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emplaw

emplaw

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Published by: hls13bro on Dec 17, 2012
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UsinginoncioltotemenlnolysisoEvoluoleirmerformunc
Here'sWhereYou've een
You eornedoconstructsiotementf cosh lows romon income totementndcomporotiveolonce heets.
Whenyouarefinishedstudyingthis chapter,youshould be able to:1.Recognizeand explain the componentsof net income.2.Perform and interpreJ a horizontal analysis and a vertical analysis of f,rnancialstatementnformation.3.Perform a basic ratio analysisof a set of financialstatements nd explain what theratios mean.4.Recognize he risks ofinvestingin stockand explainhowto control those risks.
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475
 
476CHAPTER O.USINGFINANCIAL TATEMENT NALYSISO EVALUATE IRMPERFORMANCE
#fAies
Accountingnformation san importantpartof thefinancial nfor-mation investorsse oevaluateafirm'sperformance.As an in-vestor,ouneedto feelconfident n a firm's reported earnings.When a firm hasmadean error,earningsmay need o be restated.There were arecord numberof earnings estatementsn 2005-around 1,200.he surprisinghing about his high numberof re-statementss hatonly vewereheresultf an nvestor lass-actionlawsuitagainstaccountingirms.This sa sharpdecline rom previous ears.According oProfessor osephGrundfestof StanfordLaw School,formerSEC ommissioneLne reasonsheimprovedorporateovernancefter hepassagefthe Sarbanes-Oxleyct. Evenwhen a firm must restate ts earnings,investorsrebeginning o realizehat honest irmsaredoing heir best o pro-duceaccurateinancial tatements.
lSource:LegalBeat;Earnings estated? on't Blamea Lawsuit or lt,"byStephen abaton, heNew Yorklmes. February3, 2005.1
ACloserookat theIncometatement
You have learned agreatdeal aboutthebasic financial statementsand how accountantsrecord,summarize,and report transactions. here s informationyoucan easily see n the fi-nancial statement, ut theres also nformation that sdifficulttosee.t isimportant to lookbeyond he size and sourceof thenumbers oseewhat the numbersmean.We havebeenex- amining the individualpartsofthe financialstatements.Now we will examine all thepartsof the four financial statementsogether o answerhefollowingquestions:What informa-tion do financial statementsrovide?What does he information mean?How canweuse t?Before beginning the detailedanalysis of the financial statements,we need to take acloser ook at some of the characteristicsof the incomestatement.Becauseearnings-netincome-is the focus of financialreporting,companies worry about how current andpo-tential investorswill interpretthe announcement fearningseachquarter.t is not uncom-mon for companies o be accusedof manipulating their earnings o appearmoreprofitablethan they actuallyare. n an effort to make the componentsof earningsclear and to repre-sent exactlywhat they should tofinancialstatementusers, he Financial Accounting Stan-dardsBoard(FASB)requires thattwoitems be separated rom the regular earnings of acompany.Themajor reason or segregating hese tems is that they should notbe consid-ered aspartof the ongoing earningsof the firm. Reported earnings san amount used topredictfuture earnings,but thesewo itemsare not expected o be repeated n the future.1. Discontinued operations2. Extraordinary itemsExhibit 10.1shows he componentsf net ncome.
Discontinuedperations
Ifyoupayattention o the financialnews,youarebound to hear about a company selling offadivision.In2004, Motorola, oneof theargestcommunications irms in theworld, discon-tinued operating ts semiconductorusinessegmentso hat the segment ould form its ownfirm, FreescaleSemiconductor.Thegainsor losses rom these kinds of transactionsareshown separately n the ncomestatement. irmsare always evaluating he contribution hatthevariousdivisions make o theprofitsof the firm. If a division is notprofitableor no longerfits the strategyofthe firm, a frrm may sell t to remainprofitableor changehefirm'sfocus.Partsof a company'soperationshat are eliminatedarecalleddiscontinued operations.
L.()"r
Recognizend explain hecomponentsf net income.
DiscontinuedoperationsThosepartsof the firm thatacompanyhaseliminatedbysellingdivision.
 
CHAPTER0oA CLOSEROOKAT THENCOMESTATEMENT477
Whena firmeliminatesa division,thefinancialimplicationsareshown separatelyfromthe regular operationsof thefirm.Whywouldthisseparationbeuseful? Earningsisan importantnumberbecausetis usedto evaluateheperformanceofa firm andtopre-dict itsfutureperformance.To maketheseevaluationsandpredictionsmore meaningful,it is importantthat one-timetransactionsbeseparatedromrecurringtransactions.Thisseparationallowsinvestorso seeone-timetransactionsas exceptionso the normaloper-ationsof the firm.In additiontothegainor lossfromthesale, heearningsor lossfor theaccountingperiod forthe discontinuedoperationsmustalso beshownseparately.We willlook at an exampleofa firm withdiscontinuedoperations.n2007,Muzby Manufactur-ingsold off amajor businesssegment,hecrate-productiondivision,because he firmwantedto focusits operationsonits corebusiness,whichdidnotincludethe crate divi-sion.Both the currentyear's ncomeor lossromthe crate-productiondivisionand hegainor loss fromthe sale ofthoseoperationsare shownseparatelyontheincomestatement'Suppose:L. Muzby Manufacturing'sncomerom continuingoperationsbeforeaxeswas$395,600'2.Taxes elated othat ncomewere$155,000.3. The discontinuedsegmentcontributedncomeof$12,000duringtheyear.4. Taxes elatedo thatcontributedncomewere$1,900.5.The discontinuedsegmentwassoldfor againof$63'000.6.The taxes elatedo theprofit from thatgain were$28'000.Exhibit10.2 showshow thisinformationwouldbepresentedontheincomestatementorMuzbyManufacturing.
Extraordinarytems
Youhave earnedthat discontinuedoperationsarethe firstitemthataccountantsdiscloseseparatelyon the incomestatement.The secondtemis thefinancialeffect ofany eventhatis unusualn natureand nfrequenln occurrence.Thefinancialeffectsof such eventsarecalled extraordinaryitems.Toqualify asextraordinary,heeventsmust beabnormalandmustnot be reasonablyexpectedo occuragainnthe foreseeableuture.There isagreatdealofjudgmentrequiredto decidef aneventshouldbeconsideredextraordinary.Exam-plesof occurrenceshat havebeen consideredextraordinaryncludeeruptionsof a volcano,a takeover offoreign operationsby theforeigngovernment,andtheeffectsof new lawsorregulationshatresult ina one-timecostto comply.Eachsituationisunique andmustbeconsideredn lightof the environmentnwhichthebusinessoperates.SupposeMuzbyManufacturinghasa factoryin China,andtheChinesegovernmentdecides o takepossessionof allAmericanbusinessesnthe country.Thevalue of the lostfactory is$200,000.U.S.taxlaw allowscompanieso writeoffthistype of extraordinaryloss, which meanshecompanyreceivesa taxsavings.Supposeheapplicableaxsavingsis$67,000.Exhibit10.3 showshowMuzbyManufacturingwouldpresentheinformationon itsincome statementortheyear.
EXHIBIT10.1ComponentsofNetlncome
It'simportantfor investorsoseetheindividualpiecesofearnings.ExtraordinarytemsEventsthat areunusualn natureandnfrequentn occurrence.

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