CHAPTER 4 STATEMENT OF INCOME AND RETAINED EARNINGS Objectives 1 Illustrate an understanding of the proper format for income and retained earnings statements a Given trans

							CHAPTER 4: STATEMENT OF INCOME
AND RETAINED EARNINGS

Objectives

1.   Illustrate an understanding of the proper format for
     income and retained earnings statements.

     a.   Given transaction data or account balances, be
          able to prepare single step and multi-step income
          statements, r/e statements and combined
          statements.

2.   Illustrate an understanding of the concepts underlying
     the measurement and presentation of income.

3.   Illustrate an understanding of the intermediate
     components of income and reporting of other
     irregular items.

     a.   Be able to recognize items when encountered in
          problem material.

     b.   Be able to identify the proper accounting and
          disclosure procedure for each.

                                                            1
Objective 1: Income Statement Format

1. Step 1: Broad classification

   Elements of the Income Statement (Review:
   Concept Statement No. 6):

       Revenues: inflows...from ongoing
       central operations.

       Expenses: outflows...from ongoing
       central operations.

       Gains: increases in net assets from
       incidental nonowner sources.

       Losses: decreases in net assets from
       incidental nonowner sources.




                                               2
(Objective 1, continued)

2. Step 2: Presentation of intermediate
   components of income

   Items before income from continuing
   operations: Multi-step versus single step
   format (both permitted by GAAP)

       Operating

       Nonoperating

       Income Tax related to income from
       continuing operation




                                               3
(Objective 1, continued)

Step 2, continued

   Items after income from continuing
   operations (separate disclosures due to
   separate pronouncements)

       "D" - Discontinued operations

       "E" - Extraordinary items


   NOTE: GAAP requires presentation of these
   items net of tax.

       "EPS" - Earnings per share




                                             4
Objective 2: How we measure

1. Again review from Concept Statement No. 5:

   revenue recognition

   matching

   periodicity

2. Reporting Comprehensive Income
   (Statement of Financial Accounting
   Standard No. 130). FASB encourages but
   does not require use of the term
   comprehensive income.




                                            5
(Objective 2, continued)

Which of the transactions that produce changes
in net assets should be included in income for
the period?


   Profession has adopted modified all-
   inclusive that includes all changes in net
   assets EXCEPT those items which bypass
   income statement (and are called other
   comprehensive income)

3. Quality of Earnings and Earnings
   Management:

   SEC has expressed concern or earnings
   manipulation to meet targets. Much research
   is examining this topic.




                                                 6
Objective 3: "Irregular" items after income from
continuing operations

1. Discontinued operations: results from
   disposal of a segment of the business

   a. Examples of disposals that qualify

   b. Examples of disposals that do not
      qualify

   c. Disposals are reported net of tax
      immediately below income from
      continuing ops. 2 components:

       1. Income or loss from ops of the
          discontinued segment up to the
          measurement date, net of tax

       2. Gain or loss from disposal of
          discontinued segment, net of tax

                                               7
Objective 3, continued

2. Extraordinary Items: Unusual in nature and
   infrequent in occurrence (considering the
   environment in which the entity operates)

   a. Examples of extraordinary items


   b. Examples of items that are not
      extraordinary


   c. Some items are given extraordinary
      treatment by pronouncement.


   d. Reported net of tax in income statement
      below discontinued ops.



                                                8
Objective 3, continued

SPECIAL NOTE: unusual gains and losses
(unusual OR infrequent, but not both)

   Reported in "other revenues and gains" or
   "other expenses and losses" in multi-step

   Not net of tax




                                           9
Objective 3, continued

3. Changes in accounting principle:

       Adoption of an accounting method that
       is different from the one previously used

   a. Examples: change from FIFO to average
      cost. Change from straight line to
      double-declining depreciation

   b. A retrospective adjustment to the
      financial statements is made. The
      adjustment recasts the prior years’
      statements consistent with the newly
      adopted principle. The cumulative effect
      of the change for prior periods is an
      adjustment to the beginning balance of
      retained earnings.



                                               10
Objective 3, continued

SPECIAL NOTE: Changes in estimates
(normal, recurring corrections and adjustments)

   a. Examples:

       changes in estimated lives or salvage
       value of fixed assets

       changes in estimated collectibility of
       receivables

       adjustment of inventory costs or
       estimated realizability

   b. They are not treated as errors or
      extraordinary items




                                                11
Objective 3, continued

4. Disclosure Requirements

   a. Intraperiod tax allocation

       1. A breakdown of total income tax
          expense into separate components
          which are disclosed in different
          portions of the financial statements

       2. Income from continuing ops

          discontinued items

          extraordinary items

          prior period adjustments

          [net of tax = item * (1-tr)]


                                                 12
Objective 3, continued


   b. Earnings Per Share

       1. A widely used measure of business
          performance

       2. NI - preferred dividends
          weighted ave. shares o/s

       3. What is dilution?




                                          13
Objective 3, continued

       4. Disclose EPS for

          Income from continuing ops

          Income (loss) from disposal of
          discontinued  operations   (two
          components)

          Income before extraordinary item

          Extraordinary item

          Net income




                                             14
Back to Objective 1

Statement of Retained Earnings: a summary
disclosure of the changes in the balance of the
r/e account from the beginning to the end of the
year.

What's in it:

    Prior period adjustments (corrections of
    errors, realization of tax benefits from
    operating loss carryforwards, certain
    accounting changes) shown net of tax

    Dividends and net income

    Appropriations of retained earnings




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