4

Income Statement
and Related Information

CHAPTER LEARNING OBJECTIVES

1. Identify the uses and limitations of an income statement.

2. Describe the content and format of the income statement.
3. Discuss how to report various income items.
4. Explain the reporting of accounting changes and errors.
5. Describe related stockholders’ equity statements.

6. Compare the accounting procedures for income reporting under GAAP and IFRS.

CHAPTER REVIEW

1. Chapter 4 presents a detailed discussion of the concepts and techniques that

underlie the preparation of the Income Statement and Statement of Retained Earnings
and the reporting of other comprehensive income. The requirements for adequate
presentation of reported net income are described and illustrated throughout the chapter.
2. (L.O. 1) The income statement helps users of financial statements (1) evaluate the
past performance of the enterprise, (2) provide a basis for predicting future performance,
and (3) help assess the risk or uncertainty of achieving future cash flows. The limitations
of the income statement include (1) items that cannot be measured reliably are not
reported in the income statement, (2) income numbers are affected by the accounting
methods employed, and (3) income measurement involves judgment.
3. Quality of earnings is important because markets are based on trust and it is
imperative that investors have faith in the numbers reported. If that trust is damaged,
capital markets will be damaged.

Format of the Income Statement

4. (L.O. 2) The major elements of net income, as described in Chapter 2, are:

revenues, expenses, gains, and losses. The distinction between revenues and gains
and the distinction between expenses and losses depends to a great extent on the typical
activities of a business enterprise. When inflows or enhancements of assets result from
typical business activities (generally the activities the entity is in business to perform),
revenues result. Likewise, outflows or the using up of assets resulting from typical

 Note: All asterisked (*) items relate to material contained in the Appendices to the chapter.
4-2 Student Study Guide for Intermediate Accounting, 17th Edition

business activities will generate expenses. Nontypical business activities resulting in

inflows or outflows of assets will normally generate transactions classified as gains or
losses.

Single-Step vs. Multiple-Step

5. The income statement may be presented in the single-step format or the

multiple-step format. Single-step income statements derive their name from the fact
that total costs and expenses are subtracted from total revenues in a “single step” to
arrive at net income. Income taxes are normally shown as a separate item among the
expenses (usually last) to indicate their relationship to income before taxes. The multiple-
step format separates results achieved by regular operations of the entity from those
obtained by nonoperating activities. Expenses are also classified by function such as cost
of sales, selling, and administrative. The multiple-step format provides more information
to financial statement users than does the single-step format; however, both are found in
actual practice.

Prepare an Income Statement

6. An income statement is composed of various sections that relate to different

aspects of the earning process. The six sections identified in the chapter, in the general
order of their appearance in the income statement, are:
1. Operating Section. Revenues and expenses from the entity’s principal
operations.
A. Sales or revenue.
B. Cost of goods sold.
C. Selling expenses.
D. Administrative or general expenses.
2. Nonoperating Section. Revenues and expenses resulting from secondary or
auxiliary activities of the company.
A. Other revenues and gains.
B. Other expenses and losses.
3. Income Tax. All taxes levied on income from continuing operations.
4. Discontinued Operations. Material gains and losses resulting from disposal
of a component of the business or a component that represents a strategic
shift.
5. Noncontrolling Interest.
6. Earnings Per Share.
The informative content of the income statement may be further enhanced by adding
additional subsections to the above major sections.

Modified All-Inclusive Concept vs. Current Operating Performance Concept

7. (L.O. 3) For the most part, accountants tend to agree on the composition of items
included on the income statement. However, certain unusual or infrequent items have
 Chapter 4: Income Statement and Related Information 4-3

stirred controversy in regard to the effect they should have on the presentation of net
income. Those who support the current operating performance concept to income
measurement believe that the unusual and infrequent items should be closed directly to
retained earnings (not included in computing net income). The accounting profession has
adopted a modified all-inclusive concept and requires application of this approach in
practice.

Reporting Various Income Items

8. In an attempt to provide financial statement users with the ability to better

determine the long-range earning power of an enterprise, certain professional
pronouncements require that the following unusual or infrequent items be highlighted in
the financial statements.
A. Unusual and infrequent gains and losses
B. Discontinued operations
C. Noncontrolling interest
D. Earnings per share

Unusual and Infrequent Gains and Losses

9. The following items may need separate disclosure in the income statement to help
users predict the amounts, timing, and uncertainty of future cash flows.
• Losses on the write-down or write-off of receivables; inventories; property,
plant and equipment; goodwill or other intangible assets.
• Gains or losses on extinguishment of debt obligations or on sale of investment
securities.
• Restructuring charges.
• Other gains or losses from sale or abandonment of property, plant, or
equipment used in the business.
• Effects of a strike, including those against competitors and major suppliers.
• Gains and losses related to casualties such as floods, fires, and earthquakes.
Companies will itemize each gain or loss on the income statement or show one amount
for all these items and then itemize these items in the notes to the financial statements.

