Income Statement and Related

Information

4-1
 Income Statement

Usefulness
 Evaluate past performance.

 Predicting future performance.

 Help assess the risk or uncertainty of

achieving future cash flows.

4-2 2
 Income Statement

Limitations
 Companies omit items that cannot be
measured reliably.

 Income numbers are 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 earnings targets or
 to make earnings look less risky.

Earnings management is the planned timing of revenues, expenses,

gains, and losses to smooth out earnings.

Quality of earnings is reduced if earnings management results in

information that is less useful for predicting future earnings and cash
flows.

4-4 4
 Content and Format of the Income
Statement

Elements of the Income Statement

Income – Increases in economic benefits during the accounting
period in the form of
• inflows or enhancements of assets or
• decreases of liabilities
that result in increases in equity, other than those relating to
contributions from shareholders.

4-5 5
 Elements of the Income Statement

Income includes both revenues and gains.

 Revenues - ordinary activities of a company
 Gains - may or may not arise from ordinary activities.
Revenue Accounts Gain Accounts
 Sales  Gains on the sale of long-
 Fee term assets
  Unrealized gains on trading
Interest
 securities
Dividend Income
 Rent

4-6 6
 Elements of the Income Statement

Expenses represent decreases in economic benefits during the

accounting period in the form of
 outflows or depletions of assets or
 incurrences of liabilities
that result in decreases in equity, other than those relating to
distributions to shareholders.

4-7 7
 Elements of the Income Statement

Expenses include both expenses and losses.

 Expenses - ordinary activities of a company
 Losses - may or may not arise from ordinary activities.
Expense Accounts Loss Accounts
 Cost of goods sold  Losses on restructuring
 Depreciation charges
  Losses on to sale of long-term
Interest
 Rent Salary and assets
 Unrealized losses on trading
wages
 Taxes securities

4-8 8
 Income 1. Sales or Revenue
2. Cost of Goods Sold
Statement
Gross Profit
3. Selling Expenses
Intermediate
4. Administrative or General Expenses
Components
5. Other Income and Expense
Companies generally Income from Operations
present some or all of 6. Financing costs
these sections and totals Income before Income Tax
within the income
7. Income Tax
statement.
Income from Continuing Operations
8. Discontinued Operations
Net Income
9. Non-Controlling Interest
10. Earnings Per Share
4-9
 Format of the
Income Statement 1

Includes all of the

major items in
previous list, except
4

for discontinued
operations.

ILLUSTRATION 4.2 9
Income Statement 10
4-10
 Condensed
Income Statement

More representative of the

type found in practice.

ILLUSTRATION 4.3
Condensed Income
Statement

Company prepares
supplementary
schedules to support the
totals.
ILLUSTRATION 4.4
Sample Supporting
Schedule
4-11
 Reporting Various Income Items

Gross Profit
 Computed by deducting cost of goods sold from net sales.
 Provides a useful number for evaluating performance and
predicting future earnings.

Unusual or incidental revenues are disclosed in other income and

expense.

4-12 12
 Reporting Various Income Items

Income from Operations

 Determined by deducting selling and administrative expenses
as well as other income and expense from gross profit.
 Highlights items that affect regular business activities.
 Used to predict the amount, timing, and uncertainty of future
cash flows.

4-13 13
 Income From Operations
Expense Classification

Nature Function

 Cost of materials used  Employee benefits

 Direct labor incurred  Depreciation expense
 Delivery expense  Amortization expense
 Advertising expense

4-14 14
 Income From Operations
Expense Classification

Nature Function

 Cost of goods sold

 Selling expenses
 Administrative
expenses

4-15 15
 Income From Operations

Expense Classification
Illustration: The firm of Telaris Co. performs audit, tax, and consulting
services. It has the following revenues and expenses.

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 Expense Classification

Nature-of-Expense Approach
ILLUSTRATION 4.5

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 Expense Classification

Function-of-Expense Approach
ILLUSTRATION 4.6

The function-of-expense method is generally used in practice

although many companies believe both approaches have merit.
4-18 18
 Income From Operations
ILLUSTRATION 4.7
Gains and Losses Number of Unusual Items
Reported in a Recent Year
by 500 Large Companies

4-19 19
 Income From Operations

Gains and Losses

IASB takes the position that both
 revenues and expenses and
 other income and expense

should be reported as part of income from operations.

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4-20
20
 Income From Operations

Gains and Losses

Additional items that may need disclosure:
 Losses on write-downs of inventories to net realizable value or of
property, plant, and equipment to recoverable amount, as well as
reversals of such write-downs.
 Losses on restructurings of the activities and reversals of any provisions
for the costs of restructuring.
 Gains or losses on the disposal of items of property, plant, and,
equipment or investments.
 Litigation settlements.
 Other reversals of liabilities.

4-21 21
 Reporting Various Income Items
ILLUSTRATION 4.8
Income before Income Tax Presentation of
Finance Costs

Illustration 4-8

Financing costs must be reported on the income statement.

4-22 22
 Reporting Various Income Items

Net Income
Represents the income after all
 revenues and

 expenses

for the period are considered.

Viewed by many as the most important measure of a company’s success

or failure for a given period of time.

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  Common-size income statements
A common size income statement is an income
statement in which each line item is expressed as a
percentage of the value of revenue or sales

4-24
  Common profitability ratios
 ROA(return on assets)=Net income/average total assets
 ROE(return on equity)=Net income/average total equities

4-25
 Reporting Various Income Items

Earnings per Share (EPS)

Net Income - Preferred Dividends

Weighted Average of Ordinary Shares Outstanding

 A significant business indicator.

