The Income Statement in Detail

1
The Income Statement in Detail

• MIM 517
• Fall 2009
• Class 3

2
Learning Objectives

• Exposure to real income statement complexity
• Overview of more complex line items
• Introduction to earnings management
• Understand definition of Other Comprehensive
  Income and distinguish from Net Income

3
U.S. Income Statement

• Sales
• - Cost of Goods Sold
• Gross Profit on Sales
• - Selling General and Admin. Expenses
• - Research Development Expenses
• - Restructuring Charges
• Operating Income (EBIT)
• (-) Other income (expenses)
• Interest and dividend income
• - Interest expense
• Income in equity investees
• Income before taxes, disc ops extraordinary
  items
• - Income tax
• Net income before disc ops extraordinary
  items
• (-) Discontinued operations, net of tax
• (-) Extraordinary gain (loss), net of tax
• - Net income attributable to the
  non-controlling interest
• Net income

4
Requirement for I/S Format

• U.S.
• SEC Registrants certain prescribed format and
  minimum disclosure items
• Non-registrants limited guidance
• Income expense must be broken out separately
  and not offset
• IRFS
• Certain items must be presented on the face of
  the income statement
• Offset of income and expense not allowed

5
Revenue Recognition

• Criteria US and IFRS
• Earned The earnings process must be complete and
  the value of the transaction can be measured.
• Realization The revenue must have been collected
  OR there must be some assurance that it will be
  collected.
• Sticky situation examples
• Bundled sales (Dell)
• Multi-year deliverables
• Gift cards (Starbucks)

6
Cost of Goods Sold (COGS)

• What is the relationship between COGS and
  inventory?
• How is product cost determined?
• Allowable methods
• U.S. FIFO, LIFO, Average
• IFRS FIFO, Average
• What goes into product cost?
• Retailer
• Wholesaler
• Manufacturer
• Service Provider

7
Operating Expenses

• What is included?
• U.S. and IFRS basically the same
• What is broken out individually?
• RD
• Items significant individually
• Where else can information be found on specific
  operating expenses?
• Footnotes
• Proxy Statement

8
Restructuring Charges (US)

• What are restructuring charges?
• Changes in structure, strategies or organization
  to boost future N/I.
• Includes employee severance, new systems
  development, product line elimination, losses
  related to asset impairments and disposals, and
  costs to consolidate or relocate operations.
• Reported as a separate line item within
  continuing operations.
• U.S. IRFS basically same treatment, some
  measurement difference
• Examples Kodak, Rubbermade, Alcoa
• Issues
• Why should these costs be broken out?
• Are companies using them to take a big bath
• What message are companies trying to send with
  restructuring charges?

9
Restructuring Charges (US)

• SEC Chairman Arthur Levitt gave a speech
  entitled, The Numbers Game. One of the accounting
  gimmicks that the Chairman cited in his speech
  was the abuse of restructuring charge accounting.
  He stated
• Let me first deal with "Big Bath" restructuring
  charges. Companies remain competitive by
  regularly assessing the efficiency and
  profitability of their operations. Problems
  arise, however, when we see large charges
  associated with companies restructuring. These
  charges help companies "clean up" their balance
  sheet giving them a so-called "big bath."
• Why are companies tempted to overstate these
  charges? When earnings take a major hit, the
  theory goes Wall Street will look beyond a
  one-time loss and focus only on future earnings.

10

• And if these charges are conservatively estimated
  with a little extra cushioning, that so-called
  conservative estimate is miraculously reborn as
  income when estimates change or future earnings
  fall short.
• When a company decides to restructure, management
  and employees, investors and creditors, customers
  and suppliers all want to understand the expected
  effects. We need, of course, to ensure that
  financial reporting provides this information.
  But this should not lead to flushing all the
  associated costs and maybe a little extra
  through the financial statements.

11
Restructuring Charges

• Consider Starbucks
• How much of a restructuring charge was recorded
  in 2008?
• What changes in the business are captured by
  these charges?

12
Income from ownership in other companies

• Cost Method
• Income takes form of dividends paid to company
• Recorded as interest and dividend income
• Gains (losses) from sales recorded separately
• Unrealized gains (losses) recorded where????
• Equity Method
• Income from subsidiary is separate line item
• Consolidated Method
• Revenues and expenses of subsidiary are added to
  the parent, then net income from non-controlling
  (minority) interest is subtracted out

13
Discontinued Operations

• Accounting treatment
• Distinct geographical or business segment
• Record separately from continuing operations upon
  decision
• Present separately
• Income/loss from discontinued operations
• Gain/loss on disposal of assets
• Net of tax presentation
• U.S. and IFRS substantially the same

14
Extraordinary Items

• U.S.
• Requirements
• Unusual in nature and
• infrequent in occurrence
• Presented net of tax
• IFRS
• Not allowed

15
Employee Stock and Benefit Plans

• Generally
• Used to motivate (and compensate) employees.
• Wide range of specific plans
• Accounting issues
• When does expense get recognized (if at all)
• What is disclosed in the financial statements?

16
Employee Stock and Benefit Plans - Definitions

• Stock option plans
• Granted the right to purchase stock at a set
  price at some point in the future. Price may be
  dramatically lower than the market price.
• May or may not be taxable to the grantee
• Co records as expense for stock option value over
  vesting period
• Determining value of stock option is tricky
• Employee stock purchase plan
• enables employees to purchase company's stock
  through payroll deduction, often at discount from
  market
• Co records expense for discount and discloses
  details of plan

17
Employee Stock and Benefit Plans - Definitions

• Restricted stock awards (RSA)
• A form of equity compensation whereby the company
  grants company stock.
• Recipient's rights in the stock are restricted
  until the shares vest.
• Co records expense for award and discloses
  details of plan
• Restricted stock units (RSU)
• A form of equity compensation whereby the co
  grants an amount valued in terms of company
  stock.
• Upon vesting, the co distributes either shares or
  the cash equivalent of the shares.
• Co records expense for award and discloses
  details of plan

18
Other Comprehensive Income

• What is it?
• What items are included?
• How should it be interpreted?
• Lets look at Starbucks