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The Corporate Income Statement and the Statement of Stockholders’ Equity

The Corporate Income Statement and the Statement of Stockholders’ Equity. Chapter 13. Importance of Net Income. Expected changes in earning per share Expected return on equity. Quality of Earnings. Substance of earnings Sustainability into future accounting period Affected by

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The Corporate Income Statement and the Statement of Stockholders’ Equity

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  1. The Corporate Income Statement and the Statement of Stockholders’ Equity Chapter 13

  2. Importance of Net Income • Expected changes in earning per share • Expected return on equity

  3. Quality of Earnings • Substance of earnings • Sustainability into future accounting period • Affected by • The accounting methods and estimates the company’s management chooses • The nature of nonoperating items on the income statement

  4. Choice of Accounting Methods and estimates • Examples • Depreciation methods and estimates of long term assets • Criteria for deciding revenue versus capital expenditures • Methods for bond amortization • Estimate of uncollectible A/R • Estimate of expected environment cleanup costs

  5. Choices • Aging vs. Percentage of Net Sales • LIFO, FIFO, Weighted Average, Specific identification • Accelerated, production or straight-line depreciation method

  6. Effects • See spreadsheet demonstration on 595 • In general, an accounting method or estimate that results in lower current earnings is considered to produce a better quality of operating income

  7. Full Disclosure • Requires that management explain the significant accounting policies used in preparing the financial statements in a note to the statements

  8. Nonoperating items • Discontinued operations • Extraordinary gains and losses • Effects of accounting changes • Examples • Loss through restructuring charges • Gain through one time gain (medical companies through bio-terrorism)

  9. Comprehensive income • The change in a company’s equity during a period from sources other than owners and includes net income, change in unrealized investment gains and losses and other items affecting equity

  10. Deferred income taxes • Accounting income vs. taxable income • Can be a material difference • A simple example: magazine subscriptions are not recognized in financial income until the product is shipped, but for tax purposes they are usually recognized as revenue when cash is received. • The result is that taxes paid exceed tax expense, which creates a deferred income tax asset (or prepaid taxes)

  11. Net of taxes • Means that the effect of applicable taxes has been considered in determining the overall effect of an item on the financial statements

  12. Extraordinary items • “events or transactions that are distinguished by their unusual nature and by the infrequency of their occurrence” • Examples: • A gain or loss resulting from the passage of a new law • The expropriation of property by a foreign government

  13. Accounting changes • Need adequate justification • The cumulative effect of an accounting change should be shown on the income statement immediately after extraordinary items. • Relevant information about the change is shown in the notes to the financial statements

  14. EPS • Earning Per Share • Basic earning per share is net income applicable to common stock divided by weighted-average number of common shares outstanding • See demo on page. 603

  15. Capital structure • Simple • No bonds, stocks, or stock options that could be converted into common stock • Complex • Convertible securities have the potential of diluting the earning per share of common stock. • Diluted earning per share

  16. The statement of stockholders’ equity • Also called the statement of changes in stockholders’ equity • Summarizes the changes in the components of the stockholders’ equity section of the balance sheet • See page 605 Exhibit 2 and Exhibit 3

  17. Retained earnings • The part of stockholders’ equity that represents stockholders’ claims to assets arising from the earnings of the business • Are not the assets themselves • Means that assets as a whole have been increased since the date of its inception

  18. Stock Dividends • A proportional distribution of shares of a corporation’s stock to its shareholders. • It does not change the firm’s assets and liabilities b/c there is no distribution of assets. • The effect is to transfer a dollar amount from R/E to the CC section on the date of declaration • The amount is the fair market value of the additional shares to be issued

  19. Stock dividend • See demo on 609 • That is, a comparison of the stockholders’ equity before dividend and after dividend

  20. Stock split • Occurs when a corporation increases the number of issued shares of stock and reduces the par of stated value proportionally. • On page 610, see that before split and after split have the exact number on the right hand side but the par value has reduced to the same proportion.

  21. Book Value • The book value of a company’s stock represents the total assets of the company less its liabilities. • It is simply the stockholders’ equity of company, or • The company’s net assets

  22. The calculation of book value • The general rule is that the call value of the P/S plus any dividends in arrears is substracted from total stockholders’ equity to determine the equity pertaining to common stock. • See demo on page 611

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