Title: Chapter 15 The Corporate Income Statement and the Statement of Stockholders Equity
1Chapter 15The Corporate Income Statement and
the Statement of Stockholders Equity
2LEARNING OBJECTIVES
- Identify the issues related to evaluating the
quality of a companys earnings. - Prepare a corporate income statement.
- Show the relationships among income taxes
expense, deferred income taxes, and net of taxes. - Describe the disclosure on the income statement
of discontinued operations, extraordinary items,
and accounting changes.
3 LEARNING OBJECTIVES (continued)
- Compute earnings per share.
- Prepare a statement of stockholders equity.
- Account for stock dividends and stock splits.
- Calculate book value per share.
4Performance MeasurementQuality of Earnings
Issues
- OBJECTIVE 1
- Identify the issues related to evaluating the
quality of a companys earnings.
5Quality of Earnings Issues
- Current and expected earnings are an important
factor to consider in evaluating a companys
performance and analyzing its prospects. - Because of the importance of net income (bottom
line), there is significant interest in
evaluating the quality of earnings.
6Quality of Earnings Issues
- Quality of earnings refers to the substance of
earnings and their sustainability into future
accounting periods and may be affected by
- Accounting methods and estimates chosen by
management. - The nature of non-operating items in the income
statement.
7Choice of Accounting Methods and Estimates
- Choices of accounting methods and estimates
affect a firms operating income. - The choice of estimates affects both current and
future operating income.
8Choice of Accounting Methods and Estimates
- Due to the considerable latitude in the choice of
estimates, management and other financial
statement users must be aware of the impact of
accounting estimates on reported operating
income. - The relative importance of each estimate depends
on the industry in which the firm operates.
9Effect of Accounting Methods and Estimates
- An accounting method or estimate that results in
lower current earnings produces a better quality
of operating income.
10Effect of Accounting Methods and Estimates
- 1. Full disclosure.
- Requires that management explain the significant
accounting policies used in preparing the
financial statements in a note to the statements. - 2. Consistency.
- Requires that the same accounting procedures be
followed from year to year.
11Nature of Non-operating Items
- The top of the income statement shows income from
continuing operations. - The lower part of the corporate income statement
can contain such non-operating items as
discontinued operations, extraordinary gains and
losses, and effects of accounting changes. - When analyzing financial statements, the analyst
must be careful to look beyond a bottom line
that may have been influenced by non-operating
items that are not expected to recur.
12The Corporate Income Statement
- OBJECTIVE 2
- Prepare a corporate income statement.
13Corporate Income Statement Issues
- Either single-step or multi step formats can be
used. - The accounting profession has taken the position
that income for a period should be all-inclusive
comprehensive income.
14Corporate Income Statement Issues
- Comprehensive income includes all revenues,
expenses, gains, and losses over the period,
except for prior period adjustments. - Several items must be added to the income
statement discontinued operations, extraordinary
items, accounting changes, earnings per share.
15Discussion
Q. Define the concept of comprehensive
income. A. Comprehensive income is the change in
a companys equity during a period from sources
other than owners and includes newt income,
change in unrealized investment gains or losses
and other items affecting equity.
16Income Taxes Expense
- OBJECTIVE 3
- Show the relationships among income taxes
expense, deferred income taxes, and net of taxes.
17Income Taxes Expense
- Income taxes expense is the expense recognized in
the accounting records on an accrual basis that
applies to income from continuing operations. - The amount payable is determined from taxable
income, measured according to the rules and
regulations of the income tax code.
18Income Taxes Expense
- Management has an incentive to use methods that
minimize the firms tax liability. - There can be a material difference between
accounting income and taxable income. - This discrepancy can result from differences in
the timing of the recognition of revenues and
expenses between GAAP and income tax accounting.
19Deferred Income Taxes
- The amount by which income taxes expense differs
from income taxes payable is reconciled in an
account called deferred income taxes.
20Deferred Income Taxes
- Income tax allocation is a technique used to
account for the difference between income taxes
expense based on accounting income and the actual
income taxes payable based on taxable income.
Dec. 31 Income Taxes Expense
144,500 Income Taxes Payable
92,000 Deferred Income Taxes 52,500
To record estimated current and
deferred income taxes
21Net of Taxes
- Net of taxes means the effect of applicable
taxes (usually income taxes) has been considered
in determining the overall effect of an item on
the financial statements. - The phrase is used when a company has items that
must be disclosed in a separate section. - Each such item should be reported net of the
applicable taxes.
22Discussion
Q. Accounting income should be geared to the
concept of taxable income because the public
understands that concept. Comment on this
statement, and tell why income tax allocation is
necessary.
23Discussion (continued)
A.
Accounting income and taxable income should
not be treated the same because they serve
different purposes. The purpose of accounting
income is to give some indication (however
imperfect) of the increase or decrease in the
businesss well-being the sole purpose of
taxable income is to provide a basis for the
collection of government revenues from the
taxpayer. Income tax allocation is necessary
because there are differences between accounting
and taxable income caused by the timing of
revenues and expenses.
