Chapter 4

Income Statement

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 The Income Statement

• Covers a period of time

– For the Year/Quarter/Month Ended...
• Multiple-step format
– Gross profit (sales – cost of goods sold)
– Operating income (income before taxes, interest, and other
revenues and expenses)
– Income before taxes
– Net income
• Single-step format
– Total of all revenues and gains
– Less the total of all expenses and losses
– No operating Income in this analysis

Chapter 4, Slide #2
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 Multiple-Step Single Step
Multiple-Step Company Single-Step Company
Income Statement Income Statement
For the Year Ended December 31, 20XX For the Year Ended December 31, 20XX

Sales $ 496,120 Sales $ 496,120

Cost of Goods Sold 234,972 Interest Income 122,757
Gross Profit 261,148 Other Income 44,715
Operating Expenses: 663,592
General & Administrative $ 131,409 Costs and Expenses:
Advertising 128,325 Cost of Goods Sold $ 234,972
Uncollectible Accounts 22,664 282,398 General & Administrative 131,409
Operating Income (21,250) Advertising 128,325
Interest Income 122,757 Uncollectible Accounts 22,664 517,370
Other Revenue 44,715 167,472
Income Before Taxes 146,222
Income Before Taxes 146,222 Income Taxes 8,498
Income Taxes 8,498
Net Income $ 137,724
Net Income $ 137,724

Chapter 4, Slide #3
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 Net Sales

• Revenue from the sale of principal goods or

services sold to customers
• Shown net of
– Discounts
– Returns
– Allowances

Chapter 4, Slide #4
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 Cost of Goods Sold

• The cost of goods that were sold to produce

revenue
Retailer Manufacturer
Beginning Inventory Beginning Inventory
+ Purchases + Cost of Goods
Manufactured
– Ending Inventory
– Ending Inventory
= Cost of Goods Sold
= Cost of Goods Sold

Chapter 4, Slide #5
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 Other Operating Revenue

• Reflects the nature of the business

• Examples
– Lease revenue
– Royalty revenue
– Finance charges
– Commission revenue

Chapter 4, Slide #6
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 Operating Expenses

• Selling expenses
– Result from the company’s effort to create sales
– Examples
• Advertising
• Sales commissions
• Sales supplies used
• Administrative expenses
– Relate to the general administration of the
company’s operation
– Examples
• Salaries
• Insurance
• Bad debt expense

Chapter 4, Slide #7
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 Other Income or Expense

• Secondary activities not directly related to

operations
– Dividend income
– Interest income
– Gains (losses) from sale of assets
– Interest expense

Chapter 4, Slide #8
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 Special Income Statement Items

• Unusual or Infrequent Items Disclosed

Separately
– If material, disclosed separately, before income
taxes
– Relate to operations

Chapter 4, Slide #9
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Special Income Statement Items (cont’d)

• Equity in Earnings of Nonconsolidated

Subsidiaries
– The investor’s proportional share of the investee’s
net income
– Does not represent cash flow to the investor
• Cash dividends received represent cash flow
– Analysis issues:
• Investor’s net income includes revenue of other entity
• May distort ratios
• Presented before tax; tax consequences typically
immaterial

Chapter 4, Slide #10

Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Special Income Statement Items (cont’d)

• Income Taxes Related to Operations

– Federal, state, and local
– Includes both paid and deferred taxes
• Discontinued Operations
– Reported net of income tax
– Analysis issues:
• Inadequate disclosure of associated assets
• Lack of historical profit and loss information on the
discontinued operations

Chapter 4, Slide #11

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Special Income Statement Items (cont’d)

• Extraordinary Items
– Unusual and infrequent
– Reported net of income tax
– Analysis issues:
• Exclude from primary analysis
• Include for supplementary analysis

Chapter 4, Slide #12

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Special Income Statement Items (cont’d)
• Cumulative Effect of a Change in Accounting
Principle
– For fiscal years beginning before 12/15/05
• Cumulative effect of the change shown net of tax on the income
statement of the period in which change was made
• Earlier statements not restated to reflect application of the new
principle
– Effective for fiscal years beginning after 12/15/05
• All comparative statements are retrospectively restated to reflect
application of the new accounting principle
• The cumulative effect on income of earlier years is shown as a
net-of-tax adjustment to the beginning Retained Earnings balance
of the earliest period presented

