FRA – Chapter 2- Income statement
Financial Reporting
& Analysis
4th Year
Chapter (2)
Income statement
2024 – 2025
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FRA – Chapter 2- Income statement
(2) Income Statement
- The Income Statement is the report that measures the success of company operations for
a given period of time.
- It covers a period of time (For the Year/Quarter/Month Ended...).
- The accounts that record revenues, expenses, gains and losses are temporary accounts.
- The income statement helps to predict future cash flows, as follows:
o It helps users to evaluate the company’s past performance and to compare it to the
performance of its competitors.
o It provides a basis for predicting future performance.
o It helps users assess the risk or uncertainty of achieving future cash flows
There are two formats for preparing income statement:
(1) Single-step format:
o Total of all revenues and gains Less the total of all expenses and losses
o No operating income in this analysis (disadvantage)
XYZ Company
Income Statement
For the Year Ended December 31, 2020
Sales $ 493,252
Interest Income 132,452
Other Income 43,215
668,919
Costs and Expenses:
Cost of Goods Sold $ 232,152
General & Administrative 121,409
Advertising 126,225
Uncollectible Accounts 21,464 501,250
Income Before Taxes 167,669
Income Taxes (8,382)
Net Income $ 159,287
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FRA – Chapter 2- Income statement
(2) Multiple-step format:
- Gross profit (sales – cost of goods sold)
- Operating income (income before taxes, interest, and other revenues and expenses)
- Income before taxes
- Net income
XYZ Company
Income Statement
For the Year Ended December 31, 2020
Sales $ 493,252
Cost of Goods Sold 232,152
Gross Profit 261,100
Operating Expenses:
General & Administrative $ 121,409
Advertising 126,225
Uncollectible Accounts 21,464 269,098
Operating Income (7,998)
Interest Income 132,452
Other Revenue 43,215 175,667
Income Before Taxes 167,669
Income Taxes 8,382
Net Income $ 159,287
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FRA – Chapter 2- Income statement
Multiple-step method
1- Operating income Section:
Net Sales: Net sales = Sales – (sales return& allowance, sales discount) XX
(-) Cost of Goods sold: The cost of goods that were sold to produce revenue (XX)
GROSS PROFIT XX
(-) operating Expense (selling, general, and administrative expenses) (XX)
Selling Expense: Result from the company’s effort to create sales
(advertising, sales commissions, supplies used, depreciation ,amortization).
Administrative expense: Relate to the general administration of the
company’s operation (salaries expense, insurance expense, uncollected
accounts (bad debt expenses)
+other operating revenue “commissions, finance charges ...etc”
Operating income (most important number)
XX
2- Non-operating income section: Secondary activities don’t directly relate to
operations
Other income:(dividends income, interest income, gain from sale of assets). XX
Other expenses: (interest expense, loss from sale of assets) (XX)
Unusual OR infrequent Items:
- If material, disclosed separately, before income taxes. XX
INCOME BEFORE TAX XX
3.(Deduct) Income Tax (XX)
Net Income from continuing operation (RECURRING NET INCOME) XX
[Link] items (unusual AND infrequent) net of tax:
*Discontinued operations
a) gain or loss from operation (net of tax) XX
b) gain or loss from sale or disposal ( net of tax) XX
*Extra ordinary items gain or loss (Net of tax) (flood loss, earthquake loss) XX
expropriation loss
Net income XX
Earnings per share = net income / n. of shares outstanding XX
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FRA – Chapter 2- Income statement
Discontinued Operation:
When an entity reports a discontinued operation, it must be presented in a separate section
between income from continuing operations and net income.
- Because these items are reported after the presentation of income taxes, they must be
shown net of tax.
Discontinued operations, if reported, may have two components:
a) Gain or loss from operations of the component that has been disposed of or is
classified as held for sale from the first day of the reporting period until the date of
disposal (or the end of the reporting period if it is classified as held for sale)
b) Gain or loss on the disposal of this component
Special Income Statement Items:
1) Equity in Earnings of Nonconsolidated Subsidiaries:
- presented below “Unusual OR infrequent Items”
-The investor’s proportional share of the investee’s net income.
- Does not represent cash flow to the investor (until cash dividends).
- Cash dividends received represent cash flow.
- Analysis issues:
• Investor’s net income includes revenue of other entity.
• May distort ratios
2) Minority Share of Earnings (consolidated subsidiary):
- Earnings of a partially-owned consolidated subsidiary that would accrue to the
minority owners (deducted if income, added if loss).
