Chapter Four

Chapter Four - Intermediate Accounting Chapter 4 Income...

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Unformatted text preview: Intermediate Accounting Chapter 4 Income Statement and Related Information Learning Objectives Learning Understand the uses and limitations of an income statement Prepare a single­step income statement Prepare a multiple­step income statement Explain how to report irregular items Explain intraperiod tax allocation Identify where to report earnings per share information Prepare a retained earnings statement Explain how to report other comprehensive income 2 Income Statement Income Usefulness Predicting future performance. 3 Evaluate past performance. Help assess the risk or uncertainty of achieving future cash flows. LO 1: Understand the uses and limitations of an income statement Income Statement Income Limitations Companies omit items that cannot be measured reliably. Income is affected by the accounting methods employed. Income measurement involves judgment. 4 LO 1: Understand the uses and limitations of an income statement Income Statement Income Quality of Earnings Companies have incentives to manage income to meet or beat Wall Street expectations, so that • • market price of stock increases and value of stock options increase. Quality of earnings is reduced if earnings management results in information that is less useful for predicting future earnings and cash flows. 5 LO 1: Understand the uses and limitations of an income statement Format of the Income Statement Format Elements of the Income Statement Revenues – Inflows or other enhancements of assets or settlements of its liabilities that constitute the entity’s ongoing major or central operations. Examples of Revenue Accounts 6 Sales Fee revenue Interest revenue Dividend revenue Rent revenue LO 1: Understand the uses and limitations of an income statement Format of the Income Statement Format Elements of the Income Statement Expenses – Outflows or other using­up of assets or incurrences of liabilities that constitute the entity’s ongoing major or central operations. Examples of Expense Accounts 7 Cost of goods sold Depreciation expense Interest expense Rent expense Salary expense LO 1: Understand the uses and limitations of an income statement Format of the Income Statement Format Elements of the Income Statement Gains – Increases in equity (net assets) from peripheral or incidental transactions. Losses ­ decreases in equity (net assets) from peripheral or incidental transactions. Gains and losses can result from • sale of investments or plant assets, • settlement of liabilities, • write­offs of assets 8 LO 1: Understand the uses and limitations of an income statement Single-Step Format Single-Step The single­step statement consists of just two groupings: Revenues Expenses } Single­ Step Net Income No distinction between Operating and Non­operating categories. 9 LO 2: Prepare a single­step income statement Income Statement (in thousands) Revenues: S a le s $ 2 8 5 ,0 0 0 In te re s t re ve n u e 1 7 ,0 0 0 T o ta l re ve n ue 3 0 2 ,0 0 0 Expenses: C o s t o f g o o d s s o ld 1 4 9 ,0 0 0 S e llin g e xp e n s e 1 0 ,0 0 0 Ad m in is tra tive e xp e ns e 4 3 ,0 0 0 In te re s t e xp e n s e 2 1 ,0 0 0 In c o m e ta x e xp e ns e 2 4 ,0 0 0 T o ta l e xp e n s e s 2 4 7 ,0 0 0 Net income $ 5 5 ,0 0 0 Earnings per share $ 0 .7 5 Multiple-Step Format Multiple-Step Background Separates operating transactions from nonoperating transactions. Matches costs and expenses with related revenues. Highlights certain intermediate components of income that analysts use. 10 LO 3: Prepare a multiple­step income statement Multiple-Step Format Multiple-Step Income Statement Sections 1. Operating section 2. Nonoperating section 3. Income tax 4. Discontinued operations 5. Extraordinary items 6. Earnings per share 11 LO 3: Prepare a multiple­step income statement Multiple-Step Format Multiple-Step The presentation divides information into major sections. 