Intermed Acc 1 PPT Ch04

Intermediate Accounting
4-1
Prepared by Coby Harmon University of California, Santa Barbara
Income Statement and Related Information
Intermediate Accounting 14th Edition
Kieso, Weygandt, and Warfield

4-2
Learning Objectives
1. 2. 3. 4. 5. Understand the uses and limitations of an income statement. Prepare a single-step income statement. Prepare a multiple-step income statement. Explain how to report irregular items. Explain intraperiod tax allocation.
6.
7. 8.
Identify where to report earnings per share information.

Prepare a retained earnings statement. Explain how to report other comprehensive income.
4-3
Income Statement and Related Information
Income Statement
Usefulness Limitations Quality of Earnings
Format of the Income Statement

Elements Single-step Multiple-step Condensed income statements
Reporting Irregular Items

Discontinued operations Extraordinary items Unusual gains and losses Changes in accounting principles Changes in estimates Corrections of errors
Special Reporting Issues

Intraperiod tax allocation Earnings per share Retained earnings statement Comprehensive income
4-4
Income Statement
Usefulness
Evaluate past performance.
Predicting future performance.
Help assess the risk or uncertainty of achieving future cash flows.
4-5
LO 1 Understand the uses and limitations of an income statement.
Income Statement
Limitations
Companies omit items that cannot be measured reliably.
Income is affected by the accounting methods employed.
Income measurement involves judgment.
4-6
Income Statement
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.
Quality of earnings is reduced if earnings management
results in information that is less useful for predicting future

earnings and cash flows.
4-7

Elements of the Income Statement
Revenues Inflows or other enhancements of assets or settlements of its liabilities that constitute the entitys ongoing major or central operations. Examples of Revenue Accounts
Sales
Fee revenue Interest revenue
Dividend revenue Rent revenue
4-8

Expenses Outflows or other using-up of assets or incurrences of liabilities that constitute the entitys ongoing major or central operations. Examples of Expense Accounts
Cost of goods sold

Depreciation expense
Rent expense Salary expense
Interest expense
4-9

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,
4-10
settlement of liabilities,
write-offs of assets.
Single-Step Format
Single-Step Income Statement
Revenues Expenses Net Income
No distinction between Operating and Non-operating categories.
Income Statement (in thousands) Revenues: Sales Interest revenue Total revenue $ 285,000 17,000 302,000 149,000 10,000 43,000 21,000 24,000 247,000 $ 55,000 $ 0.75
SingleStep
Expenses: Cost of goods sold Selling expense Administrative expense Interest expense Income tax expense Total expenses Net income Earnings per share
4-11
LO 2 Prepare a single-step income statement.
E4-4: Prepare an income statement from the data below.
Single-Step Format
Income Statement For the year ended Dec. 31, 2012
Administrative expense: Officers' salaries Depreciation Cost of goods sold Rental revenue Selling expense: Transportation-out Sales commissions Depreciation Sales Income tax expense Interest expense 2,690 7,980 6,480 96,500 7,580 1,860 $ 4,900 3,960 63,570 17,230
Revenues: Sales Rental revenue Total revenues Expenses: Cost of goods sold Selling expense Administrative exense Interest expense Income tax expense Total expenses Net income $ 63,570 17,150 8,860 1,860 7,580 99,020 14,710 $ 96,500 17,230 113,730
4-12
Single-Step Format Review

The single-step income statement emphasizes a. the gross profit figure. b. total revenues and total expenses. c. extraordinary items more than it is emphasized in the multiple-step income statement.
d. the various components of income from continuing operations.
4-13

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.
4-14
LO 3 Prepare a multiple-step income statement.
Multiple-Step Format
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
4-15
The presentation divides information into major sections.
1. Operating Section
Income Statement (in thousands) Sales Cost of goods sold Gross profit Operating expenses: Selling expenses Administrative expenses Total operating expense Income from operations Other revenue (expense): Interest revenue Interest expense Total other Income before taxes Income tax expense Net income $ 285,000 149,000 136,000 10,000 43,000 53,000 83,000 17,000 (21,000) (4,000) 79,000 24,000 55,000
2. Nonoperating Section 3. Income tax
4-16
Illustration (E4-4): Prepare an income statement from the data below.

