Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. The Income Statement and Statement of Cash Flows 4 4-2 Learning Objectives Explain the difference between net income and comprehensive income and how we report components of the difference. 4-3 Comprehensive Income An expanded version of income that includes four types of gains and losses that traditionally have not been included in income statements. 4-4 Other Comprehensive Income Statement of Financial Accounting Standards No. 130 Comprehensive income includes traditional net income and changes in equity from nonowner transactions. Statement of Financial Accounting Standards No. 130 Comprehensive income includes traditional net income and changes in equity from nonowner transactions. 1. Changes in the market value of securities available for sale (described in Chapter 12). 2. Reporting a pension liability sometimes requires a reduction in shareholders’ equity (described in Chapter 17). 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 (described in Chapter 14). 4. Gains or losses from changes in foreign currency exchange rates (discussed elsewhere in your accounting curriculum). 1. Changes in the market value of securities available for sale (described in Chapter 12). 2. Reporting a pension liability sometimes requires a reduction in shareholders’ equity (described in Chapter 17). 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 (described in Chapter 14). 4. Gains or losses from changes in foreign currency exchange rates (discussed elsewhere in your accounting curriculum). 4-5 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. (In millions, except shares) 2004 2003 Common Stockholders' Investment: Common stock, $.10 par value, 800 million shares authorized, 300 million shares issued for 2004 and 299 million shares 30$ 30$ issued for 2003 Additional paid-in capital 1,079 1,088 Retained earnings 7,001 6,250 Accumulated other comprehensive loss (46) (30) 8,064 7,338 Less deferred compensation and treasury stock at cost 28 50 Total common stockholders' investment 8,036$ 7,288$ FedEx Corporation Balance Sheet 31-May 4-6 Learning Objectives Discuss the importance of income from continuing operations and describe its components. 4-7 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 Operations Income from Continuing Operations Income Tax Expense Because of its importance and size, income tax expense is a separate item. 4-8 Operating Income Nonoperating Income Operating Income 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 4-9 Income Statement (Single-Step) Expenses & Losses { { Revenues & Gains { Proper Heading 4-10 Income Statement (Multiple-Step) { Non- operating Items { Gross Profit { Proper Heading Operating Expenses { [...]... income statement? 4-3 1 Extraordinary Items Example Computation of Loss from Extraordinary Item (Net of Tax Effect): Income Statement Presentation: 4-3 2 Unusual or Infrequent Items Items that are material and are either unusual or infrequent—but not both— are included as a separate item in continuing operations  4-3 3 Accounting Changes Type of Accounting Change Definition Change in Accounting Principle... GAAP method Change in Accounting Estimate Revision of an estimate because of new information or new experience Preparation of financial statements for an accounting entity other than the entity that existed in the previous period Change in Reporting Entity 4-3 4 Learning Objectives Describe the measurement and reporting requirements for a change in accounting principle  4-3 5 Change in Accounting Principle... • Long-lived asset impairment • In-process research and development 4-1 6 Operating Income and Earnings Quality 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 (discussed further in Chapters 10 & 11) In-process... 4-1 1 Learning Objectives Describe earnings quality and how it is impacted by management practices to manipulate earnings  4-1 2 Earnings Quality Earnings quality refers to the ability of reported earnings to predict a company’s future The relevance of any historical-based financial statement hinges on its predictive value  4-1 3 Manipulating Income and Income Smoothing... Operations (Net of Tax Effect): 4-2 7 Discontinued Operations Example Income Statement Presentation: 4-2 8 Learning Objectives Define extraordinary items and describe the appropriate income statement presentation for these transactions  4-2 9 Extraordinary Items  Material events or transactions  Unusual in nature  Infrequent in occurrence  Reported net of related taxes 4-3 0 Extraordinary Items Example... method  For example, a change from LIFO to FIFO  Voluntary changes in accounting principles are accounted for retrospectively by revising prior years’ financial statements  Changes in depreciation, amortization, or depletion methods are accounted for the same way as a change in accounting estimate  4-3 6 Learning Objectives Explain the accounting treatments of changes in estimates and correction of errors... Are they transitory or permanent? 4-1 8 Pro Forma Earnings Companies often voluntarily provide a pro forma earnings number when they announce annual or quarterly earnings Pro forma earnings are management’s assessment of permanent earnings The Sarbanes-Oxley Act Section 401 requires a reconciliation between pro forma earnings and earnings determined according to GAAP  4-1 9 Separately Reported Items Reported... taxes) Extraordinary items (net of $xx in taxes) Net Income Extraordinary items $ xxx xx xxx xx xx $ xxx A third item, the cumulative effect of a change in accounting principle, was eliminated from separate reporting by a new accounting standard in 2005  4-2 0 Intraperiod Income Tax Allocation Income Tax Expense must be associated with Income Tax Expense must be associated with each component of income that... ways to manipulate income: 1 Income shifting 2 Income statement classification 1 Bethany McLean, “Hocus-Pocus: How IBM Grew 27% a Year,” Fortune, June 26, 2000, p 168  4-1 4 Learning Objectives Discuss the components of operating and nonoperating income and their relationship to earnings quality  4-1 5 Operating Income and Earnings Quality Should all items of revenue and expense included in operating... units Subsidiaries Asset groups 4-2 3 Discontinued Operations Report results of operations separately if two conditions are met: The operations and cash flows of the component have been (or will be) eliminated from the ongoing operations The entity will not have any significant continuing involvement in the operations of the component after the disposal transaction  4-2 4 Discontinued Operations Reporting . company 4-9 Income Statement (Single-Step) Expenses & Losses { { Revenues & Gains { Proper Heading 4-1 0 Income Statement (Multiple-Step) { Non- operating. Corporation Balance Sheet 31-May 4-6 Learning Objectives Discuss the importance of income from continuing operations and describe its components. 4-7 Expenses Outflows