chapter 4 schedule 9/26income measurement and income statement form pps. 153—166 10/01 components...
TRANSCRIPT
Chapter 4 Schedule
• 9/26 Income Measurement and Income Statement Form pps. 153—166
• 10/01 Components of the Income Statement, Comprehensive Income & Stockholders Equity pps. 167--187
• 10/03 no class• 10/08 completion of chapter 4
• Required problems: 40, 41, 48, 51• Exam 4 opens 10/08, closes 10/09
Learning Objectives—chapter 4
1. Define the concept of income.2. Explain why an income measure is
important.3. Explain how income is measured,
including the revenue recognition and expense matching concepts.
4. Understand the format of an income statement.
Learning Objectives (cont.)
5. Describe the specific components of an income statement.
6. Compute comprehensive income and prepare a statement of stockholders’ equity.
7. Construct simple forecasts of income for future periods.
INCOME—FASB CONCEPTUAL FRAMEWORK• “information about earnings and its
components measured by accrual accounting generally provides a better indication of enterprise performance than information about current cash receipts and payments.”
What is Income?
• Income is a Return over and above the investment
• Income is the amount an entity could return to investors and still leave the entity as “well-off” at the end of the period as it was at the beginning
Income Determination
• Financial Capital Maintenance Concept states:
Net assets (ending)- Net assets (beginning) = Income IF:
No investments by owners or distributions were made in the period.
• Thus, the change in net assets could be equal to income for the period.
Kreidler, Inc. had the following assets and liabilities at the
beginning and at the end of a period.
Kreidler, Inc. had the following assets and liabilities at the
beginning and at the end of a period.
Beginning of Period
End of Period
Total assets $510,000 $560,000
Total liabilities 430,000 390,000
Net assets (owners’ equity)$ 80,000 $170,000
Financial Capital Maintenance
Income is $90,000
If the owners invested $40,000 in the business and received dividends of $15,000, what
would be the income?
If the owners invested $40,000 in the business and received dividends of $15,000, what
would be the income?
Net assets, end of period $170,000 Net assets, beginning of period 80,000 Increase in net assets $ 90,000 Deduct investment by owners (40,000)Add dividends to owners 15,000 Income $ 65,000
Financial Capital Maintenance
Why is Income measurement important?
• Inherently important as a major component of business and evaluation of activities
• Helps assist in allocating resources to the most efficient and effective use
• Used by creditors, investors, govt.
How is Income measured?
• The transaction approach yields the same net income number as financial capital maintenance and provides means of measuring cash flows as well.
• Also known as the matching method.
How is Income measured?
• Transaction approach focuses on business events that affect financial statement elements: revenues, expenses, gains, losses
• Measures the net effect over time
Problems with Income measurement
• At what point should we recognize a revenue or gain
• When should an expense or loss be matched
Revenue and Gain Recognition
• Revenue is recognized when goods or services have been provided and the customer commits to payment.
• Revenues & gains recognized when:1. They are realized* or realizable*, and 2. They have been earned through substantial
completion of the activities involved in the earnings process.
Realized means payment has been receivedRelizable means we have received an assetthat is convertible to cash
Earlier Recognition
• Situations where revenue can be recognized earlier:
1. If a product will sell at an established price which is practically ensured without significant selling effort.
2. If a product or service is contracted for in advance, revenue may be recognized as production occurs (percentage-of-completion or proportional performance methods of revenue recognition.
Later Recognition
• If payment for products or services is considered doubtful, revenues and gains may be recognized as the cash is received.– Installment Sales method– Cost Recovery method
• Point-of-sale method will generally be followed for our problems unless othewise indicated
Expenses and Loss Recognition
• Three categories for expense recognition:
1. Direct Matching2. Systematic and rational
allocation3. Immediate recognition
• Direct Matching- relating expenses to specific revenues.
• Systematic and Rational Allocation- costs of assets that benefit more than one period are spread across periods in a systematic and rational way. (depreciation)
• Immediate Recognition- expenses that do not relate to specific revenues, but are incurred to indirectly generate revenue or when future benefits are highly uncertain. (admin expenses)
Expenses and Loss Recognition
Let’s Practice
• 4-1, 3, 4, 5• Ex 22, 23, 24, 25
• Traditionally, income from continuing operations is presented:– In a single step form- all revenues and
gains are first on the statement.– Multiple step form- divided into separate
sections and various subtotals are reported that reflect different levels of profitability.
