CHAPTER 4
THE INCOME STATEMENT, COMPREHENSIVE INCOME, AND THE
STATEMENT OF CASH FLOWS
Overview
The purpose of the income statement is to summarize the profit-generating activities that occurred
during a particular reporting period. Comprehensive income includes net income as well as a few
gains and losses that are not part of net income and are considered other comprehensive income
items instead.
The purpose of the statement of cash flows is to provide information about the cash receipts and
cash disbursements of an enterprise that occurred during the period.
This chapter has a twofold purpose: (1) to consider important issues dealing with the content,
presentation, and disclosure of net income and other components of comprehensive income and (2)
to provide an overview of the statement of cash flows, which is covered in depth in Chapter 21.
Learning Objectives
LO4-1 Discuss the importance of income from continuing operations and describe its
components.
LO4-2 Describe earnings quality and how it is impacted by management practices to manipulate
earnings.
LO4-3 Discuss the components of operating and nonoperating income and their relationship to
earnings quality.
LO4-4 Define what constitutes discontinued operations and describe the appropriate income
statement presentation for these transactions.
LO4-5 Define extraordinary items and describe the appropriate income statement presentation
for these transactions.
LO4-6 Define earnings per share (EPS) and explain required disclosures of EPS for certain
income statement components.
LO4-7 Explain the difference between net income and comprehensive income and how we
report components of the difference.
LO4-8 Describe the purpose of the statement of cash flows.
LO4-9 Identify and describe the various classifications of cash flows presented in a statement of
cash flows.
LO4-10 Discuss the primary differences between U.S. GAAP and IFRS with respect to the
income statement and statement of cash flows.
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Lecture Outline
Part A: The Income Statement and Comprehensive Income
I.
Income from Continuing Operations
A. Income from continuing operations includes the revenues, expenses, gains, and losses that
will probably continue in future periods.
1. Income tax expense always is shown as a separate expense.
2. A distinction often is made between operating and nonoperating income. (T4-1)
3. A single-step income statement format groups all revenues and gains together and all
expenses and losses together. (T4-2)
4. A multiple-step income statement format includes a number of intermediate subtotals
before arriving at income from continuing operations. (T4-3)
5. There are more similarities than differences between income statements prepared
according to U.S. GAAP and those prepared applying IFRS. (T4-4)
II. Earnings Quality
A. Earnings quality refers to the ability of reported earnings (income) to predict a company’s
future earnings.
1. To enhance predictive value, analysts try to separate a company’s transitory earnings
effects from its permanent earnings.
2. Many believe that corporate earnings management practices reduce the quality of
earnings. Two major methods used by managers to manipulate income are (1) income
shifting and (2) income statement classification.
B. Not all items included in operating income should be considered indicative of a company’s
permanent earnings. (T4-5)
1. Restructuring costs include costs associated with shutdown or relocation of facilities
or downsizing of operations. GAAP requires these costs to be expensed in the
period(s) incurred.
2. Asset impairment losses and inventory write-down charges are other operating
expenses that call into question the issue of earnings quality.
3. Earnings quality is affected by revenue issues as well.
C. Some nonoperating items have generated considerable discussion with respect to earnings
quality, notably gains and losses generated from the sale of investments. (T4-6)
III. Separately Reported Items (T4-7)
A. Intraperiod tax allocation associates tax expense or tax benefit with continuing operations
and any item reported below continuing operations. (T4-8)
B. Discontinued operations involve the disposal or planned disposal of a component of an
entity. (T4-9)
1. The FASB and IASB are working together to develop a common definition of what
constitutes a component of an entity. At the time this text was published, a final
Accounting Standards Update had not been issued,
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2. When the component has been sold, the income effects of a discontinued operation
includes (1) the operating income or loss of the component from the beginning of the
reporting period to the disposal date, and (2) the gain or loss on disposal. (T4-10)
3. When the component is considered held for sale, the income effects of a discontinued
operation includes (1) operating income or loss of the component from the beginning
of the reporting period to the end of the reporting period, and (2) an impairment loss if
the carrying value (book value) of the assets of the component is more than fair value
minus cost to sell. (T4-11)
4. The assets and liabilities of a component considered held for sale are reported
separately in the balance sheet at the lower of their carrying amount (book value) or
fair value minus cost to sell.
C. Extraordinary items are material gains and losses that are both unusual in nature and
infrequent in occurrence. (T4-12)
1. Extraordinary gains and losses are presented, net-of-tax, in the income statement below
discontinued operations.
