BYU ACC 310 Topic 2

Statement of Shareholders equity and Income Statement

Income statement (definition)

Reports a company’s profit (or loss) during a particular period of time, usually one year or one quarter

Net Income (Profit)

Revenues and gains minus expenses and losses

Revenues

The amount of resources generated by providing goods or services to customers during a given time period

What are revenues net of?

reported net of any actual or predicted merchandise returns

What are the major challenges related to reporting revenue?

When it should be reported in the income statement and how much should be reported

Expenses

The cost incurred to generate revenue and run the business

When should expenses be reported?

Should be reported in the period resources are used in operations. Should align with the timing of the revenues they help create

Cost of goods sold

COGS

the purchase or manufacturing cost of merchandise inventory sold to customers

Cost of services

cost incurred by a service or digital company directly related to delivering services and providing support to customers

Selling, general, and administrative expenses

SG&A

a catch-all account that includes the cost of operations, including salaries, marketing, distribution, facilities maintenance, depreciation, and research and development.

Interest Expense

the cost of debt financing and other credit arrangements

Tax expense

the cost of all income taxes, including foreign, federal, and local income taxes

Gains and Losses

Increases and decreases in income from transactions not classified as revenues or expenses.

They do not represent normal activities of the company but they represent transactions that affect the companies financial position.

Gross Profit

Sales/service revenue minus cost of goods/services sold

A measure of direct profitability that links revenues directly to the costs needed to generate those revenues.

Operating Income

Gross profit less additional expenses related to operating activities

The additional operating expenses include items that are not directly related to inventory or services.

Nonoperating income

Includes revenues, expenses, gains, and losses related to investing and financing activities, not operating activities.

EX: interest revenue, gains and losses from selling investments, interest expenses on nonoperating income. (for merchandising companies)

Often labeled as “Other income (expense)”

Pretax Income

The sum of operating income and nonoperating income

The amount of profits before accounting for income taxes

Net Income

Total amount of all revenues and gains minus the total of all expenses and losses.

Considered the “Bottom Line”

Total performance over a given period of time

Earnings per Share

the amount of net income a company generated relative to the average number of common shares outstanding for the year.

What does calculating Earnings per Share make easier?

Makes it easier to compare the performance of the company over time BUT not comparable from one company to another.

Income statement formats

The Single-step format

The multiple-step format

Singe-step Format

groups all revenues and gains into a single subtotal then expenses and losses are grouped and subtotaled. The difference of the two subtotals equals pretax income.

Multiple-Step Format

Reports a series of intermediate totals such as gross profit, operating income, nonoperating income, and pretax income.

What are the advantages of using the Multiple-Step Format?

It clearly separates operating and nonoperating income items which allow the company to asses their core profitability

The classification of expenses into seperate functions also provides assessment of costs of differing types.

Discontinued operations income

These won’t give income in the future. They are from selling or gaining income for a prior core operation of the company.

Limitations of the Income Statement

The inclusion of recurring and nonrecurring items

The inclusion of operating and nonoperating Items

The potential misuse of estimates and judgments

The statement of stockholders’ equity

Summarizes the changes in each stockholders’ equity account during a particular period.

3 Primary sources of equity reported

Contributed capital (Common stock , Additional paid in capital)

Retained earnings

Accumulated other comprehensive income (AOCI)

Treasury Stock

contra asset account, Repurchasing shares from investors

Comprehensive Income

All changes in equity that arise from both owner and nonowner sources

From what two sources do changes in equity come?

Transactions with owners and non-owners

Non-owner Sources

transactions with customers, suppliers, employees, landlords, utility providers, and tax authorities, etc…

Other Comprehensive income

Gains and losses from non-owner transactions that are not reported in the income statement

Comprehensive income calculation

Comprehensive income = Net income + Other comprehensive income

PE (price-earnings)

The ratio of stock prices to EPS

Provides a simple measure of what investors are willing to pay for ownership of $1 of current earnings.

The inclusion of recurring and nonrecurring items

Makes it difficult to predict what income will look like in the future

EX of recurring :Salaries expenses, advertising expense, and depreciation

EX of nonrecurring: One time gains and losses on the sale of long term assets, one time changes to restructure the business and unusual charges associated with unpredictable events

The inclusion of operating and non operating items

It is not clear from the statement how much tax expense relates to operating and non operating which makes it difficult to determine the portion of net income stemming from operating vs non operating.

Ex of operating items: sale revenue, COGS, depreciation, and salaries

Ex of non operating items: Investing and financing activities (short term securities, etc…)

The potential misuse of estimates and judgements

Can be manipulated or biased because companies face a strong incentive to show growth and profits.

Many company managers are compensated for showing growth