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The Income Statement & Statement of Stockholders’ EquityChapter 11

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Analyze a corporate income statement

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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

•Interest expense represents charges for borrowed money

•Interest revenue represents return earned on invested money

•Income tax expense

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Operating Earnings

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Value of Corporate Stock

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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

Investment Decision Rule

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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

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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Accounting ChangesChange 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

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Earnings per Share (EPS)

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Net income minus Preferred Dividends

Average # of Common Shares Outstanding

Key measure of business

success

Exercise 11-16A

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Preferred stock $60 par, 3%, 12,000 shares issued

Common stock, $0.75 par, 1,100,000 shares issued

Treasury stock, common, 90,000 shares at cost

Preferred Dividend = $720,000 x 3% ?

Common shares outstanding = shares issued less treasury

shares?

Exercise 11-16A

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Net Income minus Preferred Dividends

Average # of Common Shares Outstanding

Earnings per share

?

??

Account for a corporation’s income tax

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Corporate Income Taxes

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Income tax

expense

Income before taxes

Income tax rate

From the Income

Statement

Income tax

payable

Taxable income

From the tax return

Income tax rate

Income Statement account

Balance sheet account

Exercise 11-18A

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Quinn Advertising Inc.Income Statement (partial)

For year ending December 31, 2010

Income before income tax

Income tax expense (375,000 x 30%)

Net Income

Exercise 11-18A

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Quinn Advertising, Inc.Balance Sheet (partial)

December 31, 2010

Current liabilities:

Income tax payable (300,000 x 30%)

Long-term liabilities:

Deferred tax liability (112,500 – 90,000)

Correcting Retained Earnings

•Prior period adjustments▫Revenue or expense recorded incorrectly in

an earlier period▫Correction of error adjusts beginning

balance of retained earnings

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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

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Analyze a statement of stockholders’ equity

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Statement of Stockholders’ Equity•Column for each element of equity

•Row for each transaction that affected equity

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Common stock

Additional paid-in capital

Retained

earnings

Accumulated other

comprehensive income

Treasury stock

Beginning balance

+ Net earnings

+ or – Accumulated other comprehensive income

+ Issuance of stock

- Repurchase of stock

- Dividends

Understand managers’ and auditors’ responsibilities for the financial statements

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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

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Auditor’s Report

•CPAs examine financial statements of publicly-traded companies

•Auditors determine if statements comply with GAAP

•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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