Learning Objectives

CHAPTER 4 1. Understand the uses and limitations of an income

statement.
2. Understand the content and format of the income
INCOME STATEMENT AND RELATED statement.
INFORMATION 3. Prepare an income statement.
4. Explain how to report items in the income statement.
5. Identify where to report earnings per share information.
6. Explain intraperiod tax allocation.
7. Understand the reporting of accounting changes and
errors.
8. Prepare a retained earnings statement.
9. Explain how to report other comprehensive income.
4-1 4-2

Income Statement and Related Information LO1: Income Statement - Usefulness

Reporting Within
Format of Income Other Reporting
Income Statement the Income
Statement Issues
Statement 1. Evaluate past performance.
 Usefulness  Elements  Gross profit  Accounting
 Limitations  Minimum  Income from changes and
disclosure operations errors
 Quality of
Earnings  Intermediate  Income before  Retained earnings 2. Predict future performance.
components income tax statement
 Illustration  Net income  Comprehensive
income
 Condensed  Non-controlling
income interests  Changes in equity
statements  Earnings per
statement 3. Help assess the risk or
share
 Discontinued
uncertainty of achieving future
operations cash flows.
 Intraperiod tax
4-3 allocation 4-4
 Income Statement - Limitations Quality of Earnings
Companies have incentives to manage income to meet
1. Companies omit items that or beat market expectations, so that
cannot be measured reliably.  market price of stock increases and
 value of management’s compensation increase.

2. Income is affected by the

accounting methods employed. Earnings management is the planned timing of
revenues, expenses, gains, and losses to smooth out
earnings.
3. Income measurement involves
If earnings management
judgment.
 information is less useful for predicting future
earnings and cash flows 
4-5 4-6

LO2: Format of the Income Statement Elements of The Income Statement

Elements of the Income Statement • INCOME includes both revenues and gains.
INCOME – Increases in economic benefits during the • Revenues - ordinary activities of a company
accounting period in the form of • Gains - may or may not arise from ordinary
- inflows or enhancements of assets or activities.
- decreases of liabilities
that result in increases in equity, other than those Revenue Accounts Gain Accounts
relating to contributions from shareholders.
• Sales revenue • Gains on the sale of
Income includes both revenues and gains. • Fee revenue long-term assets
• Interest revenue • Unrealized gains on
Sales of CD: Order of magazine/newspaper: trading securities.
• Dividend revenue
Cash or A/R Advance from customer • Rent revenue
4-7 Sales Sales 4-8
 Elements of The Income Statement Elements of The Income Statement

EXPENSES – Decreases in economic benefits during • EXPENSES include both expenses and losses.
the accounting period in the form of
• Expenses - ordinary activities of a company
• outflows or depletions of assets or
• Losses - may or may not arise from ordinary
• incurrences of liabilities
activities.
that result in decreases in equity, other than those
relating to distributions to shareholders.
Expense Accounts Loss Accounts
• Cost of goods sold • Losses on restructuring
Sale of CD: Depreciate CD racks Electricity bill • Depreciation expense charges
• Interest expense • Losses on the sale of long-term

• Rent expense assets

• Unrealized losses on trading
• Salary expense
securities.
4-9 4-10

1. Sales or Revenue
FORMAT OF 2. Cost of Goods Sold
THE INCOME Gross Profit
STATEMENT 3. Selling Expenses
4. Administrative or General
Expenses
Intermediate 5. Other Income and Expense
Components Income from Operations
6. Financing costs
Companies generally
Income before Income Tax
present some or all of 7. Income Tax
these sections and Income from Continuing
totals within the Operations
income statement. 8. Discontinued Operations
Net Income
9. Non-Controlling Interest
4-11
10.Earnings Per Share 4-12
 FORMAT OF LO3: CONDENSED
THE INCOME INCOME
STATEMENT STATEMENT

Illustration More representative of

the type found in
Includes all of the practice.
major items in
previous list, except ILLUSTRATION 4-3
Condensed Income Statement
for discontinued
operations.
Company prepares
ILLUSTRATION 4-2
Income Statement
supplementary schedules to
support the totals.
ILLUSTRATION 4-4
Sample Supporting Schedule

4-13 4-14

Condensed I/S
LO4: REPORTING WITHIN THE INCOME
STATEMENT
Gross Profit
 Net sales revenue - cost of goods sold
 Disclosure of net sales revenue is useful.
 Unusual or incidental revenue is disclosed in other
income and expense.
 Provides a useful number for evaluating
performance and predicting future earnings.
 Analysts can more easily understand and assess
trends in revenue from continuing operations.