2. A material gain or loss that is either unusual or infrequent should be reported as a
separate component of continuing operations.
3. There are no extraordinary gains and losses under IFRS. (T4-13)
IV. Accounting Changes
A. Accounting changes fall into one of three categories: (1) a change in an accounting
principle, (2) a change in estimate, or (3) a change in reporting entity.
B. Most voluntary changes in accounting principles are accounted for retrospectively by
revising prior years’ financial statements. (T4-14)
1. The comparative financial statements are revised.
2. The appropriate accounts are adjusted.
3. A disclosure note provides clear justification that the change is appropriate. The note
also indicates the effects of the change on items not reported on the face of the primary
statements, as well as any per share amounts affected for the current period and all
prior periods presented.
C. A change in depreciation, amortization, or depletion method is considered to be a change
in accounting estimate that is achieved by a change in accounting principle. These
changes are accounted for prospectively, exactly as we would account for any other change
in estimate.
D. A change in accounting estimate is reflected in the financial statements of the current
period and future periods. (T4-15)
V. Correction of Accounting Errors
A. Errors discovered in the same year they are made are simply corrected by journal entry.
B. Treatment of errors discovered in a year subsequent to the year the error is made depends
on whether the error is material.
1. If the error is not material, it is simply corrected in the year discovered.
2. If the error is material, the correction is considered a prior period adjustment which
requires an addition to or reduction in beginning retained earnings and a restatement of
previous years' financial statements.
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VI. Earnings per Share Disclosures
A. Earnings per share (EPS) is the amount of income achieved during a period for each share
of common stock outstanding.
B. All corporations whose common stock is publicly traded must disclose EPS.
C. The EPS for (a) income before any separately reported items, (b) each separately reported
item, and (3) net income, must be disclosed. (T4-16)
VII. Comprehensive Income
A. The purpose of the income statement is to summarize the profit-generating activities that
occurred during a particular reporting period.
B. Comprehensive income is the total change in equity for a reporting period other than from
transactions with owners.
C. The information in the income statement and other comprehensive income items can be
presented either (1) in a single, continuous statement of comprehensive income or (2) in
two separate, but consecutive statements, an income statement and a statement of
comprehensive income. (T4-17)
D. Both U.S. GAAP and IFRS allow companies to report comprehensive income in either a
single statement of comprehensive income or in two separate statements. (T4-18)
Part B: The Statement of Cash Flows
I.
Usefulness of the Statement of Cash Flows
A. The purpose of the statement of cash flows (SCF) is to provide information about cash
receipts and cash disbursements that occurred during a period.
B. A SCF is presented for each period in which results of operations are provided.
II. Classifying Cash Flows
A. The SCF classifies all transactions affecting cash into one of three categories: (T4-19)
1. Operating activities are inflows and outflows of cash related to the transactions
entering into the determination of net operating income. (T4-20)
a. The Direct Method
b. The Indirect Method
2. Investing activities involve the acquisition and sale of (1) long-term assets used in the
business and (2) nonoperating investment assets.
3. Financing activities involve cash inflows and outflows from transactions with creditors
(excluding trade creditors) and owners.
B. Significant investing and financing transactions not involving cash also are reported.
C. The classification of certain cash flows differs between U.S. GAAP and international
accounting standards. (T4-21)
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PowerPoint Slides
A PowerPoint presentation of the chapter is available at the textbook website.
Teaching Transparency Masters
The following can be reproduced on transparency film as they appear here, or
you can use the disk version of this manual and first modify them to suit your
particular needs or preferences.
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INCOME STATEMENTS —
DELL INC.
.
Consolidated Statements of Income
(In millions, except per share amounts)
January 28,
2011
Net revenue:
Products
Services, including software related
Total net revenue
Cost of net revenue:
Products
Services, including software related
Total cost of net revenue
Gross margin
Operating expenses:
Selling, general, and administrative
Research, development, and engineering
Total operating expenses
Operating income
Interest and other, net
Income before income taxes
Income tax provision
Net income
Earnings per common share:
Basic
Diluted
Fiscal Year Ended
January 29,
2010
January 30,
2009
$50,002
11,492
61,494
$43,697
9,205
52,902
$52,337
8,764
61,101
42,068
8,030
50,098
11,396
37,534
6,107
43,641
9,261
44,670
5,474
50,144
10,957
7,302
661
7,963
3,433
(83)
3,350
715
$ 2,635
6,645
624
7,089
2,172
(148)
2,024
591
$ 1,433
7,102
665
7,767
3,190
134
3,324
846
$ 2,478
$ 1.36
$ 1.35
$ .73
$ .73
$ 1.25
$ 1.25
Illustration 4-2
T4-1
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SINGLE-STEP INCOME STATEMENT

