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Chapter 4: Income Statement
Format of the Income Statement
Net Income results from revenue, expense, gain and loss transactions.
Income Statement Summarizes these transactions
Transaction Approach: Focused on income-related activities that have occurred during the period.
Major Of the Income Statement
Revenues: Inflows or other enhancements of assets of an entity or settlements of its
liabilities during a period from delivering or producing goods/services or activities that
constitute the entitys ongoing major/central operations
Expenses-Outflows or other using up of assets or incurrences of liabilities during a period
from activities that constitutes entitys ongoing major/central operations
Gains-Increase in equity(net assets) from peripheral or incidental transactions of an entity
except those that result from revenues or investments by owners
Losses-Decreases in equity or net assets from peripheral or incidental transactions of anentity.
Forms of Revenue
Sales, fees, interest, dividends, rents, etc
Forms of Expenses
CoGS, depreciation, interest, rent, salaries/wages, taxes, etc
Forms of Gains/Losses
Sale of investments or plant assets, settlement of liabilities, write-offs of assets due to
impairment or casualty.
Single Step Income Statement
Two Groupings Revenues
Expenses
Expenses deducted from revenues to calculate net income or loss
Sometimes companies report income tax separately as last item before net income to show its
relationship to income before income tax.
Single Step Income Statement Format:
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Revenues
Net Sales xxxx
Dividend Revenue xxxx
Rent Revenue xxxx
Total Revenue
Expenses
CoGS xxxx
Selling Expenses xxx
Admin Expenses xxxx
Interest Expense xxxx
Income Tax Expense xxxx
Total Expenses yyyy
Net Income NI=(xxxx-yyyy)
Earnings Per Share =NI/Shares Outstanding
Multi Step Income Statement
Further classifications:
Seperation of Operating and Non-Operating Activities of the Company
Income from operations followed by sections titles Other revenues and Gains and
Other Expenses and Losses
Other Categories include transactions like interest revenues and expenses, gains or
losses from sale of long term assets, and dividends received.
Classification of expenses by functions like merchandising(CoGS), selling and administration.
Permits immediate comparison w/costs of previous years with other departments in the
same year.
Separates operating transactions from non-operating and matches costs and expenses with
related revenues.
Intermediate Components of the Income Statement
Companies using multistep income statement may prepare some or all of the following
sections:
Operating Section-Report of revenues and expenses of the companys principal
operations.
Includes:
Sales or Revenue Section Subsection presenting sales, discounts, allowances, returns and other
related info.
Purpose is to arrive at net amount of sales revenue
Cost of Goods Sold Section
Subsection that shows CoG sold to produce sales
Selling Expenses
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Lists expenses resulting from the companys efforts to make sales
Admin or General Expenses
Reports expenses of general administration
Non Operating Section
Report of rev. and exp. From secondary or auxiliary activities of the company.
Special Gains or Losses that are Infrequent or Unusual(BUT NOT BOTH) are
generally reported here as well.
Two Main Subsections:
Other Revenues and Gains
Lists rev. earned or gains incurred
Generally net of related expenses from Non Operating transactions
Other Expenses and Losses
List of exp. or losses incurred, generally net of an related incomes, from
non operating transactions.
