Chapter 4 Notes Income Statement Income Statement the report that measures the success of company operations for a given period of time o used to determine profitability investment value creditworthiness o helps investors predict the amounts timing and uncertainty of future cash flows Usefulness of the Income Statement 3 main uses for investors and creditors o 1 Evaluate the past performance of the company revenue and expense comparison indicates performance and how a company compares to others in its industry o 2 Provide a basis for predicting future performance past performance can help predict future performance not 100 sure but analysts can at least look for relevant correlations o 3 Help assess the risk or uncertainty of achieving future cash flows results from continuing operations usually have a greater significance for predicting future cash flows than do results of nonrecurring events Limitations of the Income Statement 1 Companies omit items from the income statement that they cannot measure reliably o some items are prohibited by current practice from being recognized even though they can affect company performance i e brand recognition 2 Income numbers are affected by the accounting methods employed o i e accelerated depreciation vs straight line depreciation accelerated lower income Quality of Earnings Earnings Management the planned timing of revenues expenses gains and losses to smooth out bumps in earnings o mainly used to increase income in the current year at the expense of income in future years o can also be used to decrease earnings in order to increase future income i e cookie jar reserves Quality of Earnings o negatively affected if earnings management distorts the info in a way that makes it less useful Format of the Income Statement Elements of the Income Statement Transaction Approach method used when the income statement summarizes transactions such as revenue expense gain and loss transactions o focuses on the income related activities that occurred during the period Revenues inflows or other enhancements of assets of an entity or settlements of its liabilities during a period from delivering or producing goods rendering services or other activities that constitute the entity s ongoing major or central operations o i e sales fees interest dividends rents etc Expenses outflows or other using up of assets or incurrences of liabilities 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 o i e cost of goods sold depreciation interest rent salaries and wages taxes etc Gains increases in equity net assets from peripheral or incidental transactions of an entity except those that result from revenues or investments by owners o i e sale of investments or plant assets etc Losses decreases in equity net assets from peripheral or incidental transactions of an entity except those that result from expenses or distributions to owners o i e settlement of liabilities write offs of assets due to impairments or casualty etc difference between revenue and gain revenue is part of the company s regular operations a gain is not o same for expenses and losses Intermediate Components of the Income Statement Multiple Step Income Statement when companies present some all of the sections and totals within an income statement o i e breaking down the operating section nonoperating section etc Operating Section a report of the revenues and expenses of the company s principal operations o Sales or Revenue Section subsection presenting sales discounts allowances returns and other related information purpose to arrive at the net amount of sales revenue o Cost of Goods Sold Section subsection that shows the cost of goods that were sold to produce the sales o Selling Expenses subsection that lists expenses resulting from the company s efforts to make sales o Administrative or General Expenses subsection reporting expenses of general administration Nonoperating Section report of revenues and expenses resulting from secondary or auxiliary activities of the company special gains and losses that are infrequent or unusual not both are normally reported in this section o Other Revenues and Gains list of the revenues recognized or gains incurred generally net of related expenses from nonperating transactions o Other Expenses and Losses a list of the expenses or losses incurred generally net of any related incomes from nonoperating transactions Income Tax a section reporting federal and state taxes levied on income from continuing operations Discontinued Operations material gains or losses resulting from the disposition of a component of the business Extraordinary Items unusual and infrequent material gains and losses Noncontrolling Interest allocation of income to noncontrolling shareholders Earnings Per Share Condensed Income Statements example sometimes it is impossible for a company to present all desired expense detail o solution company includes only the totals of expense groups in the income statement o supplementary schedules are prepared to support the totals Single Step Income Statements Single Step Income Statement o consists of just 2 groupings revenues and expenses revenues expenses net income loss income tax is sometimes reported as the last item before net income to show relationship between that and income before income tax o primary advantage lies in its simple presentation no implication that one type of revenue or expense item has priority over another Reporting Various Income Items FASB developed specific guidelines for 2 important areas o what to include in income o how to report certain unusual or irregular events What should be included in income income reporting practices need to be consistent and comparable o Current Operating Performance Approach argues that most useful income measure reflects only regular and reoccurring revenue and expense elements irregular items do not reflect a company s future earning power o others say that focusing only on income can miss out on important info about a company s performance any gain or loss is relevant determining what is irregular or unusual is subjective Modified All Inclusive Concept o adopted by the accounting profession o most items including unusual or irregular ones are part of net income companies are required to highlight unusual or irregular items in the financial statements fall into 4 categories