Chapter 4 Class Notes

Chapter 4 Class Notes - Chapter 4 INCOME STATEMENT AND...

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Unformatted text preview: Chapter 4 INCOME STATEMENT AND RELATED INFORMATION The Income Statement is the report that measures the success of company operations for a given period of time. The business and investment community uses the Income Statement to determine profitability, investment value, and creditworthiness. It provides investors and creditors with information that helps them predict the amounts, timing, and uncertainty of future cash flows . Usefulness of the Income Statement 1. Evaluate past performance 2. Predicting future performance 3. Help assess the risk or uncertainty of achieving future cash flows Limitations of the Income Statement 1. Companies omit items that cannot be measured reliably 2. Income is affected by the accounting methods employed 3. Income measurement involves judgment Quality of Earnings Companies have incentives to manage income to meet or beat Wall Street expectations, so that • The market price of stock increases and • The value of stock options increases 1 Earnings management is the planned timing of revenues, expenses, gains and losses to smooth out bumps in earnings. In most cases, companies use earnings management to increase income in the current year at the expense of income in future years . Or, companies also use earnings management to decrease current earnings in order to increase income in the future – the use of “cookie jar” reserves . The quality of earnings is reduced if earnings management results in information that is less useful for predicting future earnings and cash flows. IMPORTANT DEFINITIONS : REVENUES – inflows or other enhancements of assets of an entity or settlements of its liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations EXPENSES – outflows or other using-up of assets or incurrences of liabilities during a period from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity’s ongoing or central operations GAINS – increases in equity (net assets) from peripheral or incidental transactions of an entity except those that result from revenues or investments by owners LOSSES – decreases in equity (net assets) from peripheral or incidental transactions of an entity except those that result from expenses or distributions to owners Gains and losses can result from: a. sale of investments or plant assets b. settlement of liabilities c. write-off of assets Single-Step Income Statement A single-step income statement consists of just two groupings - revenues and expenses....
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This note was uploaded on 12/09/2011 for the course ACC 371 taught by Professor Proscott during the Spring '11 term at S. Alabama.

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Chapter 4 Class Notes - Chapter 4 INCOME STATEMENT AND...

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