The Income Statement and Statement of Cash Flows

1. C 4 hapter The Income Statement and Statement of Cash Flows

2. Objectives 1. Understand the concept of income. 2. Explain the conceptual guidelines for reporting income. 3. Define the elements of an income statement. 4. Describe the major components of an income statement. 5. Compute income from continuing operations.

3. Objectives 6. Compute results from discontinued operations. 7. Identify extraordinary items. 8. Prepare a statement of retained earnings. 9. Report comprehensive income. 10. Explain the statement of cash flows. 11. Classify cash flows as operating, investing, or financing.

4. Concepts of Income Capital Maintenance Concept Under this concept, corporate income for a period of time is the amount that may be paid to stockholders during that period and still enable the corporation to be as well off at the end of the period as it was at the beginning.

5. Ending net assets $90,000 Less: Additional investment 0 Ending net assets excluding investment $90,000 Less: Beginning net assets (50,000) Total income for the year $40,000 The corporation could pay out $40,000 to stockholders and still be as well off at year-end. Concepts of Income Capital Maintenance Concept Assume a corporation has net assets of $50,000 at the beginning and $90,000 at the end of the year, and that no additional investments or withdrawals were made.

6. Ending net assets $80,000 Less: Additional investment -10,000 Ending net assets excluding investment $70,000 Less: Beginning net assets (45,000) Total income for the year $25,000 Concepts of Income Capital Maintenance Concept Assume a corporation has net assets of $45,000 at the beginning and $80,000 at the end of the year. Stock- holders made additional capital investments of $10,000.

7. The transactional approach to income measurement is used in accounting today. Concepts of Income Transactional Approach Under this concept, a company records its net assets at their historical cost, and it does not record changes in the asset and liabilities unless a transaction, event, or circumstance has occurred that provides reliable evidence of a change in value.

8. Conceptual Reporting Guidelines • Providing information about its operating performance separately from other aspects of performance. • Presenting the results of particularly significant activities or events that predict the amounts, timing, and uncertainty of its future income and cash flows. • Providing information useful for assessing the return on investment. The FASB suggests that a company’s income statement can be improved by-- Continued

9. Conceptual Reporting Guidelines • Providing feedback that enables users to assess their previous predictions of income and its components. • Providing information to help assess the cost of maintaining its operating capability. • Presenting information about how effectively management has discharged its stewardship responsibilities regarding the company’s resources.

10. Specific Conceptual Guidelines • Those items that are judged to be unusual in amount based on past experience should be reported separately. • Revenues, expenses, gains, and losses that are affected in different ways by changes in economic conditions should be distinguished from one another. • Sufficient detail should be given to aid in understanding the primary relationships among revenues, expenses, gains, and losses. Guidelines on how to report revenues, expenses, gains, and losses. Continued

11. Specific Conceptual Guidelines • When the measurements of revenues, expenses, gains, or losses are subject to different levels of reliability, they should be reported separately. • Items whose amounts must be known for the calculation of summary indicators (e.g., rate of return) should be reported separately.

12. Revenues …from delivering or producing goods, rendering services, or other activities that are the company’s ongoing major or central operations. Revenues are inflows of assets of a company or settlement of its liabilities during a period...

13. Revenues Recognition is the process of formally recording and reporting an item in a company’s financial statements.

14. Revenues A company usually recognizes revenue at the time goods are sold or services are rendered.

15. Expenses …rendering services, or carrying out other activities that are the company’s ongoing major or central operations. Expenses are outflows of assets of a company or incurrences of liabilities during a period from delivering or producing goods,...

16. If a cost results in an economic resource providing future benefits, record it as an... Cost Cost: Asset or Expense Transaction Asset Continue

17. If a cost is a result of providing goods or services in a time period, record it as an... Cost Cost: Asset or Expense Transaction Expense

18. Cost: Asset or Expense If the benefits have been used up, the asset is changed to an expense.

19. Income Statement Content 1. Income from continuing operations. a. Sales revenue (net) b. Cost of goods sold c. Operating expenses d. Other items e. Income tax expense related to continued operations

20. Income Statement Content 2. Results from discontinued operations. a. Income (loss) from operations of discontinued segments (net of income taxes). b. Gain (loss) from disposals of discontinued segments (net of income taxes).

