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BSAD 221 Introductory Financial Accounting Donna Gunn, CA. Income Statement Elements. Revenues. Less : Operating Expenses. Subtotal: Operating Income. Non-operating Items. Subtotal: Earnings before income tax. Less: Income Tax Expenses. Total : Net Income. Income Statement Elements.
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Income Statement Elements Revenues Less: Operating Expenses Subtotal: Operating Income Non-operating Items Subtotal: Earnings before income tax Less: Income Tax Expenses Total: Net Income
Income Statement Elements Revenues Revenues are transactions that result in an increase in a company’s assets from the selling of goods or services
Income Statement Elements Less: Operating Expenses Costs of good sold The direct cost of the products sold to customers Other operating expenses The usual expenses that make up business operations, other than costs of goods sold
Income Statement Elements Subtotal:Operating Income Earnings from ongoing operations
Income Statement Elements Non-operating items Gains or losses that result from items outside of normal operating activities
Income Statement Elements Earnings before income taxes Equal to revenues minus ALL expenses except for income tax expenses
Income Statement Elements Income tax expense Income taxes for the year required for the federal and provincial governments Difference between revenues and expenses times the tax rate
Income Statement Elements Total: Net Income Total of ALL revenues and expense for the period
Income Statement Elements Results of continuing operations can be presented in one of the two formats Single step format: Revenues (All Operating Expenses) Operating income Multiple step format: Sales (Cost of Goods Sold) Gross Margin (Other Operating Expenses) Operating income
Presents only two groupingsfor operating income: Revenues (includes gains) Expenses (includes losses) Advantages: Simplicity Eliminates classification problems for revenues/ expenses Disadvantage: Operating and non-operating activities reported together Single-Step Income Statement
Operating and non-operating activities are separated Advantages: Greater predictive value and feedback value Provides better detail to compare companies Allows for ratio analysis used to assess performance Disadvantage: More work due to increased complexity Multiple-Step Income Statement
Largely other comprehensive income is a separate section that reports unrealized gains and losses not included on the income statement. Other Comprehensive Income
Example of a combined income and comprehensive I/S: Sales 800,000 Cost of goods sold 600,000 Gross profit 200,000 Operating expenses 90,000 Net income 110,000 Other comprehensive income Unrealized gain 30,000 Comprehensive income 140,000 Comprehensive Income Statement
Uses: Evaluate past performance and profitability Assist in predicting future performance Assess potential risk or uncertainty in achieving future cash flows Uses and Limitations of the Income Statement
Limitations: Items are excluded if they cannot be measured reliably Amounts reported are affected by accounting methods used Use of estimates in measuring income Uses and Limitations of the Income Statement
Nature of Content Free from bias Represents economic reality Reflects earnings from ongoing operations Can be correlated with cash flows from operations Presentation Does not disguise or mislead (transparent) Information presented is understandable Information is clear and concise Quality of Earnings
Evaluating theQuality of Earnings Research has shown that about half of all financial statement fraud over the past two decades hasinvolved improper revenue recognition – such as: Recognizing revenue before it is earned Providing incentives for customers to buy more inventory than needed Reporting revenue when significant services/goods are still to be delivered Reporting sales to fictitious or nonexistent customers
Earnings per share (EPS) is considered one of the most significant business indicators Indicates dollars earned per common share; it does not report the dollars paid (or to be paid) per common share Earnings per Share
Earnings per Share Calculated as: Net Income – Preferred Dividends Weighted Average of Common Shares Outstanding
Value of a Company Income from continuing operations can be used in estimating the value of common shares. To do this we use a capitalization rate.
Estimated annual income in the future Investment capitalization rate $54,000 ÷ 0.12 = $450,000 = = ÷ Earnings Valuation of a Company Assume an interest rate of 12% to value Westmount. Estimated value of Westmount’s common shares
$513,000 = × Current market value of the company Number of common shares outstanding Current market price per share $41.04 12,500 Market Value of a Company = ×
Continuing Operations:Investment Decision The investment decision rule may take this form: Estimated Value > Market Value …… BUY Estimated Value = Market Value ……. HOLD Estimated Value < Market Value ……. SELL
Continuing Operations:Investment Decision In the case of Westmount… Estimated Value = $450,000 Market Value = $513,000 Estimated Value < Market Value, therefore sell
Taxable income is $9.2 million on the company’s income tax return. Suppose for 2011, Red Lake Outfitters Ltd. has pretax accounting income of $10 million on the income statement. The tax rate is 30%. Accounting for CorporateIncome Taxes
Accounting for CorporateIncome Taxes Dr. Income Tax Expense (1) 3M Cr. Income Tax Payable (2) 2.76M Cr. Future Income Tax Liability (3) 0.24M Recorded income tax for the year $10M x 30% $9.2M x 30% $3M - $2.76M
Income statement Income before income tax $10.00 Income tax expense (3.00) Net income $ 7.00 Balance sheet Current Liabilities: Income tax payable $2.76 Long-term liabilities: Future income tax liability 0.24* Accounting for CorporateIncome Taxes *Assumes beginning tax liability was zero.
