conducted by: mr. koy chumnith the income statement and statement of cash flows 4 2011, royal...
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Conducted by: Mr. Koy Chumnith
The Income Statement and Statement of Cash Flows
4
2011, Royal University of Law and EconomicsMcGraw-Hill/Irwin
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An income statement for a
hypothetical manufacturing
company that you can refer to as we proceed through
the chapter.
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Expenses
Outflows of resources incurred in generating revenues.
Revenues
Inflows of resources resulting
from providing goods or
services to customers.
Gains and Losses
Increases or decreases in equity from
peripheral or incidental
transactions of an entity.
Income from Continuing OperationsIncome from Continuing Operations
Income Tax Expense
Because of its
importance and size,
income tax expense is a
separate item.
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Operating Income
Nonoperating Income
Operating versus Nonoperating Income
Includes revenues and expenses
directly related to the principal
revenue-generating
activities of the company
Includes gains and losses and revenues and
expenses related to peripheral or
incidental activities of the
company
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Income Statement (Single-Step)
Expenses & Losses
Revenues & Gains
Proper Heading
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Income Statement (Multiple-Step)
Non- operating Items
Gross Profit
Operating Expenses
Proper Heading
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U. S. GAAP vs. IFRS
• Has no minimum requirements.
SEC requires that expenses be classified by function.
• “Bottom line” called net income or net loss.
• Report extraordinary items separately.
There are more similarities than differences between income statements prepared according to U.S. GAAP
and those prepared applying IFRS. Some differences are highlighted below.
• 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.
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Earnings Quality
Earnings quality refers to the ability of reported earnings to predict a company’s future earnings.
Transitory Earningsversus
Permanent Earnings
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Manipulating Income and Income Smoothing
Two ways to manipulate income:
1. Income shifting
2. Income statement classification
“Most executives prefer to report earnings that follow a smooth, regular, upward path.”
~Ford S. Worthy, “Manipulating Profits: How It’s Done”, Fortune
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Operating Income and Earnings Quality
Restructuring CostsCosts 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.
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Nonoperating Income and Earnings Quality
Gains and losses generated from the sale of investments often can significantly inflate or
deflate current earnings.
ExampleAs the stock market boom reached
its height late in the year 2000, many companies recorded large gains from sale of investments
that had appreciated significantly in value.
How should those gains be interpreted
in terms of their relationship to
future earnings? Are they transitory
or permanent?
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Separately Reported Items
Reported separately, net of taxes:
Discontinued operations
Extraordinary items
A third separately reported item, the cumulative effect of a change in accounting principle, might be included for certain mandated changes in
accounting principles.
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Intraperiod Income Tax Allocation
Income Tax Expense must be associated with each component of income that causes it.
Income Tax Expense must be associated with each component of income that causes it.
Show Income Tax Expense related to
Income from Continuing Operations.
Show Income Tax Expense related to
Income from Continuing Operations.
Report effects of Discontinued Operations and
Extraordinary Items net of related income tax effect.
Report effects of Discontinued Operations and
Extraordinary Items net of related income tax effect.
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Reporting Discontinued Operations
The FASB and IASB worked together to develop a common definition of discontinued operations and a
common set of disclosures for disposals of components of an entity.
A “component” of an entity for this purpose is defined as either:1.An operating segment that has either been disposed of or is classified as “held for sale”; or2.A business that meets the criteria to be classified as held for sale on acquisition.
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Reporting Discontinued Operations
Reporting for Components Sold
Operating income or loss of the component from the beginning of the reporting period to
the disposal date.
Gain or loss on the disposal of the
component’s assets.
Reporting for Components Held For Sale
Operating income or loss of the component from the beginning of the reporting period to the end of the reporting
period.
An “impairment loss” if the carrying value of
the assets of the component is more than the fair value minus cost to sell.
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An extraordinary item is a material event or transaction that is both:
1.Unusual in nature, and
2.Infrequent in occurrence
Extraordinary items are reported net of related taxes
Extraordinary Items
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U. S. GAAP vs. IFRS
• Report extraordinary items separately in the income statement.
The scarcity of extraordinary gains and losses reported in corporate income statements and the desire to converge U.S. and international accounting standards could guide
the FASB to the elimination of the extraordinary item classification.
• Prohibits reporting extraordinary items in the income statement or notes.
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Unusual or Infrequent Items
Items that are material and are either unusual or infrequent—but not
both—are included as separate items in continuing operations.
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Type of Accounting Change Definition
Change in Accounting Principle
Change from one GAAP method to another GAAP method
Change in Accounting Estimate
Revision of an estimate because of new information or new experience
Change in Reporting Entity
Preparation of financial statements for an accounting entity other than the entity that existed in the previous period
Accounting Changes
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Change in Accounting Principle
• Occurs when changing from one GAAP method to another GAAP method, for example, a change from LIFO to FIFO
• GAAP requires that most voluntary accounting changes be accounted for retrospectively by revising prior years’ financial statements.
• For mandated changes in accounting principles, the FASB often allows companies to choose to account for the change retrospectively or as a separately reported item below extraordinary items.
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Change in Depreciation, Amortization, or Depletion Method
A change in depreciation, amortization, or depletion
method is treated the same as a change in accounting estimate.
