FINANCIAL STATEMENT I: THE INCOME

STATEMENT
Adilla Ikhsani
Muhammad Mukhsin
Romi Hidayat
 Contents

Discussion in this session will start by giving an attention to economic aspects and
consequences of financial reporting. This followed by elaborating the format and
elements of income statements; accounting changes; the usefulness of earning per
share; comprehensive income and prior period of adjustments.
 OVERVIEW
The objectives of financial reporting is to provide financial information about the reporting entity
that is useful for the exist and potential equity investors, lenders, and another capital provider in
making decisions about providing resources to the entity (Chapter 2. Conceptual Framework of
Investors
Financial Accounting and Reporting)
Creditors

FINANCIAL REPORTING In US Any various groups that are affected by and have a Securities
ENVIRONMENT stake in the financial reporting required by FASB and Analyst
SEC
Regulators

Managements

Auditors

Central
Focus

It is because the investment involves forgoing current uses of

resources for ownership interests in companies. These
ownership interests are claims to uncertain future cash flow.
Thus, the investors truly rely on the information to help them in
assess future cashflow from the securities.
The Economic Consequences of Financial Reporting

Economic Economic consequences refers to the impact of of accounting reports on various segments
Consequences of our society. The accounting practices that company adopts can affect its security and
value. (Chapter 1 Pages 17)

The economic consequences of financial reporting and Income measurement:

1. Financial information can affect the distribution of wealth among investors.
2. Financial information can affect the level of risk accepted by a firm.
3. Financial information can affect the rate of capital formation in the
economy and result in a reallocation of wealth between consumption and
investment within the economy
4. Financial information can affect how investment is allocated among firms
Income Statement Elements
SFAC No 8 about general purpose of financial reporting.
Incomes statement is primary importance because of its predictive value (information that can be
used as the basis of predicting the future). -> Explained on SFAC No.8 about qualitative
characteristics.
Income Reporting has a value as:
 A measure of future cash flow
 A measure of management efficiency
 A guide to to the accomplishment of managerial objectives
SFAC No. 6 INCOME STATEMENT ELEMENTS:
 Revenues : Inflows or other enhancements of assets of an entity or settlement of its liabilities (or
a combination of both) during a period from delivering or producing goods or services, or other
activities that constitute the entity's ongoing major or central operations.
 Gains : Increases in net assets from peripheral or incidental transactions of an entity and from
all other transactions and other events and circumstances affecting the entity during a period
except those that result from revenues or investments by owners.
 Expenses : Outflows or other using up of assets or incurrences of liabilities (or a combination of
both) during a period from delivering or producing goods, rendering services, or carrying out
other activities that constitute the entity's ongoing major or central operations.
 Losses : Decreases in net assets from peripheral or incidental transactions of an entity and from
Defined as changes in
all other transactions and other events and circumstances affecting the entity during a period
assets and liabilities
except from expenses or distributions to owners
Income Statement Elements
The difference among the changes in asset/liabilities and the inflows outflows in defining income:
The changes in assets and/or liabilities approach The inflows and outflows approach

earnings as a measure of the change in net income as a measure of effectiveness.

economic resources for a period

depends on the definition of assets and liabilities to depends on definitions of revenues and expenses
define earnings and matching them to determine income

recognizes deferred items only when they are recognizes deferred items when measuring periodic
economic resources or obligations. income

Income can estimate future resource flows, thus the income statement is more useful to investors than the
balance sheet.

An important
limits distinction
the population between
from which (revenues
the elements of & gains) andand
revenues (expenses
expenses &
maylosses)
includeisitems
whether or not
financial
they are statements
associatedcan be ongoing
with selected to net economic necessary to match costs with revenues, even if they
operations
resources and to the transactions and events that do not represent changes in net resources.
change measurable attributes of those net resources.
Statement Format
2 Concept of income that could affect how
financial information is presented:
 Current Operating Performance Concept
of income : net income should reflect
the day-to-day, profit-directed activities
of the enterprise, and the inclusion of
other items of profit or loss
 All-inclusive concept of income : net The underlying assumption is
that the way financial information
income should reflect all items that
is presented is important
affected the net increase or decrease in
stockholders' equity during the period,
with the exception of capital
transactions. the total net income for
the life of an enterprise should be
determinable by summing the periodic
net income figures

