Ch04 Income.Statement and Cash.Flow

4-1

Chapter 4

The Income Statement and
Statement of Cash Flows


4-2

Learning Objectives
Explain the difference between net income and
comprehensive income and how we report
components of the difference.


4-3

An income
statement for a
hypothetical
manufacturing
company that you
can refer to as we
proceed through
the chapter.


4-4

Learning Objectives

Discuss the importance of income from
continuing operations and describe its
components.


4-5

Income
Income from
from Continuing
Continuing Operations
Operations

Revenues

Expenses

Inflows of
resources
resulting
from
providing
goods or
services to
customers.

Outflows of
resources
incurred in
generating

revenues.

Gains and
Losses

Income Tax
Expense

Increases or
decreases in
equity from
peripheral or
incidental
transactions
of an entity.

Because of
its
importance
and size,
income tax
expense is a
separate
item.


4-6

Operating Income Versus Nonoperating
Income

Operating
Income

Nonoperating
Income

Includes revenues
and expenses
directly related to
the principal
revenuegenerating
activities of the
company

Includes gains and
losses and
revenues and
expenses related
to peripheral or
incidental
activities of the
company


4-7

Income Statement (Single-Step)

{

Proper Heading
Revenues
& Gains

Expenses
& Losses

{

{


4-8

Income Statement (Multiple-Step)
Proper Heading
Gross
Profit
Operating
Expenses
Nonoperating
Items

{
{

{

{

4-9

Learning Objectives
Describe earnings quality and how it is
impacted by management practices to
manipulate earnings.


4-10

Earnings Quality
Earnings quality refers to the ability of
reported earnings to predict
a company’s future earnings.

Transitory Earnings
versus
Permanent Earnings


4-11

Earnings Quality
Should all items of revenue and expense included in
operating income be considered indicative of a
company’s permanent earnings?
No, not necessarily.
Operating expenses may include the following unusual items
that may or may not continue in the future:

• Restructuring costs
• Goodwill impairment
• Long-lived asset impairment
• In-process research and development


4-12

Nonoperating Income and Earnings Quality
Gains and losses from the sale of operational
assets and investments often can significantly
inflate or deflate current earnings.

Example
As the stock market boom reached its
height late in the year 2000, many
companies recorded large gains from
sale of investments that had
appreciated significantly in value.

How should
those gains be
interpreted in
terms of their
relationship to
future
earnings? Are
they transitory
or permanent?

4-13

Separately Reported Items
Reported separately, net of taxes:
Discontinued
operations
Income from continuing operations
before income taxes and
extraordinary items
Income tax expense
Income from continuing operations
before extraordinary items
Discontinued operations (net of $xx
in taxes)
Extraordinary items (net of $xx in
taxes)
Net Income

Extraordinary
items

$ xxx
xx
xxx
xx
xx
$ xxx

A third item, the

cumulative effect of
a change in
accounting
principle, was
eliminated from
separate reporting
by a new
accounting
standard in 2005.


4-14

Reporting Discontinued Operations
Reporting for Components Sold
Income or loss from
operations of the
component from the
beginning of the
reporting period to the
disposal date.

Gain or loss on the
disposal of the
component’s assets.

Reporting for Components Held For Sale
Income or loss from
operations of the
component from the

beginning of the
reporting period to the
end of the reporting
period.

An “impairment loss” if
the carrying value of
the assets of the
component is more
than the fair value
minus cost to sell.


4-15

Discontinued Operations Example
During the year, Apex Co. sold an
unprofitable component of the company. The
component had a net loss from operations
during the period of $150,000 and its assets
sold at a loss of $100,000. Apex reported
income from continuing operations of
$128,387. All items are taxed at 30%.

How will this appear in the income
statement?


4-16

Discontinued Operations Example
Computation of Loss from Discontinued Operations
(Net of Tax Effect):


4-17

Discontinued Operations Example
Income Statement Presentation:


4-18

Learning Objectives
Define extraordinary items and describe the
appropriate income statement presentation for
these transactions.


4-19

Extraordinary Items
 Material

events or
transactions
 Unusual in nature
 Infrequent in occurrence
 Reported net of related
taxes

4-20

Extraordinary Items Example
During the year, Apex Co. experienced a
loss of $75,000 due to an earthquake at one
of its manufacturing plants in Nashville.
This was considered an extraordinary item.
The company reported income before
extraordinary item of $128,387. All gains
and losses are subject to a 30% tax rate.

How would this item appear in the
income statement?


4-21

Extraordinary Items Example
Computation of Loss from Extraordinary Item (Net of
Tax Effect):

Income Statement Presentation:


4-22

Unusual or Infrequent Items

Items that are material and are either
unusual or infrequent—but not both—
are included as a separate item in
continuing operations.


4-23

Learning Objectives
Define earnings per share (EPS) and explain
required disclosures of EPS for certain income
statement components.


4-24

Earnings Per Share Disclosure
One of the most widely used ratios is earnings per
share (EPS), which shows the amount of income
earned by a company expressed on a per share basis.

Basic EPS

Net income less preferred dividends
Weighted-average number of
common shares outstanding for the
period

Diluted EPS

Reflects the potential 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.


4-25

Earnings Per Share Disclosure
Report EPS data separately for:
1. Income from Continuing Operations
2. Separately Reported Items
a) Discontinued Operations
b) Extraordinary Items
3. Net Income