Chapter 5 The Income Statement. 2 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Business...

Chapter 5The

Income Statement

2

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

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Beginning of Year End of Year

Income Measurement

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Accrual Accounting

• Raw transaction data is refined from– When paid/collected to– When incurred/earned

• Resulting from transactions of the current period

• Measures economic performance

Different Measuresof Income

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Different Measures Of Income

Increase in wealth– a simple definition

Physical capital maintenance– income is earned only when there

is an increase in actual physical resources

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Financial capital maintenance– income exists when the dollar

amount of a company’s net assets increases during the year, excluding the effects of owner investments and dividends

– this is the approach that accountants use to measure income


Sales– Cost of goods sold= Gross profit– Other operating expenses, gains, and losses= Operating income– Interest expense± Miscellaneous revenues, expenses, gains,

and losses= Income before taxes– Income tax expense= Income from continuing operations± Income from discontinued operations± Extraordinary items± Cumulative effect of accounting changes= Net income± Unrealized gains and losses not included in

net income= Comprehensive income

operating income minus interest expense, income tax expense, and other miscellaneous items





income from continuing operations adjusted for “below the line” items

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“Below the Line” Items

Income or loss from discontinued operations

– results from the disposal of a major business segment

Extraordinary gains and losses– unusual in nature and infrequent in

occurrence

Cumulative effect of accounting changes

– a “catch-up” adjustment for a change to a new accounting method`





net income plus (minus) changes in market condition unrelated to business operations

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Unrealized Gains & Losses

• Changes in the dollar value of foreign subsidiaries caused by movement of foreign currency exchange rates

• Changes in the value of investment securities that are not actively traded

• Changes in the value of certain derivative financial instruments

Individual Income Statement Items

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Revenues

• The value of the goods and services provided by a company in its business operations– Sales revenue: the aggregate

selling price of goods sold during the period

– Service revenue: fees charged for services

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Non-Operating Revenues

• Interest revenue: earned from extending credit or loaning money

• Other revenue: comprised of revenues that come from different sources

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Expenses

The value of resources used in generating reported revenue

Cost of goods sold: the expense directly associated with the sales revenue for the period

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Expenses (con’t)

Selling General, & Administrative Expense

– Research and development•Expensing required

– Wages and salaries– Bad debt

•The cost of selling merchandise on credit

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Expenses (con’t)

Depreciation – Allocation of the cost of long-lived

assets

Interest expense– The cost of borrowing money

Income tax expense– The sum of all income tax

consequences of all transactions during a year

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Gains and Losses

Created by activities peripheral to a company’s primary operations

– Sale of long-term assets– Restructuring charges

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“Below the Line” Items

All reported net of applicable income taxes

– Income (or loss) from discontinued operations

– Extraordinary (unusual and infrequent) gains and losses

– Cumulative effect from change in accounting principle

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Comprehensive Income

Reflects the overall change in a company’s wealth during a period.

Includes three items not reported in net income:

– Foreign currency translation adjustment– Unrealized gains and losses on

available-for-sale securities– Deferred gains and losses on derivative

financial instruments

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Earnings Per Share (EPS)

• The amount of net income associated with each share of stock

• Two earnings per share numbers:– Basic EPS reports earnings based

solely on shares actually outstanding during the year

– Diluted EPS reflects the existence of stock options and other potentially dilutive securities

Single-Step Income Statement

2003 2002 2001Net Sales & Revenues

Net Sales of manufactured products $153,683 $145,341 $143,666Financial services revenue 12,762 12,674 11,664 Other income 11,729 5,998 4,924

Total Net Sales and Revenues 178,174 164,013 160,254

Costs and ExpensesCost of sales and other operating charges,

exclusive of items listed below 130,028 123,195 121,300 Selling, general and administrative expenses 16,192 14,580 12,550 Depreciation and amortization expenses 16,616 11,840 11,213 Interest expense 6,113 5,695 5,182 Other deductions 1,511 2,083 1,678

Total Costs and Expenses 170,460 157,393 151,923

Income before income taxes 7,714 6,620 8,331 Income taxes 1,069 1,723 2,316

Income from continuing operations 6,645 4,897 6,015 Income from discontinued operations - 10 900 Cumulative effect of accounting change - - (52)

NET INCOME 6,645$ 4,907$ 6,863$

Basic Earnings Per Share 8.70$ 6.06$ 7.28$ Diluted Earnings Per Share 8.62$ 6.02$ 7.21$

QUICK BUCK CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF INCOME

Years Ended December 31,

Multiple-Step Income Statement

2003 2002 2001Net Sales of manufactured products $153,683 $145,341 $143,666Cost of sales and other operating charges, exclusive of items listed in operating expenses 130,028 123,195 121,300 Gross profit 23,655$ 22,146$ 22,366$

Operating expenses:Selling, general and administrative expenses 16,192 14,580 12,550 Depreciation and amortization expenses 16,616 11,840 11,213

Operating income (loss) (9,153)$ (4,274)$ (1,397)$

Financial services revenue 12,762 12,674 11,664 Other income 11,729 5,998 4,924 Interest expense (6,113) (5,695) (5,182) Other deductions (1,511) (2,083) (1,678) Total non-operating revenues and expenses 16,867 10,894 9,728 Income before income taxes 7,714 6,620 8,331

Income taxes 1,069 1,723 2,316 Income from continuing operations 6,645 4,897 6,015

Income from discontinued operations - 10 900 Cumulative effect of accounting change - - (52)

NET INCOME 6,645$ 4,907$ 6,863$

Basic Earnings Per Share 8.70$ 6.06$ 7.28$ Diluted Earnings Per Share 8.62$ 6.02$ 7.21$

