Intermediate Accounting

IFRS Edition
Kieso, Weygandt, Warfield
Fourth Edition

Chapter 4
Income Statement and Related Information
Prepared by
Coby Harmon
University of California, Santa Barbara
Westmont College

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PREVIEW OF CHAPTER 4

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 Learning Objective 1
Identify the uses and limitations of an
income statement.

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Income Statement
Usefulness
• Evaluate past performance.

• Predicting future performance.

• Help assess the risk or uncertainty of

achieving future cash flows.
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Income Statement
Limitations
• Companies omit items that
cannot be measured reliably.

• Income numbers are affected

by the accounting methods
employed.

• Income measurement
involves judgment.

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Income Statement
Quality of Earnings
Companies have incentives to manage income
• to meet earnings targets or
• to make earnings look less risky.
Earnings management is the planned timing of revenues,
expenses, gains, and losses to smooth out earnings.
Quality of earnings is reduced if earnings management results
in information that is less useful for predicting future earnings
and cash flows.

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 Learning Objective 2
Describe the content and format of the
income statement.

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Elements of the Income Statement
Income
Income – Increases in economic benefits during the
accounting period in the form of
• inflows or enhancements of assets or
• decreases of liabilities
that result in increases in equity, other than those relating to
contributions from shareholders.

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Elements of the Income Statement
Income Accounts
Income includes both revenues and gains.
• Revenues - ordinary activities of a company
• Gains - may or may not arise from ordinary activities.

Revenue Accounts Gain Accounts

• Sales • Gains on the sale of long-
• Fees term assets
• Interest • Unrealized gains on
trading securities
• Dividends
• Rent

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Elements of the Income Statement
Expenses
Expenses represent decreases in economic benefits during
the accounting period in the form of
• outflows or depletions of assets or
• incurrences of liabilities
that result in decreases in equity, other than those relating to
distributions to shareholders.

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Elements of the Income Statement
Expense Accounts
Expenses include both expenses and losses.
• Expenses - ordinary activities of a company
• Losses - may or may not arise from ordinary activities.

Expense Accounts Loss Accounts

• Cost of goods sold • Losses on restructuring
• Depreciation charges
• Interest • Losses on to sale of long-
• Rent Salary and wages term assets
• Taxes • Unrealized losses on
trading securities
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Income Statement
Intermediate Components
1. Sales or Revenue
Companies generally present
2. Cost of Goods Sold
some or all of these sections Gross Profit
and totals within the income 3. Selling Expenses
statement. 4. Administrative or General Expenses
5. Other Income and Expense
Income from Operations
6. Financing costs
Income before Income Tax
7. Income Tax
Income from Continuing Operations
8. Discontinued Operations
Net Income
9. Non-Controlling Interest
10. Earnings Per Share

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Format of the Income Statement

ILLUSTRATION 4.2
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Condensed Income Statement

More representative of the

type found in practice.

ILLUSTRATION 4.3

Company prepares
supplementary schedules to
support the totals.
ILLUSTRATION 4.4

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 Learning Objective 3
Discuss how to report various income
items.

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Reporting Various Income Items
Gross Profit
• Computed by deducting cost of goods sold from net sales.
• Provides a useful number for evaluating performance and
predicting future earnings.
Unusual or incidental revenues are disclosed in other income
and expense.

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Reporting Various Income Items
Income from Operations
• Determined by deducting selling and administrative
expenses as well as other income and expense from gross
profit.
• Highlights items that affect regular business activities.
• Used to predict the amount, timing, and uncertainty of
future cash flows.

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Income From Operations
Expense Classification
Illustration: The firm of Telaris Co. performs audit, tax, and
consulting services. It has the following revenues and
expenses.

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Expense Classification
Nature-of-Expense Approach

ILLUSTRATION 4.5
The nature-of-expense approach is simple to apply because
allocations to expense of different functions are not necessary.
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Expense Classification
Function-of-Expense Approach

ILLUSTRATION 4.6
The function-of-expense method is generally used in practice
although many companies believe both approaches have merit.
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Gains and Losses

ILLUSTRATION 4.7
ILLUSTRATION 4.7 identifies the most common types and number of gains and losses reported in a
survey of 500 large companies. Notice that more than 40 percent of the surveyed firms reported
restructuring charges, which often contain write-offs and other one-time items.

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IASB’S Position on Gains and Losses

IASB takes the position that both

• revenues and expenses and
• other income and expense
should be reported as part of income from operations.
Companies can provide additional line items, headings, and
subtotals when such presentation is relevant to an
understanding of the entity’s financial performance.

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Gains and Losses
Additional Items That May Need Disclosure
• Losses on write-downs of inventories to net realizable value or
of property, plant, and equipment to recoverable amount, as
well as reversals of such write-downs.
• Losses on restructurings of the activities and reversals of any
provisions for the costs of restructuring.
• Gains or losses on the disposal of items of property, plant, and,
equipment or investments.
• Litigation settlements.
• Other reversals of liabilities.

