Intermediate Accounting

Chapter 4:

Income Statement and Related

Information

4-1
 Income Statement

Usefulness
Evaluate past performance.

Predicting future performance.

Help assess the risk or uncertainty of

achieving future cash flows.

4-2
 Income Statement

Limitations
Companies omit items that cannot be
measured reliably.

Income is affected by the accounting

methods employed.

Income measurement involves

judgment.

4-3
 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.

4-4
 Format of the Income Statement

Elements of the Income Statement

Revenues Inflows or other enhancements of assets or
settlements of its liabilities that constitute the entitys ongoing
major or central operations.

Examples of Revenue Accounts

Sales Dividend revenue

Fee revenue Rent revenue

Interest revenue

4-5
 Format of the Income Statement

Elements of the Income Statement

Expenses Outflows or other using-up of assets or
incurrences of liabilities that constitute the entitys ongoing
major or central operations.

Examples of Expense Accounts

Cost of goods sold Rent expense

Depreciation Salary expense

expense

Interest expense

4-6
 Format of the Income Statement

Elements of the Income Statement

Gains Increases in equity (net assets) from peripheral or
incidental transactions.
Losses - Decreases in equity (net assets) from peripheral or
incidental transactions.

Gains and losses can result from

sale of investments or plant assets,
settlement of liabilities,
write-offs of assets.

4-7
 Single-Step Format

Single-Step Income Income Statement (in thousands)

Revenues:
Statement Sales $ 285,000
Interest revenue 17,000
Total revenue 302,000
Revenues Single- Expenses:
Expenses Step Cost of goods sold 149,000
Selling expense 10,000
Net Income Administrative expense 43,000
Interest expense 21,000
Income tax expense 24,000
No distinction between Total expenses 247,000
Operating and Non-operating Net income $ 55,000
categories.
Earnings per share $ 0.75

4-8
 E4-4: Prepare an income Single-Step Format
statement from the data below.
Income Statement
For the year ended Dec. 31, 2012
Administrative expense: Revenues:
Officers' salaries $ 4,900 Sales $ 96,500
Depreciation 3,960 Rental revenue 17,230
Cost of goods sold 63,570 Total revenues 113,730
Rental revenue 17,230 Expenses:
Selling expense: Cost of goods sold 63,570
Transportation-out 2,690 Selling expense 17,150
Sales commissions 7,980 Administrative exense 8,860
Depreciation 6,480 Interest expense 1,860
Sales 96,500 Income tax expense 7,580
Income tax expense 7,580 Total expenses 99,020
Interest expense 1,860 Net income $ 14,710

4-9
 Format of the Income Statement

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.

4-10
 Multiple-Step Format

Intermediate Components of the Income Statement

1. Operating section

2. Nonoperating section

3. Income tax

4. Discontinued operations

5. Extraordinary items

6. Earnings per share

4-11
 Multiple-Step Format
Income Statement (in thousands)
The presentation Sales $ 285,000
divides information Cost of goods sold 149,000
into major sections. Gross profit 136,000
Operating expenses:
Selling expenses 10,000
1. Operating Section Administrative expenses 43,000
Total operating expense 53,000
Income from operations 83,000
Other revenue (expense):
2. Nonoperating Interest revenue 17,000
Section Interest expense (21,000)
Total other (4,000)
Income before taxes 79,000
3. Income tax Income tax expense 24,000
Net income $ 55,000

4-12
 Illustration (E4-4): Prepare Multiple-Step Format
an income statement from the
data below. Income Statement
For the year ended Dec. 31, 2012
Administrative expense: Sales $ 96,500
Officers' salaries $ 4,900 Cost of goods sold 63,750
Depreciation 3,960 Gross profit 32,750
Cost of goods sold 63,750 Operating Expenses:
Rental revenue 17,230 Selling expense 17,150
Selling expense: Administrative exense 8,860
Transportation-out 2,690 Total operating expenses 26,010
Sales commissions 7,980 Income from operations 6,740
Depreciation 6,480 Other revenue (expense):
Sales 96,500 Rental revenue 17,230
Income tax expense 7,580 Interest expense (1,860)
Interest expense 1,860 Total other 15,370
Income before tax 22,110
Income tax expense 7,580
Net income $ 14,530

4-13
 Reporting Irregular Items

Irregular items fall into six categories

1. Discontinued operations.

2. Extraordinary items.

3. Unusual gains and losses.

4. Changes in accounting principle.

5. Changes in estimates.

6. Corrections of errors.

4-14
 Reporting Irregular Items

Discontinued Operations
Occurs when,

(a) company eliminates the

results of operations and

cash flows of a component.

