The Income Statement and the Statement of Stockholders' Equity

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The Income Statement and the Statement of
Stockholders Equity
Chapter 11
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Learning Objective 1
Analyze a complex income statement.
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Evaluating theQuality of Earnings
The quality of earnings takes into consideration
how net income is generated.
Income from continuing operations is considered
of higher quality than gains from selling off
assets because it is a better predictor of future
earnings.
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Income StatementContinuing Operations
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Income StatementContinuing Operations
Operating income 79,000 Other gains
(losses) Loss on restructuring operations
8,000 Gain on sale of machinery
19,000 Income from continuing operations before
income tax 90,000 Income tax
expense 36,000 Income from continuing
operations 54,000
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Income StatementSpecial Items
Discontinued operations 35,000, less income
tax of 14,000 21,000 Income before
extraordinary items and cumulative effect of
change in depreciation method 75,000 Extra
ordinary flood loss, 20,000, less income tax
savings of 8,000 12,000 Cumulative effect of
change in depreciation method, 10,000, less
income tax of 4,000 6,000 Net
income 69,000
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Income StatementEarnings per Share
Earnings per share of common stock (20,000 shares
outstanding) Income from continuous
operations 2.70 Income from discontinued
operations 1.05 Income before extraordinary
item and cumulative effect of change in
depreciation method 3.75 Extraordinary
loss (0.60) Cumulative effect of change
in depreciation method 0.30 Net
income 3.45
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Continuing Operations
The company restructured operations at a loss of
8,000.
Although the restructuring loss is part
of continuing operations, it is highlighted as an
Other item on the income statement because
restructuring falls outside of the main business
endeavor.
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Continuing Operations
Income from continuing operations can be used in
estimating the value of Allied Electronics
common stock.
The investment capitalization rate is used to
estimate the value of an investment in the
capital stock of another company.
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Continuing Operations
Assume an interest rate (i) of 12 to valuate
Allied.
Estimated value of Allied Electronics common stock
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Continuing Operations
Current market value of the company
Number of shares of common stock outstanding
Current market price per share


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Continuing OperationsInvestment Decision
The investment decision rule may take this form
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Continuing OperationsInvestment Decision
Investors often make their decisions based on the
value of a single share of stock
Estimated value of one share of common stock
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Irregular Items
1. Discontinued operations 2. Extraordinary
items 3. Cumulative effect of a change in
accounting principle
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Discontinued Operations
Most large corporations engage in several lines
of business.
Each identifiable division of a company is called
a segment of the business.
A company may sell a segment of its business
generating a gain or loss.
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Extraordinary Items
Unusual for the company and infrequent
They include losses due to natural disasters.
Expropriations
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Extraordinary Items Exceptions
Gains and losses from discontinued operations
Material gains and losses from extinguishment
of debt (to be reported as extraordinary item)
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Cumulative Effect of a Change in Accounting
Principle
From double-declining-balance (DBB) to
straight-line depreciation
From first-in, first-out (FIFO)
to weighted-average cost for inventory
Companies must report the cumulative effect of
the accounting change on net income of prior
years in a special section of the income
statement after extraordinary items.
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Cumulative Effect of a Change in Accounting
Principle
Cumulative effect of change in depreciation
method 10,000 Less income tax
4,000 Cumulative effect of change in
depreciation method net of income
tax 6,000
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Earnings per Shareof Common Stock
(Net Income Preferred Dividends)

Average Number of Common Shares Outstanding

Earnings per Share
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Earnings per Shareof Common Stock
Earnings per share is required to be disclosed on
the income statement for all the major sections.
Earnings per share is subject to dilution
(reduction), if issue of additional shares is
possible in the future.
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Reporting ofComprehensive Income
Comprehensive income is the companys change in
total stockholders equity from all sources other
than from the owners of the business.
It includes net income plus unrealized
gains (losses) on available-for-sale
investments and foreign-currency translation
adjustments.
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Statement ofComprehensive Income
Net income 69,000 Other comprehensive
income Unrealized gain on investment 6,500
Less income tax (40) 2,600 3,900
Foreign-currency translation adjustment
(loss) (9,000) Less income tax (40)
3,600 5,400 Comprehensive income 67,5
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Key Figures in Financial Analysis
Net income
Cash flow from operations
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Learning Objective 2
Account for a corporations income tax.
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Accounting for CorporateIncome Taxes
Income tax expense, an expense on the income
statement
Income tax payable, a liability on the balance
sheet
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Accounting for CorporateIncome Taxes
In general, income tax expense and income tax
payable can be computed as follows
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Accounting for CorporateIncome Taxes
The income statement reports the results of
operations.
The income tax return is filed with the
Internal Revenue Service to determine how much
tax the company must pay the government.
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Accounting for CorporateIncome Taxes
Suppose for 20x5, Nike, Inc., has pretax
accounting income of 900 million on the income
statement.
Taxable income is 800 million on the companys
income tax return.
The tax rate is 40.
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Accounting for CorporateIncome Taxes
20x5 (dollar amounts in millions) December
31 Income Tax Expense (900 .40) 360 Income
Tax Payable (800 .40) 320 Deferred Tax
Liability 40 Recorded income tax for
the year
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Accounting for CorporateIncome Taxes
Income statement Income before income
tax 900 Income tax expense 360 Net
income 540
Balance sheet Current Liabilities Income tax
payable 320 Long-term liabilities
Deferred tax liability 40 Total
360
Assumes beginning tax liability was zero.
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Prior-Period Adjustments
Prior-period adjustments are corrections to the
beginning balance of Retained Earnings for errors
of an earlier period.
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Reporting a Prior-Period Adjustment
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Restrictions on Retained Earnings
Dividends and purchases of treasury stock
require payments by the corporation to its
stockholders.
Creditors may restrict a corporations
dividend payments and treasury stock purchases.
Companies report any retained earnings restriction
s in notes to the financial statements.
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Learning Objective 3
Analyze a statement of stockholders equity.
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Analyzing the Statement of Stockholders Equity
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Analyzing the Statement of Stockholders Equity
Accumulated Other Comprehensive Income
Total Stockholders Equity
Unrealized Gain (Loss) on Investments
Foreign-Currency Translation Adjustment
Balance, Dec. 31, 20x4 6,000
(10,000) 341,000 Issuance of
stock 85,000 Net
income 69,000 Cash
dividends (21,000) Stock
dividend 8 -0- Purchase of
treasury stock (9,000) Sale of
treasury stock 11,000 Unrealized
gain on investments 1,000
1,000 Foreign-currency translation
adjustment 2,000
2,000 Balance, Dec. 31, 20x5 7,000 (
8,000) 479,000
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Learning Objective 4
Understand managers and auditors
responsibilities for the financial statements.
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Responsibility for theFinancial Statements
Management issues a statement of
responsibility along with the company's financial
statements.
Management declares its responsibility for the
financial statements and states that they conform
to GAAP.
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Auditor Report
The audit report typically contains three
paragraphs
The first paragraph identifies the audited
financial statements.
The second paragraph describes how the audit was
performed, mentioning that generally accepted
auditing standards are the benchmark for
evaluating the audits quality.
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Auditor Report
The third paragraph states the auditors opinion
that the financial statements conform to GAAP
and that people can rely on them for decision
making.
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Auditor Report
Unqualified (clean)
Qualified
Adverse
Disclaimer
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End of Chapter 11