Chapter 9The Corporate Income Statement and

Financial Statement Analysis

Chapter 9 2

Chapter 9: Objectives•Account for investments in stocks and bonds.

•Identify the key elements of the corporate income statement.

•Compute earnings per share.• •Account for corporate income taxes.

•Discuss the objectives of and sources for information for financial statement analysis for different types of decision makers.

•Prepare trend analyses of financial statement data.

•Prepare common-sized financial statements.

•Compute key financial ratios including liquidity, leverage, activity, profitability, and market strength ratios.

•Assess earnings quality.

Chapter 9 3

The Income StatementIncome From Operations = Revenue – COGS- General Expenses

Other Items include:

Interest Income/ExpenseEarnings (or losses) from stock or bond investments Discontinued operations

Extraordinary itemsCumulative effects of accounting changesDeferred income taxes

Chapter 9 4

Investments in Stocks

•Cost Method

•Equity Method

Chapter 9 5

Equity Terms

•Parent•Subsidiary

•Consolidation•Minority Interest

Chapter 9 6

Visual Recap 9.1Accounting Methods for Long-term Investment in Other Companies 

  Method Cost Equity  

  Ownership < 20% 20%–80% >80%  

  Initial Investment

InvestmentCash

 

InvestmentCash

InvestmentCash

 

  Receipt of Dividends

CashDividend Revenue

 

CashInvestment

CashInvestment

 

  Year-End Procedures

Debit or credit the Investment account to adjust it to FMV. The other debit or credit will be to Stockholders’ Equity

InvestmentIncome from

Unconsolidated Affiliates

Consolidate the financial statements of both companies; remove the effects of transactions between the two companies. Subtract minority interest.

 

           

Chapter 9 7

Investments in BondsEXHIBIT 9.2Journal Entries for a Bond Investment Purchased at a Discount  Date Description Debit Credit 2003 Apr. 1Investment in Bonds Payable 96,231

Cash 96,231To record purchase of $100,000, 10%, 5-year bonds at a market rate of 11%.

Sept. 30 Cash 5,000Investment in Bonds Payable 377

Interest Revenue 5,377To record receipt of semiannual interest and amortization of discount to the investment account.

Chapter 9 8

Dec. 31 Interest Receivable 2,500Investment in Bonds Payable 189

Interest Payable 2,689To record accrual of 3 month's of interest and amortization of discount to the investment account.

2004 Mar.31 Cash 5,000

Investment in Bonds Payable 188Interest Revenue 2,688Interest Receivable 2,500

To record receipt of semiannual interest and amortization of discount to the investment account.

Chapter 9 9

Corporate Income Taxes

Taxable income over Not over Tax rate  $ 0 $ 50,000 15% 50,000 75,000 25% 75,000 100,000 34% 100,000 335,000 39% 335,000 10,000,000 34% 10,000,000 15,000,000 35% 15,000,000 18,333,333 38%

Chapter 9 10

Two Sets of Books?

•Temporary Differences• Permanent Differences

•Deferred Tax Liability•Deferred Tax Asset

Chapter 9 11

Income From Noncontinuing Items

•Discontinued Operations

•Extraordinary Items

•Cumulative Effect of a change in Accounting Principle

Chapter 9 12

Discontinued Operations

Income Statement will contain:(1) the operating income (or loss) for that business segment (2) the gain (or loss) resulting from the disposal of the segment.

Chapter 9 13

Extraordinary ItemsUnusual in nature: The event should be highly abnormal, taking into account the environment in which the entity operates

ANDInfrequent in occurrence: The event should not reasonably be expected to recur in the foreseeable future, taking into account the environment in which the entity operates.

Chapter 9 14

Cumulative Effect of a Change in Accounting Principle

Defined as: the impact on the company's prior years' net incomes had the newly adopted accounting principle been used during those years.

Cumulative effect components of an income statement are shown "net of tax" after extraordinary items.

Chapter 9 15

Analytical Techniques• trend analysis

• common-sized financial statements• ratio analysis

Trend Analysis: Shows percentage changes from year to year.

Common Size Financials: each line item is expressed as a percentage of a major financial statement component within the year.

Ratio Analysis: study of relationships between two financial statement items.

Chapter 9 16

Ratio Analysis

Current Ratio Quick Ratio

Liquidity

Debt to Total Assets Long-term Debt to Equity Times Interest Earned

Leverage

Age of Rec. AR Turnover Age of Inventory Inventory Turnover Asset Turnover

Activity

Chapter 9 17

Ratio Analysis

Gross Margin % Profit Margin % Return on Assets Return on Equity

Profitability

Price - Earnings Market to Book

Market Strength