(b) there is no significant continuing involvement in that

component.

Amount reported net of tax.

4-15
 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

4-16
 Reporting Discontinued Operations

Discontinued Income Statement (in thousands)

Sales $ 285,000
Operations are reported
Cost of goods sold 149,000
after Income from Gross profit 136,000
continuing operations.
Interest expense (21,000)
Total other (4,000)
Income before taxes 79,000
Previously labeled as Income tax expense 24,000
Income from continuing operations 55,000
Net Income.
Discontinued operations:
Loss from operations, net of tax 315
Loss on disposal, net of tax 189
Moved to Total loss on discontinued operations 504
Net income $ 54,496

4-17
 Reporting Irregular Items

Extraordinary items are nonrecurring material items that

differ significantly from a companys 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.

4-18
 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 corporations 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)

4-19
 Reporting Extraordinary Items

Extraordinary Items Income Statement (in thousands)

Sales $ 285,000
are reported after
Cost of goods sold 149,000
Income from continuing Gross profit 136,000
operations.
Other revenue (expense):
Interest revenue 17,000
Interest expense (21,000)
Total other (4,000)
Income before taxes 79,000
Previously labeled as Income tax expense 24,000
Net Income. Income from continuing operations 55,000
Extraordinary loss, net of tax 539
Net income $ 54,461
Moved to

4-20
 Reporting Irregular Items

Reporting when both Income Statement (in thousands)

Sales $ 285,000
Discontinued
Cost of goods sold 149,000
Operations and Gross profit 136,000
Extraordinary Items
Income before taxes 79,000
are present.
Income tax expense 24,000
Income from continuing operations 55,000
Discontinued operations:
Discontinued Loss from operations, net of tax 315
Operations Loss on disposal, net of tax 189
Total loss on discontinued operations 504
Income before extraordinary item 54,496
Extraordinary Items Extraordinary loss, net of tax 539
Net income $ 54,496

4-21
 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.

4-22
 Reporting Irregular Items

Unusual Gains and Losses Illustration 4-9

Income Statement
Presentation of Unusual
Charges

4-23
 Reporting Irregular Items

Changes in Estimate
Accounted for in the period of change and future periods.
Not handled retrospectively.
Not considered errors or extraordinary items.
Examples include:
Useful lives and salvage values of depreciable assets.
Allowance for uncollectible receivables.
Inventory obsolescence.

4-24
 Change in Estimate Example

Change in Estimate: Arcadia HS, purchased equipment for

$510,000 which was estimated to have a useful life of 10 years
with a salvage value of $10,000 at the end of that time.
Depreciation has been recorded for 7 years on a straight-line
basis. In 2012 (year 8), it is determined that the total estimated
life should be 15 years with a salvage value of $5,000 at the
end of that time.
Questions:
Calculate the depreciation expense for 2012.

4-25
 Change in Estimate Example After 7 years

Equipment cost $510,000 First, establish NBV

Salvage value - 10,000 at date of change in
Depreciable base 500,000 estimate.
Useful life (original) 10 years
Annual depreciation $ 50,000 x 7 years = $350,000

Balance Sheet (Dec. 31, 2011)

Fixed Assets:
Equipment $510,000
Accumulated depreciation 350,000
Net book value (NBV) $160,000

4-26
 Change in Estimate Example After 7 years

Net book value $160,000 Depreciation

Salvage value (new) 5,000 Expense calculation
Depreciable base 155,000 for 2012.
Useful life remaining 8 years
Annual depreciation $ 19,375

Journal entry for 2012

Depreciation expense 19,375

Accumulated depreciation 19,375

4-27
 Reporting Irregular Items

Corrections of Errors
Result from:

mathematical mistakes.

mistakes in application of accounting principles.

oversight or misuse of facts.

Corrections treated as prior period adjustments.

Adjustment to the beginning balance of retained earnings.

