ch13 - CHAPTER 13 Financial Statement Analysis: The Big...

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CHAPTER 13 Financial Statement Analysis: The Big Picture CHAPTER OVERVIEW This chapter is essentially a capstone chapter for the textbook. You will learn about several new items: sustainable income and irregular items such as discontinued operations and extraordinary items; changes in accounting principle; comprehensive income; and horizontal and vertical analysis. You will revisit ratios learned in prior chapters, focusing on what the ratios indicate, and will learn about the limitations of financial analysis. Finally, you will study the concept of quality of earnings. REVIEW OF SPECIFIC STUDY OBJECTIVES SO1. Understand the concept of sustainable income. ¿ Sustainable income is net income adjusted for irregular items . It is the most likely level of income to be obtained in the future, to the extent that this year's net income is a good predictor of future years' net income. SO2. Understand how irregular items are presented. ¿ There are two types of irregular items : discontinued operations and extraordinary items . Both items are reported net of income taxes . If there is an extraordinary loss of $100,000 and the tax rate is 30%, then the loss is reported at its net amount of $70,000 (the $30,000 of income taxes is actually a tax savings in the case of a loss). ¿ Discontinued operations refer to the disposal of a significant segment of a business, such as the elimination of a major class of customers or an entire activity . The income statement should report income from continuing operations and income (or
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Kimmel Accounting: Tools for Business Decision Making 13-2 loss) from discontinued operations. (It is important to distinguish infrequently occurring items from routine, recurring operations, and, in general, it makes sense to eliminate all irregular items in estimating future sustainable income.) The income (loss) from discontinued operations consists of the income (loss) from operations and the gain (loss) on disposal of the segment . Remember that both the operating income or loss and the disposal gain or loss are reported net of income taxes . ¿ Extraordinary items are events and transactions that meet two conditions: They are unusual in nature and infrequent in occurrence . The "unusual" and "infrequent" conditions are necessarily influenced by the judgment of the accountants dealing with the items. Extraordinary items are reported net of income taxes in a separate section of the income statement immediately below discontinued operations. If a transaction meets only one of the criteria, then it is treated as a line item in the upper half of the income statement under Other Expenses and Losses or Other Revenues and Gains: It is shown at the gross amount, not net of tax. It will go into the determination of income from continuing operations, and income taxes are calculated for that number. ¿ A
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This note was uploaded on 08/02/2009 for the course BUAD 305 taught by Professor Davila during the Fall '07 term at USC.

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ch13 - CHAPTER 13 Financial Statement Analysis: The Big...

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