 Measures the dollars earned by each ordinary share.
 Must be disclosed on the face of the income statement.

25
4-26
 Earnings per Share (EPS)

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 ordinary shares outstanding during the year is
100,000 shares. Lancer computes earnings per share as follows:

Net Income - Preferred Dividends

Weighted Average of Ordinary Shares Outstanding

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

4-27 26
 Reporting Various Income Items

Discontinued Operations
A component of an entity that either has been disposed of, or is classified as
held-for-sale, and:

1. Represents a major line of business or geographical area of

operations, or

2. Is part of a single, co-coordinated plan to dispose of a major line of

business or geographical area of operations, or

3. Is a subsidiary acquired exclusively with a view to resell.

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 Discontinued Operations

Companies report as discontinued operations

1. (in a separate income statement category) the gain or loss from
disposal of a component of a business.

2. The results of operations of a component that has been or will be

disposed of separately from continuing operations.

3. The effects of discontinued operations net of tax as a separate

category, after continuing operations.

4-29 28
 Discontinued Operations

Illustration: KC Products, a highly diversified company, decides to

discontinue its electronics division. During the current year, the
electronics division lost £300,000 (net of tax). KC sold the division at
the end of the year at a loss of £500,000 (net of tax).

Income from continuing operations £20,000,000

Discontinued operations:
Loss from operations, net of tax 300,000
Loss on disposal, net of tax 500,000
Total loss on discontinued operations 800,000
Net income £19,200,000
ILLUSTRATION 4.10
Income Statement Presentation
4-30
of Discontinued Operations 29
 Discontinued Operations
ILLUSTRATION 4.11
A company that
reports a
discontinued
operation must
report per share
amounts for the
line item either on
the face of the
income statement
or in the notes to
the financial
statements.

4-31
 ILLUSTRATION 4.11
Income Statement

Divide by
weighted-
average
shares
outstanding

EPS

4-32 Earnings per Share 31

 Reporting Various Income Items

Allocation to Non-Controlling Interest

When a company prepares a consolidated income statement, IFRS
requires that net income be allocated to the controlling and non-
controlling interest. This allocation is reported at the bottom of the
income statement, after net income.

ILLUSTRATION 4.15 (amounts given)

Presentation of Non-Controlling Interest

4-33 32
 Income Statement

Summary ILLUSTRATION 4.16

Summary of Various Income Items

4-34 33
 Income Statement

Summary ILLUSTRATION 4.16

Summary of Various Income Items

4-35 34
 Related Equity Statements

Retained Earnings Statement

Increase Decrease
 Net income  Net loss
 Change in accounting  Dividends
principle  Change in accounting
 Prior period adjustments principles
 Prior period adjustments

4-36 35
 Retained Earnings Statement
CHOI LTD.
Statement of Retained Earnings
For the Year Ended December 31, 2019

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, 2019, you
discover a ₩50,000 error (net of tax) that caused 2018 inventory to
be overstated (overstated inventory caused COGS to be lower and
thus net income to be higher in 2018). Would this discovery have
any impact on the reporting of the Statement of Retained Earnings
for 2019?
4-37 36
 Retained Earnings Statement
CHOI LTD.
Statement of Retained Earnings
For the Year Ended December 31, 2019

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

4-38 37
 Retained Earnings Statement

Restrictions on Retained Earnings

Disclosed
 In notes to the financial statements.
 As Appropriated Retained Earnings.

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 Related Equity Statements

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 equity.

4-40 39
 Comprehensive Income
Net Income
Income Statement (in thousands)
Other Comprehensive
Sales
Cost of goods sold
$ 285,000
149,000 + Income
Gross profit 136,000
 Unrealized gains and
Operating expenses:
Selling expenses 10,000 losses on non-trading
Administrative expenses 43,000 equity securities.
Total operating expense 53,000  Translation gains and
Income from operations 83,000
Other revenue (expense):
losses on foreign
Interest revenue 17,000 currency.
Interest expense (21,000)  Plus others
Total other (4,000)
Income before taxes 79,000
Income tax expense 24,000 Reported in Equity
Net income $ 55,000

4-41 40
 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 ILLUSTRATION 4.21

One Statement Format:
Comprehensive Income

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
Illustration 4-19
Approach

ILLUSTRATION 4.22
Two Statement Format:
Comprehensive Income

4-44
 Related Equity Statements

Statement of Changes in Equity

Required, in addition to a statement of comprehensive income.
 Generally comprised of
► Share capital—ordinary,
► Share premium—ordinary,
► Retained earnings, and the
► Accumulated balances in other comprehensive income.

4-45
 Statement of Changes in Equity

Reports the change in each equity account and in total equity for
the period. Includes the following:
1. Accumulated comprehensive income for the period.

2. Contributions (issuances of shares) and distributions

(dividends) to owners.

3. Reconciliation of the carrying amount of each component of

equity from the beginning to the end of the period.

4-46
 Statement of Changes in Equity

ILLUSTRATION 4.23
Statement of Changes in Equity

4-47
 Statement of Changes in Equity

Regardless of the display format used, V. Gill reports the

accumulated other comprehensive income of €90,000 in the
equity section of the statement of financial position as follows.

ILLUSTRATION 4.24
Presentation of Accumulated Other Comprehensive Income in the Statement of Financial Position
4-48