24 Discontinued Operations,
Extraordinary Items, and
Accounting Changes
- OBJECTIVE 4
- Describe the disclosure on the income statement
of discontinued operations, extraordinary items,
and accounting changes.
25Discontinued Operations
- Discontinued operations are segments of a
business that are no longer part of its ongoing
operations. - GAAP require that gains or losses from
discontinued operations be reported separately on
the income statement.
26Extraordinary Items
- APB 30 defines extraordinary items as events or
transactions that are distinguished by their
unusual nature and by the infrequency of their
occurrence. - Extraordinary material items should be reported
separately from continuing operations on the
income statement.
27Extraordinary Items
- Extraordinary items include
- An uninsured loss from flood, earthquake, fire,
or theft. - Gain or loss from the passage of a new law.
- Taking of property by a foreign government.
- Gain or loss from an early retirement of debt.
28Accounting Changes
- Although a violation of the consistency
principle, a company is allowed to make
accounting changes if current procedures are
incorrect or inappropriate. - A change from LIFO to FIFO inventory method can
be made.
29Accounting Changes
- The cumulative effect of an accounting change is
the effect that the new accounting principle
would have had on net income in prior periods if
it had been applied instead of the old principle. - Accounting changes are shown on the income
statement immediately after extraordinary items.
30Earnings Per Share
- OBJECTIVE 5
- Compute earnings per share.
31Earnings per Share
- The APB concluded that earnings per share of
common stock should be presented on the face of
the income statement. - It is usually shown just below net income.
32Earnings per Share
- An EPS amount is always shown for
- Income from continuing operations.
- Income before extraordinary items and the
cumulative effect of accounting changes. - Net income.
- Gain or loss from discontinued operations or
extraordinary items.
33Earnings per Share
- It is necessary to determine if the number of
common shares changed, and if the company paid
preferred stock dividends during the year. - When a company has only common stock and has the
same number of shares outstanding throughout the
year, the EPS calculation is simple.
34Earnings per Share
- If the number of shares outstanding changes
during the year, it is necessary to figure the
weighted-average number of shares outstanding for
the year. - If a company has nonconvertible preferred stock
outstanding, its dividend must be subtracted from
net income before EPS for common stock is
computed.
35Complex Capital Structures
- Some companies have a complex capital structure
that may include exercisable stock options or
convertible stocks and bonds. - These convertible securities have the potential
of diluting the EPS of common stock.
36Complex Capital Structures
- Potential dilution means that a stockholders
proportionate share of ownership in a company
could be reduced by conversion, which would
increase the total shares outstanding.
37Complex Capital Structures
- A company with a complex capital structure must
report two earnings per share - Basic earnings per share.
- Diluted earnings per share.
- Diluted EPS is calculated by adding all potential
dilutive securities to the denominator of basic
EPS calculation.
38Discussion
Q. When does a company have a simple capital
structure? A complex capital structure? A. A
company has a simple capital structure when it
has only common stock or nonconvertible preferred
stock and no other securities that can be
converted into common stock. A complex capital
structure exists when there are additional
securities that can be converted to common stock.
39The Statement of Stockholders Equity
- OBJECTIVE 6
- Prepare a statement of stockholders equity.
40The Statement ofStockholders Equity
- The statement of stockholders equity summarizes
the changes in the components of the
stockholders equity section of the balance
sheet. - It is used because it reveals much more about the
years stockholders equity transactions than the
statement of retained earnings.
41Retained Earnings
- Retained earnings are the part of stockholders
equity that represents claims to assets arising
from the earnings of the business. - Retained earnings are not the assets themselves.
- The existence of retained earnings means that
assets generated by profitable operations have
been kept in the business.
42Retained Earnings Balances
- A credit balance does not mean that cash or
designated assets have been set aside. - A debit balance in retained earnings represents a
deficit.
43Restrictions onRetained Earnings
- A corporation may be required to or may want to
restrict all or part of its retained earnings. - A restriction means that dividends can be
declared only to the extent of unrestricted
retained earnings.
44Restrictions onRetained Earnings
- Reasons for restricting retained earnings
include - A contractual agreement.
- State law.
- Voluntary action by the board of directors.
45Restrictions onRetained Earnings
- A restriction does not change the total retained
earnings or stockholders equity of the company. - It simply divides retained earnings into
restricted and unrestricted. - The most common way to disclose restricted
retained earnings is by reference to a note to
the financial statements.
46Stock Dividends andStock Splits
- OBJECTIVE 7
- Account for stock dividends and stock splits.
47Stock Dividends
- A stock dividend is a proportional distribution
of shares of a corporations stock to its
shareholders. - It represents no change in the firms assets and
liabilities because no assets are distributed as
when a cash dividend is paid.
