Financial accounting 9th jamie pratt chapter 13

Chapter 13:
The Complete Income Statement


The Economic Consequences Associated with Income
Measurement and Disclosure
 Income is the most common measure of a company’s performance.

 A measure of a change in value
 As compared to equity, which measures the level of value (or

wealth)
 It is NOT net cash flow

 It is a measure of performance
 There are different income measures which relate to different

objectives (GAAP provides for various measures to be presented)


The Measurement of Income: Different Measures for
Different Objectives


According to Statement of Financial Accounting
Concepts No. 1 Objectives of financial reporting
are (paraphrased) to provide information that is:


Useful to those making investment and credit

decisions



Helpful in assessing amounts, timing

and uncertainty of future cash flows


About economic resources, claims and changes to


The Measurement of Income: Different Measures for Different Objectives (cont’d)

Figure 13-1 (partial) Elements of the financial statements


The Measurement of Income: Different Measures for Different Objectives (cont’d)

Figure 13-1 (partial) Elements of the financial statements


The Measurement of Income: Different
Measures for Different Objectives (cont’d)

Figure 13-1 (partial) Elements of the financial statements


The Measurement of Income: Different
Measures for Different Objectives (cont’d)

 Comprehensive income - changes in net assets from all non-

owner sources; is broken into two categories:
 Net Income: consisting of revenues, expenses, gains and

losses (next slide)
 Other Comprehensive Income

Campbell’s Soup 2012 statement of Shareholders’ Equity


The Income Statement
Operating
1 Section
2 Non-Operating
Section
3

Sales Revenue
less:
less:
less:

Cost of Goods Sold
Selling Expenses
Administrative Expenses

Add:
Less:

Other Revenues and Gains
Other Expenses and Losses

Income Tax

Irregular
4
Items
5

Net Income

6

Earnings per Share

Discontinued Operations (net of tax)
Extraordinary Items (net of tax)


Two Different Concepts of Income:
Matching and Fair Market Value
 The Matching Process:
 Revenues - Expenses = Net Income

 Fair Market Value approach:
 FMV Net Assets (end) - FMV Net Assets

(beginning) = Net Income

Financing, Investing, and Operating Transactions: A Framework

Figure 13-2 Classifying financing, investing, and operating transactions


Classifying Operating Transactions

Figure 13-3 Classifying operating transactions


A Complete Income Statement:
Disclosure and Presentation
 See Figure 13-4 for sample format:
Sales
-

COGS

= Gross profit
-

Operating expenses

= Income from operations
+ Other revenues and gains
-

Other expenses and losses

= Income from continuing operations (IFCO)
+/- Discontinued operations
+/- Extraordinary items
= Net income
Earnings per Share


Presentation
 Note the subtotals:
 Gross profit is presented when a company uses a multi-step

income statement; more relevant for companies that are primarily
retail or manufacturing (less relevant for service industries).

 Income from operations indicates income from primary, on-

going activity (usual and frequent).

 Income from continuing operations (IFCO) also includes

peripheral activity like interest income, as well as potentially
nonrecurring activity like restructuring Charges (unusual or
infrequent).

 Net income also includes “special” items that are presented

separately because they are significant activities that are usually
nonrecurring.

(1) Operating Revenues and Expenses: Usual and
Frequent

Looking at Figure 13-4 A Complete Income
Statement
Asset and liability inflows and outflows related
to the delivery of goods or services provided by
a company and Operating Revenues and
Expenses
They are usual and frequent and therefore are
likely to represent ongoing activity


(2) Other Revenues and Expenses: Unusual or
Infrequent
 Related to secondary or auxiliary activities:


Interest Income – from financing



Interest Expense – from financing



Dividend Income



Gains and Losses from trading securities



Gains and Losses from sale of investments and long-lived assets

 Some of these are recurring, but none are core

activities


(3) Disposal of a Business Segment
 Discontinued operations (DO) relate to the disposal of a

segment of a company. Because the disposal means that the
segment activity will be discontinued, separate disclosures are
required so that investors could distinguish between ongoing
activity and nonrecurring activity.

