Chapter12 INCOME AND CHANGES IN RETAINED EARNINGS
Normal, recurring revenue and expense transactions. Unusual, nonrecurring events that affect net income. 1. The results of discontinued operations 2. The impact of extraordinary items. 3. The effects of changes in accounting principles. Reporting the Results of Operations Information about net income can be divided into two major categories Income from continuing operations.
This tax expense does not include effects of unusual, nonrecurring items. These unusual, nonrecurring items are each reported net of taxes.
Income/Loss from operating the segment prior to disposal. Income/Loss on disposal of the segment. Discontinued Operations When management enters into a formal plan to sell or discontinue a segment of the business, the related gains and losses must be disclosed on the income statement. Discontinued Operations
Discontinued Operations When management enters into a formal plan to sell or discontinue a segment of the business, the related gains and losses must be disclosed on the income statement. A segment must be a separate line of business activity or an operation that services a distinct category of customers.
Discontinued Operations - Example During 2003, Apex Co. sold an unprofitable segment of the company. The segment had a net loss from operations during the period of $150,000 and its assets sold at a loss of $100,000. Apex reported income from continuing operations of $350,000. All items are taxed at 30%. How will this appear on the income statement?
Discontinued Operations - Example Income Statement Presentation:
Extraordinary Items • Material in amount. • Gains or losses that are both unusual in nature and not expected to recur in the foreseeable future. • Reported net of related taxes.
Extraordinary Items - Example During 2003, Apex Co. experienced a loss of $75,000 due to an earthquake at one of its manufacturing plants in Nashville. This was considered an extraordinary item. The company reported income before extraordinary item of $175,000. All gains and losses are subject to a 30% tax rate. How would this item appear on the 2003 income statement?
Extraordinary Items - Example Income Statement Presentation:
Change in Accounting Principle • Occurs when changing from one GAAP method to another GAAP method. • Make a catch-up adjustment known as the cumulative effect of a change in accounting principle. • The cumulative effect is reported net of taxes and after extraordinary items.
Change in Accounting Principle Example Also in 2003, Apex Co. decided to change from the double-declining balance to the straight-line method for depreciation. The effect of this change is an increase in net income of $65,000. Apex reported income before cumulative effect of an accounting change of $122,500 during the year. All items of income are subject to a 30% tax rate. How would this item appear on the income statement?
Change in Accounting Principle Example Computation: Income Statement Presentation:
Change in Estimates • Revision of a previous accounting estimate. • The new estimate should be used in the current and future periods. • The prior accounting results should not be disturbed.
Change in Estimates - Example On January 1, 2000, we purchased equipment costing $30,000, with a useful life of 10 years and no salvage value. During 2003, we determine that the remaining useful is 5 years (8-year total life). We use straight-line depreciation. Compute the revised depreciation expense for 2003.
Change in Estimates - Example Record depreciation expense of $4,200 for 2003 and subsequent years.
Price-earnings Ratio (P/E) Often, the Price-Earnings Ratio is used to evaluate the reasonableness of a company’s stock price. Let’s examine this further.
Earnings Per Share (EPS) A measure of the company’s profitability and earning power for the period. Based on the number of shares issued and the length of time that number remained unchanged.
Earnings Per Share (EPS) -Partial Income Statement Remember that Apex Co. income from continuing operations of $350,000. The after-tax loss from discontinued operations was $175,000. The extraordinary loss was $52,500 and the cumulative effect of accounting changes was a gain of $45,500. Assume that Apex has weighted average shares outstanding of 156,250. Prepare a partial income statement showing the EPS for Income from Operations and for the other special items.
Earnings Per Share (EPS) If preferred stock is present, subtract preferred dividends from net income prior to computing EPS. EPS is required to be reported in the income statement.
Accounting for Cash Dividends Declared by board of directors. Not legally required. Requires sufficient Retained Earnings and Cash. Creates liability at declaration.
Date of Declaration Board of directors declares the dividend. Record a liability. Dividend Dates
Ex-Dividend Date The day which serves as the ownership cut-off point for the receipt of the most recently declared dividend. Dividend Dates NO ENTRY
Dividend Dates • Date of Record • Stockholders holding shares on this date will receive the dividend.(No entry) X
Dividend Dates • Date of Payment • Record the payment of the dividend to stockholders.
$100 × 8% = $8 dividend per share $8 × 2,500 = $20,000 total dividend Dividend Dates - Question On June 1, 2003, a corporation’s board of directors declared a dividend for the 2,500 shares of its $100 par value, 8% preferred stock. The dividend will be paid on July 15. Which of the following will be included in the July 15 entry? a. Debit Retained Earnings $20,000. b. Debit Dividends Payable $20,000. c. Credit Dividends Payable $20,000. d. Credit Preferred Stock $20,000.
No change in total stockholders’ equity. No change in par values. Accounting for Stock Dividends Distribution of additional shares of stock to stockholders. All stockholders retain same percentage ownership.
Adjust retained earnings retroactively. The adjustment should be disclosed net of any taxes. Prior Period Adjustments The correction of an error identified as affecting net income in a prior period.
Issuance of new shares of stock. Net Income or Net Loss Payment of Dividends Comprehensive Income Normally, there are 3 ways that financial position can change. GAAP excludes some unrealized items from income, such as the change in market value of available-for-sale debt and equity investments.
The accumulated amount of changes affecting Comprehensive Income is reported in equity. There are 3 options for reporting Comprehensive Income. As a second Income statement. Combined with Net Income on the Income Statement. As an element of Stockholders’ Equity. Comprehensive Income GAAP requires that unrealized items that are normally reported on the balance sheet be added back to compute “Comprehensive Income.”
Hang in there! We’re coming down the home stretch! Yeah, that’s easy for you to say! End of Chapter 12