Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPA

The Income Statement, Comprehensive Income, and the Statement of Cash Flows

Chapter 4

4-2

An income statement for a

hypothetical manufacturing

company that you can refer to as we proceed through

the chapter.

4-3

Expenses

Outflows of resources incurred in generating revenues.

Revenues

Inflows of resources resulting

from providing goods or

services to customers.

Gains and Losses

Increases or decreases in equity from

peripheral or incidental

transactions of an entity.

Income from Continuing Operations

Income Tax Expense

Because of its

importance and size,

income tax expense is a

separate item.

4-4

Operating Income

Nonoperating Income

Operating versus Nonoperating Income

Includes revenues and expenses

directly related to the principal

revenue-generating

activities of the company

Includes certain gains and losses and revenues and expenses related to peripheral or

incidental activities of the

company

4-5

Earnings Quality

Earnings quality refers to the ability of reported earnings to predict a company’s future earnings.

Transitory Earningsversus

Permanent Earnings

4-6

Separately Reported ItemsReported separately, net of taxes:

Discontinued operations

Extraordinary items

4-7

Intraperiod Income Tax AllocationIncome 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 tax effect.

4-8

Reporting Discontinued OperationsReporting for Components Sold

Income or loss from operations of the

component from the beginning of the

reporting period to the disposal date.

Gain or loss on the disposal of the

component’s assets.

Reporting for Components Held For SaleIncome or loss from

operations of the component from the

beginning of the reporting period to the

end of the reporting period.

An “impairment loss” if the carrying value of

the assets of the component is more than the fair value minus cost to sell.

4-9

An extraordinary item is a material event or transaction that is both:1.Unusual in nature, and2.Infrequent in occurrenceExtraordinary items are reported net of related taxes

Extraordinary Items

4-10

Unusual or Infrequent Items

Items that are material and are either unusual or infrequent—but not

both—are included as separate items in continuing operations.

4-11

Type of Accounting Changes Definition

Change in Accounting Principle

Change from one GAAP method to another GAAP method

Change in Accounting Estimate

Revision of an estimate because of new information or new experience

Change in Reporting Entity

Preparation of financial statements for an accounting entity other than the entity that existed in the previous period

Accounting Changes

4-12

Correction of Accounting ErrorsErrors occur when transactions are either recorded incorrectly or not recorded at all.

Errors Discovered in

Same Year

Reverse original erroneous journal entry and record the appropriate journal entry.

Record a prior period adjustment to the beginning retained

earnings balance in a statement of shareholders’ equity.Previous years’ financial

statements that are incorrect as a result of the error are

retrospectively restated to reflect the correction.

Material Errors

Discovered in Subsequent

Year

4-13

Earnings Per Share DisclosureOne of the most widely used ratios is earnings per share (EPS), which shows the amount of income

earned by a company expressed on a per share basis.

Basic EPS

Net income less preferred dividends

Weighted-average number of common shares outstanding for the

period

Diluted EPS

Reflects the potential dilution that could occur for companies that have certain

securities outstanding that are convertible into common shares or stock options that could create additional common shares if

the options were exercised.

4-14

Earnings Per Share Disclosure

Report EPS data separately for:

1. Income or Loss from Continuing Operations

2. Separately Reported Items

a) discontinued operations

b) extraordinary Items

3. Net Income or Loss

4-15

Comprehensive Income

An expanded version of income that includes four types of gains and

losses that traditionally have not been included

in income statements.

4-16

The Statement of Cash Flows Provides relevant information about a

company’s cash receipts and cash disbursements.

Helps investors and creditors to assess future net cash flows liquidity long-term solvency.

Required for each income statement period reported.

4-17

Operating Activities

Cash Flows from

Operating Activities

Inflows from: sales to customers. interest and dividends

received. +

Outflows for: purchase of inventory. salaries, wages, and other

operating expenses. interest on debt. income taxes.

_

4-18Direct and Indirect Methods of

Reporting

Two Formats for Reporting Operating Activities

Reports the cash effects of each operating

activity

Direct Method

Starts with accrual net income and converts to cash basis

Indirect Method

4-19

Cash Flows from

Investing Activities

+

Investing ActivitiesInflows from:

sale of long-lived assets used in the business.

sale of investment securities (stocks and bonds).

collection of nontrade receivables.

_Outflows for:

purchase of long-lived assets used in the business.

purchase of investment securities (stocks and bonds).

loans to other entities.

4-20

Cash Flows from

Financing Activities

+

_

Financing Activities

Inflows from: sale of shares to owners. borrowing from creditors

through notes, loans, mortgages, and bonds.

Outflows for: owners in the form of dividends

or other distributions. owners for the reacquisition of

shares previously sold. creditors as repayment of the

principal amounts of debt.

4-21Noncash Investing and Financing

Activities

Significant investing and financing transactions not involving cash

also are reported.Acquisition of equipment (an investing

activity) by issuing a long-term note payable (a financing activity).

4-22

End of Chapter 4