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Intermediate Accounting

Chapter 4:

Income Statement and Related Information

Income Statement
Income Statement
Income Statement Usefulness  Evaluate past performance.  Predicting future performance.  Help assess the risk

Usefulness

Income Statement Usefulness  Evaluate past performance.  Predicting future performance.  Help assess the risk

Evaluate past performance.

Income Statement Usefulness  Evaluate past performance.  Predicting future performance.  Help assess the risk

Predicting future performance.

Help assess the risk or uncertainty of achieving future cash flows.

 Predicting future performance.  Help assess the risk or uncertainty of achieving future cash flows.
Income Statement
Income Statement
Income Statement Limitations  Companies omit items that cannot be measured reliably.  Income is affected

Limitations

Companies omit items that cannot be measured reliably.

 Companies omit items that cannot be measured reliably.  Income is affected by the accounting
 Companies omit items that cannot be measured reliably.  Income is affected by the accounting

Income is affected by the accounting

methods employed.

Income measurement involves judgment.

reliably.  Income is affected by the accounting methods employed.  Income measurement involves judgment. 4-3
Income Statement
Income Statement
Income Statement Quality of Earnings Companies have incentives to manage income to meet or beat Wall

Quality of Earnings

Companies have incentives to manage income to meet or beat Wall Street expectations, so that

market price of stock increases and

value of stock options increase.

Format of the Income Statement
Format of the Income Statement
Format of the Income Statement Elements of the Income Statement Revenues – Inflows or other enhancements

Elements of the Income Statement

Revenues Inflows or other enhancements of assets or settlements of its liabilities that constitute the entity’s ongoing major or central operations.

Examples of Revenue Accounts

Sales

Dividend revenue

Fee revenue

Rent revenue

Interest revenue

Format of the Income Statement
Format of the Income Statement
Format of the Income Statement Elements of the Income Statement Expenses – Outflows or other using-up

Elements of the Income Statement

Expenses Outflows or other using-up of assets or incurrences of liabilities that constitute the entity’s ongoing major or central operations.

Examples of Expense Accounts

Cost of goods sold

Rent expense

Depreciation

Salary expense

expense

Interest expense

Format of the Income Statement
Format of the Income Statement
Format of the Income Statement Elements of the Income Statement Gains – Increases in equity (net

Elements of the Income Statement

Gains Increases in equity (net assets) from peripheral or incidental transactions.

Losses - Decreases in equity (net assets) from peripheral or

incidental transactions.

Gains and losses can result from

sale of investments or plant assets,

settlement of liabilities,

write-offs of assets.

Single-Step Format Single-Step Income Statement Revenues Expenses Net Income Single- Step No distinction between

Single-Step Format

Single-Step Income

Statement

Single-Step Format Single-Step Income Statement Revenues Expenses Net Income Single- Step No distinction between

Revenues

Expenses

Net Income

Single-Step Income Statement Revenues Expenses Net Income Single- Step No distinction between Operating and

Single-

Step

No distinction between Operating and Non-operating categories.

Income Statement (in thousands)

Revenues:

Sales

$ 285,000

Interest revenue

17,000

Total revenue

302,000

Expenses:

Cost of goods sold

149,000

Selling expense

10,000

Administrative expense

43,000

Interest expense

21,000

Income tax expense

24,000

Total expenses

247,000

Net income

$

55,000

Earnings per share

$

0.75

tax expense 24,000 Total expenses 247,000 Net income $ 55,000 Earnings per share $ 0.75

E4-4: Prepare an income statement from the data below.

