Intermediate Accounting

Seventeenth Edition

Kieso ● Weygandt ● Warfield

Chapter 4
Income Statement and
Related Information
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Learning Objectives
After studying this chapter, you should be able to:
1. Identify the uses and limitations of an income
statement.
2. Describe the content and format of the income
statement.
3. Discuss how to report various income items.
4. Explain the reporting of accounting changes and errors.
5. Describe related stockholders’ equity statements.

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Preview of Chapter 4 (1 of 5)
Income Statement and Related Information
Income Statement
• Usefulness
• Limitations
• Quality of earnings

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Preview of Chapter 4 (2 of 5)
Income Statement and Related Information
Content and Format of the Income Statement
• Elements
• Intermediate components
• Condensed income statements
• Single-step income statements

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Preview of Chapter 4 (3 of 5)
Income Statement and Related Information
Reporting Various Income Items
• Unusual and infrequent gains and losses
• Discontinued operations
• Noncontrolling interest in income
• Earnings per share
• Summary

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Preview of Chapter 4 (4 of 5)
Income Statement and Related Information
Accounting Changes and Errors
• Changes in accounting principle
• Change in accounting estimates
• Corrections of errors
• Summary

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Preview of Chapter 4 (5 of 5)
Income Statement and Related Information
Related Stockholders’ Equity Statements
• Retained earnings statement
• Comprehensive income
• Statement of stockholders’ equity
• Balance sheet presentation

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Learning Objective 1
Identify the Uses and Limitations of an
Income Statement

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 Income Statement

Usefulness

• Evaluate past performance of the company

• Provide a basis for predicting future performance
• Help assess the risk or uncertainty of achieving
future cash flows

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 Income Statement

Limitations

• Companies omit items they cannot measure reliably

• Income is affected by the accounting methods
employed
• Income measurement involves judgment

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 Income Statement
Quality of Earnings
Companies have incentives to manage income to meet or
beat Wall Street expectations, so that
• market price of stock increases and
• value of management’s stock compensation
packages.

Quality of earnings is reduced if earnings management

results in information that is less useful for predicting
future earnings and cash flows.
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Learning Objective 2
Describe the Content and Format of the
Income Statement

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 Content and Format of the Income
Statement
Elements of the Income Statement (Revenues)
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.
Examples include sales, fees, interest, dividends, and
rents.

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 Elements of the Income Statement
(Expenses)

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.
Examples include cost of goods sold, depreciation,
interest, rent, salaries and wages, and taxes.

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 Elements of the Income Statement
(Gains and Losses)

Gains – Increases in equity (net assets) from peripheral or

incidental transactions of an entity except those that
result from revenues or investments by owners.
Losses – Decreases in equity (net assets) from peripheral
or incidental transactions of an entity except those that
result from expenses or distributions to owners.
Gains and losses result from the sale of investments or
plant assets, settlement of liabilities, and write-offs of
assets due to impairments or casualty.
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 Intermediate Components of the
Income Statement
Multiple-Step Income Statement
• Separates operating transactions from nonoperating
transactions
• Matches costs and expenses with related revenues
• Highlights certain components of income that
analysts use assessing financial performance

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 Intermediate Components
Common to present some or all of the following sections
and totals within the income statement.
1. Operating section
2. Nonoperating section
3. Income tax
4. Discontinued operations
5. Noncontrolling interest
6. Earnings per share

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 Multiple-Step
CABRERA COMPANY
Income Statement
For The Year Ended December 31, 2020

1. Operating Section

2. Nonoperating
Section

3. Income tax
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 Condensed Income Statements

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 Single-Step Income
Statements
Revenues
Single-
Expenses Step
Net Income

No implication that one

type of revenue or
expense item has priority
over another.

