Intermediate Accounting S t I c e | S t I c e | S k o u s e n The Income Statement Chapter 4 Intermediate Accounting 16E Prepared by: Sarita Sheth | Santa Monica College COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

Learning Objectives Define the concept of income. Explain why an income measure is important. Explain how income is measured, including the revenue recognition and expense matching concepts. Understand the format of an income statement.

Learning Objectives (cont.) Describe the specific components of an income statement. Compute comprehensive income and prepare a statement of stockholders’ equity. Construct simple forecasts of income for future periods.

Income Determination Financial Capital Maintenance Concept states: Net assets (ending)- Net assets (beginning) = Income IF: No investments by owners or distributions were made in the period. Thus, the change in net assets could be equal to income for the period.

Transaction Approach The transaction approach yields the same net income number as financial capital maintenance and provides means of measuring cash flows as well. Also known as the matching method.

Revenue and Gain Recognition Revenue is recognized when goods or services have been provided and the customer commits to payment. Revenues & gains recognized when: They are realized or realizable, and They have been earned through substantial completion of the activities involved in the earnings process.

Expenses and Loss Recognition Three categories for expense recognition: Direct Matching Systematic and rational allocation Immediate recognition

Form of the Income Statement Traditionally, income from continuing operations is presented: In a single step form- all revenues and gains are first on the statement. Multiple step form- divided into separate sections and various subtotals are reported that reflect different levels of profitability.

Components of the Income Statement Income from Continuing Operations: Revenue Cost of goods sold Operating expenses Other revenues and gains Other expenses and losses Income taxes on continuing operations

Income from Continuing Operations Determining Subtotals: Gross profit = Revenue – Cost of goods sold Operating income = Gross profit – Operating expenses

Income from Continuing Operations Determining Subtotals: Income from Continuing Operations Before Taxes = Operating income + Other revenues and gain – Other expenses and losses Income from continuing operations = Income from continuing operations before income taxes – Income taxes on continuing operations

Discontinued Operations To report discontinued operations: The operations and cash flows of the component must be clearly identifiable For example, discontinued operations would result if a company closed one of four operating segments which tracks its cash flows and income separately.

To be reported as an extraordinary item the event must be BOTH: Extraordinary Items To be reported as an extraordinary item the event must be BOTH: Unusual and Infrequent.

Not Extraordinary Write-down or write-off of receivables, inventory, etc. Effects of a strike. Gains or losses from exchange or remeasurement of foreign currencies. Gains or losses on disposal of business segment. Gains or losses from sale or abandonment of productive assets. Adjustment of accruals on long-term contracts.

Changes in Accounting Principle Criteria for Change: only if the new principle: provides more useful information. is less costly per benefit.

Change in Estimate Employ current and prospective approach. Report current and future financial statements on new basis. Present prior periods as previously reported. Make no adjustments to current period opening balances. Present no pro forma data. If there is both a change in principle and a change in estimate for an item, the event is treated as a change in estimate.

Earnings Per Share When presenting EPS figures: EPS amounts are computed for income from continuing operations And EPS amounts are calculated for each irregular or extraordinary item.

Earnings Per Share Formula for Income from Continuing Operations Weighted average number of shares of common stock outstanding

Widely referred to as the PE ratio Earnings Per Share Price-Earnings Ratio Market value per share Earnings per share Widely referred to as the PE ratio

Comprehensive Income Comprehensive income- the amount that reflects the change in a company’s wealth during the period. It includes items that arise from changes in market conditions unrelated to the business operations of a company. Most companies include a report of comprehensive income as part of the statement of stockholders’ equity.

Comprehensive Income The more common adjustments made in arriving at comprehensive income are: Foreign currency translation adjustments. Unrealized gains and losses on available-for-sale securities. Deferred gains and losses on derivative financial instruments.

Forecasting Future Performance Financial statements report the past, but are used to predict the future. Key to a good forecast involves identifying factors that determine a certain level of revenue or expense. Forecasting starts with a forecast for sales. Most expense forecast are driven from the sales forecast.