ACCT 3323 Ch 4: The Income Statement, Comprehensive Income, and Statement of Cash Flows

What are the three major sections of the income statement?

-income from continuing operations

-discontinued operations

-earnings per share

How should we characterize the income statement in terms of time?

over a period of time

What are the elements presented on the income statement?

revenues, expenses, gains and losses

What are inflows of resources resulting from providing goods or services to customers?

revenues

What are outflows of resources incurred while generating revenue?

expenses

What increase or decreases in equity from transactions not classified as revenues or expenses and not involving owners?

gains and losses

What includes revenues, expenses, gains, and losses that are part of the ongoing operations of the company?

income from continuing operations

What are items that will not continue into the future?

discontinued operations

What are three major components of income from continuing operations?

operating income, non-operating income, income tax expense

most central income?

operating income

What includes revenues, expenses, gains, and losses directly related to the primary revenue-generating activities of the company?

operating income

Operating income typically includes?

-sales revenue from selling goods and products

-cost of goods sold

-operating expenses related to those primary activities (salaries expense)

gross profit =

gross profit = revenues - cost of goods sold

How is gross profit differ from operating income?

Operating income includes subtracting operating expenses in addition to cost of goods sold.

What includes revenues, expenses, gains, and losses not related to the primary revenue-generating activities of the company (e.g., gain on sale of equipment, interest expense).

non-operating income

What is always presented as a separate item on the income statement because of its importance?

income tax expense

Companies must separate income taxes related to continuing from operations that will be discontinued is called?

intraperiod tax allocation

What are the two basic formats for an income statement?

single-step income statement, multiple-step income statement

What are revenues that are listed first and expenses are listed second?

_____ _____ _____ is still separately presented, but here is no distinction in the types of revenues and expenses.

single-step income statement

Income tax expense

This format includes several intermediate sub-totals such as gross-profit, operating income, and income before taxes. What is this called?

multi-step income statement

There is much more variation that what is seen compared to the _____ _____. However, the bottom line _____ _____ is the same regardless of the format.

balance sheet

net income

Which general format is more useful to financial statement users?

multiple-step income statement

What is the most basic definition of earnings quality?

The ability of reported earnings (income) to predict a company's future earnings.

A key feature to _____ _____ is the ability to distinguish ______ ______ (earnings that are unlikely to persist) from _____ _____ (earnings that are likely to persist).

earnings quality

temporary earnings

permanent earnings

A broad and simple distinction is between earnings from _____ operations and _____ operations. But there are portions of earnings within continuing operations that are as _____ as other portions. It takes a lot of _____ and in-depth research to truly understand the temporary and permanent aspects of income.

continuing

discontinued

predictive

experience

Even then, users of financial statement must _____ and thus must make a _____ assessment of earnings quality for any given company.

estimate

subjective

What is using estimates and judgement to shift income from period to another in order to report "smooth" earnings?

income smoothing

Moving certain expenses to different parts of the income statement is?

classification shifting

What are the two main points from these issues with earnings quality?

-Income smoothing (earnings management) can produce a picture of predictable performance, but there could be things hidden though the active management of earnings.

-Classification shifting does not misstate net income, but it does make certain measures of performance (gross profit and income from operations) seem stronger than it may actually be.

What is typically deemed more permanent than other measures of income?

operating income (more high quality)

Operating income may include significant _____ items. This can _____ operating income up or down. Users must carefully ______ the financial statements and the notes to financial statements to ascertain the quality of operating income.

temporary

skew

analyze

What are two items highlighted in the textbook that may impact operating income but may have unknown or varying impacts on earnings quality?

restructuring costs, other unusual items

What are costs incurred to reorganize or plans to materially change the scope of a company's operations?

restructuring costs

Restructuring costs are _____, but are accounted for _____ ____ ____ of time though estimation and cost allocation.

non-recurring

over a period

What are atypical costs incurred during the period?

other unusual items

Other unusual items. Users must assess whether unusual items are ____ or _____.

permanent

temporary

What are typically non-recurring or temporary?

non-operating items

A voluntary disclosure of earnings that management deems more permanent. This measure typically excludes certain expenses and even certain revenues.

non-GAAP earning

_____ addressed the wide variation in non-GAAP earnings reporting by requiring increased disclosure about this measurement. Primarily, companies must now _____ ___ _____ between GAAP measures of earnings and the company's non-GAAP measures of earnings.

