THE INCOME STATEMENT, COMPREHENSIVE INCOME, AND THE STATEMENT OF CASH FLOWS

OverviewThe purpose of the income statement is to summarize the profit-generating activities that occurred during a particular reporting period. Comprehensive income includes net income as well as a few gains and losses that are not part of net income and are considered other comprehensive income items instead.

The purpose of the statement of cash flows is to provide information about the cash receipts and cash disbursements of an enterprise that occurred during the period.

This chapter has a twofold purpose: (1) to consider important issues dealing with the content, presentation, and disclosure of net income and other components of comprehensive income and (2) to provide an overview of the statement of cash flows, which is covered in depth in Chapter 21.

Learning Objectives LO4-1 Discuss the importance of income from continuing operations and describe its

components. LO4-2 Describe earnings quality and how it is impacted by management practices to manipulate

earnings. LO4-3 Discuss the components of operating and nonoperating income and their relationship to

earnings quality. LO4-4 Define what constitutes discontinued operations and describe the appropriate income

statement presentation for these transactions. LO4-5 Define extraordinary items and describe the appropriate income statement presentation

for these transactions. LO4-6 Define earnings per share (EPS) and explain required disclosures of EPS for certain

income statement components. LO4-7 Explain the difference between net income and comprehensive income and how we

report components of the difference. LO4-8 Describe the purpose of the statement of cash flows. LO4-9 Identify and describe the various classifications of cash flows presented in a statement of

cash flows. LO4-10 Discuss the primary differences between U.S. GAAP and IFRS with respect to the

income statement and statement of cash flows.

© The McGraw-Hill Companies, Inc. 2013Instructors Resource Manual 4-1

Lecture Outline

Part A: The Income Statement and Comprehensive Income

I. Income from Continuing OperationsA. Income from continuing operations includes the revenues, expenses, gains, and losses that

will probably continue in future periods.1. Income tax expense always is shown as a separate expense.2. A distinction often is made between operating and nonoperating income. (T4-1)3. A single-step income statement format groups all revenues and gains together and all

expenses and losses together. (T4-2)4. A multiple-step income statement format includes a number of intermediate subtotals

before arriving at income from continuing operations. (T4-3)5. There are more similarities than differences between income statements prepared

according to U.S. GAAP and those prepared applying IFRS. (T4-4)

II. Earnings QualityA. Earnings quality refers to the ability of reported earnings (income) to predict a company’s

future earnings.1. To enhance predictive value, analysts try to separate a company’s transitory earnings

effects from its permanent earnings.2. Many believe that corporate earnings management practices reduce the quality of

earnings. Two major methods used by managers to manipulate income are (1) income shifting and (2) income statement classification.

B. Not all items included in operating income should be considered indicative of a company’s permanent earnings. (T4-5)1. Restructuring costs include costs associated with shutdown or relocation of facilities

or downsizing of operations. GAAP requires these costs to be expensed in the period(s) incurred.

2. Asset impairment losses and inventory write-down charges are other operating expenses that call into question the issue of earnings quality.

3. Earnings quality is affected by revenue issues as well.C. Some nonoperating items have generated considerable discussion with respect to earnings

quality, notably gains and losses generated from the sale of investments. (T4-6)

III. Separately Reported Items (T4-7)A. Intraperiod tax allocation associates tax expense or tax benefit with continuing operations

and any item reported below continuing operations. (T4-8)B. Discontinued operations involve the disposal or planned disposal of a component of an

entity. (T4-9)1. The FASB and IASB are working together to develop a common definition of what

constitutes a component of an entity. At the time this text was published, a finalAccounting Standards Update had not been issued,

2. When the component has been sold, the income effects of a discontinued operation includes (1) the operating income or loss of the component from the beginning of the reporting period to the disposal date, and (2) the gain or loss on disposal. (T4-10)

3. When the component is considered held for sale, the income effects of a discontinued operation includes (1) operating income or loss of the component from the beginning of the reporting period to the end of the reporting period, and (2) an impairment loss if the carrying value (book value) of the assets of the component is more than fair value minus cost to sell. (T4-11)

4. The assets and liabilities of a component considered held for sale are reported separately in the balance sheet at the lower of their carrying amount (book value) or fair value minus cost to sell.

