acct550 ch 4 summary for students

7/26/2019 ACCT550 Ch 4 Summary for Students

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CHAPTER 4

Income Statement and Related Information

LEARNING OBJECTIVES

1. Understand the uses and limitations of an income statement.

2. Describe the content and format of the income statement.

3. Prepare an income statement.

4. Explain how to report various income items.

5. Explain where to report earnings per share information

6. Understand the reporting of accounting changes and errors.

7. Prepare a retained earnings statement.

8. Explain how to report other comprehensive income.

Copyright 2013 John Wiley & Sons, Inc. Ki eso, Intermediate Accounting,15/e Instructors Manual ( For Instructor Use Only)


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CHAPTER REVIEW

1. Chapter 4 presents a detailed discussion of the concepts and techniques that underlie thepreparation of the income statement and retained earnings statement and the reporting ofother comprehensive income. The requirements for adequate presentation of reported netincome are described and illustrated throughout the chapter.

2. (L.O. 1) The income statement helps users of financial statements (1) evaluate the past

performance of the company, (2) provide a basis for predicting future performance, and(3) help assess the risk or uncertainty of achieving future cash flows. The limitations ofthe income statement include (1) companies omit items from the income statement thatthey cannot measure, (2) income numbers are affected by the accounting methodsemployed, and (3) income measurement involves judgment.

3. Quality of earnings is important because markets are based on trust and it is imperativethat investors have faith in the numbers reported. If that trust is damaged, capital marketswill be damaged.

Elements of the Income Statement

4. (L.O. 2) The major elements of net income are: revenues, expenses, gains, and losses.The distinction between revenues and gains and the distinction between expenses andlosses depend to a great extent on the typical activities of a business enterprise. Wheninflows or enhancements of assets result from typical business activities (generally theactivities the entity is in business to perform), revenues result. Likewise, outflows or theusing up of assets resulting from typical business activities will generate expenses.Nontypical business activities resulting in inflows or outflows of assets will normallygenerate transactions classified as gains or losses.

ncome Statement Formats

5. (L.O. 3) The income statement may be presented in the single-step format or the

multiple-step format. Single-step income statements derive their name from the fact thattotal costs and expenses are subtracted from total revenues in a single step to arrive at netincome. Income taxes are normally shown as a separate item among the expenses (usuallylast) to indicate their relationship to income before taxes. The multiple-step format separatesresults achieved by regular operations of the entity from those obtained by nonoperatingactivities. Expenses are also classified by function such as cost of sales, selling, andadministrative. The multiple-step format provides more information to financial statementusers than does the single-step format; however, both are found in actual practice.

6. An income statement is composed of various sections that relate to different aspects ofthe earning process. The seven sections identified in the chapter, in the general order oftheir appearance in the income statement, are:

(1) Operating Section. Revenues and expenses from the entitys principal operations.

a. Sales or revenue section.

b. Cost of goods sold section.

c. Selling expenses.

d. Administrative or general expenses.

4-2 Copyright 2013 John Wiley & Sons, Inc. Ki eso, Intermediate Accounting,15/e Instructors Manual ( For Instructor Use Only)


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(2) Nonoperating Section.Revenues and expenses resulting from secondary or auxilactivities of the company.

a. Other revenues and gains.

b. Other expenses and losses.

(3) Income Tax.All taxes levied on income from continuing operations.

(4) Discontinued Operations.

Material gains and losses resulting from disposal a segment of the business.

(5) Extraordinary Items.Unusual and infrequent material gains and losses.

(6) Noncontrollable Interest.

(7) Earnings per Share.

7. Condensed income statements.Includes only totals of expense groups. Supplemenschedules support the totals.

Reporting Various Income Items

8. (L.O. 4) For the most part, accountants tend to agree on the composition of items incluon the income statement. However, certain unusual items (irregular gains/losses) hstirred controversy in regard to the effect they should have on the presentation of income. Some accountants favor reporting the unusual items directly in the incostatement. Those who support the current operating performance concept to incomeasurement believe that the unusual items should be closed directly to retaiearnings (not included in computing net income). The accounting profession adoptemodified all-inclusive conceptand requires application of this approach in practice.

