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The Income Statement and

Statement of Cash Flows


TOPIC 3
Revenues, Expenses, Gains and
Losses
Net Income

Revenues Expenses Gains and Losses


Inflows of Outflows of Increases or
resources resources decreases in equity
resulting from incurred in from peripheral or
providing goods generating incidental
or services to revenues. transactions of an
customers. entity.

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Income Statement

Operating Nonoperating
Activities vs. Activities
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Income Statement (Single-Step)
{
Central Company
Proper Heading Income Statement
For the Year Ended 12/31/99
Revenues and gains:
Revenues
& Gains { Sales, net
Interest income
Gain on sale of plant assets
Total revenues and gains
$ 785,250
62,187
24,600
872,037

Expenses and losses:

{
Cost of goods sold $ 351,800
Selling expenses 197,350
Expenses General and admin. exp. 78,500
& Losses Depreciation 17,500
Interest 27,000
Income taxes 62,500
Loss: sale of investment 9,000
Total expenses & losses 743,650
Net income $ 128,387

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Let’s take a
look at a
Multi-Step
Income
Statement
next.

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Income Statement (Multiple-Step)
{
Central Company
Proper Heading Income Statement
For the Year Ended 12/31/99

{
Sales, net $ 785,250
Gross Cost of goods sold 351,800
Margin Gross margin 433,450
Operating expenses:
Operating
Expenses { Selling expenses
General & admin.
Depreciation
Income from operations
$ 197,350
78,500
17,500 293,350
140,100
Other revenues & gains:

{
Non- Interest income $ 62,187
operating Gain 24,600 86,787
Other expenses:
Items Interest $ 27,000
Loss 9,000 (36,000)
Income before taxes 190,887
Income taxes 62,500
Net income $ 128,387

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Separately Reported Items
Discontinued operations, extraordinary items,
and the cumulative effect of a change in
accounting principle are reported separately, net
of taxes.
Income from continuing operations $ xxx
Discontinued operations (net of tax
effect) xx
Extraordinary items (net of tax effect) xx
Cumulative effect of a change in
accounting principle (net of tax effect) xx
Net Income $ xxx

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Intraperiod Income Tax
Allocation
Income Tax Expense must be associated with
each component of income that causes it.

Show Income Tax Report effects of Discontinued


Expense related to Operations, Extraordinary
Income from Items, and Cumulative Effect of
Continuing Accounting Changes NET OF
Operations. INCOME TAXES.

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Discontinued Operations
 Sale or disposal of an
identifiable segment of a
business.
 The income or loss from an
identifiable discontinued
operation should be reported
separately from the income or
loss related to continuing
operations.
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Discontinued Operations
 Two components are
accounted for:
Results of operations for
the discontinued segment
before the disposal
decision.
 Gain or loss from disposal
of a segment.

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Discontinued Operations
Example
During the year, Apex Co. sold an
unprofitable segment of the company. The
segment had a net loss from operations
during the period of $150,000 and its assets
sold at a loss of $100,000. Apex reported
income from continuing operations of
$128,387. All items are taxed at 30%.

How will this appear on the income


statement?
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Discontinued Operations
Example
Computation of Loss from Discontinued Operations
(Net of Tax Effect):

Loss on segment operations $ (150,000)


Less: Tax benefits ($150,000 × 30%) 45,000
Net loss $ (105,000)

Loss on disposal of assets $ (100,000)


Less: Tax benefits ($100,000 × 30%) 30,000
Net loss $ (70,000)

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Discontinued Operations
Example
Income Statement Presentation:

Income from continuing operations $ 128,387


Discontinued operations:
Loss on operations (net of
tax benefit of $45,000) (105,000)
Loss on disposal of assets (net
of tax benefits of $30,000) (70,000)
Net loss $ (46,613)

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Extraordinary Items
 Materialin amount
 Gains or losses that are
unusual in nature and
infrequent in occurrence.
required by GAAP.
 Reported net of related
taxes

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Extraordinary Items
Specific extraordinary items
identified in APB Opinion 30.
The direct result of a major
casualty (such as an
earthquake).
An expropriation.
A prohibition under a newly
enacted law or regulation that
clearly meets both criteria.

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Extraordinary Items
Example
During 1998, Apex Co. experienced a loss of
$75,000 due to an earthquake at one of its
manufacturing plants in Nashville. This was
considered an extraordinary item. The
company reported income before
extraordinary item of $128,387. All gains
and losses are subject to a 30% tax rate.

How would this item appear on the


1998 income statement?
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Extraordinary Items
Example
Extraordinary Loss $ (75,000)
Less: Tax Benefits
($75,000 × 30%) 22,500
Net Loss $ (52,500)

Income Statement Presentation:

Income before extraordinary item $ 128,387


Extraordinary Loss:
Earthquake loss
(net of tax benefit of $22,500) (52,500)
Net income $ 75,887

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Reporting Unusual or Infrequent
Items
 Some events are unusual or infrequent,
but not both.
For example:
 restructuring charges
 gain or loss from the sale of assets.

I wonder how I
should report
these items.

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Reporting Unusual or Infrequent
Items
Report them in Income
from Operations.

I wonder how I
should report
these items.

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Accounting Changes
Type of Accounting
Change Definition
Change in Accounting Replaces one GAAP with
Principle another
Change in Accounting Revision of an estimate
Estimate because of new
information or new
experience
Change in Reporting Change from reporting as
Entity one type of entity to
another type of entity

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Change in Accounting Principle
 Occurs when
Changing from one GAAP method to
another GAAP method, or
Changing the method of application of an
existing principle.
 Make a catch-up adjustment known as
the cumulative effect of a change
in accounting principle.
 The cumulative effect is reported net
of taxes and after extraordinary items.
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Change in Accounting Principle
Example
During the year, Apex Co. decided to change
from the double-declining balance to the
straight-line method for depreciation. The
effect of this change is an increase in net
income of $65,000. Apex reported income of
$128,387 during the year. All items of
income are subject to a 30% tax rate.