C. Extraordinary items are material gains and losses that are both unusual in nature and infrequent in occurrence. (T4-12)1. Extraordinary gains and losses are presented, net-of-tax, in the income statement

below discontinued operations.2. A material gain or loss that is either unusual or infrequent should be reported as a

separate component of continuing operations. 3. There are no extraordinary gains and losses under IFRS. (T4-13)

IV. Accounting ChangesA. Accounting changes fall into one of three categories: (1) a change in an accounting

principle, (2) a change in estimate, or (3) a change in reporting entity.B. Most voluntary changes in accounting principles are accounted for retrospectively by

revising prior years’ financial statements. (T4-14)1. The comparative financial statements are revised.2. The appropriate accounts are adjusted. 3. A disclosure note provides clear justification that the change is appropriate. The note

also indicates the effects of the change on items not reported on the face of the primary statements, as well as any per share amounts affected for the current period and all prior periods presented.

C. A change in depreciation, amortization, or depletion method is considered to be a change in accounting estimate that is achieved by a change in accounting principle. These changes are accounted for prospectively, exactly as we would account for any other change in estimate.

D. A change in accounting estimate is reflected in the financial statements of the current period and future periods. (T4-15)

V. Correction of Accounting ErrorsA. Errors discovered in the same year they are made are simply corrected by journal entry.B. Treatment of errors discovered in a year subsequent to the year the error is made depends

on whether the error is material.1. If the error is not material, it is simply corrected in the year discovered.2. If the error is material, the correction is considered a prior period adjustment which

requires an addition to or reduction in beginning retained earnings and a restatement of previous years' financial statements.

VI. Earnings per Share DisclosuresA. Earnings per share (EPS) is the amount of income achieved during a period for each share

of common stock outstanding.B. All corporations whose common stock is publicly traded must disclose EPS.

C. The EPS for (a) income before any separately reported items, (b) each separately reported item, and (3) net income, must be disclosed. (T4-16)

VII.Comprehensive IncomeA. The purpose of the income statement is to summarize the profit-generating activities that

occurred during a particular reporting period.B. Comprehensive income is the total change in equity for a reporting period other than from

transactions with owners.C. The information in the income statement and other comprehensive income items can be

presented either (1) in a single, continuous statement of comprehensive income or (2) in two separate, but consecutive statements, an income statement and a statement of comprehensive income. (T4-17)

D. Both U.S. GAAP and IFRS allow companies to report comprehensive income in either a single statement of comprehensive income or in two separate statements. (T4-18)

Part B: The Statement of Cash Flows

I. Usefulness of the Statement of Cash FlowsA. The purpose of the statement of cash flows (SCF) is to provide information about cash

receipts and cash disbursements that occurred during a period.B. A SCF is presented for each period in which results of operations are provided.

II. Classifying Cash FlowsA. The SCF classifies all transactions affecting cash into one of three categories: (T4-19)

1. Operating activities are inflows and outflows of cash related to the transactions entering into the determination of net operating income. (T4-20)a. The Direct Methodb. The Indirect Method

2. Investing activities involve the acquisition and sale of (1) long-term assets used in the business and (2) nonoperating investment assets.

3. Financing activities involve cash inflows and outflows from transactions with creditors (excluding trade creditors) and owners.

B. Significant investing and financing transactions not involving cash also are reported.C. The classification of certain cash flows differs between U.S. GAAP and international

accounting standards. (T4-21)

PowerPoint SlidesA PowerPoint presentation of the chapter is available at the textbook website.

Teaching Transparency Masters

The following can be reproduced on transparency film as they appear here, or you can use the disk version of this manual and first modify them to suit your particular needs or preferences.

.