4-15 4-16
 REPORTING WITHIN THE INCOME Expense Classification
STATEMENT
Income from Operations Nature Function
 Gross profit – SG&A - other income and expense
 Highlights items that affect regular business
activities. • Cost of materials used
• Cost of goods sold
 Used to predict the amount, timing, and uncertainty • Direct labor incurred
• Selling expenses
of future cash flows. • Delivery expense
• Advertising expense • Administrative
Expense Classification • Employee benefits expenses
Reported by • Depreciation expense
- Nature, or • Amortization expense
- Function

4-17 4-18

Expense Classification Expense Classification (Nature-of-Expense

Illustration: The firm of Telaris Co. performs audit, tax, Approach) Illustration 4-5

and consulting services. It has the following revenues and

expenses.

2017

4-19 4-20
 Expense Classification
Function-of-Expense Approach
2017
Gains and Losses
Illustration 4-6
IASB takes the position that both
 revenues and expenses and
 other income and expense
should be reported as part of income from operations.

- However, companies can provide additional line items,

headings, and subtotals when such presentation is
relevant to an understanding of the entity’s financial
performance.
 This method is more relevant, but may be arbitrary.
 The function-of-expense method is generally used in
practice although many companies believe both
approaches have merit.
4-21 4-22

Illustration 4-8
Gains and Losses Income before Income Tax
Financing costs must be reported on the I/S.
Additional items that may need disclosure:
 Losses on write-downs of inventories to net realizable
value or of property, plant, and equipment to
recoverable amount, as well as reversals of such
write-downs.
 Losses on restructurings of the activities and reversals
of any provisions for the costs of restructuring.
 Gains or losses on the disposal of items of property,
plant, and, equipment or investments.
 Litigation settlements.
 Other reversals of liabilities.

4-23 4-24
 Net Income Allocation to Non-Controlling Interest
Represents the income after all  If a company prepares a consolidated income
 revenues and statement that includes a partially own subsidiary, IFRS
requires that net income of the subsidiary be allocated
 expenses
to the controlling (majority) and non-controlling interest
for the period are considered. (minority).
Viewed by many as the most important measure of a
 This allocation is reported at the bottom of the income
company’s success or failure for a given period of
statement after net income.
time.
Net income $164,489
Attributable to:
Shareholders of Boc Hong $120,000
Non-controlling interest 44,489

4-25 4-26

BE4-3: Presented below is some financial information

related to Volaire Group. Prepare the income
statement.
Revenues €1,200,000
COGS 400,000
Income from continuing operations 100,000
Comprehensive income 120,000
Net income 90,000
Income from operations 220,000
Selling and administrative expenses 500,000
Income before income tax 200,000

4-27 4-28
 Illustration: Lancer, Inc. reports net income of $350,000.
LO5: Earnings Per Share It declares and pays preferred dividends of $50,000 for
the year. The weighted-average number of ordinary
shares (OS) outstanding during the year is 100,000
Net income - preference dividends shares. Lancer computes earnings per share as follows:

Weighted average of ordinary shares outstanding

 A significant business indicator.

 Measures the dollars earned by each ordinary share. Case 2: The company has 90,000 shares of O.S. in the
 Must be disclosed on the income statement. beginning of the year and issues 40,000 shares of
O.S. on October 1. What’s the EPS?

