© 2004 the mcgraw-hill companies, inc. mcgraw-hill/irwin chapter 4 the income statement and...
Post on 20-Dec-2015
214 views
TRANSCRIPT
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Chapter 4
The Income Statement and Statement of
Cash Flows
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-2
Comprehensive Income
Proponents argue that certain
changes in equity should be included
in the determination of
net income.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-3
Comprehensive Income
Statement of Financial Accounting Standards No. 130
Comprehensive income includes traditional net income and changes in equity from nonowner
transactions.
Statement of Financial Accounting Standards No. 130
Comprehensive income includes traditional net income and changes in equity from nonowner
transactions.
Examples of nonowner transactions:
•Foreign currency translation adjustment, net of tax
•Unrealized gains(losses) on investment securities, net of tax
•Minimum pension liability adjustment, net of tax
Examples of nonowner transactions:
•Foreign currency translation adjustment, net of tax
•Unrealized gains(losses) on investment securities, net of tax
•Minimum pension liability adjustment, net of tax
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-4
Expenses
Outflows of resources incurred in generating revenues.
Revenues
Inflows of resources resulting
from providing goods or
services to customers.
Gains and Losses
Increases or decreases in equity from
peripheral or incidental
transactions of an entity.
Income from Continuing OperationsIncome from Continuing Operations
Income Tax Expense
Because of its
importance and size,
income tax expense is a
separate item.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-5
Operating Income
Nonoperating Incomevs.
Income Statement
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-6
Income Statement (Single-Step)
Expenses & Losses {
{Revenues & Gains
{Proper Heading
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-7
Income Statement (Multiple-Step)
{Non- operating Items
{Gross Margin
{Proper Heading
Operating Expenses {
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-8
Earnings Quality
Earnings quality refers to the ability of reported earnings to predict a company’s future.
The relevance of any historical-based financial statement hinges on its
predictive value.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-9 Manipulating Income and
Income Smoothing
“Most managers prefer to report earnings that follow a smooth, regular, upward path.”
Two ways to manipulate income:
1. Income shifting
2. Income statement classification
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-10
Separately Reported Items
Three types of events are reported separately, net of taxes:
1.
2.
3.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-11 Intraperiod Income Tax
Allocation
Income Tax Expense must be associated with each component of income that causes it.
Income Tax Expense must be associated with each component of income that causes it.
Show Income Tax Expense related to
Income from Continuing Operations.
Show Income Tax Expense related to
Income from Continuing Operations.
Report effects of Discontinued Operations, Extraordinary
Items, and Cumulative Effect of Accounting Changes NET OF
INCOME TAXES.
Report effects of Discontinued Operations, Extraordinary
Items, and Cumulative Effect of Accounting Changes NET OF
INCOME TAXES.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-12
Sale or disposal of a component of an entity.A component includes:
Reportable segments Operating segments Reporting units Subsidiaries Asset groups
Discontinued Operations
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-13
Report results of operations separately if two conditions are met:
1. The operations and cash flows of the component have been (or will be) eliminated from the ongoing operations.
2. The entity will not have any significant continuing involvement in the operations of the component after the disposal transaction.
Discontinued Operations
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-14
Results of operations include two items:
1. The income or loss stream for the period from the identifiable discontinued operation.
2. The actual gain or loss from disposal of the component
or
an “impairment loss” if the component is held for resale.
Discontinued Operations
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-15
Results of operations include two items:
1. The income or loss stream for the period from the identifiable discontinued operation.
2. The actual gain or loss from disposal of the component
or
an “impairment loss” if the component is held for resale.
Discontinued Operations
Carrying Value of Assets < (Fair Value of Assets - Cost to Sell)
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-16
During the year, Apex Co. sold an unprofitable component of the company. The
component had a net loss from operations during the period of $150,000 and its assets
sold at a loss of $100,000. Apex reported income from continuing operations of $128,387. All items are taxed at 30%.
How will this appear on the income statement?
Discontinued Operations Example
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-17
Discontinued Operations Example
Computation of Loss from Discontinued Operations (Net of Tax Effect):
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-18
Income Statement Presentation:
Discontinued Operations Example
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-19
Material in amount
Gains or losses that are unusual in nature and infrequent in occurrence. required by GAAP.
Reported net of related taxes
Extraordinary Items
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-20
During the year, Apex Co. experienced a loss of $75,000 due to an earthquake at one
of its manufacturing plants in Nashville. This was considered an extraordinary item.
The company reported income before extraordinary item of $128,387. All gains and losses are subject to a 30% tax rate.
How would this item appear on the income statement?
Extraordinary Items Example
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-21
Income Statement Presentation:
Extraordinary Items Example
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-22
Unusual or Infrequent Items
Items that are material and are either unusual or infrequent—but not both—
are included as a separate item in continuing operations.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-23
Type of Accounting Change Definition
Change in Accounting Principle
Replaces one GAAP with another
Change in Accounting Estimate
Revision of an estimate because of new information or new experience
Change in Reporting Entity
Change from reporting as one type of entity to another type of entity
Accounting Changes
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-24
Change in Accounting Principle
Occurs when Changing from one GAAP method to another
GAAP method, or Changing the method of application of an
existing principle.
Make a catch-up adjustment known as the cumulative effect of a change in accounting principle.The cumulative effect is reported net of taxes and after extraordinary items.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-25
Change in Accounting Principle Example
During the year, Apex Co. decided to change from the double-declining balance to the
straight-line method for depreciation. The effect of this change is an increase in net
income of $65,000. Apex reported income of $128,387 during the year. All items of income are subject to a 30% tax rate.
