Understanding Income Statemets Flashcards
Income statements report the revenues and expenses of the firm over a period of time.
Income statement equation
revenues - expenses = net income
Net Revenue
= revenue less adjustments for estimated returns and allowances
Net Income equation
net income = revenues - ordinary expenses + other income - other expenses + gains - losses
Gross profit
the amount that remains after the direct costs of producing a product or service are subtracted from revenue.
Accrual accounting method recognizes revenue when earned and expenses when they are incurred. It doesn’t follow the payment of cash.
…
Revenue is recognized when it is realized and earned.
…
SEC’s four criteria for revenue recognition:
- Evidence of arrangement between buyer and seller
- Product has been delivered
- Price is determined
- Seller is reasonably sure of collecting money
Unearned revenue
- when a firm receives cash before revenue recognition
- Unearned Revenue = liability, Assets ^ and Liabilities^
Long-term contracts
- percentage of completion is measured by the total cost incurred to date divided by the total expected cost of the project.
- Under GAAP, contract completed method is used when the outcome of a project cannot be reliably estimated.
- Revenue, expense and profit are recognized only when contract is complete.
- Loss must be immediately recognized under both.
Installment Sales
- An installment sale occurs when a firm finances a sale and payments are expected to be received over a period of time
- If collectability is certain, revenue is recognized at time of sale. If collectability is not certain, installment method is used.
- In installment method, profit is recognized as cash is collected.
- profit = cash collected * total expected profit as % of sales
Cost-recovery method
profit is recognized only when cash collected exceeds costs incurred.
Barter Transactions
- In barter transaction, 2 parties exchange goods/services without cash payment
Roundtrip Transaction
involves sale of goods to one party with the simultaneous purchase of almost identical goods for same payment.
Gross revenue reporting
the selling firm reports sales revenues and COGS separately
Net revenue reporting
= difference in sales and COGS reported
Under US GAAP, gross revenue reporting must have a firm that:
- Primary obligor in contract
- Bear the inventory and credit risk
- Be able to choose its supplier
- Have reasonable latitude to establish the price
FIFO v. LIFO
- LIFO is utilized often due to its tax benefits.
- LIFO is prohibited by IFRS
Weighted average cost
- Makes no assumption about physical flow of inventory.
- COGS / units available
The depletion of an assets life, by category, is known as…
- depreciation – for tangible
- depletion – for natural resources
- amortization – for intangible
Straight-line depreciation
- equal amount of depreciation per period.
= (cost - residual value) / useful life
Accelerated depreciation
lower depreciation in early age of asset, and generally increases as the asset ages.
Declining balance method
- applies a constant rate of depreciation to an assets book value
= (2/useful life)( cost- accumulated depreciation)
Amortization
the allocation of the cost of an intangible asset over its useful life
- firms use straight-line depreciation on intangibles
- goodwill not amortized
Discontinued operations
- nonrecurring item
- management decided the dispose of, but either not yet done so, or has disposed of in current year after the operation has generated income/losses.
- recorded separately on income statement net of tax
Examples of unusual/infrequent items
- gains/losses from sale of asset
- write offs for restructuring debts
- REPORTED BEFORE TAX
Extraordinary items
Under GAAP, it is a material transaction or event that is unusual and infrequent.
Examples:
- gains/losses from early retirement of debt
- Uninsured losses from natural disasters
Reported separately on IS, net of tax
IFRS does not allow it to be separated from operating results
Non-operating transactions
Income from investments or expense from financing
Earnings per Share
EPS is a common measure of firm profitability
= (net income - preferred dividends) / (weighted average of common shares outstanding)
Dilutive Security
examples = options, warrants and convertible security
Indilutive Security
examples = common stock, nonconvertible debt
Simple capital structure contains no potentially dilutive securities.
Complex capital structures contains potentially dilutive securities.
- firms must report basic and diluted EPS if complex
Dilutive securities would decrease EPS if exercised or converted to common stock.
Indilutive securities would increase EPS if exercised.
For convertible preferred stock being dilutive, converted preferred dividends must be added to earnings available to common stockholders
…
If convertible bonds are dilutive, then the bonds after-tax interest expense is not considered an interest expense for diluted EPS. Interest expense multiplied by (1-tax rate) must be added back to the numerator
…
Treasury Stock Method
Assumes that the funds received by the company from the exercise of the options would be hypothetically purchase share of the company’s common stock at average market price.
- a net increase in the number of shares created by exercising the options less number of shares hypothetically repurchased with proceeds of exercise.
Diluted EPS
= (adjusted income available for common shares) / (weighted average common and potential common shares)
= [(net income - preferred dividends) + (convertible preferred dividends) + (convertible debt interest)*(1-tax rate)] / [(weighted average shares) + (shares from conversion of convertible preferred shares) + (shares from conversion of convertible debt) + (shares issued from stock options)]
Common size income statement expresses each category of the income statement as a percentage of revenue
- it eliminates the effects of size, allowing for a comparison across time (time-series) and across firms (cross-sectional)
Tax expense is more meaningful when expressed as a percentage of pretax income
= effective tax rate.
Gross profit margin
= gross profit / revenue = revenue - COGS
Net profit margin
net income / revenue
Net income = Retained Earnings in stockholders’ equity
…
Comprehensive Income
Sum of net income and all other income, including:
- Foreign currency translation
- Adjustment for minimum pension liability
- Unrealized gains/losses from cash flow hedging derivatives
- Unrealized gains/losses from available for-sale securities
