ACC 313 Chapter 3

Knight, Creighton University

what type of statement is the income statement?

a period statement

what would the third line of an income statement’s heading look like?

“For the Year Ended mm/dd/yyyy”

what are the major components of the income statement?

revenues, expenses, gains and losses

revenues are based on the _______ principle

revenue recognition

revenue recognition principle

companies recognize revenue in the accounting period in which a performance obligation is satisfied`

expenses are based on the ______ principle

matching

matching principle

expenses should be matched against the revenues they produce or the time periods over which the expense is incurred

product costs

costs that are related directly to a product; cost was incurred to get the product “ready for its intended use”

when are product costs expensed?

in the period that the product is sold

what are product costs for a merchandising company?

• cost of merchandising inventory

• freight-in costs

what are product costs for a manufacturing company?

• direct materials

• direct labor

• factory overhead

period costs

costs that are not related to a specific product, but to a particular time period

when are period costs expensed?

the periods of time in which the cost is incurred

what are period costs for a merchandising company?

• depreciation expense

• salaries expense

• rent expense

what are period costs for a manufacturing company?

all costs incurred outside of the production facility

gains and losses

result from transactions that are outside of a businesses main operations (incidental or peripheral)

what are the limitations of the income statement?

• does not consider all types of income; such as certain elements of comprehensive income

• some items reported on the income statement are difficult to measure

• the amount of reported income is affected by accounting methods, estimates, and judgements

• most companies try to perform “income smoothing” and are able to do so even with rules limiting this

what does the income statement help evaluate?

• historical profitability

• historical operating efficiency

• the possibility and probability of future profitability

• the possibility and probability of future cash flows

income statement

the report that measures the success of company operations for a given period of time

revenues

inflows or other enhancements of assets of an entity or settlement of its liabilities from delivering or producing goods, rendering services, or carrying out other activities

expenses

outflows or other using-up of assets or incurrences of liabilities from delivering or producing goods, rendering services, or carrying out other activities

gains

increases in equity (net assets) from transactions and other events/circumstances affecting an entity except those that result from revenues or investments by owners

losses

decreases in equity (net assets) from transactions and other events/circumstances affecting an entity except those that result from expenses or distributions to owners

transaction approach

the normal, proper way of computing net income

net income is computed using the ______ approach

transaction

how is the transaction approach accomplished?

by making appropriate journal entries throughout the period and then preparing an income statement with the use of all income statement accounts (revenues, expenses, gains & losses)

what is the primary thing users are trying to evaluate with an income statement?

profitability

historical profitability provides ______ value

confirmatory

historical operating efficiency provides _______ value

confirmatory

the possibility and probability of future profitability provides _______ value

predictive

the possibility and probability of future cash flows provides _______ value

predictive

confirmatory value

information that provides feedback about previous evaluations (confirms or correct prior expectations)

predictive value

information that can be used as an input to processes employed by users to predict future outcomes

transparency

financial statements that are of high quality because they are very clear, easily understood, and candid

quality of earnings

earnings that are the result of true business operations (only bc of high revenues and low costs)

a company that has a high quality of earnings has earnings that are…

more predictable

types of income statements

• multiple-step income statement

• single-step income statement

multiple-step income statement layout

sales

(-) COGS

gross profit

(-) operating expenses

(-) general & administrative expenses

(-) certain gains and losses

net operating income

(±) other income-other expense

net income before taxes

(-) income tax expense

net income from continuing operations

(±) gain or loss from discontinued operations

net income

operating expenses include…

• general and administrative expenses

• selling expenses

• certain gains & losses

what income statement lines are included in the operating section?

net sales, COGS, gross profit, operating expenses, net operating income

what items are classified as certain gains & losses in the operating expense section?

• losses from permanent impairment of certain assets

• losses from the write-down of “assets to be disposed of” or “held for resale”

• gains or losses from adjusting “assets to be disposed of” or “held for resale” to fair value

• gains or losses from the sale of “assets to be disposed of” or “held for resale”

what is the criteria for an item to be classified as other income-other expense?

non-operating; not related to the company’s main line of business

examples of other income-other expense items

• interest income

• interest expense

• most gains

• most losses

• non-operating revenues

• non-operating expenses

• unusual or infrequent items

• restructuring (layoff) charges

“general & administrative expenses” are classified as…

operating expense

“selling expenses” are classified as…

operating expense

“loss from impairment” is classified as…

operating expense

“gain/loss on adjusting assets to be disposed of to fair value” is classified as…

operating expense

“gain/loss on adjusting assets held for resale to fair value” is classified as…

operating expense

“gain/loss from the sale of assets to be disposed of” is classified as…

operating expense

“gain/loss from the sale of assets held for resale” is classified as…

operating expense

“loss from the write-down of assets to be disposed of” is classified as…

operating expense

“loss from the write-down of assets held for resale” is classified as…

operating expense

“interest income” is classified as…

other income-other expense

“interest expense” is classified as…

other income-other expense

most gains are classified as…

other income-other expense

most losses are classified as…

other income-other expense

non-operating revenues are classified as…

other income-other expense

non-operating expenses are classified as…

other income-other expense

unusual or infrequent items are classified as…

other income-other expense

restructuring charges are classified as…

other income-other expense

format of other income-other expense section

net operating income 

(+) other income 

(-) other expense

net income before taxes

how are items that are “unusual in nature” and/or “infrequent in occurrence” treated?

