PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPA

Income Statement (pp. 169-198) and Statement of Cash Flows (pp.198-207)

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Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

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On text page 171:

1)Placement of tax expense2)Cont. oper.3)Discont oper.4)Extraordinary5)Net Income6)EPS

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Page 173: Single-Step Income Statement

Expenses & Losses

Revenues & Gains

Proper Heading

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(text page 174)Multiple-Step Income Statement

Non- operating Items

Gross Profit

Operating Expenses

Proper Heading

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U. S. GAAP vs. IFRS

• SEC requires that expenses be classified by function. (e.g., selling expenses not salaries, advertising, etc.)

• “Bottom line” called net income or net loss.

• Report extraordinary items separately.

• Allows expenses classified by function or natural description.

• “Bottom line” called profit or loss.

• Prohibits reporting extraordinary items.

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.

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Earnings Quality / Manipulating Income(page 175)

Earnings quality: if good quality, reported earnings helps to predict

a company’s future earnings.

Transitory Earningsversus

Permanent Earnings (examples: next slide)

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Three “non-permanent” itemsthat may appear in Operating Income

1) Restructuring costsa) (see JDS example on page 177)

2) Impairment of Goodwill

3) Impairment of Long-Lived assets

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“Proforma Earnings” (page 179)

• Google example – January 2009• Fourth quarter income = $382 million ($1.21

EPS)• Proforma income = $1.62 billion, which

excluded:– Stock-based compensation– Impairment charges– Loss on settlement of copyright infringement lawsuit

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Separately Reported Items(text pages 180-187)

Reported separately, net of taxes:

1) Discontinued operations

2) Extraordinary items

3) A third separately reported item, the cumulative effect of a change in accounting principle, might be included for certain mandated changes in

accounting principles.

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Intraperiod Income Tax Allocation(text pages 180-182)

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

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

Show Income Tax Expense related to

Income from Continuing Operations.

Show Income Tax Expense related to

Income from Continuing Operations.

Report effects of Discontinued Operations and

Extraordinary Items net of related income tax effect.

Report effects of Discontinued Operations and

Extraordinary Items net of related income tax effect.

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Numbers on the Income Statement for “Discontinued Operations”? (pgs.182-185)

• Meaning of “operation”• When the operation (component of business)

has already been sold– Illustr 4-4 – page 184 (note the “gain on disposal”

• When the decision to sell has been made, but the sale has not yet taken place– Illus 4-5 – page 185 (note the “impairment loss”)– Graphic 4-6: Balance Sheet “assets / liabilities held

for sale’

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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

Extraordinary Items(text pages 186-187)

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U. S. GAAP vs. IFRS

• Report extraordinary items separately in the income statement.

A BIG difference!

But, the desire to converge U.S. and international accounting standards could guide FASB to eliminate the extraordinary item classification.

• Prohibits reporting extraordinary items in the income statement or notes.

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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.

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Type of Accounting Change Definition

Change in Accounting Principle

Change from one GAAP method to another GAAP method

Change in Accounting Estimate

Revision of an estimate because of new information or new experience

Change in Reporting Entity

Preparation of financial statements for an accounting entity other than the entity that existed in the previous period

Accounting Changes in: principles, estimates or entity

(text pages 188-191)

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Change in Accounting Principle

• Example: change from LIFO to FIFO

• GAAP requires that most voluntary accounting changes be accounted for retrospectively by revising prior years’ financial statements.

• For mandated changes in accounting principles, the FASB often allows companies to choose to account for the change retrospectively or as a separately reported item below extraordinary items.

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Change in Depreciation, Amortization, or Depletion Method

… is treated the same as a change in accounting estimate (not as a change in principle)

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Change in Accounting Estimate (review Illustr. 4-6 on page 190)

If the company revises an accounting estimate made in a prior period (say, last year)

….

… we use the new estimate in current and future periods

That is, you do not “correct” previously reported

numbers!

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Change in Reporting Entity:two examples with very different answers

a) New rule: you must consolidate financial subsidiaries

b) prior-period financials should be restated to appear as if the “new entity” existed in those periods.

a) When one company acquires another one, the financials of the acquirer include the acquiree as of the date of acquisition

b) prior-period financial statements are not restated.