SOX

disclose a reconciliation

Example: 49er Company has $12,000 of pre-tax net income. $15,000 of the pre-tax net income is from continuing operations. The company disposed of an operating unit on June 30. The unit had an operating loss of 5,000 through the sales date and the company recorded a gain from the sale of the disposed unit of $2,000 pre-tax. Assume 49er Company has a 30% income tax rate. Present the lower portion of 49er Company's multiple step income statement starting with income from continuing operations before income taxes.

lower portion of income statement

income from continuing operations before income taxes = $8,000

refer to study guide

What constitutes a discontinued operation?

Component of an entity or group of components is sold, disposed of, or considered held for sale.

A _____ represents a strategic shift that has or will have a major effect on the company's ____ and ____ results.

disposal

operations

financial

The results of discontinued operations need to be _____ from what is reported as _____.

Then the results of discontinued operations are reported _____ (net of tax)

The separation of these two components of net income must be presented in ____ _____ on the financial statement, even prior years.

removed, continuing

separately

every year

Most of the time, the discontinued component is sold during the _____ _____. In this case, there are two effects on the _____ _____.

fiscal year

income statement

What are the effects in the income statement when the discontinued component is sold?

-income or loss from operations from the beginning of the year through the disposal date

-any gains or losses from the sale of the disposed component

The company can report the discontinued component _____ (in one line) or in _____ lines and must be reported net of any income tax effects.

together

separate

Example: 49er Company has $12,000 of pre-tax net income. $15,000 of the pre-tax net income is from continuing operations. The company disposed of an operating unit on June 30. The unit had an operating loss of 5,000 through the sales date and the company recorded a gain from the sale of the disposed unit of $2,000 pre-tax. Assume 49er Company has a 30% income tax rate. Present the lower portion of 49er Company's multiple step income statement starting with income from continuing operations before income taxes.

refer to study guide

What is a change in accounting principle?

When regulators require or companies choose to change from acceptable accounting method to another one (LIFO to FIFO for inventory).

What are the three approaches to applying a change in accounting principle to financial statements?

retrospective approach, modified retrospective approach, prospective approach

What is retrospective aproach?

All presented financial statements must reflect the new method

What is a modified retrospective approach?

The new method is applied only to the current accounting period. The cumulative effect on prior periods is reported as an adjustment to retained earning.

What is a prospective approach?

The new method is applied only to the current and future accounting periods. There is no adjustment to retained earnings.

Mandated changes can use any of the three methods, but _____ changes must use the _____ approach.

voluntary

retrospective

Companies may update or change an accounting estimate, such as amended the useful life of a long-term asset or changing the estimate for uncollectible accounts. When a company has a change in accounting estimate they use the ______ _____.

prospective approach

Accounting systems are complex and transaction analysis is not always easy. At times, systems or accounting judgments are incorrect and require correction. The vast majority of the time, the error is discovered and corrected in the same accounting period. These corrections are very easy and typically just require a correcting journal entry is?

correction of accounting erros

A _____ _____ _____ is more serious and affects prior periods.

prior period adjustment

Often prior period adjustment requires?

a journal entry to adjust balance sheet elements

A prior period adjustment. The error will likely also require the company to?

to restate prior period financial statements and disclose the nature of the error.

_____ _____ provides a measure of income that is available to all _____, but does not directly communicate how much is available to each shareholder.

Net income, shareholders

What is the amount of net income divided by the number common shares outstanding-providing a measure of income per shareholder.

earnings per share

What is the difference between basic EPS and diluted EPS?

Basic EPS is a straight-forward measure of earnings per share

Basic EPS =

( Net Income - Preferred Stock Dividends) / ( Weighted Average Shares Outstanding)

What takes into account several factors that could affect basic EPS like employee stock options and convertible securities? It is more restrictive

diluted EPS

GAAP requires the companies reconcile net income to _____ _____ because the two fully capture the impact of _____ _____ on shareholders' equity. However, GAAP affords a lot of flexibility in the way this is reported.

comprehensive income

non-owner transactions

What is the difference between net income and comprehensive income?

