The Income Statement, and Comprehensive Income.

Chapter 4

LEARNING OBJECTIVES

1. Discuss the importance of income from continuing operations and describe its components.2. Describe earnings quality and how it is impacted by management practices to manipulate earnings.3. Discuss the components of operating and non-operating income and their relationship to earnings quality.4. Define what constitutes discontinued operations and describe the appropriate income statement presentation for these transactions.5. Define extraordinary items and describe the appropriate income statement presentation for these transactions.6. Define earnings per share (EPS) and explain required disclosures of EPS for certain income statement components. 7. Explain the difference between net income and comprehensive income and how we report components of the difference.

NOT COVERED8. Describe the purpose of the statement of cash flows.9. Identify and describe the various classifications of cash flows presented in a| statement of cash flows.10. Discuss the primary differences between U.S. GAAP and IFRS with respect to the income statement.

An income statement for a

hypothetical manufacturing

company that you can refer to as we proceed through

the chapter.

4-4

Expenses

Outflows of resources incurred in generating revenues.

Revenues

Inflows of resources resulting

from providing goods or

services to customers.

Gains and Losses

Increases or decreases in equity from

peripheral or incidental

transactions of an entity.

Income from Continuing OperationsIncome from Continuing Operations

Income Tax Expense

Because of its

importance and size,

income tax expense is a

separate item.

4-5

Operating Income

Nonoperating Income

Operating versus Nonoperating Income

Includes revenues and expenses

directly related to the principal

revenue-generating

activities of the company

Includes certain gains and losses and revenues and expenses related to peripheral or

incidental activities of the

company

4-6

Income Stmt. (Single-Step) NOT COVERED

Expenses & Losses

Revenues & Gains

Proper Heading

4-7

Income Statement (Multiple-Step)

Non- operating Items

Gross Profit

Operating Expenses

Proper Heading

4-8

U. S. GAAP vs. IFRS

Has no minimum requirements.

SEC requires that expenses be classified by function.

“Bottom line” called net income or net loss.

Report extraordinary items separately.

There are more similarities than differences between income statements prepared according to U.S. GAAP

and those prepared applying IFRS. Some differences are highlighted below.

Specifies certain minimum information to be reported on the face of the income statement.

Allows expenses classified by function or natural description.

“Bottom line” called profit or loss. Prohibits reporting extraordinary

items.

4-9

Earnings Quality

Earnings quality refers to the ability of reported earnings to predict a company’s future earnings.

Transitory Earningsversus

Permanent Earnings

4-10Manipulating Income and

Income Smoothing

Two ways to manipulate income:

1. Income shifting

2. Income statement classification

“Most executives prefer to report earnings that follow a smooth, regular, upward path.”

~Ford S. Worthy, “Manipulating Profits: How It’s Done,” Fortune

4-11

Operating Income and Earnings Quality

Restructuring CostsCosts associated with shutdown or

relocation of facilities or downsizing of operations are

recognized in the period incurred.

Goodwill Impairment and Long-lived Asset

Impairment

Involves asset impairment losses or charges.

4-12Nonoperating Income and

Earnings Quality

Gains and losses generated from the sale of investments often can significantly inflate or

deflate current earnings.

ExampleAs the stock market boom reached

its height late in the year 2000, many companies recorded large gains from sale of investments

that had appreciated significantly in value.

How should those gains be interpreted

in terms of their relationship to

future earnings? Are they transitory

or permanent?

4-13

Separately Reported Items

Reported separately, net of taxes:

Discontinued operations

Extraordinary items

4-14

Intraperiod Income Tax Allocation

Income Tax Expense must be associated with each component of income that causes it.

Income Tax Expense must be associated with each component of income that causes it.

Show Income Tax Expense related to

Income from Continuing Operations.

Show Income Tax Expense related to

Income from Continuing Operations.

Report effects of Discontinued Operations and

Extraordinary Items net of related income tax effect.

