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Chapter 4 income statement and related information Sommers – ACCT 3311

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1 Chapter 4 income statement and related information Sommers – ACCT 3311
Chapter 1: Environment and Theoretical Structure of Financial Accounting.

2 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?

3 Income Statement Usefulness Evaluate past performance.
Predicting future performance. Help assess the risk or uncertainty of achieving future cash flows.

4 Income Statement Limitations
Companies omit items that cannot be measured reliably. Income is affected by the accounting methods employed. Income measurement involves judgment.

5 Discussion Questions Q4-3 Identify at least two situations in which important changes in value are not reported in the income statement.

6 Discussion Question Q4-8 Why should caution be exercised in the use of the net income figure derived in an income statement?

7 Income Statement Quality of Earnings
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.

8 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. Most of the components of earnings in an income statement relate directly to the ordinary, continuing operations of the company. Some, though, such as interest and gains and losses are only tangentially related to normal operations. These we refer to as nonoperating items. Some nonoperating items have generated considerable discussion with respect to earnings quality, notably gains and losses generated either from the sale of operational assets or from the sale of investments. 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?

9 Classification Operating Nonoperating 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?

10 Discussion Question Q4-10 What is the major distinction (a) between revenues and gains and (b) between expenses and losses?

11 Single-Step Format Single-Step Income Statement Revenues Expenses
Net Income Single- Step No distinction between Operating and Non-operating categories.

12 Multiple-Step Format Multiple-Step Income Statement
Separates operating transactions from nonoperating transactions. Matches costs and expenses with related revenues. Highlights certain intermediate components of income that analysts use.

13 Multiple-Step Format Intermediate Components of the Income Statement
Operating section Nonoperating section Income tax Discontinued operations Extraordinary items Earnings per share

14 Multiple-Step Format The presentation divides information into major sections. 1. Operating Section 2. Nonoperating Section 3. Income tax

15 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, 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 sold 516,000 Net sales 980,000 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.

16 E4-7

17 For the Year Ended December 31, 2014
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 $ ,400 Earnings per share ($59,400 ÷ 20,000) $2.97

18 Income Statement Classifications

19 Reporting Irregular Items
Irregular items fall into six categories Discontinued operations. Extraordinary items. Unusual gains and losses. Changes in accounting principle. Changes in estimates. Corrections of errors.

20 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

21 Reporting Irregular Items
Discontinued Operations Occurs when, (a) company eliminates the results of operations and cash flows of a component. there is no significant continuing involvement in that component. Amount reported “net of tax.”

22 Reporting Discontinued Operations
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 tax 315,000 Loss on disposal, net of $81,000 tax 189,000 Total loss on discontinued operations 504,000 Net income $54,496,000

23 Reporting Discontinued Operations
Discontinued Operations are reported after “Income from continuing operations.” Previously labeled as “Net Income”. Moved to

24 P&G’s Income Statement

25 Reporting Irregular Items
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.”

26 Reporting Extraordinary 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 tax 539,000 Net income $54,461,000 ($770,000 x 30% = $231,000 tax)

27 Reporting Irregular Items
Reporting when both Discontinued Operations and Extraordinary Items are present. Discontinued Operations Extraordinary Items

28 Reporting Irregular Items
Unusual Gains and Losses 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.

29 Reporting Irregular Items
Unusual Gains and Losses Illustration 4-7 Income Statement Presentation of Unusual Charges

30 Special Reporting Issues
Intraperiod Tax Allocation 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.

31 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 and Extraordinary Items NET OF RELATED INCOME TAXES. Intraperiod tax allocation associates (or allocates) income tax expense (or income tax benefits if there is a loss) with each major component of income that causes it. As a result, the two items reported separately below income from continuing operations are presented net of the related income tax effect.

32 Special Reporting Issues
Intraperiod Tax Allocation 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

33 Special Reporting Issues
Intraperiod Tax Allocation 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

34 Example of Intraperiod Tax Allocation
Note: losses reduce the total tax Calculation of Total Tax $24,000 (135) (61) (231) $23,573

35 E4-6B The following balances were taken from the books of Schimank Corp. on December 31, 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 Cash 71,400 Sales 1,932,000 Accounts receivable 210,000 Prepaid insurance 28,000 Sales returns & allowances 210,000 Allowance for bad debts 9,800 Sales discounts 63,000 Land 140,000 Equipment 280,000 Building 196,000 Cost of goods sold 869,400 Accum deprec—equipment $ 56,000 Accum deprec—building 39,200 Notes receivable 217,000 Selling expenses 271,600 Accounts payable 238,000 Bonds payable 140,000 Admin & general expenses 135,800 Accrued liabilities 44,800 Interest expense 84,000 Notes payable 140,000 Loss from earthquake damage (extraordinary item) 210,000 Common stock 700,000 Retained earnings 29,400

36 E4-6B

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