Intermediate Accounting, 10th Edition

Kieso, Weygandt, and Warfield

Chapter 4: Income Statement and

Related Information
Prepared by
Krishnan Ranganathan, Angelo State University,
San Angelo, Texas
 Approaches to Measurement in Income
Statement
• Generally, income measurement follows the all-
inclusive approach, recording even irregular items
in income.
• Advocates of a current operating performance
approach emphasize regular and recurring items
only.
• The profession’s modified all-inclusive approach
requires irregular items to be highlighted in the
presentation.

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 The Single Step Income Statement
• This statement presents information in
broad categories.
• Major sections are Revenues, Expenses and
Income Tax Expense.
• The Earnings per Share amount is shown at
the bottom of the statement.
• There is no distinction between operating
and non-operating activities.
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 Single Step Statement

Revenues
Revenues Sales
Other Revenues
- Expenses
Expenses Cost of Goods Sold
Selling & Admn Expenses
= Interest Expense
Income Tax Expense
NET INCOME

Earnings per
Share
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 The Multiple Step Income Statement

• The presentation divides information into

major sections on the statement.
• The statements distinguishes operating from
non-operating activities.
• Continuing operations are shown separately
from irregular items.
• The income tax effects are shown separately
as well.
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 Multiple Step Income Statement
Sales Revenue
Operating
1 less: Cost of Goods Sold
Section less: Selling Expenses
less: Administrative Expenses

Non-Operating Add: Other Revenues and Gains

2 Less: Other Expenses and Losses
Section
3 Income Tax
Discontinued Operations (net of tax)
Irregular Extraordinary Items (net of tax)
4 Cumulative Effect of a Change in
Items
Accounting Principle (net of tax)
5 Earnings per Share
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 Discontinued
Operations:
Presentation

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 Criteria for Discontinued Operations

Discontinued operations refer to the disposal of a

segment.
To qualify:
1 The segment must be a distinct line of business
2 Its assets and operations must be distinguishable
from other assets and operations.
A distinction is made between:
1 the segment’s results of operations and
2 the disposal of the segment’s assets
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 Reporting Discontinued Operations

• There are two important dates in reporting

discontinued operations:
the measurement date and
the disposal date
• The measurement date is when management
commits itself to a plan of segment’s disposal.
• The disposal date is the date of sale of segment.

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 Reporting Discontinued Operations

• The Appendix discusses three reporting cases.

• Case 1: Measurement date and disposal date are
the same (and are within fiscal year.)
• Case 2: Disposal date falls after the measurement
date (but both are within fiscal year)
• Case 3: Disposal date falls after the measurement
date as well as end of the fiscal year.

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 Discontinued Operations: Case 1
• Measurement date: October 1, 2000
• Disposal date: October 1, 2000
• Facts:
Fiscal year: Jan 1 - Dec 31, 2000
Discontinued Operations:
Loss from operations: ($150,000)
(through Oct 1, 2000)
Gain on disposal (Oct 1): $400,000
• Tax Rate: 30%
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 Discontinued Operations: Case 1
1.1.2000 10.1.2000 12.31.2000

Measurement
Date and
Disposal
Date

Loss from operations of Discontinued

segment (through Oct 1): ($150,000)

Gain on disposal,
$400,000.
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 Case 1: Reporting

Income from Continuing Operations (before tax): $XXXX

Income Taxes: ($XXXX)
Income from Continuing Operations (after tax): $XXXX
Discontinued Operations:
Loss from operations (less income tax of $45,000): $(105,000)
Gain on disposal (less income tax of $120,000) : $280,000

Net Income : $XXXX

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 Discontinued Operations: Case 2
• Measurement date: October 1, 2000
• Disposal date: December 1, 2000
• Fiscal year: Jan 1 - Dec 31, 2000
Discontinued Operations:
Loss from operations: ($150,000)
(through Oct 1, 2000)
Loss (Oct 1 - Dec 1) ($50,000)
Gain on disposal (Dec 1): $350,000
• Tax Rate: 30%
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 Discontinued Operations
Year end
1.1.2000 10.1.2000 12.1.2000 12.31.2000