Both of them are agree the information to be

presented, but disagree on “where to
disclose I/S elements”
APB Opinion No.9
● APB opinion No.9 was released by various entities disclosed some reporting abuses
● APB Opinion No. 9 “Reporting the Results of Operations.” took a middle position between the current
operating performance and all-inclusive concepts by stating that net income should reflect all items of profit
and loss recognized during the period, with the exception of prior-period adjustments. In addition, the APB's
prescribed statement format included two income figures: net income from operations and net income from
operations plus extraordinary items
● APB suggested statement format included : net income from operations and net income from operations plus
extraordinary items
● APB Opinion No. 9 required preparers of financial statements to determine whether revenues and expenses
and gains and losses were properly classified as normal recurring items, extraordinary items, or prior period
adjustments according to established criteria.
● Separating the income statement into net income from operations and net income after extraordinary items
allowed the disclosure of most items of revenue and expense and gains and losses on the income statement
during any period, hence the users can evaluate the results of normal operations or total income according to
their needs.
● The SEC requires all companies to provide three-year comparative income statements and two-year
comparative balance sheets.
Income from Continuing Operations

● Recurring Items of Income

● Income from continuing operations are the company’s normal
and recurring revenues and expenses. It is represents the
amount expected to recur in the future, often referred to as
the company's sustainable income.
● Sustainable income is the amount investors should use as a
starting point to predict future earnings
 Discontinued Operations

Nonrecurring Items of Income

Extraordinary Items

Discontinued Operations Accounting Changes

A discontinued operation is a component that has either been disposed of or is classified as held for sale, and:

○ Represents a separate major line of business or major geographical area of operations,

○ Is part of a single,coordinated plan to dispose of a separate major line of business or geographical area of
operations, or

○ Is a subsidary acquired exclusively with a view to resell.

The additional criteria to identify disposed segments of a business. It required the separate presentation of

(1) the results of operations of the disposed segment and

(2) gain or loss on the sale of assets for disposed segments including any operating gains or losses during the disposal
period.

Total Gain/Loss on Disposing segments of business = gains or losses on disposal of segment assets + gains or losses
incurred by the operations of the disposed segment during the period of disposal
Extraordinary Items

APB Opinion No. 9 as events and transactions of material effect that would not
be expected to recur frequently and that would not be considered as recurring
factors in any evaluation of the ordinary operating processes of the business
APB Opinion No. 30, “Reporting the Results of Operations,” extraordinary items
were originally defined as follows:
● Unusual nature. The event or transaction should possess a high degree
of abnormality and be unrelated or only incidentally related to ordinary
activities.
● Infrequency of occurrence. The event or transaction would not
reasonably be expected to recur in the foreseeable future

Problems due to APB opinion No. 30 :

The separation of extraordinary items from other items on the income

statement does not result in a separation of recurring from nonrecurring
items. An item that is infrequent but not unusual is classified as non
operating income in the other gains and losses section of the income
statement. As a result, there is a tendency to increase the variability
of operating income and decrease the predictive ability of earnings
9/11 terrorist attack :
Emerging Issues Task Force (EITF) met to consider the
accounting and reporting issues raised by the terrorist
attacks. Firms suffering from the attacks had requested
guidance from the FASB concerning certain financial
reporting issues.
At its September 21, 2001, meeting, the EITF tentatively
agreed that losses sustained by companies as a result of
attacks should be considered extraordinary
September 28 meeting, the task force decided against
treating losses associated with the attack as extraordinary
because the events were so extensive and pervasive that it
would be impossible to capture them in any one financial
statement line item.
 Accounting Changes

The accounting standard of consistency indicates that similar transactions should be

reported in the same manner each year. Stated differently, management should
choose the set of accounting practices that most correctly presents the resources
and performance of the reporting unit and continue to use those practices each
year.

