Chapter 4: Income Statement and Related Information

Question 1

Corrections of errors on financial statements

Answer 1

Treated as prior periods adjustments:

1) make proper entries
2) report corrections in financial statements

Recorded in year discovered - show as adjustment to beginning retained earnings
- restate any prior statements to include adjustments

Shown net of tax

Question 2

Multi-step income statement

Answer 2

Operating Section
- sales or revenue (net of returns/ discounts/ allowances)
- Cost of goods sold
- selling expenses
- administrative/ general expenses
Non-Operating section
- other revenue / gains
- other expenses/ losses
Income Tax
Discontinued Operations
Noncontrolling interest
Earnings per share

Question 3

Change in accounting principle

Answer 3

Must demonstrate that new principle is preferable

results in loss of consistence - requiring retrospective adjustment

shown net of tax

Question 4

Changes in accounting estimates

Answer 4

NOT shown net of tax

New info can change even good faith estimates

• accounts for change in period affected or period affected + future periods affected, but never past

Not errors

Question 5

Retrospective adjustment

Answer 5

When accounting principle change

recasts prior years statements on a basis consistent with newly adopted principle

• records cumulative affect of change for prior periods as an adjustment to beginning retained earnings for earliest year presented

Question 6

Revenues

Answer 6

inflows or other enhancements of assets of an entity of 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

Question 7

EBITDA

Answer 7

Earnings before interest, taxes, depreciation and amortization

Non-GAAP financial measure

Question 8

Non-GAAP Reporting

Answer 8

Financial measures on financial statements not in accordance with GAAP but that companies claim are more indicative of true results/ operations

Often show higher income numbers than GAAP

creates difficulty in cross-company comparison.

SEC requires these to be reconciled to GAAP

Question 9

Quality of earnings

Answer 9

Usefulness of reporting for predicting future earnings and cash flow

Question 10

Earnings Management

Answer 10

Planned timing of revenues, expenses, gains and losses to smooth out bumps in earnings

choices made in accounting methods to provide more favorable statements of earnings (could be increases or decreases)
“cookie jar reserves”

Question 11

Modified all-inclusive concept

Answer 11

Income reporting method
- companies record most revenue/ expense items INCLUDING unusual / infrequent items as part of net income

Certain items are required to be highlighted:

• unusual and infrequent gains and losses
• discontinued operations
• noncontrolling interest
• earnings per share

Question 12

Current operating performance approach

Answer 12

An income reporting method

most useful income measures reflect only regular and recurring revenue and expense elements

(unusual / infrequent events not considered informationally useful)

Question 13

Natural Expense Classification

Answer 13

COGS
Selling Expenses
Admin/General expenses

manufacturing and wholesale merchandisers

Question 14

Functional Expense classification

Answer 14

example:
Administrative
Occupancy
Publicity
Buying
Selling

(retail store use)

Question 15

Discontinued Operations

Answer 15

two requirements:

1) company eliminates the results of operations of a component of business
2) elimination of the component represents a strategic shift (has a major affect on company’s financial result)

Usually disposal of:

• major business line
• major geographical area
• major equity investment

Question 16

Component of a business

Answer 16

Operation and cash flow that can be clearly distinguished operationally and for financial purposes

Question 17

Intraperiod tax allocation

Answer 17

Allocation of tax within the income statement of a period

relates income tax expense (provision) to specific items that gave rise to it

Helps understand impact of income tax and future cash flows

discourages pretax measures of performance

Question 18

Noncontrolling interest

Answer 18

The portion of equity interest in a subsidiary not attributable to the parent company

Question 19

Restrictions of retained earnings

Answer 19

• contract requirements, board policy etc…
• disclosed in notes to financial statements
  or transferred to “appropriated retained earnings” account
• still reported on statement of retained earnings

Question 20

Comprehensive income

Answer 20

Due to fair value measurement some items are excluded from net income and reported only as “accumulated other comprehensive income”
- unrealized gains and losses and AFS debt investments

includes all changes in equity during a period except those resulting from investments by or distributions to owners

Question 21

Income statement usefulness

Answer 21

Measures the success of operations in a given period of time

Provides information to investors / creditors

• predicting future cash flow
• evaluating past performance
• predicting future performance (trends)
• assess the risk or uncertainty of achieving future cash flows
• operating vs non-recurring information

Question 22

Income Statement Limitations

Answer 22

• companies omit items they cannot measure reliably
  - unrealized gains or losses on certain investment
  - brand value
• income numbers are affected by the accounting methods employed
  - depreciation type, inventory type
  - estimating asset useful life, future warranty/ bad debt costs
• income measurement involves judgement

Question 23

Transaction approach to income statement

Answer 23

focuses on income-related activities that have occurred in the period

(vs capital maintenance approach: income determined based on changes in equity after adjusting for capital contributions and distributions)