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 P. Bride Company
Income Statement Income Statement
For the Year Ended December 31, 2020
Exercise E4.5: Prepare a income
Sales revenue $96,500
statement from the data below using Cost of goods sold 60,570
the multiple-step form. Gross profit 35,930
Operating expenses:
Administrative expense Selling expense 17,150
Officers’ salaries $4,900 Administrative expense 8,860
Depreciation 3,960 Total operating expenses 26,010
Cost of goods sold 60,570 Income from operations 9,920
Other revenue (expense):
Rent revenue 17,230
Rent revenue 17,230
Selling expense Interest expense (1,860)
Delivery expense 2,690 Total other 15,370
Sales commissions 7,980 Income before tax 25,290
Depreciation 6,480 Income tax 9,070
Sales revenue 96,500 Net income $16,220
Income tax 9,070
Interest expense 1,860

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 Format of the Income Statement
Review Question

A separation of operating and non operating activities of a

company exists in
a. both a multiple-step and single-step income statement.
b. a multiple-step but not a single-step income statement.
c. a single-step but not a multiple-step income statement.
d. neither a single-step nor a multiple-step income
statement.

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 Format of the Income Statement
Review Question Answer

A separation of operating and non operating activities of a

company exists in
a. both a multiple-step and single-step income statement.
b. a multiple-step but not a single-step income statement.
c. a single-step but not a multiple-step income statement.
d. neither a single-step nor a multiple-step income
statement.

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Learning Objective 3
Discuss How to Report Various Income
Items

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 Reporting Various Income Items
Companies are required to report additional items as part
of net income so users can better determine the long-run
earning power of the company.
These income items fall into four general categories:
1. Unusual and infrequent gains and losses
2. Discontinued operations Modified all
inclusive concept
3. Noncontrolling interest
4. Earnings per share

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 Reporting Various Income Items
Unusual and Infrequent Gains and Losses

a. Unusual. High degree of abnormality and of a type

clearly unrelated to, or only incidentally related to, the
ordinary and typical activities of the company, taking
into account the environment in which it operates.
b. Infrequency of occurrence. Type of transaction that is
not reasonably expected to recur in the foreseeable
future, taking into account the environment in which
the company operates.

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 Unusual and Infrequent Gains and
Losses (1 of 3)
Common types of unusual or infrequent gains and losses:
• Losses on write-down (impairment) of receivables;
inventories; property, plant, and equipment; goodwill
or other intangible assets
• Restructuring charges
• Gains and losses from sale or abandonment of
property, plant and equipment
• Effects of a strike
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 Unusual and Infrequent Gains and
Losses (2 of 3)
Common types of unusual or infrequent gains and losses:
• Gains and losses on extinguishment (redemption) of
debt obligations.
• Gains and losses related to casualties such as fires,
floods, and earthquakes.
• Gains or losses on sale of investment securities.

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 Unusual and Infrequent Gains and
Losses (3 of 3)
Number of unusual items reported in a recent year by 500 large companies.

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 Reporting Various Income Items
Discontinued Operations

Occurs when two things happen:

1. A company eliminates the results of operations of a
component of the business.
2. The elimination of a component that represents a
strategic shift, having a major effect on the
company’s operations and financial results.
Amounts are reported “net of tax.”

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 Discontinued Operations Illustration 1
Illustration: Multiplex Products Inc., a highly diversified company,
decides to discontinue its electronics division. During the current
year, the electronics division lost $300,000 (net of tax). Multiplex
Products sold the division at the end of the year at a loss of
$500,000 (net of tax). Multiplex determines that the electronics
division discontinuation meets the strategic shift criteria because
the division is a major line of business (its assets exceed 20 percent
of Multiplex’s total assets).

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 Discontinued Operations Illustration 2
Illustration: The following illustration shows how the discontinued
operations would be reported on the income statement for
Multiplex Products.
Income from continuing operations $20,000,000
Discontinued operations:
Loss from operation of discontinued electronics
division (net of tax) 300,000
Loss from disposal of electronics division (net of tax) 500,000
Total loss on discontinued operations 800,000
Net income $19,200,000

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 Discontinued
Operations
Discontinued
Operations are
reported after
“Income from
continuing
operations.”
Without any
discontinued
operations, “Income
from continuing
operations” would
be “net income.”
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 Discontinued Operations

Intraperiod Tax Allocation

• Allocation of tax within a period

• Helps users understand impact of income taxes on
various components of net income
• Intraperiod tax allocation is used for:
1. income from continuing operations
2. discontinued operations

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 Discontinued Operations
Discontinued Operations (Gain)

Illustration: Schindler Co. has income before income tax of

$250,000. It has a gain of $100,000 from a discontinued
operation. Assuming a 30 percent income tax rate, Schindler
presents the following information on the income statement.