Form of the Income Statement
Revenue $xxxCosts and expenses:
Costs of sales xxxSelling and administrative xxxInterest expense xxxOther income/expense, net xxxRestructuring charge xxx Total costs and expenses xxxIncome before income taxes xxIncome taxes xxNet income $ xx
Single-Step Single-Step Income Income
StatementStatement
Single-Step Single-Step Income Income
StatementStatement
Form of the Income Statement
Revenue $xxxCosts of goods sold:
Beginning inventory xxxNet purchases xxxCost of goods available for sale xxxLess ending inventory xxx xxx
Gross profit on sales xxxOperating expenses:
Selling expenses xxxGeneral expenses xxx xxx
Other income xxx
Multiple-Step Multiple-Step Income Income
StatementStatement
Multiple-Step Multiple-Step Income Income
StatementStatement
Form of the Income Statement
Other income (from previous page) $xxx Other revenue and gains xxx Other expenses and losses (xxx)Income from continuing operations before income taxes xxx Income taxes on continuing operations (xxx)Net income from Continuing Operations xxx
Form of the Income Statement
Continued:Discontinued operations:
Loss from operations of discontinued business segment (net of tax) $xxxLoss on disposal of segment (net of tax) xxx (xxx)
Extraordinary gain (net of tax) xxx Net income $xxx Cumulative Effect of a Change in Accounting Principle (net of tax) xxxNet income $xxx
=========
*Comprehensive items may be shown as a note to arrive at Comprehensive Net Income
Form of the Income Statement
Form of the Income Statement
Comparative financial statements present
several years’ financial statements side by side.
This enables users to analyze performance over
multiple periods and identify significant trends.
Comparative financial statements present
several years’ financial statements side by side.
This enables users to analyze performance over
multiple periods and identify significant trends.
Consolidated financial statements combine the
financial results of the “parent company” with other companies that it
owns, called subsidiaries.
Consolidated financial statements combine the
financial results of the “parent company” with other companies that it
owns, called subsidiaries.
Determining Subtotals:Income from Continuing Operations Before Taxes =
Operating income + Other revenues and gain – Other expenses and losses
Income from continuing operations =Income from continuing operations before income taxes – Income taxes on continuing operations
Income from Continuing Operations
Components of the Income Statement
• Income from Continuing Operations:1. Revenue2. Cost of goods sold3. Operating expenses4. Other revenues and gains5. Other expenses and losses6. Income taxes on continuing
operations
Determining Subtotals:Gross profit =
Revenue – Cost of goods soldOperating income =
Gross profit – Operating expenses
Income from Continuing Operations
RevenueRevenue
Revenue reports the total sales to
customers for the period less any sales
returns and allowances or
discounts. Does not include taxes or
shipping charges.
Components of the Income Statement
Beginning inventory
+ Net purchases
+ Freight-in
+ Other inventory acquisition costs
= Cost of goods available for sale
– Ending inventory
= Cost of goods sold
Components of the Income Statement
Cost of Goods SoldCost of Goods Sold
Cost of goods sold is a significant item on merchandising and manufacturing companies’
income statement.
Cost of goods sold is a significant item on merchandising and manufacturing companies’
income statement.
Net sales
– Cost of goods sold
= Gross profit
Gross profit ÷ Net sales = Gross profit
percentage
Gross profit ÷ Net sales = Gross profit
percentage
Gross ProfitGross Profit
Components of the Income Statement
Why is Gross Profit important?
---what is it used for?
Operating expenses may be reported in two parts:
1) Selling expenses
List some examples
2) General and Administrative expenses
List some examples
Components of the Income Statement
Operating ExpensesOperating Expenses
Operating income measures the performance of the fundamental business operations conducted by a company.
Gross profit
– Operating expenses
= Operating income
also call EBIT
Components of the Income Statement
Operating IncomeOperating Income
This section usually includes items identified with the
peripheral activities of the company.List some examples:
1) Rent revenue2) Interest revenue3) Dividend revenue4) Gains from the sale of assets
Components of the Income Statement
Other Revenues and GainsOther Revenues and Gains
This section parallels “Other Revenues and Gains” except the items result in deductions
from operating income.
List some examples1) Interest expense2) Losses from the sale of assets3) Restructuring charges
Components of the Income Statement
Other Expenses and Losses
Other Expenses and Losses
Income tax expense is calculated on income from all transactions of
consequence for the year.
Below the line items (transitory, irregular, and extraordinary items) are reported net of their individual tax effect.
