the income statement, the statement of comprehensive income, and the statement of stockholders’...
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Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.
1
Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.
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The Income Statement, the Statement of Comprehensive Income, & the Statement of Stockholders’ EquityChapter 11
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3
Evaluate quality of earnings
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Earnings Quality
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Revenue Recognition
•Revenue is recognized when earned
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Cost of Goods Sold and Gross Profit
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Operating and Other Expenses
•Largest operating expenses include salaries, wages, utilities, and supplies
•The lower the cost relative to sales, the more efficiently management is operating the business
•Cutting costs can either help or hurt the bottom line
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Account for foreign-currency gains and losses
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International Transactions
JOURNAL
Date Accounts Debit Credit
7-28 Accounts Receivable (1 million pesos x $0.086)
86,000
Sales 86,000
10-18 Cash (1 million pesos x $0.083) 83,000
Foreign currency transaction loss 3,000
Accounts Receivable 86,000
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International Transactions
JOURNAL
Date Accounts Debit Credit
9-15 Inventory (20,000 Swiss francs x $1.15)
23,000
Accounts payable 23,000
10-18 Accounts payable 23,000
Cash (20,000 Swiss francs x $1.10)
22,000
Foreign-currency transaction gain
1,000
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Reporting Foreign-Currency Gains & Losses•Gains and losses netted
▫Shown as Other Revenue or Expense
Income Statement (Partial)
Other Expenses and Losses:
Foreign-Currency Transaction Loss, net
$2,000
$3,000 loss less $1,000 gain
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Account for other items on the income statement
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Interest expense Interest income
• Cost of borrowing money • Return earned on invested money
Interest Expense and Interest Income
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Corporate Income Taxes
Income tax
expense
Income before taxes
Income tax rate
From the income
statement
From the income
statement
Income tax
payable
Taxable income
From the tax return
From the tax return
Income tax rate
Income Statement account
Income Statement account
Balance sheet account
Balance sheet account
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Exercise 11-19A
JOURNAL
Date Accounts Debit Credit
12-31 Income Tax Expense ($500,000 x 40%) 200,000
Deferred Tax Liability 24,000
Income Tax Payable ($440,000 x 40%)
176,000
Income taxes paid
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Exercise 11-19A
Deferred tax liability
32,000
24,000
56,000
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Value of Corporate Stock
Estimated value of common
stock
Estimated future annual income
Investment capitalization rate
Current market value of company
Number of common shares
outstanding
Current market
price per share
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Investment Decision Rule
If the estimated value of the company
Decision
Exceeds
Current market
value of the company
Buy the stock because the price may go up
Equals
Hold the stock because the price will hold steady
Is less than
Sell the stock because the price may go down
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Discontinued Operations
•Sale or closure of a business segment•Gain or loss reported net of income tax•Typically not considered by analysts in
making predictions
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Change in estimates Change in principles
• Examples:▫ Estimated life of plant
asset ▫ Percent uncollectible of
receivables• Report new amounts for
current and future periods
• Example:▫ Change in inventory
method (FIFO to LIFO)• Report retrospectively
▫ Prior period amounts are restated
Accounting Changes
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Compute earnings per share
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Earnings per Share (EPS)
Net income minus Preferred DividendsNet income minus Preferred Dividends
Average # of Common Shares Outstanding
Average # of Common Shares Outstanding
Key measure of business
success
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Exercise 11-20A
Preferred stock $20 par, 2%, 11,000 shares issued
$220,000
Common stock, $2.50 par, 1,100,000 shares issued
2,750,000
Treasury stock, common, 120,000 shares at cost
480,000Preferred Dividend = $220,000 x 2%
Preferred Dividend = $220,000 x 2% $4,400$4,400
Common shares outstanding = shares issued less treasury
shares
Common shares outstanding = shares issued less treasury
shares
1,100,000 – 120,000 = 980,000
1,100,000 – 120,000 = 980,000
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Exercise 11-20A
Net Income minus Preferred DividendsNet Income minus Preferred Dividends
Average # of Common Shares Outstanding
Average # of Common Shares Outstanding
Earnings per share
980,000
$6,200,000 – $4,400 $6.32
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Correcting Retained Earnings
•Prior period adjustments▫Corrections to Retained Earnings for errors
of an earlier period Revenue or expense recorded incorrectly in
an earlier period▫Correction of error adjusts beginning
balance of retained earnings
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Analyze the statement of comprehensive income and the statement of stockholders’ equity
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Comprehensive Income
•Change in total stockholders’ equity from all non-owner sources
•Net income plus:▫Unrealized gains (losses) on available-for-
sale investments▫Foreign-currency translation adjustments
•Reported:▫Separate statement OR▫Combined with net income in unified
statement of comprehensive income
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Statement of Stockholders’ Equity•Column for each element of equity
•Row for each transaction that affected equity
Common stock
Additional paid-in capital
Retained
earnings
Accumulated other comprehensive
incomeTreasury stock
Beginning balance
+ Net earnings
+ or - Accumulated other comprehensive income
+ Issuance of stock
- Repurchase of stock
- Dividends
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Differentiate management’s and auditors’ responsibilities in financial reporting
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Management’s Responsibility
•Issues report on and declares responsibility for internal control over financial reporting
•States it has conducted an assessment of internal controls based on developed frameworks▫Internal controls determined to be effective▫Internal controls audited by outside
auditors
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Auditor’s Report
•CPAs examine financial statements of publicly-traded companies
•Auditors determine if statements comply with GAAP▫Decide if internal controls meet standards
•Combined report issued on the financial statements and system of internal controls
•Audit adds credibility to financial statements and internal control system
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