review13 - CHAPTER 13 The Corporate Income Statement and...

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CHAPTER 13 The Corporate Income Statement and the Statement of Stockholders’ Equity 0REVIEWING THE CHAPTER Objective 1: Define quality of earnings , and identify the components of a corporate income statement. 10. The most commonly used predictors of a company’s performance are expected changes in earnings per share and expected return on equity. Net income is a key component of both measures. 20. Because net income is so important in measuring a company’s prospects, it is equally important to evaluate the quality of the net income figure, or the quality of earnings. The quality of earnings refers to the substance of earnings and their sustainability into future accounting periods. It is affected by the accounting methods and estimates that management chooses and by the gains and losses, write-downs and restructurings, and nature of the nonoperating items reported on the income statement. Management also has choices about the content and positioning of these income-statement categories. 30. Net income or loss for a period includes all revenues, expenses, gains, and losses. A corporate income statement may therefore contain many line items and subtotals. On the income statement of a corporation that has both continuing and discontinued operations, the operating income section is called income from continuing operations. This section, which includes revenues, costs and expenses, gains and losses on the sale of assets, write- downs of assets, and restructurings, is followed by a section on income taxes. Appearing below that are nonoperating items, such as discontinued operations, extraordinary gains and losses, and the write-off of goodwill that has been impaired. Earnings per share data appear at the bottom of the statement. 40. The different estimates and methods that management can choose for dealing with such matters as uncollectible accounts, inventory, and depreciation produce different net income figures. In general, an accounting method or estimate that produces a lower, or more conservative, figure produces a more reliable quality of earnings. Management’s choices about how nonoperating and nonrecurring items are reported on the income statement also affect the “bottom line.” Financial analysts should therefore look beyond the net income figure to the notes to the financial statements, where generally accepted accounting principles require full disclosure of the significant accounting methods used in preparing the statements and any changes in those methods. 50. Although gains or losses on the sale of assets appear in the operating section of the income statement, they usually represent one-time events. They are not sustainable, ongoing operations, and management often has some choice as to their timing. Analysts should therefore ignore them when considering operating income.
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60. A write-down ( also known as a write-off ) is recorded when the value of an asset drops below its carrying value. (Write-downs are reflected on both the balance sheet and the
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review13 - CHAPTER 13 The Corporate Income Statement and...

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