Consolidated Statements of Income(In millions, except per share amounts) Fiscal Year Ended

January 28, 2011

January 29, 2010

January 30, 2009

Net revenue: Products Services, including software related Total net revenue

$50,00211,492 61,494

$43,697 9,205 52,902

$52,337 8,764 61,101

Cost of net revenue: Products Services, including software related Total cost of net revenue

42,068 8,030 50,098

37,534 6,107 43,641

44,670 5,474 50,144

 Gross margin 11,396 9,261 10,957 Operating expenses: Selling, general, and administrative 7,302 6,645 7,102  Research, development, and engineering 661 624 665   Total operating expenses 7,963 7,089 7,767 Operating income 3,433 2,172 3,190Interest and other, net (83 ) (148 ) 134  Income before income taxes 3,350 2,024 3,324Income tax provision 715 591 846 Net income $ 2,635 $ 1,433 $ 2,478 Earnings per common share:   Basic $ 1.36 $ .73 $ 1.25   Diluted $ 1.35 $ .73 $ 1.25

Illustration 4-2

T4-1

INCOME STATEMENTS — DELL INC.

An advantage of the single-step format is its simplicity.

MAXWELL GEAR CORPORATIONIncome Statement

For the Year Ended December 31, 2013Revenues and gains:

Sales $573,522Interest and dividends 26,400Gain on sale of investments 5,500

Total revenues and gains 605,422Expenses and losses:

Cost of goods sold $302,371Office salaries 47,341Depreciation 24,888Miscellaneous 16,300Interest 14,522

Total expenses and losses 405,422Income before income taxes 200,000Income tax expense 80,000Net income $120,000

Illustration 4-3

T4-2

SINGLE-STEP INCOME STATEMENT

MULTIPLE-STEP INCOME STATEMENT An advantage of the multiple-step format is that it separately

reports operating and nonoperating activities.

MAXWELL GEAR CORPORATIONIncome Statement

For the Year Ended December 31, 2013Sales revenue $573,522Cost of goods sold 302,371Gross profit 271,151Operating expenses:Office salaries $47,341Depreciation 24,888Miscellaneous 16,300

Total operating expenses 88,529Operating income 182,622Other income (expense):Interest and dividend revenue 26,400Gain on sale of investments 5,500Interest expense (14,522 )

Total other income, net 17,378Income before income taxes 200,000Income tax expense 80,000Net income $120,000

Illustration 4-4

T4-3

INTERNATIONAL FINANCIAL REPORTING STANDARDS

Income Statement Presentation. There are more similarities than differences between income statements prepared according to U.S. GAAP and those prepared applying international standards. Some of the differences are:

International standards require certain minimum information to be reported on the face of the income statement. U.S. GAAP has no minimum requirements.

International standards allow expenses to be classified either by function (e.g., cost of goods sold, general and administrative, etc), or by natural description (e.g., salaries, rent, etc.). SEC regulations require that expenses be classified by function.

In the U.S., the “bottom line” of the income statement usually is called either net income or net loss. The descriptive term for the bottom line of the income statement prepared according to international standards is either profit or loss.

As we discuss later, we report “extraordinary items” separately in an income statement prepared according to U.S. GAAP. International standards prohibit reporting “extraordinary items.”

T4-4

OPERATING INCOME AND EARNINGS QUALITY

Operating income could include some unusual items that may or may not continue in the future.

Income Statements – JDS Uniphase Corporation

Income Statements (in part)($ in millions) Years Ended

July 3,2010

June 27, 2009

Net revenue $1,363.9 $1,283.3 Cost of sales 816 .8 796 .7 Gross profit 547 .1 486 .6 Operating expenses: Research and development 174.9 167.1 Selling, general, and administrative 380.9 399.0 Amortization of intangibles 27.8 27.0 Impairment of goodwill -- 741.7 Impairment of long-lived assets -- 13.2 Restructuring costs 17 .7 38 .5 Total operating expenses 601 .3 1,386 .5 Operating loss (54 .2 (899 .9 )

Illustration 4-5

T4-5

NONOPERATING INCOME AND EARNINGS QUALITY

Some nonoperating items have generated considerable discussion with respect to earnings quality, notably gains and losses from the sale of investments.

