ACCT550 CH 4 Summary For Students

CHAPTER 4
Income Statement and Related Information

LEARNING OBJECTIVES
1.
2.
3.
4.
5.
6.
7.
8.
Understand the uses and limitations of an income statement.

Describe the content and format of the income statement.
Prepare an income statement.
Explain how to report various income items.
Explain where to report earnings per share information
Understand the reporting of accounting changes and errors.
Prepare a retained earnings statement.
Explain how to report other comprehensive income.
Copyright 2013 John Wiley & Sons, Inc. K i eso, Intermediate Accounting, 15/e Instructors Manual ( For Instructor Use Only)
4-1
CHAPTER REVIEW
1. Chapter 4 presents a detailed discussion of the concepts and techniques that underlie the
preparation of the income statement and retained earnings statement and the reporting of
other comprehensive income. The requirements for adequate presentation of reported net
income are described and illustrated throughout the chapter.
2. (L.O. 1) The income statement helps users of financial statements (1) evaluate the past
performance of the company, (2) provide a basis for predicting future performance, and
(3) help assess the risk or uncertainty of achieving future cash flows. The limitations of
the income statement include (1) companies omit items from the income statement that
they cannot measure, (2) income numbers are affected by the accounting methods
employed, and (3) income measurement involves judgment.
3. Quality of earnings is important because markets are based on trust and it is imperative
that investors have faith in the numbers reported. If that trust is damaged, capital markets
will be damaged.
Elements of the Income Statement
4. (L.O. 2) The major elements of net income are: revenues, expenses, gains, and losses.
The distinction between revenues and gains and the distinction between expenses and
losses depend to a great extent on the typical activities of a business enterprise. When
inflows or enhancements of assets result from typical business activities (generally the
activities the entity is in business to perform), revenues result. Likewise, outflows or the
using up of assets resulting from typical business activities will generate expenses.
Nontypical business activities resulting in inflows or outflows of assets will normally
generate transactions classified as gains or losses.
Income Statement Formats
5. (L.O. 3) The income statement may be presented in the single-step format or the
multiple-step format. Single-step income statements derive their name from the fact that
total costs and expenses are subtracted from total revenues in a single step to arrive at net
income. Income taxes are normally shown as a separate item among the expenses (usually
last) to indicate their relationship to income before taxes. The multiple-step format separates
results achieved by regular operations of the entity from those obtained by nonoperating
activities. Expenses are also classified by function such as cost of sales, selling, and
administrative. The multiple-step format provides more information to financial statement
users than does the single-step format; however, both are found in actual practice.
6. An income statement is composed of various sections that relate to different aspects of
the earning process. The seven sections identified in the chapter, in the general order of
their appearance in the income statement, are:
(1) Operating Section.Revenues and expenses from the entitys principal operations.
a. Sales or revenue section.
b. Cost of goods sold section.
c. Selling expenses.
d. Administrative or general expenses.
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(2) Nonoperating Section.Revenues and expenses resulting from secondary or auxiliary

activities of the company.
a. Other revenues and gains.
b. Other expenses and losses.
(3) Income Tax.All taxes levied on income from continuing operations.
(4) Discontinued Operations.Material gains and losses resulting from disposal of
a segment of the business.
(5) Extraordinary Items.Unusual and infrequent material gains and losses.
(6) Noncontrollable Interest.
(7) Earnings per Share.
7. Condensed income statements. Includes only totals of expense groups. Supplementary
schedules support the totals.
Reporting Various Income Items
8. (L.O. 4) For the most part, accountants tend to agree on the composition of items included
on the income statement. However, certain unusual items (irregular gains/losses) have
stirred controversy in regard to the effect they should have on the presentation of net
income. Some accountants favor reporting the unusual items directly in the income
statement. Those who support the current operating performance concept to income
measurement believe that the unusual items should be closed directly to retained
earnings (not included in computing net income). The accounting profession adopted a
modified all-inclusive concept and requires application of this approach in practice.
9. In an attempt to provide financial statement users with the ability to better determine the
long-range earning power of an enterprise, certain professional pronouncements require
that the following irregular items be highlighted in the financial statements.
a. Discontinued operations.
b. Extraordinary items.
c. Unusual gains and losses.
d. Changes in estimates.
e. Corrections of errors.
4-3
Unusual Gains and Losses

