Understanding Income Statements Flashcards
Different names for the I.S.
- statement of operations
- statement of earnings
- profit and loss (P&L) statement
Income - expenses = net income
Expenses on I.S. can be grouped together by either:
- Grouping by nature
- Grouping by function
Grouping by nature:
- Grouping expenses method
- group multiple line items of depreciation expenses into one line item, “Depreciation”
Grouping by function:
- grouping expenses method
- “cost of goods sold”: grouping labor, materials costs, depreciation, salaries, etc
I.S. presentation formats
- single-step: all revenues and all expenses are grouped together with no sub-totals
- multi-step: includes subtotals such as gross profit and operating profit
On the I.S., Accounts receivables is a ___________ and unearned revenue is a _____
AR: and asset on the I.S.
Unearned revenue: a liability on the I.S.
The 5 steps to follow in order to recognize revenue:
for IASB and FASB
- identify the contract(s) with the customer
- identify the performance obligations in the contract
- determine the transaction price
- allocate the transaction price to the performance obligations in the contract
- recognize revenue when (or as) the entity satisfies a performance obligation
Matching principle
- expenses incurred to generate revenue are recognized in the same period as revenue
- ex. if some goods bought in the current year remain unsold at the end of the year, they are not included in the cost of goods sold for the current year. If they are sold in the next year, they will be included in the cost of goods sold for the next year.
Periodic costs
- cant be tied directly to the generation of revenues
- rent paid
- these costs are expensed in the period paid
Inventory methods
- FIFO
- LIFO
- Weighted avg cost
- Specific identification
Doubtful account estimate required by the matching principle:
- record an estimate of credit losses, using historical data, at the time of revenue recognition
Warranty expense required by the matching principle:
- estimate a warranty expense, using historical data, at the time of revenue recognition
Conservative approach to expense recognition - can affect net income
- recognition of expenses early (doubtful accts, warranty expenses, and depreciation amounts)
Aggressive approach to expense recognition - can affect net income
- the company delays the recognition of expenses
Retrospective approach
- financial statements in previous years are presented as if the newly adopted accounting principle had been used throughout the period
- a change in accounting policy is applied retrospectively, ex: shifting from LIFO to FIFO
Prospective application
- only financial statements for the period of change and for future periods are changed
- changes in accounting estimates are applied prospectively, ex changing accounting estimates of the useful life of a depreciable asset
Operating items and non-operating items under IFRS:
- no definition of operating activities - companies use judgement to classify
Operating items and non-operating items under GAAP:
- operating activities involve producing and delivering goods and providing services
- all others are considered investing or financing activities
- ex interest expense, extraordinary items
Potentially dilutive securities:
- will decrease EPS when exercised
- securities that can be converted into ordinary shares
- includes convertible bonds, convertible preferred stock, and employee stock options
Simple v Complex capital structure
- complex capital structure: if a company has potentially dilutive securities, simple if not
Anti-dilutive securities
- if exercised, it increases EPS
- only dilutive securities are included in diluted EPS calculations
Basic EPS formula =
basic EPS = (( NI - PREFERRED dividends) / weighted avg # sh.o )
total sh.o Jan 1: 10,000
additional shs added 7/1: 2000
find weighted avg sh.o EOY =
- the number of sh.o during the year, weighted by the portion of the year they were outstanding
10,000 sh to start the year and 12,000 total at EOY
= (10,000 sh * 6 months/12months) + (12,000 sh / 6months/12months)
Diluted EPS (If-converted) formula =
Diluted EPS =
(NI + after tax interest - preferred dividends + convertible pref divs / weighted avg shs + new shs if convertible debt is converted)
After tax interest: conv debt int (1 - t)
- applies to convertible bonds
- add the after-tax interest cost savings to the numerator
= (# of convt bonds * par * coupon %) * (1 - t)
Diluted EPS: for stock options
- use the “treasury stock method”
- assumes that the funds received by the company from the exercise of options are used to purchase shs of the company’s common stock at the avg market price over the reporting period
denominator = # of shs created with the exercise - # of shs hypothetically repurchased with the proceeds of the exercise
- # of options * strike price = x (proceeds to firm)
- x / avg stock price = y (the number of shs the firm repurchased)
- x - y (the net new shares issued)
In general, EPS increases if:
- EPS increases if
NI increases, a decrease in the number of sh.o, or a combination of both
Common-size analysis of I.S.
- shows each line item on the I.S. as a percentage of revenue
- removes effects of company size
Gross profit margin:
= gross profit / revenue
Operating profit margin:
= operating profit / revenue
Net profit margin:
= net profit / revenue
Higher margin ratios are better and achieved by:
increasing selling prices and or lowering costs
Other comprehensive income (OCI):
- includes transactions that are not included in net income
- “amount that bypassed the I.S.
Both IFRS and GAAP:
- unrealized gain/losses from available for sale securities
- foreign currency translation adjustments
- unrealized gains/losses on derivative contracts used for hedging
- adjustments for minimum pension liability
Comprehensive Income (CI)
Both IFRS and GAAP
- the sum of NI and OCI
- measures all changes to equity apart from owner contributions and distributions (ie, those resulting from transactions with shareholders: dividends paid and stock repurchases are not included in CI)
OCI formula:
OCI =
ending sh.e - (beg sh.e + NI - divids paid)
