Income Statement. Single-Step Income Statement Revenue All types are listed and totaled Expenses ...

Income Statement

Single-Step Income Statement

Revenue All types are listed and

totaled Expenses

All types are listed and totaled

Difference is Net Income (Loss)

Multiple-Step Income Statement Separate sections Various subtotals reflect

different levels of profitability.

(continues)(continues)

Components of the Income Statement

1. Revenue2. Cost of goods sold3. Operating expenses4. Other revenues and gains5. Other expenses and losses6. Income taxes on continuing

operations

RevenueRevenue

Revenue reports the total sales to customers for the period less any sales returns and allowances or discounts.


Cost of Goods SoldCost of Goods Sold


Beginning inventory+ Net purchases+ Freight-in+ Other inventory acquisition costs= Cost of goods available for sale– Ending inventory= Cost of goods sold

Net sales – Cost of goods sold = Gross profit

Gross profit ÷ Net sales = Gross profit percentage

Gross profit ÷ Net sales = Gross profit percentage

Gross ProfitGross Profit


Operating expenses may be reported in two parts:

1.1. Selling expenses

Operating ExpensesOperating Expenses

2.2. General and administrative expenses


Operating income measures the performance of the fundamental business operations conducted by a company.

Operating IncomeOperating Income


Gross profit– Operating expenses= Operating income

This section usually includes items identified with the peripheral activities of the company.

• Rent revenue• Interest revenue• Dividend revenue• Gains from the sale of assets

Other Revenues and GainsOther Revenues and Gains


This section parallels “Other Revenues and Gains” except the items result in deductions from operating income.• Interest expense• Losses from the sale of

assets

Other Expenses and LossesOther Expenses and Losses


Gain or loss from the sale or termination of operations

Gain or loss from the operations themselves

Disclose financial details in financial statement notes

Discontinued Operations

Extraordinary Items

Events and transactions Unusual in nature Infrequent in occurrence.

Not Extraordinary

The write-down or write-off of receivables, inventories, equipment leased to others, etc.

The gains or losses from exchange or remeasurement of foreign currencies

The gains or losses on disposal of business segment

Other gains or losses from sale or abandonment of productive assets

The effects of a strike Adjustment of accruals on long-term

contracts

Changes in Accounting Principles Criteria for change:

1. Change in economic conditions suggests that an accounting change will provide better information.

2. The FASB issues a new pronouncement requiring a change in principle.

Changes in Accounting Principles

A company is required to determine how the income statement would have been different in past years if the new accounting method had been used all along.

Income statements for all years presented must be restated using the new accounting method.


Changes in Accounting Principles The beginning balance of Retained

Earnings for the oldest period presented should reflect an adjustment for the cumulative income effect of the accounting change on the net income of all preceding years for which a detailed income statement is not presented.

Include information as if the change were retroactive—direct and indirect effects.

Disclosure requirements include: Employ current and prospective

approach. Report current and future financial

statements on new basis. Present prior periods as previously

reported. Make no adjustments to current

period opening balances.

Change in Estimate

If there is both a change in principle and a change in estimate for an item, the event is treated as a change in estimate.

Change in Estimate

Earnings Per Share

Earnings-per-share figures: Computed for income from

continuing operations. Calculated for each irregular or

extraordinary item.

Earnings per share =

Income from continuing operations

Weighted average number of shares of common stock outstanding

Earnings Per Share

Comprehensive Income

The number used to reflect an overall measure of the change in a company’s wealth during the period

Includes items that arise from changes in market conditions unrelated to the business operations of a company

Include a report of comprehensive income as part of the statement of stockholders’ equity.

Comprehensive Income

The more common adjustments made in arriving at comprehensive income are:• Foreign currency translation

adjustments• Unrealized gains and losses on

available-for-sale securities• Deferred gains and losses on

derivative financial instruments

Balance Sheet


Classified Balance Sheet

(concluded)(concluded)

Classified Balance Sheet

Current Assets

Cash and resources expected to be converted to cash during the entity’s normal operating cycle or one year, whichever is longer, are current assets.

Cash Receivables Inventories

Listed before noncurrent assets

Listed in the order of their liquidity, with the most liquid items first.

Current Assets Assets

Noncurrent Assets

Investments Property, plant, and equipment Intangible assets Deferred income taxes

Investments

Assets held for long-term purposes Regular income Appreciation Ownership control

Properties of a tangible and relatively permanent nature that are used in the normal business operations.