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 Discontinued Operations
Discontinued Operations (Loss)

Illustration: Schindler Co. has income before income tax of

$250,000. It suffers a loss from discontinued operations of
$100,000. Assuming a 30 percent tax rate, Schindler presents
the income tax on the income statement as shown

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 Reporting Various Income Items
Noncontrolling Interest in Income

When a company owns substantial interests (generally

greater than 50%) in another company, GAAP generally
require that the financial statements of both companies
be consolidated together into one set of financials.
Noncontrolling interest is the portion of equity (net
assets) interest in a subsidiary not attributable to the
parent company.

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 Noncontrolling Interest in Income
Illustration: Assume that Coca-Cola acquires 70 percent of the
outstanding stock of Koch Company. Because Coca-Cola owns
more than 50 percent of Koch, it consolidates Koch’s financial
results with its own. GAAP requires that net income be
allocated to the controlling and noncontrolling interest.

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 Reporting Various Income Items
Earnings per Share

Net Income - Preferred Dividends

Weighted Average of Common Shares Outstanding

• A significant business indicator

• Measures the dollars earned by each share of
common stock
• Must be disclosed on the income statement

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 Earnings per Share Illustration
Illustration: Lancer, Inc. reports net income of $350,000. It
declares and pays preferred dividends of $50,000 for the year.
The weighted-average number of common shares outstanding
during the year is 100,000 shares. Lancer computes earnings
per share as follows:
Net Income - Preferred Dividends
Weighted Average of Common Shares Outstanding

$350,000 - $50,000
= $3.00 per share
100,000

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 Earnings per Share

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Learning Objective 4
Explain the Reporting of Accounting
Changes and Errors

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 Accounting Changes and Errors
Changes in Accounting Principle
• Retrospective adjustment
• Cumulative effect adjustment to beginning retained
earnings
• Approach preserves comparability across years
• Examples include:
 change from FIFO to average-cost
 change from percentage-of-completion to
completed-contract method
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 Changes in Accounting Principle Illustration 1
Illustration: Gaubert Inc. decided in March 2020 to change from
FIFO to weighted-average inventory pricing. Gaubert’s income
before taxes, using the new weighted-average method in 2020, is
$30,000. This illustration presents the pretax income data for
2018 and 2019 for this example.

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 Changes in Accounting Principle Illustration 2
Illustration: Gaubert Inc. decided in March 2020 to change from
FIFO to weighted-average inventory pricing. Gaubert’s income
before taxes, using the new weighted-average method in 2020, is
$30,000. This illustration shows the information Gaubert
presented in its comparative income statements, based on a 30
percent tax rate.

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 Accounting Changes and Errors
Change in Accounting Estimates

• Accounted for in period of change or period of

change and future periods if change affects both
• Not handled retrospectively, not considered an error
• Examples include:
 Useful lives and salvage values of depreciable
assets
 Allowance for uncollectible receivables
 Inventory obsolescence
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 Change in Accounting Estimate (1 of 3)
Illustration: Arcadia HS, purchased equipment for $510,000
which was estimated to have a useful life of 10 years with a
salvage value of $10,000 at the end of that time. Depreciation
has been recorded for 7 years on a straight-line basis. In 2020
(year 8), it is determined that the total estimated life should
be 15 years with a salvage value of $5,000 at the end of that
time.
Questions:
• What is the entry to correct prior years’ depreciation?
• Calculate the depreciation expense for 2020.

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 Change in Accounting Estimate (2 of 3)
Calculation of depreciation for first 7 years.
Equipment cost $510,000
Salvage value − 10,000
Depreciable base 500,000
Useful life (original) ÷ 10 years
Annual depreciation $ 50,000
× 7 years = $350,000

After 7 Balance Sheet (December 31, 2019)

years Fixed Assets:
Equipment $510,000
Accumulated depreciation 350,000
Net book value (NBV) $160,000

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 Change in Accounting Estimate (3 of 3)
Calculate depreciation expense for 2020 and remaining years.
Net book value $160,000
Salvage value (revised) − 5,000
Depreciable base 155,000
Useful life ÷ 8 years
Annual expense $ 19,375

Journal entry for 2020 and remaining years.