Income Statements – Intel Corporation

Income Statements (in part)Years Ended December 30

(in millions)2000 1999

Operating income 10,395 9,767 Gains on investments, net 3,759 883 Interest and other, net 987 578 Income before taxes 15,141 11,228

Illustration 4-7

T4-6

SEPARATELY REPORTED ITEMS

► Discontinued operations, and

► Extraordinary items

Income from continuing operations before income taxes and extraordinary item $XXXIncome tax expense XXIncome from continuing operations before extraordinary item XXX

Discontinued operations, net of $xx in taxes XXExtraordinary items, net of $xx in taxes XX

Net income $XXX

Their income tax effect is included in the separate presentation rather than as part of the amount reported as income tax expense.

T4-7

INTRAPERIOD TAX ALLOCATION► Intraperiod tax allocation associates tax expense or tax benefit

with continuing operations and any separately reported item.

► The Maxwell Gear Corporation had income from continuing operations of $200,000 before income tax expense and an extraordinary gain of $60,000 in 2013. The income tax rate is 40% on all items of income or loss. Therefore, the company’s total income tax expense is $104,000 (40% x $260,000).

Illustration 4-8

Income Statement Presented Incorrectly — No Intraperiod Tax Allocation (Extraordinary Gain)

Incorrect Presentation

Income from continuing operations before income taxes $200,000Income tax expense (104,000 )

Income before extraordinary gain 96,000Extraordinary gain (gross) 60,000

Net income $156,000

Illustration 4-8a

Income Statement — Intraperiod Tax Allocation (Extraordinary Gain)

Correct Presentation

Income from continuing operations before income taxes $200,000Income tax expense (80,000 )

Income before extraordinary gain 120,000Extraordinary gain, net of $24,000 tax expense 36,000

Net income $156,000

Illustration 4-8b, T4-8

DISCONTINUED OPERATION

► If a component of an entity has either been disposed of or classified as held for sale, we report the results of its operations separately in discontinued operations.

T4-9

DISCONTINUED OPERATIONS —When the component has been sold

When the component has been sold, the income effects of a discontinued operation includes:

1. Operating income or loss (revenues, expenses, gains and losses) of the component from the beginning of the reporting period to the disposal date.

2. Gain or loss on disposal.

The Duluth Holding Company has several operating divisions. In October 2013, management decided to sell one of its divisions that qualifies as a separate component according to generally accepted accounting principles. The division was sold on December 18, 2013 for a net selling price of $14,000,000. On that date, the assets of the division had a book value of $12,000,000. For the period January 1 through disposal, the division reported a pre-tax loss from operations of $4,200,000. The company’s income tax rate is 40% on all items of income or loss. Duluth generated after-tax profits of $22,350,000 from its continuing operations.

Duluth’s income statement for the year 2013, beginning with income from continuing operations, would be reported as follows:

Income from continuing operations $22,350,000Discontinued operations: Loss from operations of discontinued component (including gain on disposal of $2,000,000*) $(2,200,000) † Income tax benefit 880,000 ‡Loss on discontinued operations (1,320,000)Net income $21,030,000

* Net selling price of $14 million less book value of $12 million† Loss from operations of $4.2 million less gain on disposal of $2 million‡ $2,200,000 x 40%

Illustration 4-9T4-10

DISCONTINUED OPERATIONS —When the component is considered held for sale

When the component is considered held for sale, the income effects of a discontinued operation includes:

1. Operating income or loss (revenues, expenses, gains and losses) of the component from the beginning of the reporting period to the end of the reporting period.

2. An “impairment loss” if the carrying value (book value) of the assets of the component is more than fair value minus cost to sell.

The Duluth Holding Company has several operating divisions. In October of 2013, management decided to sell one of its divisions that qualifies as a separate component according to generally accepted accounting principles. On December 31, 2013, the end of the company’s fiscal year, the division had not yet been sold. On that date, the assets of the division had a book value of $12,000,000 and a fair value, minus anticipated costs to sell, of $9,000,000. For the year, the division reported a pre-tax loss from operations of $4,200,000. The company’s income tax rate is 40% on all items of income or loss. Duluth generated after-tax profits of $22,350,000 from its continuing operations.