An advantage of the single-step format is its simplicity.
MAXWELL GEAR CORPORATION
Income Statement
For the Year Ended December 31, 2013
Revenues and gains:
Sales ............................................................................
Interest and dividends .................................................
Gain on sale of investments ........................................
Total revenues and gains .......................................
Expenses and losses:
Cost of goods sold ......................................................
Office salaries .............................................................
Depreciation ................................................................
Miscellaneous .............................................................
Interest ........................................................................
Total expenses and losses ......................................
Income before income taxes ..........................................
Income tax expense .......................................................
Net income .....................................................................
$573,522
26,400
5,500
605,422
$302,371
47,341
24,888
16,300
14,522
405,422
200,000
80,000
$120,000
Illustration 4-3
T4-2
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MULTIPLE-STEP INCOME STATEMENT

An advantage of the multiple-step format is that it separately
reports operating and nonoperating activities.
MAXWELL GEAR CORPORATION
Income Statement
For the Year Ended December 31, 2013
Sales revenue ................................................................
Cost of goods sold ........................................................
Gross profit ...................................................................
Operating expenses:
Office salaries ..............................................................
$47,341
Depreciation .................................................................
24,888
Miscellaneous ..............................................................
16,300
Total operating expenses ......................................
Operating income ..........................................................
Other income (expense):
Interest and dividend revenue .....................................
26,400
Gain on sale of investments ..........................................
5,500
Interest expense ...........................................................
(14,522)
Total other income, net .........................................
Income before income taxes .........................................
Income tax expense .......................................................
Net income ....................................................................
$573,522
302,371
271,151
88,529
182,622
17,378
200,000
80,000
$120,000
Illustration 4-4
T4-3
© The McGraw-Hill Companies, Inc. 2013
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INTERNATIONAL FINANCIAL REPORTING STANDARDS
Income Statement Presentation. There are more similarities than
differences between income statements prepared according to U.S. GAAP
and those prepared applying international standards. Some of the
differences are:

International standards require certain minimum information to be
reported on the face of the income statement. U.S. GAAP has no
minimum requirements.
 International standards allow expenses to be classified either by
function (e.g., cost of goods sold, general and administrative, etc), or
by natural description (e.g., salaries, rent, etc.). SEC regulations
require that expenses be classified by function.
 In the U.S., the “bottom line” of the income statement usually is called
either net income or net loss. The descriptive term for the bottom line
of the income statement prepared according to international standards
is either profit or loss.
 As we discuss later, we report “extraordinary items” separately in an
income statement prepared according to U.S. GAAP. International
standards prohibit reporting “extraordinary items.”
T4-4
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OPERATING INCOME AND EARNINGS QUALITY

Operating income could include some unusual items that may
or may not continue in the future.
Income Statements – JDS Uniphase Corporation
Income Statements (in part)
($ in millions)
Net revenue
Cost of sales
Gross profit
Operating expenses:
Research and development
Selling, general, and
administrative
Amortization of intangibles
Impairment of goodwill
Impairment of long-lived assets
Restructuring costs
Total operating expenses
Operating loss
Years Ended
July 3, ,,,
June 27,
2010
2009
$1,363.9
$1,283.3
816.8
796.7
547.1
486.6
174.9
167.1
380.9
27.8
--17.7
601.3
(54.2)
399.0
27.0
741.7
13.2
38.5
1,386.5
(899.9)
Illustration 4-5
T4-5
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NONOPERATING INCOME AND EARNINGS QUALITY

Some nonoperating items have generated considerable
discussion with respect to earnings quality, notably gains and
losses from the sale of investments.
Income Statements – Intel Corporation
Income Statements (in part)
Years Ended December 30
(in millions)
Operating income
Gains on investments, net
Interest and other, net
Income before taxes
2000
10,395
3,759
987
15,141
1999
9,767
883
578
11,228
Illustration 4-7
T4-6
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SEPARATELY REPORTED ITEMS
► Discontinued operations, and
► Extraordinary items
Income from continuing operations before income taxes
and extraordinary item
Income tax expense
Income from continuing operations before extraordinary item
Discontinued operations, net of $xx in taxes
Extraordinary items, net of $xx in taxes
Net income
$XXX
XX
XXX
XX
XX
$XXX
 Their income tax effect is included in the separate presentation
rather than as part of the amount reported as income tax
expense.
T4-7
© The McGraw-Hill Companies, Inc. 2013
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INTRAPERIOD TAX ALLOCATION
►
Intraperiod tax allocation associates tax expense or tax benefit
with continuing operations and any separately reported item.
►
The Maxwell Gear Corporation had income from continuing operations of
$200,000 before income tax expense and an extraordinary gain of $60,000 in
2013. The income tax rate is 40% on all items of income or loss. Therefore,
the company’s total income tax expense is $104,000 (40% x $260,000).
Illustration 4-8

Income Statement Presented Incorrectly — No Intraperiod Tax Allocation
(Extraordinary Gain)
Incorrect Presentation
Income from continuing operations before income taxes
Income tax expense
Income before extraordinary gain
Extraordinary gain (gross)
Net income
$200,000
(104,000)
96,000
60,000
$156,000
Illustration 4-8a

Income Statement — Intraperiod Tax Allocation (Extraordinary Gain)
Correct Presentation
Income from continuing operations before income taxes
Income tax expense
Income before extraordinary gain
Extraordinary gain, net of $24,000 tax expense
Net income
$200,000
(80,000)
120,000
36,000
$156,000
Illustration 4-8b, T4-8
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DISCONTINUED OPERATION
►
If a component of an entity has either been disposed of or
classified as held for sale, we report the results of its
operations separately in discontinued operations.
T4-9
© The McGraw-Hill Companies, Inc. 2013
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Intermediate Accounting, 7/e
DISCONTINUED OPERATIONS —
When the component has been sold