10. Material gains and losses that are either unusual or occur infrequently, but not both, are
excluded from the extraordinary item classification. These items are presented with the
normal, recurring revenues, costs, and expenses. If material, these items are disclosed
separately; if immaterial, they may be combined with other items in the income statement.
Discontinued Operations
11. A discontinued operation occurs when (a) a company eliminates the results of
operations of a component of the business, and (b) there is no significant continuing
involvement in that component after the disposal transaction. When an entity decides to
dispose of a component of its business, certain classification and disclosure requirements
must be met. A separate income statement category for gain or loss from disposal of a
component of a business must be provided. In addition, the results of operations of a
component that has been or will be disposed of are also reported separately from
continuing operations.
Intraperiod Tax Allocation
12. Intraperiod tax allocation is the process of relating the income tax effect of an unusual
item to that item when it appears on the income statement. Income tax expense related to
continuing operations is shown on the income statement at its appropriately computed
amount. All other items included in the determination of net income should be shown net
of their related tax effect. The tax amount may be disclosed in the income statement or in
a footnote.
Extraordinary Items
13. Extraordinary items are defined as material items that are unusual in nature and occur
infrequently. Both characteristics must exist for an item to be classified as an
extraordinary item on the income statement. Only rarely does an event or transaction
clearly meet both criteria and thus give rise to an extraordinary gain or loss. If an event or
transaction meets both tests, it is shown net of taxes in a separate section of the income
statement usually just above net income.
Noncontrolling Interest
14. Noncontrolling interest is the portion of equity (net assets) interest in a subsidiary not
attributable to the parent company.
4-4
Earnings per Share

15. (L.O. 5) In general, earnings per share represents the ratio of net income minus preferred
dividends (income available to common shareholders) divided by the weighted average
number of common shares outstanding. It is considered by many financial statement users
to be the most significant statistic presented in the financial statements, and must be
disclosed on the face of the income statement. Per share amounts for gain or loss on
discontinued operations and gain or loss on extraordinary items must be disclosed on the
face of the income statement or in the notes to the financial statements.
Changes in Accounting Principles
16. (L.O. 6) A change in accounting principle results when a company adopts a new
accounting principle that is different from the one previously used. A company recognizes a
change in accounting principle by making a retrospective adjustment to the financial
statements. Such an adjustment recasts the prior years statements on a basis consistent
with the newly adopted principle. The company records the cumulative effect of the change
for prior periods as an adjustment to beginning retained earnings of the earliest year
presented.
Changes in Estimates
17. Accountants make extensive use of estimates in preparing financial statements. Adjustments
that grow out of the use of estimates in accounting are used in the determination of
income for the current period and future periods and are not charged or credited directly
to Retained Earnings. It should be noted that changes in estimates are not considered
errors (prior period adjustments) nor extraordinary items.
Corrections of Errors
18. Companies must correct errors by making proper entries in the accounts and reporting
corrections in the financial statements. Corrections of errors are treated as prior period
adjustments, similar to changes in accounting principles. Companies record an error in
the year in which it is discovered. They report the effect of the error as an adjustment to
the beginning balance of retained earnings. If a company prepares comparative financial
statements, it should restate the prior statements for the effects of the error.
Retained Earnings
19. (L.O. 7) The retained earnings statement serves to reconcile the balance of the retained
earnings account from the beginning to the end of the year. The important information
communicated by the retained earnings statement includes: (a) prior period adjustments
(income or loss related to corrections of errors in the financial statements of a prior period
net of tax), (b) changes in accounting principle, (c) the relationship of dividend distributions
to net income for the period, and (d) any transfers to and from retained earnings.
4-5
Comprehensive Income
20. (L.O. 8) Items that bypass the income statement are included under the concept of
comprehensive income. Comprehensive income includes all changes in equity during
a period except those resulting from investments by owners and distributions to owners.
21. The FASB requires that the components of other comprehensive income must be
displayed in one of two ways: (1) a one statement approach, or (2) a two statement
approach. In the one statement approach, the traditional net income is a subtotal, with
total comprehensive income shown as a final total. The combined statement has the
advantage of not requiring the creation of a new financial statement. The two statement
format reports comprehensive income in a separate statement, which indicates that the
gains and losses identified as other comprehensive income have the same status as
traditional gains and losses.
Statement of Stockholders Equity
22. This statement reports the changes in each stockholders equity account and in total
stockholders equity during the year. Both contributions (issuances of shares) and
distributions (dividends) to owners, and a reconciliation of the carrying amount of each
component of stockholders equity from the beginning to the end of the period are
disclosed in the statement.
*Q. (L.O. 9) IFRS Insights. As in GAAP, the income statement is a required statement for
IFRS. In addition, the content and presentation of an IFRS income statement is similar to
the one used for GAAP.
1.
IAS 1, Presentation of Financial Statements, provides general guidelines for the