48Reasons for Declaringa Stock Dividend
- A board of directors may declare a stock dividend
for several reasons - To give stockholders some evidence of the
companys success without paying a cash dividend. - To reduce the stocks market price by increasing
the number of shares outstanding. - To make a nontaxable distribution to
stockholders. - To increase the companys permanent capital.
49Accounting for Stock Dividends
- The effect of a stock dividend is to transfer a
dollar amount from retained earnings to the
contributed capital section on the date of
declaration. - The amount transferred is the FMV (usually market
price) of the additional shares to be issued.
50- Entries to record the declaration and
distribution of the stock dividend are - Feb. 24 Stock Dividends Declared
60,000 - Common Stock Distributable 15,000
- Paid-in Capital in Excess of Par
- Value, Common 45,000
- Declared a 10 stock dividend
- on common stock
- Mar. 15 Date of Record no entry required.
51- (continued)
- Entries to record the declaration and
distribution of the stock dividend are - Mar. 31 Common Stock Distributable 15,000
- Common Stock 15,000
- Distributed stock
- dividend of 3,000 shares
- Stock Dividends Declared account is closed out to
Retained Earnings at the end of the accounting
period. - The effect of the stock dividend is to
- Permanently transfer the market value of the
stock, 60,000, from retained earnings to
contributed capital. - Increase the number of shares outstanding by
3,000. - Common Stock Distributable is not a liability
account because there is no obligation to
distribute assets.
52Stockholders EquityBefore and After Stock
Dividends
- BEFORE AFTER
- Common Stock 150,000 165,000
- Paid-in Capital in Excess of
- Par Value, Common 30,000 75,000
- Total Contributed Capital 180,000
240,000 - Retained Earnings 900,000
840,000 - Total Stockholders Equity 1,080,000
1,080,000 - Shares Outstanding 30,000 33,000
- Stockholders Equity per Share 36.00 32.73
53Stockholders InvestmentBefore and After Stock
Dividends
- BEFORE AFTER
- Shares owned (individual) 1,000 1,100
- Shares outstanding 30,000 33,000
- Percentage of ownership 3 1/3 3 1/3
- Proportionate investment
- (1,080,000 x .03 1/3) 36,000 36,000
- Before and after the stock dividend, the
stockholder owns 3 1/3 of the company. - All stock dividends have an effect on the market
price. Some are so large that they have a
material effect. - A large stock dividend (gt 20-25) should be
accounted for by a transfer of the par or stated
value of the stock on the date of
declaration from Retained Earnings to
Contributed Capital.
54Stock Splits
- A stock split occurs when a corporation increases
the number of issued shares of stock and reduces
the par or stated value proportionally. - This may be done when a company wants to lower
the stocks market value per share of stock and
increase its liquidity, since a high market price
hinders marketability. - A stock split does not increase the number of
shares authorized.
55Before Stock Split
- Contributed Capital
- Common Stock, 5 par value,
- 100,000 shares authorized,
- 30,000 shares issued and
- outstanding 150,000
- Paid-in Capital in Excess of
- Par Value, Common 30,000
- Total Contributed Capital 180,000
- Retained Earnings 900,000
- Total Stockholders Equity 1,080,000
56After Stock Split
- Contributed Capital
- Common Stock, 2.50 par value,
- 100,000 shares authorized,
- 60,000 shares issued and
- outstanding 150,000
- Paid-in Capital in Excess of
- Par Value, Common 30,000
- Total Contributed Capital 180,000
- Retained Earnings 900,000
- Total Stockholders Equity 1,080,000
57Stock Splits
- No journal entry is necessary, but a memorandum
entry in the general journal, identifying the
change in shares is issued and par value is made.
- After a stock split, equity per share is cut in
half. - However, the shareholders proportionate interest
in the company remains the same. - If the number of split shares exceeds the number
of authorized shares, the board of directors must
secure state and stockholders approval before
additional shares can be issued.
58Discussion
- Q. What is the difference between a stock
dividend and a stock split?
59A.
Discussion (continued)
- A stock dividend is a distribution of shares
to stockholders that involves a transfer from
retained earnings to contributed capital. A stock
split involves an increase in the number of
shares outstanding and a proportional decrease in
par or stated value, but it has no effect on the
balances in the stockholders equity accounts.
60Book Value
- OBJECTIVE 8
- Calculate book value per share.
61Book Value
- The book value of a companys stock represents
the total assets of the company less its
liabilities.
62Book Value per Share
- Book value per share represents the equity of the
owner of one share of stock in the net assets of
the corporation. - Book value per share does not necessarily equal
the amount the shareholder would receive if the
company were sold or liquidated.
63Book Value per Share
- Book value per share (common stock only) equals
- Total Stockholders Equity Shares
Outstanding - If a company has both preferred and common stock,
the determination of book value per share is more
complex.