Report effects of Discontinued Operations and

Extraordinary Items net of related income tax effect.

4-15

An extraordinary item is a material event or transaction that is both:1.Unusual in nature, and2.Infrequent in occurrenceExtraordinary items are reported net of related taxes

Extraordinary Items

4-16

U. S. GAAP vs. IFRS

Report extraordinary items separately in the income statement.

The scarcity of extraordinary gains and losses reported in corporate income statements and the desire to converge U.S. and international accounting standards could guide

the FASB to the elimination of the extraordinary item classification.

Prohibits reporting extraordinary items in the income statement or notes.

4-17

Unusual or Infrequent Items

Items that are material and are either unusual or infrequent—but not

both—are included as separate items in continuing operations.

4-18

Discontinued Operations

As part of the continuing process to converge U.S. GAAP and international standards, the FASB and IASB have been working together to develop a common definition and a common set of disclosures for discontinued operations.

The proposed ASU defines a discontinued operation as a “component” that either (a) has been disposed of or (b) is classified as held for sale, and represents one of the following:1.a separate major line of business or major geographical area of operations,2.part of a single coordinated plan to dispose of a separate major line of business or geographical area of operations, or3.a business that meets the criteria to be classified as held for sale on acquisition.

4-19

Reporting Discontinued Operations

Reporting for Components SoldIncome or loss from

operations of the component from the

beginning of the reporting period to the

disposal date.

Gain or loss on the disposal of the

component’s assets.

Reporting for Components Held For SaleIncome or loss from

operations of the component from the

beginning of the reporting period to the

end of the reporting period.

An “impairment loss” if the carrying value of

the assets of the component is more than the fair value minus cost to sell.

BE 7, 8 and 9Ex 5, 6, 7, and 8

4-21

Earnings Per Share Disclosure

One of the most widely used ratios is earnings per share (EPS), which shows the amount of income

earned by a company expressed on a per share basis.

Basic EPS

Net income less preferred dividends

Weighted-average number of common shares outstanding for the

period

Diluted EPS

Reflects the potential dilution that could occur for companies that have certain

securities outstanding that are convertible into common shares or stock options that could create additional common shares if

the options were exercised.

4-22

Earnings Per Share Disclosure

Report EPS data separately for:

1. Income or Loss from Continuing Operations

2. Separately Reported Items

a) discontinued operations

b) extraordinary Items

3. Net Income or Loss

4-23

Comprehensive Income

An expanded version of income that includes four types of gains and

losses that traditionally have not been included

in income statements.

4-24

Other Comprehensive Income (OCI)

Comprehensive income includes traditional net income as well as four additional gains and losses that change

shareholders’ equity.

1. Changes in the market value of certain investments (described in chapter 12).

2. 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).

3. 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).

4. 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).

4-25

Other Comprehensive Income

($ in millions) Net income $xxx Other comprehensive income: Net unrealized holding gains (losses) on investments (net of tax)* $x Gains (losses) from and amendments to postretirement benefit 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.)

4-26

U. S. GAAP vs. IFRS

Includes four possible Other Comprehensive Income items.

Includes same four.

Includes a fifth possible item, changes in revaluation surplus, from the optional revaluation of property, plant, and equipment and intangible assets.

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.

4-27Accumulated Other Comprehensive

Income

In addition to reporting comprehensive income that occurs in the current period, we must also report these amounts on a cumulative basis in the balance sheet as

an additional component of shareholders’ equity.

In addition to reporting comprehensive income that occurs in the current period, we must also report these amounts on a cumulative basis in the balance sheet as

an additional component of shareholders’ equity.

ASTRO-MED INC. Consolidated Balance Sheets (in part)

Years ended January 31

($ in thousands) 2011 2010

Shareholders’ equity: Common stock 433 416 Additional paid-in capital 36,586 34,713 Retained earnings 26,843 26,817 Accumulated other comprehensive income 266 317 Treasury stock (9,840) (8,030) Total shareholders’ equity $54,288 $54,233