Chapter 4: Income Statement Format of the Income Statement Net Income results from revenue, expense, gain and

nd loss transactions. Income Statement Summarizes these transactions Transaction Approach: Focused on income-related activities that have occurred during the period. Major Of the Income Statement Revenues: Inflows or other enhancements of assets of an entity or settlements of its liabilities during a period from delivering or producing goods/services or activities that constitute the entitys ongoing major/central operations Expenses-Outflows or other using up of assets or incurrences of liabilities during a period from activities that constitutes entitys ongoing major/central operations Gains-Increase in equity(net assets) from peripheral or incidental transactions of an entity except those that result from revenues or investments by owners Losses-Decreases in equity or net assets from peripheral or incidental transactions of an entity. Forms of Revenue Sales, fees, interest, dividends, rents, etc Forms of Expenses CoGS, depreciation, interest, rent, salaries/wages, taxes, etc Forms of Gains/Losses Sale of investments or plant assets, settlement of liabilities, write-offs of assets due to impairment or casualty. Single Step Income Statement Two Groupings Revenues Expenses Expenses deducted from revenues to calculate net income or loss Sometimes companies report income tax separately as last item before net income to show its relationship to income before income tax. Single Step Income Statement Format:

Revenues Net Sales Dividend Revenue Rent Revenue Total Revenue Expenses CoGS Selling Expenses Admin Expenses Interest Expense Income Tax Expense Total Expenses Net Income Earnings Per Share

xxxx xxxx xxxx

xxxx xxx xxxx xxxx xxxx yyyy NI=(xxxx-yyyy) =NI/Shares Outstanding

Multi Step Income Statement Further classifications: Seperation of Operating and Non-Operating Activities of the Company Income from operations followed by sections titles Other revenues and Gains and Other Expenses and Losses Other Categories include transactions like interest revenues and expenses, gains or losses from sale of long term assets, and dividends received. Classification of expenses by functions like merchandising(CoGS), selling and administration. Permits immediate comparison w/costs of previous years with other departments in the same year. Separates operating transactions from non-operating and matches costs and expenses with related revenues. Intermediate Components of the Income Statement Companies using multistep income statement may prepare some or all of the following sections: Operating Section-Report of revenues and expenses of the companys principal operations. Includes: Sales or Revenue Section Subsection presenting sales, discounts, allowances, returns and other related info. Purpose is to arrive at net amount of sales revenue Cost of Goods Sold Section Subsection that shows CoG sold to produce sales Selling Expenses

 Lists expenses resulting from the companys efforts to make sales Admin or General Expenses Reports expenses of general administration Non Operating Section Report of rev. and exp. From secondary or auxiliary activities of the company. Special Gains or Losses that are Infrequent or Unusual(BUT NOT BOTH) are generally reported here as well. Two Main Subsections: Other Revenues and Gains Lists rev. earned or gains incurred Generally net of related expenses from Non Operating transactions Other Expenses and Losses List of exp. or losses incurred, generally net of an related incomes, from non operating transactions. Income Tax Short section reporting federal and state taxes on income from continuing operations Discontinued Operations Material Gains/Losses resulting from disposition of a segment of the business Extraordinary Items Unusual and Infrequent material gains and losses Earnings Per Share Although Content is always the same in the operating section, organization of material can differ Natural Expense Classification Manufacturing/Merchandising companies in wholesale trade Operating Section broken down into: Sales or Rev CoGS Selling Expenses Admin or General Expense Functional Expense Classification Retail stores Op. Section broken down to: Admin Occupancy Publicity Buying Selling

Multi Step Example:

