Lecture 03 Income Statement Flashcards
1
Q
What is the income statement?
A
- The income statement (also called profit and loss statement, or statement of operations, or statement of earnings) shows details about the resource inflows and outflows that generate value for the entity’s equity owners.
- Net income, i.e., the net amount of all these inflows and outflows, is a change in the amount of owners’ equity on the balance sheet, specifically, the balance of the retained earnings account.
- (Recall from the accounting equation that an increase in equity means that either assets have increased or liabilities have decreased. Hence, the equity owners’ claims to the entity’s resources have increased.)
2
Q
What is income?
A
- The resource inflows on the income statement are called income, defined as increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.
3
Q
What are expenses?
A
The resource outflows are called expenses and are defined as
decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.
4
Q
What is the difference between revenues and gains?
A
- Revenues are inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations.
- Gains are increases in equity (net assets) from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity except those that result from revenues or investments by owners.
5
Q
What is the difference between (operating) expenses and losses?
A
- Expenses are outflows or other using up of assets or incurrences of liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity’s ongoing major or central operations.
- Losses are decreases in equity (net assets) from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity except those that result from expenses or distributions to owners.
6
Q
How do we decide if inflows and outflows should be netted?
A
- In any transaction pertaining to the entity’s central ongoing business operations, revenue (inflows) and related expenses (outflows) are captured separately on the income statement.
- In any incidental or peripheral transaction, the related inflows and outflows are added together on the income statement into a single net gain (or loss) amount.
7
Q
What is the standard hierarchy of items in an income statement?
A
- Sales revenue, followed by cost of sales (or cost of goods sold). The net of the two is the entity’s gross profit.
- Operating expenses, including operating gains and losses. The net of gross profit and operating expenses is the entity’s operating profit.
- Other income (or expenses), mostly financial items. The net of operating profit and other income is the entity’s net income before income taxes.
- The provision for income taxes, subtracting which yields the entity’s net income (after tax).
8
Q
What are the two methods of grouping items on the income statement?
A
- one can aggregate costs by their nature (labor, material, depreciation, service fees, utility, insurance, …); or
- one can aggregate costs by their function (cost of sales, administration, marketing, research and development, …).
9
Q
What are some items usually found on an income statement grouped by nature?
A
- Cost of materials
- Labor expense
- Depreciation expense
10
Q
What are some items usually found on an income statement grouped by function?
A
- Selling, General, and administrative expenses
- Research and Development expenses
11
Q
What are the items that appear after the net income line?
A
- Disbanded or sold business segments or divisions are shown as ‘discontinued operations,’ including their operating profit (loss) in the periods preceding the shutdown and the gain (loss) on disposal.
Income from discontinued operations is shown net of tax, on a single line. - At the bottom of the income statement, you can find the earnings per share (i.e., net income divided by the average number of shares outstanding during the year).
12
Q
What is other comprehensive income?
A
- A few income items are not shown on the face of the income statement. These are referred to as other comprehensive income (OCI).
- OCI is presented in the statement of comprehensive income, underneath the income statement, and is shown net of income taxes. Comprehensive income is the sum of net income and OCI.
- OCI flows into retained earnings under IFRS and into a separate equity account called accumulated other comprehensive income under US GAAP.
- Some OCI gains and losses are reversed (recycled) later and moved into regular income, when the underlying asset or liability is sold or settled.
13
Q
What items are usually included in other comprehensive income?
A
Other comprehensive income (OCI) includes income items that are considered (relatively) volatile and uninformative:
- most gains and losses in the value of assets and liabilities denominated in foreign currency, as a result of exchange rate movements;
- gains and losses in post-retirement benefit obligations from changes in actuarial assumptions;
- value changes in certain financial investments and obligations, including, e.g., derivative instruments designated as cash flow hedges and debt investments designated as ‘available-for-sale;’
- fair value changes in long-term assets (optional and only under IFRS).
14
Q
What is the statement of changes in owners’ equity?
A
- Net income is the most important, but not the only, component of the change in equity between two balance sheet dates.
- The statement of changes in owners’ equity summarizes the various changes (including net income) to equity since the previous balance sheet date and thereby reconciles the beginning and ending equity balances.
- This linkage between the financial statements is called articulation.
15
Q
What are the two types of income recognition?
A
- Accrual-basis income vs cash-basis income
- Accrual income mirrors the accretion or consumption of economic value. Its principle is causality.
- Cash-basis income tracks cash payments as they are incurred. Its principle is chronology.