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Reporting Various Income Items
Presentation of Finance Costs

ILLUSTRATION 4.8
Financing costs must be reported on the income statement.

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Reporting Various Income Items
Net Income
Represents the income after all
• revenues and
• expenses
for the period are considered.
Viewed by many as the most important measure of a
company’s success or failure for a given period of time.

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Reporting Various Income Items
Earnings per Share

Net Income  Preferred Dividends

Weighted Average of Ordinary Shares Outstanding

• A significant business indicator.

• Measures the dollars earned by each ordinary share.
• Must be disclosed on the face of the income statement.

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Earnings per Share

Illustration: Lancer, Inc. reports net income of $350,000. It

declares and pays preferred dividends of $50,000 for the year. The
weighted-average number of ordinary shares outstanding during
the year is 100,000 shares. Lancer computes earnings per share as
follows:

Net Income  Preferred Dividends

Weighted Average of Ordinary Shares Outstanding

$350,000  $50,000
= $3.00 per share
100,000

ILLUSTRATION 4.9

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Reporting Various Income Items
Discontinued Operations
A component of an entity that either has been disposed of, or
is classified as held-for-sale, and:
1. Represents a major line of business or geographical
area of operations, or
2. Is part of a single, co-coordinated plan to dispose of a
major line of business or geographical area of
operations, or
3. Is a subsidiary acquired exclusively with a view to
resell.

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Components of Discontinued
Operations
Companies report as discontinued operations
1. (in a separate income statement category) the gain or
loss from disposal of a component of a business.
2. The results of operations of a component that has been
or will be disposed of separately from continuing
operations.
3. The effects of discontinued operations net of tax as a
separate category, after continuing operations.

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Income Statement Presentation of
Discontinued Operations
Illustration: Multiplex Products, a highly diversified company,
decides to discontinue its electronics division. During the current
year, the electronics division lost £300,000 (net of tax). Multiplex
sold the division at the end of the year at a loss of £500,000 (net of
tax).

ILLUSTRATION 4.10

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Earnings per Share Amounts on Income
Statement
A company that reports a
discontinued operation
must report per share
amounts for the line item
either on the face of the
income statement or in
the notes to the financial
statements.

ILLUSTRATION 4.11

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Reporting Various Income Items

Intraperiod Tax Allocation

Relates the income tax expense to the specific items that give
rise to the amount of the tax provision.
On the income statement, income tax is allocated to:
1) Income from continuing operations
2) Discontinued operations
“let the tax follow the income”

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Intraperiod Tax Allocation
Discontinued Operations (Gain)
Illustration: Schindler AG has income before income tax of
€250,000. It has a gain of €100,000 from a discontinued
operation. Assuming a 30 percent income tax rate, Schindler
presents the following information on the income statement.

ILLUSTRATION 4.12

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Intraperiod Tax Allocation
Discontinued Operations (Loss)
Illustration: Schindler AG has income before income tax of
€250,000. It has a loss of €100,000 from a discontinued operation.
Assuming a 30 percent income tax rate, Schindler presents the
following information on the income statement.

ILLUSTRATION 4.13

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Intraperiod Tax Allocation
Note Disclosure
Companies may also report the tax effect of a
discontinued item by means of a note disclosure.

ILLUSTRATION 4.14

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Reporting Various Income Items
Presentation of Non-Controlling Interest
When a company prepares a consolidated income statement, IFRS
requires that net income be allocated to the controlling and non-
controlling interest. This allocation is reported at the bottom of the
income statement, after net income.

ILLUSTRATION 4.15

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Brief Exercise 4-3
Other Income and Expense
Presented below is some financial information related to
Volaire Group. Compute the following:

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Brief Exercise 4-3
Financing Costs
Presented below is some financial information related to
Volaire Group. Compute the following:

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Brief Exercise 4-3
Income Tax
Presented below is some financial information related
to Volaire Group. Compute the following:

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Brief Exercise 4-3
Discontinued Operations
Presented below is some financial information related to
Volaire Group. Compute the following:

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Brief Exercise 4-3
Other Comprehensive Income
Presented below is some financial information related to
Volaire Group. Compute the following:

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 Summary of Various Income Items (1 of 2)

ILLUSTRATION 4.16

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 Summary of Various Income Items (2 of 2)

ILLUSTRATION 4.16

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 Learning Objective 4
Explain the reporting of accounting changes
and errors.

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Accounting Changes and Errors
Changes in Accounting Principle
• Retrospective adjustment.
• Cumulative effect adjustment to beginning retained
earnings.
• Approach preserves comparability across years.
• Examples include:
o Change from FIFO to average-cost.
o Change from the percentage-of-completion to the
completed-contract method.

