mcgraw-hill /irwin© 2009 the mcgraw-hill companies, inc. the income statement and statement of cash...
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McGraw-Hill /Irwin © 2009 The McGraw-Hill Companies, Inc.
THE INCOME STATEMENT THE INCOME STATEMENT AND STATEMENT OF CASH AND STATEMENT OF CASH FLOWSFLOWS
Chapter 4
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4-2
Expenses
Outflows of resources incurred in generating revenues.
Revenues
Inflows of resources resulting
from providing goods or
services to customers.
Gains and Losses
Increases or decreases in equity from
peripheral or incidental
transactions of an entity.
Income from Continuing OperationsIncome from Continuing Operations
Income Tax Expense
Because of its
importance and size,
income tax expense is a
separate item.
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4-3
Operating Income
Nonoperating Income
Operating Versus Nonoperating IncomeOperating Versus Nonoperating Income
Includes revenues and expenses
directly related to the principal
revenue-generating
activities of the company
Includes gains and losses and revenues and
expenses related to peripheral or
incidental activities of the
company
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4-4
Income Statement (Single-Step)Income Statement (Single-Step)
Expenses & Losses {
{Revenues & Gains
{Proper Heading
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4-5
Income Statement (Multiple-Step)Income Statement (Multiple-Step)
{Non- operating Items
{Gross Profit
Operating Expenses {
MAXWELL GEAR CORPORATIONIncome Statement
For the Year Ended December 31, 2009
Sales revenue 573,522$
Cost of goods sold 302,371
Gross profit 271,151
Operating expenses:
Selling 47,341$
General and administrative 24,888
Research and development 16,300 88,529
Operating income 182,622
Other income (expense):
Interest and dividend revenue 26,400$
Gain on sale of operating assets 5,500
Interest expense (6,200)
Loss on sale of investments (8,322) 17,378
Income before income taxes 200,000
Income tax expense 80,000
Net income 120,000$
{Proper Heading
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4-6
Earnings Earnings QualityQuality
Earnings quality refers to the ability of reported earnings to predict a company’s future earnings.
Transitory Earningsversus
Permanent Earnings
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4-7
Manipulating Income and Income SmoothingManipulating Income and Income Smoothing
Two ways to manipulate income:
1. Income shifting
2. Income statement classification
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4-8
Operating Income and Earnings QualityOperating Income and Earnings Quality
Restructuring CostsCosts associated with shutdown or
relocation of facilities or downsizing of operations are
recognized in the period incurred.
Goodwill Impairment and Long-lived Asset
Impairment
Involves asset impairment losses or charges.
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Nonoperating Income and Earnings QualityNonoperating Income and Earnings Quality
Gains and losses from the sale of operational assets and investments often can significantly
inflate or deflate current earnings.
ExampleAs the stock market boom reached
its height late in the year 2000, many companies recorded large gains from sale of investments
that had appreciated significantly in value.
How should those gains be interpreted in terms of their relationship to
future earnings? Are they transitory or permanent?
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4-10
Separately Reported ItemsSeparately Reported Items
Reported separately, net of taxes:
Discontinued operations
$ xxxxx
xxx
xx
xxNet Income $ xxx
Extraordinary items (net of $xx in taxes)
Income from continuing operations before income taxes and extraordinary itemsIncome tax expenseIncome from continuing operations before extraordinary itemsDiscontinued operations (net of $xx in taxes)
Extraordinary items
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4-11
Intraperiod Income Tax AllocationIntraperiod Income Tax Allocation
Income Tax Expense must be associated with each component of income that causes it.
Income Tax Expense must be associated with each component of income that causes it.
Show Income Tax Expense related to
Income from Continuing Operations.
Show Income Tax Expense related to
Income from Continuing Operations.
Report effects of Discontinued Operations and Extraordinary Items
NET OF RELATED INCOME TAXES.
Report effects of Discontinued Operations and Extraordinary Items
NET OF RELATED INCOME TAXES.
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A discontinued operation is the sale or disposal of a component of an entity.