Question 24

Elements of the income statement

Answer 24

Revenues: sales, fees, interest, dividends, rents

Expenses: COGS, depreciation, interest, rent, salaries, taxes

Gains/Losses: sale of investments, settlement of liabilities, write off due to impairment

Revenue/Expenses: affects assets/ liabilities (operations)
Gain/ Loss: affects equity (non-operational)

Question 25

Unusual/ infrequent gains and losses

Answer 25

Required to be in the income statement or in notes to financial statements Truly unusual or infrequent accounting for normal operating enviroment still income before taxes NOT reported net of tax

Question 26

Single Step income statement

Answer 26

Total revenues (listed out and totaled) less total expenses (listed out and totaled) = net income (income tax may be separated out)

Question 27

Condense Income statement

Answer 27

company includes only totals for expense groups on the income statement and then includes supplementary schedules with supportive numbers

Question 28

Income from discontinued operations on income statement

Answer 28

Discontinued Operations Gain or loss from operations Gain or loss from disposal Total Usually shown net of tax "income from continuing ops" only used when discontinued operations also shown

Question 29

EPS and Discontinued operations

Answer 29

Company must include per share effect of income from continuing operations + net income - must report share amounts for discontinued operations on IS or in the notes Per share: - income from Operations EPS - income from discontinued operations EPS - Net income total EPS

Question 30

Intraperiod Tax Allocation

Answer 30

Loss or gain from Discontinued operations Less applicable income tax (or reduction) Separates the taxes from continuing operations and discontinued operations may also be given in notes

Question 31

Noncontrolling interest on a consolidated income statement

Answer 31

Consolidated net income (parent + subsidiary) Less; net income attributable to non-controlling interest = Net income attributable to stockholders and parent company must also be accounted for in EPS

Question 32

Corrections on retained earning statemen

Answer 32

Reconcile with beginning balance ``` Retained earnings at date (as reported) Correction (net of tax) Retained earnings at date (as adjusted) + net income / - net loss less cash/ stock dividends = Retained Earnings end of period ```

Question 33

Comprehensive income on financial statements

Answer 33

One statement approach: buries net income (statement of comprehensive income) - traditional net income is shown as subtotal - total comprehensive income is final total Two statement approach: - create income statement totaled with net income - separate comprehensive income statement Net income +/- other gains/ losses

Question 34

Statement of Shareholder's Equity

Answer 34

Shows changes in stockholder's equity - used instead of a detained stockholder's equity section on Balance Sheet and Retained Earnings statement Shows changes in each stockholders' equity account throughout the year: - common stock - capital in excess of par - Retained earnings - Treasury stock - total each shows beginning balance +/- various transactions and ending balance shows contributions, dividends, net income etc...

Question 35

Accumulated other comprehensive income on the balance sheet

Answer 35

Shown SEPARATE from stock and retained earnings in stockholder's equity section (shows a complete picture of changes in net assets)

Question 36

Income Tax on income Statement

Answer 36

``` Sales less COGS = Gross Profit Less Operating Expenses = income from operations +/- other gains or losses = income before income taxes LESS INCOME TAX EXPENSE = Net income ```

Question 37

Corporate income statement

Answer 37

Continuing operations Income from continuing operations Discontinued operations Net income Earnings per share of common stock outstanding Income from continuing ops: Income from discontinued operations: Net income EPS:

Question 38

Receivables on income statements

Answer 38

Bad debt expense + service charge expense = selling expenses interest revenue goes under other revenue and gains (not operating)

Question 39

Sales revenue section of income statement

Answer 39

``` Sales Revenue Sales Less; Sales returns and allowances Less; Sales discounts = Net Sales ```

Question 40

Discontinued Operations on income statement

Answer 40

reported on income statement after income from continuing operations

Question 41

Comprehensive Income on Statement of Comprehensive Income

Answer 41

Shows net income + or - comprehensive items: like available for sale securities (unrealized gains and losses) reported separately from net income to remove the market volatility from income but gives information to users as to cash realized if securities were sold Also shows on balance sheet

Question 42

Extraordinary items on income statements

Answer 42

Reported after income from continuing operations - after discontinued operations if they exist - always stated net of tax

Question 43

Earnings per share

Answer 43

EPS Sale under IFRS and GAAP Net income minus preferred dividends / weighted average common shares outstanding (weighted average required if number of shares has changed during the year) FASB requires that this is on the income statement Shows net income earned by each share outstanding of COMMON stock

Question 44

Net of tax

Answer 44

Full amount x (1-tax rate) = net of tax amount

Question 45

GAAP vs IFRS comprehensive income reporting

Answer 45

Now converged