Discontinued Operations

10. A discontinued operation occurs when (a) a company eliminates the results of
operations of a component of the business, and (b) there is the elimination of a
component that represents a strategic shift. A strategic shift includes the disposal of (1)
a major line of business, (2) a major geographical area, or (3) a major equity method
investment. When an entity decides to dispose of a component of its business, certain
classification and disclosure requirements must be met. A separate income statement
category for gain or loss from disposal of a component of a business must be provided. In
addition, the results of operations of a component that has been or will be disposed of are
also reported—separately from continuing operations. Both items are reported net of tax.
4-4 Student Study Guide for Intermediate Accounting, 17th Edition

Intraperiod Tax Allocation

11. Companies use intraperiod tax allocation on the income statement for (1)
income from continuing operations, and (2) discontinued operations. The concept being
followed is “let the tax follow the income.”

Noncontrolling Interest

12. When a company owns substantial interests in other companies, that company
generally consolidates the financial results of these companies into its own financial
statements. In these cases, the original company is referred to as the parent, and the
other companies are referred to as subsidiaries. Noncontrolling interest is then the
portion of equity (net assets) interest in a subsidiary not attributable to the parent
company.
13. When a company prepares a consolidated income statement, GAAP requires the
net income be allocated to the controlling and noncontrolling interest. This allocation is
reported at the bottom of the income statement after net income.

Earnings per Share

14. In general, earnings per share represents the ratio of net income minus preferred
dividends (income available to common shareholders) divided by the weighted average
number of common shares outstanding. It is considered by many financial statement
users to be the most significant statistic presented in the financial statements, and must
be disclosed on the face of the income statement. Per share amounts for gain or loss
on discontinued operations must be disclosed on the face of the income statement or in
the notes to the financial statements.

Changes in Accounting Principle

15. (L.O. 4) A change in accounting principle results when an entity adopts a new
accounting principle that is different from the one previously used. A company recognizes
a change in accounting principle by making a retrospective adjustment to the financial
statements. Such an adjustment recasts the prior years’ statements on a basis consistent
with the newly adopted principle. The company records the cumulative effect of the
change for prior periods as an adjustment to beginning retained earnings of the earliest
year presented.

Changes in Estimates

16. Accountants make extensive use of estimates in preparing financial statements.

Adjustments that grow out of the use of estimates in accounting are used in the
determination of income for the current period and future periods and are not handled
retrospectively. It should be noted that changes in estimates are not considered errors
(prior period adjustments).
 Chapter 4: Income Statement and Related Information 4-5

Corrections of Errors

17. Companies must correct errors by making proper entries in the accounts and
reporting corrections in the financial statements. Corrections of errors are treated as prior
period adjustments, similar to changes in accounting principles. Companies record an
error in the year in which it is discovered. They report the effect of the error as an
adjustment to the beginning balance of retained earnings. If a company prepares
comparative financial statements, it should restate the prior statements for the effects of
the error.

Related Stockholders’ Equity Statements

Retained Earnings Statement

18. (L.O. 5) The statement of retained earnings serves to reconcile the balance of
the retained earnings account from the beginning to the end of the year. The important
information communicated by the statement of retained earnings includes: (a) prior period
adjustments (income or loss related to corrections of errors in the financial statements of
a prior period net of tax), (b) changes in accounting principle, and (c) dividend
distributions (cash or stock) for the period.

Comprehensive Income

19. (L.O. 7) Items that bypass the income statement are included under the concept of
comprehensive income. Comprehensive income includes all changes in equity during a
period except those resulting from investments by owners and distributions to owners.
Components of other comprehensive income must be displayed in one of two ways: (1) a
single continuous statement (one statement approach) or (2) two separate but
consecutive statements of net income and other comprehensive income (two statement
approach).

*IFRS Insights

*20. (L.O. 8) Presentation of the income statement under GAAP follows either a single-
step or multiple-step format. IFRS does not mention a single-step or multiple-step
approach. Under IFRS, companies must classify expenses by either nature or function;
GAAP does not have that requirement, but the SEC requires a functional presentation.

GLOSSARY

Appropriated retained earnings. Retained earnings that are restricted in

accordance with contractual
requirements, board of directors’ policy,
or the apparent necessity of the moment.
4-6 Student Study Guide for Intermediate Accounting, 17th Edition

Change in accounting principle. The use of a principle in the current year

that is different from the one used in the
preceding year.
Comprehensive income. An income amount that includes all
revenues and gains, expenses and
losses reported in net income, and, in
addition it includes gains and losses that
bypass net income but affect
stockholders’ equity.
Changes in estimates. Normal, recurring corrections and
adjustments.
Corrections of errors. Mathematical mistakes, mistakes in the
application of accounting principles, or
oversight or misuse of facts that existed
at the time financial statements were
prepared.
Current operating performance approach. A concept that states that the net income
figure should show only the regular,
recurring earnings of the business.
Discontinued operations. The disposal of a component of a
business or the elimination of a
component that represents a strategic
shift.
Earnings per share. The net income earned by each share of
outstanding common stock.
Intraperiod tax allocation. The procedure of associating income
taxes with the specific item that directly
affects the income taxes for the period.
Multiple-step income statement. An income statement that shows
numerous steps in determining net
income (or net loss), including operating
and nonoperating sections.
Prior period adjustments. Items of income or loss related to
corrections of errors in the financial
statements of a prior period.
Unusual and infrequent gains and losses. Items that may need separate disclosure
in the income statement to help users
predict the amounts, timing, and
uncertainty of future cash flows.