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Accounting Chapter 4 "Income Statement"

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- report that measures the success of company operations for a given period of time

- provides investors/creditors with information to help predict the

1. amount

2. timing

3. uncertainty

of future cash flows

TAP THE ARROWS BELOW TO ADVANCE

Usefulness of Income Statement

1. Evaluate the past performance of the company

2. Provide a basis for predicting future performance

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

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Terms in this set (46)

Income Statement

- report that measures the success of company operations for a given period of time

- provides investors/creditors with information to help predict the

1. amount

2. timing

3. uncertainty

of future cash flows

Usefulness of Income Statement

1. Evaluate the past performance of the company

2. Provide a basis for predicting future performance

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

Limitations of Income Statement

1. Companies omit items from the I/S that they cannot measure reliably

2. Income numbers are affected by the accounting methods employed

3. Income measurement involves judgment

Quality of Earnings
can be negatively effected by...

1. earnings management - the planned timing of revenues, expenses, gains, and losses to smooth out
bumps in earnings

2. Managing earnings up - increase income in current year

3. Managing earnings down - increase expenses in current year

Transaction Approach (Elements of I/S)

- focuses on income-related activities that have occurred during the period

1. Revenues - activities of central operations

2. Expenses - activities of central operations

3. Gains - from peripheral transactions

4. Losses - from peripheral transactions

Multi-step Income Statement

1. Operating Section:

a. Sales/Revenue Section

b. Cost of Goods Sold Section

c. Selling Expenses

d. Administrative/General Expenses

2. Non-operating Section:

a. Other Revenues/Gains

b. Other Expenses/Losses

3. Income Tax

4. Discontinued Operations

5. Extraordinary Items

6. Noncontrolling Interest
7. Earnings Per Share

Format of Multi-Step I/S

Sales Revenue

Cost of Goods Sold

Gross Profit

Selling and Administrative Expense

Income from operations

Other income/expense

Income from continuing operations before tax

Income Tax

Income from continuing operations

Discontinued Operations (net of tax)

Extraordinary Items (net of tax)

Net Income

Earnings Per Share

Condensed Income Statement

- Company includes only the totals of expense groups in the statement of income

- Prepares supplementary schedules to support the totals

Single-Step Income Statement

Just two groupings: Revenues & Expenses

Advantages:

- simple presentation
- absence of any implication that one type of revenue/expense item has priority over another

Modified All-Inclusive Concept

- companies record most items, including unusual or irregular ones, as part of net income

- companies must highlight these items:

1. Unusual gains/losses

2. Discontinued Operations

3. Extraordinary Items

4. Non-controlling Interest

Unusual Gains/Losses

1. Losses on write-down or write-off of receivables, inventories, property, plant, and equipment, etc.

2. Gains/Losses from exchange or translation of foreign currencies

3. Restructuring charges

4. Other gains/losses from sale or abandonment of property, plant, or equipment used in the business

5. Effects of a strike

6. Adjustment of accruals on long-term contracts

Restructuring Charge (unusual loss)

-a major reorganization of company affairs

Discontinued Operations

1) a company eliminates the results of operations of a component of the business

2) there is no significant involvement in that component after the disposal transaction

Report gain or loss from...

1) disposal of a component of a business

2) results of operations of a component that has been or will be disposed of

Intra-period Tax Allocation

- "let the tax follow the income"

- relates income tax expense of the fiscal period to the specific items that give rise to the amount

- helps users better understand the impact of income taxes on various components of net income

What is Intraperiod Tax Allocation Used ON?

1. Income from continuing operations

2. Discontinued Operations

3. Extraordinary Items

Extraordinary Items

- Material items (nonrecurring)

- Unusual Nature

- Infrequency of Occurrence

Examples of Extraordinary Items

1) resulted directly from major casualty (natural disaster)

2. Expropriation (eminent domain)

3. Prohibition under a newly enacted law/regulation

- company must consider the environment in which it operates

Non-controlling Interest

- the portion of equity interest in a subsidiary not attributable to the parent company.

