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Chapter

Income Statement

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The Income Statement

Statement of Earnings, Profit/Loss Account


Summary of revenues, expenses, gains & losses
Bottom line= net income for a specific period
Multiple-step formatpresents separately

Gross profit
Operating income
Interest expense (Financing costs)
Income before taxes
Net income

Single-step format
Totals all revenues and gains

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Multiple-Step

Single-Step

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Basic Elements of the Income Statement

Net Sales (Revenues)


Cost of Goods Sold (Cost of Sales)
Gross Profit (Gross Margin)
Selling Expenses
Admin. Expenses
Other Income or Expense
Income from Operations
Interest Expense (Financing Costs)
Income before Tax
Income Tax

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Net Sales (Revenues)


Represents revenue from the sale of principal
goods or services sold to customers
Shown net of
Discounts
Returns
Allowances

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Cost of Goods Sold (Cost of Sales)


The cost of goods that were sold to produce
revenue
Retailer
Beginning Inventory
Cost of Goods
+ Purchased
Ending Inventory
Cost of Goods Sold

Manufacturer
Beginning Inventory
+ Cost of Goods Manufactured
Ending Inventory
Cost of Goods Sold

A service firm will not have cost of goods sold,


but it will often have cost of services
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Other Operating Revenue


Depends on the operations of the business
Examples
Lease revenue
Royalties

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product or service or otherwise on a password-protected website for classroom use.

Operating Expenses
Consist of two types
Selling expenses
Result from a companys effort to create sales
Advertising. Sales commissions, and Sales supplies used

Administrative expenses
Relate to the general administration of a companys
operation
Salaries, Insurance, and Bad debt expense

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Other Income or Expense


Secondary activities not directly related to
operations
Dividend income. Interest income, Gains
(losses) from sale of assets.
But Interest expense = Financing Costs (should
be reported separately).

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Special Income Statement Items


Unusual or Infrequent Item Disclosed Separately
Shown with normal recurring revenues and expenses
If material, disclosed separately, before tax
Treatment for analysis
Included in primary analysis as they relate to operations
In supplementary analysis, its better removed net after tax

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Special ItemsContinued
Equity Earnings of Nonconsolidated Subsidiaries
The investors proportionate share of the investees
net income
Does not represent cash flow to the investor
Cash dividends received represent cash flow

Analysis issues
Investors net income includes revenue of other entity
May distort ratios
Presented before tax (tax consequences typically immaterial)

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Special ItemsContinued
Discontinued Operations
Reported net of income tax
Profitability analysis issues
Inadequate disclosure of associated assets
Lack of historical profit and loss information on the
discontinued operations

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Special Items (Only in the US!)


Extraordinary Items
Unusual and infrequent
Reported net of income tax
Analysis issues
Exclude from primary analysis; it is not expected to recur
Include for supplementary analysis; this approach avoids
disregarding extraordinary items

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Special ItemsContinued
Change in Accounting Principles
US-GAAP: Historically, the retrospective cumulative
effect is reported at the bottom of Income Statement
(net of tax). But now changed to comply with IFRS!
IFRS: the retrospective cumulative effect is reported
as an adjustment (net of tax) to the beginning balance
of retained earnings (i.e. bypass Income Statement).
So it is a special item for the US-GAAP income but
not for the IFRS income.

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Special ItemsContinued
Net IncomeNoncontrolling Interest (prior to
Dec. 31, 2009 it was called minority share of
earnings)
Earnings of a partially-owned consolidated subsidiary
that would accrue to the minority owners
US-GAAP: Deducted before Net Income (net of tax)
IFRS: Presented after Net Income
*** Note that Net Income is therefore measured
differently!