A component comprises operations and cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity.
A component could include: reportable segments operating segments reporting units subsidiaries asset groups
Discontinued OperationsDiscontinued Operations
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Discontinued OperationsDiscontinued Operations
Report results of operations separately if two conditions are met:
The operations and cash flows of the
component have been (or will be) eliminated
from the ongoing operations.
The entity will not have any significant
continuing involvement in the operations of the
component after the disposal transaction.
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Discontinued OperationsDiscontinued Operations
Reporting for Components Sold
Operating income or loss of the component from the beginning of the reporting period to
the disposal date.
Gain or loss on the disposal of the
component’s assets.
Reporting for Components Held For Sale
Operating income or loss of the component from the beginning of the reporting period to the end of the reporting
period.
An “impairment loss” if the carrying value of
the assets of the component is more than the fair value minus cost to sell.
4-15
Material events or transactionsUnusual in natureInfrequent in occurrenceReported net of related taxes
Extraordinary ItemsExtraordinary Items
4-16
Unusual or Infrequent ItemsUnusual or Infrequent Items
Items that are material and are either unusual or infrequent—but not
both—are included as separate items in continuing operations.
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4-17
Type of Accounting Change Definition
Change in Accounting Principle
Change from one GAAP method to another GAAP method
Change in Accounting Estimate
Revision of an estimate because of new information or new experience
Change in Reporting Entity
Preparation of financial statements for an accounting entity other than the entity that existed in the previous period
Accounting ChangesAccounting Changes
4-18
Change in Accounting PrincipleChange in Accounting Principle
Occurs when changing from one GAAP method to another GAAP method, for example, a change from LIFO to FIFO
Most voluntary changes in accounting principles are accounted for retrospectively by revising prior years’ financial statements.
Changes in depreciation, amortization, or depletion methods are accounted for in a similar way as a change in accounting estimate.
4-19
Change in Accounting EstimateChange in Accounting Estimate
Revision of a previous accounting estimate
Use new estimate in current and future
periods
Includes treatment for changes in depreciation,
amortization, and depletion methods
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4-20
Change in Reporting EntityChange in Reporting Entity
If two entities combine, a single
set of consolidated financial
statements is generally required.
4-21
Correction of errors from a previous period
Appear in the Statement of Retained Earnings as an adjustment to beginning retained earnings (show the adjustment net of income taxes)
Previous years’ financial statements that are incorrect are retrospectively restated to reflect the correction.
Correction of Accounting ErrorsCorrection of Accounting Errors
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4-22
Earnings Per Share DisclosureEarnings Per Share Disclosure
One of the most widely used ratios is earnings per share (EPS), which shows the amount of income
earned by a company expressed on a per share basis.
Basic EPS
Net income less preferred dividends
Weighted-average number of common shares outstanding for the
period
Diluted EPS
Reflects the potential dilution that could occur for companies that have certain
securities outstanding that are convertible into common shares or stock options that could create additional common shares if
the options were exercised.
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4-23
Earnings Per Share DisclosureEarnings Per Share Disclosure
Report EPS data separately for:
1. Income from Continuing Operations
2. Separately Reported Items
a) discontinued operations
b) extraordinary Items
3. Net Income
Slide 24
4-24
Comprehensive IncomeComprehensive Income
An expanded version of income that includes four types of gains and
losses that traditionally have not been included
in income statements.
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4-25
Other Comprehensive IncomeOther Comprehensive IncomeStatement of Financial Accounting Standards No. 130
Comprehensive income includes traditional net income and changes in equity from nonowner transactions.
1. Net unrealized holding gains (losses) from investments (net of tax).
2. Gains and losses due to reviewing assumptions or market returns differing from expectations and prior service cost from amending the postretirement benefit plan.
3. When a derivative is designated as a cash flow hedge is adjusted to fair value, the gain or loss is deferred as a component of comprehensive income and included in earnings later, at the same time as earnings are affected by the hedged transaction.
4. Gains or losses from changes in foreign currency exchange rates. The amount could be an addition to or reduction in shareholders’ equity. (This item is discussed elsewhere in your accounting curriculum).