Administrative expense:

Single-Step Format
Single-Step Format

Income Statement

For the year ended Dec. 31, 2012

Revenues:

Officers' salaries

$

4,900

Sales

$

96,500

Depreciation

3,960

Rental revenue

17,230

Cost of goods sold

63,570

Total revenues

113,730

Rental revenue

17,230

Expenses:

Selling expense:

Cost of goods sold

63,570

Transportation-out

2,690

Selling expense

17,150

Sales commissions

7,980

Administrative exense

8,860

Depreciation

6,480

Interest expense

1,860

Sales

96,500

Income tax expense

7,580

Income tax expense

7,580

Total expenses

99,020

Interest expense

1,860

Net income

$

14,710

Format of the Income Statement
Format of the Income Statement
Format of the Income Statement Multiple-Step Income Statement  Separates operating transactions from nonoperating

Multiple-Step Income Statement

Separates operating transactions from nonoperating

transactions.

Matches costs and expenses with related revenues.

Highlights certain intermediate components of income that analysts use.

Multiple-Step Format
Multiple-Step Format
Multiple-Step Format Intermediate Components of the Income Statement 1. Operating section 2. Nonoperating

Intermediate Components of the Income Statement

1.

Operating section

2.

Nonoperating section

3.

Income tax

4.

Discontinued operations

5.

Extraordinary items

6.

Earnings per share

Multiple-Step Format The presentation divides information into major sections. 1. Operating Section 2. Nonoperating

Multiple-Step Format

The presentation

divides information

into major sections.

1. Operating Section

2. Nonoperating

Section

3. Income tax

1. Operating Section 2. Nonoperating Section 3. Income tax Income Statement (in thousands)   Sales $

Income Statement (in thousands)

 

Sales

$

285,000

Cost of goods sold

149,000

Gross profit

136,000

Operating expenses:

Selling expenses

10,000

Administrative expenses

43,000

Total operating expense

53,000

Income from operations

83,000

Other revenue (expense):

Interest revenue

17,000

Interest expense

(21,000)

Total other

(4,000)

Income before taxes

79,000

Income tax expense

24,000

Net income

$

55,000

Illustration (E4-4): Prepare an income statement from the data below.

Multiple-Step Format
Multiple-Step Format

Income Statement

For the year ended Dec. 31, 2012

Administrative expense:

Sales

$

96,500

Officers' salaries

$

4,900

Cost of goods sold

63,750

Depreciation

3,960

Gross profit

32,750

Cost of goods sold

63,750

Operating Expenses:

Rental revenue

17,230

Selling expense

17,150

Selling expense:

Administrative exense

8,860

Transportation-out

2,690

Total operating expenses

26,010

Sales commissions

7,980

Income from operations

6,740

Depreciation

6,480

Other revenue (expense):

Sales

96,500

Rental revenue

17,230

Income tax expense

7,580

Interest expense

(1,860)

Interest expense

1,860

Total other

15,370

 

Income before tax

22,110

Income tax expense

7,580

Net income

$

14,530

Reporting Irregular Items
Reporting Irregular Items
Reporting Irregular Items Irregular items fall into six categories 1. Discontinued operations. 2. Extraordinary

Irregular items fall into six categories

1.

Discontinued operations.

2.

Extraordinary items.

3.

Unusual gains and losses.

4.

Changes in accounting principle.

5.

Changes in estimates.

6.

Corrections of errors.

Reporting Irregular Items
Reporting Irregular Items
Reporting Irregular Items Discontinued Operations Occurs when, (a) company eliminates the  results of

Discontinued Operations

Occurs when,

(a)

company eliminates the

results of operations and

cash flows of a component.

(b)

there is no significant continuing involvement in that component.

Amount reported “net of tax.”

Reporting Discontinued Operations
Reporting Discontinued Operations
Reporting Discontinued Operations Illustration: KC Corporation had after tax income from continuing operations of

Illustration: KC Corporation had after tax income from continuing operations of $55,000,000 for the year. During the year, it disposed of its restaurant division at a pretax loss of $270,000. Prior to disposal, the division operated at a pretax loss of $450,000 for the year. Assume a tax rate of 30%. Prepare a partial income statement for KC.

Income from continuing operations Discontinued operations:

$55,000,000

Loss from operations, net of $135,000 tax Loss on disposal, net of $81,000 tax Total loss on discontinued operations

315,000

189,000

504,000

Net income

$54,496,000

Reporting Discontinued Operations
Reporting Discontinued Operations
Reporting Discontinued Operations Discontinued Operations are reported after “Income from continuing operations.”

