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Unformatted text preview: 5-15THE INCOME STATEMENT AND THE STATEMENT OF CASH FLOWS CHAPTER OBJECTIVESAfter careful study of this chapter, students will be able to: 1. Understand the concepts of income. 2. Explain the conceptual guidelines for reporting income. 3. Define the elements of an income statement. 4. Describe the major components of an income statement. 5. Compute income from continuing operations. 6. Report results from discontinued operations. 7. Identify extraordinary items. 8. Prepare a statement of retained earnings. 9. Report comprehensive income. 10. Explain the statement of cash flows. 11. Classify cash flows as operating, investing, or financing. 5-2SYNOPSISConcepts of Income1. The income statement summarizes the results of a company's operations for the period. It often is considered the most important financial statement for several reasons. First, the income statement enables absentee owners (stockholders) to evaluate the stewardshipof management over invested capital. Second, past income may be used to predict future earnings and net cash flowswhich, in turn, are useful in predicting future stock prices and current and future dividend payments. Finally, income information can also be used to predict the company's ability to generate cash from operations to meet interest payments and operating obligations. 2. Under the capital maintenanceconcept, income for a period is the amount that may be paid to stockholders during that period while leaving the company as well off at the end of the period as it was at the beginning. In other words, income is the difference between the beginning and ending capital (or net asset) balances after adjustment for investments and disinvestments during the period. Accountants and economists could probably agree on the measurement of total income for the entire life of a company. However, for shorter time periods income is subject to dispute, because the values of a company's beginning and ending assets and liabilities may be measured in a variety of ways. 3. The transactional approachis currently used for income measurement. Under this approach, a company records its assets and liabilities at historical cost, and does not record any changes in value unless a transaction, event, or circumstance has provided reliable evidence of the change. The transactional approach uses the accrualbasis. That is, the impact of any change is recorded in the period in which it occurs, rather than the period in which related cash is paid or received by the company, and efforts and accomplishments are matched, so that reported income measures a company's earnings performance. Using the accrual-based transactional approach, a company's net income is measured by the equation: Net Income = Revenues - Expenses + Gains - Losses 4. Consistent with the transactional approach, the FASB has defined comprehensive incomeas the change in equity of a company during a period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a...
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- Spring '11