MODULE 9
ADVANCED INCOME STATEMENT ISSUES
Advanced Income Statement
1
ADVANCED INCOME STATEMENT ISSUES
 Irregular Items
 Discontinued Items
 Extraordinary Items
 Unusual Items (Restructuring)
 Earnings per Share
Advanced Income Statement
2
INCOME STATEMENT FORMATS
A Review
A multi-step income statement:
 Separates operating and non-operating activities
 Classifies expenses by function
X CORPORATION
INCOME STATEMENT
For the period ending December 31, 20XX
Sales
Cost of Goods Sold
Gross Profit
Selling, General, and Administrative Expenses
Income from Operations
Rent Income
Investment Gains
Interest Expense
Income before Tax
Tax Expense
Net Income
Earnings per Share (44,000 shares outstanding)
$150,000
-70,000
80,000
-10,000
70,000
10,000
5,000
-5,000
80,000
-25,000
$55,000
Operating
revenues and
expenses
NonOperating
revenues and
expenses
$1.25
Operating – within corporate mission
Non-Operating – rent, interest, equipment sales
Note: Multistep income statements usually include Gross Profit
(Sales – Cost of Goods Sold).
Advanced Income Statement
3
CONSOLIDATED STATEMENT OF EARNINGS
The Home Depot, Inc. and Subsidiaries
AMOUNTS IN MILLIONS, EXCEPT SHARE DATA
Amounts in millions
NET SALES
Cost of Sales
GROSS PROFIT
Operating Expenses:
Selling, General and Administrative
Depreciation and Amortization
Total Operating Expenses
January
28,
2007
January 29,
2012
$70,395
46,133
24,262
100.0%
65.5%
34.5%
$90,837
61,054
29,783
100.0%
67.2%
32.8%
16,028
1,573
17,601
22.8%
2.2%
25.0%
18,348
1,762
20,110
20.2%
1.9%
22.1%
OPERATING INCOME
Interest and Other (Income) Expense:
Interest and Investment Income
Interest Expense
Other
Interest and Other, net
6,661
9.5%
9,673
10.6%
EARNINGS BEFORE TAXES
6,068
8.6%
9,308
10.2%
Provision for Income Taxes
2,185
3.1%
3,547
3.9%
EARNINGS FROM CONTINUING
OPERATIONS
3,883
Advanced Income Statement
13
-606
0
-593
-0.9%
5.5%
27
-392
0
-365
5,761
4
-0.4%
6.3%
IRREGULAR ITEMS
“DE” Items
In the US, two items:
 Discontinued Operations
 Extraordinary Items
receive special treatment.
Treatment: Show
 near the bottom of the income statement (prior to
net income)
 net of taxes
Note:
 DE items receive this treatment whether single or
multi-step.
 Income before DE items is referred to as “Income
from Continuing Operations”
 IFRS standards do not recognize extraordinary items.
Advanced Income Statement
5
INCOME STATEMENT WITH “DE” ITEMS
X CORPORATION
INCOME STATEMENT
For the period ending December 31, 20XX
Sales
Cost of Goods Sold
Gross Profit
Selling, General, and Administrative Expenses
Income Before Unusual and Infrequent Items
Unusual Item
Infrequent Item
Income from Cont Operations Before Tax
Tax Expense
Income from Continuing Operations
Discontinued Operations ($2,700 before tax effect of $700)
Extraordinary Items (5,400 before tax effect of $1400)
Net Income
Earnings per Share from (10,000 shares):
Continuing Operations
Discontinued Operations
Extraordinary Items
Net Income
Advanced Income Statement
$100,000
-25,000
75,000
-10,000
65,000
-5,000
-5,000
55,000
-30,000
25,000
-2,000
-4,000
$19,000
These taxes
apply to
items above
and not
“DE” items
DE
items
are net
of tax
$2.50
.20
.40
$1.90
Show
separate
EPS for
DE items
6
IRREGULAR ITEMS
Discontinued Operations
Discontinued Operations – component that (1) will be
eliminated from ongoing operations, and (2) has no
management involvement after disposal.
Rules:
 a component must be a product
group or division, but not a brand
 Discontinued operations are
always reported net of taxes
Reported in two parts:
 Part 1 - Gain or loss from operations of discontinued
operations
 Part 2 - Gain or loss from the disposal (FMV – BV)
Advanced Income Statement
7
IRREGULAR ITEMS
Discontinued Operations
Al Carbon’s Tacos operates Fire in the Hole Donuts (FITH), a
subsidiary that management believes does not fit well in the
company.
During 20X1, Al Carbon, announced a plan to sell FITH. Fire in
the Hole lost $300 and $250 thousand during 20X1 and 20X2
respectively, and no buyer seemed interested in purchasing
FITH. (See A)
However, in 20X3, FITH earned $100 thousand (see B) and Taco
Joe agreed to purchase FITH for $500 thousand, $50 thousand
more than the current net worth (see C).
