Chapter 4
The Income Statement
and Related Information
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1. Big Picture


Quality of earnings
Ability of reported earnings to predict future earnings
◦ permanent earnings
◦ transitory earnings

Management of earnings
◦
◦
◦
◦

shifting income between periods
manipulating I/S classifications (e.g., restructuring charges)
reserves
pro forma reporting
All revenue and expense transactions include a change in an asset
or liability account
◦ How should those transactions be reported on I/S to best reflect the
quality of earnings information users need?
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1a. Big Picture


Two I/S approaches
Current operating approach
◦ income should only reflect normal, current
operations
◦ non-current operating revenues, expenses, gains,
and losses should go directly to RE

All inclusive approach
◦ income should include all non-owner changes in
net assets

What is GAAP?
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1b. Big Picture

Comprehensive income
◦ all changes in equity of an entity from
transactions and other events from nonowner sources
◦ includes net income and other items

How reported?
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2. Income Statement Basics

Form of income statement
◦ single-step
◦ multi-step
Income from continuing operations
 Special items

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Income Statement (Single-Step)
{
Proper Heading
Revenues
& Gains
Expenses
& Losses
{
{
MAXWELL GEAR CORPORATION
Income Statement
For the Year Ended December 31, 2009
Revenues and gains:
Sales
Interest and dividends
Gain on sale of opearting assets
Total revenues and gains
Expenses and losses:
Cost of goods sold
Selling
General and administrative
Research and development
Interest
Loss on sale of investment
Income taxes
Total expenses & losses
Net income
$
$
573,522
26,400
5,500
605,422
302,371
47,341
24,888
16,300
6,200
8,322
80,000
$
485,422
120,000
Income Statement (Multiple-Step)
Proper
Heading
Gross
Profit
Operating
Expenses
Nonoperating
Items
{
{
{
{
MAXWELL GEAR CORPORATION
Income Statement
For the Year Ended December 31, 2009
Sales revenue
Cost of goods sold
Gross profit
Operating expenses:
Selling
General and administrative
Research and development
Operating income
Other income (expense):
Interest and dividend revenue
Gain on sale of operating assets
Interest expense
Loss on sale of investments
Income before income taxes
Income tax expense
Net income
$ 573,522
302,371
271,151
$ 47,341
24,888
16,300
$ 26,400
5,500
(6,200)
(8,322)
88,529
182,622
17,378
200,000
80,000
$ 120,000
3. Continuing Operations


Purpose
Items included
◦ operating income
 includes: revenue, cost of good sold, operating expenses
(selling & general and administrative expenses)
◦ other income (expense)
 sometimes called nonoperating section
 includes: other revenue, gains, other expenses (interest
expense), losses
◦ income tax expense
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Income Statement (Lower portion)
Income from continuing operations
before income taxes and
extraordinary items
Income tax expense
Income from continuing operations
before extraordinary items
Discontinued operations (net of $xx
in taxes)
Extraordinary items (net of $xx in
taxes)
Net Income
$ xxx
xx
xxx
xx
xx
$ xxx
4. Intraperiod Tax Allocation
Each section of the I/S m/b shown net of
tax
 Could be tax expense or tax benefit

 Interperiod tax allocation complex topic

Examples
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5. Discontinued Operations
Disposal of a component of an entity
 Location on IS
 Must disclose separately

◦ income or loss from operating component
from beginning of period
◦ gain or loss on disposal of component’s assets
Sold v. Held for Sale
 Items reported net of tax

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6. Extraordinary Items

Material unusual and infrequent gains and losses
◦ most meet both criteria
 unusual in nature
 infrequent in occurrence
◦ if only meets one – goes in regular section





Location on I/S
Reported net of tax
Fairly rare items
Consider in particular circumstances
BE 4-5
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7. Accounting Changes

Change in accounting principle
◦ change from one GAAP to another GAAP
◦ examples
◦ accounting

Change in accounting estimate
◦ revision of an estimate used in implementing an
accounting principle
◦ examples
◦ accounting
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7a. Accounting Changes

Change in reporting entity
◦ current accounting entity differs from
accounting entity in previous reporting period
Change in depreciation or depletion
method
 Change from unacceptable GAAP to
acceptable GAAP

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8. Prior Period Adjustments
Correction of a material mistake in net
income in a prior year not discovered
until current year
 Only item that qualifies

◦ correction of an error

Reported as an adjustment to the
beginning balance of RE
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9. EPS
Shown for each section of I/S
 Complex topic
 Basic formula

NI - PS Div
EPS = ———————
WAS
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