4-29 4-30

ILLUSTRATION 4-12
Income Statement Discontinued Operations
Definition: A component of an entity that either has been
disposed of, or is classified as held-for-sale, and:
1. Represents a major line of business or geographical
area of operations, or
2. Is part of a single, coordinated plan to dispose of a
major line of business or geographical area of
Divide by operations, or
weighted-
average 3. Is a subsidiary acquired exclusively with a view to
shares resell.
outstanding Ex: 2017-9-20 HTC sold its cell phone segment to Google
上次Google賣Motorola手機部門是29億美元，這次則是用11億
EPS
美元把HTC的手機部門買回來，基本上這2次多是手機研發和
IP（智慧財產權），然後Google把貴的美國Motorola員工賣掉
Earnings per Share LO 5
，接下來換成便宜的台灣員工。
4-31 4-32
 Discontinued Operations
Companies report as discontinued operations
1. (in a separate income statement category) the gain
or loss from disposal of a component of a business.
2. The results of operations of a component that has
been or will be disposed of separately from
continuing operations.
3. The effects of discontinued operations net of tax, as
a separate category after continuing operations.
Amount reported “net of tax.”
4-33
A company that reports a discontinued operation must report
per share amount for the line item either on the face of the
income statement or in the notes to the financial statements.
Illustration 4-12
4-35
Discontinued Operations
Illustration: Multiplex Products, a highly diversified company,
decides to discontinue its electronics division.
During the current year, the electronics division lost $300,000
(net of tax).
Multiplex sold the division at the end of the year at a loss of
$500,000 (net of tax).
Income from continuing operations
Discontinued operations:
Loss from operations, net of tax
Loss on disposal, net of tax
Total loss on discontinued operations
Net income
4-34
LO6: Special Reporting Issues
Intra-period Tax Allocation
Relates the income tax expense to the specific items
that give rise to the amount of the tax expense.
On the income statement, income tax is allocated to:
(1) Income from continuing operations before tax
(2) Discontinued operations
“let the tax follow the income”
4-36
 Illustration 1 Illustration 2
Schindler Co. has income before income tax of $250,000. Schindler Co. has income before income tax of
It has a gain of $100,000 from a discontinued operation. $250,000. It has a loss of $100,000 from a discontinued
Assuming a 30 percent income tax rate, Schindler operation. Assuming a 30 percent income tax rate,
Schindler presents the following information on the
presents the following information on the income
income statement.
statement. Income before income tax $250,000
Income before income tax $250,000 Income tax
Income tax Income from continuing operations
Income from continuing operations Loss from discontinued operations
Gain on discontinued operations Net income
Net income
Companies may also report the tax effect of a discontinued
item by means of a note disclosure.
4-37 4-38

Summary Summary

4-39 4-40

OTHER REPORTING ISSUES
LO7: Accounting Changes and Errors
1. Changes in Accounting Principle
Example: Gaubert Inc. decided in March 2015 to change
from FIFO to weighted-average inventory pricing.
Gaubert’s income before taxes, using the new weighted-
average method in 2015, is $30,000.
Pretax Income Data

 Company adopts a different accounting principle. Illustration 4-17

Calculation of a
 Retrospective adjustment. Change in
Accounting
Cumulative effect adjustment to beginning retained Principle

earnings.
Restatement of F/S Approach preserves
comparability. Illustration 4-18
adjusted to
Income Statement Presentation of a Change in Accounting Principle (Based on 30% tax
 Examples include: rate)

• Change from FIFO to average cost.

• Change from the percentage-of-completion to
the completed-contract method.
4-41 4-42

2. Changes in Accounting Estimates Example: Arcadia HS, purchased equipment for

$510,000 which was estimated to have a useful life of 10
 Accounted for in the period of change and future years with a salvage value of $10,000 at the end of that
periods. time. Depreciation has been recorded for 7 years on a
 Not handled retrospectively. straight-line basis.
 Not considered errors. In 2017 (year 8), it is determined that the total estimated
life should be 15 years with a salvage value of $5,000 at
 Examples include:
the end of that time.
 Useful lives and residual values of depreciable
Questions:
assets.
 Allowance for uncollectible receivables.
1. What is the journal entry to correct
the prior years’ depreciation?
 Inventory obsolescence.
2. Calculate the depreciation expense
for 2017.
4-43 4-44
 Depreciation Expense calculation for 2017.
First, establish NBV at date of change in estimate.

Equipment cost
Net book value
Residual value
Residual value (new)
Depreciable base
Depreciable base
Useful life (original)
Useful life remaining years
Annual depreciation
Annual depreciation

Statement of Financial Position (Dec. 31, 2016) Journal entry for 2017
Fixed Assets:
Equipment
Accumulated depreciation
Net book value (NBV)

4-45 4-46

3. Corrections of Errors
Example: In 2017, Hillsboro Co. determined that it
• Result from: incorrectly overstated its accounts receivable and
sales revenue by $100,000 in 2016. In 2017,
o mathematical mistakes.
Hillsboro makes the following entry to correct for this
o mistakes in application of accounting
error (ignore income taxes).
principles.
o oversight or misuse of facts.

• Corrections treated as prior period adjustments.

• Adjustment to the beginning balance of retained
earnings.

