Financial accounting 9th jamie pratt chapter 13

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Chapter 13: The Complete Income Statement The Economic Consequences Associated with Income Measurement and Disclosure  Income is the most common measure of a company’s performance  A measure of a change in value  As compared to equity, which measures the level of value (or wealth)  It is NOT net cash flow  It is a measure of performance  There are different income measures which relate to different objectives (GAAP provides for various measures to be presented) 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 resources, claims and changes to 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 - changes in net assets from all non- owner sources; is broken into two categories:  Net Income: consisting of revenues, expenses, gains and losses (next slide)  Other Comprehensive Income Campbell’s Soup 2012 statement of Shareholders’ Equity The Income Statement Operating Section Non-Operating Section Sales Revenue less: less: less: Cost of Goods Sold Selling Expenses Administrative Expenses Add: Less: Other Revenues and Gains Other Expenses and Losses Income Tax Irregular Items Net Income Earnings per Share Discontinued Operations (net of tax) Extraordinary Items (net of tax) Two Different Concepts of Income: Matching and Fair Market Value  The Matching Process:  Revenues - Expenses = Net Income  Fair Market Value approach:  FMV Net Assets (end) - FMV Net Assets (beginning) = Net Income (1) Operating Revenues and Expenses: Usual and Frequent Looking at Figure 13-4 A Complete Income Statement Asset and liability inflows and outflows related to the delivery of goods or services provided by a company and Operating Revenues and Expenses They are usual and frequent and therefore are likely to represent ongoing activity (2) Other Revenues and Expenses: Unusual or Infrequent  Related to secondary or auxiliary activities:  Interest Income – from financing  Interest Expense – from financing  Dividend Income  Gains and Losses from trading securities  Gains and Losses from sale of investments and long-lived assets  Some of these are recurring, but none are core activities (3) Disposal of a Business Segment  Discontinued operations (DO) 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 could 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 to the measurement date (the date the board of directors declares intention to dispose of the segment), as well as any gain or loss on the disposal of the assets (4) Extraordinary Items: Unusual and Infrequent  Extraordinary items (EI) are defined as those activities that are material in amount, unusual in nature, and infrequent in occurrence  To determine, consider the natural, political, and economic environment of the firm (i.e the same type of event may be extraordinary for some and may not be extraordinary for other organizations)  Examples of EI include natural disasters, nationalization or expropriation of assets by a foreign government, and one-time major economic transactions (5) Mandatory Changes in Accounting Principles  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 (5) Mandatory Changes (cont’d) Figure 13-5 Starbucks excerpts from the annual report 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  Extraordinary items  Changes in Accounting principles  All of these items are presented net of tax on the income statement Earnings-Per-Share Disclosure (EPS)  SFAS 128 simplified the presentation of earnings per share to two components:  Basic EPS  Diluted EPS  Calculation of Basic EPS = _ Net Income - preferred dividends Weighted average common shares outstanding  Concept: To indicate how much each common shareholder “owns” with respect to earnings  Preferred dividends are deducted - if declared or if cumulative - because they are “owed” to preferred shareholders  This is a calculation of “what is” - the numerator and denominator use actual shares outstanding and actual net income for the year Earnings-Per-Share (EPS) (cont’d)  Class problem: Bush Company reported net income of $30,000 in 2014 The company had 60,000 shares of common stock outstanding for all of 2014 Bush also had 5,000 shares of convertible preferred stock outstanding for all of 2014 During 2014, the company declared a $4,000 cash dividend to preferred shareholders Each share of preferred stock is convertible to shares of common stock 1.Calculate basic EPS: $30,000 - 4,000 = $0.43 per share 60,000 *Note that the convertibility component is ignored for basic EPS Earnings-Per-Share (EPS) (cont’d) Calculate diluted EPS: $30,000 - = $0.38 per share 60,000 + (5,000 x 4) *Note that the convertibility component is assumed to have been exercised for diluted EPS If the PS was converted to CS at the beginning of the year, there would have been NO preferred dividend, and there would have been 20,000 additional shares of common stock outstanding all year *The effects for convertible bonds and employee stock options are similar for diluted EPS EPS Disclosure  Separate EPS disclosure for:  Net income from continuing operations (after tax)  Disposals of business segments  Extraordinary items  Calculation  Separate dollar amount (from above categories) divided by number of common shares outstanding  If diluted EPS exists, the company should also calculate diluted EPS for each level of presentation  If diluted EPS is antidilutive (the calculation is actually higher than basic EPS), the company does not have to present diluted EPS Problems with EPS  The numerator can be manipulated by a number of earning management techniques  The denominator can be manipulated by stock buybacks (treasury stock)  The “what-if” presentation of diluted EPS is a fictitious number - it can never actually happen The potentially dilutive securities have not been converted at year end, and they can never have claims to the current year’s income The only benefit of diluted EPS is that it can indicate the magnitude of the maximum potential dilution for the future 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 due 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 Economic Consequences of Reporting Net Income – After the Chapter  Investors focus heavily on income and related indices like earnings per share and the P/E (price per share to earnings per share) ratio  Recent announcements (noting that the reported EPS was off the estimate by as little as a penny) have caused the market price of reporting companies to drop significantly  Because of investor focus, and because of compensation bonuses, managers continue to focus heavily on the bottom line, sometimes with dire effects  Expanded financial statement disclosure and increased awareness by investors may drive this earnings fixation Copyright © 2014 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein ... (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... Different Measures for Different Objectives  According to Statement of Financial Accounting Concepts No Objectives of financial reporting are (paraphrased) to provide information that is: ... Changes in Accounting Principles  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
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