Duluth’s income statement for 2013, beginning with income from continuing operations, would be reported as follows:

Income from continuing operations $22,350,000Discontinued operations: Loss from operations of discontinued component (including impairment loss of $3,000,000*) $(7,200,000) † Income tax benefit 2,880,000 ‡Loss on discontinued operations (4,320,000)Net income $18,030,000

* Book value of $12 million less fair value net of cost to sell of $9 million† Operating loss of $4.2 million plus impairment loss of $3 million‡ $7,200,000 x 40%

Illustration 4-10T4-11

EXTRAORDINARY ITEMS► Extraordinary items are material gains and losses resulting

from transactions or events that are both:

Unusual in nature.

Infrequent in occurrence, considering the environment in which the entity operates.

► Extraordinary gains and losses are presented in the income statement, net-of-tax, below discontinued operations.

► If an event is material and either unusual or infrequent, but not both, it should be reported as a separate component of continuing operations.

A common example of an unusual or infrequent item is restructuring costs.

T4-12

INTERNATIONAL FINANCIAL REPORTING STANDARDS

Extraordinary items. U.S. GAAP provides for the separate reporting, as an extraordinary item, of a material gain or loss that is unusual in nature and infrequent in occurrence. In 2003, the IASB revised IAS No. 1. The revision states that neither the income statement nor any notes may contain any items called “extraordinary.”

T4-13

CHANGE IN ACCOUNTING PRINCIPLE► Most voluntary changes in accounting principles are

accounted for retrospectively by revising prior years’ financial statements.

► The steps used to account for changes are as follows:

1. The comparative financial statements are revised.

2. The appropriate accounts are adjusted.

3. A disclosure note provides clear justification for the change along with the effects of the change on items not reported on the face of the primary statements, as well as any per share amounts affected for the current period and all prior periods presented.

► A change in depreciation, amortization, or depletion method is considered to be a change in accounting estimate that is achieved by a change in accounting principle. We account for these changes prospectively, exactly as we would any other change in estimate.

T4-14

CHANGE IN ACCOUNTING ESTIMATE► A change in accounting estimate is reflected in the financial

statements of the current period and future periods.

T4-15

EARNINGS PER SHARE Earnings per share (EPS) is the amount of income earned

expressed on a per share basis.

In its simplest form, EPS is computed by dividing net income by the weighted average number of common shares outstanding.

All corporations whose common stock is publicly traded must disclose EPS.

The EPS for (a) income before any separately reported items, (b) each separately reported item, and (3) net income, must be disclosed.

T4-16

EARNINGS PER SHARE(continued)

Charming Shoppes, Inc.Consolidated Statements of Operations (in part)

Year Ended January 30, January 31, February 2,($ in thousands, except per share data) 2010 2009 2008Loss from continuing operations before extraordinary item $ (77,962) $ (180,351) $ (4,163) Loss from discontinued operations, net of tax _ (74,922) (85,039) Extraordinary item, net of tax -- -- 912 Net loss $ (77,962) $ (255,273 ) $ (88,290 )

Basic earnings (loss) per shareLoss from continuing operations before extraordinary item $ (.67) $ (1.57) $ (.03)Loss from discontinued operations -- (.65) (.70)Extraordinary item -- -- .01 Net loss $ (.67) $ (2 .22 ) $ ( .72 )

Diluted earnings (loss) per share:Loss from continuing operations before extraordinary item $ (.67) $ (1.57) $ (.03)Loss from discontinued operations -- (.65) (.70)Extraordinary gain -- -- .01 Net loss $ (.67) $ (2 .22 ) $ ( .72 )

Illustration 4-13T4-16 (continued)

COMPREHENSIVE INCOME

► Comprehensive income is the total nonowner change in equity for a period.

