Income Statement Chapter 4
What is Income Statement? What is the major difference between Income Statement and Balance Sheet?
Income Statement Balance Sheet Reports the assets, liabilities, and owner’s equity At a specific date Presents the revenues And expenses and resulting net income Or net loss For a specific Period of time
Usefulness of the income Statement • Evaluate the past performance of the enterprise • Predict future performance • Assess the risk of achieving future cash flows
Limitations of the Income Statement • Items that might be relevant but cannot be reliably measured are not reported • Some numbers depend on accounting methods used • Some numbers depend on judgments and estimates
Format of the Income Statement • Gross Profit is the excess of net sales over the cost of goods sold. • Net Income is the amount by which revenues exceed expenses. • Net Loss is the amount by which expenses exceed revenues. • Revenue is the gross increase in owner’s equity resulting from business activities entered into for the purpose of earning income. • Expense is the cost of assets consumed or services used in the process of earning revenue. • Net sales “sales less sales returns and allowance and sales discount” • Cost of goods sold is the total cost of merchandise sold during the period.
Elements of income statement • Revenues • Expenses • Gains • Losses
Single-Step Income Statement Two groups exist • Expenses are deducted from revenues to arrive at net income or net loss • Income tax is reported separately as the last item before net income to indicate its relationship to income before income tax Revenues Expenses
Multiple-Step Income Statement It provides more useful information because: • It separates operating and non-operating activities. • It classifies expenses by function. • It allows instant comparisons and ratio computations which evaluate performance of the company
Income Statement Sections 1- Operating Section A-Sales or RevenueUsually presented as sales minus sales discounts, returns, and allowances. B-Cost of Goods represents the amount a product cost you. C-Selling expenses represent expenses needed to sell products (e.g., sales salaries and commissions, advertising, freight, shipping, depreciation of sales equipment). D- General and administrative expenses represent expenses to manage the business (e.g., officer salaries, legal and professional fees, utilities, insurance, depreciation of office building and equipment, stationery supplies)
2- Non-operating section A- Other revenues or gains - revenues and gains from other than primary business activities (e.g. rent, patents). It also includes unusual gains and losses that are either unusual or infrequent, but not both (e.g. sale of securities or fixed assets). B-Other expenses or losses - expenses or losses not related to primary business operations. 3- Income Tax 4- Irregular items A- Discontinued operations (e.g. Shifting business location, stopping production temporarily). • Discontinued operations are classified as a separate items shown in a separate section in the income statement after continuing operations but before extraordinary items.
B-Extraordinary items - unusual (abnormal) and infrequent, for example, unexpected nature disaster, expropriation, prohibitions under new regulations. Note: nature disaster might not qualify depending on location. • Separate section in the income statement entitled “Extraordinary items” between discontinued operations and changes in principles. C- Changes in accounting principle - for example, changing method of computing depreciation from straight-line to sum-of-the-years'-digits. However, changes in estimates (e.g. estimated useful life of a fixed asset) do not qualify. • The effect on net income of adopting the new accounting principle should be disclosed as a separate item following extraordinary items in the income statements. “between extraordinary items and net income”
5- Earnings per share Net Income – Preferred Dividends = Earnings per Share Weighted Average of Common Shares Outstanding EPS is “the net income earned by each share of outstanding common stock”. Outstanding stock is “capital stock that has been issued and is being held by stockholders”. Dividend is “a distribution by a corporation to its stockholders on proportional basis”.
Exercise Presented below are selected ledger accounts of Garden Corporation at Dec 31, 2004 Sales 3,040,000 Depreciation of Furniture 15,000 Sales discount 40,000 Sales commissions 17,000 Freight-out 12,000 Miscellaneous expense 3,000 Officers’ salaries 120,000 Loss on sale of assets 6,000 Inventory, Jan 1, 2004 40,000 Insurance expense 4,000 Loss due to earthquake 275,200 Tel expense 5,000 Purchases 2,020,000 Advertising expense 8,000 Gain on sales of investments 200,000 Rent expense 30,000 Purchase returns and allowance 20,000 Freight-in 8,000 Inventory, Dec 31 88,000 Instructions Prepare the income statement for 2004. Assume that 100,000 shares of common stock are outstanding. And dividends applicable to preferred stock SR10,000.