ACCT 3323 (Intermediate 1) Chapter 4 with Brian Burnett

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

Revenues

Inflows of resources from providing goods or services

Expenses

Outflows of resources to generate revenue

Gains and Losses

increase or decrease in equity from non revenues or expenses or not involving owners

Income from continuing operations

includes revenues, expenses, gains and losses that are a part of of ongoing operations

Discontinued Operations

items that won't continue in the future

What are three major components of income from continuing operations?

Operating Income
Non-Operating Income
Income Tax Expense

Operating Income

revenues, expenses, gains and losses directly related to primary revenue-generating activities. (sales revenue from selling goods also COGS)

Gross Profit

Revenues - COGS

Non-Operating Income

revenues, expenses, gains and losses not related to primary revenue-generating activities (gains on sale of equipment or interest expense)

intraperiod tax allocation

separate income tax related to discontinued operations

What are the two basic formats for an income statement?

Single-step Income statement and Multi Step Income Statement

Single-Step Income Statement

Revenue first and expenses second. income tax still separate. no distinction between types of revenue and expenses

Multi-Step Income Statement

Includes sub-totals like gross profit, operating income, and income before taxes

Which general format is more useful to financial statement users?

Multi-Step Income Statement

What is the most basic definition of earnings quality?

The ability of reported earnings to predict a company's future earnings

What is a key feature of earnings quality?

know the difference between temporary earnings and permanent earnings

Income Smoothing (earnings management)

using estimates and judgment to shift income from one period to another. can make performance seem predictable when it isn't as stable

Classification Shifting

moving certain expenses to different parts of income statements. make certain measures of performance (gross profit and income from operations) seem stronger

Things to know about Operating Income

deemed more permanent than other measures of income. may include significant temporary items that can skew it.

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

Restructuring Costs

incurred to reorganize the scope of a companies operations. non-recurring but accounted over time. predictable

Other Unusual Items

Atypical costs incurred during the period. users must decide if it's permanent or temporary (like litigation)

Non-operating items

typically non recurring or temporary

What are non-GAAP earnings?

Voluntary disclosure of earnings that management deems permanent. management has complete flexibility because no GAAP

What constitutes a discontinued operation?

component of business is sold, disposed of or held for sale

Reporting Discontinued Operations

need to be removed from continuing operations. reported separately. must show in every year

change in Accounting Principle

when regulators require or company chooses from one accounting method to another (LIFO to FIFO)

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

Retrospective Approach
Modified Retrospective Approach
Prospective Approach

Retrospective Approach

All financial statements must show new method. voluntary changes must do this

Modified Retrospective Approach

new method only applied to the current accounting period. adjust retained earnings

Prospective Approach

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

Change in Accounting Estimate

companies may change accounting estimates. use prospective approach

Correction of Accounting Errors

not unusual. typically just require correcting a journal entry

Prior period adjustment

more serious and affects prior periods. often require journal entry to adjust balance sheet. no income statement adjustment.

Net income doesn't provide?

doesn't show how much is available to each shareholder

Earnings per share

net income divided by number of shares outstanding. primary for making pricing decisions for capital markets

What is the difference between Basic EPS and Diluted EPS?

Basic- straight forward measure
Diluted- takes into account more factors like employee stock options. always less than or equal to basic

What is the difference between net income and comprehensive income?

few gains and losses aren't reported as net income but are reported as other comprehensive income.

Comprehensive income

Net income+ other comprehensive income= comprehensive income

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

net income is closed to retained earnings. other comprehensive income accounts are not closed, but are permanent accounts

What are the three major types of cash flows?

Operating: Day to Day
Investing: buying and selling long-term assets
Financing: Cash flows with capital sources, except interest payment

Operating cash flows

correspond closely with the income statement because both focus on the underlying operations of the company.

Examples of operating cashflows?

Payment of interest, payments to suppliers, payment for rent

How is sales revenue different from cash flow?

Sales revenue is total sales recorded (even if no pay). Cash flow is actual cash received during period

What influences cash flow from customers?

Receivables collected from past sales.

Deferred revenue (prepaid but not yet earned).

Outstanding receivables (sales made but not yet paid).

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

Income Statement → Reports total sales revenue, even if unpaid.

Balance Sheet → Shows receivables (money owed) and deferred revenue (prepaid but not earned).

Cash Flow Statement → Reflects actual cash collected, adjusting for receivables & deferred revenue.

What are the two methods for preparing cash flows?

Direct Method
Indirect Method

Direct Method

operating activities reported separate, directly on the statement

Indirect Method

starts with net income and adjusts it for non-cash items and changes in working capital to arrive at cash flow from operations

Examples of investing cash flows?

Cash purchase of land or other long term assets

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.

What are some examples of financing cash flows?

Cash received from issuing stocks or bonds. Payments for dividends

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.

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

activity or turnover ratios

What do turnover ratios do?

measure the amount of assets required to maintain a given level of activity

What are the three most commonly calculated turnover ratios?

Asset Turnover Ratio, Receivables Turnover Ratio, Inventory Turnover Ratio

Profitability Ratios

measure a companies ability to earn an good return relative to sales or resources used

What are the three most common profitability measures?

Profit Margin on Sales, Return on Assets, Return on Equity

DuPont Framework

Breaks down return on equity into profitability, activity, and financial leverag