CHAPTER 4 Income Statement and Related Information ……..…………………………………………………………... Usefulness of the Income Statement Income and expenses for a given period of time.  evaluate past performance  predict future performance  assess uncertainty of future cash flows

Limitations of the Income Statement Not every relevant item is included. Reliable measures not always available. Numbers not always comparable. Differences in methods are allowed. Numbers not completely reliable. Judgment is frequently involved. LIFO FIFO D LL E $

Transaction approach  Income calculated based on summary information of revenue, expense, gain, and loss transactions Ledger Accounts Income Statement Salesxxx Cost of Goods Sld Beg Invxxx Purchxxx

FORMAT OF THE INCOME STATEMENT Elements Increase in Net Assets Decrease in Net Assets From ongoing, major operations From peripheral transactions

Single-Step Income Statement Revenues Net Income - Expenses List and total all revenues and gains List and total all expenses and losses

Sales Revenues + Other Rev. & Gains Income before income tax Net Income - Cost of Goods Sold - Other Exp. & Losses Multiple-Step Income Statement Shows both gross and net sales. Breakdown of purchases and merchandise inventory.

REPORTING IRREGULAR ITEMS ALL-INCLUSIVE APPROACH most items are recorded in current period income CURRENT OPERATING APPROACH income from regular and recurrent items is reported MODIFIED ALL-INCLUSIVE APPROACH irregular items are highlighted

Discontinued Operations Assets Operating Results Activities of the segment Clearly distinguishable Not “discontinued operations”  disposal of a part of a business line  shifting production locations  phasing out a product line

Income from continuing operations$20,000,000 Discontinued operations Loss from operation of discontinued division (net of tax)$300,000 Loss from disposal of division (net of tax) 500, ,000 Net Income$19,200,000

Extraordinary Items  Unusual (unrelated to ordinary activities)  Infrequent Not “extraordinary”  write-down of receivables, inventories, etc.  gains or losses from sale of PP&E  effects of a strike Question 27, p. 151 $450,000 gain on forced condemnation sale of facility.

Unusual Gains and Losses  unusual or infrequent but not both  report in “Other Gains and Losses”  before income tax

Changes in Accounting Principle  e.g. change in inventory or depreciation method  report the retroactive impact as of the beginning of the year  report as an adjustment to beginning R/E; not on the income statement Brief Exercise 4-7, p. 153 Change in estimate of bad debt expense.

Changes in Estimates  e.g. change in estimate of the useful life of an asset or bad debts expense  do not handle retroactively  include in ordinary income Prior Period Adjustments  record as an adjustment to the beginning balance of retained earnings  does not affect net income

SPECIAL REPORTING ISSUES Earnings per Share perhaps the most widely followed number in all of the financial statements  break-down EPS for extraordinary items Basic EPS = Net Income – Preferred dividends Weighted average common shares outstanding