COMPANY NAME Income Statement For The Year Ended Month Day, Year Sales Revenue Sales Less: Sales discounts Sales Returns and Allowances Net Sales Revenue Cost of Goods Sold Gross Profit Operating Expenses Sales and Saleries Expense Sales Office Salaries Travel and Entertainment Advertising Expense Freight and Trans-Out Shipping Supplies and Expense Postage and Stationary Telephone and Internet Exp Depreciation of Sales Expenses Admin Expenses Officer Salaries Office Salaries Legal and Prof. Services Utilities Exp Insurance Exp Depr. Of building Dep. Of Office Equip. Stationary, Supplies and Postage Misc. Office Expenses Income from Operations Other Revenue/gains Dividend Revenue Rent Revenue Other Expenses and Losses Int. On bonds and Notes Income before Income Tax Income tax Net Income for Year $xxx $aaa bbb (aaa+bbb) xxx-(aaa+bbb) yyyy Net Sales-COGS

yyyy yyyy yyyy yyyy yyyy yyyy yyyy yyyy yyyy (yyyy) zzzz zzzz zzzz zzzz zzzz zzzz zzzz zzzz zzzz

zzzz

(yyyy+zzzz) Gross Profit-Sum(admin and Selling exp)

xxxx xxxx

(xxxx)

Income from Operations+Other R (tttt) Income-other expenses/losses (ddd) Income-Income Tax net income/tot shares outstandingg

Earnings Per common share

First Column of Totals=Only numbers from individual expense accounts both Operating Expense Groupings Second Column= Totals from selling and admin. exp.; Sales discounts and allowances; other revenues and gains(if more than one); other expenses and losses(if more than one) Third Column= Sales; sum(disc and allow.); Net sales Revenue; CoGS; Gross Profit; Sum(both operating expense totals); Income from operations; Sum(other revenues and gains); Sum(other exp. and losses); Income before tax; income Tax; Net Income; Earnings per Common Share Net Sales useful because regular revenues reported separately from irregular/incidental revenues. Analysts can better understand and asses trends in rev. from continuing operations Gross Profit also reported Can study trend to see how well company uses resources Income from operations highlights difference between regular and incidental activities

Irregular Items Modified all inclusive concept Requires companies record most items, even irregular ones, as part of net income. Required to highlight irregular items in the fin. statements Six Categories of Irregular Items Discontinued Operations Extraordinary Items Unusual Gains/Losses Changes in Acct. principle Changes in estimates Correction of Errors Discontinued Operations Occurs when two things happen: A company eliminates the results of operations and cash flows of a component from its ongoing operations There is no significant continuing involvement in that component after the disposal transaction. Product Group= lowest level at which company can distinguish the operations and cash flows from the rest of the companys operations. Each Product Group is a component of the company. Disposing of a Product Group must be classified as a discontinued operation For example: Company has experienced losses with certain brands in a product group. Company decides to sell that product group. After the sale Company will discontinue any continuing Involvement with that group Company eliminates operations and cash flows from that group from its ongoing operations => Discontinued Operation

Example: Same as before, but company decided to only discontinue the brands that are experiencing losses. Cant differentiate between the cash flows from the brands and the cash flows of the product group as a whole Cant consider brands a component Cant classify any gains/losses from sale of brand as Discontinued operations. Gains or losses from Discontinued operations of a COMPONENT of BUSINESS are reported in a separate category on the income statement Companies also report the results of operations of a component that has been or will be disposed of separately from continuing operations. Effects of Disc. Operations net of Tax shown as a separate category, After Continuing Operations but Before Extraordinary Items Disc. Operations Category Example Income from Continuing Operations Discontinued Operations Loss from operations of component (net of tax) Loss from disposal of component (net of tax) Net Income xxx

xxx xxx (sum) (xxx-sum)

Disc. Operations Category Example Income from Continuing Operations Discontinued Operations Gain from operations of component (net of tax) Gain from disposal of component (net of tax) Net Income xxx

xxx xxx sum (xxx+sum)

Extraordinary Items Non Recurring Material Items that differ significantly from companys typical business activities. Criteria Events and transactions that are distinguished by their unusual nature and by the infrequency of their occurance. Requires meeting both of the following criteria Unusual Nature Event or Transaction should possess high degree of abnormality and be of a type clearly unrelated to, or only incidentally related to, the ordinary and