 A segment is defined as an entire line of business or a

separately identifiable segment. For example, General Motors
would need to discontinue Chevrolet (not just a manufacturing
plant).

 Financial statement presentation includes any operating

income or loss to the measurement date (the date the board of
directors declares intention to dispose of the segment), as well
as any gain or loss on the disposal of the assets.

(4) Extraordinary Items: Unusual and Infrequent
 Extraordinary items (EI) are defined as those

activities that are material in amount, unusual in
nature, and infrequent in occurrence.

 To determine, consider the natural, political, and

economic environment of the firm (i.e. the same
type of event may be extraordinary for some and
may not be extraordinary for other organizations).

 Examples of EI include natural disasters,

nationalization or expropriation of assets by a
foreign government, and one-time major economic
transactions.


(5) Mandatory Changes in Accounting Principles
 Consistency requires the use of the same accounting method from

year to year.

 However, a company may on occasion choose to change to an

alternative accounting method (ex: depreciation method or FIFO to
average cost for inventory).

 A company may be required to change to a new accounting

technique by the issue of a new accounting standard.

 Changes may require retrospective application or involve adjustments

to retained earnings. They may require disclosure on the income
statement.
 For mandatory changes the method is dictated in the new standard
 For discretionary changes, retroactive treatment with disclosure is

required.


(5) Mandatory Changes (cont’d)

Figure 13-5 Starbucks excerpts from the annual report


Intraperiod Tax Allocation
 Accounting standards require certain items to be presented

on the income statement net of taxes to better determine
and isolate the true impact of the events.
 Disposal of a business segment
 Extraordinary items
 Changes in Accounting principles

 All of these items are presented net of tax on the income

statement


Earnings-Per-Share Disclosure (EPS)
 SFAS 128 simplified the presentation of earnings per share to two components:
 Basic EPS
 Diluted EPS

 Calculation of Basic EPS =

_ Net Income - preferred dividends__
Weighted average common shares outstanding
 Concept: To indicate how much each common shareholder “owns” with respect

to earnings.

 Preferred dividends are deducted - if declared or if cumulative - because they are

“owed” to preferred shareholders.

 This is a calculation of “what is” - the numerator and denominator use actual

shares outstanding and actual net income for the year.


Earnings-Per-Share (EPS) (cont’d)

 Class problem:
Bush Company reported net income of $30,000 in 2014. The

company had 60,000 shares of common stock outstanding for all of
2014. Bush also had 5,000 shares of convertible preferred stock
outstanding for all of 2014. During 2014, the company declared a
$4,000 cash dividend to preferred shareholders. Each share of
preferred stock is convertible to 4 shares of common stock.

1.Calculate basic EPS:
$30,000 - 4,000 = $0.43 per share
60,000
*Note that the convertibility component is ignored for
basic EPS.


Earnings-Per-Share (EPS) (cont’d)

2. Calculate diluted EPS:
$30,000 - 0 = $0.38 per share
60,000 + (5,000 x 4)
*Note that the convertibility component is assumed to
have been exercised for diluted EPS. If the PS was
converted to CS at the beginning of the year, there would
have been NO preferred dividend, and there would have
been 20,000 additional shares of common stock
outstanding all year.
*The effects for convertible bonds and employee stock
options are similar for diluted EPS.


EPS Disclosure
 Separate EPS disclosure for:

 Net income from continuing operations (after tax)
 Disposals of business segments
 Extraordinary items

 Calculation
 Separate dollar amount (from above categories) divided by number of

common shares outstanding

 If diluted EPS exists, the company should also calculate

diluted EPS for each level of presentation.

 If diluted EPS is antidilutive (the calculation is actually higher

than basic EPS), the company does not have to present
diluted EPS.