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Income Statement
COPYRIGHT ©2007 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.
Chapter 4
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #2
The Income Statement
• Covers a period of time– For the Year/Quarter/Month Ended...
• Multiple-step format– Gross profit (sales – cost of goods sold)– Operating income (income before taxes, interest, and other
revenues and expenses)– Income before taxes– Net income
• Single-step format– Total of all revenues and gains– Less the total of all expenses and losses– No operating Income in this analysis
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #3
Multiple-Step Single Step
Sales 496,120$
Cost of Goods Sold 234,972
Gross Profit 261,148 Operating Expenses:
General & Administrative 131,409$ Advertising 128,325 Uncollectible Accounts 22,664 282,398
Operating Income (21,250) Interest Income 122,757 Other Revenue 44,715 167,472
Income Before Taxes 146,222 Income Taxes 8,498
Net Income 137,724$
Multiple-Step CompanyIncome Statement
For the Year Ended December 31, 20XX
Sales 496,120$ Interest Income 122,757 Other Income 44,715
663,592 Costs and Expenses:
Cost of Goods Sold 234,972$ General & Administrative 131,409 Advertising 128,325 Uncollectible Accounts 22,664 517,370
Income Before Taxes 146,222 Income Taxes 8,498
Net Income 137,724$
Single-Step CompanyIncome Statement
For the Year Ended December 31, 20XX
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #4
Net Sales
• Revenue from the sale of principal goods or services sold to customers
• Shown net of– Discounts– Returns– Allowances
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #5
Cost of Goods Sold
• The cost of goods that were sold to produce revenue
Retailer
Beginning Inventory
+ Purchases
– Ending Inventory
= Cost of Goods Sold
Manufacturer
Beginning Inventory
+ Cost of Goods Manufactured
– Ending Inventory
= Cost of Goods Sold
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #6
Other Operating Revenue
• Reflects the nature of the business• Examples
– Lease revenue– Royalty revenue– Finance charges– Commission revenue
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #7
Operating Expenses
• Selling expenses– Result from the company’s effort to create sales– Examples
• Advertising• Sales commissions• Sales supplies used
• Administrative expenses– Relate to the general administration of the
company’s operation– Examples
• Salaries• Insurance• Bad debt expense
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #8
Other Income or Expense
• Secondary activities not directly related to operations– Dividend income– Interest income– Gains (losses) from sale of assets– Interest expense
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #9
Special Income Statement Items
• Unusual or Infrequent Items Disclosed Separately– If material, disclosed separately, before income
taxes– Relate to operations
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #10
Special Income Statement Items (cont’d)
• Equity in Earnings of Nonconsolidated Subsidiaries– The investor’s proportional share of the investee’s
net income– Does not represent cash flow to the investor
• Cash dividends received represent cash flow
– Analysis issues:• Investor’s net income includes revenue of other entity• May distort ratios• Presented before tax; tax consequences typically
immaterial
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #11
Special Income Statement Items (cont’d)
• Income Taxes Related to Operations– Federal, state, and local– Includes both paid and deferred taxes
• Discontinued Operations– Reported net of income tax– Analysis issues:
• Inadequate disclosure of associated assets• Lack of historical profit and loss information on the
discontinued operations
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #12
Special Income Statement Items (cont’d)
• Extraordinary Items– Unusual and infrequent– Reported net of income tax– Analysis issues:
• Exclude from primary analysis• Include for supplementary analysis
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #13
Special Income Statement Items (cont’d)
• Cumulative Effect of a Change in Accounting Principle– For fiscal years beginning before 12/15/05
• Cumulative effect of the change shown net of tax on the income statement of the period in which change was made
• Earlier statements not restated to reflect application of the new principle
– Effective for fiscal years beginning after 12/15/05• All comparative statements are retrospectively restated to reflect
application of the new accounting principle• The cumulative effect on income of earlier years is shown as a
