Income Statement

Two most common formats:

Single-Step Format

Multiple-Step Format
 Income Statement
Single-step format: classify all revenues
then subtract all expenses to arrive at net income.
Net Sales $1,000,000
Rental Revenue $525,000
Total Revs $1,525,000
Cost of Goods Sold $725,000
Selling Exps $115,000
Admin Exps $45,000
Income Tax Expense $35,000
Total Exps $920,000

Net Income $605,000

 Income Statement
Multiple-step format
• Compute Operating Income
- Operating Revenue – Operating Expenses
• Add other income and gains.
•Subtract other expenses and losses to arrive at net income.

Allows a better picture of whether operations provided

sufficient net income, since income from operations is
directly computed.
 Multi-step Income Statement

Sales (Operating Revenue) $2,000,000 Operating

Less COGS $1,150,000
Revenues –
Gross Margin $850,000
Less Operating Expenses $350,000 Operating
Less Administration Expenses $175,000 Expenses
Operating Income $325,000
Other
Other Revenues and Gains $55,000 Revenues –
Less Other Expenses $48,000 Other
Net Income (before tax) $332,000 Expenses
Less Income Tax (30%) $99,600
Net Income $232,400
 Income Statement
Most common general format
Sales
minus COGS
equals Gross Margin
Note: from this point forward,
minus Selling Expenses
all additions and subtractions
minus Administrative and General Expenses need to be made in after-tax
equals Operating Income dollars (i.e. net of tax).
plus Other Revenues and Gains
plus Unusual Gains
minus Unusual Losses
equals Net Income Before Taxes, Disc. Operations, & Extraord. Items
minus Income Taxes
equals Net Income Before Disc. Operations & Extraord. Items (net of tax)
minus Discontinued Operations (net of tax)
minus Extraordinary Items (net of tax)
plus/min Cumulative Effect of Change in Accounting Principle (net of tax)
equals Net Income
Earnings Per Share
 Income Statement

Major income statement “highlights”

• Called “highlighting” because each of the following

categories must be represented in its own line on the
income statement.

- Discontinued Operations
- Extraordinary Items
- Unusual Gains and Losses
- Changes in Accounting Principle
- Changes in Estimates
 Income Statement
Discontinued Operations
Gains or losses from
disposal of a segment of a business
are reported separately from the normal operating
income of the parent.
This is reported net of tax since it comes after taxes have
been subtracted.
Normal disposal of assets, partial segment disposal,
phasing out a product line do not qualify for this
treatment.
These are considered normal operating
disposals and are reported as operating gains
and losses.
 Income Statement
Extraordinary Items

Material, non-normal, non-recurring gains or losses.

Must meet two criteria:
• Unusual in nature
• Infrequent occurrence

The following cannot be considered extraordinary:

• Write down of receivables, inventory, intangible assets
• Foreign currency exchange gains or losses
• Effects of a labor strike
• Adjustments of accruals on long-term contracts
 Income Statement
Extraordinary Items

Material, non-normal, non-recurring gains or losses.

Must meet two criteria:
• Unusual in nature
• Infrequent occurrence

The following might be considered extraordinary:

• Major, unusual natural disasters
• Terrorism (assuming it’s not frequent, like Israel)

Report net of tax

 Income Statement
Unusual Gains and Losses

Items that are considered unusual but generally

occur frequently and therefore cannot be called
extraordinary.
The following might be considered unusual:
• Restructuring charges
• Layoffs
• Plant Closings Note that these are not
• Asset write-offs discontinued operations, because
they do not pertain to an entire
Report in before-tax
dollars (since this is
business segment.
highlighted before taxes
are deducted).
 Income Statement
Changes in Accounting Principle
• If there is a change in GAAP
• If the company changes its reporting choice for a particular
item (LIFO for FIFO, for example)

the retroactive cumulative (all prior years) effect

of the change is reported as a separate item.

Reported net of tax.

 Income Statement
Changes in Accounting Principle
Example: Inventory was purchased in 2000:
1/10 100 units @ $4.00
1/25 400 units @ $5.00
2/10 200 units @ $6.00
Inventory sold (and method chosen):
Year 2000: 300 units (LIFO)
Year 2001: 350 units (switch to FIFO)

The switch to FIFO requires us to report 2001 income under FIFO

and fix 2000 income as if it were reported under FIFO.
This is done using a cumulative adjustment on the new year’s
income statement (2001).
 Income Statement
Changes in Accounting Principle
Purchases
Sales
1/10/00 100 units @ $4.00
2000: 300 units (LIFO)
1/25/00 400 units @ $5.00
2001: 350 units (switch to FIFO)
2/10/00 200 units @ $6.00

First, compute the 2000 adjustment for change in principle:

COGS under old system (LIFO): COGS under new system (FIFO):
200 x $6.00 $1200 100 x $4.00 $400
100 x $5.00 $500 200 x $5.00 $1000
Total $1700 Total $1400
The difference is a $300 reduction in 2000 COGS

If the tax rate is 30%, this results in a $210, net of tax, cumulative
increase to income to be reported on the 2001 income statement.
now 200 are Income Statement
left here Changes in Accounting Principle
Purchases
Sales
1/10/00 100 units @ $4.00
2000: 300 units (LIFO) (now FIFO)
1/25/00 400 units @ $5.00
2001: 350 units (switch to FIFO)
2/10/00 200 units @ $6.00

Next, compute the 2001 COGS:

200 x $5.00 $1000

150 x $6.00 $900
Total $1900
 Income Statement
Changes in Accounting Principle

This will be reflected in the 2001 (current year’s) income statement as follows:

Sales $3,875
COGS $1,900
Gross Margin $1,975
Selling Exps $350
Admin Exps $200
Operating Income $1,425
Taxes Paid (30%) $427.50
Net Income bef. Cumulative
effect of acctg change $997.50
Cumulative effect of
accounting change (net of tax) $210
Net Income $1207.50
 Income Statement
Changes in Estimates

Covered in Chapter 23.

Not retroactively applied.

Examples:

• Changes in bad debt allowance estimate

• Changes in expected useful life for an asset
 Income Statement
Earnings Per Share

• Required to be reported in Income Statement

• Must be reported for discontinued operations,

extraordinary items, and cumulative effect of
accounting changes (see example, bottom of
illustration 4-17 on pg. 148)

Net Income – Preferred Dividends

Weighted Average # of Shares Outstanding
 Income Statement
Retained Earnings

Retained
Revenues Expenses
Earnings
Dividends
 Income Statement
Retained Earnings

Alternatively,

Revenues – Retained
Expenses = Expenses
Earnings
Net Income Dividends
 Income Statement
Statement of Retained Earnings

Reconciles activities in the Retained Earnings account

 Income Statement
Statement of Retained Earnings

Reconciles activities in the Retained Earnings account

Beginning Balance $1,000,000

 Income Statement
Statement of Retained Earnings

Reconciles activities in the Retained Earnings account

Beginning Balance $1,000,000

Correction for understatement of
income error, prior year $100,000

Any prior year net income errors are adjusted directly to

the Retained Earnings account.
 Income Statement
Statement of Retained Earnings

Reconciles activities in the Retained Earnings account

Beginning Balance $1,000,000

Correction for understatement of
income error, prior year $100,000
Adjusted Beginning Balance $1,100,000
Add: Net Income $450,000
Less: Dividends Paid $350,000
Ending Balance $1,200,000