1. Operating Section 2. Nonoperating Section Income Statement (in thousands) Sales: $ 2 8 5 ,0 0 0 C o s t o f g o o d s s o ld G ro s s p ro fit 1 4 9 ,0 0 0 1 3 6 ,0 0 0 Operating Expenses: S e llin g e xp e n s e s Ad m in is tra tive e xp e ns e s T o ta l o p e ra tin g e xp e ns e 1 0 ,0 0 0 4 3 ,0 0 0 5 3 ,0 0 0 Income from operations 8 3 ,0 0 0 Other revenue (expense): In te re s t re ve n u e 1 7 ,0 0 0 In te re s t e xp e n s e (2 1 ,0 0 0 ) 3. Income tax 12 LO 3: Prepare a multiple­step income statement T o ta l o th e r In c o m e b e fo re ta xe s In c o m e ta x e xp e ns e Net Income Earnings per share 4 ,0 0 0 7 9 ,0 0 0 2 4 ,0 0 0 5 5 ,0 0 0 0.75 Multiple-Step Format Multiple-Step Irregular items fall into six categories Irregular fall into six categories 1. Discontinued operations 2. Extraordinary items 3. Unusual gains and losses 4. Changes in accounting principle 5. Changes in estimates 6. Corrections of errors 13 LO 4: Explain how to report irregular items. Reporting Irregular Items Reporting Discontinued Operations occurs when, Discontinued occurs when, (a) company eliminates the results of operations and cash flows of a component (b) there is no significant continuing involvement in that component. Amount reported “net of tax.” 14 LO 4: Explain how to report irregular items. Reporting Discontinued Operations Reporting Illustration: KC Corporation had after tax income from continuing operations of Illustration: KC Corporation had after tax income from continuing operations of $55,000,000 in 2008. During 2008, it disposed of its restaurant division at a pretax loss of $270,000. Prior to disposal, the division operated at a pretax loss of $450,000 in 2008. Assume a tax rate of 30%. Prepare a partial income statement for KC. Income from continuing operations Discontinued operations: Loss from operations, net of $135,000 tax Loss on disposal, net of $81,000 tax Total loss on discontinued operations Net income 15 $55,000,000 $54,496,000 LO 4: Explain how to report irregular items. 315,000 189,000 504,000 Reporting Discontinued Operations Reporting Discontinued Operations are reported after “Income from continuing operations.” Income Statement ( in th o us a nd s ) Sales C o s t o f g o o d s s o ld $ 2 8 5 ,0 0 0 1 4 9 ,0 0 0 Other revenue (expense): Previously labeled as “Net Income”. Mo ve d to 16 LO 4: Explain how to report irregular items. Inte re s t re ve n ue 1 7 ,0 0 0 In te re s t e xp e n s e (2 1 ,0 0 0 ) T o ta l o th e r (4 ,0 0 0 ) In c o m e b e fo re ta xe s 7 9 ,0 0 0 In c o m e ta x e xp e ns e 2 4 ,0 0 0 Income from continuing operations 5 5 ,0 0 0 Discontinued operations: Loss from operations, net of tax 315 Loss on disposal, net of tax 189 Total loss on discontinued operations 504 Net Income $ 5 4 ,4 9 6 Reporting Irregular Items Reporting Extraordinary items are nonrecurring material items that are nonrecurring material items that differ significantly from a company’s typical business activities. Extraordinary Item must be both of an Unusual Nature and Occur Infrequently Company must consider the environment in which it operates. Amount reported “net of tax.” 17 LO 4: Explain how to report irregular items. Reporting Extraordinary Items Reporting Illustration: KC Corporation had after tax income from continuing Illustration: KC Corporation had after tax income from continuing operations of $55,000,000 in 2007. In addition, it suffered an unusual and infrequent pretax loss of $770,000 from a volcano eruption. The corporation’s tax rate is 30%. Prepare a partial income statement for KC Corporation beginning with income from continuing operations. Income from continuing operations $55,000,000 Extraordinary loss, net of $231,000 tax 539,000 Net income $54,461,000 ($770,000 x 30% = $231,000 tax) 18 LO 4: Explain how to report irregular items. Reporting Extraordinary Items Reporting Extraordinary Items are reported after “Income from continuing operations.” Income Statement ( in th o us a nd s ) Sales C o s t o f g o o d s s o ld $ 2 8 5 ,0 0 0 4 9 ,0 0 0 Other revenue (expense): Previously labeled as “Net Income”. Mo ve d to 19 Interest re ve n u e 1 7 ,0 0 0 In te re s t e xp e n s e (2 1 ,0 0 0 ) T o ta l o th e r (4 ,0 0 0 ) In c o m e b e fo re ta xe s 7 9 ,0 0 0 In c o m e ta x e xp e ns e 2 4 ,0 0 0 Income from continuing operations 5 5 ,0 0 0 Extraordinary loss, net of tax 539 Net Income $ 5 4 ,4 6 1 LO 4: Explain how to report irregular items. Reporting Irregular Items Reporting Reporting when both Discontinued Operations and Extraordinary Items are present. Discontinued Operations Extraordinary Item 20 LO 4: Explain how to report irregular items. Income Statement ( in th o us a nd s ) Sales C o s t o f g o o d s s o ld $ 2 8 5 ,0 0 0 4 9 ,0 0 0 