typical activities of the company, taking into account the environment in which it operates. Infrequency of Occurrence Company should not expect that the Event/Transaction to happen in the foreseeable future; taking into account the environment in which the company operates. Following gains/losses not extraordinary items because they are usual in nature and can be expected to occur in the future as a consequence of customary and continuing business activities: **Write-downs or write offs of recievables, inventories, equipment leased to others, deferred research and dev. Costs, or other intangible assets Gains/Losses from exchange or translation of foreign currencies, including those related to major devaluations and revaluations Gains/losses on the disposal of a component of an entity **Other gains/losses from sale or abandonment of property, plant or equipment used in the business Effects of a strike, including those against competitors/major suppliers Adjustment of accruals on long-term contracts. Example of extraordinary item would be both of the ** above if they resulted directly from a major casualty(like an earthquake) or prohibition under a newly acted law/regulation. Company must consider the environment in which it operates Environment includes factors like industry characteristics, geographic location, and nature/extent of government regulation. Hail damage to crop if hail damage is rare in area=Extraordinary Frost Damage to citrus crops in Florida= Not Extraordinary bc frost damage occurs normally there every few years. Also, if company sells only significant security investment its ever owned , the gain/loss is extraordinary. Gains/losses from Extraordinary Items shown on Income statement just before Net Income : XXXX + - extraordinary Item

Income before Extraordinary Items Extraordinary Items (less applicable income tax of $___)

Unusual Gains/Losses Items that are: Unusual or Infrequent, BUT NOT BOTH If items are not material, they are combined with other items in income statement IF material, they must be disclosed separately and reported ABOVE Income/Loss before extraordinary items Restructuring Charge Not Extraordinary

Unusual Items usually reported in separate section just above income from operations before income taxes and extraordinary items, especially when there are multiple unusual items. For HW or school purposes, usually report unusual gains/losses in the Other Revenues and Gains or Other Expenses and Losses section. Changes in Acct. Principles Company recognizes change in acct. principles by making retrospective adjustment to financial statements. Recasts prior years statements on a basis consistent with newly adopted principle. Company records cumulative effect of change for prior periods as an adjustment to beginning retained earnings of earliest year presented. Changes in estimates Company accounts for changes in estimates in the period of change if they affect only that period or in the period of change and future periods if the change affects both. Companies dont handle changes in estimates retroactiviely. Changes not carried back to adjust prior years Changes in estimates not considered errors or extraordinary items Correction of Errors Result of mathematical mistakes, mistakes in application of acct. principles, or oversight/misuse of facts at the time statements were prepared. Errors must be corrected by making proper entries in the accts and reporting the corrections in the financial statements. Correction of errors treated as prior period adjustments. Record a correction of an error in the year in which it was discovered. Report error in the statements as an adjustment to beginning balance of retained earnings. If comparative statements are prepared, it should restate the prior statements for the effects of the error. Summary of Irregular Items
Except for changes in accounting principle and error corrections, which are charged or credited directly to retained earnings, companies close all other irregular gains or losses or nonrecurring items to Income Summary and include them in the income statement. discontinued operations of a component of a business as a separate item in the income statement, after Income from continuing operations. Extraordinary items section below Discontinued operations.separately disclose other items of a material amount that are of an unusual or nonrecurring nature and are not considered extraordinary.

Intraperiod Tax Allocation Irregular Items (excapet for unusual gains/losses) on the income statement or statement of retained earnings net of tax. Called Intraperiod Tax Allocation Relates Income Tax expense of fiscal period to specific items that give rise to the amt. of the tax provision. Helps users understand how much tax expense relates to income from continuing operations and how much relates to certain irregular transactions and events. Used on the following items in the income statement: Income from continuing operations Discontinued Operations Extraordinary Items

Let the Tax Follow the Income Company computes tax expense for income from cont. Operations Find tax expense related to both rev. and exp transactions used in determining this income. Does not consider tax of items excluded from determining income from operations Compute separate tax effect with each irregular item (i.e. discontinued operations and extraordinary items.) Extraordinary Gains: Income before taxes and extraordinary gain of 250,000 Extraordinary gain of 100,000 from condemnation settlement received on property. 30% income tax rate. Income before Income Tax and Extraordinary Item Income Tax Income before Extraordinary Item Extraordinary Gain-Condemnation Settlement Less: Applicable Income Tax reduction Net Income $250,000 (75000) 175,000 $100,000 (30,000) 70,000 $245,000

