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Income Statement Review. Income Statement Basics. Income statement explains changes in retained earnings: RE YE ’02 = RE YE ‘01 + NI In ‘02 - Dividends In ’02 Net Income In ‘02 = Revenue In ‘02 - Expense In ‘02. Retained Earnings is a permanent account

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income statement basics
Income Statement Basics

Income statement explains changes in retained earnings:

REYE ’02= REYE ‘01 + NIIn ‘02 - DividendsIn ’02

Net IncomeIn ‘02 = RevenueIn ‘02 - ExpenseIn ‘02

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Retained Earnings is a permanent account
  • Net Income, Revenues and Expenses are temporary accounts
    • get folded into retained earnings at period-end
    • keep track of net income during the period
    • begin and end the period with zero balances
net income and cash flows
Net Income and Cash Flows
  • Over a long enough period net income = cash from operations + cash from investing
  • Therefore, the only issue is timing
revenue recognition
Revenue recognition
  • Have performed all (or a substantial portion) of your service
  • Have received an asset (e.g., cash or receivable) which can be measured
  • Amount is adjusted up front for bad debts, sales discounts and allowances, etc.
  • Most common source of fraud
expense recognition
Expense recognition
  • Generally involves transforming an asset (stock) to an expense (flow)
  • Match to revenue if possible (e.g., product cost)
    • Merchandising--cost of acquiring inventory
    • Manufacturing--cost of making product (including overhead)
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Otherwise charge to expense as consumed (e.g., SG&A and R&D)
  • Measured on same basis as the asset being expensed.
income statement format
Income Statement Format

Sales

- Cost of Goods Sold

Gross Profit

- Selling, General and Administrative Expense

Operating Income

+/- Interest Expense/Income

+/- Other Income, Gains, Expenses, Losses, etc.

Pre-Tax Income from Continuing Operations

- Income Tax Expense

Net Income from Continuing Operations

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+/- Income/Loss from Operations of Businesses Sold (net of income tax)

+/- Gain/Loss on Business Sold (net of income tax)

Income from Discontinued Operations

+/- Extraordinary Gains/Losses (net of income tax)

+/- Cumulative Effect of Accounting Change

NET INCOME

earnings per share
Earnings Per Share
  • Basic EPS = Net Income to Common / Ave. Number of Common Shares Outstanding
  • For Coke, $3,050M Net Income / 2,478M Common Shares = $1.23
  • Diluted EPS takes into account securities convertible into stock (e.g., stock options)