($ in millions)Net income $xxxOther comprehensive income:

Net unrealized holding gains (losses) from investments (net of tax)* $xx Gains (losses) from and amendments to postretirement

benefits plans (net of tax)† (x)Deferred gains (losses) from derivatives (net of tax) ‡ (x) Gains (losses) from foreign currency translation (net of tax) § x xx

Comprehensive income $xxx

* Changes in the market value of certain investments (described in Chapter 12).† Gains and losses due to revising assumptions or market returns differing from

expectations and prior service cost from amending the plan (described in Chapter 17).

‡ When a derivative designated as a cash flow hedge is adjusted to fair value, the gain or loss is deferred as a component of comprehensive income and included in earnings later, at the same time as earnings are affected by the hedged transaction (described in the Derivatives Appendix to the text).

§ Gains or losses from changes in foreign currency exchange rates. The amount could be an addition to or reduction in shareholders’ equity. (This item is discussed elsewhere in your accounting curriculum.)

Illustration 4-15

The information in the income statement and other comprehensive income items can be presented either (1) in a single, continuous statement of comprehensive income or (2) in two separate, but consecutive statements, an income statement and a statement of comprehensive income.

T4-17

INTERNATIONAL FINANCIAL REPORTING STANDARDS

Comprehensive Income. Both U.S. GAAP and IFRS allow companies to report comprehensive income in either a single statement of comprehensive income or in two separate statements.

Other comprehensive income items are similar under the two sets of standards. However, an additional OCI item, changes in revaluation surplus, is possible under IFRS. In Chapter 10 you will learn that IAS No. 1647 permits companies to value property, plant, and equipment at (1) cost less accumulated depreciation or (2) fair value (revaluation). IAS No. 38 provides a similar option for the valuation of intangible assets. U.S. GAAP prohibits revaluation. If the revaluation option is chosen and fair value is higher than book value, the difference, changes in revaluation surplus, is reported as other comprehensive income and then accumulates in a revaluation surplus account in equity.

T4-18

STATEMENT OF CASH FLOWS

► OPERATING ACTIVITIES

Inflows and outflows of cash that result from activities reported in the income statement.

Includes most of the elements of net income, but reported on a cash basis rather than an accrual basis.

► INVESTING ACTIVITIES

Inflows and outflows of cash related to the acquisition and disposition of long-term assets (such as property, plant and equipment, and intangible assets) and investment assets (except those classified as cash equivalents and trading securities).

The purchase and sale of inventories are not considered investing activities.

► FINANCING ACTIVITIES

Cash inflows and outflows from transactions with creditors (excluding trade creditors) and owners.

T4-19

CASH FLOWS FROM OPERATIONS ACTIVITIES

Under the direct method, the cash effect of each operating activity is reported directly in the statement.

By the indirect method, we arrive at net cash flow from operating activities indirectly by starting with reported net income and working backwards to convert that amount to a cash basis.

T 4-20

CASH FLOWS FROM OPERATIONS ACTIVITIES(continued)

Arlington Lawn Care (ALC) began operations at the beginning of 2013. ALC’s 2013 income statement and its year-end balance sheet are shown below ($ in thousands).

ARLINGTON LAWN CAREIncome Statement

For the Year Ended December 31, 2013

Service revenue $90Operating expenses: General and administrative $32* Depreciation 8 Total operating expenses 40Income before income taxes 50 Income tax expense 15Net income $35

* Includes $6 in insurance expense.

ARLINGTON LAWN CAREBalance Sheet

At December 31, 2013

Assets Liabilities and shareholders’ equityCurrent assets: Current liabilities: Cash $54 Accounts payable** $ 7 Accounts receivable 12 Income taxes payable 15 Prepaid insurance 4 Total current liabilities 22 Total current assets 70 Shareholders’ equity: Equipment 40 Common stock 50Less: Accumulated depreciation (8) Retained earnings 30*** Total assets $102 Total liabilities and

shareholders’ equity $102 ** For general and administrative expenses*** Net income of $35 less $5 in cash dividends paid

Illustration 4-17T4-20 (continued)

CASH FLOWS FROM OPERATIONS ACTIVITIES(continued)

ARLINGTON LAWN CAREStatement of Cash Flows

For the Year Ended December 31, 2013($ in thousands)

Cash Flows from Operating Activities Cash received from customers* $78 Cash paid for general and administrative expenses** (29)Net cash flows from operating activities $49

* Service revenue of $90 thousand, less increase of $12 thousand in accounts receivable.**General and administrative expenses of $32 thousand, less increase of $7 thousand in accounts payable, plus increase of $4 thousand in prepaid insurance.