The income statement disclosure related to the discontinued
operation would be:
(in thousands of US$)
20X3
20X2
20X1
Income from continuing operations
3,000
2,500
2,000
Discontinued operations
Gain(Loss) from discontinued operations
Gain on sale of discontinued operations
Net income
Advanced Income Statement
C
B
A
100
50
(250)
--
(300)
–
$3,150
$2,250
$1,700
8
DISCONTINUED OPERATIONS EXAMPLE
On December 22, 2003 GM completed a series of transactions that
resulted in the split-off of Hughes from GM and the simultaneous sale
of GM’s approximately 19.8% economic interest in Hughes to the News
Corporation.
GENERAL MOTORS CORP. & SUBSIDIARIES
Consolidated Statements of Income
Years ended December 31
2004
2003
2002
$193,517
$185,837
$177,867
159,951
20,394
11,980
192,325
152,435
20,957
9,464
182,856
147,192
20,834
7,503
175,529
Income before income taxes
1,192
2,981
2,338
Income tax (benefit) expense
Equity income and minority interests
Income from continuing operations
(911)
702
2,805
731
612
2,862
644
281
1,975
–
–
(219)
1,179
(239)
–
$2,805
$3,822
$1,736
(Dollars in millions)
Net sales
Cost of sales and other expenses
Selling, general, and administrative expenses
Interest expense
Total costs and expenses
Discontinued operations
(Loss) from discontinued operations
Gain on sale of discontinued operations
Net income
Part 1 – Hughes
lost $458 million
over 2002-2003.
Advanced Income Statement
Part 2 – GM sold
Hughes in 2003 at a
gain of $1.179 billion.
9
IRREGULAR ITEMS
Extraordinary Items
Extraordinary Item – non recurring material items that
differ from the entity’s business activities.
They are both:
 Unusual in Nature – possess a high degree of
abnormality
 Infrequent in Occurrence – not reasonably expected to
recur in the foreseeable future
The following are not extraordinary:
 Write downs of receivables, inventories and equipment
 Foreign currency gains and losses
 Sale of PP&E and investments
 Corporate restructuring
It’s unusual.
 Effects of a strike
It’s infrequent.
 Early extinguishment of debt
It’s highly
extraordinary
 Immaterial items
my dear Watson.
 IFRS standards do not recognize extraordinary items.
Advanced Income Statement
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IRREGULAR ITEMS
Restructuring Charges
Attention should be paid to items that
may be unusual or infrequent, but not
both. Restructuring charges are a
common example.
Restructuring charges – usually relate to activities
such as layoffs, closings, asset impairments.
Some companies report restructuring charges as unusual
items (“other losses” or “other expenses”).
Restructuring charges are NOT “DE” items and should
NOT be shown net of taxes.
Advanced Income Statement
11
RESTRUCTURING EXAMPLE
McDonald’s Corporation
Consolidated Statement of Income
(In millions, except per share data)
Years ended December 31,
Revenues from Company-operated restaurants
Revenues from franchised restaurants
Total revenues
Operating costs and expenses
Food and packaging
Payroll and employee benefits
Occupancy and other operating expenses
Total Company-operated restaurant expenses
Franchised restaurants--occupancy expenses
Selling, general and administrative expenses
Other operating (income) expense
Made for You costs
Special charge
Total operating costs and expenses
Operating income
Interest expense
Nonoperating (income) expense
Income before provision for income taxes
Provision for income taxes
Net income
1999
1998
1997
$ 9,512.5
3,746.8
13,259.3
$ 8,894.9
3,526.5
12,421.4
$ 8,136.5
3,272.3
11,408.8
3,204.6
2,418.3
2,206.7
7,829.6
737.7
1,477.6
(124.1)
18.9
0
9,939.7
3,319.6
396.3
39.2
2,884.1
936.2
$ 1,947.9
2,997.4
2,220.3
2,043.9
7,261.6
678.0
1,458.5
(60.2)
161.6
160.0
9,659.5
2,761.9
413.8
40.7
2,307.4
757.3
$ 1,550.1
2,772.6
2,025.1
1,851.9
6,649.6
613.9
1,450.5
(113.5)
0
0
8,600.5
2,808.3
364.4
36.6
2,407.3
764.8
$ 1,642.5
Made for You – a new food preparation system that allows us to
serve fresher, better-tasting food at high speed. The system supports
future growth because it can more easily accommodate an expanded
menu.
Why did
income go
down in 1998?
Special Charge – comprised of employee severance, lease cancellation
and write-off of capitalized technology made obsolete.

How do we distinguish between restructuring and items
that should have been normal expenditures in past years?
Advanced Income Statement
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DICK’S SPORTING GOODS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
February 2, February 3, January 28,
2008
2007
2006
Fiscal Year Ended
(Amounts in thousands, except per share data)
Net sales
Cost of goods sold,
GROSS PROFIT
$3,888,422
2,730,359
1,158,063
$3,114,162
2,217,463
896,699
$2,624,987
1,887,347
737,640
Selling, general and administrative expenses
Merger integration and store closing costs
Pre-opening expenses
INCOME FROM OPERATIONS
870,415
—
18,831
268,817
682,625
—
16,364
197,710
556,320
37,790
10,781
132,749
Gain on sale of investment
Interest expense, net
INCOME BEFORE INCOME TAXES
—
11,290
257,527
—
10,025
187,685
(1,844)
12,959
121,634
102,491
$155,036
75,074
$112,611
48,654
$72,980
$1.42
$1.33
$1.10
$1.02
$0.73
$0.68
109,383
116,504
102,512
110,790
99,584
107,958
Provision for income taxes
NET INCOME
EARNINGS PER COMMON SHARE:
Basic
Diluted
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic
Diluted
In Notes: Merger integration and store closing costs associated with the purchase
of Galyan’s of $37.8 million were recognized in 2005. The cost relates primarily to
closing Dick’s stores in overlapping markets and advertising the re-branding and
re-grand opening of the former Galyan’s stores.