Administrative expense: Officers' salaries Depreciation Cost of goods sold Rental revenue Selling expense: Transportation-out Sales commissions Depreciation Sales Income tax expense Interest expense 2,690 7,980 6,480 96,500 7,580 1,860 $ 4,900 3,960 63,750 17,230
Income Statement For the year ended Dec. 31, 2012 Sales Cost of goods sold Gross profit Operating Expenses: Selling expense Administrative exense Total operating expenses Income from operations Other revenue (expense): Rental revenue Interest expense Total other Income before tax Income tax expense Net income $ 17,230 (1,860) 15,370 22,110 7,580 14,530 17,150 8,860 26,010 6,740 $ 96,500 63,750 32,750
4-17
Multiple-Step Format Review

A separation of operating and non operating activities of a company exists in
a. both a multiple-step and single-step income statement.
b. a multiple-step but not a single-step income statement.

c. a single-step but not a multiple-step income statement. d. neither a single-step nor a multiple-step income statement.
4-18

Companies are required to report irregular items in the financial statements so users can determine the long-run earning power of the company. Illustration 4-5
Number of Irregular Items Reported in a Recent Year by 500 Large Companies
4-19
LO 4 Explain how to report irregular items.

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.
4-20

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.
4-21
Reporting Discontinued Operations

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: Loss from operations, net of $135,000 tax Loss on disposal, net of $81,000 tax Total loss on discontinued operations Net income
4-22
$55,000,000 315,000 189,000 504,000 $54,496,000
Reporting Discontinued Operations

Discontinued Operations are reported after Income from continuing operations.
Income Statement (in thousands) Sales Cost of goods sold Gross profit
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
$ 285,000 149,000 136,000

(21,000) (4,000) 79,000 24,000 55,000 315 189 504 $ 54,496
Previously labeled as Net Income.
Moved to
4-23
LO 4

Extraordinary items are nonrecurring material items that
differ significantly from a companys 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.
4-24
Reporting Extraordinary Items

Are these items Extraordinary?
(a) A large portion of a tobacco manufacturers crops are destroyed by a hail storm. Severe damage from hail storms in the locality where the manufacturer grows tobacco is rare. (b) A citrus grower's Florida crop is damaged by frost. (c) A company sells a block of common stock of a publicly traded company. The block of shares, which represents less than 10% of the publicly-held company, is the only security investment the company has ever owned.
4-25
YES
NO
YES

Are these items Extraordinary?
(d) A large diversified company sells a block of shares from its portfolio of securities which it has acquired for investment purposes. This is the first sale from its portfolio of securities. (e) An earthquake destroys one of the oil refineries owned by a large multi-national oil company. Earthquakes are rare in this geographical location.
NO
YES
(f)
A company experiences a material loss in the repurchase of a large bond issue that has been outstanding for 3 years. The company regularly repurchases bonds of this nature.
NO
4-26
LO 4

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 corporations 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 $55,000,000 539,000
Net income
($770,000 x 30% = $231,000 tax)
4-27
$54,461,000

Extraordinary Items are reported after Income from continuing operations.
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
$ 285,000 149,000 136,000
Previously labeled as Net Income.

Moved to
4-28
17,000 (21,000) (4,000) 79,000 24,000 55,000 539 $ 54,461
LO 4

Illustration 4-8 Income Statement Presentation of Extraordinary Items
4-29
LO 4

Reporting when both Discontinued Operations and Extraordinary Items are present.
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
$ 285,000 149,000 136,000

79,000 24,000 55,000 315 189 504 54,496 539 $ 54,496
LO 4
Discontinued Operations
Extraordinary Items
4-30
Reporting Irregular Items Review

Irregular transactions such as discontinued operations and extraordinary items should be reported separately in
a. both a single-step and multiple-step income statement. a single-step income statement only. a multiple-step income statement only. neither a single-step nor a multiple-step income statement.
b. c. d.
4-31

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.
4-32

Unusual Gains and Losses
Illustration 4-9 Income Statement Presentation of Unusual Charges
4-33

Changes in Accounting Principles

Retrospective adjustment.
Cumulative effect adjustment to beginning retained earnings.