Illustration 4-17A

ARLINGTON LAWN CAREStatement of Cash Flows

For the Year Ended December 31, 2013($ in thousands)

Cash Flows from Operating ActivitiesNet income $35Adjustments for noncash effects: Depreciation expense $ 8Changes in operating assets and liabilities: Increase in prepaid insurance (4) Increase in accounts receivable (12) Increase in accounts payable 7 Increase in income taxes payable 15 14Net cash flows from operating activities $49

Illustration 4-17B, T4-20 (continued)

INTERNATIONAL FINANCIAL REPORTING STANDARDS

Classification of Cash Flows. Like U.S. GAAP, international standards also require a statement of cash flows. Consistent with U.S. GAAP, cash flows are classified as operating, investing, or financing. However, the U.S. standard designates cash outflows for interest payments and cash inflows from interest and dividends received as operating cash flows. Dividends paid to shareholders are classified as financing cash flows.

IAS No. 7, on the other hand, allows more flexibility. Companies can report interest and dividends paid as either operating or financing cash flows and interest and dividends received as either operating or investing cash flows. Interest and dividend payments usually are reported as financing activities. Interest and dividends received normally are classified as investing activities.

Typical Classification of Cash Flows from Interest and Dividends

U.S. GAAP IFRSOperating Activities Operating Activities Dividends received Interest received Interest paid

Investing Activities Investing Activities Dividends received Interest received

Financing Activities Financing Activities Dividends paid Dividends paid

Interest paid

Siemens AG, a German company, prepares its financial statements according to IFRS. In the statement of cash flows for quarter ended March 31, 2011, the company reported interest and dividends received as operating cash flows, as would a U.S. company. However, Siemens classified interest paid as a financing cash flow.

Siemens AGStatement of Cash Flows (partial)

For the Nine Months Ended March 31, 2011(€ in millions)Cash flows from financing activities: Proceeds from re-issuance of treasury stock 109 Repayment of long-term debt (13) Change in short-term debt and other 85 Interest paid (72) Dividends paid (2,356) Dividends paid to minority shareholders (81) Financing discontinued operations (401)Net cash used in financing activities-continuing operations (2,729)

T 4-21

Suggestions for Class Activities

1. Real World Scenario

In March of 2005, Daimler-Chrysler AG announced that it would recall some 1.3 million Mercedez-Benz cars worldwide to fix problems with their alternators and batteries. The recall covered E-class, CLS-class, E, and SL models. In 2010, Toyota recalled several of its brand models to fix problems involving accelerator pedals. These recalls cost Daimler-Chrysler and Toyota tens of millions of dollars.

In 2005, Hurricane Katrina destroyed much of the city of New Orleans. That hurricane was the costliest hurricane, as well as one of the five deadliest, in the United States.

Suggestions:Have the class consider the income statement presentation of the income effects of these events.

Will the effects be included in continuing operations? Will they be presented gross, or net-of-tax? How do the events underlying the income effects differ in terms of the likelihood that they will occur again in the foreseeable future?

Points to note:The product recall event can be compared to the recall of Tylenol capsules in 1982. In the

Tylenol case, the circumstances surrounding the event led Johnson & Johnson to classify the loss as an extraordinary item. This product recall event resulted in a new package design for the product (in fact for the entire industry) reducing the likelihood that similar losses would occur in the future. The capsules were recalled because someone put poison in some of the capsules. In the auto industry, however, product recalls are not uncommon.

You might have your students access the most recent financial statements of Ford Motor. In the financial statements for the year ended December 31, 2010, in Note 31 under Commitments and Contingencies they will find that product recalls are included in accrued liabilities in the balance sheet. In the balance sheet for the year ended December 31, 2010, the current and noncurrent liability “Dealer and customer allowances and claims,” exceeded $10 billion (note 17).