Measurement Disposal
Date Date

Phase out
Period Gain on
disposal:
$350,000

Loss from operations Loss from operations:

Jan 1 - Oct 1: ($150,000) ($50,000)
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 Case 2: Reporting

Income from Continuing Operations (before tax): $XXXX

Income Taxes: ($XXXX)
Income from Continuing Operations (after tax): $XXXX
Discontinued Operations:
Loss from operations (less income tax of $45,000): $(105,000)
Gain on disposal:
Loss of $50,000 and Gain of $350,000
(less income tax of $90,000) : $210,000

Net Income : $XXXX

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 Discontinued Operations: Case 3
• Measurement date: October 1, 2000
• Fiscal year ends: December 31, 2000
• Disposal Date: May 1, 2001
• Discontinued Operations:
Loss from operations (Jan 1 - Sept 30)
($150,000) Loss (Oct 1 - Dec 31)
($400,000) Loss (Jan 1 - May 1, 2001)
($200,000) Gain on disposal (May 1, 2001):
$350,000
• Tax Rate: 30%
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 Discontinued Operations
Year end
1.1.2000 Oct 1, 00 Dec 31, 00 May 1,.01

Extended Disposal
Measurement
Phase out Date:
Date Gain, $350,000
Period

Loss - operations Loss - operations: Loss - operations:

through Sept 30: ($150,000) ($400,000): ($200,000):
Oct 1 - Dec 31. Jan 1 - May 1.
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 Gain / Loss Recognition Rules
Gain or loss When recognized
1 If a loss on disposal is 1 Recognize estimated
expected loss at measurement
date
2 If a gain on disposal is 2 Recognize estimated
expected gain at disposal date
3 If realized gains on 3 Recognize net realized
disposal exceed gains at measurement
estimated realized and date
unrealized losses
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 Case 3: Reporting
Income from Continuing Operations (before tax): $XXXX
Income Taxes: ($XXXX)
Income from Continuing Operations (after tax): $XXXX
Discontinued Operations:
Loss from operations (less income tax of $45,000): $(105,000)
Net Loss on disposal:
Realized loss (Oct 1 - Dec 31) : ($400,000)
Expected loss (Jan 1 - May 1) : ($200,000)
Expected gain on sale of assets: $350,000
less: income tax of $75,000 $(175,000)
Net Income : $XXXX
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 Discontinued Operations:
Extended Phase-out -
Examples (4)

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 Extended Phase Out Example (1)
Oct 1 - Jan 1, 01 Expected Year when
Dec 31 May 1 (Loss) Gain recognized
Realized Estimated on sale of
(Loss) Gain (Loss) Gain assets:
May 1

$400,000 $300,000 $250,000 2000: $400,000

2001: $550,000

Realized gain is recognized at measurement date.

Expected gain is recognized at disposal date.

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 Extended Phase Out Example (2)
Oct 1 - Jan 1, 01 Expected When recognized
Dec 31 May 1 (Loss) Gain
Realized Estimated on sale of
(Loss) Gain (Loss) Gain assets:
May 1

$400,000 ($300,000) $350,000 2000: $400,000

2001: $ 50,000

Realized gain is recognized at measurement date.

Estimated gain is recognized at disposal date.
Note: the realized gain and estimated gain and loss
are not added together.
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 Extended Phase Out Example (3)
Oct 1 - Jan 1, 01 Expected When recognized
Dec 31 May 1 (Loss) Gain
Realized Estimated on sale of
(Loss) Gain (Loss) Gain assets:
May 1

($500,000) ($300,000) $900,000 year: 2001:

$100,000

Gain of $100,000 on disposal is expected.

Recognize gain at disposal date (May 1, 2001).
Note: no part of the gain is realized in 2000.

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 Extended Phase Out Example (4)
Oct 1 - Jan 1, 01 Expected When recognized
Dec 31 May 1 (Loss) Gain
Realized Estimated on sale of
(Loss) Gain (Loss) Gain assets:
May 1

($400,000) ($200,000) $350,000 year 2000:

($250,000).