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Earnings per Share


Earnings divided by the number of shares of
outstanding common Share
EPS =

Net income NCI Preferred Dividends


W.A Outstanding shares of common Share

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Retained Earnings
The accumulated undistributed earnings of the
corporation reported on the balance sheet
Appropriated
Restricted by law, contract, or management decision
Not available for dividends
Does not represent cash or any other asset

Unappropriated
Available for dividends

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Reconciliation of Retained Earnings


Reported as part of the statement of
Shareholders equity or combined with the
income statement

=
+

Beginning balance of retained earnings


Prior period adjustments (net of tax)
Cumulative effect of a change in accounting principle
(net of tax)
Beginning balance as adjusted
Net income
Dividends
End-of-year balance of retained earnings

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Dividends
Dividends return profits to the owners of a
corporation
Date of declaration
Creates liability and reduces retained earnings

Date of payment
Eliminates liability and reduces cash

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Legality of Distributions to Shareholders


As per various active laws
Distributions to Shareholders are acceptable as long
as the firm has the ability to pay debts as they come
due in the normal course of business
Distributions to Shareholders are acceptable as long
as the firm is solvent and the distributions do not
exceed the fair value of the assets
Distributions consist of solvency and balance sheet
test of liquidity and risk

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Share Dividends
Issuing a percentage of outstanding share as
new shares to existing shareholders
Assuming a small distribution (less than 25%)
Removing the fair market value of the share from retained
earnings and transferring it to Share capital

If the Share dividend is material


The amount transferred to Share Capital is determined by
multiplying the par value by the number of additional shares

Total equity is unaffected by a Share dividend


Restate share quantities to reflect Share dividend
activity
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Share DividendExample
100,000 shares outstanding; $1 par; $5 market
10% Share dividend on 100,000 shares, issue
10,000 additional shares recorded at $5 per
share

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Share Dividend Example


100,000 shares outstanding; $1 par; $5 market
40% Share dividend on 100,000 shares, issue
40,000 additional shares recorded at $1 per
share

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Share Splits
2-for-1 split
Doubles the quantity of Share
Par or stated value is halved

No effect on retained earnings, Share Premium,


or share capital accounts
Analysis issues
Restate share quantities to reflect split activity

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Market Capitalization
Firm Value is not affected by neither stock
dividends nor stock split
Market Capitalization = Number of Shares
Outstanding
X
Market Price per Share

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HERE>>>Comprehensive Income
Foreign currency translation adjustments
Unrealized holding gains and losses on
available-for-sale marketable securities
Changes to Shareholders equity resulting from
additional minimum pension liability adjustments
Unrealized gains and losses from derivative
instruments
Net income
The periods change in accumulated other
+
comprehensive income
= Comprehensive income

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Comprehensive IncomeContinued
Required disclosures
Comprehensive income
Each category of other comprehensive income
Reclassification adjustments for each category of
other comprehensive income
Tax effects for each category of other comprehensive
income
Balances for each category of accumulated other
comprehensive income

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Comprehensive IncomeContinued
Presentation
A single income statement reporting net income and
comprehensive income, or
Report comprehensive income in a separate
statement immediately following the statement of
income

Analysis issues
Typically more volatile than net income

A better indication of long-run profitability

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Comprehensive Income
Combined with Income Statement

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Comprehensive IncomeSeparate
Statement

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Income Statement IFRS vs. GAAP


IFRS and U.S. GAAP for income statements are
similar, with some presentation differences
IFRS has no required format of the income statement
IFRS classifies expenses based on their nature or
function (recommends both)
IFRS (some of) plant assets may be revalued which
result in the adjustment of depreciation expenses
IFRS allows for alternative performance measures to
be presented in income statement

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Assignment:
1) Review the Income Statement of your company:
A) spot if there are any special items.
B) what is the EPS of your company?

2) What is the Market Capitalization of your Co.?


3) What is the number of shares authorized, issued and
outstanding?
4) are there any OCI at the Comprehensive Income Statement?
What are they?
5) What is the dividends policy of the company? What was the
dividends per share last year?
6) Are there any Appropriations for Retained Earnings? What
are they?
2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain
product or service or otherwise on a password-protected website for classroom use.