Income Tax
Short section reporting federal and state taxes on income from continuing
operations
Discontinued Operations
Material Gains/Losses resulting from disposition of a segment of the business
Extraordinary Items
Unusual and Infrequent material gains and losses
Earnings Per Share
Although Content is always the same in the operating section, organization of material can differ
Natural Expense Classification
Manufacturing/Merchandising companies in wholesale trade Operating Section broken down into:
Sales or Rev
CoGS
Selling Expenses
Admin or General Expense
Functional Expense Classification
Retail stores
Op. Section broken down to:
Admin
Occupancy
Publicity
Buying
Selling
Multi Step Example:
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COMPANY NAME
Income Statement
For The Year Ended Month Day, Year
Sales Revenue
Sales $xxx
Less: Sales discounts $aaa
Sales Returns and Allowances bbb (aaa+bbb)
Net Sales Revenue xxx-(aaa+bbb)
Cost of Goods Sold yyyy
Gross Profit Net Sales-COGS
Operating Expenses
Sales and Saleries Expense yyyy
Sales Office Salaries yyyy
Travel and Entertainment yyyy
Advertising Expense yyyy
Freight and Trans-Out yyyyShipping Supplies and Expense yyyy
Postage and Stationary yyyy
Telephone and Internet Exp yyyy
Depreciation of Sales Expenses yyyy (yyyy)
Admin Expenses
Officer Salaries zzzz
Office Salaries zzzz
Legal and Prof. Services zzzz
Utilities Exp zzzz
Insurance Exp zzzzDepr. Of building zzzz
Dep. Of Office Equip. zzzz
Stationary, Supplies and Postage zzzz
Misc. Office Expenses zzzz zzzz (yyyy+zzzz)
Income from Operations Gross Profit-Sum(admin and Selling
Other Revenue/gains
Dividend Revenue xxxx
Rent Revenue xxxx (xxxx)
Income from Operation
Other Expenses and Losses
Int. On bonds and Notes (tttt)
Income before Income Tax Income-other expenses/losses
Income tax (ddd)
Net Income for Year Income-Income Tax
Earnings Per common share
net income/tot shares
outstandingg
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First Column of Totals=Only numbers from individual expense accounts both OperatingExpense Groupings
Second Column= Totals from selling and admin. exp.; Sales discounts and allowances;other revenues and gains(if more than one); other expenses and losses(if more than
one)
Third Column= Sales; sum(disc and allow.); Net sales Revenue; CoGS; Gross Profit;Sum(both operating expense totals); Income from operations; Sum(other revenues andgains); Sum(other exp. and losses); Income before tax; income Tax; Net Income;
Earnings per Common Share
Net Sales useful because regular revenues reported separately from irregular/incidentalrevenues.
Analysts can better understand and asses trends in rev. from continuing operations Gross Profit also reported
Can study trend to see how well company uses resources Income from operations highlights difference between regular and incidental activities
Irregular Items Modified all inclusive concept
Requires companies record most items, even irregular ones, as part of net income. Required to highlight irregular items in the fin. statements Six Categories of Irregular Items
Discontinued Operations
Extraordinary Items
Unusual Gains/Losses
Changes in Acct. principle
Changes in estimates
Correction of Errors Discontinued Operations
Occurs when two things happen:
A company eliminates the results of operations and cash flows of a component from itsongoing operations
There is no significant continuing involvement in that component after the disposaltransaction.
Product Group= lowest level at which company can distinguish the operations and cashflows from the rest of the companys operations.
Each Product Group is a component of the company.
Disposing of a Product Group must be classified as a discontinued operation
For example: Company has experienced losses with certain brands in a product group.
Company decides to sell that product group. After the sale Company will discontinue any continuing Involvement with that
group
Company eliminates operations and cash flows from that group from its ongoingoperations
=> Discontinued Operation
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typical activities of the company, taking into account the environment in
which it operates.
Infrequency of Occurrence
Company should not expect that the Event/Transaction to happen in theforeseeable future; taking into account the environment in which the
company operates.
Following gains/losses not extraordinary items because they are usual innature and can be expected to occur in the future as a consequence of
customary and continuing business activities:
**Write-downs or write offs of recievables, inventories, equipmentleased to others, deferred research and dev. Costs, or other intangible
assets
Gains/Losses from exchange or translation of foreign currencies,including those related to major devaluations and revaluations
Gains/losses on the disposal of a component of an entity
**Other gains/losses from sale or abandonment of property, plant orequipment used in the business
Effects of a strike, including those against competitors/major suppliers
Adjustment of accruals on long-term contracts. Example of extraordinary item would be both of the ** above if they
resulted directly from a major casualty(like an earthquake) or prohibition
under a newly acted law/regulation.
Company must consider the environment in which it operates
Environment includes factors like industry characteristics, geographiclocation, and nature/extent of government regulation.