There are a few gains and losses that are not reported as net income but instead are classified as other comprehensive income.

Comprehensive income =

net income + other comprehensive income

How does net income and other comprehensive income map to the balance sheet?

_____ _____ accounts are closed to _____ _____.

Net income

retained earnings

How does net income and other comprehensive income map to the balance sheet?

Other comprehensive income maps to changes in _____ _____ _____ _____.

These other comprehensive income accounts are not _____, but are _____ accounts.

Accumulated Other Comprehensive Income

closed, permanent

What are the three major types of cash flows?

-operating

-investing

-financing

What is operating cash flow?

day-to-day activities, inclluding interest payments

What is investing cash flow?

buying and selling long-term assets

What is financing cash flow?

cash flows with capital sources (investors and creditors), except interest payments

Operating cash flows correspond closely with the _____ _____ because both focus on the underlying _____ of the company.

income statement

operations

What are some examples of operating cash flows?

-receipts from customers

-payments for suppliers

-payments to employees

-payments for interest

-payments for rent

-payments for insurance

What is the difference between cash flows from customers and sales revenue for a particular fiscal year?

-Sales Revenue includes the economic transactions of completing a sale for the period.

How does the cash flow connect to the income statement and balance sheet?

-Cash flows are also influenced by collection of receivables from prior periods and any prepaid deferred revenues that have not yet been recognized.

-Sales revenue may include deferred revenues from the prior period and receivables still outstanding at the end of the current period which would not be included in the cash flow.

What are the two methods for preparing operating cash flows?

direct method

indirect method

What is direct method?

Each operating activity is reported separately, directly on the statemetn

Reconciles net income to operating cash flows by adjusting the incomes statement and examining changes to working capital balance sheet items is what?

indirect method

_____ cash flows focus on the cash flows related to ____ and _____ of long-term assets.

Investing

buying

disposing

What are some examples of investing cash flows?

Cash purchase of land, building, equipment or other long-term assets.

Cash from sale of the same items.

How does the cash flow from selling land connect to the income statement and balance sheet?

The sale would reduce the land balance (at cost) on the balance sheet and could include a gain or loss that is reported on the income statement. The cash flow would reconcile the cost of the land to the gain or loss on the income statement.

Financing cash flows focus on the cash flows between _____ _____ (investors and creditors) and the _____.

capital sources

company

What are some examples of financing cash flows?

-Cash received from issuing stocks or bonds.

-Cash payments for dividends, repurchasing stock, or retiring debt.

How would a cash retirement of a bond be reflected on the balance sheet?

A reduction to the bond payable account. There could potentially also be a gain or loss on bond retirement depending on the situation, but that is for a later chapter.

How might dividend payments be a little more complicated?

Dividends show up on the statement of shareholders' equity based on what is declared. There could be a dividend payable on the balance sheet, which would then require a reconciliation between declared dividends and the actual dividend payment.

A key driver of a profitability is what?

A key driver of a profitability is how well a company manages and utilizes its resources.

What is activity/turnover ratio?

It is a measure the amount of assets required to maintain a given level of activity (revenue).

What category of ratios help financial statement users evaluate the company's effectiveness in managing its assets?

Activity/turnover ratios

What are the three most commonly calculated turnover ratios?

Asset turnover ratio, receivables turnover ratio, inventory ratio

asset turnover ratio =

net sales / average total assets

The ____ ____ ratio provides an indication of how efficiently a company utilizes of all its assets to generate revenue.

asset turnover

A _____ asset turnover ratio implies more effective use of a company's assets.

higher

receivables turnover ratio =

net sales/ average accounts receivable

The receivables turnover ratio provides an indication what?

a company's efficiency in collecting cash from customers

inventory turnover ratio =

cost of goods sold / average inventory

What is inventory turnover ratio?

Inventory turnover ratio shows the number of times the average inventory balance is sold during a reporting period.

The more _____ a business is able to sell, or turn over its inventory, the _____ its investment in inventory must be for a given level of sales.

frequently

lower

What is profitability ratios?

Profitability ratios attempt to measure a company's ability to earn an adequate return relative to sales or resources devoted to operations

Profitability ratios resources can be defined as?

total assets or equity