Plant, Property, and Equipment

Land Buildings Machinery Tools

Long-term rights and privileges of a nonphysical nature acquired for use in business operations.

Intangible Assets

Goodwill Patents Trademarks Franchises

Obligations expected to be paid using current assets or by creating other current liabilities.

•Accounts and notes payable

•Accrued expenses•Current portion of long-

term obligations•Unearned revenues

Current Liabilities Liabilities

Short-Term ObligationsShort-Term Obligations

Expected to be refinanced or paid back with the proceeds of a replacement loan

Will not require the use of current assets even though it is scheduled to mature within a year

Current Liabilities Liabilities

The existing loan is not classified as current as long as:1. The intent of the company is to

refinance the loan on a long-term basis.2. The company’s intent is evidenced by

an actual refinancing after the balance sheet date but before the financial statements are finalized or by the existence of an explicit refinancing agreement.

Current Liabilities

Noncurrent Liabilities

Current liabilities do not usually include: Debts to be liquidated from a

noncurrent sinking fund. Short-term obligations to be refinanced.

•Long-term debt•Long-term lease obligations•Deferred income tax

liability•Pension obligations

Obligations not reasonably expected to be paid or otherwise satisfied within 12 months.


Reported at its discounted present value When a note, bond issue, or a mortgage

becomes payable within a year, it should be reclassified as a current liability.

For a capital lease, the present value of the future minimum payments is recorded as a long-term liability.

Most large companies include deferred income tax liabilities on the balance sheet.


Contingent Liabilities

Potential claims that involve uncertainty as to possible losses

Definite obligation with only the amount in question and subject to estimation on the balance sheet date.

Owners’ Equity

Also called stockholders’ or shareholders’ equity

Generally divided into two parts: Contributed capital (also known as

paid-in-capital) Retained earnings

Contributed Capital

Two parts of contributed capital:1. Capital stock — the number of shares the par

valuea. Preferred stock — usually pays a fixed

annual cash dividend and provides rights to recover investment in case of bankruptcy

b. Common stock — provides real ownership of the corporation and grants voting power, but holders are last in line for assets in case of bankruptcy

2. Additional paid-in capital — investment by shareholders in excess of par value of capital stock

Retained Earnings

Retained earnings (RE) — the amount of undistributed earnings of past periods

RE deficit — an excess of dividends and losses over earnings results in a negative retained earnings balance

Sometimes, retained earnings is restricted and unavailable for cash dividends.

Treasury Stock

Stock issued and subsequently bought back by a company

Treasury shares can be retired, or they can be retained and reissued later.

Format of the Balance Sheet

Generally: Assets and liabilities presented in

order of liquidity Presented in comparative form,

including data from both the current year and the previous year

Foreign balance sheets frequently list the current assets and current liabilities together.

(continues)

(concluded)(concluded)

Statement of Cash Flows

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Statement of Cash Flows

How did a company acquire cash and how did it spend it?

Why did cash increase/decrease during the period?

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Purposes of the Statement of Cash Flows Predict future cash flows Evaluate management decisions Predict ability to pay debts and to

pay dividends

Reporting Cash Flows

1. Cash flows from operating activities are cash flows from transactions that affect net income.

2. Cash flows from investing activities are cash flows from transactions that affect the investments in noncurrent assets.

3. Cash flows from financing activities are cash flows from transactions that affect the equity and debt of the business.

Noncash Investing and Financing Activities

Noncash investing and financing activities are transactions that do not involve cash. The effect of such transactions is recorded in a separate schedule that appears at the bottom of the statement of cash flows.

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Operating Activities

Inflows – cash receipts from earning revenues Sale of goods or

services Interest revenue Dividend revenue Other revenues

Outflows – cash paid from incurring expenses Salaries and wages Payments to

suppliers for inventory

Taxes and fines Interest paid to

lenders Other expenses

Focus your attention on: income statement, and changes in current assets, current liabilities

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Investing Activities

Transactions that increase and decrease long-term assets

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Inflows Selling long-term

productive assets Selling equity

investments Collecting of

principal on loans Other

Outflows Purchase long-

term productive assets

Purchase equity investments

Purchase debt investments

Make loans

Focus your attention on changes in:plant assets, long-term investments, other long-term assets

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Financing Activities

Increases and decreases in long-term liabilities and owner’s equity

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Inflows Issuing stock Issuing bonds and

notes

Outflows Cash dividends or

withdrawals by owner

Purchase treasury stock

Repay cash loans

Focus your attention on changes in:long-term debt and stockholder’s equity

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Format of the Statement of Cash Flows

