The Income Statement,

and Comprehensive
Income.
 LEARNING OBJECTIVES
1. Discuss the importance of income from continuing operations and describe its
components.
2. Describe earnings quality and how it is impacted by management practices to
manipulate earnings.
3. Discuss the components of operating and non-operating income and their
relationship to earnings quality.
4. Define what constitutes discontinued operations and describe the appropriate
income statement presentation for these transactions.
5. Define extraordinary items and describe the appropriate income statement
presentation for these transactions.
6. Define earnings per share (EPS) and explain required disclosures of EPS for
certain income statement components.
7. Explain the difference between net income and comprehensive income and
how we report components of the difference.
NOT COVERED
8. Describe the purpose of the statement of cash flows.
9. Identify and describe the various classifications of cash flows presented in a
| statement of cash flows.
10. Discuss the primary differences between U.S. GAAP and IFRS with respect
to the income statement.
 An income
statement for a
hypothetical
manufacturing
company that you
can refer to as we
proceed through
the chapter.
 4-4

Income
Income from
from Continuing
Continuing Operations
Operations

Revenues Expenses Gains and Income Tax

Losses Expense
Inflows of Outflows of
resources resources Increases or Because of
resulting incurred in decreases in its
from generating equity from importance
providing revenues. peripheral or and size,
goods or incidental income tax
services to transactions expense is a
customers. of an entity. separate
item.
 4-5

Operating versus Nonoperating Income

Operating Nonoperating
Income Income

Includes revenues Includes certain

and expenses gains and losses
directly related to and revenues and
the principal expenses related
revenue- to peripheral or
generating incidental
activities of the activities of the
company company
 4-6

Income Stmt. (Single-Step) NOT COVERED

Proper Heading

Revenues
& Gains

Expenses
& Losses
 4-7

Income Statement (Multiple-Step)

Proper
Heading
Gross
Profit

Operating
Expenses

Non-
operating
Items
 4-8

U. S. GAAP vs. IFRS

There are more similarities than differences between
income statements prepared according to U.S. GAAP
and those prepared applying IFRS.
Some differences are highlighted below.

 Has no minimum requirements.  Specifies certain minimum information

 SEC requires that expenses be classified
by function.
 “Bottom line” called net income or net
loss.
 Report extraordinary items separately.
to be reported on the face of the income
statement.
 Allows expenses classified by function
or natural description.
 “Bottom line” called profit or loss.
 Prohibits reporting extraordinary items.
 4-9

Earnings Quality

Earnings quality refers to the ability of

reported earnings to predict
a company’s future earnings.

Transitory Earnings
versus
Permanent Earnings
 4-10

Manipulating Income and

Income Smoothing

“Most executives prefer to report earnings

that follow a smooth, regular, upward path.”
~Ford S. Worthy, “Manipulating Profits: How It’s Done,” Fortune

Two ways to manipulate

income:
1. Income shifting
2. Income statement
classification
 4-11

Operating Income and Earnings Quality

Costs associated with shutdown or
relocation of facilities or
Restructuring Costs downsizing of operations are
recognized in the period incurred.

Goodwill Impairment
Involves asset impairment losses
and Long-lived Asset or charges.
Impairment
 4-12

Nonoperating Income and

Earnings Quality

Gains and losses generated from the sale of

investments often can significantly inflate or
deflate current earnings.

Example How should those

As the stock market boom reached gains be interpreted
its height late in the year 2000, in terms of their
many companies recorded large relationship to
gains from sale of investments future earnings?
that had appreciated significantly Are they transitory
in value. or permanent?
 4-13

Separately Reported Items

Reported separately, net of taxes:

Discontinued Extraordinary
operations items
 4-14

Intraperiod Income Tax Allocation

Income
Income Tax
Tax Expense
Expense must
must be
be associated
associated with
with
each
each component
component of
of income
income that
that causes
causes it.
it.

Show
ShowIncome
IncomeTaxTax Report
Reporteffects
effectsof
of
Expense
Expenserelated
relatedto
to Discontinued
DiscontinuedOperations
Operationsandand
Income
Incomefrom
fromContinuing
Continuing Extraordinary
ExtraordinaryItems
Itemsnet
netof
of
Operations.
Operations. related
relatedincome
incometax
taxeffect.
effect.
 4-15

Extraordinary Items

An extraordinary item is a material event

or transaction that is both:
1.Unusual in nature, and
2.Infrequent in occurrence
Extraordinary items are reported net of
related taxes
 4-16

U. S. GAAP vs. IFRS

The scarcity of extraordinary gains and losses reported in

corporate income statements and the desire to converge
U.S. and international accounting standards could guide
the FASB to the elimination of the extraordinary item
classification.

 Report extraordinary items  Prohibits reporting

separately in the income statement. extraordinary items in the
income statement or notes.
 4-17

Unusual or Infrequent Items

Items that are material and are

either unusual or infrequent—but not
both—are included as separate
items in continuing operations.
 4-18

Discontinued Operations
As part of the continuing process to converge U.S. GAAP and
international standards, the FASB and IASB have been
working together to develop a common definition and a
common set of disclosures for discontinued operations.

