Slide 12-1

Chapter

12

INCOME AND CHANGES IN RETAINED EARNINGS

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Slide 12-2

Reporting the Results of Operations

Information about net income can be divided into two major categories
Normal, recurring revenue and expense transactions. Unusual, nonrecurring events that affect net income.

Income from continuing operations.

1. The results of discontinued operations

2. The impact of extraordinary items.

3. The effects of changes in accounting principles.

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Slide 12-3

Ross Corporation Income Statement For the Year Ended December 31, 2003
Net Sales Cost of goods sold Gross margin Operating expenses: Selling expenses General & Admin. exp. Loss on settlement of lawsuit Income taxes Income from Continuing Operations Discontinued Operations Extraordinary Items Cumulative effect of a change in accounting principle Net income
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$ $

This tax expense $ does not include 1,500,000 920,000 effects of unusual, 80,000 nonrecurring items. 300,000 2,800,000
700,000 These unusual, 245,000 (70,000) nonrecurring items $

8,000,000 4,500,000 3,500,000

are each reported 140,000 net of taxes. $ 1,015,000

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Slide 12-4

Discontinued Operations
When management enters into a formal plan to sell or discontinue a segment of the business, the related gains and losses must be disclosed on the income statement.

Discontinued Operations

Income/Loss from operating the segment prior to disposal.

Income/Loss on disposal of the segment.

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Slide 12-5

Discontinued Operations
When management enters into a formal plan to sell or discontinue a segment of the business, the related gains and losses must be disclosed on the income statement.

A segment must be a separate line of business activity or an operation that services a distinct category of customers.

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Slide 12-6

Discontinued Operations - Example

During 2003, 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 $350,000. All items are taxed at 30%. How will this appear on the income statement?
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Slide 12-7

Discontinued Operations - Example

Loss on segment operations Less: ax enefits ($150,000 0%) et loss Loss on isposal of assets Less: ax enefits ($100,000 0%) et loss $ (150,000) 45,000 $ (105,000) $ (100,000) 30,000 $ (70,000)

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Slide 12-8

Discontinued Operations - Example

Income Statement Presentation:
Income from continuing operations Discontinued operations: Loss on operations (net of tax benefit of $45,000) Loss on disposal of assets (net of tax benefits of $30,000) Earnings before extraordinary item $ 350,000

(105,000) (70,000) $ 175,000

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Slide 12-9

Extraordinary Items
 Material in amount.  Gains or losses that

are both unusual in nature and not expected to recur in the foreseeable future.  Reported net of related taxes.

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Slide 12-10

Extraordinary Items - Example

During 2003, 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 $175,000. All gains and losses are subject to a 30% tax rate. How would this item appear on the 2003 income statement?
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Slide 12-11

Extraordinary Items - Example

E T B %
P

E E E E ?
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k ? ?

Slide 12-12

Accounting Changes
Type of Accounting Change
Change in Accounting Principle Change in Accounting Estimate

Definition
Replaces one GAAP with another Revision of an estimate because of new information or new experience

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Slide 12-13

Change in Accounting Principle

 Occurs when changing from

one GAAP method to another GAAP method.  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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Slide 12-14

Change in Accounting Principle Example

Also in 2003, 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 before cumulative effect of an accounting change of $122,500 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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Slide 12-15

Change in Accounting Principle Example

Computation:
Increase in income ess: Tax expense 65, Net increase in income %) $ 65, (19,500) 45,500

Income Statement Presentation:

Earnings efore cumulative effect of re lative effect f a change in accounting principle accounting rinci le Cumulative effect of change in change in accounting principle: rinci le: Change in accounting method accounting method net of 19,tax expense) tax expense) ? Net Income
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122,

4 ? , 168, ?
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Slide 12-16

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.

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Slide 12-17

Change in Estimates - Example

On January 1, 2000, we purchased equipment costing $30,000, with a useful life of 10 years and no salvage value. During 2003, we determine that the remaining useful is 5 years (8-year total life). We use straight-line depreciation. Compute the revised depreciation expense for 2003.
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Slide 12-18

Change in Estimates - Example

Asset cost Accumulated depreciation 12/31/02 - ($3,000 3 years) Remaining to be depreciated Remaining useful life Revised annual depreciation $ 30,000 (9,000) 21,000 5 years 4,200

$ $

Record depreciation expense of $4,200 for 2003 and subsequent years.

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Slide 12-19

Lets move on to a few final topics.

