ch04 - Chapter4 IncomeStatementandRelatedInformation...

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 Chapter 4 Income Statement and Related Information
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Chapter 4: Key Concepts 2 Discuss the uses and limitations of the Income Statement. Discuss issues relating to Earnings Quality. Discuss the format of the Income Statement. Discuss the reporting of Irregular Items. Discuss some special reporting issues. Accounting 301A-Eiler
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The Income Statement Accounting 301A-Eiler 3 The income statement lists the following for a firm over a period of time: Revenues Expenses Gains Losses The excess of revenues and gains over expenses and losses is equal to net income (or net loss, if negative) for the period. SEC rules requires firms to report 3 years of income statement data.
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Usefulness of the Income Statement Accounting 301A-Eiler 4 Evaluate past performance of a company. Did Target outperform Wal-Mart? Provide a basis for predicting future performance. What is the trend? Assist in assessing the risk or uncertainty of future cash flows. Continuing operations (i.e., recurring) versus non- recurring items.
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Limitations of the Income Statement Accounting 301A-Eiler 5 Does not report items that cannot be measured reliably (e.g., unrealized gains/losses on certain investment securities, intangible items such as brand recognition, customer satisfaction, product quality). Reported income is a function of the accounting methods a company uses (e.g., different depreciation methods within GAAP). Are you comparing Apples to Apples or Apples to Oranges? Managers exercise judgment in measuring income. Managers might choose a different estimates, even in good faith.
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Earnings quality Accounting 301A-Eiler 6 Ability of reported earnings to predict future earnings. Permanent versus transitory earnings: Permanent: Expected to persist indefinitely. Transitory: Earnings affected currently, but not in the future. Analysts try to separate permanent earnings from transitory earnings. “Income from Continuing Operations”. “Pro forma” earnings.
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Earnings management Accounting 301A-Eiler 7 Manipulation of reported earnings (income) may lead to lower earnings quality Why might managers manipulate reported earnings? How might managers manipulate reported earnings? Income shifting Income Statement classification
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Format of the Income Statement Accounting 301A-Eiler 8 Single-Step Income Statement: Groups together all revenues and all expenses and Net Income is the difference between the two groups. No distinction between operating and non-operating activities. Eliminates potential classification issues.
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Format of the Income Statement (cont.) Accounting 301A-Eiler 9 Multiple-Step Income Statement: Divides information into major sections on the statement. Differentiates between operating
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ch04 - Chapter4 IncomeStatementandRelatedInformation...

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