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Chapter 4 Income Statement

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  1. Chapter 4 Income Statement

  2. Income Statement Usefulness of the Income Statement • Evaluate past performance. • Predicting future performance. • Help assess the risk or uncertainty of achieving future cash flows. LO 1 Understand the uses and limitations of an income statement.

  3. Income Statement Limitations of the Income Statement • Companies omit items that cannot be measured reliably. • Income is affected by the accounting methods employed. • Income measurement involves judgment. LO 1 Understand the uses and limitations of an income statement.

  4. Format of the Income Statement Elements of the Income Statement Revenues – Inflows or other enhancements of assets or settlements of its liabilities that constitute the entity’s ongoing major or central operations. Examples of Revenue Accounts • Sales • Fee revenue • Interest revenue • Dividend revenue • Rent revenue LO 1 Understand the uses and limitations of an income statement.

  5. Format of the Income Statement Elements of the Income Statement Expenses – Outflows or other using-up of assets or incurrences of liabilities that constitute the entity’s ongoing major or central operations. Examples of Expense Accounts • Cost of goods sold • Depreciation expense • Interest expense • Rent expense • Salary expense LO 1 Understand the uses and limitations of an income statement.

  6. Format of the Income Statement Elements of the Income Statement Gains – Increases in equity (net assets) from peripheral or incidental transactions. Losses - Decreases in equity (net assets) from peripheral or incidental transactions. • Gains and losses can result from • sale of investments or plant assets, • settlement of liabilities, • write-offs of assets. LO 1 Understand the uses and limitations of an income statement.

  7. Single-Step Income Statement The single-step statement consists of just two groupings: Revenues Expenses Net Income Single- Step No distinction between Operating and Non-operating categories. LO 2 Prepare a single-step income statement.

  8. Multi-Step Income Statement

  9. Multiple-Step Income Statement Background • Separates operating transactions from nonoperating transactions. • Matches costs and expenses with related revenues. • Highlights certain intermediate components [or subtotals] of income that analysts use. LO 3 Prepare a multiple-step income statement.

  10. Multiple-Step Income Statement The presentation divides information into major sections. 1. Operating Section 2. Nonoperating Section 3. Income tax LO 3 Prepare a multiple-step income statement.

  11. Multi-Step Income Statement Sales – Cost of goods sold = Gross profit Operating expenses: – Selling expenses – General and administrative expenses = Income from operations +/– Other revenues and expenses = Income before taxes – Income tax expense = Net income Four important subtotals

  12. JC Penney, Inc. Statement of OperationsIn Millions For the Years Ended January 30, 20132012

  13. Multiple-Step Format Illustration (E4-4): Prepare an income statement from the data below. Solution on notes page

  14. Multiple-Step Income Statement Review A separation of operating and non operating activities of a company exists in a. both a multiple-step and single-step income statement. b. a multiple-step but not a single-step income statement. c. a single-step but not a multiple-step income statement. d. neither a single-step nor a multiple-step income statement. LO 3 Prepare a multiple-step income statement.

  15. Irregular Items

  16. Reporting Irregular Items Irregular itemsfall into six categories • Discontinued operations. • Extraordinary items. • Unusual gains and losses. • Changes in accounting principle. • Changes in estimates. • Corrections of errors. LO 4 Explain how to report irregular items.

  17. Irregular Items Shown Below Income After Taxes/Before Net Income on the Income Statement • Discontinued Operations • Extraordinary Items

  18. Reporting Irregular Items • Discontinued Operations occurs when, • (a) company eliminates the • results of operations and • cash flows of a component. • there is no significant continuing involvement in that component. • Amount reported “net of tax.” LO 4 Explain how to report irregular items.

  19. Reporting Discontinued Operations Discontinued Operations are reported after “Income from continuing operations.” Net of Tax LO 4 Explain how to report irregular items.

  20. Reporting Extraordinary Items Extraordinary items are nonrecurring material items that differ significantly from a company’s typical business activities. Extraordinary Item must be both of an • Unusual Nature and • Occur Infrequently Company must consider the environment in which it operates. Amount reported “net of tax.” LO 4 Explain how to report irregular items.

  21. Reporting Extraordinary Items Are these items Extraordinary? (a) A large portion of a tobacco manufacturer’s crops are destroyed by a hail storm. Severe damage from hail storms in the locality where the manufacturer grows tobacco is rare. • A citrus grower's Florida crop is damaged by frost. • A large diversified company sells a block of shares from its portfolio of securities which it has acquired for investment purposes. This is the first sale from its portfolio of securities. YES NO NO LO 4 Explain how to report irregular items.

  22. Reporting Extraordinary Items Are these items Extraordinary? (d) An earthquake destroys one of the oil refineries owned by a large multi-national oil company. Earthquakes are rare in this geographical location. (e) A company experiences a material loss in the repurchase of a large bond issue that has been outstanding for 3 years. The company regularly repurchases bonds of this nature. YES NO LO 4 Explain how to report irregular items.

  23. Reporting Extraordinary Items Extraordinary Items are reported after “Income from continuing operations” Net of Tax LO 4 Explain how to report irregular items.

  24. Reporting Irregular Items Reporting when both Discontinued Operations and Extraordinary Items are present. Discontinued Operations Extraordinary Item LO 4 Explain how to report irregular items.