Net income as a percent of sales for each of the years was:
2008
2007
2006
3.99%
3.62%
2.78%
Would have been
4.22% without
merger costs
What is the reason for a significantly lower percentage during 2006?
Are you willing to “excuse” Dick’s Sporting Goods for this reason?
Advanced Income Statement
13
EARNINGS PER SHARE
Earnings per share are required at the bottom of the
income statement.
The Basic EPS Calculation:
EPS
=
Earnings (or loss) for period - earnings applicable to senior securities*
Weighted average number of shares of CS
* for example, preferred stock dividends
The denominator is weighed to prevent end of year
manipulation.
Diluted EPS must also be shown if the company has
 stock options,
 convertible bonds and preferred stock, or
 other agreements that potentially reduce common
stockholders earnings
Did you know: EPS is
the only ratio GAAP
tells us how to
calculate?
NI – PS Div
# shares
 IFRS and US GAAP calculate basic and diluted EPS similarly.
Advanced Income Statement
14
Earnings per Share Example
Walmart
(in millions except per share data)
Sales
Other income-net
Cost of sales
Selling and administrative expenses
Interest costs:
Debt
Capital leases
Interest income
Provision for income taxes
Minority interest
Net income
Per share of common stock:
Basic net income
Diluted net income
Dividends
2003
2002
2001
$ 244,524
2,001
191,838
41,043
$ 217,799
1,873
171,562
36,173
$ 191,329
1,787
150,255
31,550
803
260
(138)
4,487
(193)
8,039
1,083
274
(171)
3,897
(183)
6,671
1,104
279
(188)
3,692
(129)
6,295
1.81
1.81
0.30
1.49
1.49
0.28
1.41
1.40
0.24
Earnings per share are required on the face of the
income statement for all publicly-traded companies.
Discussion Question: Does Walmart use a single step or
multistep income statement?
Thought question: If Company A has an EPS of $5, and
Company B has an EPS of $4, which has higher profitability?
Advanced Income Statement
15
Advanced Income Statement
16
ANALYSIS OF AN INCOME STATEMENT
McCormick & Co.
Consolidated Statement of Income
(millions except per share data)
for the year ended November 30
Net sales
Cost of goods sold
2007
2006
$2,916.2
1,724.4
1,191.8
$2,716.4
1,601.8
X
Selling, general and administrative expense
Restructuring charges
Operating income
806.9
30.7
354.2
772.6
72.4
269.6
Interest expense
Other income, net
Income from consolidated operations before income taxes
60.6
8.8
302.4
53.7
7.1
223.0
Income taxes
Net income from consolidated operations
92.2
210.2
64.7
158.3
(.8)
21.4
.7
$X
26.8
19.9
2.8
$202.2
$1.78
$1.73
$1.53
$1.50
(Loss) gain on sale of unconsolidated operations
Income from unconsolidated operations
Minority interest
Net income
Earnings per share – basic
Earnings per share – diluted
Does McCormick use a single step or multi-step income statement?
Multi-step – Non operating is shown separately.
What is the gross profit of McCormick for 2006?
$2,716.4 – 1,601.8 = $1,114.6
What is net income for McCormick in 2007?
$210.2 – 0.8 + 21.4 + 0.7 = 230.1
What is the number of shares outstanding for McCormick in 2007?
Basis EPS = $230.1 million / Shares = $1.78 ; Shares = 129.3 million
Advanced Income Statement
17
PROFITABILITY RATIOS
1.
Profit Margin on Sales
Indicates: The relation of profits to sales.
Profit
Margin
=
Net Income
Sales
Interpretation:
Higher - less sales are needed to generate a desired level of profit.
How is the ratio improved? Hint: The denominator is the top of the IS and the
numerator is the bottom of the IS. What is in between?
2.
Return on Assets
Indicates: How assets are utilized to achieve a profit.
Return
on Assets
=
Current Year Net Income
Average Total Assets
Options: Some add interest expense to the numerator to put leveraged and
unleveraged entities on equal basis.
Interpretation:
Higher - greater ability to produce profits.
Advanced Income Statement
18
3.
Return on Stockholders' Equity
Indicates: The degree of profitability attributable to stockholders. Differs from
ROA to extent that the entity is leveraged (has debt).
Return
on Equity
=
Current Year Net Income
Average Stockholders’ Equity
Options: Some subtract PS dividends from numerator to evaluate only amounts
available to CS.
Interpretation:
Higher - a greater degree of profits available to stockholders.
Advanced Income Statement
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