Discontinued Operations are reported after “Income from continuing operations.”

Previously labeled as “Net Income”.

operations.” Previously labeled as “Net Income”. Moved to Income Statement (in thousands)   Sales

Moved to

Income Statement (in thousands)

 

Sales Cost of goods sold Gross profit

 

$ 285,000

149,000

136,000

Income Statement (in thousands)   Sales Cost of goods sold Gross profit   $ 285,000 149,000
Income Statement (in thousands)   Sales Cost of goods sold Gross profit   $ 285,000 149,000
Income Statement (in thousands)   Sales Cost of goods sold Gross profit   $ 285,000 149,000

Interest expense

Total other

Income before taxes

Income tax expense

Income from continuing operations

Discontinued operations:

Loss from operations, net of tax

Loss on disposal, net of tax

Total loss on discontinued operations

Net income

Loss from operations, net of tax Loss on disposal, net of tax Total loss on discontinued
Loss from operations, net of tax Loss on disposal, net of tax Total loss on discontinued
Reporting Irregular Items
Reporting Irregular Items
Reporting Irregular Items Extraordinary items are nonrecurring material items that differ significantly from a

Extraordinary items are nonrecurring material items that differ significantly from a company’s typical business activities.

Extraordinary Item must be both of an

Unusual Nature and

Occur Infrequently

Company must consider the environment in which it operates.

Amount reported “net of tax.”

Reporting Extraordinary Items
Reporting Extraordinary Items
Reporting Extraordinary Items Illustration: KC Corporation had after tax income from continuing operations of $55,000,000

Illustration: KC Corporation had after tax income from continuing

operations of $55,000,000 during the year. In addition, it suffered an unusual and infrequent pretax loss of $770,000 from a volcano eruption. The corporation’s tax rate is 30%. Prepare a partial income statement for KC Corporation beginning with income from

continuing operations.

Income from continuing operations Extraordinary loss, net of $231,000 tax

Net income

$55,000,000

539,000

$54,461,000

($770,000 x 30% = $231,000 tax)

Reporting Extraordinary Items
Reporting Extraordinary Items
Reporting Extraordinary Items Extraordinary Items are reported after “Income from continuing operations.” Previously

Extraordinary Items are reported after “Income from continuing operations.”

Previously labeled as “Net Income”.

Previously labeled as “Net Income”.

Previously labeled as “Net Income”.
Previously labeled as “Net Income”.
operations.” Previously labeled as “Net Income”. Moved to Income Statement (in thousands)   Sales
operations.” Previously labeled as “Net Income”. Moved to Income Statement (in thousands)   Sales

Moved to

Income Statement (in thousands)

 

Sales Cost of goods sold Gross profit

 

$ 285,000

149,000

136,000

Income Statement (in thousands)   Sales Cost of goods sold Gross profit   $ 285,000 149,000
Income Statement (in thousands)   Sales Cost of goods sold Gross profit   $ 285,000 149,000
Income Statement (in thousands)   Sales Cost of goods sold Gross profit   $ 285,000 149,000

Other revenue (expense):

Interest revenue

Interest expense

Total other

Income before taxes

Income tax expense

Income from continuing operations

Extraordinary loss, net of tax

Net income

17,000

(21,000)

tax expense Income from continuing operations Extraordinary loss, net of tax Net income 17,000 (21,000)
tax expense Income from continuing operations Extraordinary loss, net of tax Net income 17,000 (21,000)
Reporting Irregular Items
Reporting Irregular Items
Reporting Irregular Items Reporting when both Discontinued Operations and Extraordinary Items are present. Discontinued

Reporting when both

Discontinued

Operations and Extraordinary Items are present.

