Financial accounting 10th pratt peters chapter 13

Chapter 13: The Complete Income Statement Learning Objective Briefly describe how net income is used and why it is considered so important The Economic Consequences Associated with Income Measurement and Disclosure Income is the most common measure of a company’s performance • Relate to stock prices – investors use income in their decisions to buy and sell equity securities • Relate to bond prices – debt investors use income in their decisions to buy and sell corporate bonds • Used by credit ratings agencies in determining credit ratings • Earnings announcements focus on income • Measures of income often found in contracts written with shareholders, creditors and managers Learning Objective Define and distinguish ten key concepts referred to as the elements of the financial statements The Measurement of Income: Different Measures for Different Objectives • According to Statement of Financial Accounting Concepts No objectives of financial reporting are (paraphrased) to provide information that is: Useful to those making investment and credit decisions Helpful in assessing amounts, timing and uncertainty of future cash flows About economic resource claims and changes in them The Measurement of Income: Different Measures for Different Objectives (cont’d) Figure 13-1 (partial) Elements of the financial statements The Measurement of Income: Different Measures for Different Objectives (cont’d) Figure 13-1 (partial) Elements of the financial statements The Measurement of Income: Different Measures for Different Objectives (cont’d) Figure 13-1 (partial) Elements of the financial statements The Measurement of Income: Different Measures for Different Objectives (cont’d) • Comprehensive income – broad definition including any changes in the company’s equity from all nonowner transactions: • Net Income: consisting of • Revenues and expenses – ongoing core business • Gains and losses – peripheral or incidental to operations • Other comprehensive income • Foreign translation adjustments • Unrealized gains andpartial lossesstatement of shareholders’ equity Campbell’s Soup 2014 (2) Other Revenues and Expenses: Unusual and/or Infrequent •Related to secondary or auxiliary activities: • • • • • • • • • • • • • Interest Income – from financing Interest Expense – from financing Dividend Income Gains and losses on foreign currency transactions Gains and losses from price changes in trading securities Gains and losses from sale of investments and long-lived assets Long term asset and goodwill impairments Receivable and inventory write-downs Employee strikes Rental of space Gains and losses on litigation Restructuring Divesture of subsidiary •These activities may be unusual or infrequent – for example, interest payments may be recurring, but are not a part of the core business operations and therefore are considered unusual (3) Disposal of a Business Segment •Discontinued operations relate to the disposal of a segment of a company Because the disposal means that the segment activity will be discontinued, separate disclosures are required so that investors can distinguish between ongoing activity and nonrecurring activity •A segment is defined as an entire line of business or a separately identifiable segment For example, General Motors would need to discontinue Chevrolet (not just a manufacturing plant) •Financial statement presentation includes any operating income or loss from the previous balance sheet date until the date that the segment is actually disposed of, as well as any gain or loss on the actual sale (4) Mandatory Changes in Accounting Principle •Consistency requires the use of the same accounting method from year to year •However, a company may on occasion choose to change to an alternative accounting method (ex: depreciation method or FIFO to average cost for inventory) •A company may be required to change to a new accounting technique by the issue of a new accounting standard •Changes may require retrospective application or involve adjustments to retained earnings They may require disclosure on the income statement •For mandatory changes the method is dictated in the new standard •For discretionary changes, retroactive treatment with disclosure is required (4) Mandatory Changes in Accounting Principle (cont.) Figure 13-5 Starbucks excerpts from the annual report On the income statement, a gain from the sale of stock is reported as a operating revenues and expenses b other revenues and expenses c a disposal of a business segment d a cumulative effect of a change in accounting principle On the income statement, the loss from selling an independent business component of the company is reports as a(n) a operating revenues and expenses b other revenues and expenses c a disposal of a business segment d a cumulative effect of a change in accounting principle Learning Objective Describe the concept of intraperiod tax allocation and how it relates to the complete income statement Intraperiod Tax Allocation •Accounting standards require certain items to be presented on the income statement net of taxes to better determine and isolate the true impact of the events •Disposal of a business segment •Changes in accounting principles •All of these items are presented net of tax on the income statement •Allows users to assess the total financial impact of these special transactions as well as the tax benefit or cost Concept Practice Learning Objective Compute earnings per share and discuss income statement categories Earnings-Per-Share Disclosure •GAAP requires separate disclosure on the face of the income statement and specific dollar amounts associated with • Net income from continuing operations (after tax) • Disposals of business segments • Changes in accounting principle Calculation of EPS = Dollar amount of the gain or loss from the associated category Common shares outstanding Earnings-Per-Share Disclosure •GAAP requires an additional disclosure for diluted earnings per share – if the company has significant potential for dilution • Dilution occurs when common shares could be increased because of outstanding stock options or convertible debt securities (i.e convertible bonds) thereby decrease earningsper-share Income Statement Categories: Useful For Decisions but Subjective •Earning persistence is the concept that some earnings dollar are likely to continue in the future, but others are not Those that provide future cash flow and are valued higher by external users of financial statements •Categorizing may be used subjectively by companies to ‘manage earnings’ and public perception of the financial outcomes International Perspective: Investments and Income Statement Disclosure •Strong international presence increases the number of transactions that require special disclosure • Gains and losses in foreign currency • Unique risks with high inflation and volatile economies •Financial statement users must be aware of and carefully interpret these special gains and losses on the financial statements Wiley © 2018 ... elements of the financial statements The Measurement of Income: Different Measures for Different Objectives • According to Statement of Financial Accounting Concepts No objectives of financial reporting... (cont’d) Figure 13- 1 (partial) Elements of the financial statements The Measurement of Income: Different Measures for Different Objectives (cont’d) Figure 13- 1 (partial) Elements of the financial statements... Changes in Accounting Principle •Consistency requires the use of the same accounting method from year to year •However, a company may on occasion choose to change to an alternative accounting