Extraordinary Losses Income before taxes and extraordinary gain of 250,000 Extraordinary loss of 100,000 from major casualty Tax rate of 30% Income before Income Tax and Extraordinary Item Income Tax Income before Extraordinary Item Extraordinary Loss-Major Casualty Less: Applicable Income Tax reduction Net Income $250,000 (75000) 175,000 $100,000 (30,000) 70,000 $105,000

Because its a loss, its tax deductible. Subtract tax rate from loss, to get net of applicable income tax reduction. Earnings Per Share EPS=Net Income-Preferred Dividends(Income Available to Common Stockholders) Weighted Average of Common Shares Outstanding Net income=350,000 Preff. Div= 50,000 Weighted Avg. Shares Outstandind=100,000 EPS=$3.00 per share EPS must be disclosed on Face of Income Statement

If company reports Discontinued Operation, or extraordinary Item: Per share amts for these items must be reported on face on income statement or in the notes to the financial statements. Net Income Per Share of Common Stock Income from Cont. Operations Income/Loss from discontinued component Net of Tax Loss/Gain on disposale of disc. Operation, Net of Tax xxx x.xx + - y.yy +- z.zz

Income before extraordinary Item x.xx +-y.yy+-z.zz Extraorindary Gain/Loss , net of tax +-e.ee Net Income s.ss Retained Earnings Statement Net Income increases Retained Earnings Net Loss Decreases Retained Earnings Cash/Stock Dividends decrease retained earnings. Changes in Acct. Principles(generally) and prior period adj. may increase or decrease retained earnings. Companies charge/credit these adjustments(net of tax) to the opening balance of retained earnings. This Excludes adj. from the determination of net income for the current period. Companies may show retained earnings info in diff . Ways. Some prepare statement of retained earnings. Statement of Retained Earnings Example Retained Earnings, Beginning as reported Adjustment Retained Earnings, Beginning, as adjusted Add: Net Income Less: Cash Dividends Stock Dividends Retained Earnings, End Comprehensive Income
Because fair values are continually changing, some argue that recognizing these gains and losses in net income is misleading.

xxx +-yyy xxx yyy Xxx xxx yyy (xxx) xxx

Limited number of transactions should be recorded directly to stockholders equity. Unrealized gains and losses on available for sale securities. These are excluded from net income Items that bypass the income statement are included in a measure called comprehensive income. Includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. Because fair values are continually changing, some

argue that recognizing these gains and losses in net income is misleading. Comprehensive Income includes: All revenues and gains All expenses and losses reported in net income All gains and losses that bypass net income but affect stockholder equity. Other Comprehensive Income Items that bypass net income but affect stockholders equity Non Owner Changes in equity that bypass income statements. Can Display Other Comprehensive Income 3 ways: Second Income Statement Combined Statement of comprehensive Income Part of the statement to stockholders equity. Comprehensive Income= Net Income + Other Comprehensive Income

Example: Sales Revenue=800,000 CoGS= 600,000 Op. Exp = 90,000 Unrealized Holding Gain on AFS securities= 30,000, net of tax Second Income Statement Method Income Statement Sales Revenue CoGS Gross Profit Op. Exp. Net Income Comprehensive Income Statement Net Income Other Comprehensive Income Unrealized Holding gain, Net of Tax Comprehensive Income Combined Statement of Comprehensive Income: 800,000 600,000 200,000 90,000 110,000

110,000

30,000 140,000

the traditional net income is a subtotal, with total comprehensive income shown as a final total Statement of Stockholders Equity: Reports changes in each stockholder equity account and in total stockholders equity during the year. Prepared in Columnar Form Columns Used for Each Account and for Stockholders Equity

 Ex: Same info as before Common Stock 300000 Ret. Earnings 50,000 Acc. Other Comprehensive Inc. 60,000 Statement of SH Equity Total Comprehensive Income Ret. Earnings Beg. Balance 410,000 50,000 Comp. Income 110,000 110,000 110,000 OCI Unrealized Holding Gain, Net of Tax 30,000 30,000 Comp. Inc. 140,000 End Balance 550,000 160,000

Acc. OCI 60,000

Common Stock 300,0000

30,000 90,000 300,000