Approach preserves comparability.
Examples include:

change from FIFO to average cost. change from the percentage-of-completion to the
completed-contract method.
4-34

Change in Accounting Principle: Gaubert Inc. decided in
March 2012 to change from FIFO to weighted-average inventory pricing. Gauberts income before taxes, using the new weightedaverage method in 2012, is $30,000.
Pretax Income Data Illustration 4-10 Calculation of a Change in Accounting Principle
Illustration 4-11 Income Statement Presentation of a Change in Accounting Principle (Based on 30% tax rate)
4-35

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.
4-36
Change in Estimate Example

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:
What is the journal entry to correct the prior years depreciation? Calculate the depreciation expense for 2012.
4-37

Equipment cost Salvage value Depreciable base Useful life (original) Annual depreciation
After 7 years
$510,000 First, establish NBV - 10,000 at date of change in estimate. 500,000 10 years $ 50,000 x 7 years = $350,000
Balance Sheet (Dec. 31, 2011) Fixed Assets: Equipment Accumulated depreciation Net book value (NBV)
4-38
$510,000 350,000 $160,000

Net book value Salvage value (new) Depreciable base Useful life remaining Annual depreciation Journal entry for 2012 $160,000 5,000 155,000 8 years $ 19,375
After 7 years
Depreciation Expense calculation for 2012.
Depreciation expense
Accumulated depreciation
4-39
19,375
19,375

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.
4-40

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 100,000
Accounts receivable
100,000
4-41

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.
4-42
LO 5 Explain 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
4-43

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
4-44
Example of Intraperiod Tax Allocation

Income Statement (in thousands) Sales Cost of goods sold $ 285,000 149,000
Note: losses reduce the total tax
Total other Income from cont. oper. before taxes Income tax expense Income from continuing operations Discontinued operations: Loss on operations, net of $135 tax Loss on disposal, net of $61 tax Total loss on discontinued operations Income before extraordinary item Extraordinary loss, net of $231 tax Net income
(4,000) 79,000 24,000 55,000 315 189 504 54,496 539 $ 53,957
Calculation of Total Tax

$24,000 (135) (61) (231) $23,573
4-45

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.
4-46
LO 6 Identify where to report earnings per share information.

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 Holliss 2012 earnings per share.
Net income - Preferred dividends

Weighted average number of shares outstanding $1,000,000 $250,000
= $3.95 per share
190,000
4-47
LO 6 Identify where to report earnings per share information.

Illustration 4-17
Divide by weightedaverage shares outstanding
EPS
4-48
LO 6

Retained Earnings Statement
Increase
Decrease
Net income
Net loss
Change in accounting principle

Error corrections
Dividends
Change in accounting principles Error corrections
4-49
LO 7 Prepare a retained earnings statement.

Woods, Inc. Statement of Retained Earnings For the Year Ended December 31, 2012 Balance, January 1 Net income Dividends Balance, December 31 $ 1,050,000 360,000 (300,000) 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?
4-50

Woods, Inc. Statement of Retained Earnings For the Year Ended December 31, 2012 Balance, January 1 Prior period adjustment - error correction Balance, January 1 (restated) Net income Dividends Balance, December 31 $ 1,050,000 (50,000) 1,000,000 360,000 (300,000) 1,060,000
4-51

Restrictions on Retained Earnings
Disclosed

In notes to the financial statements.

As Appropriated Retained Earnings.
4-52

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.
4-53
LO 8 Explain how to report other comprehensive income.

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
4-54
Other Comprehensive Income
Unrealized gains and losses on available-forsale securities. Translation gains and losses on foreign currency. Plus others
Reported in Stockholders Equity
Special Reporting Issues Review

Gains and losses that bypass net income but affect stockholders' equity are referred to as a. comprehensive income. b. other comprehensive income. c. prior period income.
d. unusual gains and losses.
4-55

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
4-56

Second income statement
Illustration 4-19
4-57
LO 8

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
4-58
LO 8

Statement of Stockholders Equity
Illustration 4-20
4-59

Balance Sheet Presentation
Illustration 4-21 Presentation of Accumulated Other Comprehensive Income in the Balance Sheet
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.
4-60
Special Reporting Issues Review

