The Income Statement and Statement of Cash Flows CHAPTER 3

Revenues, Expenses, Gains and Losses Net Income Revenues Inflows of resources resulting from providing goods or services to customers. Expenses Outflows of resources incurred in generating revenues. Gains and Losses Increases or decreases in equity from peripheral or incidental transactions of an entity.

Nonoperating Activities Income Statement Operating Activities Nonoperating Activities vs.

Income Statement (Single-Step) { Proper Heading { Revenues & Gains Expenses & Losses {

Let’s take a look at a Multi-Step Income Statement next.

Income Statement (Multiple-Step) { Proper Heading { Gross Margin Operating Expenses { { Non- operating Items

Separately Reported Items Discontinued operations, extraordinary items, and the cumulative effect of a change in accounting principle are reported separately, net of taxes.

Intraperiod Income Tax Allocation Income Tax Expense must be associated with each component of income that causes it. Show Income Tax Expense related to Income from Continuing Operations. Report effects of Discontinued Operations, Extraordinary Items, and Cumulative Effect of Accounting Changes NET OF INCOME TAXES.

Discontinued Operations Sale or disposal of an identifiable segment of a business. The income or loss from an identifiable discontinued operation should be reported separately from the income or loss related to continuing operations.

Discontinued Operations Two components are accounted for: Results of operations for the discontinued segment before the disposal decision. Gain or loss from disposal of a segment.

Discontinued Operations Example During the year, Apex Co. sold an unprofitable segment of the company. The segment 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 on the income statement?

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

Discontinued Operations Example Income Statement Presentation:

Extraordinary Items Material in amount Gains or losses that are unusual in nature and infrequent in occurrence. required by GAAP. Reported net of related taxes

Specific extraordinary items identified in APB Opinion 30. The direct result of a major casualty (such as an earthquake). An expropriation. A prohibition under a newly enacted law or regulation that clearly meets both criteria.

Extraordinary Items Example During 1998, 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 on the 1998 income statement?

Extraordinary Items Example Income Statement Presentation:

Reporting Unusual or Infrequent Items Some events are unusual or infrequent, but not both. For example: restructuring charges gain or loss from the sale of assets. I wonder how I should report these items.

Reporting Unusual or Infrequent Items Report them in Income from Operations. I wonder how I should report these items.

Accounting Changes 5 5 5

Change in Accounting Principle Occurs when Changing from one GAAP method to another GAAP method, or Changing the method of application of an existing principle. Make a catch-up adjustment known as the cumulative effect of a change in accounting principle. The cumulative effect is reported net of taxes and after extraordinary items.

Change in Accounting Principle Example During the year, Apex Co. decided to change from the double-declining balance to the straight-line method for depreciation. The effect of this change is an increase in net income of $65,000. Apex reported income of $128,387 during the year. All items of income are subject to a 30% tax rate. How would this item appear on the income statement?

Change in Accounting Principle Example Computation: Income Statement Presentation:

Change in Estimates Revision of a previous accounting estimate. The new estimate should be used in the current and future periods. The prior accounting results should not be disturbed - per APB Opinion No. 20.

Change in Estimates Example On January 1, 1996, we purchased equipment costing $30,000, with a useful life of 10 years and no salvage value. During 1999, we determine that the remaining useful is 5 years (8-year total life). We use straight-line depreciation. Compute the revised depreciation expense for 1999.

Change in Estimates Example Record depreciation expense of $4,200 for 1999 and subsequent years.

Let’s move on to a few final topics.

Other Topics Prior Period Adjustments. Earnings Per Share. Comprehensive Income. Statement of Cash Flows.

Prior Period Adjustments Corrections of errors from a previous period. Appear on the Statement of Retained Earnings as an adjustment to beginning retained earnings. Must show the adjustment net of income taxes.

Prior Period Adjustments Example While reviewing the depreciation entries for 2001-2004, the controller found that in 2003 depreciation expense was incorrectly debited for $150,000 when in fact it should have been debited $125,000. All items are taxed at 30%. Prepare the necessary journal entry in 2004 to correct this prior period error.

Prior Period Adjustments Example If this was the original entry, how do we correct it? Can we just reverse it? Why or why not?

Prior Period Adjustments Example To correct the 2003 error in 2004, we can debit Accumulated Depreciation since it is a permanent account.

Prior Period Adjustments Example We can’t credit Depreciation Expense since it was closed in 2003, so we credit Retained Earnings.

Prior Period Adjustments Example Remember to consider the tax effects: $25,000 × 30% = $7,500 taxes payable

Financial Statement Presentation of Earnings Per Share Data EPS must be disclosed for: Income from continuing operations Income before extraordinary items The cumulative effect of a change in accounting principle Net income EPS values are desirable (but not required) for extraordinary items and discontinued operations. 10

Financial Statement Presentation of Earnings Per Share Data A summary description of the rights and privileges of the company’s various securities. A reconciliation of the numerators and the denominators used in EPS computations. Supplemental EPS data for transactions occurring after the balance sheet date that would result in a material change to the number of shares outstanding at the balance sheet date. 10

Basic Earnings Per Share Simple form of the computation:

FASB Concept Statement 6 Comprehensive Income FASB Concept Statement 6 The change in equity from nonowner transactions. This must be reported in addition to Net Income.. Includes Net Income plus other items not ordinarily included in Net Income: Foreign currency translation adjustment, net of tax Unrealized gains(losses) on investment securities, net of tax Minimum pension liability adjustment, net of tax

Statement of Cash Flows Provides relevant information about a company’s inflows and outflows of cash. Helps investors and creditors to assess future net cash flows liquidity long-term solvency.

Cash Flows From Operating Activities Inflow - cash received from Customers Interest on receivables Dividends from investments Outflows - cash paid for Purchase of inventory Salaries, wages, and other operating expenses Interest on debt Income taxes

Cash Flows From Investing Activities Inflows - cash received from Sales of long-term assets Sale of investments Collection of nontrade receivables Outflows - cash paid for Purchase of long-term assets Purchase of investments Loans to others

Cash Flows From Financing Activities Inflows - cash received from Sale of equity securities Borrowing through notes, loans, mortgages, or bonds Outflows - cash paid to Owners for dividends Retire stock or acquire treasury stock Repay principal portion of debt

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