Two acceptable methods for reporting cash flows from operating activities1. Indirect method2. Direct method

The Investing and Financing sections of the statement will not differ

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Indirect Method

Cash flows from operating activities:Net incomeAdjustments to reconcile net income to net

cash provided by operating activities:+ Depreciation / amortization / depletion

expense+ Loss on sale of long-term assets- Gain on sale of long-term assets- Increases in current assets other than cash+ Decreases in current assets other than cash+ Increases in current liabilities- Decreases in current liabilitiesNet cash provided by operating activities

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Indirect and Direct Method

Cash flows from investing activities:

+Sales of long-term assets - Purchases of long-term assetsNet cash provided by (used for)

investing activities

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Indirect and Direct Method

Cash flows from financing activities:+ Issuance of stock+ Sale of treasury stock- Purchase of treasury stock+ Issuance of notes or bonds payable - Payment of notes or bonds payable- Payment of dividendsNet cash provided by (used for)

financing activities

Orchard Blossom Company

Direct Method

Sales and Cash Collected from Customers

Beginning accounts receivable $ 40+ Sales 150= Cash available for collection $190 Ending accounts receivable 60= Cash collected from customers $130

Direct Method

Cost of Goods Sold and Cash Cost of Goods Sold and Cash Paid for InventoryPaid for Inventory

Ending inventory $ 75+ Cost of goods sold 80= Required inventory $155 Beginning inventory 100= Inventory purchased this year $ 55

Direct Method

Wages Expense and Cash Paid for Wages

Beginning wages payable $ 7+ Wages expense 25= Total obligation to employees $32– Ending wages payable 10= Cash paid for wages $22

Operating Activities Section Operating Activities Section of the Statement of Cash of the Statement of Cash

Flows—Direct MethodFlows—Direct Method

Direct Method

Indirect Method

SalesSales

The $20 increase in accounts receivable means that cash collected is $20 less than the $150 the sales number indicates. So, the necessary adjustment is to subtract the $20 to show that $130 was collected on account.

Cost of Goods Sold

The $25 decrease in inventory means that although cost of good sold of $80 is included in the income statement, less cash was used to purchase inventory than suggested—add $25 to net income.

Indirect Method

Wages Expense

The $3 increase in wages payable indicates that only $22 of the $25 expense was paid in cash. The $3 increase in wages payable is added to net income.

Indirect Method

Depreciation Expense

The $30 depreciation expense is a noncash expense. It must be added back to net income because it was deducted from net income to determine the accrual net income.

Indirect Method

Note the same net cash from operating activities as calculated using the direct method.

Indirect Method

Comparison of Direct and Indirect Methods

Direct MethodDirect Method

Focus on this column

Indirect Method

Comparison of Direct and Indirect Methods

Focus on this column

Step 1

Compute how much the cash balance changed during the year.


Cash increased $10 during the year.Cash increased $10 during the year.


Step 2

Convert the income statement from an accrual-basis to a cash-basis summary of operations. Start with depreciation.


Step 3

Analyze the long-term assets to identify the cash flow effects of investing activities.



Cash Inflow• Sale of plant assets• Sale of securities,

other than trading securities

• Collection of principal on loans

Cash Outflow• Purchase of plant

assets• Purchase of

securities, other than trading securities

• Making of loans with other entities

Land

Because there is no indication of a land sale, we conclude that land

increased by $15 during the year..


The building account increased $40. We are told that a building was sold for $32 during the year.


Building

Building

Cash proceeds (given) $32Book value ($36 $14) 22Gain on sale of building $10


Known


Building

Building(s) costing $76 must have been purchased during the year.

Building

Step 4

Analyze the long-term debt and stockholders’ equity accounts to determine the cash flow effects of any financing transactions.


Cash Inflow• Issuance of own

stock

• Borrowings

Cash Outflow• Dividend

payments• Repaying

principal on borrowing

• Treasury stock purchase

Long-Term Debt

We can infer that Orchard Blossom repaid $21 in long-term loans during the year.

Retained Earnings

Retained earnings decreased by $9. We know there was a $15 net income, so we can use a T-account to determine the amount of the dividend.

Long-Term Debt

The $6 debit, or “squeeze” figure, has to be the dividends declared (and we will assume paid) during the year.

Step 5

Prepare a formal statement of cash flows.

Step 6

Prepare supplemental disclosures.• Cash paid for interest and

income taxes• Noncash investing and

financing activities

Income Statement. Single-Step Income Statement Revenue All types are listed and totaled Expenses ...

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