4-47 4-48
 Summary-Accounting Changes and Errors Summary-Accounting Changes and Errors
ILLUSTRATION 4-19
ILLUSTRATION 4-19 Summary of Accounting Changes and Errors
Summary of Accounting Changes and Errors

Type of Type of
Changes in Accounting Principle Situation Changes in Accounting Estimate
Situation
Criteria Normal, recurring corrections and
Criteria Change from one generally accepted
adjustments.
accounting principle to another.
Examples Changes in the realizability of receivables
Examples Change in the basis of inventory pricing from and inventories; changes in estimated lives
of equipment, intangible assets; changes in
FIFO to average-cost.
estimated liability for warranty costs, income
Placement Recast prior years’ income statements on the taxes, and salary payments.
on Income same basis as the newly adopted principle. Placement Show change only in the affected accounts
Statement on Income (not shown net of tax) and disclose the
LO 7
Statement nature of the change.
4-49 4-50

Summary-Accounting Changes and Errors OTHER REPORTING ISSUES

ILLUSTRATION 4-19
Summary of Accounting Changes and Errors
LO8: Retained Earnings Statement
Type of
Situation Corrections of Errors Increase Decrease
Criteria Mistake, misuse of facts.
 Net income  Net loss
Examples Error in reporting income and expense.  Change in  Dividends
accounting principle  Change in
Placement Restate prior years’ income statements to
on Income correct for error.  Prior period accounting principle
Statement adjustment  Prior period
adjustment

4-51 4-52
 Illustration
Retained Earnings Statement

Illustration 4-20

Before issuing the report for the year ended December 31,
2015, you discover a ₩50,000 error (net of tax) that caused
2014 inventory to be overstated (overstated inventory caused
COGS to be lower and thus net income to be higher in 2014).
Would this discovery have any impact on the reporting of the
Statement of Retained Earnings for 2015?

4-53 4-54

Illustration
LO9: Comprehensive Income
All changes in equity during a period except
those resulting from investments by owners and
distributions to owners.
Includes:
(overstated inventory caused COGS to be lower and thus  NI: all revenues and gains, expenses and
net income to be higher in 2014).
losses reported in net income, and
Restrictions of Retained Earnings  OCI: all gains and losses that bypass net
Disclosed income but affect equity.
o In notes to the financial statements.
o As Appropriated Retained Earnings.
4-55 4-56
 Comprehensive Income
Other Reporting Issues

Income Statement + Other Companies must display the components of other

Comprehensive comprehensive income in one of two ways:
Income
1. A single continuous statement (one
 Unrealized gains and
statement approach) or
losses on available-
for-sale securities. 2. two separate, but consecutive statements of
 Translation gains and net income and other comprehensive income
(two statement approach).
losses on foreign
currency.
 Plus others

Reported in Equity
4-57 4-58

Comprehensive Income- Comprehensive Income-

One Statement Approach Two Statement Approach ILLUSTRATION 4-22
Two Statement Format:
Comprehensive Income
ILLUSTRATION 4-21
One Statement Format: Comprehensive Income

Advantage – Illustration 4-19

does not
require the
creation of a
new financial
statement.
Disadvantage -
net income
buried as a
subtotal on the
statement.

4-59 4-60
 Statement of Changes in Equity Statement of Changes in Equity
ILLUSTRATION 4-23

Required, in addition to a statement of comprehensive Statement of Changes in Equity

income. Generally comprised of

 share capital—ordinary,
 share premium—ordinary,
 retained earnings, and the
 accumulated balances in other comprehensive items.

4-61 4-62

About The Numbers

Statement of Changes in Equity The terminology used in the IFRS literature is sometimes
different than what is used in U.S. GAAP. For example, here are
Regardless of the display format used, V. Gill reports some of the differences.
the accumulated other comprehensive income of
$90,000 in the equity section of the statement of
financial position as follows. Illustration 4-24