Discontinued

Operations

Extraordinary Items

Income Statement (in thousands)

 

Sales Cost of goods sold Gross profit

 

$ 285,000

149,000

136,000

Income Statement (in thousands)   Sales Cost of goods sold Gross profit   $ 285,000 149,000
Income Statement (in thousands)   Sales Cost of goods sold Gross profit   $ 285,000 149,000
Income Statement (in thousands)   Sales Cost of goods sold Gross profit   $ 285,000 149,000
Gross profit   $ 285,000 149,000 136,000 Income before taxes Income tax expense Income from

Income before taxes

Income tax expense

Income from continuing operations

Discontinued operations:

Loss from operations, net of tax

Loss on disposal, net of tax

Total loss on discontinued operations

Income before extraordinary item

Extraordinary loss, net of tax

Net income

Total loss on discontinued operations Income before extraordinary item Extraordinary loss, net of tax Net income
Total loss on discontinued operations Income before extraordinary item Extraordinary loss, net of tax Net income
Reporting Irregular Items
Reporting Irregular Items
Reporting Irregular Items Unusual Gains and Losses Material items that are unusual or infrequent , but

Unusual Gains and Losses

Material items that are unusual or infrequent, but not both, should be reported in a separate section just above “Income from continuing operations before income taxes.”

Examples can include:

Write-downs of inventories

Foreign exchange transaction gains and losses

The Board prohibits net-of-tax treatment for these items.

Reporting Irregular Items
Reporting Irregular Items
Reporting Irregular Items Unusual Gains and Losses Illustration 4-9 Income Statement Presentation of Unusual Charges 4-23

Unusual Gains and Losses

Illustration 4-9 Income Statement

Presentation of Unusual

Charges
Charges
Reporting Irregular Items
Reporting Irregular Items
Reporting Irregular Items Changes in Estimate  Accounted for in the period of change and future

Changes in Estimate

Accounted for in the period of change and future periods.

Not handled retrospectively.

Not considered errors or extraordinary items.

Examples include:

Useful lives and salvage values of depreciable assets.

Allowance for uncollectible receivables.

Inventory obsolescence.

Change in Estimate Example
Change in Estimate Example
Change in Estimate Example Change in Estimate: Arcadia HS, purchased equipment for $510,000 which was estimated

Change in Estimate: Arcadia HS, purchased equipment for $510,000 which was estimated to have a useful life of 10 years with a salvage value of $10,000 at the end of that time. Depreciation has been recorded for 7 years on a straight-line basis. In 2012 (year 8), it is determined that the total estimated life should be 15 years with a salvage value of $5,000 at the end of that time.

Questions:

Calculate the depreciation expense for 2012.

Change in Estimate Example After 7 years
Change in Estimate Example
After 7 years

Equipment cost Salvage value Depreciable base Useful life (original) Annual depreciation

$510,000

-

10,000

 

500,000

10 years

$ 50,000

- 10,000   500,000 10 years $ 50,000 First, establish NBV at date of change in
First, establish NBV at date of change in estimate.
First, establish NBV
at date of change in
estimate.

x 7 years = $350,000

Balance Sheet Fixed Assets:

Equipment

Accumulated depreciation

Net book value (NBV)

(Dec. 31, 2011)

$510,000

350,000

$160,000

Change in Estimate Example After 7 years
Change in Estimate Example
After 7 years

Net book value Salvage value (new) Depreciable base

Useful life remaining

Annual depreciation

$160,000

5,000

155,000

8 years

$ 19,375

Annual depreciation $160,000 5,000 155,000 8 years $ 19,375 Depreciation Expense calculation for 2012. Journal entry
Depreciation Expense calculation for 2012.
Depreciation
Expense calculation
for 2012.

Journal entry for 2012

Depreciation expense

19,375

Accumulated depreciation

19,375

Reporting Irregular Items
Reporting Irregular Items
Reporting Irregular Items Corrections of Errors  Result from: ► mathematical mistakes. ► mistakes in application

Corrections of Errors

Result from:

mathematical mistakes.

mistakes in application of accounting principles.

oversight or misuse of facts.

