Income Statement and Related Information

1. Income Statement and Related Information Chapter 4

2. Income Statement • Used for • Relevance • Evaluate past performance (feedback). • Predicting future performance. • Assess future cash flow risks. (conceptual framework objective) • Limitations • Reliability • Does not include items that cannot be measured reliably. • Based on entity discretion • Accounting methods employed. • Management and measurement judgment. • Management is often paid through entity profitability.

3. Inflows or other asset enhancements or liability settlements. Examples Sales Fee revenue; Interest revenue; Dividend revenue; Rent revenue. Income Statement - Revenue

4. Outflows or other use of assets or increases in liabilities Examples Cost of goods sold; Depreciation expense; Interest expense; Rent expense; Salary expense. Income Statement - Expenses

5. Gains and losses can result from sale of investments or plant assets; settlement of liabilities; write-offs of assets. Gains – Increases in equity (net assets) from transactions during the period. Losses - Decreases in equity (net assets) transactions during the period. Income Statement - Gains/Losses

6. Single Step Used by service firms, banks, utilities Multiple Step Used by merchandising and manufacturing firms Why? How are they different? Income Statement Formats

7. Single-Step Income Statement The single-step statement consists of just two groupings: Revenues Expenses Net Income Single- Step No distinction between Operating and Non-operating categories.

8. Single-Step Format Ex 4-4: Prepare a single-step income statement.

9. Multiple-Step Income Statement The presentation divides information into major sections. 1. Operating Section 2. Nonoperating Section 3. Income tax

10. Multiple-Step Format Illustration (E4-4): Prepare a multi-step income statement from the data below.

11. Earnings Per Share (EPS) • Basic – net of preferred share dividends • Diluted EPS – takes account of potential dilution from • Options; • Convertible debt; or • preferred stock • EPS to be reported for continuing operations, each of the non-continuing operations account, and net income. • Net income - Preferred dividends • Weighted average number of shares outstanding

12. Earnings Per Share In 2010, Kirby Puckett Corporation reported net income of $1,200,000. It declared and paid preferred stock dividends of $250,000. During 2010, Puckett had 100,000 common shares outstanding the whole year and 180,000 outstanding since June 30. Compute Puckett’s 2010 earnings per share.

13. Irregular Items • Irregular items fall into six categories • Discontinued operations. • Extraordinary items. • Unusual gains and losses. • Changes in accounting principle. • Changes in estimates. • Corrections of errors.

14. Irregular Items Companies are required to report irregular items in the financial statements so users can better understand the long-run earnings power of the company.

15. Unusual Gains/Losses [P4-3; CA4-1, 8] Material items that are unusual or infrequent, but not both, should be reported in a separate section just above “Income from continuing operations before income taxes.” Examples can include: Write-downs of inventories Foreign exchange transaction gains and losses. Not net-of-tax.

16. Unusual Gains/Losses

17. Discontinued Operations [BE4-4, E4-7, CA4-7] Discontinued Operations occurs when the entity, Eliminates the results of operations and cash flows of a component. Has no significant continuing involvement in that component. Amount reported “net of tax.” Show Operating results separate from gain/loss on disposal. Separate line item or in footnote.

18. Reporting Discontinued Operations Exercise:McCarthy Corporation had after tax income from continuing operations of $55,000,000 in 2010. During 2010, it disposed of its restaurant division at a pretax loss of $270,000. Prior to disposal, the division operated at a pretax loss of $450,000 in 2010. Assume a tax rate of 30%. Prepare a partial income statement for McCarthy. Income from continuing operations $55,000,000 Discontinued operations: Loss from operations, net of $135,000 tax 315,000 Loss on disposal, net of $81,000 tax 189,000 Total loss on discontinued operations 504,000 Net income $54,496,000

19. Reporting Discontinued Operations Discontinued Operations are reported after “Income from continuing operations.” Previously labeled as “Net Income”. Moved to

20. Extraordinary Item [CA 3, 8] Measured in relation to the entity’s environment Business; Economic; Industry Government regulation. Must be Unusual; and In relation to the entity’s typical business activities. Infrequent; Material. Measured item-by-item. Net of Tax Reported after Discontinued Operations.

21. Reporting Extraordinary Items Are these items Extraordinary? (a) A large portion of a tobacco manufacturer’s crops are destroyed by a hail storm. Severe damage from hail storms in the locality where the manufacturer grows tobacco is rare. (b) A citrus grower's Florida crop is damaged by frost. (c) A company sells a block of common stock of a publicly traded company. The block of shares, which represents less than 10% of the publicly-held company, is the only security investment the company has ever owned.

22. Reporting Extraordinary Items Are these items Extraordinary? (d) A large diversified company sells a block of shares from its portfolio of securities which it has acquired for investment purposes. This is the first sale from its portfolio of securities. (e) An earthquake destroys one of the oil refineries owned by a large multi-national oil company. Earthquakes are rare in this geographical location. (f) A company experiences a material loss in the repurchase of a large bond issue that has been outstanding for 3 years. The company regularly repurchases bonds of this nature.

