Presentation on theme: "CHAPTER 4 INCOME STATEMENT AND RELATED INFORMATION Sommers – ACCT 3311."— Presentation transcript:
CHAPTER 4 INCOME STATEMENT AND RELATED INFORMATION Sommers – ACCT 3311
Discussion Question Q4-1 What kinds of questions about future cash flows do investors and creditors attempt to answer with information in the income statement?
Evaluate past performance. Help assess the risk or uncertainty of achieving future cash flows. Predicting future performance. Usefulness Income Statement
Limitations Companies omit items that cannot be measured reliably. Income is affected by the accounting methods employed. Income measurement involves judgment. Income Statement
Discussion Questions Q4-3 Identify at least two situations in which important changes in value are not reported in the income statement.
Discussion Question Q4-8 Why should caution be exercised in the use of the net income figure derived in an income statement?
Companies have incentives to manage income to meet or beat Wall Street expectations, so that market price of stock increases and value of stock options increase. Quality of earnings is reduced if earnings management results in information that is less useful for predicting future earnings and cash flows. Quality of Earnings Income Statement
Earnings Quality – Operating/Nonoperating Operating Income Restructuring Costs – Costs associated with shutdown or relocation of facilities or downsizing of operations are recognized in the period incurred. Goodwill Impairment and Long-lived Asset Impairment - Involves asset impairment losses or charges. Nonoperating Income 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?
OperatingNonoperating Permanent Transitory Where would the following items lie? Sales revenue Restructuring charges Royalty income Interest expense Payment made for settlement of lawsuit R&D expense Incentives for disclosures that influence user classification? Classification
Discussion Question Q4-10 What is the major distinction (a) between revenues and gains and (b) between expenses and losses?
Revenues Expenses Net Income Single- Step No distinction between Operating and Non-operating categories. Single-Step Income Statement Single-Step Format
Separates operating transactions from nonoperating transactions. Matches costs and expenses with related revenues. Highlights certain intermediate components of income that analysts use. Multiple-Step Income Statement Multiple-Step Format
1.Operating section 2.Nonoperating section 3.Income tax 4.Discontinued operations 5.Extraordinary items 6.Earnings per share Intermediate Components of the Income Statement Multiple-Step Format
The presentation divides information into major sections. 1. Operating Section 2. Nonoperating Section 3. Income tax Multiple-Step Format
E4-7 The accountant of Weatherspoon Shoe Co. has compiled the following information from the company’s records as a basis for an income statement for the year ended December 31, 2014. Rent revenue$29,000 Interest expense 18,000 Market appreciation on land above cost 31,000 Salaries and wages expense (sales)114,800 Supplies (sales) 17,600 Income tax 30,600 Salaries and wages expense (administrative)135,900 Other administrative expenses 51,700 Cost of goods sold516,000 Net sales980,000 Depreciation on plant assets (70% selling, 30% administrative) 65,000 Cash dividends declared 16,000 There were 20,000 shares of common stock outstanding during the year. Prepare a multiple-step income statement.