reporting of income statement information. Subsequently, a number of international
standards have been issued that provide additional guidance to issues related to
income statement presentation.
2. Relevant Facts.
a. Similarities.
4-6
(1)
Both GAAP and IFRS require companies to indicate the amount of net
income attributable to noncontrolling interest.
(2)
Both GAAP and IFRS follow the same presentation guidelines for
discontinued operations, but IFRS defines a discontinued operation more
narrowly.
(3)
Both GAAP and IFRS have items that are recognized in equity as part of
comprehensive income but do not affect net income. Both GAAP and IFRS
allow a separate statement of comprehensive income or a combined
statement.
b. Differences.
(1)
Presentation of the income statement under GAAP follows either a singlestep or multiple-step format. IFRS does not mention a single-step or multiplestep approach. Under GAAP, companies must report an item as extraordinary
if it is unusual in nature and infrequent in occurrence. Extraordinary items are
prohibited under IFRS.
(2)
Under IFRS, companies must classify expenses by either nature or function.

GAAP does not have that requirement, but the SEC requires a functional
presentation.
(3)
IFRS identifies certain minimum items that should be presented on the

income statement. GAAP has no minimum information requirements.
However, the SEC rules have more rigorous presentation requirements.
(4)
IFRS does not define key measures like income from operations. SEC
regulations define many key measures and provide requirements and
limitations on companies reporting non-GAAP/IFRS information.
(5)
Under IFRS, revaluation of property, plant, and equipment, and intangible

assets is permitted and is reported as other comprehensive income. The
effect of this difference is that application of IFRS results in more transactions
affecting equity but not net income.
4-7
ILLUSTRATION 4-1
SINGLE-STEP INCOME STATEMENT
4-8
ILLUSTRATION 4-2
MULTIPLE-STEP INCOME STATEMENT
4-9
ILLUSTRATION 4-3
REPORTING SPECIAL ITEMS
4-10
ILLUSTRATION 4-4
SUMMARY OF IRREGULAR ITEMS
4-11
ILLUSTRATION 4-5
SUMMARY OF ACCOUNTING CHANGES AND ERRORS
4-12
ILLUSTRATION 4-6
REPORTING ACCUMULATED OTHER COMPREHENSIVE INCOME
(a) One Statement Approach
ABC Company
Statement of Comprehensive Income
For the Year Ended December 31, 2014
Sales revenue
Cost of goods sold
Gross profit
Operating expenses
Net income
Other comprehensive income
Unrealized holding gain (loss), net of taxes
Comprehensive income
$ xx
xx
xx
xx
xx
xx
$ xx
(b) Two Statement Approach

ABC Company
Income Statement
Sales revenue
Cost of goods sold
Gross profit
Operating expenses
Net income
ABC Company
Comprehensive Income Statement
Net income
Other comprehensive income
Unrealized holding gain (loss), net of taxes
Comprehensive income
$ xx
xx
xx
xx
$ xx
xx
xx
$ xx
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ILLUSTRATION 4-7
STOCKHOLDERS EQUITY STATEMENT
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CHAPTER 4

Income Statement and Related Information

Understand the uses and limitations of an income statement.

(2) Nonoperating Section.Revenues and expenses resulting from secondary or auxiliary

Unusual Gains and Losses

Earnings per Share

IAS 1, Presentation of Financial Statements, provides general guidelines for the

Under IFRS, companies must classify expenses by either nature or function.

IFRS identifies certain minimum items that should be presented on the

Under IFRS, revaluation of property, plant, and equipment, and intangible

(b) Two Statement Approach

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