  25. Financial Ratios to Remember *Gross Profit Margin % *Profit Margin %

  26. Analysis of Profitability Of particular interest to current and potential investors Gross Profit % Profit Margin %

  27. JC Penney, Inc. Statement of OperationsIn Millions For the Years Ended January 30, 20132012

  28. Gross Profit (Margin) % = Gross Profit Sales (How many cents on every $ of sales are left over after covering the cost of the product) JC Penney, Inc. - Profitability (in Millions) 2013 2012 2011 Net sales $11,859 $12,985 $17,260 Cost of sales 8,367 8,91911,042 Gross profit $ 3,492 $ 4,006 $ 6,218 Gross profit % = 29% 31% 36%

  29. Profit Margin % = Net Income Sales (How many cents on every $ of sales are left over after covering all expenses) JC Penney, Inc. - Profitability (in Millions) 2013 2012 2011 Net sales $ 11,859 $12,985 $17,260 Net income $ (1,388) $ (985) $ (152) Profit margin % = - 11.7% - 7.6% -0.9%

  30. Earnings Per Share

  31. Earnings Per Share Calculation Net income - Preferred dividends Weighted average number of shares outstanding • An important business indicator. • Measures the dollars earned by each share of common stock. • Must be disclosed on the the income statement. LO 6 Identify where to report earnings per share information.

  32. Earnings Per Share Brief Exercise 4-8 In 2014, Kirby Puckett Corporation reported net income of $1,200,000. It declared and paid preferred stock dividends of $250,000. During 2014, Puckett had a weighted average of 190,000 common shares outstanding. Compute Puckett’s 2014 earnings per share. Net income - Preferred dividends Weighted average number of shares outstanding $1,200,000 - $250,000 = $5.00 per share 190,000 LO 6 Identify where to report earnings per share information.

  33. Earnings Per Share Craig Rusch Corporation reports the following information: Net income $500,000 Dividends on common stock 140,000 Dividends on preferred stock 60,000 Weighted average common shares outstanding 100,000 Rusch should report earnings per share of a. $3.00. b. $3.60 c. $4.40. d. $5.00.

  34. Statement of Retained Earnings And Prior Period Adjustments

  35. Prior Period Adjustments • Adjustments to the Beginning Balance of Retained Earnings to correct accumulated earnings reported from prior years. • Prior Period Adjustments may be reported to adjust for • Changes in Accounting Principle • Corrections of Errors LO 4 Explain how to report irregular items.

  36. Retained Earnings Statement Before issuing the report for the year ended December 31, 2014, you discover a $50,000 error (net of tax) that caused the 2013 inventory to be overstated (overstated inventory caused COGS to be lower and thus net income to be higher in 2013). Would this discovery have any impact on the reporting of the Statement of Retained Earnings for 2014? LO 7 Prepare a retained earnings statement.

  37. Retained Earnings Statement LO 7 Prepare a retained earnings statement.

  38. Retained Earnings Statement XMax Corporation reports the following information: • Overstatement of Depreciation Expense in prior years, net of tax $ 260,000 • Dividends declared 300,000 • Net income 1,500,000 • Retained earnings, 1/1/14, as reported 2,400,000 XMax should report beginning retained earnings, 1/1/14, as adjusted at a. $2,140,000. b. $2,400,000. c. $3,860,000. d. $2,660,000.

  39. Comprehensive Income

  40. Comprehensive Income All changes in equity during a period except those resulting from investments by owners and distributions to owners. Other Comprehensive Income + • Unrealized gains and losses on available-for-sale securities. • Translation gains and losses on foreign currency. • Minimum Pension Liability Adjustments. Reported in Stockholders’ Equity LO 8 Explain how to report other comprehensive income.

  41. Comprehensive Income Review Gains and losses that bypass net income but affect stockholders' equity are referred to as a. comprehensive income. b. other comprehensive income. c. prior period income. d. unusual gains and losses. LO 8 Explain how to report other comprehensive income.

  42. Comprehensive Income Three approaches to reporting Comprehensive Income (SFAS No. 130, June 1997): • A second separate income statement; • A combined income statement of comprehensive income; or • As part of the statement of stockholders’ equity LO 8 Explain how to report other comprehensive income.

  43. Comprehensive Income Illustration 4-19 Two-Statement Format for Comprehensive Income LO 8 Explain how to report other comprehensive income.

  44. Comprehensive Income Combined Income Statement LO 8 Explain how to report other comprehensive income.

  45. Comprehensive Income Statement of Stockholders’ Equity (most common) Illustration 4-20 LO 8 Explain how to report other comprehensive income.

  46. Comprehensive Income Balance Sheet Presentation Illustration 4-21 Regardless of the display format used, the accumulated other comprehensive income of $90,000 is reported in the stockholders’ equity section of the balance sheet. LO 8 Explain how to report other comprehensive income.

  47. Under iGAAP, companies must classify expenses by either nature or function. If a company uses the functional expense method on the income statement, disclosure by nature is required in the notes to the financial statements. • Presentation of the income statement under U.S. GAAP follows either a single-step or multiple-step format. iGAAP does not mention a single-step or multiple-step approach. In addition, under U.S. GAAP, companies must report an item as extraordinary if it is unusual in nature and infrequent in occurrence. Extraordinary items are prohibited under iGAAP.

  48. Under iGAAP, companies are required to prepare as a primary financial statement either a statement of stockholders’ equity similar to the one prepared under U.S. GAAP or a statement of recognized income and expense (called a SoRIE ). • Both iGAAP and U.S. GAAP have items that are recognized in equity as part of comprehensive income but do not affect net income. U.S. GAAP provides three possible formats for presenting this information. iGAAP allows either the statement of stockholders’ equity approach or the SoRIE format. • Under iGAAP revaluation of land, buildings, and intangible assets is permitted.