21. That’s it! Income Statement Content 3. Extraordinary items (net of income taxes). 4. Cumulative effects of changes in accounting principles (net of income taxes). 5. Net income. 6. Earnings per share .

22. BANNER CORPORATION Schedule 1: Cost of Goods Sold For Year Ended December 31, 2000 Inventory, January 1, 2000 $ 41,000 Purchases $80,300 Freight-in 5,500 Cost of purchases $85,800 Less: Purchases returns (2,800) Net purchases 83,000 Cost of goods available for sale $124,000 Less: Inventory, December 31, 2000 (38,000) Cost of goods sold $ 86,000 Cost of Goods Sold: Merchandising Company

23. BANNER CORPORATION Schedule 1: Cost of Goods Sold For Year Ended December 31, 2000 Raw materials used $ 35,000 Direct labor 29,000 Factory overhead Depreciation of factory items $5,100 Heat, light, and power 4,000 Indirect factory labor 7,300 Repairs and maintenance 3,400 Miscellaneous factory expense 1,200 21,000 Current manufacturing costs $ 85,000 Cost of Goods Sold: Manufacturing Company Continued

24. Cost of Goods Sold: Current manufacturing costs $ 85,000 Add: Goods in process, January 1, 2000 27,000 Less: Gods in process, December 31, 2000 (29,000) Cost of goods manufactured $ 83,000 Add: Finished goods inventory, Jan. 1, 2000 41,000 Cost of goods available for sale $124,000 Less: Finished goods inventory, December 31, 2000 (38,000) Cost of goods sold $ 86,000

25. Income Tax Expense Interperiod tax allocation involves allocating a corporation’s income tax obligation as an expense to various accounting periods because of temporary (timing) differences between its taxable income and pretax financial income.

26. Income Tax Expense Intraperiod tax allocation involves allocating a corporation’s total income tax expense for a period to the various components of its net income, retained earnings, and other comprehensive income.

27. Income Tax Expense Income tax expense is matched against the following: • income from continuing operations • income (loss) from the operations of a discontinued segment • gain (loss) from the disposal of a discontinued segment • extraordinary items • cumulative effect of any change in accounting principles • any prior period adjustments • any items of other comprehensive income

28. Single-Step Income Statement Revenues Sales revenue $143,700 Interest revenue 1,800 Dividend revenue 600 Total revenues $146,100 Expenses Cost of goods sold $ 86,000 Selling expense 10,200 General and admin. expense 16,000 Depreciation expense 7,800 Continued

29. Expenses (continued) Loss on sale of equipment 4,000 Interest expense 2,100 Income tax expense 6,000 Total expenses (132,100) Income from continuing operations $14,000 Results from discontinued operations Income from operations of segment A (net of $1,950 income taxes) $ 4,550 Loss on disposal of segment A (net of $3,150 income tax) (7,350) (2,800) Income before extraordinary items $ 11,200 Continued

30. Earnings per Common Share (8,000 shares) Components of Income Income from continuing operations $2.80 Results from discontinued operations (0.56) Extraordinary loss from explosion (0.35) Cumulative effect on prior years’ income 0.28 Net income $2.17 Income before extraordinary items $ 11,200 Extraordinary loss from explosion (net of $750 income tax credit) (1,750) Cumulative effect on prior years’ income of change in depreciation method (net of $600 income taxes) 1,400 Net income $ 10,850

31. Income Statement: Results from Discontinued Operations Examples from APB No. 30 The sale by a diversified company of a major division that represented the company’s only activities in the electronic industry. The sale by a diversified company of a major division that represented the company’s only activities in the electronic industry.

32. Income Statement: Results from Discontinued Operations Examples from APB No. 30 The sale by a meat packing company of its 20% interest in a professional football team. The sale by a meat packing company of its 20% interest in a professional football team.

33. Reported net of taxes Reported net of taxes Income Statement: Results from Discontinued Operations Income from continuing operations $93,000 Results from discontinued operations: Income from operations of discontinued Division X (net of $2,880 income taxes) $ 6,720 Loss on disposal of Division X (net of $6,000 income tax credit) (14,000) (7,280) Income before extraordinary items $85,720

34. Income Statement: Results from Discontinued Operations Discontinued operations are reported on the income statement after the continuing operations, but before extraordinary items.