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Changes in Accounting Principle

Change in Accounting Principle: Gaubert Inc. decided in March

2022 to change from FIFO to weighted-average inventory pricing.
Gaubert’s income before taxes, using the new weighted-average
method in 2022, is $30,000.

ILLUSTRATION 4.17

ILLUSTRATION 4.18

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Accounting Changes

Change in Accounting Estimates

• Accounted for in the period of change or the period of and
the future periods if the change affects both.
• Not handled retrospectively.
• Not considered errors.
• Examples include:
o Useful lives and residual values of depreciable assets.
o Uncollectible receivables.
o Inventory obsolescence.

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Change in Accounting Estimates

DuPage Materials AG consistently estimated its bad debt

expense at 1% of accounts receivable. In 2022, however,
DuPage determines that it must revise upward the estimate of
bad debts for the current year’s credit sales to 2 percent. The
2 percent rate is necessary to reduce accounts receivable to
net realizable value. Using 2 percent results in a bad debt
charge of CHF240,000, or double the amount using the 1
percent estimate for prior years.
Questions:
• Does prior years’ bad debt estimates need to be restated?
• Calculate the bad debt expense for 2022.
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Changes in Accounting Estimates

DuPage records the bad debt expense and related allowance at

December 31, 2022 as follows.

Bad Debt Expense 240,000

Allowance for Doubtful Accounts 240,000

DuPage includes the entire change in estimate in 2022 income

because the effect of the change does not affect future periods.
Companies do not handle changes in estimate retrospectively.
Changes in estimates are not considered errors.

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Accounting Errors

Corrections of Errors
• Result from:
o mathematical mistakes.
o mistakes in application of accounting principles.
o oversight or misuse of facts.
• Corrections treated as prior period adjustments.
• Adjustment to the beginning balance of retained earnings.

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Corrections of Errors

Illustration: In 2022, Tsang Ltd. determined that it incorrectly

overstated its accounts receivable and sales revenue by
NT$100,000 in 2021. In 2022, Tsang makes the following entry to
correct for this error (ignore income taxes).

Retained Earnings 100,000

Accounts Receivable 100,000

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Summary of Accounting Changes and
Errors

ILLUSTRATION 4.19

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 Learning Objective 5
Describe related equity statements.

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Related Equity Statements
Retained Earnings Statement

Increase Decrease
• Net income • Net loss
• Change in accounting • Dividends
principles • Change in accounting
• Prior period adjustments principles
• Prior period adjustments

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Retained Earnings Statement
Prior Period Adjustments

ILLUSTRATION 4.20

Before issuing the report for the year ended December 31, 2022,
you discover a ₩50,000 error (net of tax) that caused 2021
inventory to be overstated (overstated inventory caused COGS to
be lower and thus net income to be higher in 2021).
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Retained Earnings Statement
Restrictions on Retained Earnings
Disclosed
• In notes to the financial statements.
• As Appropriated Retained Earnings.

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Related Equity Statements
Comprehensive Income
All changes in equity during a period except those resulting
from investments by owners and distributions to owners.
Includes:
• all revenues and gains, expenses and losses reported in
net income, and
• all gains and losses that bypass net income but affect
equity.

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Comprehensive Income

Companies must display the components of other

comprehensive income in one of two ways:
1. A single continuous statement (one statement approach)
or
2. two separate, but consecutive statements of net income
and other comprehensive income (two statement
approach).

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Comprehensive Income
One Statement Approach

Advantage – does not

require the creation of a
new financial statement.
Disadvantage - net
income buried as a
subtotal on the
statement.

ILLUSTRATION 4.21

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Comprehensive Income
Two Statement Approach
Reporting
comprehensive income
in a separate statement
indicates that the gains
and losses identified as
other comprehensive
income have the same
status as traditional
gains and losses.

ILLUSTRATION 4.22

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Related Equity Statements
Statement of Changes in Equity
Required, in addition to a statement of comprehensive
income.
• Generally comprised of
o Share capital—ordinary,
o Share premium—ordinary,
o Retained earnings, and the
o Accumulated balances in other comprehensive income.

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Statement of Changes in Equity

Reports the change in each equity account and in total equity

for the period. Includes the following:
1. Accumulated comprehensive income for the period.
2. Contributions (issuances of shares) and distributions
(dividends) to owners.
3. Reconciliation of the carrying amount of each component
of equity from the beginning to the end of the period.

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Statement of Changes in Equity
Example

ILLUSTRATION 4.23

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Presentation of Accumulated Other
Comprehensive Income in the Statement of
Financial Position
Regardless of the display format used, Gill reports the
accumulated other comprehensive income of €90,000 in the
equity section of the statement of financial position as
follows.

ILLUSTRATION 4.24

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