APB Opinion No. 20, “Accounting Changes” identified three types of accounting
changes and error :
1. Change in an accounting principle. This type of change occurs when an entity
adopts a GAAP that differs from one previously used for reporting purposes.
Examples of such changes are a change from LIFO to FIFO inventory pricing or a
change in depreciation methods.
APB Opinion No. 20 when an accounting principle was changed, it was treated
currently. That is, the company presented its previously issued financial statements
as they were before the change occurred, with the cumulative prior effects of the
change shown as a component of net income for the period in which the change
occurred. This requirement necessitated determining the yearly changes in net
income of all prior periods attributable to changing from one GAAP to another
SFAS No. 154 The application of a different accounting principle to one or more
previously issued financial statements, or to the statement of financial position at
the beginning of the current period, as if that principle had always been used, or a
change to financial statements of prior accounting periods to present the financial
statements of a new reporting entity as if it had existed in those prior years
2. Change in an accounting estimate. These changes result from the necessary consequences of periodic
presentation. That is, financial statement presentation requires estimation of future events, and such estimates
are subject to periodic review. Examples of such changes are the life of depreciable assets and the estimated
collectability of receivables.
Estimated changes are handled prospectively. They require no adjustments to previously issued financial
statements. These changes are accounted for in the period of the change, or if more than one period is
affected, in both the period of change and in the future.
3. Change in a reporting entity. Changes of this type are caused by changes in reporting units, which may be the
result of consolidations, changes in specific subsidiaries, or a change in the number of companies consolidated.
Changes in reporting entities must be disclosed retroactively by restating all financial statements presented as
if the new reporting unit had been in existence at the time the statements were first prepared. That is,
previously issued statements are recast to reflect the results of a change in reporting entity. It should also
indicate the nature of the change and the reason for the change.

Errors. Errors are not viewed as accounting changes; it’s the result of mistakes or oversights such as the use of
incorrect accounting methods or mathematical miscalculations, it’s defined as prior period adjustments.
The following are examples of errors:
● A change from an accounting practice that is not generally acceptable to a practice that is generally acceptable
● Mathematical mistakes
● The failure to accrue or defer revenues and expenses at the end of any accounting period
● The incorrect classification of costs and expenses
 Earning Per Share

Analysts, investors, and creditors often look for some way to condense a firm's
performance into a single figure, some quick and efficient way to compare firms'
performance. It allows users to summarize the firm's performance in a single number.

A company's net income is already net of interest expense (the claims of debt holders). If
the company also has preferred shares outstanding, the claims of these senior securities
(dividends) must be subtracted from net income to determine the company's income
available to common stockholders.

Basic EPS is historical. It measures the performance that actually occurred during the
accounting period from the perspective of a single share of common stock. However,
reporting basic EPS is considered insufficient to meet investor needs because of the
potential impact on EPS of a wide variety of securities issued by corporations.
complicated when a company has convertible securities outstanding, because, in addition
to issuing new shares of common stock, the amount of the company's reported earnings
would also increase. Consequently, the effect of conversion could be either an increase or
decrease in reported EPS because the increase in common shares outstanding might be
 APB Opinion No. 9
When more than one class of common stock is outstanding, or when an outstanding
security has participation dividend rights, or when an outstanding security clearly derives
a major portion of its value from its conversion rights or its common stock characteristics,
such securities should be considered “residual securities” and not “senior securities” for
purposes of computing earnings per share

APB Opinion No. 15, Earnings per Share

a company had either a simple or complex capital structure. A simple capital structure was
composed solely of common stock or other securities whose exercise . Companies with
complex capital structures were required to disclose dual EPS figures: primary EPS and fully
diluted EPS.
Primary EPS was intended to display the most likely dilutive effect of exercise or conversion
on EPS. It included only the dilutive effects of common stock equivalents.
Dual presentation required that EPS be recast
under the assumption that the exercise or
conversion of potentially dilutive securities
(common stock equivalents for primary EPS
and all securities for fully dilutive EPS) had
actually occurred.
 Criticism of APB No. 15
1. being arbitrary, too complex, and illogical. a convertible security was considered a common
stock equivalent if, at issuance, its yield was less than two-thirds of the corporate bond yield.
This requirement did not reflect the likelihood of conversion in a dynamic securities market.
2. Companies with complex capital structures were not required to report basic (undiluted) EPS.
many users contended that basic EPS would be more useful than primary EPS because it
displays what actually occurred. Consistent with these views, a research study indicated that
primary EPS seldom differs from fully diluted EPS

SFAS No 128
● The FASB decided to replace primary EPS with basic EPS, citing the following reasons:
● Basic EPS and diluted EPS data would give users the most factually supportable range of EPS
possibilities.
● Use of a common international EPS statistic is important because of database-oriented
financial analysis and the internationalization of business and capital markets.
● The notion of common stock equivalents does not operate effectively in practice.
● The computation of primary EPS is complex and might not be well understood or consistently
applied.
● Presenting basic EPS would eliminate the criticisms about the arbitrary determination of
whether a security is a common stock equivalent

Requires presentation of EPS by all publicly traded companies issuing common

stock.Companies with a simple capital structure will only report basic earnings per share. All
Diluted EPS
The objective of diluted
EPS To measure a company's pro forma
performance over the reporting period from the
perspective of the common stockholder as if
the exercise or conversion of potentially
dilutive securities had actually occurred.

