1. HUANGHUAI UNIVERSITY
& BANGOR UNIVERSITY
Chapter 4
Income Statement
DR. AZIZ JAAFAR

2. The Income Statement Dated for a period of time Multiple-step format
For the Year Ended...
Multiple-step format
Gross profit
Operating income
Income before taxes
Net income
Single-step format
Total of all revenues and gains
Less the total of all expenses and losses

3. Multiple-Step Single Step

4. Basic Elements of the Income Statement
Net Sales (Revenues)
Cost of Goods Sold (Cost of Sales)
Other Operating Revenue
Operating Expenses
Other Income or Expense

5. Net Sales
Revenue from the sale of principal goods or services sold to customers
Shown net of
Discounts
Returns
Allowances

6. Cost of Goods Sold The cost of goods that were sold to produce revenue
Retailer
Beginning Inventory
+ Purchases
– Ending Inventory
= Cost of Goods Sold
Manufacturer
Beginning Inventory
+ Cost of Goods Manufactured
– Ending Inventory
= Cost of Goods Sold

7. Other Operating Revenue
Reflects the nature of the business
Examples
Lease revenue
Royalty revenue
Finance charges
Commission revenue

8. Operating Expenses Selling expenses Administrative expenses
Result from the company’s effort to create sales
Examples
Advertising
Sales commissions
Sales supplies used
Administrative expenses
Relate to the general administration of the company’s operation
Salaries
Insurance
Bad debt expense

9. Other Income or Expense
Secondary activities not directly related to operations
Dividend income
Interest income
Gains (losses) from sale of assets
Interest expense

10. Special Income Statement Items
Unusual or Infrequent Items Disclosed Separately
Included with normal recurring revenues and expenses
If material, disclosed separately, before income taxes
Relate to operations
Treatment for analysis
Primary analysis: include
Supplementary analysis: exclude

11. Special Income Statement Items (cont’d)
Equity in Earnings of Nonconsolidated Subsidiaries
The investor’s proportional share of the investee’s net income
Does not represent cash flow to the investor
Cash dividends received represent cash flow
Analysis issues:
Investor’s net income includes revenue of other entity
May distort ratios
Presented before tax; tax consequences typically immaterial

12. Special Income Statement Items (cont’d)
Income Taxes Related to Operations
Federal, state, and local
Includes both paid and deferred taxes
Discontinued Operations
Reported net of income tax
Analysis issues:
Inadequate disclosure of associated assets
Lack of historical profit and loss information on the discontinued operations

13. Special Income Statement Items (cont’d)
Extraordinary Items
Unusual and infrequent
Reported net of income tax
Analysis issues:
Exclude from primary analysis
Include for supplementary analysis

14. Special Income Statement Items (cont’d)
Cumulative Effect of a Change in Accounting Principle
For fiscal years beginning before 12/15/05
Cumulative effect of the change shown net of tax on the income statement of the period in which change was made
Earlier statements not restated to reflect application of the new principle
Effective for fiscal years beginning after 12/15/05
All comparative statements are retrospectively restated to reflect application of the new accounting principle
The cumulative effect on income of earlier years is shown as a net-of-tax adjustment to the beginning Retained Earnings balance of the earliest period presented

15. Special Income Statement Items (cont’d)
Minority Share of Earnings
Earnings of a partially-owned consolidated subsidiary that would accrue to the minority owners
Presentation may be either pre-tax or net-of-tax
Earnings per Share
Net income ÷ Number of shares outstanding

16. Reconciliation of Retained Earnings
Reported as part of the Statement of Stockholders’ Equity or combined with the Income Statement
Beginning of year balance of retained earnings
+ Prior period adjustments (net of tax)
± Cumulative effect of a change in accounting principle (net of tax)
= Beginning balance as adjusted
+ Net income
– Dividends
= End-of-year balance of retained earnings

17. Retained Earnings
The accumulated undistributed earnings of the corporation reported on the balance sheet
Appropriated
Restricted by law, contract, or management decision
Not available for dividends
Unappropriated
Available for dividends
Does not represent cash or any other asset

18. Stock Dividends Cash dividends Stock dividends
Date of declaration: create liability and reduce retained earnings
Date of payment: reduce liability and cash
Stock dividends
Small (less then 25%): capitalize the market value of the stock
Material: capitalize the par value of the stock
Total equity is unaffected by a stock dividend
Analysis issues:
Restate share quantities to reflect stock dividend activity

19. Stock Dividend Example
100,000 shares outstanding; $1 par; $5 market
10% stock dividend on 100,000 shares: issue 10,000 additional shares recorded at $5 per share
40% stock dividend on 100,000 shares: issue 40,000 additional shares recorded at $1 per share
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20. Stock Splits 2-for-1 split
Doubles the quantity of stock
Par or stated value is halved
No effect on retained earnings, additional paid-in capital, or capital stock accounts
Analysis issues:
Restate share quantities to reflect split activity

21. Legality of Distributions to Shareholders
Per various state laws
Distributions are acceptable as long as the firm has the ability to pay debts as they come due in the normal course of business
Distributions to stockholders are acceptable as long as the firm is solvent and the distributions do not exceed the fair value of the assets
Distributions consist of solvency and balance sheet test of liquidity and risk

22. Comprehensive Income Net income
+ The period’s change in accumulated other comprehensive income
= Comprehensive income
Foreign currency translation adjustments
Unrealized holding gains and losses on available-for-sale marketable securities
Changes to stockholders’ equity resulting from additional minimum pension liability adjustments
Unrealized gains and losses from derivative instruments
Copyright 2009 by South-Western, a part of Cengage Learning. All rights reserved.

23. Comprehensive Income (cont’d)
Required disclosures
Comprehensive income
Other comprehensive income from each category
Reclassification adjustments for each category of other comprehensive income
Tax effects for each category of other comprehensive income
Balances for each category of other comprehensive income
Copyright 2009 by South-Western, a part of Cengage Learning. All rights reserved.

24. Comprehensive Income (cont’d)
Presentation
In a separate financial statement
Combined with the income statement
As part of the schedule of changes in stockholders’ equity
Copyright 2009 by South-Western, a part of Cengage Learning. All rights reserved.

25. Comprehensive Income – Separate Statement
Copyright 2009 by South-Western, a part of Cengage Learning. All rights reserved.

26. Comprehensive Income – Combined with Income Statement

27. Comprehensive Income – As Part of the Statement of Stockholders’ Equity

28. Comprehensive Income (cont’d)
Analysis issues:
Typically more volatile than net income
A better indication of long-run profitability