4-63 4-64

GLOBAL ACCOUNTING INSIGHTS
INCOME STATEMENT
Standards issued by the FASB (U.S. GAAP) are the
primary global alternative to IFRS. As in IFRS, the income
statement is a required statement for U.S. GAAP. In
addition, the content and presentation of the U.S. GAAP
income statement is similar to the one used for IFRS.
On the Horizon
The IASB and FASB are working on a project that would rework the
structure of financial statements. One stage of this project will
address the issue of how to classify various items in the income
statement. A main goal of this new approach is to provide
information that better represents how businesses are run. In
addition, this approach draws attention away from just one
number—net income.
4-65
Differences
• The U.S. SEC requires companies to have a functional
presentation of expenses. Under IFRS, companies must classify
expenses by either nature or function. U.S. GAAP does not have
that requirement.
• U.S. GAAP has no minimum information requirements for the
income statement. However, the U.S. SEC rules have more
rigorous presentation requirements. IFRS identifies certain
minimum items that should be presented on the income statement.
• U.S. SEC regulations define many key measures and provide
requirements and limitations on companies reporting non-U.S.
GAAP information. IFRS does not define key measures like
income from operations.
• U.S. GAAP does not permit revaluation accounting. Under IFRS,
revaluation of property, plant, and equipment, and intangible
assets is permitted and is reported as other comprehensive
income. The effect of this difference is that application of IFRS
results in more transactions affecting equity but not net income.
4-67
Relevant Facts
Following are the key similarities and differences between
U.S. GAAP and IFRS related to the income statement.
Similarities
• Both U.S. GAAP and IFRS require companies to indicate
the amount of net income attributable to non-controlling
interest.
• Both U.S. GAAP and IFRS follow the same presentation
guidelines for discontinued operations, but IFRS defines a
discontinued operation more narrowly. Both standard-
setters have indicated a willingness to develop a similar
definition to be used in the joint project on financial
statement presentation.
• Both U.S. GAAP and IFRS have items that are recognized
in equity as part of other comprehensive income but do not
affect net income. Both U.S. GAAP and IFRS allow a one
statement or two statement approach to preparing the
4-66 statement of comprehensive income.
1. The major elements of the income statement are
a. revenue, cost of goods sold, selling expenses, and
general expense.
b. operating section, nonoperating section, discontinued
operations and cumulative effect.
c. revenues, expenses, gains, and losses.
d. All of these.
2. The income statement information would help in which of
the following tasks?
a. Evaluate the liquidity of a company.
b. Evaluate the solvency of a company.
c. Estimate future cash flows.
d. Estimate future financial flexibility.
4-68
 3. The income statement provides investors and creditors
information that helps them predict
a. the amounts of future cash flows.
b. the timing of future cash flows.
c. the uncertainty of future cash flows.
d. All of the above.
4. If a company prepares a consolidated income statement,
IFRS requires that net income be reported for
a. the majority interest only.
b. the minority interest only.
c. both the majority interest and the minority interest.
d. as a single amount only.
5. IFRS requires that a single amount be disclosed within
the income statement for
a. the post-tax profit/loss on discontinued operations and the
pre-tax gain/loss on the disposal of discontinued
operational assets.
b. the pre-tax profit/loss on discontinued operations and the
post-tax gain/loss on the disposal of discontinued
operational assets.
c. the pre-tax profit/loss on discontinued operations and the
pre-tax gain/loss on the disposal of discontinued
operational assets.
d. the post-tax profit/loss on discontinued operations and the
post-tax gain/loss on the disposal of discontinued
operational assets.

4-69 4-70

E4-5 Presented below is information related to Webster Company

6. Gains and losses that bypass net income but affect
($000 omitted).
equity are referred to as
Officers' salaries $4,900
a. comprehensive income.
Depreciation of office furniture and equipment 3,960
b. other comprehensive income.
Cost of goods sold 63,570
c. prior period income. Rental revenue 17,230
d. unusual gains and losses. Transportation-out 2,690
Sales commissions 7,980
7. Changes in estimates affect reported amounts Depreciation of sales equipment 6,480
a. retrospectively only.
Sales 96,500
b. prospectively only.
c. currently and prospectively. Income tax 7,580
d. currently and retrospectively. Interest expense 1,860

Prepare an income statement for the year 2017 using the multiple-
step form. Ordinary shares outstanding for 2017 total 40,550 (000
4-71 omitted).
4-72
 EXERCISE 4-11 WOODS CORPORATION
WEBSTER COMPANY
Income Statement Income Statement
For the Year Ended December 31, 2017 For the Year Ended December 31, 2017
(In thousands, except earnings per share) Net sales(a)
Cost of goods sold(b)
Sales
Cost of goods sold Gross profit
Gross profit Selling expenses(c)
Operating Expenses
Administrative expenses(d)
Selling expenses
Sales commissions Other income and expense
Depreciation of sales equipment Rent revenue
Transportation-out Income from operations (interest)
Administrative expenses
Interest expense
Officers' salaries
Depreciation of office furniture and equip. Income before income tax
Other Income and Expense Income tax
Rental revenue Income from continuing operations
Other Expenses and Losses Discontinued operation
Interest expense Loss on sale of division
Income before income taxes Less: Applicable income tax
Income tax
Net income
Earnings per share Net income
4-73 4-74

E4-6 Practice (revision)

PARNEVIK CORP.
Income Statement
For the Year Ended December 31, 2017
Sales Revenue
Sales
Less: Sales returns and allowances
Sales discounts
Net sales revenue
Cost of goods sold
Gross profit

Selling expenses
Admin. and general expenses

Other Income and Expense

Loss from impairment of plant assets
Interest revenue
Income from operations
Interest expense
Income before income tax
Income tax
Net income
4-75 Earnings per share