2. The Income Statement - General Knowledge

What are the three major sections of the income statement?

1. Income from continuing operations,

2. Discontinued operations, and

3. Earnings per share

What are the four elements that can be on the income statement?

1. Revenues (sales, fees earned, dividend revenue, etc)

2. Expenses (COGS, depreciation expense, etc)

3. Gains

4. Losses

What can gains and losses result from?

Gains and losses can result from sale of investments, sale of plant assets, settlement of liabilities, and write-offs of assets.

Describe the single step income statement

Consist of just two groupings - revenues and expenses. Most companies do not use this income format.

Describe the multi-step income statement.

Provides more detailed information, most companies use this format.

What are the major sections of a multi-step income statement?

1. Sales (Sales revenue - sales returns and allowances - sales discounts)

2. Cost of goods sold (Sales - cost of goods sold = gross profit)

3. Operating expenses (split into selling expenses and administrative expenses)

4. Other Revenues and Gains - not part of normal business operations

5. Other Expenses and Losses - not part of normal business operations

6. Calculate net income (Make sure to subtract income tax: Income before income tax - Income tax)

7. Earnings per common share (at the end)

Where are unusual and infrequent gains / losses reported?

“Other revenues and gains” or “Other expenses and losses” section of the income statement

What is income from continuing operations?

The total income or loss that results from business activities that happen year to year.

What are the three major components of income from continuing operations?

1. Operating income

2. Nonoperating income

3. Income tax expense

When are the two times a discontinued operation can occur?

1. A company eliminates the results of operations of a component of the business. A component comprises operations and cash flows that can be clearly distinguished, operationally and for financial reporting purposes.
   

2. The elimination of a component that represents a strategic shift, having a major effect on the company's operations and financial results. A strategic shift generally includes the disposal of

   -  a major line of business

   -  a major geographical area, or

   -  a major equity method investment

What is a more simplistic definition of discontinued operations?

Discontinued operations usually occurs when a company sells a segment of its business. 

Are gains and losses from sale of company assets (i.e. equipment) part of continued operations or discontinued?

Part of continued operations because this occurs all the time in the normal course of business.

The gain or loss from discontinued operations usually consists of 2 parts. What are these two parts?

1. Gain or loss from the disposal of the segment AND

2. Income or loss from the operations of the operating segment prior to its disposal.

How are the gains / losses from discontinued operations shown on the income statement?

They are shown net of taxes with the tax effect disclosed on the income statement. This concept is known as intraperiod tax allocation.

Example:

Gain from disposal of electronics division $10,000, less income tax of $4,000 ( $10,000 x .04) 6,000

Describe intraperiod tax allocation.

Intraperiod tax allocation is the distribution of income taxes to specific line items appearing in a financial statement.  Intraperiod tax allocations occur within a given accounting period and allow the reader to understand the income tax implication of the line item. 

What are consolidations?

This is when a company owns greater than 50% of another company. The investor is called a parent and the investee is a subsidiary.

What is minority interest?

This is when a parent company owns less than 100% of the subsidiary’s stock. This is portion of stock owned by outsiders (people other than the parent company).

What should consolidated financial statements include?

Should include the combined financial statements of the parent company and its subsidiaries.

What is earnings per share (EPS) used for?

It is a ratio used to measure the success of a corporation.

What does earnings per share represent?

Net income for each share of common stock outstanding.

What is the formula for basic earnings per share?

Basic earnings per share = (Net income - preferred dividends (declared)) / Weighted Average # of Common Stock Outstanding

Why do we need to subtract preferred dividends from net income in the basic earnings per share equation?

The preferred dividends relate to income to preferred stockholders and not common stockholders.

What is earnings per share shown for?

1. Continuing operations (Income from continuing operations)

2. Discontinued operations (Income from operations of discontinued division, net of tax) - includes a separate line for any gain or loss on disposal of discontinued operations, net of tax

3. Net income
   
   
   - See professor’s notes under earnings per share section for example.

What is operating income?

Includes revenues, expenses, gains, and losses directly related to the primary revenue-generating activities of the company.

What is non operating income?

Includes revenues, expenses, gains, and losses not related to primary activities of the company.
For example a manufacturer would include interest revenue, gains and losses from selling investments, and interest expense in nonoperating income.