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Slide 12-20

Price-earnings Ratio (P/E)

Often, the Price-Earnings Ratio is used to evaluate the reasonableness of a companys stock price.

Price-Earnings Ratio

urrent Stock Price

Earnings Per Share

Lets examine this further.

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Slide 12-21

Earnings Per Share (EPS)

A measure of the companys profitability and earning power for the period.
eighted Average umber of Shares utstanding

arnings Per Share

et = Income

Based on the number of shares issued and the length of time that number remained unchanged.
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Slide 12-22

Earnings Per Share (EPS) Partial Income Statement

Remember that Apex Co. income from continuing operations of $350,000. The after-tax loss from discontinued operations was $175,000. The extraordinary loss was $52,500 and the cumulative effect of accounting changes was a gain of $45,500. Assume that Apex has weighted average shares outstanding of 156,250. Prepare a partial income statement showing the EPS for Income from Operations and for the other special items.

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Slide 12-23

Earnings Per Share (EPS) Partial Income Statement

I A

I i I l i i l i l

i i

i i i i i i

, , , , , ,

. . . . . 9 . *

* Rounded.
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Slide 12-24

Earnings Per Share (EPS)

If preferred stock is present, subtract preferred dividends from net income prior to computing EPS.
Earnings Per Share Net Income - Preferred Dividends Weighted Average Number of Common Shares Outstanding

EPS is required to be reported in the income statement.

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Slide 12-25

Accounting for Cash Dividends

Declared by board of directors. Not legally required.

Creates liability at declaration.

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Requires sufficient Retained Earnings and Cash.

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Slide 12-26

Dividend Dates
Date of Declaration
 

Board of directors declares the dividend. Record a liability.

Da te

De scription

De bit

Cre dit

D iv ide nds D iv ide nds Payable

$$$$ $$$$

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Slide 12-27

Dividend Dates
Ex-Dividend Date


The day which serves as the ownership cut-off point for the receipt of the most recently declared dividend.

Date

Description

Debit

Credit

NO ENTRY

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Slide 12-28

Dividend Dates
Date of Record


Stockholders holding shares on this date will receive the dividend. (No entry)

X
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Slide 12-29

Dividend Dates
Date of Payment


Record the payment of the dividend to stockholders.

Da te

De scription

De it

re dit

D iv ide nds Paya le ash

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Slide 12-30

Dividend Dates - Question

De board Cre dit June 1,De scription 2003, a corporationsbit of 15 Jul Div ide nds Payable 20,000 directors declared a dividend for the 2,500 shares Cash of its $100 par value, 8% preferred stock. 20,000 The dividend will be paid on July 15. Which of the following will be included in the July 15 entry? Da te On

$100

8%

$8 dividend per share

$8 2,500 $20,000 $20,000. a. Debit Retained Earnings total dividend b. Debit Dividends Payable $20,000. c. Credit Dividends Payable $20,000. d. Credit Preferred Stock $20,000.
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Slide 12-31

Accounting for Stock Dividends

Distribution of additional shares of stock to stockholders.
No change in total stockholders equity. No change in par values.

All stockholders retain same percentage ownership.

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Slide 12-32

Summary of Effects of Stock Dividends and Stock Splits

S ll St Divi t l l r ' St it St P i -i it l t i r i r r ff I I D I r r r r ff t t I D I r ff r r ff t I D r r t r St Divi ff t St S lit ff ff ff ff t t t t

r fS t t i P rV l S r
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Slide 12-33

Prior Period Adjustments

The correction of an error identified as affecting net income in a prior period.

Adjust retained earnings retroactively.

The adjustment should be disclosed net of any taxes.

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Slide 12-34

Comprehensive Income
Normally, there are 3 ways that financial position can change.

Issuance of new shares of stock.

Net Income or Net Loss

Payment of Dividends

GAAP excludes some unrealized items from income, such as the change in market value of available-for-sale debt and equity investments.
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Slide 12-35

Comprehensive Income
GAAP requires that unrealized items that are normally reported on the balance sheet be added back to compute Comprehensive Income.

The accumulated amount of changes affecting Comprehensive Income is reported in equity.

There are 3 options for reporting Comprehensive Income.

As a second Income statement.

Combined with Net Income on the Income Statement.

As an element of Stockholders Equity.

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Slide 12-36

Hang in there! Were coming down the home stretch! Yeah, thats easy for you to say!

End of Chapter 12
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