23. Reporting Extraordinary Items Extraordinary Items are reported after “Income from continuing operations.” Previously labeled as “Net Income”. Moved to

24. Reporting Extraordinary Items McCarthy Corporation had after tax income from continuing operations of $55,000,000 in 2010. In addition, it suffered an unusual and infrequent pretax loss of $770,000 from a volcano eruption. The corporation’s tax rate is 30%. Prepare a partial income statement for McCarthy Corporation beginning with income from continuing operations. Income from continuing operations $__________ Extraordinary loss, ______________ Net income $__________

25. Reporting Discontinued and Extraordinary Reporting when both Discontinued Operations and Extraordinary Items are present. Discontinued Operations Extraordinary Item

26. Intraperiod Tax Allocations Relates an entity’s income tax expense to the specific items that cause the tax expense. Income tax expense is allocated to the following items: Income from continuing operations; Discontinued operations; Extraordinary items; Changes in accounting principle; Correction of errors.

27. Example of Intraperiod Tax Allocation Note: losses reduce the total tax Total Tax Allocated $23,700 (135) (81) (231) $23,253

28. Estimates [P4-3; CA4-8] Prospective, not Retrospective (e.g., accounted for in the period of change and future periods) Not considered errors or extraordinary items; Examples include Useful lives and salvage values of depreciable assets; Allowance for uncollectible receivables; Inventory obsolescence.

29. Change in Estimate - Example Arcadia HS, purchased equipment for $510,000 which was estimated to have a useful life of 10 years with a salvage value of $10,000 at the end of that time. Depreciation has been recorded for 7 years on a straight-line basis. In 2010 (year 8), it is determined that the total estimated life should be 15 years with a salvage value of $5,000 at the end of that time. Questions: • What is the journal entry to correct the prior years’ depreciation? • Calculate the depreciation expense for 2010.

30. Equipment cost $______ Salvage value ______ Depreciable base ______ Useful life (original) 10 years Annual depreciation $ __,000 Balance Sheet(Dec. 31, 2009) Fixed Assets: Equipment $______ Accumulated depreciation _______ Net book value (NBV) $_______ Change in Estimate – Example(2) First, establish NBV at date of change in estimate. After 7 years x __years = $______

31. Change in Estimate - Example(3) Net book value $______ Salvage value (new) ______ Depreciable base ______ Useful life remaining __ years Annual depreciation $______ Journal entry for 2010 Depreciation expense ______ Accumulated depreciation ______ Calculate Depreciation Expense for 2010.

32. Change in Accounting Principle Retrospective adjustment Adjust beginning Retained Earnings for cumulative effect of earliest year presented; Approach preserves comparability. Examples include: change in inventory valuation; from FIFO to average cost or LIFO; change from the percentage-of-completion to the completed-contract method.

33. Change in Accounting Principle - Example Gaubert Inc. decided in March 2010 to change from FIFO to weighted-average inventory pricing. Gaubert’s income before taxes, using the new weighted-average method in 2010, is $30,000. Pretax Income Data

34. Error Correction Result from: mathematical mistakes; mistakes in application of accounting principles; oversight or misuse of facts; Corrections treated as prior period adjustment restate all prior financial statements presented.

35. Error Correction - Example In 2011, Hillsboro Co. determined that it incorrectly overstated its accounts receivable and sales revenue by $100,000 in 2010. In 2011, Hillboro makes the following entry to correct for this error (ignore income taxes). Retained earnings 100,000 Accounts receivable 100,000

36. Changes in Retained Earnings Increase Decrease Net income Change in accounting principle Error corrections Net loss Dividends Change in accounting principles Error corrections

37. Exercise 4-11 (assume no comparative financial statements) *($40,000 + $125,000 + $160,000) – ($50,000 + $50,000) **[$220,000 – (40% X $220,000)]

38. Comprehensive Income • Changes in Net Equity not due to Owner Changes • Contributions; • Distributions. • Some examples • Unrealized gains and losses on available-for-sale securities; • Translation gains and losses on foreign currency.

39. Comprehensive Income Reported in the Equity Section of the Balance Sheet On the Income Statement OCI presented as net of tax. Three approaches to reporting Comprehensive Income (SFAS No. 130, June 1997): A second separate income statement; A combined income statement of comprehensive income; or As part of the statement of stockholders’ equity.

40. Comprehensive Income- 2nd Income Statement

41. Comprehensive Income – Combined Statement

42. Comprehensive Income – Statement of Stockholder’s Equity

43. Comprehensive Income – Balance Sheet Illustration 4-21 Regardless of the display format used, the accumulated other comprehensive income of $90,000 is reported in the stockholders’ equity section of the balance sheet.

44. International Aspects • Under international standards, companies must classify expenses by either • Nature; or • Function. • If a company uses the functional expense method on the income statement, disclosure by nature is required in the notes to the financial statements. • Income statement presentation is unrestricted • NO extraordinary items.