Chapter 13 class notes summer - Kimmel

Accounting: Tools for Business Decision Making

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Chapter 13 Financial Analysis – The Big Picture All-Inclusive Income Statement Revenues, expenses, and net income or loss are reported on the income statement. Importance of net income to: Investors: Greater likelihood of stock price appreciation as net income increases from one period to another. Greater likelihood of dividends. Creditors: The company’s ability to pay its creditors is enhanced if the company generates net income. Prudent investors and creditors look at the income statement in its entirety, and beyond (e.g. footnote disclosures in the annual report) to examine the quality of earnings of a company. Net income should be compared to something to be put into perspective. To prior years net income for the same company to look for trends. To other entities in the same industry To other numbers on the financial statements to compute ratios (e.g. return on assets, profit margin) To help assess the quality of earnings and for comparative purposes, GAAP requires some irregular items that are part of the current year’s net income or loss be reported separately because they are one-time events that were not part of prior year’s net income, and they will not affect net income in future periods either.
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IRREGULAR ITEMS: DISCONTINUED OPERATIONS When a company has sold or eliminated an entire major line of business. The discontinued segment will no longer be part of the ongoing operations of the business. Examples: Pepsi sold Taco Bell, KFC, and Pizza Hut. IBM sold hard-drive manufacturing division to Hitachi Note: Closing some locations but staying in the line of business would NOT be considered discontinued operations. Reporting Requirements: 1. Report income from continuing operations (i.e., revenues and expenses for all segments that are still operating). Income from continuing operations is used by investors and creditors as a predictor of future earnings because these earnings come from segments that will still be operating in the next period. Note that the income tax expense for the income from continuing operations is reported separately in that section. 2. The Discontinued Operations section of the income statement is divided into two components for even more clarity: a. The income (or loss) from operating the discontinued segment (i.e., the segment’s revenues minus the segment’s operating expenses). net of income tax expense – if income – or savings – if loss. b. The gain (or loss) on the sale or disposal of the assets of the discontinued segment (net of income tax expense or savings).
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The income tax effects are shown separately in these sections because the income tax expense or savings that is related to the discontinued operation is also a one-time event. Tax effect = income or loss
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Chapter 13 class notes summer - Kimmel - Chapter 13...

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