- recorded at bottom of income statement, after net income

Earnings Per Share

- net income - preferred dividends/ weighted average of common shares outstanding

- measures the number of dollars earned by each share of common stock (not the dollar amount paid to
stockholders through dividends)

- must be disclosed on the face of the I/S

EPS reported for

1) income from continuing operations

2) discontinued operations

3. extraordinary items

4. Net Income

Changes in Accounting Principles

- Adjustment to Retained Earnings! (net tax)

- includes change in method of inventory pricing (FIFO-LIFO-WA)

- must make retrospective adjustment to recast prior year's statements on basis consistent with new
principle

Changes in Accounting Estimates

- show change only in affected accounts (current and future)

- changes in the realizability of receivables and inventories

- changes in estimated lives of equipment, intangible assets

- changes in estimated liability for warranty costs, income taxes, salary payments

Correction of Errors (prior period adjustments)

- Adjustment to Retained Earnings! (net tax)

- error in reporting income/expenses

- treat as prior period adjustment

- restate prior years' income statements to correct for errors

- report error as adjustment to BB of retained earnings

Retained Earnings Statement

Beginning Balance:

Add/Less: Changes in Accounting Principles

Add/Less: Prior Period Adjustments (prior errors)

Adjusted Retained Earnings Balance

Add/Less: Net Income or Net Loss

Less: Dividends

Ending Balance:

Restriction/Appropriation of Retained Earnings

- companies often restrict earnings for money to use in certain planned operations

1) report retained earnings unrestricted

2) report retained earnings appropriated (restricted)

1+2 = total retained earnings

Other comprehensive income

- Fair-Value items excluded from Net Income

- Example: unrealized gains/losses on available for-sale securities

Comprehensive Income

- includes all changes in equity during a period EXCEPT from investments/distributions to owners

- include items (other comprehensive income) that bypass the income statement

Comprehensive Income = all revenues, gains, expenses, losses on Net Income and all gains and losses
that bypass Net Income but affect stockholder's equity

Reported:

1) One statement approach - Statement of Comprehensive Income

2) Two statement approach

Statement of Stockholder's Equity

1. Contributions and Distributions to owners

2. Reconciliation of the carrying amount of each component of stockholder's equity from the beg. to end
of period

- columnar form

- includes accumulated other comprehensive income

Balance Sheet Presentation

- reports accumulated other comprehensive income

Which of the following is an example of managing earnings down?

- Revising the estimated life of equipment from 10 years to 8 years

(Increasing expenses for the year)

An advantage of the single-step income statement over the multiple-step income statement

- The single-step income statement does not imply that one type of revenue or expense has priority over
another

What are the acceptable methods of presenting the income statement?

- A single-step income statement

- A multiple-step income statement

- A consolidated statement of income

Which of the following is not a selling expense?

a. advertising expense

b. office salaries expense (This is not a selling expense because it does not have to do with sales)

c. freight-out

d. store supplies consumed

In order to be classified as an extraordinary item in the income statement, an event or transaction

should be...

1. material in amount

2. unusual in nature

3. infrequent

What is an example of an extraordinary item:

- Gain resulting from the state exercising its right of eminent domain on a piece of land used as a parking
lot

An item that should be classified as an extraordinary item is....

- gains from a company selling the only investment it has ever owned
Which of the following is a change in accounting principle?

- A change from FIFO to LIFO and a change from straight-line to double-declining balance

A material item which is unusual in nature or infrequent in occurrence, but not both should be shown in
the income statement

- Not Net of Tax

- Disclosed Separately

Which of the following is true about intraperiod tax allocation

- It's purpose is to relate the income tax expense to the items which affect the amount of tax

Which of the following items would be reported net of tax on the face of the income statement?

a. prior period adjustment (net of tax on Statement of R/E)

b. unusual gain (not net of tax on I/S)

c. Cumulative effect of a change in an accounting principle (net of tax on R/E)

d. Discontinued Operations (YES! - net of tax on I/S)

Where must EPS be disclosed in the financial statements to satisfy generally accepted accounting
principles?

- on the face of the income statement

A correct of an error in prior period's income will be reported

- Net of tax

- On the Statement of Retained Earnings

Which one of the following types of losses is excluded from the determination of net income in income
statements?

- Material losses resulting from the correction of errors related to prior periods

A company is not required to report a per share amount on the face of the income statement for which
of the following items

a. Net Income

b. Prior Period Adjustment (YES - not on I/S)

c. Extraordinary item

d. Discontinued Operations

Which of the following is included in comprehensive income?

- unrealized gains on available-for-sale securities

Which disclosure method do most companies use to display the components of other comprehensive
income

- As part of the statement of stockholder's equity

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