounting
methods employed.
Income measurement involves
judgment.
Discussion Questions
Q4-3 Identify at least two situations in which important changes
in value are not reported in the income statement.
Discussion Question
Q4-8 Why should caution be exercised in the use of the net
income figure derived in an income statement?
Income Statement
Quality of Earnings
Companies have incentives to manage income to meet or
beat Wall Street expectations, so that

market price of stock increases and

value of stock options increase.
Quality of earnings is reduced if earnings management
results in information that is less useful for predicting future
earnings and cash flows.
Earnings Quality – Operating/Nonoperating
Operating Income
• Restructuring Costs – Costs associated with shutdown or relocation
of facilities or downsizing of operations are recognized in the period
incurred.
• Goodwill Impairment and Long-lived Asset Impairment - Involves
asset impairment losses or charges.
Nonoperating Income
• Gains and losses from the sale of operational assets and
investments - Often can significantly inflate or deflate current
earnings.
Example: As the stock market boom
reached its height late in the year 2000,
many companies recorded large gains
from sale of investments that had
appreciated significantly in value.
How should those gains be
interpreted in terms of their
relationship to future earnings?
Are they transitory or permanent?
Classification
Operating
Nonoperating
Permanent
Transitory
Where would the following items lie?
•Sales revenue
•Restructuring charges
•Royalty income
•Interest expense
•Payment made for settlement of lawsuit
•R&D expense
Incentives for disclosures that influence user classification?
Discussion Question
Q4-10 What is the major distinction (a) between revenues
and gains and (b) between expenses and losses?
Single-Step Format
Single-Step Income
Statement
Revenues
Expenses
SingleStep
Net Income
No distinction between
Operating and Non-operating
categories.
Income Statement (in thousands)
Revenues:
Sales
$ 285,000
Interest revenue
17,000
Total revenue
302,000
Expenses:
Cost of goods sold
149,000
Selling expense
10,000
Administrative expense
43,000
Interest expense
21,000
Income tax expense
24,000
Total expenses
Net income
247,000
$ 55,000
Earnings per share
$
0.75
Multiple-Step Format
Multiple-Step Income Statement

Separates operating transactions from nonoperating
transactions.

Matches costs and expenses with related revenues.

Highlights certain intermediate components of
income that analysts use.
Multiple-Step Format
Intermediate Components of the Income Statement
1. Operating section
2. Nonoperating section
3. Income tax
4. Discontinued operations
5. Extraordinary items
6. Earnings per share
Multiple-Step Format
The presentation
divides information
into major sections.
1. Operating Section
2. Nonoperating
Section
3. Income tax
Income Statement (in thousands)
Sales
Cost of goods sold
Gross profit
Operating expenses:
Selling expenses
Administrative expenses
Total operating expense
Income from operations
Other revenue (expense):
Interest revenue
Interest expense
Total other
Income before taxes
Income tax expense
Net income
$ 285,000
149,000
136,000
10,000
43,000
53,000
83,000
$
17,000
(21,000)
(4,000)
79,000
24,000
55,000
E4-7
The accountant of Weatherspoon Shoe Co. has compiled the following
information from the company’s records as a basis for an income statement for
the year ended December 31, 2014.
Rent revenue
$29,000
Interest expense
18,000
Market appreciation on land above cost
31,000
Salaries and wages expense (sales)
114,800
Supplies (sales)
17,600
Income tax
30,600
Salaries and wages expense (administrative)
135,900
Other administrative expenses
51,700
Cost of goods sold
516,000
Net sales
980,000
Depreciation on plant assets (70% selling, 30% administrative) 65,000
Cash dividends declared
16,000
There were 20,000 shares of common stock outstanding during the year.
Prepare a multiple-step income statement.
E4-7
E4-7 Single Step
WEATHERSPOON SHOE CO.
Income Statement
For the Year Ended December 31, 2014
Revenues
Net sales
Rent revenue
Total revenues
Expenses
Cost of goods sold
Administrative expenses
Selling expenses
Interest expense
Total expenses
$ 980,000
29,000
1,009,000
$516,000
207,100
177,900
18,000
919,000
Income before income tax
90,000
Income tax
Net income
30,600
59,400
Earnings per share ($59,400 ÷ 20,000)
$
$2.97
Income Statement Classifications
Reporting Irregular Items
Irregular items fall into six categories
1. Discontinued operations.
2. Extraordinary items.
3. Unusual gains and losses.
4. Changes in accounting principle.
5. Changes in estimates.
6. Corrections of errors.
Reporting Irregular Items
Companies are required to report irregular items in the
financial statements so users can determine the long-run
earning power of the company.
Illustration 4-6
Number of Unusual Items
Reported in a Recent Year
by 500 Large Companies
Reporting Irregular Items
Discontinued Operations
Occurs when,
(a) company eliminates the