9. In an attempt to provide financial statement users with the ability to better determinelong-range earning power of an enterprise, certain professional pronouncements reqthat the following irregular items be highlighted in the financial statements.

a. Discontinued operations.

b. Extraordinary items.

c. Unusual gains and losses.

d. Changes in estimates.

e. Corrections of errors.



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Unusual Gains and Losses

10. Material gains and losses that are either unusual or occur infrequently, but not both, areexcluded from the extraordinary item classification. These items are presented with thenormal, recurring revenues, costs, and expenses. If material, these items are disclosedseparately; if immaterial, they may be combined with other items in the income statement.

Discontinued Operations

11. A discontinued operation occurs when (a) a company eliminates the results ofoperations of a component of the business, and (b) there is no significant continuinginvolvement in that component after the disposal transaction. When an entity decides todispose of a component of its business, certain classification and disclosure requirementsmust be met. A separate income statement category for gain or loss from disposal of acomponent of a business must be provided. In addition, the results of operations of acomponent that has been or will be disposed of are also reported separately fromcontinuing operations.

ntraperiod Tax Allocation

12. Intraperiod tax allocation is the process of relating the income tax effect of an unusualitem to that item when it appears on the income statement. Income tax expense related tocontinuing operations is shown on the income statement at its appropriately computedamount. All other items included in the determination of net income should be shown netof their related tax effect. The tax amount may be disclosed in the income statement or ina footnote.

Extraordinary Items

13. Extraordinary items are defined as material items that are unusual in nature and occurinfrequently. Both characteristics must exist for an item to be classified as anextraordinary item on the income statement. Only rarely does an event or transactionclearly meet both criteria and thus give rise to an extraordinary gain or loss. If an event ortransaction meets both tests, it is shown net of taxes in a separate section of the incomestatement usually just above net income.

Noncontrolling Interest

4. Noncontrolling interest is the portion of equity (net assets) interest in a subsidiary notattributable to the parent company.



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Earnings per Share

15. (L.O. 5) In general, earnings per share represents the ratio of net income minus prefedividends (income available to common shareholders) divided by the weighted avernumber of common shares outstanding. It is considered by many financial statement usto be the most significant statistic presented in the financial statements, and mustdisclosed on the face of the income statement. Per share amounts for gain or lossdiscontinued operations and gain or loss on extraordinary items must be disclosed on

face of the income statement or in the notes to the financial statements.

Changes in Accounting Principles

16. (L.O. 6) A change in accounting principle results when a company adopts a naccounting principle that is different from the one previously used. A company recognizechange in accounting principle by making a retrospective adjustment to the finanstatements. Such an adjustment recasts the prior years statements on a basis consiswith the newly adopted principle. The company records the cumulative effect of the chafor prior periods as an adjustment to beginning retained earnings of the earliest ypresented.

Changes in Estimates

17. Accountants make extensive use of estimates in preparing financial statements. Adjustmthat grow out of the use of estimates in accounting are used in the determinationincome for the current period and future periods and are not charged or credited direto Retained Earnings. It should be noted that changes in estimates are not consideerrors (prior period adjustments) nor extraordinary items.

Corrections of Errors

18. Companies must correct errors by making proper entries in the accounts and reporcorrections in the financial statements. Corrections of errors are treated as prior peadjustments, similar to changes in accounting principles. Companies record an errothe year in which it is discovered. They report the effect of the error as an adjustmenthe beginning balance of retained earnings. If a company prepares comparative finanstatements, it should restate the prior statements for the effects of the error.

Retained Earnings

19. (L.O. 7) The retained earnings statementserves to reconcile the balance of the retaiearnings account from the beginning to the end of the year. The important informacommunicated by the retained earnings statement includes: (a) prior period adjustme(income or loss related to corrections of errors in the financial statements of a prior penet of tax), (b) changes in accounting principle, (c) the relationship of dividend distributito net income for the period, and (d) any transfers to and from retained earnings.



