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Chapter 5

Chapter 5 The Income Statement Income Measurement Beginning of Year End of Year Business Deals Business Deals Accrual Accounting Raw transaction data is refined from When paid/collected to When incurred/earned Resulting from transactions of the current period

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Chapter 5

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  1. Chapter 5 The Income Statement

  2. Income Measurement Beginning of Year End of Year Business Deals Business Deals Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  3. Accrual Accounting • Raw transaction data is refined from • When paid/collected to • When incurred/earned • Resulting from transactions of the current period • Measures economic performance Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  4. Different Measuresof Income

  5. Different Measures Of Income Increase in wealth • a simple definition Physical capital maintenance • income is earned only when there is an increase in actual physical resources Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  6. Different Measures Of Income Financial capital maintenance • income exists when the dollar amount of a company’s net assets increases during the year, excluding the effects of owner investments and dividends • this is the approach that accountants use to measure income Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  7. Different Measures Of Income Sales – Cost of goods sold = Gross profit – Other operating expenses, gains, and losses = Operating income – Interest expense ± Miscellaneous revenues, expenses, gains, and losses = Income before taxes – Income tax expense = Income from continuing operations ± Income from discontinued operations ± Extraordinary items ± Cumulative effect of accounting changes = Net income ± Unrealized gains and losses not included in net income = Comprehensive income operating income minus interest expense, income tax expense, and other miscellaneous items

  8. Different Measures Of Income Sales – Cost of goods sold = Gross profit – Other operating expenses, gains, and losses = Operating income – Interest expense ± Miscellaneous revenues, expenses, gains, and losses = Income before taxes – Income tax expense = Income from continuing operations ± Income from discontinued operations ± Extraordinary items ± Cumulative effect of accounting changes = Net income ± Unrealized gains and losses not included in net income = Comprehensive income income from continuing operations adjusted for “below the line” items

  9. “Below the Line” Items Income or loss from discontinued operations • results from the disposal of a major business segment Extraordinary gains and losses • unusual in nature and infrequent in occurrence Cumulative effect of accounting changes • a “catch-up” adjustment for a change to a new accounting method` Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  10. Different Measures Of Income Sales – Cost of goods sold = Gross profit – Other operating expenses, gains, and losses = Operating income – Interest expense ± Miscellaneous revenues, expenses, gains, and losses = Income before taxes – Income tax expense = Income from continuing operations ± Income from discontinued operations ± Extraordinary items ± Cumulative effect of accounting changes = Net income ± Unrealized gains and losses not included in net income = Comprehensive income net income plus (minus) changes in market condition unrelated to business operations

  11. Unrealized Gains & Losses • Changes in the dollar value of foreign subsidiaries caused by movement of foreign currency exchange rates • Changes in the value of investment securities that are not actively traded • Changes in the value of certain derivative financial instruments Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  12. Individual Income Statement Items

  13. Revenues • The value of the goods and services provided by a company in its business operations • Sales revenue: the aggregate selling price of goods sold during the period • Service revenue: fees charged for services Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  14. Non-Operating Revenues • Interest revenue: earned from extending credit or loaning money • Other revenue: comprised of revenues that come from different sources Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  15. Expenses The value of resources used in generating reported revenue Cost of goods sold: the expense directly associated with the sales revenue for the period Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  16. Expenses (con’t) Selling General, & Administrative Expense • Research and development • Expensing required • Wages and salaries • Bad debt • The cost of selling merchandise on credit Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  17. Expenses (con’t) Depreciation • Allocation of the cost of long-lived assets Interest expense • The cost of borrowing money Income tax expense • The sum of all income tax consequences of all transactions during a year Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  18. Gains and Losses Created by activities peripheral to a company’s primary operations • Sale of long-term assets • Restructuring charges Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  19. “Below the Line” Items All reported net of applicable income taxes • Income (or loss) from discontinued operations • Extraordinary (unusual and infrequent) gains and losses • Cumulative effect from change in accounting principle Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  20. Comprehensive Income Reflects the overall change in a company’s wealth during a period. Includes three items not reported in net income: • Foreign currency translation adjustment • Unrealized gains and losses on available-for-sale securities • Deferred gains and losses on derivative financial instruments Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  21. Earnings Per Share (EPS) • The amount of net income associated with each share of stock • Two earnings per share numbers: • Basic EPS reports earnings based solely on shares actually outstanding during the year • Diluted EPS reflects the existence of stock options and other potentially dilutive securities Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  22. Single-Step Income Statement

  23. Multiple-Step Income Statement

  24. Revenue Recognition Revenue is recognized when • The promised work is done, and • Cash collectibility is reasonably assured Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  25. Expense Recognition Is based on the matching principle • An expense should be recognized in the same period in which the revenue it generates is recognized Three bases of expense recognition: • Direct matching (or cause and effect) • Systematic allocation • Immediate recognition Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  26. Expense Recognition:Direct Matching The expense is directly traceable to the revenue it generates (cause and effect) • Cost of goods sold matched with sales • Sales commissions matched with sales Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  27. Expense Recognition:Systematic Allocation The expense is associated more with the passage of time than a specific revenue-generating activity • Depreciation expense • Insurance expense Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  28. Expense Recognition:Immediate Recognition An expenditure is expensed currently because there is no future benefit or the future benefit is uncertain • Advertising expense • Research and development expense Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  29. Expanded Accounting Equation Paid-In Capital + Retained Earnings Beginning RE + Net Income - Dividends Revenues + Gains – Expenses - Losses Assets = Liabilities + Stockholders’ Equity Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  30. Veda Landscape SolutionsJanuary 1 transactions (from chapter 4) Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  31. Transaction Analysis • Key points to remember • Revenues increase retained earnings • Expenses decrease retained earnings • Dividends decrease retained earnings • The income statement can be prepared from the revenue and expense columns of the spreadsheet Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  32. Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  33. Forecasting the Future Past income statements can be used to predict income in future periods Good forecasting requires an understanding of what factors determine the amount of a future revenue or expense Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  34. Forecasting Sales Forecasting begins with a forecast of sales The sales forecast forms the basis of predicting the future balance sheet, income statement, and statement of cash flows Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  35. Forecasting the Balance Sheet Natural Increase • Cash, accounts receivable, inventory, and accounts payable Long-term Planning • Property, plant, and equipment Financing Choices • Long-term debt and paid-in capital Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  36. Forecasting the Income Statement Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  37. Forecasting the Income Statement Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  38. In Summary ... • A variety of income measurements • Income statement reports revenues, expenses, gains, and losses • Comprehensive income includes additional unrealized gains and losses • Expanded accounting equation • Forecasting the future from historical statements Financial Accounting, 7e Stice/Stice, 2006 © Thomson

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