Loss of $250,000 is expected on disposal of segment.

Recognize at measurement date (Oct 1, 2000)

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 Irregular Items:
Extraordinary Items

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 Extraordinary Items
• Extraordinary items are:
1 nonrecurring material items that
2 differ significantly from typical activities
• Extraordinary items must meet two tests:
1 they must be unusual and
2 they must be infrequent
• The environment in which the business operates
is of primary importance
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 Extraordinary Items: what they are not

• Losses from write-down of receivables

• Gains and losses from exchange or translation of
foreign currency
• Gains and losses from the abandonment of
property used in business
• Effects of strike
• Adjustments or accruals on long term contracts.

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 Extraordinary Items: Exceptions
• Certain events, though not extraordinary, need
special treatment.
1 Gains and losses from discontinued operations
(discussed earlier)
2 Material gains and losses from extinguishment of
debt (to be reported as extraordinary item)

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 Irregular Items:

Cumulative Effect of a Change

in Accounting Principle

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 Change in Accounting Principle
• An accounting change results when:
• a new principle, different from the one in use,
is adopted.
• A change from FIFO to LIFO method in inventory
costing is an example.
• The effect of the change is to be disclosed after
extraordinary items.
• A change in principle is to be distinguished from a
change in estimates.

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 Change in Accounting Principle

Gilbert company buys and places in service an asset

on 1.1.2000. The cost is $100,000. Estimated useful
life is 4 years. Ignore salvage value. Tax rate is 30%.

The company uses the double-declining method of

depreciation in 2000 and 2001. It changes to the
straight-line method in 2002 (1.1.2002.)

Present the effect of the change in accounting principle.

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 Change in Accounting Principle
Year Double-declining Straight line Difference
balance depreciation depreciation
2000 $50,000 $25,000 $25,000
2001 $25,000 $25,000 $ -0-
Net difference $25,000
Presentation Increases net income
Extraordinary Item $XXXX
Cumulative Effect on prior years of
retroactive application of new depreciation
method (net of tax, $7,500) $17,500
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 Changes in Accounting Estimates

• Changes in accounting estimates are

effected in future periods.
• Such changes do not affect prior periods.
• See example next slide.

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 Changes in Accounting Estimates:
Example
On 1.1.2002, Gilbert company (see preceding example
for accounting principle change) revises the useful life
of the asset to be 3 more years (2002, 2003 and 2004).

The salvage value is estimated to be $5,000.

This change involves a revision of initial estimates.

The depreciation method remains straight-line.

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 Changes in Accounting Estimates: Example

Book value (1.1.2002): $50,000

Less: Salvage value ($5,000)
----------
Revised depreciable cost: $45,000

Revised depreciable cost: $45,000

Remaining useful life: 3 years
Annual straight-line depreciation: $15,000
(years 2002, 2003 and 2004)

Note: The changes in useful life and salvage value

do not affect prior periods
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 Earnings per Share
• Earnings per share is probably the most important
business indicator figure.
• It is computed as:
Net Income less Preferred Dividends
Weighted Average of Common Shares Outstanding
• Earnings per share is required to be disclosed on the
income statement for all the major sections.
• Earnings per share is subject to dilution (reduction), if
issue of additional shares is possible in the future.

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 Retained Earnings Statement
• Retained earnings are increased by net income and
decreased by net loss and dividends for the year.
• Corrections of errors in prior period financial
statements are shown as prior period adjustments
to the beginning balance in retained earnings.
• Any part of retained earnings, appropriated for a
specific purpose, is shown as restricted earnings.

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 COPYRIGHT
Copyright © 2001 John Wiley & Sons, Inc. All rights
reserved. Reproduction or translation of this work
beyond that permitted in Section 117 of the 1976
United States Copyright Act without the express
written permission of the copyright owner is unlawful.
Request for further information should be addressed
to the Permissions Department, John Wiley & Sons,
Inc. The purchaser may make back-up copies for
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resale. The Publisher assumes no responsibility for
errors, omissions, or damages, caused by the use of
these programs or from the use of the information
contained herein.

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