Corrections treated as prior period adjustments.

Adjustment to the beginning balance of retained earnings.

Reporting Irregular Items
Reporting Irregular Items
Reporting Irregular Items Corrections of Errors: To illustrate, in 2013, Hillsboro Co. determined that it incorrectly

Corrections of Errors: To illustrate, in 2013, Hillsboro Co. determined that it incorrectly overstated its accounts receivable and sales revenue by $100,000 in 2010. In 2013, Hillboro makes the following entry to correct for this error (ignore income taxes).

Retained earnings

Accounts receivable

100,000

100,000

Special Reporting Issues
Special Reporting Issues
Special Reporting Issues Intraperiod Tax Allocation Relates the income tax expense to the specific items that

Intraperiod Tax Allocation

Relates the income tax expense to the specific items that give rise to the amount of the tax expense.

Income tax is allocated to the following items:

(1)

Income from continuing operations before tax.

(2)

Discontinued operations.

(3)

Extraordinary items.

Special Reporting Issues
Special Reporting Issues
Special Reporting Issues Intraperiod Tax Allocation Extraordinary Gain: Schindler Co. has income before income tax and

Intraperiod Tax Allocation

Extraordinary Gain: Schindler Co. has income before income

tax and extraordinary item of $250,000. It has an extraordinary

gain of $100,000 from a condemnation settlement received on

one its properties. Assuming a 30 percent income tax rate.

Illustration 4-13

a condemnation settlement received on one its properties. Assuming a 30 percent income tax rate. Illustration
Special Reporting Issues
Special Reporting Issues
Special Reporting Issues Intraperiod Tax Allocation Extraordinary Loss: Schindler Co. has income before income tax and

Intraperiod Tax Allocation

Extraordinary Loss: Schindler Co. has income before income

tax and extraordinary item of $250,000. It has an extraordinary

loss from a major casualty of $100,000. Assuming a 30 percent

income tax rate.

Illustration 4-14

has an extraordinary loss from a major casualty of $100,000. Assuming a 30 percent income tax
Special Reporting Issues
Special Reporting Issues
Special Reporting Issues Earnings Per Share Net income - Preferred dividends Weighted average number of shares

Earnings Per Share

Net income - Preferred dividends

Weighted average number of shares outstanding

An important business indicator.

Measures the dollars earned by each share of common stock.

Must be disclosed on the the income statement.

Special Reporting Issues
Special Reporting Issues
Special Reporting Issues Earnings Per Share (BE4-8): In 2012, Hollis Corporation reported net income of $1,000,000.

Earnings Per Share (BE4-8): In 2012, Hollis Corporation

reported net income of $1,000,000. It declared and paid preferred stock dividends of $250,000. During 2012, Hollis had a weighted average of 190,000 common shares outstanding. Compute Hollis’s 2012 earnings per share.

Net income - Preferred dividends

Weighted average number of shares outstanding

$1,000,000

-

$250,000

190,000

= $3.95 per share

Special Reporting Issues Illustration 4-17 Divide by weighted- average shares outstanding EPS
Special Reporting Issues
Illustration 4-17
Divide by
weighted-
average
shares
outstanding
EPS
Special Reporting Issues Illustration 4-17 Divide by weighted- average shares outstanding EPS 4-35

4-35

Special Reporting Issues
Special Reporting Issues
Special Reporting Issues Retained Earnings Statement Increase  Net income  Change in accounting principle

Retained Earnings Statement

Increase

Net income

Change in accounting principle

Error corrections

Decrease

Net loss

Dividends

Change in accounting principles

Error corrections

Special Reporting Issues Woods, Inc. Statement of Retained Earnings For the Year Ended December 31,

Special Reporting Issues

Woods, Inc.