The proposed ASU defines a discontinued operation as a

“component” that either (a) has been disposed of or (b) is
classified as held for sale, and represents one of the following:
1.a separate major line of business or major geographical area of
operations,
2.part of a single coordinated plan to dispose of a separate major
line of business or geographical area of operations, or
3.a business that meets the criteria to be classified as held for sale
on acquisition.
 4-19

Reporting Discontinued Operations

Reporting for Components Sold
Income or loss from
operations of the Gain or loss on the
component from the
disposal of the
beginning of the
component’s assets.
reporting period to the
disposal date.

Reporting for Components Held For Sale

Income or loss from
An “impairment loss”
operations of the
if the carrying value of
component from the
the assets of the
beginning of the
component is more
reporting period to the
than the fair value
end of the reporting
minus cost to sell.
period.
 4-20

Earnings Per Share Disclosure

One of the most widely used ratios is earnings per
share (EPS), which shows the amount of income
earned by a company expressed on a per share basis.

Basic EPS Diluted EPS

Reflects the potential dilution that could

Net income less preferred dividends
Weighted-average number of
common shares outstanding for the
period
occur for companies that have certain
securities outstanding that are convertible
into common shares or stock options that
could create additional common shares if
the options were exercised.
 4-21

Earnings Per Share Disclosure

Report EPS data separately for:

1. Income or Loss from Continuing
Operations
2. Separately Reported Items
a) discontinued operations
b) extraordinary Items
3. Net Income or Loss
 4-22

Comprehensive Income

An expanded
version of income
that includes four
types of gains and
losses that
traditionally have
not been included
in income
statements.
 4-23

Other Comprehensive Income (OCI)

Comprehensive income includes traditional net income
as well as four additional gains and losses that change
shareholders’ equity.
1. Changes in the market value of certain investments (described in chapter 12).
2. Gains and losses due to revising assumptions or market returns differing from
expectations and prior service cost from amending the plan (described in
chapter 17).
3. When a derivative designated as a cash flow hedge is adjusted to fair value,
the gain or loss is deferred as a component of comprehensive income and
included in earnings later, at the same time as earnings are affected by the
hedged transaction (described in the Derivatives Appendix to the text).
4. Gains or losses from changes in foreign currency exchange rates. The amount
could be an addition to or reduction in shareholders’ equity. (This item is
discussed elsewhere in your accounting curriculum).
 4-24

Other Comprehensive Income

($ in millions)
Net income $xxx
Other comprehensive income:
Net unrealized holding gains (losses) on investments (net of tax)* $x
Gains (losses) from and amendments to postretirement benefit plans (net of
tax)† (x)
Deferred gains (losses) from derivatives (net of tax)‡ (x)
Gains (losses) from foreign currency translation (net of tax)§ x xx
Comprehensive income $xxx

*Changes in the market value of certain investments (described in Chapter 12).

†
Gains and losses due to revising assumptions or market returns differing from expectations and prior service
cost from amending the plan (described in Chapter 17).
‡
When a derivative designated as a cash flow hedge is adjusted to fair value, the gain or loss is deferred as a
component of comprehensive income and included in earnings later, at the same time as earnings are affected
by the hedged transaction (described in the Derivatives Appendix to the text).
§
Gains or losses from changes in foreign currency exchange rates. The amount could be an addition to or
reduction in shareholders’ equity. (This item is discussed elsewhere in your accounting curriculum.)
 4-25

U. S. GAAP vs. IFRS

Both U.S. GAAP and IFRS allow companies to report

comprehensive income in either a single statement of
comprehensive income or in two separate statements. Other
comprehensive income items are similar under the two sets
of standards.

 Includes four possible Other  Includes same four.

Comprehensive Income items.
 Includes a fifth possible item,
changes in revaluation surplus,
from the optional revaluation of
property, plant, and equipment and
intangible assets.
 4-26

Accumulated Other Comprehensive

Income
In
Inaddition
additionto
toreporting
reportingcomprehensive
comprehensiveincome
incomethat
that
occurs
occursin inthe
thecurrent
currentperiod,
period, we
wemust
mustalso
alsoreport
reportthese
these
amounts
amountson onaacumulative
cumulativebasis
basisininthe
thebalance
balancesheet
sheetasas
an
anadditional
additional component
componentof ofshareholders’
shareholders’ equity.
equity.
ASTRO-MED INC.
Consolidated Balance Sheets (in part)
Years ended January 31
($ in thousands) 2011 2010
Shareholders’ equity:
Common stock 433 416
Additional paid-in capital 36,586 34,713
Retained earnings 26,843 26,817
Accumulated other comprehensive income 266 317
Treasury stock (9,840) (8,030)
Total shareholders’ equity $54,288 $54,233
 4-27

What information does an IS provide?

 TR: Product 1, 2 , 3
 TE
 Various Profits
 Gains/loss
 EPS
Operating Performance:
Ability to generate Revenues
Ability to reduce Expenses
Ability to make profits
 4-28

IS
 Statement of Financial Performance
 R>E
 TP Increase
 4-29

Study the balance sheet and IS of

i)Manufacturing firms
ii)Banks
iii)Insurance Companies
iv)Mutual funds

 identify their main A, L and OE

Identify their R, Expenses, gains and losses