Depreciation Expense 19,375
Accumulated Depreciation 19,375

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 Accounting Errors
Corrections of Errors

• Result from:
 mathematical mistakes
 mistakes in application of accounting principles
 oversight or misuse of facts
• Corrections treated as prior period adjustments
• Adjustment to the beginning balance of retained
earnings

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 Accounting Errors
Illustration: In 2021, Hillsboro Co. determined that it
incorrectly overstated its accounts receivable and sales
revenue by $100,000 in 2020. In 2021, Hillboro makes the
following entry to correct for this error (ignore income taxes).

Retained Earnings 100,000

Accounts Receivable 100,000

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 Accounting Changes and Errors
Summary: Changes in Accounting Principle

Placement on
Type of Situation Criteria Examples Income Statement
Changes in Change from Change in the basis of Recast prior years'
accounting one generally inventory pricing from income statement
principle accepted FIFO to average-cost. on the same basis
accounting as the newly
principle to adopted principle.
another. (Shown net of tax.)

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 Accounting Changes and Errors
Summary: Changes in Estimates

Placement on
Type of Situation Criteria Examples Income Statement
Changes in Normal, Changes in the Show change only
estimates recurring realizability of in the affected
corrections receivables and accounts in current
and inventories; changes in and future periods.
adjustments. estimated lives of (Not shown net of
equipment, intangible tax.)
assets; changes in
estimated liability for
warranty costs, income
taxes, and salary
payments.

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 Accounting Changes and Errors
Summary: Corrections of Errors

Placement on
Type of Situation Criteria Examples Income Statement
Corrections of Mistake, Error in reporting Treat as prior
errors misuse of income and expenses. period adjustment;
facts. restate prior years'
income statements
to correct for error.
(Shown net of tax.)

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Learning Objective 5
Describe Related Stockholders’ Equity
Statements

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 Retained Earnings Statement (1 of 3)
Increase
• Net income
• Change in accounting principle
• Prior period adjustments
Decrease
• Net loss
• Dividends
• Change in accounting principles
• Prior period adjustments
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 Retained Earnings Statement (2 of 3)
Woods, Inc.
Statement of Retained Earnings
For the Year Ended December 31, 2020
Balance, January 1 $ 1,050,000
Net income 360,000
Dividends (300,000)
Balance, December 31 $ 1,110,000

Before issuing the report for the year ended December 31, 2020, you
discover a $50,000 error (net of tax) that caused 2019 inventory to be
overstated (overstated inventory caused COGS to be lower and thus net
income to be higher in 2019). Would this discovery have any impact on the
reporting of the Statement of Retained Earnings for 2020?

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 Retained Earnings Statement (3 of 3)
Woods, Inc.
Statement of Retained Earnings
For the Year Ended December 31, 2020
Balance, January 1 $ 1,050,000
Prior period adjustment - error correction (50,000)
Balance, January 1 (restated) 1,000,000
Net income 360,000
Dividends (300,000)
Balance, December 31 $ 1,060,000

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 Retained Earnings Statement

Restrictions on Retained Earnings

Disclosed
• In notes to the financial statements
• As Appropriated Retained Earnings

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 Comprehensive Income

All changes in equity during a period except those resulting from

investments by owners and distributions to owners.

