Chapter 4 - The income statement and statement of cash flows. This chapter has a twofold purpose: to consider important issues dealing with income statement content, presentation, and disclosure and to provide an overview of the statement of cash flows, which is covered in depth in Chapter 21.
Chapter THE INCOME STATEMENT AND STATEMENT OF CASH FLOWS © 2013 The McGraw-Hill Companies, Inc An income statement for a hypothetical manufacturing company that you can refer to as we proceed through the chapter 4-2 Income Income from from Continuing Continuing Operations Operations Revenues Expenses Inflows of resources resulting from providing goods or services to customers Outflows of resources incurred in generating revenues 4-3 Gains and Losses Income Tax Expense Increases or decreases in equity from peripheral or incidental transactions of an entity Because of its importance and size, income tax expense is a separate item Operating versus Nonoperating Income 4-4 Operating Income Nonoperating Income Includes revenues and expenses directly related to the principal revenuegenerating activities of the company Includes gains and losses and revenues and expenses related to peripheral or incidental activities of the company Income Statement (Single-Step) Proper Heading Revenues & Gains Expenses & Losses 4-5 Income Statement (Multiple-Step) Proper Heading Gross Profit Operating Expenses Nonoperating Items 4-6 U S GAAP vs IFRS There are more similarities than differences between income statements prepared according to IFRS and those prepared according to U.S GAAP Some differences are highlighted below • • • 4-7 Has no minimum requirements • SEC requires that expenses be classified by function • “Bottom line” called net income or net loss Report extraordinary items separately • • Specifies certain minimum information to be reported on the face of the income statement Allows expenses classified by function or natural description “Bottom line” called profit or loss Prohibits reporting extraordinary items Earnings Quality Earnings quality refers to the ability of reported earnings to predict a company’s future earnings Transitory Earnings versus Permanent Earnings 4-8 Manipulating Income and Income Smoothing “Most executives prefer to report earnings that follow a smooth, regular, upward path.” ~Ford S Worthy, “Manipulating Profits: How It’s Done”, Fortune Two ways to manipulate income: Income shifting Income statement classification 4-9 Operating Income and Earnings Quality - 10 Restructuring Costs Costs associated with shutdown or relocation of facilities or downsizing of operations are recognized in the period incurred Goodwill Impairment and Long-lived Asset Impairment Involves asset impairment losses or charges Accumulated Other Comprehensive Income In Inaddition additionto toreporting reportingOCI OCI that thatoccurs occurs in in the the current current reporting reportingperiod, period, U.S U.S.GAAP GAAPrequires requirescompanies companiesto toreport report OCI OCIon onaacumulative cumulativebasis basisin inthe thestatement statement of of financial financial position position.IFRS IFRSdoes doesnot notrequire requirecompanies companiesto toreport report accumulated accumulatedother other comprehensive comprehensiveincome income(AOCI) (AOCI) - 27 Flexibility in Reporting The Theinformation information in in the theincome incomestatement statement and andother other comprehensive comprehensiveincome incomeitems items can can be bepresented presentedeither: either: 1) 1) in inaasingle, single,continuous continuousstatement statement of of comprehensive comprehensive income income or or 2) 2) in intwo twoseparate, separate,but but consecutive consecutivestatements, statements,an an income incomestatement statementand andaastatement statementof of comprehensive comprehensive income income - 28 The Statement of Cash Flows • Provides relevant information about a company’s cash receipts and cash disbursements • Helps investors and creditors to assess future net cash flows liquidity long-term solvency • Required for each income statement period reported - 29 Operating Activities Inflows from: sales to customers interest and dividends received from investments + Outflows for: purchase of inventory salaries, wages, and other operating expenses interest on debt income taxes dividends paid - 30 _ Cash Flows from Operating Activities Direct and Indirect Methods of Reporting Two Formats for Reporting Operating Activities - 31 Direct Method Indirect Method Reports the cash effects of each operating activity Starts with accrual net income and converts to cash basis - 32 Direct Method Under the direct method, the cash effect of each operating activity is reported directly in the statement - 33 Indirect Method By the indirect method, we arrive at net cash flow from operating activities indirectly by starting with reported net income and working backwards to convert that amount to a cash basis - 34 Investing Activities Inflows from: sale of long-lived assets used in the business sale of investment securities (shares and bonds) collection of nontrade receivables interest or dividends received from investments Outflows for: purchase of long-lived assets used in the business purchase of investment securities (shares and bonds) loans to other entities - 35 + _ Cash Flows from Investing Activities Financing Activities Inflows from: sale of shares to owners borrowing from creditors through notes, loans, mortgages, and bonds Outflows for: owners for the repurchase or reacquisition of shares previously sold owners in the form of dividends or other distributions creditors for the repayment of the principal amounts of debt creditors for the payment of interest on debt - 36 + _ Cash Flows from Financing Activities ALC’s Statement of Cash Flows - 37 Noncash Investing and Financing Activities Significant investing and financing transactions not involving cash also are reported Acquisition of equipment (an investing activity) by issuing a long-term note payable (a financing activity) - 38 U S GAAP vs IFRS Both U.S GAAP and IFRS require a statement of cash flows and classify cash flows as operating, investing, or financing Typical Classification of Cash Flows from Interest and Dividends • Operating Activities • Operating Activities – Dividends Received – Interest Received – Interest Paid • Investing Activities • Investing Activities • Financing Activities – Dividends Paid - 39 – Dividends Received – Interest Received • Financing Activities – Dividends Paid – Interest Paid U S GAAP vs IFRS The FASB and IASB are working together on a project, Financial Statement Presentation, to establish a common standard for presenting information in the financial statements - 40 End of Chapter 4 - 41 ... consecutive consecutivestatements, statements,an an income incomestatement statementand andaastatement statementof of comprehensive comprehensive income income - 28 The Statement of Cash Flows • Provides... comprehensiveincome income( AOCI) (AOCI) - 27 Flexibility in Reporting The Theinformation information in in the theincome incomestatement statement and andother other comprehensive comprehensiveincome incomeitems... report income and other comprehensive income items in either a single, continuous statement of comprehensive income or in two separate, but consecutive statements (an income statement and a statement