Chapter 4 Notes

Chapter 4 Notes - Chapter 4: Income Statement and Related...

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Chapter 4: Income Statement and Related Information Income Statement - Report that measures the success of company operations for a given period of time - Business and investment community uses it to determine: 1) Profitability 2) Investment Value 3) Creditworthiness - Helps investors and creditors predict the amounts, timing and uncertainty of future cash flows Usefulness of the Income Statement - Investors and creditors use income statements to: 1) Evaluate the past performance of the company. 2) Provide a basis for predicting future performance. 3) Help assess the risk or uncertainty of achieving future cash flows. Limitations of Cash Flows - Since net income is an estimate and reflects a number of assumptions, users need to be aware of certain limitations: 1) Companies omit items from the income statement that they cannot measure reliably. 2) Income numbers are affected by the accounting methods employed. 3) Income measurement involves judgment. Quality of Earnings - Earnings management - planned timing of revenues, expenses, gains, and losses to smooth out bumps in earnings o Some companies use this to increase income in the current year at the expense of income in future years
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o Also used to decrease current earnings in order to increase earnings in the future - Such earning management techniques negatively affect the quality of earnings if it distorts information in a way that is less useful for predicting future earnings and cash flows Format of the Income Statement Elements of the Income Statement - Net income results from revenue, expense, gain, and loss transactions - Income Summary summarizes these transactions - Transaction approach - focuses on the income-related activities that have occurred during the period - Can further classify income by customer, product line, or function or by operation and nonoperating, continuing and discontinued, and regular and irregular categories - Major elements of the Income Statement: o Revenues o Expenses o Gains o Losses - Revenues take many forms: sales, fees, interest, dividends, and rents - Expenses: cost of goods sold, depreciation, interest, rent, salaries and wages, and taxes - Gains and losses: sale of investment or plant assets, settlement of liabilities, write-off of assets due to impairment or casualty - Revenues and expenses are from regular operations, gains and losses are from irregular operations Single-Step Income Statement - Consist of two groupings: 1) Revenues 2) Expenses Page 2 of 10
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- Illustration 4-1 - Simple presentation and absence of any implication that one type of revenue or expense item has priority over another is its primary advantage Multi-Step Income Statement - Including other important revenue and expense classifications makes the income statement more useful: o A separation of operating and nonoperating activities of a company o A classification of expenses by functions, such as merchandising, selling, and administration - Separates operating and nonoperating transactions and matches costs and expenses with
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Chapter 4 Notes - Chapter 4: Income Statement and Related...

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