When the component has been sold, the income effects of a
discontinued operation includes:
1.
Operating income or loss (revenues, expenses, gains and losses)
of the component from the beginning of the reporting period to
the disposal date.
2.
Gain or loss on disposal.
The Duluth Holding Company has several operating divisions. In October 2013, management
decided to sell one of its divisions that qualifies as a separate component according to generally
accepted accounting principles. The division was sold on December 18, 2013 for a net selling
price of $14,000,000. On that date, the assets of the division had a book value of $12,000,000. For
the period January 1 through disposal, the division reported a pre-tax loss from operations of
$4,200,000. The company’s income tax rate is 40% on all items of income or loss. Duluth
generated after-tax profits of $22,350,000 from its continuing operations.
Duluth’s income statement for the year 2013, beginning with income from continuing
operations, would be reported as follows:
Income from continuing operations
$22,350,000
Discontinued operations:
Loss from operations of discontinued component
(including gain on disposal of $2,000,000*)
$(2,200,000) †
Income tax benefit
880,000 ‡
Loss on discontinued operations
(1,320,000)
Net income
$21,030,000
* Net selling price of $14 million less book value of $12 million
† Loss from operations of $4.2 million less gain on disposal of $2 million
‡ $2,200,000 x 40%
Illustration 4-9
T4-10
Instructors Resource Manual
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DISCONTINUED OPERATIONS —
When the component is considered held for sale

When the component is considered held for sale, the income
effects of a discontinued operation includes:
1.
Operating income or loss (revenues, expenses, gains and losses)
of the component from the beginning of the reporting period to
the end of the reporting period.
2.
An “impairment loss” if the carrying value (book value) of the
assets of the component is more than fair value minus cost to
sell.
The Duluth Holding Company has several operating divisions. In October of 2013, management
decided to sell one of its divisions that qualifies as a separate component according to generally
accepted accounting principles. On December 31, 2013, the end of the company’s fiscal year, the
division had not yet been sold. On that date, the assets of the division had a book value of
$12,000,000 and a fair value, minus anticipated costs to sell, of $9,000,000. For the year, the
division reported a pre-tax loss from operations of $4,200,000. The company’s income tax rate is
40% on all items of income or loss. Duluth generated after-tax profits of $22,350,000 from its
continuing operations.
Duluth’s income statement for 2013, beginning with income from continuing operations, would
be reported as follows:
Income from continuing operations
$22,350,000
Discontinued operations:
Loss from operations of discontinued component
(including impairment loss of $3,000,000*)
$(7,200,000) †
Income tax benefit
2,880,000 ‡
Loss on discontinued operations
(4,320,000)
Net income
$18,030,000
* Book value of $12 million less fair value net of cost to sell of $9 million
† Operating loss of $4.2 million plus impairment loss of $3 million
‡ $7,200,000 x 40%
Illustration 4-10
T4-11
© The McGraw-Hill Companies, Inc. 2013
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Intermediate Accounting, 7/e
EXTRAORDINARY ITEMS
►
Extraordinary items are material gains and losses resulting
from transactions or events that are both:


Unusual in nature.
Infrequent in occurrence, considering the environment in
which the entity operates.
►
Extraordinary gains and losses are presented in the income
statement, net-of-tax, below discontinued operations.
►
If an event is material and either unusual or infrequent, but
not both, it should be reported as a separate component of
continuing operations.

A common example of an unusual or infrequent item is
restructuring costs.
T4-12
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INTERNATIONAL FINANCIAL REPORTING STANDARDS
Extraordinary items. U.S. GAAP provides for the separate reporting, as
an extraordinary item, of a material gain or loss that is unusual in nature
and infrequent in occurrence. In 2003, the IASB revised IAS No. 1. The
revision states that neither the income statement nor any notes may contain
any items called “extraordinary.”
T4-13
© The McGraw-Hill Companies, Inc. 2013
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Intermediate Accounting, 7/e
CHANGE IN ACCOUNTING PRINCIPLE
►
Most voluntary changes in accounting principles are
accounted for retrospectively by revising prior years’
financial statements.
►
The steps used to account for changes are as follows:
►
1.
The comparative financial statements are revised.
2.
The appropriate accounts are adjusted.
3.
A disclosure note provides clear justification for the
change along with the effects of the change on items not
reported on the face of the primary statements, as well as
any per share amounts affected for the current period and
all prior periods presented.
A change in depreciation, amortization, or depletion method
is considered to be a change in accounting estimate that is
achieved by a change in accounting principle. We account
for these changes prospectively, exactly as we would any
other change in estimate.
T4-14
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CHANGE IN ACCOUNTING ESTIMATE
►
A change in accounting estimate is reflected in the financial
statements of the current period and future periods.
T4-15
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Intermediate Accounting, 7/e
EARNINGS PER SHARE

Earnings per share (EPS) is the amount of income earned
expressed on a per share basis.

In its simplest form, EPS is computed by dividing net income
by the weighted average number of common shares
outstanding.

All corporations whose common stock is publicly traded must
disclose EPS.

The EPS for (a) income before any separately reported items,
(b) each separately reported item, and (3) net income, must be
disclosed.
T4-16
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EARNINGS PER SHARE
(continued)
Charming Shoppes, Inc.
Consolidated Statements of Operations (in part)
($ in thousands, except per share data)
Loss from continuing operations before
extraordinary item
Loss from discontinued operations, net of tax
Extraordinary item, net of tax
Net loss
Basic earnings (loss) per share
Loss from continuing operations before
extraordinary item
Loss from discontinued operations
Extraordinary item
Net loss
Diluted earnings (loss) per share:
Loss from continuing operations before
extraordinary item
Loss from discontinued operations
Extraordinary gain
Net loss
Year Ended
January 30, January 31, February 2,
2010
2009
2008
$ (77,962)
_
-$ (77,962)
$ (.67)
--$ (.67)
$ (.67)
--$ (.67)
$ (180,351)
(74,922)
-$ (255,273)
$ (4,163)
(85,039)
912
$ (88,290)
$ (1.57)
(.65)
-$ (2.22)
$ (.03)
(.70)
.01
$ (.72)
$ (1.57)
(.65)
-$ (2.22)
$ (.03)
(.70)
.01
$ (.72)
Illustration 4-13
T4-16 (continued)
© The McGraw-Hill Companies, Inc. 2013
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Intermediate Accounting, 7/e
COMPREHENSIVE INCOME
►
Comprehensive income is the total nonowner change in
equity for a period.
($ in millions)
Net income
Other comprehensive income:
Net unrealized holding gains (losses) from investments (net of tax)*
Gains (losses) from and amendments to postretirement
benefits plans (net of tax)†
Deferred gains (losses) from derivatives (net of tax) ‡
Gains (losses) from foreign currency translation (net of tax) §
Comprehensive income
*
†
‡
§
$xxx
$xx
(x)
(x)
x
xx
$xxx
Changes in the market value of certain investments (described in Chapter 12).
Gains and losses due to revising assumptions or market returns differing from
expectations and prior service cost from amending the plan (described in
Chapter 17).
When a derivative designated as a cash flow hedge is adjusted to fair value, the
gain or loss is deferred as a component of comprehensive income and included
in earnings later, at the same time as earnings are affected by the hedged
transaction (described in the Derivatives Appendix to the text).
Gains or losses from changes in foreign currency exchange rates. The amount
could be an addition to or reduction in shareholders’ equity. (This item is
discussed elsewhere in your accounting curriculum.)
Illustration 4-15

The information in the income statement and other
comprehensive income items can be presented either (1) in a
single, continuous statement of comprehensive income or (2)
in two separate, but consecutive statements, an income
statement and a statement of comprehensive income.
T4-17
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INTERNATIONAL FINANCIAL REPORTING STANDARDS
Comprehensive Income. Both U.S. GAAP and IFRS allow companies to
report comprehensive income in either a single statement of comprehensive
income or in two separate statements.
Other comprehensive income items are similar under the two sets of
standards. However, an additional OCI item, changes in revaluation
surplus, is possible under IFRS. In Chapter 10 you will learn that IAS No.
1647 permits companies to value property, plant, and equipment at (1) cost
less accumulated depreciation or (2) fair value (revaluation). IAS No. 38
provides a similar option for the valuation of intangible assets. U.S. GAAP
prohibits revaluation.
If the revaluation option is chosen and fair value is higher than book
value, the difference, changes in revaluation surplus, is reported as other
comprehensive income and then accumulates in a revaluation surplus
account in equity.
T4-18
© The McGraw-Hill Companies, Inc. 2013
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Intermediate Accounting, 7/e
STATEMENT OF CASH FLOWS
►
►
►
OPERATING ACTIVITIES

Inflows and outflows of cash that result from activities
reported in the income statement.

Includes most of the elements of net income, but
reported on a cash basis rather than an accrual basis.
INVESTING ACTIVITIES

Inflows and outflows of cash related to the acquisition
and disposition of long-term assets (such as property,
plant and equipment, and intangible assets) and
investment assets (except those classified as cash
equivalents and trading securities).

The purchase and sale of inventories are not considered
investing activities.
FINANCING ACTIVITIES

Cash inflows and outflows from transactions with
creditors (excluding trade creditors) and owners.
T4-19
Instructors Resource Manual
© The McGraw-Hill Companies, Inc. 2013
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CASH FLOWS FROM OPERATIONS ACTIVITIES

Under the direct method, the cash effect of each operating
activity is reported directly in the statement.

By the indirect method, we arrive at net cash flow from
operating activities indirectly by starting with reported net
income and working backwards to convert that amount to a
cash basis.
T 4-20
© The McGraw-Hill Companies, Inc. 2013
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Intermediate Accounting, 7/e
CASH FLOWS FROM OPERATIONS ACTIVITIES
(continued)
Arlington Lawn Care (ALC) began operations at the beginning of 2013. ALC’s 2013 income
statement and its year-end balance sheet are shown below ($ in thousands).
ARLINGTON LAWN CARE
Income Statement
For the Year Ended December 31, 2013
Service revenue
Operating expenses:
General and administrative
Depreciation
Total operating expenses
Income before income taxes
Income tax expense
Net income
$90
$32*
8
40
50
15
$35
* Includes $6 in insurance expense.
ARLINGTON LAWN CARE
Balance Sheet
At December 31, 2013
Assets
Current assets:
Cash
$54
Accounts receivable
12
Prepaid insurance
4
Total current assets
70
Equipment
40
Less: Accumulated depreciation (8)
Total assets
$102
Liabilities and shareholders’ equity
Current liabilities:
Accounts payable**
$7
Income taxes payable
15
Total current liabilities
22
Shareholders’ equity:
Common stock
50
Retained earnings
30***
Total liabilities and
shareholders’ equity
$102
** For general and administrative expenses
*** Net income of $35 less $5 in cash dividends paid
Illustration 4-17
T4-20 (continued)
Instructors Resource Manual
© The McGraw-Hill Companies, Inc. 2013
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CASH FLOWS FROM OPERATIONS ACTIVITIES
(continued)
ARLINGTON LAWN CARE
Statement of Cash Flows
For the Year Ended December 31, 2013
($ in thousands)
Cash Flows from Operating Activities
Cash received from customers*
$78
Cash paid for general and administrative expenses** (29)
Net cash flows from operating activities
$49
* Service revenue of $90 thousand, less increase of $12 thousand in accounts
receivable.
**General and administrative expenses of $32 thousand, less increase of $7
thousand in accounts payable, plus increase of $4 thousand in prepaid insurance.
Illustration 4-17A
ARLINGTON LAWN CARE
Statement of Cash Flows
For the Year Ended December 31, 2013
($ in thousands)
Cash Flows from Operating Activities
Net income
Adjustments for noncash effects:
Depreciation expense
$ 8
Changes in operating assets and liabilities:
Increase in prepaid insurance
(4)
Increase in accounts receivable
(12)
Increase in accounts payable
7
Increase in income taxes payable
15
Net cash flows from operating activities
$35
14
$49
Illustration 4-17B, T4-20 (continued)
© The McGraw-Hill Companies, Inc. 2013
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Intermediate Accounting, 7/e
INTERNATIONAL FINANCIAL REPORTING STANDARDS
Classification of Cash Flows. Like U.S. GAAP, international standards also require a statement of
cash flows. Consistent with U.S. GAAP, cash flows are classified as operating, investing, or
financing. However, the U.S. standard designates cash outflows for interest payments and cash
inflows from interest and dividends received as operating cash flows. Dividends paid to shareholders
are classified as financing cash flows.
IAS No. 7, on the other hand, allows more flexibility. Companies can report interest and
dividends paid as either operating or financing cash flows and interest and dividends received as
either operating or investing cash flows. Interest and dividend payments usually are reported as
financing activities. Interest and dividends received normally are classified as investing activities.
Typical Classification of Cash Flows from Interest and Dividends
U.S. GAAP
Operating Activities
Dividends received
Interest received
Interest paid
IFRS
Operating Activities
Investing Activities
Investing Activities
Dividends received
Interest received
Financing Activities
Dividends paid
Financing Activities
Dividends paid
Interest paid
Siemens AG, a German company, prepares its financial statements according to IFRS. In the
statement of cash flows for quarter ended March 31, 2011, the company reported interest and
dividends received as operating cash flows, as would a U.S. company. However, Siemens classified
interest paid as a financing cash flow.
Siemens AG
Statement of Cash Flows (partial)
For the Nine Months Ended March 31, 2011
(€ in millions)
Cash flows from financing activities:
Proceeds from re-issuance of treasury stock
Repayment of long-term debt
Change in short-term debt and other
Interest paid
Dividends paid
Dividends paid to minority shareholders
Financing discontinued operations
Net cash used in financing activities-continuing operations
109
(13)
85
(72)
(2,356)
(81)
(401)
(2,729)
T 4-21
Instructors Resource Manual
© The McGraw-Hill Companies, Inc. 2013
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Suggestions for Class Activities
1.
Real World Scenario
In March of 2005, Daimler-Chrysler AG announced that it would recall some 1.3 million MercedezBenz cars worldwide to fix problems with their alternators and batteries. The recall covered E-class,
CLS-class, E, and SL models. In 2010, Toyota recalled several of its brand models to fix problems
involving accelerator pedals. These recalls cost Daimler-Chrysler and Toyota tens of millions of
dollars.
In 2005, Hurricane Katrina destroyed much of the city of New Orleans. That hurricane was the
costliest hurricane, as well as one of the five deadliest, in the United States.
Suggestions:
Have the class consider the income statement presentation of the income effects of these events.
Will the effects be included in continuing operations? Will they be presented gross, or net-of-tax?
How do the events underlying the income effects differ in terms of the likelihood that they will occur
again in the foreseeable future?
Points to note:
The product recall event can be compared to the recall of Tylenol capsules in 1982. In the Tylenol
case, the circumstances surrounding the event led Johnson & Johnson to classify the loss as an
extraordinary item. This product recall event resulted in a new package design for the product (in fact
for the entire industry) reducing the likelihood that similar losses would occur in the future. The
capsules were recalled because someone put poison in some of the capsules. In the auto industry,
however, product recalls are not uncommon.
You might have your students access the most recent financial statements of Ford Motor. In the
financial statements for the year ended December 31, 2010, in Note 31 under Commitments and
Contingencies they will find that product recalls are included in accrued liabilities in the balance
sheet. In the balance sheet for the year ended December 31, 2010, the current and noncurrent
liability “Dealer and customer allowances and claims,” exceeded $10 billion (note 17).
The Hurricane Katrina losses present another good opportunity to discuss extraordinary gains and
losses. Are losses in the Gulf of Mexico from hurricanes unusual and infrequent? Is this type of loss
likely to occur again in the foreseeable future? Note that the FASB’s EITF specifically ruled that the
Hurricane Katrina losses do not qualify for extraordinary reporting.
© The McGraw-Hill Companies, Inc. 2013
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Intermediate Accounting, 7/e
2.
Research Activity
Aramark Corporation, a leading provider of a broad range of managed services to business,
educational, healthcare and governmental institutions and sports, entertainment and recreational
facilities, reported discontinued operations in its income statements for its 2011, 2010, and 2009
fiscal years.
Suggestions:
Have the class access the company’s financial statements for the fiscal year ended September 30,
2011, using EDGAR, which can be located at: www.sec.gov. Ask them to answer the following
questions:
1. What segments of the company were discontinued?
2. What was the net-of-tax income (loss) from discontinued operations for the 2011 and 2010
years?
3. What was the net proceeds (net selling price) of the component that was discontinued?
Points to note:
Aramark sold its wholly-owned subsidiary, Galls, LLC and reported net-of-tax losses from this
discontinued operation of $11,732 thousand and $1,635 thousand for fiscal years 2011 and 2010,
respectively. The net proceeds from the sale of Galls, LLC was $75 million.
3.
Dell Analysis
Have students, individually or in groups, go to the most recent Dell annual report using EDGAR
which can be located at: ww.sec.gov. Ask them to:
1. Compare revenues, operating expenses, net income, and net income as a percentage of revenue
dollars with those in the 2011 annual report in Appendix B of the text. Are there any
discernible trends? How might they be interpreted?
2. Has the company made any changes in its revenue recognition method?
3. Does the income statement contain any separately reported items?
4. Compare cash flows from operating, investing, and financing activities with those in the 2011
report. Are there any discernible trends? How might they be interpreted?
5. Use EDGAR to locate the most recent annual report information for Apple, Dell’s competitor.
Using the most recent annual report information for both companies, compare growth (from the
prior year) in revenue and net income, net income as a percentage of revenue dollars, and
operating expenses as a percentage of revenue.
Instructors Resource Manual
© The McGraw-Hill Companies, Inc. 2013
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4.
Professional Skills Development Activities
The following are suggested assignments from the end-of-chapter material that will help your
students develop their communication, research, analysis and judgment skills.
Communication Skills. In addition to Communication Case 4-6, Integrating Case 4-15 can be
adapted to ask students to answer the requirement in the form of a formal report.
Communication Case 4-5 and Integrating Case 4-15 do well as group assignments. Judgment
Case 4-1 and Ethics Case 4-7 create good class discussions. Real World Cases 4-4 and 4-17,
and Research Case 4-14 are suitable for student presentation(s).
Research Skills. In their careers, our graduates will be required to locate and extract relevant
information from available resource material to determine the correct accounting practice,
perhaps identifying the appropriate authoritative literature to support a decision. Research Case
4-8 and Exercises 4-20 and 4-21 provide excellent opportunities to help students develop this
skill. In addition, Real World Case 4-4 can be adapted to require students to research the
authoritative literature on the presentation of pro forma earnings.
Analysis Skills. The “Broaden Your Perspective” section includes Analysis Cases that direct
students to gather, assemble, organize, process, or interpret data to provide options for making
business and investment decisions. In addition to Analysis Case 4-16, Judgment Cases 4-9 and
4-10 also provide opportunities to develop and sharpen analytical skills.
Judgment Skills. The “Broaden Your Perspective” section includes Judgment Cases that require
students to critically analyze issues to apply concepts learned to business situations in order to
evaluate options for decision-making and provide an appropriate conclusion. In addition to
Judgment Cases 4-1, 4-2, 4-3, 4-9, 4-10, and 4-12, Communication Cases 4-5 and 4-6 also
require students to exercise judgment.
CPA Simulation. Students can test their knowledge of the concepts discussed in this chapter and
at the same time practice critical professional skills necessary for career success and
preparation for the computer-based CPA Exam. The simulation for this chapter, Bart Company,
tests students’ knowledge of the contents and presentation of the income statement. Access the
simulations at the text website: www.mhhe.com/spiceland7e.
© The McGraw-Hill Companies, Inc. 2013
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Intermediate Accounting, 7/e
Assignment Chart
Questions
4-1
4-2
4-3
4-4
4-5
4-6
4-7
4-8
4-9
4-10
4-11
4-12
4-13
4-14
4-15
4-16
4-17
4-18
4-19
4-20
4-21
Instructors Resource Manual
Learning
Objective(s)
1
1
1
1
2
3
4,5,6
4
5
5
---6
7
8
9
9
9
10
10
Est. time
Topic
(min.)
Purpose of the income statement
5
Income from continuing operations
5
Operating and nonoperating income
5
Single-step and multiple-step income statements 5
Earnings quality
5
Restructuring costs
5
Intraperiod tax allocation
5
Discontinued operations
5
Extraordinary items
5
Extraordinary items
5
Change in accounting principle
5
Change in accounting estimate
5
Correction of errors
5
Earnings per share
5
Comprehensive income
5
Purpose of the statement of cash flows
5
Classification of cash flows
5
Noncash investing and financing activities
5
Direct method versus indirect method
5
IFRS; separately reported items
5
IFRS; statement of cash flows
5
© The McGraw-Hill Companies, Inc. 2013
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Brief
Exercises
4-1
4-2
4-3
4-4
4-5
4-6
4-7
4-8
4-9
4-10
4-11
4-12
Learning
Objective(s)
1
1,3
1,3
1,3
5
3,5,6
4
4
4
7
9
9
4-13
4-14
© The McGraw-Hill Companies, Inc. 2013
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9
9,10
Est. time
Topic
(min.)
Single-step income statement
10
Multiple-step income statement
10
Multiple-step income statement
15
Multiple-step income statement
15
Extraordinary items
10
Separately reported items
15
Discontinued operations
10
Discontinued operations
10
Discontinued operations
10
Comprehensive income
10
Statement of cash flows; direct method
15
Statement of cash flows; investing and financing
activities
15
Statement of cash flows; indirect method
10
IFRS; statement of cash flows
10
Intermediate Accounting, 7/e
Exercises
4-1
4-2
4-3
4-4
4-5
4-6
4-7
4-8
4-9
4-10
4-11
4-12
4-13
4-14
4-15
4-16
4-17
4-18
4-19
4-20
4-21
4-22
Instructors Resource Manual
Learning
Est. time
Objective(s)
Topic
(min.)
1,6
Income statement format; single-step and
multiple-step
20
1,3,5,6
Income statement format; single-step and
multiple-step
20
1,5,6,7
Multiple-step statement and comprehensive
income
20
1,5,6
Income statement presentation; intraperiod tax
allocation
20
4,6
Discontinued operations
15
1,3,4
Income statement presentation
20
4
Discontinued operations
15
4
Discontinued operations; disposal in subsequent
year
10
6
Earnings per share
10
7
Comprehensive income
20
9
Statement of cash flows; classifications
10
11
Statement of cash flows preparation
15
9,10
IFRS; statement of cash flows
5
9
Indirect method; reconciliation of net income to
cash flows
15
9
Statement of cash flows directly from
transactions
20
9
Statement of cash flows; indirect method
15
9.10
IFRS; statement of cash flows
20
9
Statement of cash flows; indirect method
30
9
Statement of cash flows; direct method
25
6
FASB codification research
15
5,6,7,9
FASB codification research
20
1 through 9 Concepts; terminology
15
© The McGraw-Hill Companies, Inc. 2013
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CPA/CMA
Exam Questions
CPA-1
CPA-2
CPA-3
CPA-4
CPA-5
CPA-6
CPA-7
CPA-8
CMA-1
CMA-2
CMA-3

