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Classification and Format in the Income Statement

Classification and Format in the Income Statement

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Investors commonly assess a firm’s value based on the firm’s expected future sustainable earnings stream. To inform analysts and other financial statement users about sustainable earnings, firms often report income from recurring business activities separately from income effects from unusual or nonrecurring activities (such as asset impairments, restructuring, discontinued business segments, and extraordinary events).
Investors commonly assess a firm’s value based on the firm’s expected future sustainable earnings stream. To inform analysts and other financial statement users about sustainable earnings, firms often report income from recurring business activities separately from income effects from unusual or nonrecurring activities (such as asset impairments, restructuring, discontinued business segments, and extraordinary events).

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Published by: ClassOf1.com on Jul 10, 2013
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Financial Accounting
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Sub: Financial Accounting Topic:
 
Financial Statement Analysis
*
Classification and Format in the Income Statement
Investors commonly assess a firm’s value based on the firm’s expected future sustainable
earningsstream. To inform analysts and other financial statement users about sustainable earnings, firmsoften report income from recurring business activities separately from income effects from unusualor nonrecurring activities (such as asset impairments, restructuring, discontinued business segments,and extraordinary events). To provide more useful information for prediction, U.S. GAAP (
GenerallyAccepted Accounting Principles
) requires that the income statement include some or all of thefollowing sections or categories depend
ing on the nature of the firm’s
income for a period:
Income from Continuing Operations.
Reports the revenues and expenses of activities inwhich a firm anticipates an ongoing involvement. When a firm does not have items in thesecond and third categories of income in a particular year, all of its income items are relatedto continuing operations; so it does not need to use the continuing operations label. Firmsreport their expenses in various ways. Most firms in the United States report expenses bytheir function: cost of goods sold for manufacturing, selling expenses for marketing,administrative expenses for administrative management, and interest expense for financing.Other firms, particularly those in the European Community, tend to report expenses by theirnature: raw materials, compensation, advertising, and research and development.
Income from Discontinued Operations.
A firm that intends to remain in a line of business butdecides to sell or close down some portion of that line (such as closing a single plant ordropping a line of products) generally will report any income, gain, or loss from such an actionunder continuing operations. On the other hand, if a firm decides to terminate itsinvolvement in a line of business (such as selling or shuttering an entire division or subsidiary),
 
 
Sub: Financial Accounting Topic:
 
Financial Statement Analysis
*
it will report the income, gain, or loss in the second section of the income statement, labeled
“Income, Gains, and Losses from Discontinued Operations.”
 
Extraordinary Gains and Losses.
Extraordinary gains and losses arise from events that are (1)
unusual given the nature of a firm’s activities, (2)
nonrecurring, and (3) material in amount.Corporate annual reports rarely disclose such items. Many firms have reported restructuringcharges and impairment losses in their income statements in recent years. Such items oftenreflect the write-down of assets or the recognition of liabilities arising from changes ineconomic conditions and corporate strategies. Because restructuring charges and impairmentlosses do not usually satisfy the criteria for discontinued operations or extraordinary items,firms report them in the continuing operations section of the income statement. If theamounts are material, they appear on a separate line to distinguish them from recurringincome items. Income, gains, and losses from discontinued operations and extraordinarygains and losses appear in the income statement net of any income tax effects. The majorityof published income statements include only the first section because discontinuedoperations and extraordinary gains and losses occur infrequently.

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