476CHAPTER O.USINGFINANCIAL TATEMENT NALYSISO EVALUATE IRMPERFORMANCE
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
lSource:LegalBeat;Earnings estated? on't Blamea Lawsuit or lt,"byStephen abaton, heNew Yorklmes. February3, 2005.1
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.
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.
Recognizend explain hecomponentsf net income.
DiscontinuedoperationsThosepartsof the firm thatacompanyhaseliminatedbysellingdivision.