Chapter 4

The Income Statement and Related Information

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1. Big Picture Quality of earnings Ability of reported earnings to predict future earnings

◦ permanent earnings◦ transitory earnings

Management of earnings◦ shifting income between periods◦ manipulating I/S classifications (e.g., restructuring charges)◦ reserves◦ pro forma reporting

All revenue and expense transactions include a change in an asset or liability account◦ How should those transactions be reported on I/S to best

reflect the quality of earnings information users need?

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1a. Big PictureTwo I/S approachesCurrent operating approach

◦ income should only reflect normal, current operations

◦non-current operating revenues, expenses, gains, and losses should go directly to RE

All inclusive approach◦ income should include all non-owner changes

in net assetsWhat is GAAP?

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1b. Big PictureComprehensive income

◦all changes in equity of an entity from transactions and other events from non-owner sources

◦includes net income and other itemsHow reported?

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2. Income Statement BasicsForm of income statement

◦single-step◦multi-step

Income from continuing operations

Special items

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Income Statement (Single-Step)

Expenses & Losses {

MAXWELL GEAR CORPORATIONIncome Statement

For the Year Ended December 31, 2009

Revenues and gains: Sales 573,522$ Interest and dividends 26,400 Gain on sale of opearting assets 5,500 Total revenues and gains 605,422

Expenses and losses: Cost of goods sold 302,371$ Selling 47,341 General and administrative 24,888 Research and development 16,300 Interest 6,200 Loss on sale of investment 8,322 Income taxes 80,000 Total expenses & losses 485,422 Net income 120,000$

{Revenues & Gains

{Proper Heading

Income Statement (Multiple-Step)

{Non- operating Items

{Gross Profit

Operating Expenses {

MAXWELL GEAR CORPORATIONIncome Statement

For the Year Ended December 31, 2009

Sales revenue 573,522$

Cost of goods sold 302,371

Gross profit 271,151

Operating expenses:

Selling 47,341$

General and administrative 24,888

Research and development 16,300 88,529

Operating income 182,622

Other income (expense):

Interest and dividend revenue 26,400$

Gain on sale of operating assets 5,500

Interest expense (6,200)

Loss on sale of investments (8,322) 17,378

Income before income taxes 200,000

Income tax expense 80,000

Net income 120,000$

{Proper Heading

3. Continuing OperationsPurposeItems included

◦operating income includes: revenue, cost of good sold, operating

expenses (selling & general and administrative expenses)

◦other income (expense) sometimes called nonoperating section includes: other revenue, gains, other expenses

(interest expense), losses

◦ income tax expenseACCT-3030 8

$ xxxxx

xxx

xx

xxNet Income $ xxx

Extraordinary items (net of $xx in taxes)

Income from continuing operations before income taxes and extraordinary itemsIncome tax expenseIncome from continuing operations before extraordinary itemsDiscontinued operations (net of $xx in taxes)

Income Statement (Lower portion)

4. Intraperiod Tax Allocation

Each section of the I/S m/b shown net of tax

Could be tax expense or tax benefit

Interperiod tax allocation complex topic

Examples

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5. Discontinued OperationsDisposal of a component of an entityLocation on ISMust disclose separately

◦income or loss from operating component from beginning of period

◦gain or loss on disposal of component’s assets

Sold v. Held for SaleItems reported net of tax

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6. Extraordinary ItemsMaterial unusual and infrequent gains and

losses◦ most meet both criteria

unusual in nature infrequent in occurrence

◦ if only meets one – goes in regular sectionLocation on I/SReported net of taxFairly rare itemsConsider in particular circumstancesBE 4-5

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7. Accounting ChangesChange in accounting principle

◦change from one GAAP to another GAAP◦examples◦accounting

Change in accounting estimate◦ revision of an estimate used in

implementing an accounting principle◦examples◦accounting

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7a. Accounting ChangesChange in reporting entity

◦current accounting entity differs from accounting entity in previous reporting period

Change in depreciation or depletion method

Change from unacceptable GAAP to acceptable GAAP

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8. Prior Period AdjustmentsCorrection of a material mistake

in net income in a prior year not discovered until current year

Only item that qualifies◦correction of an error

Reported as an adjustment to the beginning balance of RE

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9. EPSShown for each section of I/SComplex topicBasic formula

NI - PS DivEPS = ———————

WAS

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