Problems
4-1

4-2
4-3
4-4
4-5
4-6
4-7
4-8

4-9
4-10

4-11
Learning
Objective(s)
4
3,4,5
4,5
4
9
9
10
10
1
3
5
Topic
Discontinued operations
Income from continuing operations
Single-step income statement
Discontinued operations
Statement of cash flows; classifications
Statement of cash flows; classifications
IFRS
IFRS
Income from continuing operations
Multiple-step income statement
Extraordinary items
Est. time
(min.)
3
3
3
3
3
3
3
3
3
3
3
Learning
Est. time
Objective(s)
Topic
(min.)
1,3,4,5,6 Comparative income statements; multiple-step
format
25
4
Discontinued operations
25
4,5
Income statement presentation
20
3,5
Income statement presentation; unusual items
10
1,3,5,6
Income statement presentation; unusual items
25
1,3,4,5,6 Income statement presentation
30
1,3,4,5,6,7 Income statement presentation; statement of
comprehensive income; unusual items
30
1,3,5,7
Multiple-step statement of income and
comprehensive income
20
9
Statement of cash flows
25
9
Integration of financial statements; Chapters 3 &
4
40
9
Statement of cash flows; indirect method
30
 Star Problems
© The McGraw-Hill Companies, Inc. 2013
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Intermediate Accounting, 7/e
Cases
Judgment Case 4-1
Judgment Case 4-2
Judgment Case 4-3
Real World Case 4-4
Communication Case 4-5
Communication Case 4-6
Ethics Case 4-7
Research Case 4-8
Learning
Objective(s)
2,3
3
2,3
3
5
5
3,5
2,3
Judgment Case 4-9
Judgment Case 4-10
IFRS Case 4-11
Judgment Case 4-12
3,4,5
3,4,5
9,10
3,4,5,7
Judgment Case 4-13
Research Case 4-14
Integrating Case 4-15
Analysis Case 4-16
Real World Case 4-17
2
3
3,5
1
1,3,4,5
Air France-KLM Case
CPA Simulation 4-1
Instructors Resource Manual
10
Est. time
(min.)
Earnings quality
15
Restructuring costs
15
Earnings management
15
Pro forma earnings
15
Income statement presentation of gain
20
Income statement presentation
15
Income statement presentation of unusual loss
20
FASB codification; restructuring costs; exit or
disposal cost obligations
40
Income statement presentation
20
Income statement presentation
20
Statement of cash flows; GlaxoSmithKline Plc.
15
Income statement presentation; unusual items;
20
comprehensive income
Management incentives for change
15
Pro forma earnings
60
Balance sheet and income statement
35
Income statement information; Dell
10
Income statement information
45
Topic
IFRS; income statement classifications; statement
of cash flows; Air France-KLM
15
Contents and presentation of the income statement
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