Interest expense (21,000) Total other (4,000) Income before taxes 79,000 Income tax expense 24,000 Income from continuing operations 55,000 Discontinued operations: Loss from operations, net of tax 315 Loss on disposal, net of tax 189 Total loss on discontinued operations 504 Income before extraordinary item 5 4 ,4 9 6 Extraordinary loss, net of tax 539 Net Income $ 5 4 ,4 6 1 Reporting Irregular Items Reporting Unusual Gains and Losses Material items that are unusual or infrequent, but not both, should be reported in a separate section just above “Income from continuing operations before income taxes,” Examples can include: Write­downs of inventories Foreign exchange transaction gains and losses The Board prohibits net­of­tax treatment for these items. 21 LO 4: Explain how to report irregular items. Reporting Irregular Items Reporting Changes in Accounting Principles Retrospective adjustment Cumulative effect adjustment to beginning retained earnings Approach preserves comparability Examples include: change from FIFO to average cost change from the percentage­of­completion to the completed­ contract method 22 LO 4: Explain how to report irregular items. Reporting Irregular Items Reporting Changes in Estimate Accounted for in the period of change and future periods Not handled retrospectively Not considered errors or extraordinary items Examples include: Useful lives and salvage values of depreciable assets Allowance for uncollectible receivables Inventory obsolescence 23 LO 4: Explain how to report irregular items. Change in Estimate Example Change Change in Estimate: Arcadia HS, purchased equipment for $510,000 Change Arcadia HS, purchased equipment for $510,000 which was estimated to have a useful life of 10 years with a salvage value o f $10,000 at the end of that time. Depreciation has been recorded for 7 years on a straight­line basis. In 2010 (year 8), it is determined that the total estimated life should be 15 years with a salvage value of $5,000 at the end of that time. Questions: What is the journal entry to correct the prior years’ depreciation? 24 Calculate the depreciation expense for 2010 LO 4: Explain how to report irregular items. No Entry Required Change in Estimate Example (After 7 Years) (After Equipment cost Salvage value Depreciable base Useful Life (original) Annual depreciation $510,000 First, establish NBV at ­ 10,000 date of change in estimate. 500,000 10 years $ 50,000 x 7 years = $350,000 Balance Sheet (Dec. 31, 2009) Fixed Assets: Equipment $510,000 Accumulated depreciation 350,000 Net book value (NBV) $160,000 25 LO 4: Explain how to report irregular items. Change in Estimate Example (After 7 Years) (After Net book value Salvage value (new) Depreciable base Useful life remaining Annual depreciation $160,000 5,000 155,000 8 years $ 19,375 Depreciation Expense calculation for 2010 Journal entry for 2010 Depreciation expense 19,375 Accumulated depreciation 19,375 26 LO 4: Explain how to report irregular items. Reporting Irregular Items Reporting Corrections of Errors Result from: mathematical mistakes mistakes in application of accounting principles oversight or misuse of facts 27 Corrections treated as prior period adjustments Adjustment to the beginning balance of retained earnings LO 4: Explain how to report irregular items. Reporting Irregular Items Reporting Corrections of Errors: To illustrate, in 2011, Hillsboro Co. Corrections To illustrate, in 2011, Hillsboro Co. determined that it incorrectly overstated its accounts receivable and sales revenue by $100,000 in 2010. In 2011, Hillsboro makes the following entry to correct for this error (ignore income taxes). Retained earnings Accounts receivable 28 100,000 100,000 LO 4: Explain how to report irregular items. Special Reporting Issues Special Intraperiod Tax Allocation: Relates the income tax expense to the specific items that give rise to the items that give rise to the amount of the tax expense. Income tax is allocated to the following items: (1) Income from continuing operations before tax (2) Discontinued operations (3) Extraordinary items (4) Changes in accounting principle (5) Correction of errors 29 LO 5: Explain intraperiod tax allocation. Special Reporting Issues Special Intraperiod Tax Allocation: Extraordinary Gain: Schindler Co. has income before income tax and extraordinary item of $250,000. It has an extraordinary gain of $100,000 from a condemnation settlement received on one of its properties. Assuming a 30 percent income tax rate. Income before income tax and extraordinary item Income tax $250,000 75,000 Income before extraordinary item 175,000 Extraordinary gain­condemnation settlement $100,000 Less: Applicable income tax 30,000 70,000 Net income $245,000 30 LO 5: Explain intraperiod tax allocation. Special Reporting Issues Special Intraperiod Tax Allocation: Extraordinary Loss: Schindler Co. has income before income tax and extraordinary item of $250,000. It has an extraordinary loss from a major casualty of $100,000. Assuming a 30 percent income tax rate. Income before income tax and extraordinary item Income tax $250,000 75,000 Income before extraordinary item 175,000 Extraordinary item – loss from casualty $100,000 Less: Applicable income tax reduction 30,000 70,000 Net income $105,000 31 LO 5: Explain intraperiod tax allocation. Example of Intraperiod Tax Allocation Example Income Statement ( in th o u s a n d s ) Sales C o s t o f g o o d s s o ld $ 2 8 5 ,0 0 0 4 9 ,0 0 0 Note: losses reduce the total tax 32 Interest expense (21,000) Total other (4,000) Income before taxes 79,000 Income tax expense 24,000 Income from continuing operations 5 5 ,0 0 0 Discontinued operations: Loss from operations, net of $135 tax 315 Loss on disposal, net of $61 tax 189 Total loss on discontinued operations 504 Income before extraordinary item 5 4 ,4 9 6 Extraordinary loss, net of $231 tax 539 Net Income $ 5 4 ,4 6 1 LO 5: Explain intraperiod tax allocation Calculation of Total Tax $24,000 (135) (61) (231) $23,573 Special Reporting Issues Special Earnings Per Share Net income – Preferred dividends Weighted average number of shares outstanding Measures the dollars earned by each share of common stock. 33 An important business indicator. Must be disclosed on the income statement. LO 6: Identify where to report earnings per share information. Reporting Irregular Items Reporting Earnings Per Share (BE4-8): In 2010, Hollis Corporation reported Earnings In 2010, Hollis Corporation reported net income of $1,000,000. It declared and paid preferred stock dividends of $250,000. During 2010, Hollis had a weighted average of 190,000 common shares outstanding. Compute Hollis’s 2010 earnings per share. Net income – Preferred dividends Weighted average number of shares outstanding 1,000,000 ­ $250,000 = $3.95 per share 190,000 34 LO 6: Identify where to report earnings per share information. Special Reporting Issues Special Retained Earnings Statement Increase 35 Net income Change in accounting principle Error corrections Decrease Net loss LO 7: Prepare a retained earnings statement. Dividends Change in accounting principle Error corrections Special Reporting Issues Special Restricted Retained Earnings Disclosed 36 In notes to the financial statements As Appropriated Retained Earnings LO 7: Prepare a retained earnings statement. Special Reporting Issues Special Comprehensive Income All changes in equity during a period except those resulting from investments by owners and distributions to owners. Includes: 37 all revenues and gains, expenses and losses reported in net income, and all gains and losses that bypass net income but affect stockholders’ equity. LO 7: Prepare a retained earnings statement. Special Reporting Issues Special Comprehensive Income Income Statement (in thousands) $285,000 Sales: Cost of goods sold Gross profit 136,000 149,000 Operating Expenses: Selling expenses Administrative expenses Total operating expense 43,000 53,000 Income from operations 10,000 83,000 Other revenue (expense): Interest revenue Interest expense Total other Income before taxes Income tax expense Net Income 38 17,000 (21,000) (4,000) + Other Comprehensive Income • Unrealized gains and losses on available­for­sale securities. • Translation gains and losses on foreign currency. • Plus others 79,000 24,000 $55,000 LO 8: Explain how to report other comprehensive income. Reported in Stockholders’ Equity Special Reporting Issues Special Three approaches to reporting Comprehensive Income (SFAS No. 130, June 1997): 1. A second separate income statement; 2. A combined income statement of comprehensive income; or 3. As part of the statement of stockholders’ equity 39 LO 8: Explain how to report other comprehensive income. ...
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