Chapter 6

1. Chapter 6 The Income Statementand Measures of Performance

2. Chapter 6--Learning Objectives 1. Explain the different concepts of income, cash, economic, and accrual-based income measures

3. Concepts of Income Cash Basis Economic Accrual Basis

4. Cash Basis Income Income = Cash inflow - Cash outflow Not reported as income under GAAP Reported in Statement of Cash Flows as net cash flow from operating activities

5. Economic Income Based on concept of “well-offness” Economic Income is the maximum amount that can be distributed to owners during the accounting period and leave the business as well off at the end of the accounting period as it was at the beginning of the period

6. Economic Income • A Capital maintenance concept of income • Income is the change in “value” of the net assets of the business during the accounting period • Measurements of assets and liabilities would be based on “fair value” at the balance sheet date, i.e., the present value of expected future cash flows

7. Accounting IncomeAccrual Basis Income • Transactions based • The change in net assets is measured utilizing historical cost (with modifications) • A financial capital maintenance concept of income

8. Accrual Basis IncomeCharacteristics • Revenue recognized when earned • Expenses matched with revenue • Based on historical cost Income = Revenue + Gains - Expenses - Losses

9. SFAC 1 • Objectives Of Financial Reporting • To provide information • Useful in Investment & Credit Decisions • Useful in Assessing Cash Flow Prospects • About Enterprise Resources, Claims to Those Resources, & Changes in Them

10. SFAC 1: Enterprise Performance & Earnings • The primary focus of financial reporting • Expectations about future performance are commonly based on past performance • Accrual based earnings provide a better indication of performance than cash flows • Relate Benefits and Costs of Operations, Events & Circumstances that affect the Enterprise

11. Accrual Basis Accounting Income • Consistent with the concept of Financial Capital Maintenance • Income = the change in net assets occurring during the period excluding transactions with owners

12. Chapter 6--Learning Objectives 2. Demonstrate the format of the income statement

13. Income Statement • Includes the following elements of financial statements • Revenues • Expenses • Gains & Losses

14. Income Statement Formats • Single Step • Multiple Step

15. Single Step Revenues & Gains minus Expenses & Losses Including Income Taxes

16. Single-step income statement form Revenues: Sales revenue $XXX Interest income XXX Dividend revenue XXX Gain on sale of equipment XXX Other income XXX Total revenue XXX

17. Single-step income statement form Expenses: Cost of goods sold XXX Selling & administrative expense XXX Interest expense XXX Loss on sale of land XXX Other expense XXX Provision for income taxes XXX Total expenses XXX

18. Multiple-step income statement form Sales revenue $XXX Cost of goods sold XXX Gross profit XXX Operating expenses: Selling & administrative expense XXX Other operating expenses XXX Operating expenses XXX Income from operations XXX

19. Multiple-step income statement form Other revenue and gains: Interest revenue XXX Gain on sale of equipment XXX Other expenses and losses: Loss on sale of land XXX Other expenses XXX Other revenue (expense) XXX Income before taxes XXX Provision for income taxes XXX Net Income XXX

20. Income statement form • Both single-step and multi-step formats are acceptable • APB Opinion No. 30 requires special presentation of: Discontinued operations Extraordinary items Cumulative effects of changes in accounting principles

21. Elements of the income statement Sales and operating revenues Revenues from sales less discounts, returns and allowances Cost of goods sold Beginning inventory plus purchases (net of returns & allowances but including transportation) less ending inventory Operating expenses Normally classified as administrative expenses and selling expenses

22. Elements of the income statement Non-operating items Revenues, expenses, gains and losses outside the normal operations of the business Provision for income taxes Includes federal, state and local income taxes Special reporting items Discontinued operations, extraordinary items and accounting changes

23. Chapter 6--Learning Objectives 3. Specify which circumstances qualify as special reporting items, and explain how to measure and report those special items on the income statement

24. Extraordinary ItemsAPB 30 Absent discontinued operations, the following main captions should be reported in the income statement if extraordinary items are reported Income before Extraordinary Item XXX Extraordinary Item (less applicable taxes of $____) XXX Net Income XXX

25. Net sales XXX CGS XXX Gross profit XXX Operating expenses XXX Income from operations XXX Other…(non operating items) XXX Income before tax & extraordinary item XXX Income tax XXX Income before extraordinary item XXX Extraordinary item (net of tax) XXX Net income XXX

