ACCT321 Delaney 25-26 Ch 3

How is the income statement useful?

• Can evaluate past performance

• Predict future performance

• Help asses risk & uncertainty of achieving future cash flows

What are the limitations of the income statement?

Companies may omit items that cannot be measured reliably, income is affected by the accounting methods used, income measurement involves judgment – how so?

Quality of earnings

Impacted by earnings management. Quality is reduced(less useful info) when greater earnings management occurs

Elements of Income Statement

1. Revenues – inflows or other enhancements of assets or settlements of its liabilities that constitute the entity’s ongoing major or central operation

   Examples – sales, fees, interest, dividends, rent

2. b)     Expenses – outflows or other using-up of assets or incurrence of liabilities that constitute the entity’s ongoing major or central operations

   Examples – COGS, depreciation, salaries

3. Gains – increases in equity (net assets) from peripheral or incidental transactions

   Example – gain from sale of assets

4. Losses – decreases in equity (net assets) from peripheral or incidental transactions

   Example – loss from sale of assets

Intermediate Components of Income statment

1. Operating

2. Nonoperating

3. Income tax

4. Discontinued Operations

5. Noncontrolling Interest

6. Earnings Per Share

Components of Operating section of Income Statement

i)      Sales or Revenue Section

ii)    Cost of Goods Sold Section

iii)   Selling Expenses

iv)   Administrative or General Expenses

Components of Nonoperating Section of Income Statement

i)      Other Revenues and Gains

ii)    Other Expenses and Losses

Multiple-step income statement info

a)     Separates operating transactions from nonoperating transactions

b)     Matches costs and expenses with related revenues

c)     Highlights certain intermediate components of income that analysts use

How do we report unusual and infrequent gains or losses?

• They have to be material items that are unusual, infrequent, or both

• report in between Income from continuing Operations and Income Taxes

• Ex: Write-downs of inventories, gains and losses on investments, losses due to fire, floods, earthquakes

How do we report disocntinued operations?

i)      Show gain or loss on operations net of tax effect (see intraperiod tax allocation below)

ii) Show gain or loss on disposal net of tax effect

What 2 things qualifies as a discontinued operation?

(1)   Elimination of a component of the business that can be clearly distinguished operationally and for financial statement purposes

(2)   Elimination of a component representing a strategic shift and has major effect on operations and financial results

Intraperiod tax Allocation

i)      Let the tax follow the income

• ii)    Income tax is allocated to the following

  •  Income from continuing operations before tax

  • Discontinued operations

  • Changes in accounting principle

  • Correction of errors

Earnings per Share info

i)      Measures the dollars earned by each share of common stock

ii)    Must be disclosed on the income statement showing composition (i.e. from continuing operations, and from discontinued operations)

iii)   Why deduct preferred dividends above? Because they are a diff price, not market

Earnings Per Share equation

(Net income less preferred dividends) divided by Weighted-average common sahres outstanding

Comprehensive Income is comprised of…

• All changed in Equity Section, except investments by owners and disributions to owners

• Other comprehensive income—> impacts S.E but are not reported on the income statement during that period

• ex:unrealized gains/losses on available for sale securities and translation gains/losses on foreign currency