Hail damage to crop if hail damage is rare in area=Extraordinary
Frost Damage to citrus crops in Florida= Not Extraordinary bc frostdamage occurs normally there every few years.
Also, if company sells only significant security investment its ever owned, the gain/loss is extraordinary.
Gains/losses from Extraordinary Items shown on Income statement justbefore Net Income :
Income before Extraordinary Items XXXX
Extraordinary Items
(less applicable income tax of $___) + - extraordinary Item
Unusual Gains/Losses
Items that are: Unusual or Infrequent, BUT NOT BOTH
If items are not material, they are combined with other items in income statement IF material, they must be disclosed separately and reported ABOVEIncome/Loss before
extraordinary items
Restructuring Charge
Not Extraordinary
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Unusual Items usually reported in separate section just above income from operationsbefore income taxes and extraordinary items, especially when there are multiple unusual
items.
For HW or school purposes, usually report unusual gains/losses in the Other Revenues andGains or Other Expenses and Losses section.
Changes in Acct. Principles Company recognizes change in acct. principles by making retrospective adjustment to
financial statements.
Recasts prior years statements on a basis consistent with newly adopted principle.
Company records cumulative effect of change for prior periods as an adjustment tobeginning retained earnings of earliest year presented.
Changes in estimates Company accounts for changes in estimates in the period of change if they affect only that
period or in the period of change and future periods if the change affects both.
Companies dont handle changes in estimates retroactiviely.
Changes not carried back to adjust prior years Changes in estimates not considered errors or extraordinary items
Correction of Errors Result of mathematical mistakes, mistakes in application of acct. principles, or
oversight/misuse of facts at the time statements were prepared.
Errors must be corrected by making proper entries in the accts and reporting the correctionsin the financial statements.
Correction of errors treated as prior period adjustments.
Record a correction of an error in the year in which it was discovered.
Report error in the statements as an adjustment to beginning balance of retainedearnings.
If comparative statements are prepared, it should restate the prior statements for theeffects of the error.
Summary of Irregular Items Except for changes in accounting principle and error corrections, which are charged or
credited directly to retained earnings, companies close all other irregular gains or lossesor nonrecurring items to Income Summary and include them in the income statement.
discontinued operations of a component of a business as a separate item in theincome statement, after Income from continuingoperations.
Extraordinary items section below Discontinued operations.separately disclose otheritems of a material amount that are of an unusual or nonrecurring nature and are notconsidered extraordinary.
Intraperiod Tax Allocation Irregular Items (excapet for unusual gains/losses) on the income statement or statement of
retained earnings net of tax.
Called Intraperiod Tax Allocation Relates Income Tax expense of fiscal period to specific items that give rise to the amt. of
the tax provision. Helps users understand how much tax expense relates to income from continuing
operations and how much relates to certain irregular transactions and events. Used on the following items in the income statement:
Income from continuing operations Discontinued Operations Extraordinary Items
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Let the Tax Follow the Income Company computes tax expense for income from cont. Operations
Find tax expense related to both rev. and exp transactions used in determining thisincome.
Does not consider tax of items excluded from determining income from operations Compute separate tax effect with each irregular item (i.e. discontinued operations and
extraordinary items.) Extraordinary Gains: Income before taxes and extraordinary gain of 250,000 Extraordinary gain of 100,000 from condemnation settlement received on property. 30% income tax rate.
Income before Income Tax and Extraordinary Item $250,000Income Tax (75000)
Income before Extraordinary Item 175,000Extraordinary Gain-Condemnation Settlement $100,000
Less: Applicable Income Tax reduction (30,000) 70,000Net Income $245,000
Extraordinary Losses Income before taxes and extraordinary gain of 250,000 Extraordinary loss of 100,000 from major casualty Tax rate of 30%
Income before Income Tax and Extraordinary Item $250,000Income Tax (75000)
Income before Extraordinary Item 175,000Extraordinary Loss-Major Casualty $100,000
Less: Applicable Income Tax reduction (30,000) 70,000Net Income $105,000
Because its a loss, its tax deductible. Subtract tax rate from loss, to get net ofapplicable income tax reduction.