• must be reported as a separate item in “other income-other expense”

• nature and financial effects of the item must be disclosed on the income statement itself or in the footnotes

restructuring charges

costs incurred in restructuring (usually downsizing) the company

do restructuring charges qualify for “discontinued operations” reporting?

no

examples of restructuring charges

• costs of employee buyouts

• employee relocation fees

• manufacturing plant closings

• shifting production to a new location

• writing off assets associated with restructure

income tax expense is computed based on…

the items shown above it (NIBT)

permanent differences

items included above income tax expense that are taxed differently from a company’s normal rate

is income tax expense the amount that is owed for income taxes to the government?

no; it normally never is

intraperiod tax allocation

items that are taxable but are shown below income tax expense → reported at “net of tax”

what two items are shown “net of tax” on the financial statements?

• gain or loss from discontinued operations

• prior period adjustments (shown on statement of retained earnings/stockholders’ equity)

gain or loss from discontinued operations

a nonrecurring item that is caused by the discontinuance of an identifiable (material) component of a company

what is an identifiable component of a company?

a level of the company where the operations and cash flows of the component are distinguishable from the rest of the company; also meet a certain measurement criteria

*basically, it’s a segment of the company that is big

what does the amount reported for gain/loss from discontinued operations include?

• the current year’s profit or loss from the operating activities of the discontinued segment (net sales, COGS, operating expenses)

• “other income-other expense” items earned or incurred during the current period

• income taxes incurred during the current period

what must be displayed below net income?

earnings per share information

gains/losses from discontinued operations are reported…

net of tax

what is an advantage of using a multiple-step income statement?

it distinguishes operating from non-operating activities

net sales

highlights the revenues of a company

gross profit

net sales - COGS; represents the merchandising profit of a company but does not measure overall profitability

non-controlling interest’s share of net income

reported immediately below net income from continuing operations as a deduction, which results in “net income attributable to the parent company (reporting entity); dollar amount of this item is a minority interest’s share of the net income of a partially owned subsidary

single-step income statement sections

• revenues and gains

• expenses and losses

• nonrecurring items

the “revenues and gains” section of the single-step income statement includes…

• sales

• “certain gains” reported with operating expenses

• “other income” items

the “expenses and losses” section of the single-step income statement includes…

• COGS

• operating expenses, including “certain losses” that are included with operating expenses

• “other expense” items

• income tax expense

the dollar figures shown on the single-step income statement are _____ as they would be on a multiple-step income statement

the same

*they are just shown in a different location

the “nonrecurring items” section of the single-step income statement includes…

the exact same items that would be reported in the exact same manner as they would be reported on a multiple-step income statement

*this is gains/losses from discontinued operations and non-controlling interest’s share of net income

single-step income statement format

revenues and gains

(-) expenses and losses

net income from continuing operations

(±) nonrecurring items 

net income

what does it mean that an income statement is condensed?

items on the income statement are not shown in their full detail

*both multiple-step and a single-step income statement may be prepared on a condensed basis

interim financial statements

financial statements that are prepared for a period that is less than a full year; required for pubic companies → must prepare quarterly financial statements

*interim statements are almost never audited

which income statement format is allowed by FASB?

both multiple- and single-step

which income statement format is required for public companies by the SEC?

multiple-step

the statement of retained earnings is a ______ statement

period

what is the format of a statement of retained earnings?

beg. RE balance

(±) prior period adjustments (net of tax)

corrected beg. RE balance

(±) net income/loss

retained earnings available for dividends

(-) dividends declared

end. RE balance

what is the major cause of a prior period adjustment?

this period’s correction of an error that occurred in a prior period that affected net income in that prior period

examples of items that do not classify as a prior period adjustment

• a lawsuit loss

• a change in estimate made in the current period which affects amounts reported in prior periods

what are the two ways an error affecting net income in prior periods that is corrected in the current period can be handled?

• PPA reported on earliest RE statement → financial statements in which error originally occurred are not republished

• financial statements are corrected before republication → financial statements in which error originally occurred are republished (no PPA reported)

dividends delclared

the amount of dividends declared for the current period

*not necessarily the amount of dividends that were paid/distributed

are liquidating dividends included in “dividends" declared”?

no

end. RE balance

the amount that is carried forward and shown on BS as Retained Earnings

why isn’t the ending RE balance for one year and the beginning RE balance for the next year not necessarily the balances originally reported?

because of prior period adjustments that have been made and because of revised income statements that have been prepared

where is retained earnings that has been appropriated (put into a reserve account) reported?

not on the RE statement, but on the RE section of B/S

retained earnings deficit

a debit balance in retained earnings due to continued net losses