E4-7 Single Step WEATHERSPOON SHOE CO. Income Statement For the Year Ended December 31, 2014 Revenues Net sales $ 980,000 Rent revenue 29,000 Total revenues 1,009,000 Expenses Cost of goods sold $516,000 Administrative expenses 207,100 Selling expenses 177,900 Interest expense 18,000 Total expenses 919,000 Income before income tax 90,000 Income tax 30,600 Net income $ 59,400 Earnings per share ($59,400 ÷ 20,000)$2.97
Irregular items fall into six categories 1.Discontinued operations. 2.Extraordinary items. 3.Unusual gains and losses. 4.Changes in accounting principle. 5.Changes in estimates. 6.Corrections of errors. Reporting Irregular Items
Companies are required to report irregular items in the financial statements so users can determine the long-run earning power of the company. Illustration 4-6 Number of Unusual Items Reported in a Recent Year by 500 Large Companies Reporting Irregular Items
Occurs when, (a)company eliminates the results of operations and cash flows of a component. (b)there is no significant continuing involvement in that component. Amount reported “net of tax.” Discontinued Operations Reporting Irregular Items
Illustration: KC Corporation had after tax income from continuing operations of $55,000,000 for the year. During the year, it disposed of its restaurant division at a pretax loss of $270,000. Prior to disposal, the division operated at a pretax loss of $450,000 for the year. Assume a tax rate of 30%. Prepare a partial income statement for KC. Income from continuing operations$55,000,000 Discontinued operations: Loss from operations, net of $135,000 tax315,000 Loss on disposal, net of $81,000 tax189,000 Net income$54,496,000 Total loss on discontinued operations504,000 Reporting Discontinued Operations
Discontinued Operations are reported after “Income from continuing operations.” Previously labeled as “Net Income”. Moved to Reporting Discontinued Operations
Extraordinary items are nonrecurring material items that differ significantly from a company’s typical business activities. Extraordinary Item must be both of an Unusual Nature and Occur Infrequently Company must consider the environment in which it operates. Amount reported “net of tax.” Reporting Irregular Items
Illustration: KC Corporation had after tax income from continuing operations of $55,000,000 during the year. In addition, it suffered an unusual and infrequent pretax loss of $770,000 from a volcano eruption. The corporation’s tax rate is 30%. Prepare a partial income statement for KC Corporation beginning with income from continuing operations. Income from continuing operations$55,000,000 Extraordinary loss, net of $231,000 tax539,000 Net income$54,461,000 ($770,000 x 30% = $231,000 tax) Reporting Extraordinary Items
Reporting when both Discontinued Operations and Extraordinary Items are present. Discontinued Operations Extraordinary Items Reporting Irregular Items
Material items that are unusual or infrequent, but not both, should be reported in a separate section just above “Income from continuing operations before income taxes.” Examples can include: Write-downs of inventories Foreign exchange transaction gains and losses The Board prohibits net-of-tax treatment for these items. Unusual Gains and Losses Reporting Irregular Items
Illustration 4-7 Income Statement Presentation of Unusual Charges Unusual Gains and Losses Reporting Irregular Items
Relates the income tax expense to the specific items that give rise to the amount of the tax expense. Income tax is allocated to the following items: (1)Income from continuing operations before tax. (2) Discontinued operations. (3) Extraordinary items. Intraperiod Tax Allocation Special Reporting Issues
Intraperiod Income Tax Allocation Income Tax Expense must be associated with each component of income that causes it. Income from Continuing Operations Show Income Tax Expense related to Income from Continuing Operations. Report effects of Discontinued Operations and Extraordinary Items NET OF RELATED INCOME TAXES.
Extraordinary Gain: Schindler Co. has income before income tax and extraordinary item of $250,000. It has an extraordinary gain of $100,000 from a condemnation settlement received on one its properties. Assuming a 30 percent income tax rate. Illustration 4-13 Intraperiod Tax Allocation Special Reporting Issues
Extraordinary Loss: Schindler Co. has income before income tax and extraordinary item of $250,000. It has an extraordinary loss from a major casualty of $100,000. Assuming a 30 percent income tax rate. Illustration 4-14 Intraperiod Tax Allocation Special Reporting Issues
Calculation of Total Tax $24,000 (135) (61) (231) $23,573 Note: losses reduce the total tax Example of Intraperiod Tax Allocation
The following balances were taken from the books of Schimank Corp. on December 31, 2014. Assume the total effective tax rate on all items is 34%. Prepare a multiple-step income statement; 100,000 shares of common stock were outstanding during the year. Interest revenue$ 120,400 Cash71,400 Sales1,932,000 Accounts receivable210,000 Prepaid insurance28,000 Sales returns & allowances210,000 Allowance for bad debts9,800 Sales discounts63,000 Land140,000 Equipment280,000 Building196,000 Cost of goods sold869,400 Accum deprec—equipment$ 56,000 Accum deprec—building39,200 Notes receivable217,000 Selling expenses271,600 Accounts payable238,000 Bonds payable140,000 Admin & general expenses135,800 Accrued liabilities44,800 Interest expense84,000 Notes payable140,000 Loss from earthquake damage (extraordinary item)210,000 Common stock700,000 Retained earnings29,400 E4-6B