Ch.4 Study Sheet

7/31/2019 Ch.4 Study Sheet

1/12

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:


2/12

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


3/12

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


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:


4/12

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


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


5/12

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


6/12


7/12

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


8/12

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


9/12

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


10/12

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


11/12

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


12/12

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

Documents

Ch.4 Study Sheet