Chapter6 - Analyzing Operating Activities CHAPTER 6 Income...

Info icon This preview shows pages 1–13. Sign up to view the full content.

View Full Document Right Arrow Icon
6 CHAPTER Analyzing Operating Activities
Image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Illustration Facts: • Company with $100,000 in cash • Buys condo for $100,000 • Rents condo for $12,000 per year • End of the first year: Condo valued at $125,000 Income Measurement Concepts
Image of page 2
Illustration Facts: • Net (free) cash flow = $(88,000) • Operating cash flow = $12,000 • Economic income = $37,000 • ($12,000 rental income + $25,000 holding gain) • Accounting income = $11,500 ($12,000 rental income - $500 depreciation*) *Condo’s useful life is 50 years and its salvage value is $75,000—yearly straight-line depreciation is $500 Income Measurement Concepts
Image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Economic Income: Two measures reflect the economic concept • economic income • permanent income Income Measurement Concepts
Image of page 4
Economic Income: • Equals net cash flows + the change in the present value of future cash flows • Measures change in shareholder value—reflecting the financial effects of all events in a comprehensive manner • Includes both recurring and nonrecurring components— rendering it less useful for forecasting future earnings potential • Related to Hicksian concept of income—income includes both realized (cash flow) and unrealized (holding gain or loss) components Income Measurement Concepts
Image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Permanent Income* • Equals stable average income that a company is expected to earn over its life • Reflects a long-term focus • Directly proportional to company value • Often expressed by dividing permanent income by cost of capital *Also called sustainable earning power, or sustainable or normalized earnings Income Measurement Concepts
Image of page 6
Economic Income and Permanent Income Income Measurement Concepts 0 1 2 3 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 Years $ Million Permanent Income Economic Income
Image of page 7

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Accounting Concept of Income: • Based on accrual accounting • Capture aspects of both economic income and permanent income • Suffers from measurement problems—yields accounting analysis Income Measurement Concepts
Image of page 8
Revenue Recognition and Matching : Revenue recognition Revenues must be (1) realized or realizable, and (2) earned Costs/Expenses matched with recognized revenues Product costs—recognized when product or service sold Period costs--recognized when incurred Income Measurement Concepts
Image of page 9

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Economic Income vs. Accounting Income: Economic Income and Accounting Income reflect similar concepts BUT: Accounting income is a product of the financial reporting environment—accounting standards, enforcement mechanisms, managers’ incentives, etc. HENCE: Accounting income can diverge from economic income (yielding accounting distortions) Income Measurement Concepts
Image of page 10
Accounting Income consists of: • Permanent Component--the recurring component expected to persist indefinitely • Transitory Component--the transitory (or non- recurring) component not expected to persist (Note: The concept of economic income includes both permanent and transitory components.) • Value Irrelevant Component--value irrelevant components have no economic content; they are accounting distortions Income Measurement Concepts
Image of page 11

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Analysis Implications:
Image of page 12
Image of page 13
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern