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UNDERSTANDING INCOME STATEMENTS

1Đặng Thị Thu Hằng

INCOME STATEMENT COMPONENTS AND FORMAT

• What is the income statement?• Equation: Revenues – Expenses = Net income


COMPONENTS OF THE INCOME STATEMENT

• Revenues: amounts reported from the sale of goods and services in the normal course of business.

• Revenue less adjustments for estimated returns and allowances What is this???


• Expenses: amounts incurred to generate revenue and include cost of goods sold, operating expenses, interest and taxes.

• Gain and losses: which result in an increase (gains) or decrease (losses) of economic benefits.

• Net income = Revenues – Ordinary expenses + Other income – Other expense + Gains - Losses


BHG COMPANY INCOME STATEMENTfor the year ended December 31, 20X7

Revenue $ 579,312

Cost of goods sold (362,520)

Gross profit 216,792

Selling, general, and administrative expense (109,560)

Depreciation expense (69,008)

Operating profit 38,224

Interest expense (2,462)

Income before tax 35,762

Provision for income taxes (14,305)

Income from continuing operations 21,457

Earnings (losses) from discontinued operations, net of tax

1,106

Net income $22,563 5Đặng Thị Thu Hằng

WHEN REVENUE IS RECOGNIZED?

• According to IFRS:- The risk and reward of ownership is

transferred- There is no continuing control or management

over the goods sold- Revenue can be reliably measured- There is a probable flow of economic benefits- The cost can be reliably measured


• According to US.GAAP:- There is evidence of an arrangement between

the buyer and seller- The product has been delivered or the service

has been rendered- The price is determined or determinable- The seller is reasonably sure of collecting

money


UNEARNED REVENUE

• Firm receives cash before revenue recognition is complete

• Is liability on the balance sheet• Give example???


SPECIFIC REVENUE RECOGNITION APPLICATIONS

• Long term contracts: - Include the percentage of completion method and the completed contract method.- The percentage of completion method is used both IFRS and US.GAAP- The completed contract method is used when the outcome of the project can not be reliably estimated.


EXAMPLE 1• Assume that AAA Construction Corp. has a

contract to build a ship for $1000 and a reliably estimate of the contract’s total cost is $800. Project costs incurred by AAA are as follows:

AAA Project Costs

Year 20X5 20X6 20X7 Total

Cost incurred

$400 $300 $100 $800


EXAMPLE 2

• Assume that AAA Construction Corp. has a contract to build a ship for $5000 and a reliably estimate of the contract’s total cost is $800. Project costs incurred by AAA are as follows:

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Year 20X5 20X6 20X7 Total

Cost incurred

400 300 500 1200

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SPECIFIC EXPENSE RECOGNITION

• Expenses: are subtracted from revenue to calculate net income.

• IFRS: “expenses are decrease in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities that result in decrease in equity other than those relating to distributions to equity participants”.


INVENTORY EXPENSE RECOGNITION

• Remind:- What is FIFO, LIFO, weighted average cost,

specific identification???- FIFO and average cost are permitted under

both US.GAAP and IFRS- LIFO is allowed under US.GAAP but is

prohibited under IFRS


SUMMARIZES THE EFFECTS OF THE INVENTORY METHODS

Method Assumption Cost of Goods sold consists of

Ending Inventory consists of

FIFO (US.GAAP and IFRS)

The items first purchased are the first to be sold

First purchased Most recent purchases

LIFO (only US.GAAP)

The items last purchased are the first to be sold

Last purchased Earliest purchases

Weighted average cost (US.GAAP and IFRS)

Items sold are a mix of purchases

Average cost of all items

Average cost of all items


EXAMPLE: INVENTORY COSTING

• Use the inventory data in the table below to calculate the COGS and ending inventory under each of the three methods:

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January 1 (beginning inventory)

2 units @ $2 per unit = $4

January 7 purchase 3 units @ $3 per unit = $9

January 19 purchase 5 units @ $5 per unit = $25

COGS available 10 units = $38

Units sold during January 7 units


DEPRECIATION EXPENSE RECOGNITION

• The cost of long – lived assets must also be matched with revenue.

• Long – lived assets are expected to provide economic benefits beyond one accounting period.

• The allocation of cost over an asset’ life is known as: depreciation, depletion, amortization


STRAIGHT LINE DEPRECIATION (SL)

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lueresidualvaCosttionSLdeprecia

• Example: Littlefield Company recently purchased a machine at a cost of $12.000. The machine is expected to have a residual value of $2000 at the end of its useful life in five years. Calculate depreciation expense using the straight line method.


ACCELERATED DEPRECIATION

• Speeds up the recognition of depreciation expense in a systematic way recognize more depreciation expenses in the early years of the asset’s life & less depreciation expense in the later years of its life.

• Total depreciation expense over the life of the asset will be the same as it would be if straight line depreciation were used.


DECLINING BALANCE METHOD (DDB)

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ionddepreciataccumulateCostDDB2

• Example: Littlefield Company recently purchased a machine at a cost of $12.000. The machine is expected to have a residual value of $2000 at the end of its useful life in five years. Calculate depreciation expense using the DDB.


CONVERT INCOME STATEMENTS TO COMMON – SIZE INCOME STATEMENTS

• A vertical common – size income statements: expresses each category of the income statement as a percentage of revenue.

• The common size format standardizes the income statement by eliminating the effects of size.


INCOME STATEMENTSNorth Co. South Co.

Revenue $75,000,000 $3,500,000

COGS 52,500,000 700,000

Gross profit $22,500,000 $2,800,000

Administrative expense

11,250,000 525,000

Research expense

3,750,000 700,000

Operating profit $7,500,000 $1,575,00021Đặng Thị Thu Hằng

COMMON – SIZE INCOME STATEMENTNorth Co. South Co.

Revenue 100% 100%

COGS 70% 20%

Gross profit 30% 80%

Administrative expense

15% 15%

Research expense 5% 20%

Operating profit 10% 45%


EVALUATE A COMPANY’S FINANCIAL PERFORMANCE

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Rearg

venue

NetincomeinNetprofitm

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COMPREHENSIVE INCOME• Comprehensive income: the sum of net income

and other comprehensive income.• Includes transactions that are not included in

net income, such as:- Foreign currency translation gains and losses- Adjustments for minimum pension liability- Unrealized gains and losses from CF hedging derivatives- Unrealized gains and losses from available for sale

securities.


EXAMPLE: CALCULATING COMPREHENSIVE INCOME

• Calculate comprehensive income for Triple C corporation using the selected financial statement data found in the following table:

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NET INCOME $1000Dividends received from available for sale securities 60Unrealized loss from foreign currency translation (15)Dividends paid (110)Reacquire common stock (400)Unrealized gain from CF hedge 30Unrealized loss from available for sale securities (10)Realized gain on sale of land 65