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Correction of Accounting Errors (page 192)

Errors occur when transactions are either recorded incorrectly or not recorded at all.

Errors Discovered in

Same Year

Reverse original erroneous journal entry and record the appropriate

journal entry.

Record a prior period adjustment to the beginning retained earnings

balance

Previous years’ financial statements are retrospectively restated to reflect

the correction.

Material Errors Discovered in Subsequent

Year

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Earnings per Share Disclosure(text pages 192-193)

earnings per share (EPS) shows the amount of income earned by a company expressed on a per share basis.

Basic EPS

Net income less preferred dividends

Weighted-average number of common shares outstanding for the

period

Diluted EPS

Reflects the potential dilution (reduction in EPS) that could occur for companies that have convertible securities that that could

create additional common shares if the conversions took place.

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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

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Comprehensive Income(text pages 194-197)

An expanded version of income that includes four gains and losses

that are not included in the

traditional income statement.

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Comprehensive income includes traditional net income AND four additional gains and losses that change

shareholders’ equity.

1. Some unrealized holding gains (losses) from investments.

2. Some gains and losses - postretirement benefit plans.

3. Some derivatives - gain or loss is deferred

4. Some gains or losses -foreign currency exchange

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Accumulated Other Comprehensive Income

We report other comprehensive income on a cumulative basis in the balance sheet as an additional

component of shareholders’ equity.

We report other comprehensive income on a cumulative basis in the balance sheet as an additional

component of shareholders’ equity.

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The Statement of Cash Flows(text pages 198-207)

• Three categories are presented: Operating activities Investing activities Financing activities.

• Required for each income statement period reported.

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Operating Activities

Cash Flows from

Operating Activities

Cash Flows from

Operating Activities

Inflows from: sales to customers. interest and dividends

received.

Inflows from: sales to customers. interest and dividends

received. +

Outflows for: purchase of inventory. salaries, wages, and other

operating expenses. interest on debt. income taxes.

Outflows for: purchase of inventory. salaries, wages, and other

operating expenses. interest on debt. income taxes.

_

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Two Acceptable Methods of Reporting the Operating Activities

Reports the cash effects of each operating

activity

Direct Method

Starts with accrual net income and converts to cash basis

Indirect Method

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Direct Method – pages 201-202

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Indirect Method (text page 203)We start with reported net income and work backwards to

convert that amount to a cash basis.

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Cash Flows from

Investing Activities

Cash Flows from

Investing Activities

+

Investing Activities

Inflows from: sale of long-lived assets used in

the business. sale of investment securities

(stocks and bonds). collection of nontrade

receivables.

_Outflows for:

purchase of long-lived assets used in the business.

purchase of investment securities (stocks and bonds).

loans to other entities.

Outflows for: purchase of long-lived assets

used in the business. purchase of investment

securities (stocks and bonds). loans to other entities.

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Cash Flows from

Financing Activities

+

_

Financing Activities

Inflows from: sale of shares to owners. borrowing from creditors

through notes, loans, mortgages, and bonds.

Outflows for: owners in the form of dividends

or other distributions. owners for the reacquisition of

shares previously sold. creditors as repayment of the

principal amounts of debt.

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ALC’s complete (3 categories) Statement of Cash Flows (page 204)

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Noncash Investing & Financing Activities

…. THAT DO NOT INVOLVE CASH are reported either in the Cash Flow Statement or in a Note

EXAMPLE: Acquisition of equipment (an investing activity) by issuing a long-term

note payable (a financing activity).

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Statement of Cash Flows: Some BIG differences!

U. S. GAAP vs. IFRS

• Operating Activities– A) Dividends

Received– B) Interest Received– C) Interest Paid

• Investing Activities

• Financing Activities– Dividends Paid

• Operating Activities

• Investing Activities

• A) Dividends Received

• B) Interest Received

• Financing Activities– Dividends Paid

• C) Interest Paid

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End of Chapter 4