4-28
 Reporting Irregular Items

Corrections of Errors: To illustrate, in 2013, Hillsboro Co.

determined that it incorrectly overstated its accounts
receivable and sales revenue by $100,000 in 2010. In 2013,
Hillboro makes the following entry to correct for this error
(ignore income taxes).

Retained earnings 100,000

Accounts receivable 100,000

4-29
 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.

4-30
 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

4-31
 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

4-32
 Special Reporting Issues

Earnings Per Share

Net income - Preferred dividends

Weighted average number of shares outstanding

An important business indicator.

Measures the dollars earned by each share of common

stock.

Must be disclosed on the the income statement.

4-33
 Special Reporting Issues

Earnings Per Share (BE4-8): In 2012, Hollis Corporation

reported net income of $1,000,000. It declared and paid preferred
stock dividends of $250,000. During 2012, Hollis had a weighted
average of 190,000 common shares outstanding. Compute
Holliss 2012 earnings per share.

Net income - Preferred dividends

Weighted average number of shares outstanding

$1,000,000 - $250,000
= $3.95 per share
190,000

4-34
 Special Reporting Issues

Illustration 4-17

Divide by
weighted-
average
shares
outstanding

EPS
4-35
 Special Reporting Issues

Retained Earnings Statement

Increase Decrease
Net income Net loss
Change in accounting Dividends
principle Change in accounting
Error corrections principles
Error corrections

4-36
 Special Reporting Issues

Woods, Inc.
Statement of Retained Earnings
For the Year Ended December 31, 2012

Balance, January 1 $ 1,050,000

Net income 360,000
Dividends (300,000)
Balance, December 31 $ 1,110,000

Before issuing the report for the year ended December 31, 2012, you
discover a $50,000 error (net of tax) that caused 2011 inventory to be
overstated (overstated inventory caused COGS to be lower and thus net
income to be higher in 2011). Would this discovery have any impact on the
reporting of the Statement of Retained Earnings for 2012?

4-37
 Special Reporting Issues

Woods, Inc.
Statement of Retained Earnings
For the Year Ended December 31, 2012

Balance, January 1 $ 1,050,000

Prior period adjustment - error correction (50,000)
Balance, January 1 (restated) 1,000,000
Net income 360,000
Dividends (300,000)
Balance, December 31 $ 1,060,000

4-38
 Special Reporting Issues

Comprehensive Income
All changes in equity during a period except those resulting
from investments by owners and distributions to owners.

Includes:

all revenues and gains, expenses and losses reported in

net income, and

all gains and losses that bypass net income but affect
stockholders equity.

4-39
 Special Reporting Issues
Comprehensive Income
Income Statement (in thousands) Other Comprehensive
Sales
Cost of goods sold
$ 285,000
149,000 + Income
Gross profit 136,000 Unrealized gains and
Operating expenses:
losses on available-for-
Selling expenses 10,000
Administrative expenses 43,000
sale securities.
Total operating expense 53,000 Translation gains and
Income from operations 83,000 losses on foreign
Other revenue (expense):
currency.
Interest revenue 17,000
Interest expense (21,000) Plus others
Total other (4,000)
Income before taxes 79,000
Reported in Stockholders
Income tax expense 24,000
Net income $ 55,000 Equity

4-40
 Special Reporting Issues

Companies must display the components of other

comprehensive income in one of three ways:

1. A second separate income statement;

2. A combined income statement of comprehensive

income; or

3. As part of the statement of stockholders equity

4-41
 Special Reporting Issues

Comprehensive Illustration 4-19

Income

Second income
statement

4-42
 Special Reporting Issues

Comprehensive V. Gill Inc.

Income Combined Statement of Comprehensive Income
For the Year Ended December 31, 2012
Combined
statement Sales revenue $ 800,000
Cost of goods sold 600,000
Gross profit 200,000
Operating expenses 90,000
Net income 110,000
Unrealized holding gain, net of tax 30,000
Comprehensive income $ 140,000

4-43
 Special Reporting Issues
Comprehensive Income Statement of Stockholders Equity
Illustration 4-20

4-44
 Special Reporting Issues
Comprehensive Income Balance Sheet Presentation

Illustration 4-21
Presentation of
Accumulated Other
Comprehensive
Income in the
Balance Sheet

Regardless of the display format used, the accumulated other

comprehensive income of $90,000 is reported in the stockholders
equity section of the balance sheet.
4-45