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Chapter 5 The Income Statement Income Measurement Beginning of Year End of Year Business Deals Business Deals Accrual Accounting Raw transaction data is refined from When paid/collected to When incurred/earned Resulting from transactions of the current period

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Chapter 5


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chapter 5

Chapter 5

The Income Statement

income measurement
Income Measurement

Beginning of Year

End of Year

Business Deals

Business Deals

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

accrual accounting
Accrual Accounting
  • Raw transaction data is refined from
    • When paid/collected to
    • When incurred/earned
  • Resulting from transactions of the current period
  • Measures economic performance

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

different measures of income5
Different Measures Of Income

Increase in wealth

  • a simple definition

Physical capital maintenance

  • income is earned only when there is an increase in actual physical resources

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

different measures of income6
Different Measures Of Income

Financial capital maintenance

  • income exists when the dollar amount of a company’s net assets increases during the year, excluding the effects of owner investments and dividends
  • this is the approach that accountants use to measure income

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

different measures of income7
Different Measures Of Income

Sales

– Cost of goods sold

= Gross profit

– Other operating expenses, gains, and losses

= Operating income

– Interest expense

± Miscellaneous revenues, expenses, gains, and losses

= Income before taxes

– Income tax expense

= Income from continuing operations

± Income from discontinued operations

± Extraordinary items

± Cumulative effect of accounting changes

= Net income

± Unrealized gains and losses not included in net income

= Comprehensive income

operating income minus interest expense, income tax expense, and other miscellaneous items

different measures of income8
Different Measures Of Income

Sales

– Cost of goods sold

= Gross profit

– Other operating expenses, gains, and losses

= Operating income

– Interest expense

± Miscellaneous revenues, expenses, gains, and losses

= Income before taxes

– Income tax expense

= Income from continuing operations

± Income from discontinued operations

± Extraordinary items

± Cumulative effect of accounting changes

= Net income

± Unrealized gains and losses not included in net income

= Comprehensive income

income from continuing operations adjusted for “below the line” items

below the line items
“Below the Line” Items

Income or loss from discontinued operations

  • results from the disposal of a major business segment

Extraordinary gains and losses

  • unusual in nature and infrequent in occurrence

Cumulative effect of accounting changes

  • a “catch-up” adjustment for a change to a new accounting method`

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

different measures of income10
Different Measures Of Income

Sales

– Cost of goods sold

= Gross profit

– Other operating expenses, gains, and losses

= Operating income

– Interest expense

± Miscellaneous revenues, expenses, gains, and losses

= Income before taxes

– Income tax expense

= Income from continuing operations

± Income from discontinued operations

± Extraordinary items

± Cumulative effect of accounting changes

= Net income

± Unrealized gains and losses not included in net income

= Comprehensive income

net income plus (minus) changes in market condition unrelated to business operations

unrealized gains losses
Unrealized Gains & Losses
  • Changes in the dollar value of foreign subsidiaries caused by movement of foreign currency exchange rates
  • Changes in the value of investment securities that are not actively traded
  • Changes in the value of certain derivative financial instruments

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

revenues
Revenues
  • The value of the goods and services provided by a company in its business operations
    • Sales revenue: the aggregate selling price of goods sold during the period
    • Service revenue: fees charged for services

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

non operating revenues
Non-Operating Revenues
  • Interest revenue: earned from extending credit or loaning money
  • Other revenue: comprised of revenues that come from different sources

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

expenses
Expenses

The value of resources used in generating reported revenue

Cost of goods sold: the expense directly associated with the sales revenue for the period

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

expenses con t
Expenses (con’t)

Selling General, & Administrative Expense

  • Research and development
    • Expensing required
  • Wages and salaries
  • Bad debt
    • The cost of selling merchandise on credit

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

expenses con t17
Expenses (con’t)

Depreciation

  • Allocation of the cost of long-lived assets

Interest expense

  • The cost of borrowing money

Income tax expense

  • The sum of all income tax consequences of all transactions during a year

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

gains and losses
Gains and Losses

Created by activities peripheral to a company’s primary operations

  • Sale of long-term assets
  • Restructuring charges

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

below the line items19
“Below the Line” Items

All reported net of applicable income taxes

  • Income (or loss) from discontinued operations
  • Extraordinary (unusual and infrequent) gains and losses
  • Cumulative effect from change in accounting principle

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

comprehensive income
Comprehensive Income

Reflects the overall change in a company’s wealth during a period.

Includes three items not reported in net income:

  • Foreign currency translation adjustment
  • Unrealized gains and losses on available-for-sale securities
  • Deferred gains and losses on derivative financial instruments

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

earnings per share eps
Earnings Per Share (EPS)
  • The amount of net income associated with each share of stock
  • Two earnings per share numbers:
    • Basic EPS reports earnings based solely on shares actually outstanding during the year
    • Diluted EPS reflects the existence of stock options and other potentially dilutive securities

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

revenue recognition
Revenue Recognition

Revenue is recognized when

  • The promised work is done, and
  • Cash collectibility is reasonably assured

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

expense recognition
Expense Recognition

Is based on the matching principle

  • An expense should be recognized in the same period in which the revenue it generates is recognized

Three bases of expense recognition:

  • Direct matching (or cause and effect)
  • Systematic allocation
  • Immediate recognition

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

expense recognition direct matching
Expense Recognition:Direct Matching

The expense is directly traceable to the revenue it generates (cause and effect)

  • Cost of goods sold matched with sales
  • Sales commissions matched with sales

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

expense recognition systematic allocation
Expense Recognition:Systematic Allocation

The expense is associated more with the passage of time than a specific revenue-generating activity

  • Depreciation expense
  • Insurance expense

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

expense recognition immediate recognition
Expense Recognition:Immediate Recognition

An expenditure is expensed currently because there is no future benefit or the future benefit is uncertain

  • Advertising expense
  • Research and development expense

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

expanded accounting equation
Expanded Accounting Equation

Paid-In Capital + Retained Earnings

Beginning RE + Net Income - Dividends

Revenues + Gains – Expenses - Losses

Assets = Liabilities + Stockholders’ Equity

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

veda landscape solutions january 1 transactions
Veda Landscape SolutionsJanuary 1 transactions

(from chapter 4)

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

transaction analysis
Transaction Analysis
  • Key points to remember
    • Revenues increase retained earnings
    • Expenses decrease retained earnings
    • Dividends decrease retained earnings
  • The income statement can be prepared from the revenue and expense columns of the spreadsheet

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

forecasting the future
Forecasting the Future

Past income statements can be used to predict income in future periods

Good forecasting requires an understanding of what factors determine the amount of a future revenue or expense

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

forecasting sales
Forecasting Sales

Forecasting begins with a forecast of sales

The sales forecast forms the basis of predicting the future balance sheet, income statement, and statement of cash flows

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

forecasting the balance sheet
Forecasting the Balance Sheet

Natural Increase

  • Cash, accounts receivable, inventory, and accounts payable

Long-term Planning

  • Property, plant, and equipment

Financing Choices

  • Long-term debt and paid-in capital

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

forecasting the income statement
Forecasting the Income Statement

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

forecasting the income statement38
Forecasting the Income Statement

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

in summary
In Summary ...
  • A variety of income measurements
  • Income statement reports revenues, expenses, gains, and losses
  • Comprehensive income includes additional unrealized gains and losses
  • Expanded accounting equation
  • Forecasting the future from historical statements

Financial Accounting, 7e Stice/Stice, 2006 © Thomson