Chapter 4: The Income Statement Flashcards
Usefulness:
• Evaluates past performance of the company
• provides basis for predicting future performance
• help assess the risk/uncertainty of achieving future cash flows
Limitations:
• Companies omit items they cannot measure reliably
• income is affected by the accounting methods employed
• income measurement involves judgement
Quality of earnings:
• Refers to ability of reported earnings to predict a company’s future earnings
- companies have incentives to meet or beat wall street expectations so market price of stock increases and value of stock option increase
Reduced if earnings management results information that is less useful for predicting future earnings and cash flows
What is the content and format of the income statement?
1.) revenues
2.) expenses
3.) gains
4. ) losses
The multistep income statement
- Separates operating transactions from non operating transactions
- matches cost and expenses with related revenues
- highlights certain components of income that analyst use assessing financial performance
What are the different sections of the multistep income statement?
1.) Operating section
2.) non operating section
3.) income tax
4.) discontinued operations
5.) non controlling interest
6.) earnings per share
Single step income statement
Consists only of revenues, expenses, and net income. Does NOT separate operating and non operating transactions
Reporting income items fall into these 4 categories:
1.) unusual/infrequent gains and losses - high degree of abnormality and not typically observed.
2.) Discontinued operations - company eliminates the results of operations of a component of the business.
- strategic shift having a major effect on the company’s operations and financial results
3.) non controlling interest - portion of equity interest in a subsidiary not attribute to the parent company
4.) earnings per share - net income - preferred dividends/ weighted average of common shares outstanding
What does recasting refer to?
Adjusting financial statements from what was previously reported by removing or adjusting items on your financial statements that are unrelated to the ongoing business.
What does the changes in Accounting principle include?
- Change in method inventory from FIFO to average cost
- Change in Accounting construction contests from construction of completion to completed contract method.
Essentially, a change in policies in evaluation.
Retrospective judgment for financial statements.
What does the change in Accounting estimates include:
Adjustment of carrying amount of an asset or liability, or related expenses resulting from the reassessment of expected future benefits and obligations with that asset or liability.
Examples: change in useful lives of property and equipment, uncollectible receivables, obsolete inventory, and warranty obligations.
Uses prospective judgement for financial statements.
Corrections of errors:
*Can occur from mathematical mistakes, mistakes in application of accounting principles, misuse of facts.
* corrections of errors are treated as prior adjustments.
Retained earnings statement:
*Increases with > net income, change in Accounting principles, prior period adjustments.
- Decreases with > net loss, dividend, change in Accounting principles, prior period adjustments.
Restrictions on retained earnings:
Company agrees to maintain retained earnings at a certain level, may appear as a footnote or will show as its own separate line on balance sheet.
Comprehensive income:
Changes in equity during a period except those resulting from investments by owners and distributions to owners.
Includes all revenues, gains, expenses, and losses reported in net income and all gains and losses that bypass net income but does not affect stockholders equity.