Statement of Retained Earnings

For the Year Ended December 31, 2012

Balance, January 1

$

1,050,000

Net income

360,000

Dividends

(300,000)

Balance, December 31

$

1,110,000

Before issuing the report for the year ended December 31, 2012, you

discover a $50,000 error (net of tax) that caused 2011 inventory to be

overstated (overstated inventory caused COGS to be lower and thus net income to be higher in 2011). Would this discovery have any impact on the reporting of the Statement of Retained Earnings for 2012?

Special Reporting Issues Woods, Inc. Statement of Retained Earnings For the Year Ended December 31,

Special Reporting Issues

Woods, Inc.

Statement of Retained Earnings

For the Year Ended December 31, 2012

Balance, January 1

$

1,050,000

Prior period adjustment - error correction

(50,000)

Balance, January 1 (restated)

1,000,000

Net income

360,000

Dividends

(300,000)

Balance, December 31

$

1,060,000

Special Reporting Issues
Special Reporting Issues
Special Reporting Issues Comprehensive Income All changes in equity during a period except those resulting from

Comprehensive Income

All changes in equity during a period except those resulting from investments by owners and distributions to owners.

Includes:

all revenues and gains, expenses and losses reported in net income, and

all gains and losses that bypass net income but affect stockholders’ equity.

Special Reporting Issues Comprehensive Income Income Statement (in thousands) Sales $ 285,000 Cost of goods

Special Reporting Issues

Comprehensive Income

Income Statement (in thousands) Sales $ 285,000 Cost of goods sold 149,000 Gross profit 136,000
Income Statement (in thousands)
Sales
$ 285,000
Cost of goods sold
149,000
Gross profit
136,000
Operating expenses:
Selling expenses
10,000
Administrative expenses
43,000
Total operating expense
53,000
Income from operations
83,000
Other revenue (expense):
Interest revenue
17,000
Interest expense
(21,000)
Total other
(4,000)
Income before taxes
79,000
Income tax expense
24,000
Net income
$
55,000

+

Other Comprehensive

Income

Unrealized gains and losses on available-for-

sale securities.

Translation gains and losses on foreign currency.

Plus others

Reported in Stockholders’ Equity

Special Reporting Issues
Special Reporting Issues
Special Reporting Issues Companies must display the components of other comprehensive income in one of three

Companies must display the components of other

comprehensive income in one of three ways:

1. A second separate income statement;

2. A combined income statement of comprehensive income; or

3. As part of the statement of stockholders’ equity

Special Reporting Issues
Special Reporting Issues
Special Reporting Issues Comprehensive Income Second income statement Illustration 4-19 4-42

Comprehensive

Income

Second income statement

Illustration 4-19
Illustration 4-19
Special Reporting Issues
Special Reporting Issues
Special Reporting Issues Comprehensive Income Combined statement V. Gill Inc. Combined Statement of Comprehensive Income

Comprehensive

Income

Combined

statement

V. Gill Inc.

Combined Statement of Comprehensive Income

For the Year Ended December 31, 2012

Sales revenue

Cost of goods sold

Gross profit

Operating expenses

Net income

Unrealized holding gain, net of tax

Comprehensive income

$

800,000

600,000

200,000

90,000

110,000

30,000

$

140,000

income Unrealized holding gain, net of tax Comprehensive income $ 800,000 600,000 200,000 90,000 110,000 30,000
Special Reporting Issues
Special Reporting Issues
Special Reporting Issues Comprehensive Income – Statement of Stockholder’s Equity Illustration 4-20 4-44

Comprehensive Income Statement of Stockholder’s Equity

Illustration 4-20
Illustration 4-20
Special Reporting Issues
Special Reporting Issues
Special Reporting Issues Comprehensive Income – Balance Sheet Presentation Illustration 4-21 Presentation of

Comprehensive Income Balance Sheet Presentation

Illustration 4-21 Presentation of Accumulated Other Comprehensive Income in the Balance Sheet

Accumulated Other Comprehensive Income in the Balance Sheet Regardless of the display format used, the accumulated

Regardless of the display format used, the accumulated other comprehensive income of $90,000 is reported in the stockholders’ equity section of the balance sheet.