INCOME AND CHANGES IN RETAINED EARNINGS

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Chapter12
INCOME AND CHANGES IN RETAINED EARNINGS
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Reporting the Results of Operations
Information about net income can be divided into
two major categories
Income from continuing operations.
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This tax expense does not include effects of
unusual, nonrecurring items.
These unusual, nonrecurring items are each
reported net of taxes.
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Discontinued Operations
When management enters into a formal plan to sell
or discontinue a segment of the business, the
related gains and losses must be disclosed on the
income statement.
Discontinued Operations
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Discontinued Operations
When management enters into a formal plan to sell
or discontinue a segment of the business, the
related gains and losses must be disclosed on the
income statement.
A segment must be a separate line of business
activity or an operation that services a distinct
category of customers.
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Discontinued Operations - Example
During 2003, Apex Co. sold an unprofitable
segment of the company. The segment had a net
loss from operations during the period of
150,000 and its assets sold at a loss of
100,000. Apex reported income from continuing
operations of 350,000. All items are taxed at
30. How will this appear on the income
statement?
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Discontinued Operations - Example
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Discontinued Operations - Example
Income Statement Presentation
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Extraordinary Items

• Material in amount.
• Gains or losses that are both unusual in nature
  and not expected to recur in the foreseeable
  future.
• Reported net of related taxes.

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Extraordinary Items - Example
During 2003, Apex Co. experienced a loss of
75,000 due to an earthquake at one of its
manufacturing plants in Nashville. This was
considered an extraordinary item. The company
reported income before extraordinary item of
175,000. All gains and losses are subject to a
30 tax rate. How would this item appear on the
2003 income statement?
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Extraordinary Items - Example
Income Statement Presentation
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Accounting Changes
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Change in Accounting Principle

• Occurs when changing from one GAAP method to
  another GAAP method.
• Make a catch-up adjustment known as the
  cumulative effect of a change in accounting
  principle.
• The cumulative effect is reported net of taxes
  and after extraordinary items.

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Change in Accounting Principle Example
Also in 2003, Apex Co. decided to change from the
double-declining balance to the straight-line
method for depreciation. The effect of this
change is an increase in net income of 65,000.
Apex reported income before cumulative effect of
an accounting change of 122,500 during the year.
All items of income are subject to a 30 tax
rate. How would this item appear on the income
statement?
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Change in Accounting Principle Example
Computation
Income Statement Presentation
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Change in Estimates

• Revision of a previous accounting estimate.
• The new estimate should be used in the current
  and future periods.
• The prior accounting results should not be
  disturbed.

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Change in Estimates - Example
On January 1, 2000, we purchased equipment
costing 30,000, with a useful life of 10 years
and no salvage value. During 2003, we determine
that the remaining useful is 5 years (8-year
total life). We use straight-line
depreciation. Compute the revised depreciation
expense for 2003.
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Change in Estimates - Example
Record depreciation expense of 4,200 for 2003
and subsequent years.
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Lets move on to a few final topics.
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Price-earnings Ratio (P/E)
Often, the Price-Earnings Ratio is used to
evaluate the reasonableness of a companys stock
price.
Lets examine this further.
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Earnings Per Share (EPS)
A measure of the companys profitability and
earning power for the period.
Based on the number of shares issued and the
length of time that number remained unchanged.
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Earnings Per Share (EPS) -Partial Income
Statement
Remember that Apex Co. income from continuing
operations of 350,000. The after-tax loss from
discontinued operations was 175,000. The
extraordinary loss was 52,500 and the cumulative
effect of accounting changes was a gain of
45,500. Assume that Apex has weighted average
shares outstanding of 156,250. Prepare a partial
income statement showing the EPS for Income from
Operations and for the other special items.
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Earnings Per Share (EPS) -Partial Income
Statement
Rounded.
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Earnings Per Share (EPS)
If preferred stock is present, subtract preferred
dividends from net income prior to computing EPS.
EPS is required to be reported in the income
statement.
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Accounting for Cash Dividends
Declared by board of directors.
Not legally required.
Requires sufficient Retained Earnings and Cash.
Creates liability at declaration.
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Dividend Dates

• Date of Declaration
• Board of directors declares the dividend.
• Record a liability.

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Dividend Dates

• Ex-Dividend Date
• The day which serves as the ownership cut-off
  point for the receipt of the most recently
  declared dividend.

NO ENTRY
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Dividend Dates

• Date of Record
• Stockholders holding shares on this date will
  receive the dividend. (No entry)

X
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Dividend Dates

• Date of Payment
• Record the payment of the dividend to
  stockholders.

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Dividend Dates - Question
On June 1, 2003, a corporations board of
directors declared a dividend for the 2,500
shares of its 100 par value, 8 preferred stock.
The dividend will be paid on July 15. Which of
the following will be included in the July 15
entry? a. Debit Retained Earnings 20,000. b.
Debit Dividends Payable 20,000. c. Credit
Dividends Payable 20,000. d. Credit Preferred
Stock 20,000.
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Accounting for Stock Dividends
Distribution of additional shares of stock to
stockholders.
All stockholders retain same percentage ownership.
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Summary of Effects of Stock Dividends and Stock
Splits
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Prior Period Adjustments
The correction of an error identified as
affecting net income in a prior period.
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Comprehensive Income
Normally, there are 3 ways that financial
position can change.
GAAP excludes some unrealized items from income,
such as the change in market value of
available-for-sale debt and equity investments.
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Comprehensive Income
GAAP requires that unrealized items that are
normally reported on the balance sheet be added
back to compute Comprehensive Income.
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End of Chapter 12