Chapter 4, Slide #13

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Special Income Statement Items (cont’d)

• Minority Share of Earnings

– Earnings of a partially-owned consolidated
subsidiary that would accrue to the minority owners
– Presentation may be either pre-tax or net-of-tax
• Earnings per Share
Net income ÷ Number of shares outstanding

Chapter 4, Slide #14

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Reconciliation of Retained Earnings

Reported as part of the Statement of Owners' Equity or

combined with the Income Statement

Beginning of year balance of retained earnings

+ Prior period adjustments
± Cumulative effect of a change in accounting principle
= Beginning balance as adjusted
+ Net income
– Dividends
= End-of-year balance of retained earnings

Chapter 4, Slide #15

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 Retained Earnings

• The accumulated undistributed earnings of the

corporation reported on the balance sheet
• Appropriated
– Restricted by law, contract, or management
decision
– Not available for dividends
• Unappropriated
– Available for dividends
– Does not represent cash or any other asset

Chapter 4, Slide #16

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 Dividends

• Cash dividends
– Date of declaration: create liability and reduce
retained earnings
– Date of payment: reduce liability and cash

Chapter 4, Slide #17

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 Stock Splits

• 2-for-1 split
– Doubles the quantity of stock
– Par or stated value is halved
• No effect on retained earnings, additional paid-
in capital, or capital stock accounts
• Analysis issues:
– Restate share quantities to reflect split activity

Chapter 4, Slide #18

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Legality of Distributions to Shareholders

• Per various state laws

– Distributions are acceptable as long as the firm has
the ability to pay debts as they come due in the
normal course of business
– Distributions to stockholders are acceptable as long
as the firm is solvent and the distributions do not
exceed the fair value of the assets
– Distributions consist of solvency and balance sheet
test of liquidity and risk

Chapter 4, Slide #19

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 Comprehensive Income
Net income
+ The period’s change in accumulated other comprehensive income
= Comprehensive income

• Foreign currency translation adjustments

• Unrealized holding gains and losses on
available-for-sale marketable securities
• Changes to owners' equity resulting from
additional minimum pension liability
adjustments
• Unrealized gains and losses from derivative
instruments
Chapter 4, Slide #20
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 Comprehensive Income –
Separate Statement
XYZ Corporation
Statement of Comprehensive Income
For the Year Ended December 31, 20XX

Net income $ 34,000

Other comprehensive income
Available-for-sale security adjustment, net of tax 5,500
Minimum pension liability adjustment, net of tax 3,500
Foreign currency transaction adjustment, net of tax (5,000)
Total other comprehensive income 4,000
Comprehensive income $ 38,000

Chapter 4, Slide #21

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 Comprehensive Income –
Combined with Income Statement
XYZ Corporation
Statement of Income and Comprehensive Income
For the Year Ended December 31, 20XX

Sales $ 230,000
Cost of goods sold 140,000
Gross profit 370,000
Operating expenses 40,000
Operating income 330,000
Other income 4,000
Income before income taxes 326,000
Income taxes 20,000
Net income 306,000
Other comprehensive income
Available-for-sale security adjustment, net of tax 5,500
Minimum pension liability adjustment, net of tax 3,500
Foreign currency transaction adjustment, net of tax (5,000)
Other comprehensive income 4,000
Comprehensive income $ 310,000

Earnings per share (for net income only) $ 2.80

Chapter 4, Slide #22
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Comprehensive Income – As Part of the
Statement of Owners' Equity
XYZ Corporation
Statement of Changes in Stockholders' Equity
For the Year Ended December 31, 20XX

Accumulated
Other
Retained Comprehensive Common Stock
Total Earnings Income Amount Shares
Beginning Balance $180,000 $60,000 $10,000 $110,000 55,000
Net Income 34,000 34,000
Available-for-sale
security adjustment,
net of tax 5,500 5,500
Minimum pension
liability adjustment, net
of tax 3,500 3,500
Foreign currency
transaction adjustment,
net of tax (5,000) (5,000)
Comprehensive income 38,000
Ending Balance $218,000 $94,000 $14,000 $110,000 55,000

Chapter 4, Slide #23

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 Comprehensive Income (cont’d)

• Analysis issues:
– Typically more volatile than net income
– A better indication of long-run profitability

Chapter 4, Slide #24

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