net-of-tax adjustment to the beginning Retained Earnings balance of the earliest period presented
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #14
Special Income Statement Items (cont’d)
• Minority Share of Earnings– Earnings of a partially-owned consolidated
subsidiary that would accrue to the minority owners– Presentation may be either pre-tax or net-of-tax
• Earnings per ShareNet income ÷ Number of shares outstanding
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #15
Reconciliation of Retained Earnings
Beginning of year balance of retained earnings
+ Prior period adjustments
± Cumulative effect of a change in accounting principle
= Beginning balance as adjusted
+ Net income
– Dividends
= End-of-year balance of retained earnings
Reported as part of the Statement of Owners' Equity or combined with the Income Statement
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #16
Retained Earnings
• The accumulated undistributed earnings of the corporation reported on the balance sheet
• Appropriated– Restricted by law, contract, or management
decision– Not available for dividends
• Unappropriated– Available for dividends– Does not represent cash or any other asset
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #17
Dividends
• Cash dividends– Date of declaration: create liability and reduce
retained earnings– Date of payment: reduce liability and cash
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #18
Stock Splits
• 2-for-1 split– Doubles the quantity of stock– Par or stated value is halved
• No effect on retained earnings, additional paid-in capital, or capital stock accounts
• Analysis issues:– Restate share quantities to reflect split activity
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #19
Legality of Distributions to Shareholders
• Per various state laws– Distributions are acceptable as long as the firm has
the ability to pay debts as they come due in the normal course of business
– Distributions to stockholders are acceptable as long as the firm is solvent and the distributions do not exceed the fair value of the assets
– Distributions consist of solvency and balance sheet test of liquidity and risk
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #20
Comprehensive Income
Net income
+ The period’s change in accumulated other comprehensive income
= Comprehensive income
• Foreign currency translation adjustments• Unrealized holding gains and losses on
available-for-sale marketable securities• Changes to owners' equity resulting from
additional minimum pension liability adjustments
• Unrealized gains and losses from derivative instruments
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #21
Comprehensive Income – Separate Statement
Net income 34,000$ Other comprehensive income
Available-for-sale security adjustment, net of tax 5,500 Minimum pension liability adjustment, net of tax 3,500 Foreign currency transaction adjustment, net of tax (5,000)
Total other comprehensive income 4,000
Comprehensive income 38,000$
XYZ CorporationStatement of Comprehensive Income
For the Year Ended December 31, 20XX
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #22
Comprehensive Income –Combined with Income Statement
Sales 230,000$ Cost of goods sold 140,000
Gross profit 370,000
Operating expenses 40,000
Operating income 330,000
Other income 4,000
Income before income taxes 326,000
Income taxes 20,000
Net income 306,000 Other comprehensive income
Available-for-sale security adjustment, net of tax 5,500 Minimum pension liability adjustment, net of tax 3,500 Foreign currency transaction adjustment, net of tax (5,000)
Other comprehensive income 4,000
Comprehensive income 310,000$
Earnings per share (for net income only) 2.80$
XYZ CorporationStatement of Income and Comprehensive Income
For the Year Ended December 31, 20XX
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #23
Comprehensive Income – As Part of the Statement of Owners' Equity
Retained
Accumulated Other
Comprehensive
Total Earnings Income Amount Shares
Beginning Balance $180,000 $60,000 $10,000 $110,000 55,000
Net Income 34,000 34,000Available-for-sale security adjustment, net of tax 5,500 5,500Minimum pension liability adjustment, net of tax 3,500 3,500Foreign currency transaction adjustment, net of tax (5,000) (5,000)
Comprehensive income 38,000
Ending Balance $218,000 $94,000 $14,000 $110,000 55,000
XYZ CorporationStatement of Changes in Stockholders' Equity
For the Year Ended December 31, 20XX
Common Stock
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #24
Comprehensive Income (cont’d)
• Analysis issues:– Typically more volatile than net income– A better indication of long-run profitability