26. Extraordinary Items? APB 30 • Events and transactions that are distinguished by their unusualnature and infrequency of occurrence

27. Unusual Nature • Abnormal • Significantly different from ordinary and typical activities of the entity • Beyond the control of management

28. Unusual Nature • Primary consideration • The environment in which the entity operates • Characteristics of the industry • Geographical location • Extent of governmental regulation

29. Infrequent • Not reasonably expected to recur in the foreseeable future • Take into account the environment in which the entity operates • Prior occurrence provides evidence to assess the probability of recurrence

30. Extraordinary ItemsExamples • Results of a major casualty, e.g., • Earthquake • Expropriation • Prohibition under a newly enacted law or regulation

31. Items which are NEVER considered to be extraordinary • Write-downs of receivables and inventories • Foreign exchange gains and losses • Gains and losses from sale or abandonment of property, plant and equipment • Labor disturbances

32. Accounting Change APB 20 • Change in Accounting Principle • Change in Reporting Entity • Change in Estimate

33. Change in Accounting Principle • Changing from one generally accepted accounting principle to another • Examples: • Change from LIFO to FIFO • Change from SYD Depreciation to Straight-line

34. Change in Reporting Entity • When a company has investments in other entities over which it exercises significant influence or control • Change • how the investment is reported in the balance sheet and income statement • Example • Change from the equity method of accounting to consolidation

35. Change in Estimate • Change in “good faith” estimate • Prompted by • Environmental changes • Availability of new information • Examples • Change in estimate of useful life of building • Change in fair value of investments in “trading securities”

36. Accounting Treatments for Accounting Changes • Current • Retroactive • Prospective

37. Current Treatment • Report Cumulative Effect in the Income Statement • Do not restate prior financial statements • Report Pro-forma Effects for • Income before extraordinary items • Net Income

38. Cumulative effect in income statement APB 30 Income from 0perations XXX Other…(non operating items) XXX Income before extraordinary item and cumulative effect of accounting change XXX Extraordinary item (less taxes of $____) XXX Cumulative effect of accounting change (less taxes of $_____) XXX Net income XXX

39. When to apply Current Treatment • Changes in Principle • Exceptions are treated retroactively • Example • Change from Straight-line Depreciation to Double Declining Balance

40. Retroactive Treatment • Report cumulative effect as an adjustment to the beginning balance of Retained Earnings • Restate prior financial statements • No need to report separate Pro-formas

41. Retroactive treatment is required for • Changes from LIFO • Changes to or from full cost method in the extractive industry • Changes to the equity method of accounting for investments in stock • Changes in accounting for long-term contracts • Changes from retirement/replacement accounting to other depreciation methods • Changes associated with an IPO of stock

42. Discontinued operations: APB: 30 Income from continuing operations before tax XXX Income tax expense XXX Income from continuing operations XXX Discontinued operations (less taxes) XXX Extraordinary Items (less taxes) Cum effect of accounting change (less taxes) XXX Net income XXX

43. Discontinued Operations: APB 30 • Separately identifiable segment which is being disposed of • A major class of business • Separately identifiable assets, liabilities, revenues, and expenses

44. Discontinued Operations In the Income Statement • Two components • Income (loss) from operations • Gain (loss) from disposal

45. Discontinued Segment Income (Loss) from Operations • Disclosed when the decision to discontinue was made after the beginning of the year • Amount of income (loss) is determined from the beginning of the year to the date the decision is made to discontinue a segment’s operations (measurement date)

46. Gain (loss) from disposal of segment assets • Gain (loss) during the phase-out period • Phase-out period can extend to subsequent accounting period

47. The Possibilities • Measurement Date & Disposal Date occur in same accounting period • Measurement Date occurs in current period, Disposal Date occurs in a subsequent accounting period

48. Measurement Date & Disposal Date in Same Period Year End Beginning of year Measurement Date Disposal Date A B Phase Out Realized Gain (Loss)

49. Disposal Date in Subsequent Period Year End 2 Beginning of year Measurement Date Year End 1 Disposal Date A B C Realized Gain (Loss) Estimated Gain (Loss)

50. Disposal During a Subsequent Period - Special Rules • A realized Loss on disposal • Increase by estimated loss • Decrease by estimated gain (but only to zero) • A realized Gain on disposal • Decrease by estimated loss • Do not increase by estimated gain