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Change in Accounting Estimate
Revision of a previous accounting estimate
Use new estimate in current and future
periods
Includes changes in depreciation,
amortization, and depletion methods
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Change in Reporting Entity
The prior-period financial statements that are
presented for comparative purposes should be
restated to appear as if the new entity existed in those
periods.
When one company acquires another one, the financial statements of the acquirer
include the acquiree as of the date of acquisition, and the
acquirer’s prior-period financial statements that are presented for comparative purposes are
not restated.
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Correction of Accounting Errors
Errors occur when transactions are either recorded incorrectly or not recorded at all.
Errors Discovered in
Same Year
Reverse original erroneous journal entry and record the appropriate
journal entry.
Record a prior period adjustment to the beginning retained earnings
balance in a statement of shareholders’ equity.
Previous years’ financial statements that are incorrect as a result of the error are retrospectively restated to
reflect the correction.
Material Errors Discovered in Subsequent
Year
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Earnings per Share Disclosure
One of the most widely used ratios is earnings per share (EPS), which shows the amount of income
earned by a company expressed on a per share basis.
Basic EPS
Net income less preferred dividends
Weighted-average number of common shares outstanding for the
period
Diluted EPS
Reflects the potential dilution that could occur for companies that have certain
securities outstanding that are convertible into common shares or stock options that could create additional common shares if
the options were exercised.
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Earnings per Share Disclosure
Report EPS data separately for:
1. Income or Loss from Continuing Operations
2. Separately Reported Items
a) discontinued operations
b) extraordinary Items
3. Net Income or Loss
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Comprehensive Income
An expanded version of income that includes four types of gains and
losses that traditionally have not been included
in income statements.
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Other Comprehensive IncomeComprehensive income includes traditional net income as well as four additional gains and losses that change
shareholders’ equity.
1. Net unrealized holding gains (losses) from investments (net of tax).
2. Gains and losses due to reviewing assumptions or market returns differing from expectations and prior service cost from amending the postretirement benefit plan.
3. When a derivative is designated as a cash flow hedge is adjusted to fair value, the gain or loss is deferred as a component of comprehensive income and included in earnings later, at the same time as earnings are affected by the hedged transaction.
4. Gains or losses from changes in foreign currency exchange rates. The amount could be an addition to or reduction in shareholders’ equity. (This item is discussed elsewhere in your accounting curriculum).
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U. S. GAAP vs. IFRS
• Includes four possible Other Comprehensive Income items.
As part of a joint project with the FASB, the International Accounting Standards Board (IASB) in 2007 issued a new version of IAS No. 146 that revised the standard to bring
international reporting of comprehensive income largely in line with U.S. standards.
• Includes same four.
• Includes a fifth possible item, changes in revaluation surplus, from the optional revaluation of property, plant, and equipment and intangible assets.
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Accumulated Other Comprehensive Income
In addition to reporting comprehensive income that occurs in the current period, we must also report these amounts on a cumulative basis in the balance sheet as
an additional component of shareholders’ equity.
In addition to reporting comprehensive income that occurs in the current period, we must also report these amounts on a cumulative basis in the balance sheet as
an additional component of shareholders’ equity.
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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.
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Operating Activities
Cash Flows from
Operating Activities
Cash Flows from
Operating Activities
Inflows from: sales to customers. interest and dividends
received.
Inflows from: sales to customers. interest and dividends
received. +
Outflows for: purchase of inventory. salaries, wages, and other
operating expenses. interest on debt. income taxes.
Outflows for: purchase of inventory. salaries, wages, and other
operating expenses. interest on debt. income taxes.
_
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Direct and Indirect Methods of Reporting
Two Formats for Reporting Operating Activities
Reports the cash effects of each operating
activity
Direct Method
Starts with accrual net income and converts to cash basis
Indirect Method
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Direct MethodUnder the direct method, the cash effect of each
operating activity is reported directly in the statement.
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Indirect MethodBy 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.
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Cash Flows from
Investing Activities
Cash Flows from
Investing Activities
+
Investing Activities
Inflows from: sale of long-lived assets used in
the business. sale of investment securities
(stocks and bonds). collection of nontrade
receivables.
_Outflows for:
purchase of long-lived assets used in the business.
purchase of investment securities (stocks and bonds).
loans to other entities.
Outflows for: purchase of long-lived assets
used in the business. purchase of investment
securities (stocks and bonds). loans to other entities.
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Cash Flows from
Financing Activities
+
_
Financing Activities
Inflows from: sale of shares to owners. borrowing from creditors
through notes, loans, mortgages, and bonds.
Outflows for: owners in the form of dividends
or other distributions. owners for the reacquisition of
shares previously sold. creditors as repayment of the
principal amounts of debt.
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ALC’s Statement of Cash Flows
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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).
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Like U.S. GAAP, international standards also require a statement of cash flows. Consistent with U.S. GAAP, cash flows are classified as operating, investing, or financing.
U. S. GAAP vs. IFRS
• Operating Activities– Dividends Received– Interest Received– Interest Paid
• Investing Activities
• Financing Activities– Dividends Paid
• Operating Activities
• Investing Activities– Dividends Received– Interest Received
• Financing Activities– Dividends Paid– Interest Paid
Typical Classification of Cash Flows from Interest and Dividends
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U. S. GAAP vs. IFRSThe FASB and IASB are working together on a project,
Financial Statement Presentation, to establish a common standard for presenting information in the financial
statements.
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End of Chapter 4