QUICK BUCK CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF INCOME

Years Ended December 31,

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Revenue Recognition

Revenue is recognized when– The promised work is done, and– Cash collectibility is reasonably

assured

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Expense Recognition

Is based on the matching principle– An expense should be recognized in

the same period in which the revenue it generates is recognized

Three bases of expense recognition:– Direct matching (or cause and effect)– Systematic allocation– Immediate recognition

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Expense Recognition:Direct Matching

The expense is directly traceable to the revenue it generates (cause and effect)

Cost of goods sold matched with sales

Sales commissions matched with sales

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Expense Recognition:Systematic Allocation

The expense is associated more with the passage of time than a specific revenue-generating activity

Depreciation expenseInsurance expense

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Expense Recognition:Immediate Recognition

An expenditure is expensed currently because there is no future benefit or the future benefit is uncertain

Advertising expenseResearch and development expense

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Expanded Accounting Equation

Assets = Liabilities + Stockholders’ Equity

Paid-In Capital + Retained Earnings

Beginning RE + Net Income - Dividends

Revenues + Gains – Expenses - Losses

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Tx Cash InventoryPrepaid

Ins. Land Buildings Equip.Accounts Payable

Loan Payable

Mortgage Payable

Paid In Capital

1 700,000 700,0002 300,000 300,0003 (100,000) 50,000 400,000 350,0004 (650,000) 650,0005 [no transaction]6 [no transaction]7 (10,000) 90,000 80,0008 (15,000) 15,000

225,000 90,000 15,000 50,000 400,000 650,000 80,000 300,000 350,000 700,000

Veda Landscape Solutions

January 1 transactions

(from chapter 4)

Unearn BankAccts Prepd Accts Wages Fchise Int Loan Mtg

Cash Rec Inven Ins Land Bldgs Equip Pay Pay Rev Pay Pay PayBalance, January 1 225,000 90,000 15,000 50,000 400,000 650,000 80,000 300,000 350,000 9. Purchased inventory 1,300,000 1,300,00010. Sold inventory 200,000 900,000 (800,000)11. Consulting services 200,00012. Collected consulting 160,000 (160,000)13. Landscaping work 500,000 (100,000)14. Collected retail 820,000 (820,000)15. Paid suppliers (1,200,000) (1,200,000)16. Employee wages (460,000) 40,00017. Paid lease (9,600)18. Paid SG&A (150,000)19. Franchise 50,000 50,00020. Accrued interest 58,00021. Insurance expired (15,000)22. Depreciation (20,000) (130,000)23. Dividends (5,000)Balance, December 31 130,400 120,000 490,000 0 50,000 380,000 520,000 180,000 40,000 50,000 58,000 300,000 350,000

LdnscpPaid-in Sales Consult Lndscp Cost Supplies Wages SG&A Int DepCapital Rev Rev Rev GS Exp Exp Exp Exp Exp Div

Balance, January 1 700,000 9. Purchased inventory10. Sold inventory 1,100,000 (800,000)11. Consulting services 200,00012. Collected consulting13. Landscaping work 500,000 (100,000)14. Collected retail15. Paid suppliers16. Paid employees (500,000)17. Paid lease (9,600)18. Paid SG&A (150,000)19. Franchise20. Accrued interest (58,000)21. Insurance expired (15,000)22. Depreciation (150,000)23. Dividends (5,000)Balance, December 31 700,000 1,100,000 200,000 500,000 (800,000) (100,000) (500,000) (174,600) (58,000) (150,000) (5,000)

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Transaction Analysis

• Key points to remember– Revenues increase retained earnings– Expenses decrease retained earnings– Dividends decrease retained earnings

• The income statement can be prepared from the revenue and expense columns of the spreadsheet

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Sales Revenue 1,100,000$ Consulting Revenue 200,000 Landscaping Revenue 500,000

Total Revenues 1,800,000$

Expenses:Cost of Goods Sold 800,000$ Landscaping Supplies Expense 100,000 Wages Expense 500,000 Selling, General, and Administrative Expense 174,600 Interest Expense 58,000 Depreciation Expense 150,000

Total Expenses 1,782,600

Net Income 17,400$

Veda Landscape SolutionsIncome Statement

For the Year Ended December 31, 2006

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Past income statements can be used to predict income in future periods

Good forecasting requires an understanding of what factors determine the amount of a future revenue or expense

Forecasting the Future

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Forecasting begins with a forecast of sales

The sales forecast forms the basis of predicting the future balance sheet, income statement, and statement of cash flows

Forecasting Sales

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Natural Increase– Cash, accounts receivable,

inventory, and accounts payable

Long-term Planning– Property, plant, and equipment

Financing Choices– Long-term debt and paid-in capital

Forecasting the Balance Sheet

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Forecasting the Income Statement

Income Statement Element Related To

Cost of Goods Sold Sales

Wage Expense Sales

Depreciation ExpenseProperty, Plant and Equipment

Interest Expense Debt

Income Tax Expense Pre-tax income

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Forecasting the Income Statement

Income Statement Element Related To

Cost of Goods Sold Sales

Wage Expense Sales

Depreciation ExpenseProperty, Plant and Equipment

Interest Expense Debt

Income Tax Expense Pre-tax income

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In Summary ...

• A variety of income measurements• Income statement reports revenues,

expenses, gains, and losses• Comprehensive income includes

additional unrealized gains and losses• Expanded accounting equation• Forecasting the future from historical

statements

Chapter 5 The Income Statement. 2 Financial Accounting, 7e Stice/Stice, 2006 © Thomson Business...

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