See Techtronics, p. 166
Components of the Income Statement
Income TaxesIncome Taxes
Discontinued operations:Loss from operations of discontinued business segment (net of tax) $xxxLoss on disposal of segment (net of tax) xxx (xxx)
Extraordinary gain (net of tax) xxx Net income $xxx Cumulative Effect of a Change in Accounting Principle (net of tax) xxxNet income $xxx
=========
Below the Line items
Discontinued Operations• Not expected to continue to impact
results of future years operations• To report discontinued operations:
– The operations and cash flows of the component must be clearly identifiable
– For example, discontinued operations would result if a company closed one of four operating segments which tracks its cash flows and income separately. Or may be closing of a single line or even a single store.
• Management could decide to dispose of a component of a business because:
• The component may be unprofitable.• The component may not fit into the long-
range plans for the company.• Management may need funds to reduce
long-term debt or to expand into other areas.
• Management may be fearful of a corporate takeover by new investors desiring to gain control of the company.
Discontinued Operations
• When reporting discontinued operations on the income statement it consists of two parts:
1. Income (loss) from operations- disclosed only if decision to discontinue operations is made after beginning of the year.
2. Gain (loss) on disposal of operation- consisting of income (loss) during phase out and gain (loss) from disposal of segment assets.
Discontinued Operations
Discontinued Operations
According to FASB Statement No. 144, if on the balance sheet date assets and liabilities associated with discontinued components
have not been completely disposed, they are to be listed
separately in the asset and liability sections of the balance
sheet.
According to FASB Statement No. 144, if on the balance sheet date assets and liabilities associated with discontinued components
have not been completely disposed, they are to be listed
separately in the asset and liability sections of the balance
sheet.
In addition to the summary income or loss number reported
in the income statement, the total revenue associated with the discontinued operations should
be disclosed in the financial statement notes.
In addition to the summary income or loss number reported
in the income statement, the total revenue associated with the discontinued operations should
be disclosed in the financial statement notes.
Extraordinary Items
To be reported as an
extraordinary item the event must be BOTH:
1. Unusual and 2. Infrequent.
Not Extraordinary—p. 174
• Write-down or write-off of receivables, inventory, etc.
• Effects of a strike. • Gains or losses from exchange
or remeasurement of foreign currencies.
• Gains or losses on disposal of business segment.
• Gains or losses from sale or abandonment of productive assets.
• Adjustment of accruals on long-term contracts.
Changes in Accounting Principle
1. To provide more useful information (not just for economic purpose.)
2. Is usually the result of a FASB pronouncement or SEC directive
Changes in Accounting Principle
Disclosure Requirements:1. Report current year’s income
components on the new basis.2. Determine how the income
statement would be different in past years if the new accounting method would have been used; see p. 176
Change in Estimate
Estimates are always made using the best available information at the statement date
Revision of estimates is normal, and part of the continuing accounting process
Changes in estimates should be reflected in the current period and future periods. No retroactive adjustments are made.
Disclose as supplemental note
Net Income or Loss
• What is it?Income or Loss from continuing operations
• Combined with the results of discontinued operations and extraordinary items
• Provides a summary of the company’s performance for a period
• Is often measured and compared using the ratio of return on sales:
•Net Income / Net Sales
Earnings Per Share
• Represents the amount of net income associated with a share of common stock
• EPS amounts are computed for income from continuing operations
• And EPS amounts are calculated for each irregular or extraordinary item.
Income from continuing operations*Weighted average number of shares
of common stock outstanding
*less dividends paid or promised to Preferred Stock
Earnings Per Share
Formula for Income from Continuing Operations
Formula for Income from Continuing Operations
Earnings per Share
Basic EPS based on shares actually outstanding during the year
Diluted EPS represents additional stock which may result from stock options or other conversion rights (resulting in a potentially larger number of shares of stock)
Earnings Per Share
Market value per shareEarnings per share
Widely referred to as the PE
ratio
Widely referred to as the PE
ratio
Price-Earnings RatioPrice-Earnings Ratio
Comprehensive Income
• Comprehensive income- the amount that reflects the change in a company’s wealth during the period.
• It includes items that arise from changes in market conditions unrelated to the business operations of a company.
• Most companies include a report of comprehensive income as part of the statement of stockholders’ equity.
Comprehensive IncomeThe more common adjustments made in arriving at comprehensive income are:
• Foreign currency translation adjustments.
• Unrealized gains and losses on available-for-sale securities.
• Deferred gains and losses on derivative financial instruments.
Forecasting Future Performance
• Financial statements report the past, but are used to predict the future.
• Key to a good forecast involves identifying factors that determine a certain level of revenue or expense.
• Forecasting starts with a forecast for sales.
• Most expense forecast are driven from the sales forecast.