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Accumulated Other Comprehensive IncomeAccumulated Other Comprehensive Income
In addition to reporting comprehensive income that occurs in the current period, we must also report these amounts on a cumulative basis in the balance sheet as
an additional component of shareholders’ equity.
In addition to reporting comprehensive income that occurs in the current period, we must also report these amounts on a cumulative basis in the balance sheet as
an additional component of shareholders’ equity.
(In thousands) 2007 2006Shareholders' equity:Common stock 212$ 211$ Additional paid-in capital 1,340,687 1,265,382 Retained earnings 1,131,403 1,116,035 Accumulated other comprehensive income 170,960 109,898 Treasury stock (200,251) (200,251) Total shareholders' equity 2,443,011$ 2,291,275$
JABIL CIRCUITS INC.Consolidated Balance Sheets (in part)
Yesrs Ended August 31
4-27
The Statement of Cash FlowsThe Statement of Cash Flows
Provides relevant information about a company’s cash receipts and cash disbursements.
Helps investors and creditors to assessfuture net cash flowsliquiditylong-term solvency.
Required for each income statement period reported.
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4-28
Operating ActivitiesOperating Activities
Cash Flows from
Operating Activities
Cash Flows from
Operating Activities
Inflows from: sales to customers. interest and dividends
received.
Inflows from: sales to customers. interest and dividends
received. +
Outflows for: purchase of inventory. salaries, wages, and other
operating expenses. interest on debt. income taxes.
Outflows for: purchase of inventory. salaries, wages, and other
operating expenses. interest on debt. income taxes.
_
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Direct and Indirect Methods of ReportingDirect and Indirect Methods of Reporting
Two Formats for Reporting Operating Activities
Reports the cash effects of each operating
activity
Direct Method
Starts with accrual net income and converts to cash basis
Indirect Method
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4-30
Direct and Indirect MethodsDirect and Indirect Methods
Cash flows from Operating ActivitiesCash received from customers 78$ Cash paid for administrative expenses (29)
Net cash flows from operating activities 49$
ARLINGTON LAWN CAREStatement of Cash Flows
For the Year Ended December 31, 2009($ in thousands) Direct
Method
Cash flows from Operating ActivitiesNet income 35$ Adjustments for noncash effects:
Depreciation expense 8$ Increase in prepaid insurance (4)
Increase in accounts receivable (12) Increase in accounts payable 7 Increase in income taxes payable 15 14
Net cash flows from operating activities 49$
ARLINGTON LAWN CAREStatement of Cash Flows
For the Year Ended December 31, 2009($ in thousands)
Indirect Method
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4-31
Cash Flows from
Investing Activities
Cash Flows from
Investing Activities
+
Investing ActivitiesInvesting Activities
Inflows from:sale of long-term assets used in
the business.sale of investment securities
(stocks and bonds).collection of nontrade
receivables.
Inflows from:sale of long-term assets used in
the business.sale of investment securities
(stocks and bonds).collection of nontrade
receivables.
_Outflows for:
purchase of long-term assets used in the business.
purchase of investment securities (stocks and bonds).
loans to other entities.
Outflows for: purchase of long-term assets
used in the business. purchase of investment
securities (stocks and bonds). loans to other entities.
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Cash Flows from
Financing Activities
+
_
Financing ActivitiesFinancing Activities
Inflows from:sale of shares to owners.borrowing from creditors
through notes, loans, mortgages, and bonds.
Outflows for: owners in the form of dividends
or other distributions. owners for the reacquisition of
shares previously sold. creditors as repayment of the
principal amounts of debt.
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Noncash Investing and Financing Noncash Investing and Financing ActivitiesActivities
Significant investing and financing transactions not involving cash
also are reported.
Acquisition of equipment (an investing activity) by issuing a long-term note
payable (a financing activity).
McGraw-Hill /Irwin © 2009 The McGraw-Hill Companies, Inc.
End of Chapter 4End of Chapter 4