Chapter 4 THE INCOME STATEMENT AND STATEMENT OF CASH FLOWS Sommers ACCT 3311

1. Chapter 4 THE INCOME STATEMENT AND STATEMENT OF CASH FLOWS Sommers � ACCT 3311 Chapter 1: Environment and Theoretical Structure of Financial Accounting.Chapter 1: Environment and Theoretical Structure of Financial Accounting.

2. In General The purpose of the income statement is to summarize the profit-generating activities that occurred during a particular period. The purpose of the statement of cash flows is to provide information about the cash receipts and cash disbursements of a firm that occurred during a period. Different information (sometimes complements, sometimes substitutes) therefore different audiences/uses.

3. Discussion Questions Q4�1 The income statement is a change statement. Explain what is meant by this.

4. CVS Caremark Income Statement

5. Discussion Questions Q4�3 Distinguish between operating and nonoperating income in relation to the income statement.

6. Operating Versus Nonoperating Income A distinction is often made between operating and nonoperating income. Operating income includes revenues and expenses directly related to the principal revenue-generating activities of the company. Nonoperating income is reported separately in the income statement and includes gains and losses and revenues and expenses related to peripheral or incidental activities of the company. For example, income from investments, gains and losses from the sale of operating assets and from investments, interest and dividend revenue, and interest expense are included in nonoperating income. A distinction is often made between operating and nonoperating income. Operating income includes revenues and expenses directly related to the principal revenue-generating activities of the company. Nonoperating income is reported separately in the income statement and includes gains and losses and revenues and expenses related to peripheral or incidental activities of the company. For example, income from investments, gains and losses from the sale of operating assets and from investments, interest and dividend revenue, and interest expense are included in nonoperating income.

7. Discussion Questions Q4�5 Explain what is meant by the term earnings quality. Transitory versus Permanent Earnings

8. Earnings Quality � Operating/Nonoperating Operating Income Restructuring Costs � Costs 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. Nonoperating Income Gains and losses from the sale of operational assets and investments - Often can significantly inflate or deflate current earnings. Most of the components of earnings in an income statement relate directly to the ordinary, continuing operations of the company. Some, though, such as interest and gains and losses are only tangentially related to normal operations. These we refer to as nonoperating items. Some nonoperating items have generated considerable discussion with respect to earnings quality, notably gains and losses generated either from the sale of operational assets or from the sale of investments.Most of the components of earnings in an income statement relate directly to the ordinary, continuing operations of the company. Some, though, such as interest and gains and losses are only tangentially related to normal operations. These we refer to as nonoperating items. Some nonoperating items have generated considerable discussion with respect to earnings quality, notably gains and losses generated either from the sale of operational assets or from the sale of investments.

9. Discussion Questions Q4�10 How should extraordinary gains and losses be reported in the income statement? Unusual in nature Infrequent in occurrence

10. Intraperiod Income Tax Allocation Intraperiod tax allocation associates (or allocates) income tax expense (or income tax benefits if there is a loss) with each major component of income that causes it. As a result, the two items reported separately below income from continuing operations are presented net of the related income tax effect. Intraperiod tax allocation associates (or allocates) income tax expense (or income tax benefits if there is a loss) with each major component of income that causes it. As a result, the two items reported separately below income from continuing operations are presented net of the related income tax effect.

11. Income Statement Classifications

12. Separately Reported Items Income from continuing operations before income taxes and extraordinary items $ xxx Income tax expense xx Income from continuing operations before extraordinary items xxx Discontinued operations (net of $xx in taxes) xx Extraordinary items (net of $xx in taxes) xx Net Income $ xxx Generally accepted accounting principles require that certain transactions be reported separately in the income statement, below income from continuing operations. There are two types of events that, if material, require separate reporting and disclosure: (1) discontinued operations and (2) extraordinary items. In fact, these are the only two events that are allowed to be reported below continuing operations. The presentation order is also dictated as shown on the slide. The objective is to separately report all the income effects of each of these items. Generally accepted accounting principles require that certain transactions be reported separately in the income statement, below income from continuing operations. There are two types of events that, if material, require separate reporting and disclosure: (1) discontinued operations and (2) extraordinary items. In fact, these are the only two events that are allowed to be reported below continuing operations. The presentation order is also dictated as shown on the slide. The objective is to separately report all the income effects of each of these items.

13. Discussion Questions Q4�20 Identify any differences between U.S. GAAP and International Financial Reporting Standards (IFRS) in the number of possible separately reported items that could appear in income statements.

14. Earnings Per Share Disclosure Part I One of the most widely used ratios is earnings per share, which shows the amount of income earned by a company expressed on a per share basis. Companies report both basic and diluted earnings per share. Part II Basic earnings per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding. Part III Diluted earnings per share reflects the potential for 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 Part I One of the most widely used ratios is earnings per share, which shows the amount of income earned by a company expressed on a per share basis. Companies report both basic and diluted earnings per share. Part II Basic earnings per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding. Part III Diluted earnings per share reflects the potential for 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

15. Comprehensive Income An expanded version of income that includes four types of gains and losses that traditionally have not been included in income statements. Net unrealized holding gains (losses) from investments (net of tax). Gains and losses due to reviewing assumptions or market returns differing from expectations and prior service cost from amending the postretirement benefit plan. 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. Gains or losses from changes in foreign currency exchange rates. The amount could be an addition to or reduction in shareholders� equity. Comprehensive income is the total change in equity for a reporting period other than from transactions with owners. Comprehensive income includes net income as well as other gains and losses that change shareholders� equity but are not included in traditional net income.Comprehensive income is the total change in equity for a reporting period other than from transactions with owners. Comprehensive income includes net income as well as other gains and losses that change shareholders� equity but are not included in traditional net income.

16. Accumulated 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 this example, Jabil Circuits Inc. reports Accumulated Other Comprehensive Income of $171 million and $110 million for years 2007 and 2006, respectively. 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 this example, Jabil Circuits Inc. reports Accumulated Other Comprehensive Income of $171 million and $110 million for years 2007 and 2006, respectively.

17. P4-6 Rembrandt Paint Company had the following income statement items for the year ended December 31, 2011 ($ in 000s): Net sales $18,000 Cost of goods sold $10,500 Interest income 200 Selling & admin expenses 2,500 Interest expense 350 Restructuring costs 800 Extraordinary gain 3,000 In addition, during the year the company completed the disposal of its plastics business and incurred a loss from operations of $1.6 million and a gain on disposal of the component�s assets of $2 million. 500,000 shares of common stock were outstanding throughout 2011. Income tax expense has not yet been accrued. The income tax rate is 30% on all items of income (loss). Required: Prepare a multiple- step income statement for 2011, including EPS disclosures.

18. P4-6