Reading 24 Understanding Income Statements Flashcards
The basic equation underlying the income statement
Net Income = Revenue - Expenses
The income statement is referred to as
- Statement of operations
- Statement of earnings
- Profit and loss statement
Revenue
my be called sales or turnover, and it generally refers to amounts charged (and expected to be received) for the delivery of goods or services in the ordinary activities of a business.
Net Revenue
the revenue number is reported after adjustments (e.g, for cash or volume discounts, or for estimated returns)
Gross profit (gross margin)
It’s revenue less cost of sales, i.e., the cost of delivering goods or services. When an income statement shows a gross profit subtotal, it is said to use a multi-step format rather than a single-step format.
Operating profit (sometimes referred to as EBIT, but operating profit and EBIT are not necessarily the same)
results from deducting operating expenses such as selling, general, administrative, and research and development expenses from gross profit.
Income statement format
- Unusual or infrequent items (nonrecurring items): reported “above the line” and presented on a pretax basis
- - G/L from the sale of assets or part of a business
- - Impairments, write-offs, write-downs, and restructuring costs - Extraordinary items (presented on net of tax)
- Loss from expropriation of assets
- Gains or losses from early retirement of debt
- Uninsured losses from natural disasters
- Discontinued operations: presented on net of tax
- Accounting changes (footnotes)
- Change in accounting principle (might be retrospective)
- Change in accounting estimate (prospective and not a below line item)
Unearned revenue (revenue recognition policies should be disclosed in the notes to the financial statements)
when a company receives cash in advance and actually delivers the product or service later, perhaps over a period of time. in this case, the company would record a liability for UNEARNED REVENUE when the cash is initially received, and revenue would be recognized as being earned over time as products and services are delivered.
US GAAP criteria on reporting gross revenues
the company is the primary obligor under the contract, bears inventory risk and credit risk, can choose its supplier, and has reasonable latitude to establish price. if these criteria are not met, the company should report revenues net.
Companies should disclose their revenue recognition policies in:
the notes to their financial statement, often in the first note.
Long-lived assets
assets expected to provide economic benefits over a future period of time greater than one year (land, plant, equipment)
Intangible assets
assets lacking physical substance (trademarks)
Two main types of long-lived assets whose costs are not allocated over time:
land and those intangible assets with indefinite useful lives.
Two ways to allocate costs for long-lived assets
Depreciation and amortisation (which requires the estimate of 1. useful life of an asset and 2. the residual value, i.e., salvage value)
In most cases under IFRS and US GAAP, amortisable intangible assets are amortised using the straight-line method with no residual value.
Goodwill and intangible assets with indefinite life are not amortised. Instead, they are tested at least annually for impairment.
Two items should stay under the line
- discontinued operations and 2. extraordinary items (is not permitted under IFRS)
Basic EPS
(Net income – Preferred dividends) / Weighted average number of shares outstanding
Two analytical tools to analyze the income statement:
- Common-size analysis: state each line item on the income statement as a percentage of revenue.
- Income statement ratios
Other comprehensive income types under both IFRS and US GAAP
- Foreign currency translation adjustments.
- Unrealized gains or losses on derivatives contracts accounted for as hedges
- Unrealized holding gains and losses on a certain category of investment securities, namely, available-for-sale securities
- Certain costs of a company’s defined benefit post-retirement plans that are not recognized in the current period