• Diluted EPS reveals what could happen to EPS if and when dilution occurs.
• Taken together, these two measures provide users with information to project
historical information into the future and to adjust those projections for the
effects of potential dilution.
Diluted EPS
Options and Warrants

Call Options and

Warrants The dilutive effects are reflected in EPS by applying the
treasury stock method. Under this approach, Treasury shares
are presumed to be purchased with the proceeds at the
average market price occurring during the accounting period.

Written Put
Options The dilutive effects of written put options, which require the
reporting entity to repurchase shares of its own stock, are
computed by applying the reverse treasury stock method.
CONVERTIBLE SECURITIES
 The dilutive effects of convertible securities are computed by applying the if-converted method.
 Under the if-converted method,
1. If the company has convertible preferred stock, the preferred dividend applicable to the convertible preferred stock is
not subtracted from net income in the EPS numerator.
2. If the company has convertible debt, the interest expense applicable to the convertible debt net of its tax effect is added
to the numerator. If the convertible debt had been converted, the interest would not have been paid to the creditors.
3. The number of shares that would have been issued upon conversion of the convertible security is added to the
denominator.

CONTINGENTLY ISSUABLE
SHARES
 Contingently issuable shares are shares whose issuance is contingent upon the satisfaction of certain
conditions, such as attaining a certain level of income or market price of the common shares in the future.
 If all necessary conditions have not been met by the end of the reporting period, FASB ASC 260 requires
that contingently issuable shares be included in the computation of diluted EPS based on the number of
shares that would be included, if any, if the reporting period were the end of the contingency period.
Usefulness of EPS
 Objectives of EPS reporting are to provide investors an
indication of :
1 Value of the firm
2 Expected future dividends
 Historical or forecasted?
Authoritative accounting bodies have generally taken the position that
financial information should be based only on historical data
 EPS has been termed a summary indicator
a single item that communicates considerable information about an
enterprise's performance or financial position.
Comprehensive Income

● Comprehensive income

○ the change in equity (net assets) of a business enterprise during

a period from transactions and other events and circumstances
from nonowner sources.
● Other comprehensive income

○ revenues, expenses, gains, and losses included in

comprehensive income but excluded from net income.
 SFAS No 130 - Reporting Comprehensive Income

● Original issues:
1. Should comprehensive income be reported?
2. Should cumulative accounting adjustments be included in
comprehensive income?
3. How should the components of comprehensive income be
classified for disclosure?
4. How should comprehensive income be disclosed
in the financial statements?
5. Should the components of other comprehensive
income be disclosed before or after their related
tax effects?
 Should Cumulative Accounting
Adjustments Be Included?

Include As Part Of
Cumulative Accounting Comprehensive Income
Adjustments

Cumulative
Accounting
Adjustments
How Should the Components of Comprehensive
Income Be Classified for Disclosure?

● Items included in other comprehensive

income are classified based on their nature.
● In reporting comprehensive income,
companies are required to use a gross
disclosure technique for classifications
related to items of other comprehensive
income other than minimum pension
liability adjustments.
Gross disclosure One Statement Approach. It is disclose a separate
technique classification consisting solely of reclassification
adjustments in which all reclassification
adjustments for a period are disclosed.
.

Two Statement Approach. It is as part of the

classification of other comprehensive income to which
those adjustments relate
 One Statement
Approach.

Two Statement
Approach.
 How Should Comprehensive Income be
Disclosed in the Financial Statements?

● Prior to 2011, FASB ASC 220 required

the total for comprehensive income to
be reported in a financial statement that
is displayed with the same prominence
as other financial statements. The
components of other comprehensive
income were allowed to be displayed
below the total for net income in an
income statement, a separate statement
that begins with net income, or a
statement of changes in equity.
Should Components of Other
Comprehensive Income Be Displayed
Before or After Their Related Tax Effects.
 Prior Period Adjustments
● Definition:
A prior period adjustment is the correction
of an accounting error that occurred in the
past and was reported on a prior year’s
financial statement
● Involve adjusting the beginning
retained earnings balance and
reporting the adjustment in either
the statement of stockholders' equity
or a separate statement of retained
earnings.
● The only items of profit and loss that
should be reported as prior period
adjustments were (FASB ASC 250)
○ Correction of an error
○ Adjustments from realization of operating
loss carryforward of purchased subsidiary