The Hurricane Katrina losses present another good opportunity to discuss extraordinary gains and losses. Are losses in the Gulf of Mexico from hurricanes unusual and infrequent? Is this type of loss likely to occur again in the foreseeable future? Note that the FASB’s EITF specifically ruled that the Hurricane Katrina losses do not qualify for extraordinary reporting.

2. Research Activity

Aramark Corporation, a leading provider of a broad range of managed services to business, educational, healthcare and governmental institutions and sports, entertainment and recreational facilities, reported discontinued operations in its income statements for its 2011, 2010, and 2009 fiscal years.

Suggestions:Have the class access the company’s financial statements for the fiscal year ended September 30,

2011, using EDGAR, which can be located at: www.sec.gov. Ask them to answer the following questions:

1. What segments of the company were discontinued? 2. What was the net-of-tax income (loss) from discontinued operations for the 2011 and 2010

years?3. What was the net proceeds (net selling price) of the component that was discontinued?

Points to note:Aramark sold its wholly-owned subsidiary, Galls, LLC and reported net-of-tax losses from this

discontinued operation of $11,732 thousand and $1,635 thousand for fiscal years 2011 and 2010, respectively. The net proceeds from the sale of Galls, LLC was $75 million.

3. Dell Analysis

Have students, individually or in groups, go to the most recent Dell annual report using EDGAR which can be located at: ww.sec.gov. Ask them to:

1. Compare revenues, operating expenses, net income, and net income as a percentage of revenue dollars with those in the 2011 annual report in Appendix B of the text. Are there any discernible trends? How might they be interpreted?

2. Has the company made any changes in its revenue recognition method?

3. Does the income statement contain any separately reported items?

4. Compare cash flows from operating, investing, and financing activities with those in the 2011 report. Are there any discernible trends? How might they be interpreted?

5. Use EDGAR to locate the most recent annual report information for Apple, Dell’s competitor. Using the most recent annual report information for both companies, compare growth (from the prior year) in revenue and net income, net income as a percentage of revenue dollars, and operating expenses as a percentage of revenue.

4. Professional Skills Development Activities

The following are suggested assignments from the end-of-chapter material that will help your students develop their communication, research, analysis and judgment skills.

Communication Skills. In addition to Communication Case 4-6, Integrating Case 4-15 can be adapted to ask students to answer the requirement in the form of a formal report. Communication Case 4-5 and Integrating Case 4-15 do well as group assignments. Judgment Case 4-1 and Ethics Case 4-7 create good class discussions. Real World Cases 4-4 and 4-17, and Research Case 4-14 are suitable for student presentation(s).

Research Skills. In their careers, our graduates will be required to locate and extract relevant information from available resource material to determine the correct accounting practice, perhaps identifying the appropriate authoritative literature to support a decision. Research Case 4-8 and Exercises 4-20 and 4-21 provide excellent opportunities to help students develop this skill. In addition, Real World Case 4-4 can be adapted to require students to research the authoritative literature on the presentation of pro forma earnings.

Analysis Skills. The “Broaden Your Perspective” section includes Analysis Cases that direct students to gather, assemble, organize, process, or interpret data to provide options for making business and investment decisions. In addition to Analysis Case 4-16, Judgment Cases 4-9 and 4-10 also provide opportunities to develop and sharpen analytical skills.

Judgment Skills. The “Broaden Your Perspective” section includes Judgment Cases that require students to critically analyze issues to apply concepts learned to business situations in order to evaluate options for decision-making and provide an appropriate conclusion. In addition to Judgment Cases 4-1, 4-2, 4-3, 4-9, 4-10, and 4-12, Communication Cases 4-5 and 4-6 also require students to exercise judgment.

CPA Simulation. Students can test their knowledge of the concepts discussed in this chapter and at the same time practice critical professional skills necessary for career success and preparation for the computer-based CPA Exam. The simulation for this chapter, Bart Company, tests students’ knowledge of the contents and presentation of the income statement. Access the simulations at the text website: www.mhhe.com/spiceland7e .