How would this item appear on the income statement?
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-26
Computation:
Income Statement Presentation:
Change in Accounting Principle Example
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-27
Change in Estimates
Revision of a previous accounting estimate.
The new estimate should be used in the current and future periods.
The prior accounting results should not be be restated.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-28
Change in EstimatesExampleOn January 1, 2000, we purchased
equipment costing $30,000, with a useful life of 10 years and no salvage value.
During 2003, we determine that the remaining useful is 5 years (8-year total life). We use straight-line depreciation.
Compute the revised depreciation expense for 2003.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-29
Asset cost 30,000$ Accumulated depreciation 12/31/02 - ($3,000 × 3 years) (9,000) Remaining to be depreciated 21,000 Remaining useful life ÷ 5 yearsRevised annual depreciation 4,200$
Record depreciation expense of $4,200 for2003 and subsequent years.
Change in EstimatesExample
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-30
Change in Reporting Entity
Financial statements
are prepared for separate
entities.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-31
Change in Reporting Entity
If two entities combine, a single set of consolidated financial statements
is generally required.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-32
Change in Reporting Entity
If two entities combine:
1. Prepare a single set of consolidated financial statements.
2. Retroactively restate financial statements of prior periods.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-33
Corrections of errors from a previous period.
Appear on the Statement of Retained Earnings as an adjustment to beginning retained earnings.
Must show the adjustment net of income taxes.
Prior Period Adjustments
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-34
Prior Period Adjustments Example
While reviewing the depreciation entries for 2001-2004, the controller found that
in 2003 depreciation expense was incorrectly debited for $150,000 when in
fact it should have been debited $125,000. All items are taxed at 30%.
Prepare the necessary journal entry in 2004 to correct this prior period error.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-35
GENERAL JOURNAL Page: 180Date Description PR Debit Credit
12/31/03 Depreciation Expense 150,000
Accumulated Depreciation 150,000
If this was the original entry, how do we correct it?
Can we just reverse it? Why or why not?
If this was the original entry, how do we correct it?
Can we just reverse it? Why or why not?
Prior Period Adjustments Example
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-36
GENERAL JOURNAL Page: 180Date Description PR Debit Credit
2004 Accumulated Depreciation 25,000
2004 Entry
To correct the 2003 error in 2004, we can debit Accumulated Depreciation since it is
a permanent account.
To correct the 2003 error in 2004, we can debit Accumulated Depreciation since it is
a permanent account.
Prior Period Adjustments Example
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-37
GENERAL JOURNAL Page: 180Date Description PR Debit Credit
2004 Accumulated Depreciation 25,000
Retained Earnings 17,500
2004 Entry
We can’t credit Depreciation Expensesince it was closed in 2003, so we credit
Retained Earnings.
We can’t credit Depreciation Expensesince it was closed in 2003, so we credit
Retained Earnings.
Prior Period Adjustments Example
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-38
GENERAL JOURNAL Page: 180Date Description PR Debit Credit
2004 Accumulated Depreciation 25,000
Income Taxes Payable 7,500
Retained Earnings 17,500
2004 Entry
Remember to consider the tax effects:$25,000 × 30% = $7,500 taxes payableRemember to consider the tax effects:$25,000 × 30% = $7,500 taxes payable
Prior Period Adjustments Example
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-40
Earnings Per Share Disclosure
Report EPS data separately for:
1. Income from Continuing Operations
2. Discontinued Operations
3. Extraordinary Items
4. Cumulative Effect of a Change in Accounting Principle
5. Net Income
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-41
Statement of Cash Flows
Provides relevant information about a company’s inflows and outflows of cash.
Helps investors and creditors to assess future net cash flows liquidity long-term solvency.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-42
Outflows to: Purchase of goods for resale
and services. Salaries and wages. Interest on debt. Income taxes.
Outflows to: Purchase of goods for resale
and services. Salaries and wages. Interest on debt. Income taxes.
Inflows from: Sales to customers. Interest and dividends
received.
Inflows from: Sales to customers. Interest and dividends
received.
Cash Flows from Operating Activities
Cash Flows from
Operating Activities
Cash Flows from
Operating Activities
+
_
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-43 Direct and Indirect Methods of
Reporting
Two Formats for Reporting Operating Activities
Reports the cash effects of each
operating activity
Direct Method
Starts with accrual net income and
converts to cash basis
Indirect Method
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-44
Cash Flows from
Investing Activities
Cash Flows from
Investing Activities
+
_
Cash Flows from Investing Activities
Inflows from: Sale of property, plant, and
equipment. Sale or maturity of investment
securities (stocks and bonds). Collection of nontrade
receivables.
Inflows from: Sale of property, plant, and
equipment. Sale or maturity of investment
securities (stocks and bonds). Collection of nontrade
receivables.
Outflows to: Purchase of property, plant, and
equipment. Purchase of investment
securities (stocks and bonds). Loans to other entities.
Outflows to: Purchase of property, plant, and
equipment. Purchase of investment
securities (stocks and bonds). Loans to other entities.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide4-45
Cash Flows from
Financing Activities
Cash Flows from
Financing Activities
+
_
Cash Flows from Financing Activities
Inflows from: Borrowing on notes,
mortgages, bonds, etc. from creditors.
Issuing stock to owners.
Inflows from: Borrowing on notes,
mortgages, bonds, etc. from creditors.
Issuing stock to owners.
Outflows to: Repay principal to creditors
(excluding interest). Repurchase stock from owners. Dividends to owners.
Outflows to: Repay principal to creditors
(excluding interest). Repurchase stock from owners. Dividends to owners.