The Corporate Income Statement and the Statement of Stockholders Equity

1
The Corporate Income Statement and the Statement
of Stockholders Equity

• Chapter 13

2
Importance of Net Income

• Expected changes in earning per share
• Expected return on equity

3
Quality of Earnings

• Substance of earnings
• Sustainability into future accounting period
• Affected by
• The accounting methods and estimates the
  companys management chooses
• The nature of nonoperating items on the income
  statement

4
Choice of Accounting Methods and estimates

• Examples
• Depreciation methods and estimates of long term
  assets
• Criteria for deciding revenue versus capital
  expenditures
• Methods for bond amortization
• Estimate of uncollectible A/R
• Estimate of expected environment cleanup costs

5
Choices

• Aging vs. Percentage of Net Sales
• LIFO, FIFO, Weighted Average, Specific
  identification
• Accelerated, production or straight-line
  depreciation method

6
Effects

• See spreadsheet demonstration on 595
• In general, an accounting method or estimate that
  results in lower current earnings is considered
  to produce a better quality of operating income

7
Full Disclosure

• Requires that management explain the significant
  accounting policies used in preparing the
  financial statements in a note to the statements

8
Nonoperating items

• Discontinued operations
• Extraordinary gains and losses
• Effects of accounting changes
• Examples
• Loss through restructuring charges
• Gain through one time gain (medical companies
  through bio-terrorism)

9
Comprehensive income

• The change in a companys equity during a period
  from sources other than owners and includes net
  income, change in unrealized investment gains and
  losses and other items affecting equity

10
Deferred income taxes

• Accounting income vs. taxable income
• Can be a material difference
• A simple example magazine subscriptions are not
  recognized in financial income until the product
  is shipped, but for tax purposes they are usually
  recognized as revenue when cash is received.
• The result is that taxes paid exceed tax expense,
  which creates a deferred income tax asset (or
  prepaid taxes)

11
Net of taxes

• Means that the effect of applicable taxes has
  been considered in determining the overall effect
  of an item on the financial statements

12
Extraordinary items

• events or transactions that are distinguished by
  their unusual nature and by the infrequency of
  their occurrence
• Examples
• A gain or loss resulting from the passage of a
  new law
• The expropriation of property by a foreign
  government

13
Accounting changes

• Need adequate justification
• The cumulative effect of an accounting change
  should be shown on the income statement
  immediately after extraordinary items.
• Relevant information about the change is shown in
  the notes to the financial statements

14
EPS

• Earning Per Share
• Basic earning per share is net income applicable
  to common stock divided by weighted-average
  number of common shares outstanding
• See demo on page. 603

15
Capital structure

• Simple
• No bonds, stocks, or stock options that could be
  converted into common stock
• Complex
• Convertible securities have the potential of
  diluting the earning per share of common stock.
• Diluted earning per share

16
The statement of stockholders equity

• Also called the statement of changes in
  stockholders equity
• Summarizes the changes in the components of the
  stockholders equity section of the balance sheet
• See page 605 Exhibit 2 and Exhibit 3

17
Retained earnings

• The part of stockholders equity that represents
  stockholders claims to assets arising from the
  earnings of the business
• Are not the assets themselves
• Means that assets as a whole have been increased
  since the date of its inception

18
Stock Dividends

• A proportional distribution of shares of a
  corporations stock to its shareholders.
• It does not change the firms assets and
  liabilities b/c there is no distribution of
  assets.
• The effect is to transfer a dollar amount from
  R/E to the CC section on the date of declaration
• The amount is the fair market value of the
  additional shares to be issued

19
Stock dividend

• See demo on 609
• That is, a comparison of the stockholders equity
  before dividend and after dividend

20
Stock split

• Occurs when a corporation increases the number of
  issued shares of stock and reduces the par of
  stated value proportionally.
• On page 610, see that before split and after
  split have the exact number on the right hand
  side but the par value has reduced to the same
  proportion.

21
Book Value

• The book value of a companys stock represents
  the total assets of the company less its
  liabilities.
• It is simply the stockholders equity of company,
  or
• The companys net assets

22
The calculation of book value

• The general rule is that the call value of the
  P/S plus any dividends in arrears is substracted
  from total stockholders equity to determine the
  equity pertaining to common stock.
• See demo on page 611