The FASB decided that the components of other comprehensive income must be displayed a. in a second separate income statement. b. in a combined income statement of comprehensive income. c. as a part of the statement of stockholders equity. d. Any of these options is permissible.
4-61
RELEVANT FACTS
Presentation of the income statement under GAAP follows either a single-step or multiple-step format. IFRS does not mention a singlestep or multiple-step approach. Extraordinary items are prohibited under IFRS. Under IFRS, companies must classify expenses by either nature or function. GAAP does not have that requirement, but the U.S. SEC requires a functional presentation. 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.
4-62
RELEVANT FACTS
IFRS does not define key measures like income from operations. SEC regulations define many key measures and provide requirements and limitations on companies reporting nonGAAP/IFRS information. GAAP does not require companies to indicate the amount of net income attributable to non-controlling interest. GAAP and IFRS follow the same presentation guidelines for discontinued operations, but IFRS defines a discontinued operation more narrowly. Both standard- setters have indicated a willingness to develop a similar definition to be used in the joint project on financial statement presentation.
4-63
RELEVANT FACTS
Both GAAP and IFRS have items that are recognized in equity as part of comprehensive income but do not affect net income. GAAP provides three possible formats for presenting this information: single income statement, combined statement of comprehensive income, in the statement of stockholders equity. Most companies that follow GAAP present this information in the statement of stockholders equity. IFRS allows a separate statement of comprehensive income or a combined statement. 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.
4-64
IFRS SELF-TEST QUESTION

Which of the following is not reported in an income statement under IFRS?
a. Discontinued operations. b. Extraordinary items. c. Cost of goods sold. d. Income tax.
4-65

Which of the following statements is correct regarding income reporting under IFRS?
a. IFRS does not permit revaluation of property, plant, and equipment, and intangible assets. b. IFRS provides the same options for reporting comprehensive income as GAAP. c. Companies must classify expenses either by nature or function.
d. IFRS provides a definition for all items presented in the income statement.
4-66

Which of the following is not an acceptable way of displaying the components of other comprehensive income under IFRS?
a. Within the statement of retained earnings. b. Second income statement. c. Combined statement of comprehensive income. d. All of the above are acceptable.
4-67
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4-68

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Intermediate Accounting

Prepared by Coby Harmon University of California, Santa Barbara

Income Statement and Related Information

Intermediate Accounting 14th Edition

Kieso, Weygandt, and Warfield

Identify where to report earnings per share information.

Income Statement and Related Information

Format of the Income Statement

Reporting Irregular Items

Special Reporting Issues

Evaluate past performance.

Predicting future performance.

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

LO 1 Understand the uses and limitations of an income statement.

Companies omit items that cannot be measured reliably.

Income is affected by the accounting methods employed.

Income measurement involves judgment.

LO 1 Understand the uses and limitations of an income statement.

market price of stock increases and

value of stock options increase.

Quality of earnings is reduced if earnings management

results in information that is less useful for predicting future

LO 1 Understand the uses and limitations of an income statement.

Format of the Income Statement

Dividend revenue Rent revenue

LO 1 Understand the uses and limitations of an income statement.

Format of the Income Statement

Cost of goods sold

Rent expense Salary expense

Format of the Income Statement

sale of investments or plant assets,

LO 2 Prepare a single-step income statement.

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

LO 2 Prepare a single-step income statement.

Single-Step Format Review

d. the various components of income from continuing operations.

LO 2 Prepare a single-step income statement.

Format of the Income Statement

Highlights certain intermediate components of income that analysts use.

LO 3 Prepare a multiple-step income statement.

6. Earnings per share

LO 3 Prepare a multiple-step income statement.

2. Nonoperating Section 3. Income tax

LO 3 Prepare a multiple-step income statement.

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

Multiple-Step Format Review

b. a multiple-step but not a single-step income statement.

LO 3 Prepare a multiple-step income statement.

Reporting Irregular Items

LO 4 Explain how to report irregular items.

Reporting Irregular Items

LO 4 Explain how to report irregular items.

Reporting Irregular Items

results of operations and

cash flows of a component.

LO 4 Explain how to report irregular items.

Reporting Discontinued Operations

$55,000,000 315,000 189,000 504,000 $54,496,000

LO 4 Explain how to report irregular items.

Reporting Discontinued Operations

$ 285,000 149,000 136,000

Previously labeled as Net Income.

Reporting Irregular Items