How would this item appear on the


income statement?
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Change in Accounting Principle
Example
Computation:
Increase in income $ 65,000
Less: Tax expense ($65,000 × 30%) (19,500)
Net increase in income $ 45,500

Income Statement Presentation:


Income from operations $ 128,387
Cumulative effect of change in
accounting principle:
Change in accounting method
(net of $19,500 tax expense) 45,500
Net income $ 173,887

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Change in Estimates
 Revision of a previous
accounting estimate.
 The new estimate should be
used in the current and
future periods.
 The prior accounting results
should not be disturbed - per
APB Opinion No. 20.

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Change in Estimates
Example
On January 1, 1996, we purchased
equipment costing $30,000, with a useful
life of 10 years and no salvage value.
During 1999, we determine that the
remaining useful is 5 years (8-year total
life). We use straight-line depreciation.
Compute the revised depreciation
expense for 1999.

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Change in Estimates
Example
Asset cost $ 30,000
Accumulated depreciation
12/31/98 - ($3,000 × 3 years) (9,000)
Remaining to be depreciated 21,000
Remaining useful life ÷ 5 years
Revised annual depreciation $ 4,200

Record depreciation expense of $4,200 for


1999 and subsequent years.

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Let’s
move on
to a few
final
topics.
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Other Topics

PriorPeriod
Adjustments.
Earnings Per Share.
Comprehensive Income.
Statement of Cash
Flows.

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Prior Period Adjustments
 Corrections of errors from a
previous period.
 Appear on the Statement
of Retained Earnings as
an adjustment to beginning
retained earnings.
 Must show the adjustment
net of income taxes.

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Prior Period Adjustments
Example
While reviewing the depreciation entries
for 2001-2004, the controller found that
in 2003 depreciation expense was
incorrectly debited for $150,000 when in
fact it should have been debited
$125,000. All items are taxed at 30%.
Prepare the necessary journal entry in
2004 to correct this prior period error.

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Prior Period Adjustments
Example
GENERAL JOURNAL Page: 180
Date Description PR Debit Credit
12/31/03 Depreciation Expense 150,000
Accumulated Depreciation 150,000

If this was the original


entry, how do we correct it?
Can we just reverse it?
Why or why not?

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Prior Period Adjustments
Example
GENERAL JOURNAL Page: 180
Date Description PR Debit Credit
2004 Entry
2004 Accumulated Depreciation 25,000

To correct the 2003 error in 2004, we can


debit Accumulated Depreciation since it is a
permanent account.

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Prior Period Adjustments
Example
GENERAL JOURNAL Page: 180
Date Description PR Debit Credit
2004 Entry
2004 Accumulated Depreciation 25,000

Retained Earnings 17,500

We can’t credit Depreciation Expense


since it was closed in 2003, so we credit
Retained Earnings.

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Prior Period Adjustments
Example
GENERAL JOURNAL Page: 180
Date Description PR Debit Credit
2004 Entry
2004 Accumulated Depreciation 25,000
Income Taxes Payable 7,500
Retained Earnings 17,500

Remember to consider the tax effects:


$25,000 × 30% = $7,500 taxes payable

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Financial Statement Presentation
of Earnings Per Share Data
EPS must be disclosed for:
Income from continuing operations
Income before extraordinary items
The cumulative effect of a change in
accounting principle
Net income
EPS values are desirable (but not required)
for extraordinary items and discontinued
operations.

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Financial Statement Presentation
of Earnings Per Share Data
A summary description of the rights and
privileges of the company’s various securities.
 A reconciliation of the numerators and the
denominators used in EPS computations.
 Supplemental EPS data for transactions
occurring after the balance sheet date that
would result in a material change to the
number of shares outstanding at the balance
sheet date.

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Basic Earnings Per Share
Simple form of the computation:

Net Income Available Average Number of


to Common ÷ Common Share
Shareholders Outstanding

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Comprehensive Income
FASB Concept Statement 6
The change in equity from nonowner
transactions. This must be reported in addition
to Net Income..
Includes Net Income plus other items not ordinarily
included in Net Income:
•Foreign currency translation adjustment, net of tax
•Unrealized gains(losses) on investment securities, net of tax
•Minimum pension liability adjustment, net of tax

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Statement of Cash Flows
 Provides relevant information about a
company’s inflows and outflows of cash.
 Helps investors and creditors to assess
future net cash flows
liquidity
long-term solvency.

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Cash Flows From Operating
Activities
 Inflow - cash  Outflows - cash paid
received from for
Customers Purchase of
Interest on inventory
receivables Salaries, wages, and
Dividends from other operating
investments expenses
Interest on debt
Income taxes

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Cash Flows From Investing
Activities
 Inflows - cash  Outflows - cash paid
received from for
Sales of long-term Purchase of long-
assets term assets
Sale of investments Purchase of
Collection of investments
nontrade receivables Loans to others

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Cash Flows From Financing
Activities
 Inflows - cash  Outflows - cash paid
received from to
Sale of equity Owners for dividends
securities Retire stock or
Borrowing through acquire treasury
notes, loans, stock
mortgages, or bonds Repay principal
portion of debt

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Whose
Idea OH NO!
was YOURS...
this?

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001