Includes:
• all revenues and gains, expenses and losses reported
in net income, and
• all gains and losses that bypass net income but affect
stockholders’ equity

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 Comprehensive Income
Net Income Other Comprehensive
+ Income
Income Statement (in thousands)
Sales $285,000
Cost of goods sold 149,000 • Unrealized gains and
Gross profit 136,000 losses on available-for-
Operating expenses:
Selling expenses 10,000 sale securities
Administrative expenses 43,000
Total operating expense 53,000 • Translation gains and
Income from operations 83,000 losses on foreign
Other revenue (expense):
Interest revenue 17,000 currency
Interest expense (21,000)
Total other (4,000) • Plus others
Income before taxes 79,000
Income tax expense 24,000
Net income $ 55,000 Reported in
Stockholders’ Equity

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 Comprehensive Income
Review Question

Gains and losses that bypass net income but affect

stockholders' equity are referred to as
a. comprehensive income.
b. other comprehensive income.
c. prior period income.
d. unusual gains and losses.

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 Comprehensive Income
Review Question Answer

Gains and losses that bypass net income but affect

stockholders' equity are referred to as
a. comprehensive income.
b. other comprehensive income.
c. prior period income.
d. unusual gains and losses.

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 Comprehensive Income

Companies must display the components of other comprehensive income

in one of two ways:

1. a single continuous statement (one statement

approach) or
2. two separate, but consecutive statements of net
income and other comprehensive income (two
statement approach).

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 Comprehensive Income
One Statement Approach

Advantage - does
not require the
creation of a new
financial statement.
Disadvantage - net
income buried as a
subtotal on the
statement.

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 Comprehensive Income
Two Statement
Approach

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 Statement of Stockholders’ Equity
• Reports changes in each stockholders’ equity account
and total equity for the period
• Following items are disclosed in the statement:
 Contributions (issuances of shares) and
distributions (dividends) to owners
 Reconciliation of carrying amount of each
component of stockholders’ equity from
beginning to end of period

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 Statement of Stockholders’ Equity (chart)

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 Statement of Stockholders’ Equity
Balance Sheet Presentation

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Learning Objective 6
Compare the Accounting Procedures
for Income Reporting Under GAAP and
IFRS

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 IFRS Insights (1 of 4)
Relevant Facts
Similarities
• Both GAAP and IFRS require companies to indicate the amount of net
income attributable to noncontrolling interest.
• With the recent FASB Accounting Standards Update, under both IFRS
and GAAP, unusual and infrequent income items are reported in
Income before income taxes (i.e., not an extraordinary item treatment,
with reporting similar to discontinued operations).
• Both GAAP and IFRS follow the same presentation guidelines for
discontinued operations, but IFRS defines a discontinued operation
more narrowly. Both standard-setters have indicated a willingness to
develop a similar definition to be used in the joint project on financial
statement presentation.

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 IFRS Insights (2 of 4)
Relevant Facts
Similarities
• Both GAAP and IFRS have items that are recognized in equity as part of
comprehensive income but do not affect net income. Both GAAP and IF
RS allow a one statement or two statement approach to preparing the
statement of comprehensive income.
Differences
• Presentation of the income statement under GAAP follows either a
single-step or multiple-step format. IFRS does not mention a single-
step or multiple-step approach.
• Under IFRS, companies must classify expenses by either nature or
function. GAAP does not have that requirement, but the SEC requires a
functional presentation.

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 IFRS Insights (3 of 4)
Relevant Facts
Differences
• IFRS identifies certain minimum items that should be presented on the
income statement. GAAP has no minimum information requirements.
However, the SEC rules have more rigorous presentation requirements.
• IFRS does not define key measures like income from operations. SEC
regulations define many key measures and provide requirements and
limitations on companies reporting non-GAAP/IFRS information.
• Under IFRS, revaluation of property, plant, and equipment, and
intangible assets is permitted, with gains reported as other
comprehensive income. The effect of this difference is that application
of IFRS results in more transactions affecting equity but not net
income.

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 IFRS Insights (4 of 4)
On The Horizon
The IASB and FASB have worked on a project that would restructure the
financial statements. One stage of this project will address the issue of
how to classify various items in the income statement. A main goal of this
new approach is to provide information that better represents how
businesses are run, that is, an idea to require comprehensive income be
reported in a combined statement of comprehensive income. This
approach draws attention away from just one number—net income. This
broad project is on hold; both Boards are working on separate, narrower
projects in response to non-GAAP reporting.

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Copyright
Copyright © 2019 John Wiley & Sons, Inc.
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from the use of the information contained herein.

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