results of operations and

cash flows of a component.
(b) there is no significant continuing involvement in that
component.
Amount reported “net of tax.”
Reporting Discontinued Operations
Illustration: KC Corporation had after tax income from continuing
operations of $55,000,000 for the year. During the year, it disposed
of its restaurant division at a pretax loss of $270,000. Prior to
disposal, the division operated at a pretax loss of $450,000 for the
year. Assume a tax rate of 30%. Prepare a partial income
statement for KC.
Income from continuing operations
Discontinued operations:
Loss from operations, net of $135,000 tax
Loss on disposal, net of $81,000 tax
Total loss on discontinued operations
$55,000,000
Net income
$54,496,000
315,000
189,000
504,000
Reporting Discontinued Operations
Discontinued
Operations are reported
after “Income from
continuing operations.”
Previously labeled as
“Net Income”.
Moved to
Income Statement (in thousands)
Sales
Cost of goods sold
Gross profit
Interest expense
Total other
Income before taxes
Income tax expense
Income from continuing operations
Discontinued operations:
Loss from operations, net of tax
Loss on disposal, net of tax
Total loss on discontinued operations
Net income
$ 285,000
149,000
136,000
(21,000)
(4,000)
79,000
24,000
55,000
315
189
504
$ 54,496
P&G’s Income Statement
Reporting Irregular Items
Extraordinary items are nonrecurring material items that
differ significantly from a company’s typical business activities.
Extraordinary Item must be both of an

Unusual Nature and

Occur Infrequently
Company must consider the environment in which it operates.
Amount reported “net of tax.”
Reporting Extraordinary Items
Illustration: KC Corporation had after tax income from continuing
operations of $55,000,000 during the year. In addition, it suffered
an unusual and infrequent pretax loss of $770,000 from a volcano
eruption. The corporation’s tax rate is 30%. Prepare a partial
income statement for KC Corporation beginning with income from
continuing operations.
Income from continuing operations
Extraordinary loss, net of $231,000 tax
$55,000,000
539,000
Net income
$54,461,000
($770,000 x 30% = $231,000 tax)
Reporting Irregular Items
Reporting when both
Discontinued
Operations and
Extraordinary Items
are present.
Discontinued
Operations
Extraordinary Items
Income Statement (in thousands)
Sales
Cost of goods sold
Gross profit
Income before taxes
Income tax expense
Income from continuing operations
Discontinued operations:
Loss from operations, net of tax
Loss on disposal, net of tax
Total loss on discontinued operations
Income before extraordinary item
Extraordinary loss, net of tax
Net income
$ 285,000
149,000
136,000
79,000
24,000
55,000
315
189
504
54,496
539
$ 54,496
Reporting Irregular Items
Unusual Gains and Losses
Material items that are unusual or infrequent, but not both,
should be reported in a separate section just above “Income
from continuing operations before income taxes.”
Examples can include:

Write-downs of inventories

Foreign exchange transaction gains and losses
The Board prohibits net-of-tax treatment for these items.
Reporting Irregular Items
Unusual Gains and Losses
Illustration 4-7
Income Statement
Presentation of Unusual
Charges
Special Reporting Issues
Intraperiod Tax Allocation
Relates the income tax expense to the specific items that give
rise to the amount of the tax expense.
Income tax is allocated to the following items:
(1) Income from continuing operations before tax.
(2) Discontinued operations.
(3) Extraordinary items.
Intraperiod Income Tax Allocation
Income Tax Expense must be associated with
each component of income that causes it.
Show Income Tax
Expense related to
Income from
Continuing
Operations.
Report effects of
Discontinued Operations
and Extraordinary Items
NET OF RELATED
INCOME TAXES.
Special Reporting Issues
Intraperiod Tax Allocation
Extraordinary Gain: Schindler Co. has income before income
tax and extraordinary item of $250,000. It has an extraordinary
gain of $100,000 from a condemnation settlement received on
one its properties. Assuming a 30 percent income tax rate.
Illustration 4-13
Special Reporting Issues
Intraperiod Tax Allocation
Extraordinary Loss: Schindler Co. has income before income
tax and extraordinary item of $250,000. It has an extraordinary
loss from a major casualty of $100,000. Assuming a 30 percent
income tax rate.
Illustration 4-14
Example of Intraperiod Tax Allocation
Income Statement (in thousands)
Sales
Cost of goods sold
Total other
$ 285,000
149,000
(4,000)
Income from cont. oper. before taxes
79,000
Income tax expense
24,000
Income from continuing operations
55,000
Note: losses reduce
the total tax
Calculation of
Total Tax
$24,000
Discontinued operations:
Loss on operations, net of $135 tax
315
Loss on disposal, net of $61 tax
189
Total loss on discontinued operations
Income before extraordinary item
Extraordinary loss, net of $231 tax
Net income
(135)
(61)
504
54,496
539
$ 53,957
(231)
$23,573
E4-6B
The following balances were taken from the books of Schimank Corp.
on December 31, 2014. Assume the total effective tax rate on all items
is 34%. Prepare a multiple-step income statement; 100,000 shares of
common stock were outstanding during the year.
Interest revenue
$ 120,400
Accum deprec—equipment $ 56,000
Cash
71,400
Accum deprec—building
39,200
Sales
1,932,000
Notes receivable
217,000
Accounts receivable
210,000
Selling expenses
271,600
Prepaid insurance
28,000
Accounts payable
238,000
Sales returns & allowances 210,000
Bonds payable
140,000
Allowance for bad debts
9,800
Admin & general expenses 135,800
Sales discounts
63,000
Accrued liabilities
44,800
Land
140,000
Interest expense
84,000
Equipment
280,000
Notes payable
140,000
Building
196,000
Loss from earthquake damage
Cost of goods sold
869,400
(extraordinary item)
210,000
Common stock
700,000
Retained earnings
29,400
E4-6B
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