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The Income Statement
Chapter 4
Intermediate Accounting
16E
Prepared by: Sarita Sheth | Santa Monica College
COPYRIGHT © 2007
Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are
trademarks used herein under license.
Learning Objectives
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 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.
Transaction Approach
• 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.
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.
Expenses and Loss Recognition
• Three categories for expense
recognition:
1. Direct Matching
2. Systematic and rational
allocation
3. Immediate recognition
Form of the Income Statement
• 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.
Components of the Income
Statement
•
1.
2.
3.
4.
5.
6.
Income from Continuing Operations:
Revenue
Cost of goods sold
Operating expenses
Other revenues and gains
Other expenses and losses
Income taxes on continuing
operations
Income from Continuing
Operations
Determining Subtotals:
Gross profit =
Revenue – Cost of goods sold
Operating income =
Gross profit – Operating expenses
Income from Continuing
Operations
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
Discontinued 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.
Extraordinary Items
To be reported as
an
extraordinary
item the event
must be BOTH:
1. Unusual and
2. Infrequent.
Not Extraordinary
• 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 longterm contracts.
Changes in Accounting
Principle
•
Criteria for Change:
only if the new
principle:
1. provides more
useful
information.
2. is less costly per
benefit.
Change in Estimate
• Employ current and prospective
approach.
If
there
is
both
a
• Report current and future financial
principle
statementschange
on newinbasis.
a change
in
• Present priorand
periods
as previously
estimate for an
reported.
item, the event
is
• Make no adjustments
to current
period openingtreated
balances.
as a
• Present no pro change
forma data.
in
estimate.
Earnings Per Share
• When presenting EPS
figures:
• EPS amounts are
computed for income from
continuing operations
• And EPS amounts are
calculated for each
irregular or extraordinary
item.
Earnings Per Share
Formula for Income from
Continuing Operations
Income from continuing operations
Weighted average number of shares
of common stock outstanding
Earnings Per Share
Price-Earnings Ratio
Market value per share
Earnings per share
Widely
referred to as
the PE 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 Income
The 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.