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Comprehensive Income

20. (L.O. 8) Items that bypass the income statement are included under the concept ofcomprehensive income. Comprehensive incomeincludes all changes in equity duringa period except those resulting from investments by owners and distributions to owners.

21. The FASB requires that the components of other comprehensive income must bedisplayed in one of two ways: (1) a one statement approach, or (2) a two statement

approach. In the one statement approach,the traditional net income is a subtotal, withtotal comprehensive income shown as a final total. The combined statement has theadvantage of not requiring the creation of a new financial statement. The two statementformat reports comprehensive income in a separate statement, which indicates that thegains and losses identified as other comprehensive income have the same status astraditional gains and losses.

Statement of Stockholders Equity

22. This statement reports the changes in each stockholders equity account and in totalstockholders equity during the year. Both contributions (issuances of shares) and

distributions (dividends) to owners, and a reconciliation of the carrying amount of eachcomponent of stockholders equity from the beginning to the end of the period aredisclosed in the statement.

Q. (L.O. 9) IFRS Insights. As in GAAP, the income statement is a required statement forIFRS. In addition, the content and presentation of an IFRS income statement is similar tothe one used for GAAP.

1. IAS 1, Presentation of Financial Statements, provides general guidelines for thereporting of income statement information. Subsequently, a number of internationalstandards have been issued that provide additional guidance to issues related to

income statement presentation.

2. Relevant Facts.

a. Similarities.

(1) Both GAAP and IFRS require companies to indicate the amount of netincome attributable to noncontrolling interest.

(2) Both GAAP and IFRS follow the same presentation guidelines fordiscontinued operations, but IFRS defines a discontinued operation more

narrowly.

(3) Both GAAP and IFRS have items that are recognized in equity as part ofcomprehensive income but do not affect net income. Both GAAP and IFRSallow a separate statement of comprehensive income or a combinedstatement.



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b. Differences.

(1) Presentation of the income statement under GAAP follows either a single-step or multiple-step format. IFRS does not mention a single-step or multipstep approach. Under GAAP, companies must report an item as extraordinif it is unusual in nature and infrequent in occurrence. Extraordinary items aprohibited under IFRS.

(2) Under IFRS, companies must classify expenses by either nature or functioGAAP does not have that requirement, but the SEC requires a functionalpresentation.

(3) IFRS identifies certain minimum items that should be presented on theincome statement. GAAP has no minimum information requirements.However, the SEC rules have more rigorous presentation requirements.

(4) IFRS does not define key measures like income from operations. SECregulations define many key measures and provide requirements andlimitations on companies reporting non-GAAP/IFRS information.

(5) Under IFRS, revaluation of property, plant, and equipment, and intangassets is permitted and is reported as other comprehensive income. Teffect of this difference is that application of IFRS results in more transactiaffecting equity but not net income.



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LLUSTRATION 4-1SINGLE-STEP INCOME STATEMENT



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ILLUSTRATION 4-2MULTIPLE-STEP INCOME STATEMENT



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LLUSTRATION 4-3REPORTING SPECIAL ITEMS



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ILLUSTRATION 4-4SUMMARY OF IRREGULAR ITEMS



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LLUSTRATION 4-5SUMMARY OF ACCOUNTING CHANGES AND ERRORS



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ILLUSTRATION 4-6REPORTING ACCUMULATED OTHER COMPREHENSIVE INCOM

(a) One Statement Approach

ABC Company

Statement of Comprehensive IncomeFor the Year Ended December 31, 2014

Sales revenue $ xxCost of goods sold xxGross profit xxOperating expenses xxNet income xxOther comprehensive income

Unrealized holding gain (loss), net of taxes xxComprehensive income $ xx

(b)Two Statement Approach

ABC CompanyIncome Statement

For the Year Ended December 31, 2014

Sales revenue $ xxCost of goods sold xxGross profit xxOperating expenses xxNet income $ xx

ABC CompanyComprehensive Income Statement

For the Year Ended December 31, 2014Net income xxOther comprehensive income Unrealized holding gain (loss), net of taxes xxComprehensive income $ xx



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LLUSTRATION 4-7STOCKHOLDERS EQUITY STATEMENT


acct550 ch 4 summary for students

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