Chapter 11:
The Income Statement
Evolving definitions
Future events
Comprehensive
income
Earnings Per Share
Earnings management
New proposals
Definitions: Income
Income and profit...results from the
deduction from revenues, or from operating
revenues, of COGS, other expenses, and
losses
Net income...the excess (deficit) of revenue
over expenses for an accounting period
Comprehensive income...
Definitions: Revenues
Results from the sale of goods and
rendering of services...
Gross increases in assets and gross
decreases in liabilities measured in
conformity with GAAP...
Inflows or other enhancements of assets of
an entity or settlements of its liabilities...
Revenues versus Gains
Typically have been displayed separately on
financial statements
Gains are . . . revenues . . . from other than sales of
products, merchandise, or services. . . .
Gains are increases in equity (net assets) from
peripheral or incidental transactions . . . except
those that result from revenues or investments by
owners.
Definitions: Revenue Recognition
Revenue should be identified during the period
during which the major economic activities
necessary to the creation and disposition of goods
and services has been accomplished
Alternative points in time
During production
 At completion of production
 At time of sale
 When the cash is collected

Definitions: Expenses and Losses
Includes all expired costs which are
deductible from revenues
Gross decreases in assets or gross increases
in liabilities recognized and measured in
conformity with GAAP...
Are outflows or other using up of assets or
incurrence of liabilities...
Cost Classifications
Costs directly associated with the revenue
of the period
Costs associated with the period on some
basis other than a direct relationship with
revenue
Costs that cannot, as a practical matter, be
associated with any other period
Future Events
Reporting process is grounded in recording events
that have occurred, but these past events and their
recording are very dependent upon our
interpretation of future events either happening or
not happening
Every accrual and deferral is dependent upon
future events
Treatment of future events in asset, liability,
expense, and revenue recognition has not been
well systematized
Future Events
Trade-off of
qualitative
characteristics such as
relevance and
reliability?
Answer may be
largely qualitative in
nature, which may add
to the ever-burgeoning
role of disclosure
What is the future
of accounting?
Comprehensive Income
Comprehensive income pushes the allinclusive approach toward its logical
conclusion
In addition to net income as presently
defined, comprehensive income includes
those elements of profit and loss that
bypassed the income statement
Reporting Comprehensive Income
1. in a combined statement of financial
performance (income in which the
comprehensive income elements and total would
appear below net income)
2. in a separate statement of comprehensive income
which would begin with net income
3. reported within a statement of changes in equity
Nonoperating Items
Nonoperating section of the income
statement
 discontinued
operations
 extraordinary items
 accounting principle changes
Retained earnings statement reports prior
period adjustments
Earnings Per Share (EPS)
SFAS No. 128 , an improvement over APB
Opinion No. 15
 increases
EPS comparability with other nations
 simplifies the computational aspects of EPS
 revises disclosure requirements
Calculations have to be shown right on the
income statement itself for both basic and
diluted earnings per share
Specialized Topics
Development Stage Enterprises
Any enterprise devoting substantially all of its efforts to
establishing a new business
 Question as to what should be expensed or deferred

Troubled Debt Restructuring
When the creditor for economic or legal reasons related
to the debtor’s financial problems grants a concession
to the debtor
 Present value concept does not apply

Specialized Topics
Early Extinguishment of Debt
Gains and Losses, if material, are reported as
extraordinary items net of the tax effects
 FASB conceded to the single-line financial statement
item

Stock Options
Intent is to align management and stockholder interests
 Frequently lead to dysfunctional management behavior

Specialized Topics
Stock Options
 Debate
as to whether they are an expense
 Nonqualified stock options
 Incentive stock options
 Stock options and equity theories
 Entity theory
 Proprietary theory
Reformat the Income Statement
Entity Income
Maintain the bottom line, but do not deduct interest
expense
 Result is “entity income,” income to the firm itself

Proprietary Income
From entity income deduct interest costs and stock
option costs
 Result is “proprietary income, income to the
shareholder

Earnings Management
....purposeful
intervention in the
external financial
reporting process,
with the intent of
obtaining some
private gain
(Schipper)
Earnings Management
Managing income to affect management
compensation
Income might be managed by manipulating
discretionary accruals
 Studies find that managers manage income when bonus
plans are dependent on earnings levels

Income smoothing
Managers smooth income to facilitate better predictions
of future cash flows on which firm value is based
 Studies’ tests confirm income-smoothing behavior

Developments
Pre-FASB more time and effort was placed
on refining the income statement to the
detriment of the balance sheet
Since FASB, a shift toward
 cleaning
up the balance sheet
 a movement toward more of an asset-liability
approach to the financial statements consistent
with the conceptual framework project
Developments
Cash earnings
Pro forma earnings
Retrospective reports
Quality of earnings
 Increasing
emphasis on earnings sustainability
and an absence of earnings management
 Accounting scandals
Chapter 11:
The Income Statement
Evolving definitions
Future events
Comprehensive
income
Earnings Per Share
Earnings management