Earnings Per Share EPS=Net Income-Preferred Dividends(Income Available to Common Stockholders)
Weighted Average of Common Shares Outstanding
Net income=350,000 Preff. Div= 50,000 Weighted Avg. Shares Outstandind=100,000
EPS=$3.00 per share EPS must be disclosed on Face of Income Statement
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If company reports Discontinued Operation, or extraordinary Item:
Per share amts for these items must be reported on face on income statement or in thenotes to the financial statements.
Net Income xxx
Per Share of Common Stock
Income from Cont. Operations x.xx
Income/Loss from discontinued component
Net of Tax + - y.yy
Loss/Gain on disposale of disc.
Operation, Net of Tax +- z.zz
Income before extraordinary Item x.xx +-y.yy+-z.zz
Extraorindary Gain/Loss , net of tax +-e.ee
Net Income s.ss
Retained Earnings Statement Net Income increases Retained Earnings
Net Loss Decreases Retained Earnings Cash/Stock Dividends decrease retained earnings. Changes in Acct. Principles(generally) and prior period adj. may increase or decrease
retained earnings.
Companies charge/credit these adjustments(net of tax) to the opening balance of retainedearnings.
This Excludes adj. from the determination of net income for the current period.
Companies may show retained earnings info in diff . Ways.
Some prepare statement of retained earnings.Statement of Retained Earnings Example
Retained Earnings, Beginning as reported xxxAdjustment +-yyy
Retained Earnings, Beginning, as adjusted xxx
Add: Net Income yyy
Xxx
Less: Cash Dividends xxx
Stock Dividends yyy (xxx)
Retained Earnings, End xxx
Comprehensive Income Because fair values are continually changing, some argue that recognizing these gains and
losses in net income is misleading. Limited number of transactions should be recorded directly to stockholders equity.
Unrealized gains and losses on available for sale securities.
These are excluded from net income
Items that bypass the income statement are included in a measure called comprehensive
income.
Includes all changes in equity during a period except those resulting from investments by owners and
distributions to owners. Because fair values are continually changing, some
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argue that recognizing these gains and losses in net income is misleading. Comprehensive Income includes:
All revenues and gains All expenses and losses reported in net income All gains and losses that bypass net income but affect stockholder equity.
Other Comprehensive Income
Items that bypass net income but affect stockholders equity Non Owner Changes in equity that bypass income statements.
Can Display Other Comprehensive Income 3 ways: Second Income Statement Combined Statement of comprehensive Income Part of the statement to stockholders equity.
Comprehensive Income= Net Income + Other Comprehensive Income
Example:Sales Revenue=800,000
CoGS= 600,000
Op. Exp = 90,000
Unrealized Holding Gain on AFS securities= 30,000, net of tax
Second Income Statement Method
Income Statement
Sales Revenue 800,000
CoGS 600,000
Gross Profit 200,000
Op. Exp. 90,000
Net Income 110,000
Comprehensive Income Statement
Net Income 110,000
Other Comprehensive Income
Unrealized Holding gain,
Net of Tax 30,000
Comprehensive Income 140,000
Combined Statement of Comprehensive Income:the traditional net income is a subtotal, with total comprehensive income shown as a final total
Statement of Stockholders Equity: Reports changes in each stockholder equity account and in total stockholdersequity during the year.
Prepared in Columnar Form Columns Used for Each Account and for Stockholders Equity
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Ex:Same info as beforeCommon Stock 300000Ret. Earnings 50,000Acc. Other Comprehensive Inc. 60,000
Statement of SH EquityTotal Comprehensive Income Ret. Earnings Acc. OCI Common StockBeg. Balance 410,000 50,000 60,000 300,0000Comp. Income 110,000 110,000 110,000OCI
UnrealizedHolding Gain,Net of Tax 30,000 30,000 30,000
Comp. Inc. 140,000End Balance 550,000 160,000 90,000 300,000
Recommended