35. Income Statement: Results from Discontinued Operations Income from continuing operations $93,000 Results from discontinued operations: Income from operations of discontinued Division X (net of $2,880 income taxes) $ 6,720 Loss on disposal of Division X (net of $6,000 income tax credit) (14,000) (7,280) Income before extraordinary items $85,720 Component 1: operating income (loss)

36. Income Statement: Results from Discontinued Operations Income from continuing operations $93,000 Results from discontinued operations: Income from operations of discontinued Division X (net of $2,880 income taxes) $ 6,720 Loss on disposal of Division X (net of $6,000 income tax credit) (14,000)(7,280) Income before extraordinary items $85,720 Component 2: gain or loss on disposal

37. Pretax operating income, $8,000 Gain or Loss on Disposal Phase-Out Within Accounting Period Measurement Date 7/1/00 1/1/00

38. Pretax operating income, $2,000 Gain or Loss on Disposal Phase-Out Within Accounting Period Segment X was sold at a loss of $10,000 (pretax) Measurement Date 7/1/00 Disposal Date 12/1/00

39. Operating income 1/1-7/1 $ 8,000 Less taxes (30%) (2,400) Gain or Loss on Disposal Phase-Out Within Accounting Period Results from discontinued operations Income from operations of discontinued Segment X (net of $2,400 income taxes) $ 5,600

40. Operating income 7/1-12/1 $ 2,000 Loss on sale of segment (12,000) Loss (pretax) $(10,000) Less tax credit (30%) 3,000 Gain or Loss on Disposal Phase-Out Within Accounting Period Results from discontinued operations Income from operations of discontinued Segment X (net of $2,400 income taxes) $ 5,600 Loss on disposal of Segment X (net of $3,000 income tax credit) (7,000) $(1,400)

41. Pretax operating income, $14,000 * *Recognized on the measurement date Gain or Loss on Disposal Phase-Out After Fiscal Year-End Measurement Date 8/1/00 1/1/00

42. Pretax operating loss, $8,000 Gain or Loss on Disposal Phase-Out After Fiscal Year-End Measurement Date 8/1/00 Fiscal Year-End 12/31/00 Disposal Date 5/1/01 Pretax operating income, $11,000

43. Operating income 1/1-8/1 $14,000 Less taxes (30%) (4,200) Gain or Loss on Disposal Phase-Out After Fiscal Year-End Results from discontinued operations Income from operations of discontinued Segment Y (net of $4,200 income taxes) $ 9,800

44. Operating income 8/1/00-5/1/01 $ 3,000 Loss on sale of segment (22,000) Loss (pretax) $(19,000) Less tax credit (30%) 5,700 Gain or Loss on Disposal Phase-Out After Fiscal Year-End Results from discontinued operations Income from operations of discontinued Segment Y (net of $4,200 income taxes) $ 9,800 Loss on disposal of Segment Y (net of $5,700 income tax credit) (13,300) $(3,500)

45. Extraordinary Items An extraordinary item is an event or transaction that is both unusual in nature and infrequent in occurrence. Unusual nature--the underlying event or transaction possesses a high degree of abnormality and is of a type clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the company. Infrequency of occurrence--the underlying event or transaction is of a type that is not reasonably expected to recur in the foreseeable future.

46. Extraordinary Items Events that the APB identified as not qualifying as extraordinary: • The write-down or write-off of receivables, inventories, equipment leased to others, or intangible assets. • Gains or losses from exchanges or transactions of foreign currency. • Gains or losses from the disposal of a business segment. Continued

47. Extraordinary Items Events that the APB identified as not qualifying as extraordinary (continued): • Other gains or losses from the sale or abandonment of property, plant, or equipment. • The effects of a strike. • The adjustment of accruals on long-term contracts.

48. No No or Income from Continuing Operation (Other Items section) Income from Continuing Operation (Other Items section) Extraordinary Items Event Report Gain (Loss) As Unusual? Infrequent?

49. No No Yes Yes Extraordinary Item and or Extraordinary Items Event Report Gain (Loss) As Unusual? Infrequent?

50. Statement of Retained Earnings Beginning retained earnings $59,200 Plus (minus): Prior period adjustment (net of $2,400 income taxes) 5,600 Adjusted beginning retained earnings $64,800 Plus (minus): Net income (loss) 22,300 $87,100 Minus: Dividends (specifically identified, including per share amounts) (9,400) Ending retained earnings $77,700