The Income Statement

1
The Income Statement

• Chapter 4

2
Usefulness

• Evaluate past performance
• Provide basis for predictions
• Assess uncertainty of future cash flows

3
Limitations

• Immeasurable items are left off
• Numbers reflect accounting principle choices
• Judgment involved in numerous estimates

4
Quality of Earnings

• Earnings management
• Big bath
• Indicators are in the Statement of Cash Flows

5
Income Statement Formats

• Single Step
• All grouped by element type
• Multiple Step
• Gross profit section
• Operating section
• Nonoperating section
• Tax on conitnuing operations
• Discontinued ops, extraordinary, principle change
• EPS

6
Level of Detail

• For internal purposes, more detail is shown
• For external purposes, can use a highly condensed
  version
• If too condensed, must have expanded sections in
  the notes
• Tremendous variety in practice

7
Discontinued Operations

• Criteria
• Results of operations of a component are being
  eliminated
• No significant involvement in the component after
  disposal
• Cash flows must be clearly distinguishable from
  remaining components
• Examples
• Spin off of a division
• Sale of a subsidiary
• Elimination of product group, but not particular
  brands

8
Reporting of Discontinued Operations

• Separate category in I.S. for gain or loss on
  disposal of segment
• Results of operations from discontinued
  operations also reported separately
• Both are reported net of tax to avoid confusion
  of normal tax items

9
Extraordinary Items

• Criteria
• Unusual in nature
• Infrequency of occurrence
• Environment in which it operates is crucial

• Exclusions
• Write-offs
• Discontinued operations
• Debt extinguishment g / l

• Currency exchange
• Effects of a strike
• September 11 and Hurricane Katrina

10
Reporting of Extraordinary Items

• Gain or Loss, net of tax, below discontinued
  operations

11
Restructuring Charges

• Major reorganization of company affairs
• Typical components
• Layoff costs
• Plant closing costs
• Write-off of assets
• Must be reported in other gains and losses
  section
• Not allowed to report them net of tax in separate
  section
• Still generally reported as separate line item

12
Changes in Accounting Principle

• Means changes in principles, not in estimates
• Retroactive adjustment is made
• Cumulative effect is shown as an adjustment to
  BEGINNING retained earnings
• Prior years statements are recast
• See page UP 39
• Not the same as restatement

13
Changes in Estimates

• Change is shown moving forward
• Merely changes calculations for current year,
  based on current information
• Examples
• Depreciation
• Bad debt expense
• No retroactive adjustment or change to retained
  earnings

14
Ordering of extra items

• Ordinary gains and losses, items that are unusual
  or infrequent but not both, all go after
  operations, before taxes
• Tax for ongoing operations
• Discontinued items, net of tax
• Extraordinary items, net of tax
• Net income
• EPS

15
Intraperiod Tax Allocation

• This is the idea of allocating tax to continuing,
  discontinued, and extraordinary lines
• Illustrations, page UP 41, are to show
  calculations
• In practice, shown as single line items, net of
  tax (tax amount in parentheses)
• Typo not shown for changes in accounting
  principle except in R/E statement

16
Earnings Per Share

• Basic calculation
• Net Income Preferred Dividends
• Weighted Avg shares of Common Stock
• EPS does not apply to preferred stock, so
  excluded from numerator and denominator
• EPS is calculated separately for each of the
  sections weve discussed
• Continuing
• Discontinued
• Extraordinary

17
Retained Earnings Statement

• Prior period adjustments come first, because they
  change beginning retained earnings
• Add net income
• Subtract net loss if any
• Subtract dividends if declared
• Any restrictions would be shown as division of
  ending balance

18
Example

• Balance, January 1, as reported XX
• Correction or retroactive adjustment for . . . XX
• Balance, January 1, adjusted XX
• Add Net Income XX
• Less Dividends (XX)
• Balance, December 31 XX

19
Comprehensive Income

• Includes items the FASB has taken off the income
  statement but that change a companys financial
  position
• Unrealized gains and losses on certain securities
• Foreign currency translation adjustments
• Pension related adjustments
• Hedging gains and losses
• Bypass the income statement to reduce volatility

20
Presentation options

• Second income statement
• One line for net income
• Other line(s) for comprehensive income item(s)
• Comprehensive income total
• No EPS
• Combined income statement
• Added after net income
• Still doesnt use EPS for comprehensive portion

21
Statement of Stockholders Equity

• Like a statement of retained earnings, but shows
  changes in all equity accounts
• If used, no retained earnings statement given
• Another option for comprehensive income reporting
• General format
• Beginning balances of each and total OE
• Changes in each and total
• Ending balances in each and total

22
Statement of SE and CI

• If SSE is used to report CI, there are two
  columns
• Comprehensive income (shows only changes)
• Accumulated comprehensive income (shows
  beginning, changes, and ending)
• Other columns for other SE accounts
• R/E
• Common Stock
• Additional PIC
• Preferred Stock
• Treasury Stock

23
Balance Sheet Presentation

• Owners Equity Section
• Usual stock related accounts
• Retained earnings
• Accumulated comprehensive income