Intermediate Accounting

Chapter 4:

Income Statement and Related

Information

4-1
 Income
Income Statement
Statement

Usefulness
 Evaluate past performance.

 Predicting future performance.

 Help assess the risk or uncertainty of

achieving future cash flows.

4-2
 Income
Income Statement
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
Income Statement
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
Format of
of the
the Income
Income Statement
Statement

Elements of the Income Statement

Revenues – Inflows or other enhancements of assets or
settlements of its liabilities that constitute the entity’s ongoing
major or central operations.
Examples of Revenue Accounts
 Sales  Dividend revenue
 Fee revenue  Rent revenue
 Interest revenue

4-5
 Format
Format of
of the
the Income
Income Statement
Statement

Elements of the Income Statement

Expenses – Outflows or other using-up of assets or
incurrences of liabilities that constitute the entity’s ongoing
major or central operations.
Examples of Expense Accounts
 Cost of goods sold  Rent expense
 Depreciation  Salary expense
expense
 Interest expense

4-6
 Format
Format of
of the
the Income
Income Statement
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
Single-Step Format
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
Single-Step Format
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
Format of
of the
the Income
Income Statement
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
Multiple-Step Format
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
Multiple-Step Format
Format
Income Statement (in thousands)
The presentation Sales $ 285,000
divides information Cost of goods sold 149,000
Gross profit 136,000
into major sections.
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
Multiple-Step Format
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
Reporting Irregular
Irregular Items
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
Reporting Irregular
Irregular Items
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
Reporting Discontinued
Discontinued Operations
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
Reporting Discontinued
Discontinued Operations
Operations
Income Statement (in thousands)
Discontinued
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
Income tax expense 24,000
Previously labeled as
Income from continuing operations 55,000
“Net Income”.
Discontinued operations:
Loss from operations, net of tax 315
Loss on disposal, net of tax 189
Total loss on discontinued operations 504
Moved to
Net income $ 54,496

4-17
 Reporting
Reporting Irregular
Irregular Items
Items

Extraordinary items are nonrecurring material items that

differ significantly from a company’s 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
Reporting Extraordinary
Extraordinary Items
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 corporation’s 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
Reporting Extraordinary
Extraordinary Items
Items

Income Statement (in thousands)

Extraordinary Items
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
Income tax expense 24,000
Previously labeled as
Income from continuing operations 55,000
“Net Income”.
Extraordinary loss, net of tax 539
Net income $ 54,461
Moved to

4-20
 Reporting
Reporting Irregular
Irregular Items
Items

Income Statement (in thousands)

Reporting when both
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
Reporting Irregular
Irregular Items
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
Reporting Irregular
Irregular Items
Items

Unusual Gains and Losses Illustration 4-9

Income Statement
Presentation of Unusual
Charges

4-23
 Reporting
Reporting Irregular
Irregular Items
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
Change in
in Estimate
Estimate Example
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
Change in
in Estimate
Estimate Example
Example After 7 years

Equipment cost $510,000 First,

First,establish
establishNBV
NBV
Salvage value - 10,000 at
atdate
dateof ofchange
changein
in
Depreciable base 500,000 estimate.
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
Change in
in Estimate
Estimate Example
Example After 7 years

Net book value $160,000 Depreciation

Depreciation
Salvage value (new) 5,000 Expense
Expensecalculation
calculation
Depreciable base 155,000 for
for2012.
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
Reporting Irregular
Irregular Items
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
Reporting Irregular
Irregular Items
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
Special Reporting
Reporting Issues
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
Special Reporting
Reporting Issues
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
Special Reporting
Reporting Issues
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
Special Reporting
Reporting Issues
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
Special Reporting
Reporting Issues
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
Hollis’s 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
Special Reporting
Reporting Issues
Issues

Illustration 4-17

Divide by
weighted-
average
shares
outstanding

EPS
4-35
 Special
Special Reporting
Reporting Issues
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
Special Reporting
Reporting Issues
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
Special Reporting
Reporting Issues
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
Special Reporting
Reporting Issues
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
Special Reporting
Reporting Issues
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):
Interest revenue 17,000
currency.
Interest expense (21,000)  Plus others
Total other (4,000)
Income before taxes 79,000
Income tax expense 24,000
Reported in Stockholders’
Net income $ 55,000 Equity

4-40
 Special
Special Reporting
Reporting Issues
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
Special Reporting
Reporting Issues
Issues
Comprehensive Illustration 4-19
Income

Second income
statement

4-42
 Special
Special Reporting
Reporting Issues
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
Special Reporting
Reporting Issues
Issues
Comprehensive Income – Statement of Stockholder’s Equity
Illustration 4-20

4-44
 Special
Special Reporting
Reporting Issues
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