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Uses and Limitations of the Income Statement 1. The income statement helps investors and creditors predict the amounts, timing and uncertainty of future cash flows. It helps with the following: a. evaluating past performance b. predicting future performance c. determining the risk/uncertainty of achieving future cash flows B. Limitations of the Income Statement 1. Some items are omitted that cannot be reliably measured. e.g., change in value for brand recognition, product quality, etc. 2. Items are affected by the accounting methods used. e.g., straight-line vs. double-declining depreciation 3. Measurement involves judgments. (e.g., bad debt expense) C. Format of the Income Statement 1. Single-Step two groups, revenues and expenses 2. Multiple-Step classifies expenses by function and separates operating and nonoperating activities Sales, Cost of Goods Sold, Gross Profit, Operating Expenses (Selling and Administrative), Other Revenue, Gains, Expenses and Losses, Income Tax, Discontinued Operations, Extraordinary Items and Net Income D. Discontinued Operations (shown net of tax) 1. Company eliminates the results of operations and cash flows of a component from its ongoing operations (intends to dispose) and 2. There is no significant continuing involvement in that component after the disposal transaction. E. Extraordinary Items (shown net of tax) Nonrecurring material items that are 1. Unusual in nature and 2. Infrequent in occurrence F. Unusual Gains and Losses G. Changes in Accounting Principle adoption of a GAAP accounting method that is different from the one previously used. Recognized by making a retrospective adjustment of the prior years financial statements as if the principle had been used in those prior years. The result is that the cumulative effect of the change on prior years income, net of related taxes, if shown as an adjustment to the beginning retained earnings of the earliest year presented, i.e., shown in the Statement of Retained Earnings. Changes in Estimates adjustments that result from periodic revisions in estimates. Treat these items on a forward-going basis through the income statement.


RETAINED EARNINGS STATEMENT Correction of Errors Handled as prior period adjustments, net of tax, on the retained earnings statement. Comes after beginning retained earnings to arrive at retained earnings as adjusted.

Chapter 4 Outline Income Statement and Related Information Page 2 of 2

Retained earnings beginning of year +/- Prior period adjustment, net of tax Retained earnings beginning of year as adjusted +/-Net income (Net loss) Dividends Retained earnings end of year

xxxx xxx xxxx xxx ( xxx) xxxx

Note that sometimes companies restrict retained earnings to comply with contractual requirements, board of directors resolutions, etc. This situation may be reflected by the company reclassifying the restricted portion of retained earnings into a separate account called Appropriate Retained Earnings. In that case total retained earnings would consist of the unrestricted portion plus the restricted portion. EARNINGS PER SHARE (EPS) Widely used as a measure of business performance. (Net Income Preferred Dividends) Weighted Average of Common Shares Outstanding EPS must be disclosed on the face of the income statement as follows: Income before discontinued operations and extraordinary items Discontinued operations Income before extraordinary items Extraordinary items Net income xxxx xxx xxxx xxx xxxx

COMPREHENSIVE INCOME Includes all changes in equity except investments by owners and distributions to owners. In other words comprehensive income is net income (loss) plus all changes except investments by owners and distributions to owners. These non-owner related changes in equity are called Other Comprehensive Income. Comprehensive income may be shown (1) in a second income statements, (2) in a combined statement of comprehensive income which would show net income as a subtotal or (3) in a statement of stockholders equity. IFRS AND THE INCOME STATEMENT GAAP allows single-step or multi-step formats. IFRS is silent on this point. GAAP provides for extraordinary items. IFRS prohibits such items. IFRS provides for classifying expenses by nature or function. GAAP does not. IFRS provides for a minimum presentation of items; GAAP does not. IFRS does not provide for key sections such as income from operations, etc. IFRS and GAAP are similar with respect to discontinued operations with IFRS defining the concept more narrowly. GAAP allows three formats to present comprehensive income. IFRS allows a separate statement of comprehensive income or a combined statement. IFRS provides for revaluation of PP&E and intangibles; GAAP does not.