- Presentation may be either pre-tax or net-of-tax.
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FRA – Chapter 2- Income statement
Retained Earnings
Retained Earnings:
- The accumulated undistributed earnings of the corporation reported on the balance sheet.
- Reported as part of the statement of Owner’s equity or combined with the Income
Statement.
- Appropriated:
• Restricted by law, contract, or management decision.
• Not available for dividends.
- Unappropriated:
• Available for dividends.
• Does not represent cash or any other asset.
- Cumulative effect:
- Change in accounting principle used.
- All comparative statements are retrospectively restated to reflect application of the new
accounting principle.
- The cumulative effect on income of earlier years is shown as a net-of-tax adjustment
to the beginning retained earnings balance of the earliest period presented
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FRA – Chapter 2- Income statement
Example
Machine purchases on 1/1/2015 at $180,000. Company used sum-of-year digits method, on
1/1/2018 company change to straight line method. Useful life 5 years & no salvage value.
Tax rate is 20%.
S.Y. D S. L
(old) (new)
2015 60,000 36,000
2016 48,000 36,000
2017 36,000 36,000
144,000 108,000
- The effect of change of dep. method (net of tax) = 28,800 ((144,000-108,000) *.80)
Dividends:
Dividends return profits to the owners of a corporation. Dividends can be:
- Cash dividends
o Date of declaration: create liability and reduce retained earnings.
o Date of payment: reduce liability and cash
- Stock dividends
o The firm issue a percentage of outstanding stock as new shares to existing
shareholders.
Stock split:
- 2-for-1 split
o Doubles the quantity of stock
o Reduce the market value of the shares.
o Par or stated value is halved.
- No effect on retained earnings, additional paid-in capital, or capital stock accounts.
- Analysis issues:
o Restate share quantities to reflect split activity.
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FRA – Chapter 2- Income statement
Comprehensive Income:
Net income + The period’s change in accumulated other comprehensive income (net of
tax) = Comprehensive income
- Categories within accumulated other comprehensive income is:
• Foreign currency translation adjustments.
• Unrealized holding gains and losses on available-for-sale marketable securities.
• Changes to owners' equity resulting from additional minimum pension liability
adjustments.
• Unrealized gains and losses from derivative instruments.
- There are three formats for reporting comprehensive income:
1) Separate Statement.
2) Combined with Income Statement.
3) As Part of the Statement of Owners' Equity.
- Analysis issues:
• Typically, more volatile than net income
• A better indication of long-run profitability
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FRA – Chapter 2- Income statement
(1) Separate Statement.
XYZ corporation
Statement of Comprehensive income
For the year Ended December 31, 20XX
Net income 34,000
Other comprehensive income:
Available for sale security adjustment – net of tax 5,500
Minimum pension liability adjustment – net of tax 3,500
Foreign currency transaction adjustment, net of tax (5,000)
Total other comprehensive income 4,000
Comprehensive Income 38,000
(2) Combined with Income Statement.
XYZ corporation
Statement of income and Comprehensive income
For the year Ended December 31, 20XX
Sales 230,000
COGS 140,000
Gross profit 370,000
Operating expenses 40,000
Operating income 330,000
Other income 4000
Income before income tax 326,000
Income tax 20,000
Net income 306,000
Other comprehensive income:
Available for sale security adjustment – net of tax 5,500
Minimum pension liability adjustment – net of tax 3,500
Foreign currency transaction adjustment, net of tax (5,000)
Total other comprehensive income 4,000
Comprehensive Income 310,000
Earnings per share (For net income only) $2.8
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FRA – Chapter 2- Income statement
Income statement limitations
There are some limitations that reduce the usefulness of the income statement for predicting
amounts, timing, and uncertainty of cash flows include:
- Net income is an estimate that reflects a number of assumptions.
- Income numbers are affected by the accounting methods used.
For example, differences in methods of depreciation can cause differences in the amount
of depreciation expense during each year of an asset’s life. A lack of comparability
between and among companies results from these differences in accounting methods.
- Income measurement requires judgment calls. For example, the amount of
depreciation expense recorded during a period is dependent upon estimates regarding
the useful lives of the depreciating assets.
- Items that cannot be measured reliably are not reported in the income statement.
For instance, increases in value due to brand recognition, customer service, and product
quality are not reflected in net income.
- The income statement is limited to reporting events that produce reportable revenues and
expenses. Some transactions are not reported immediately on the income statement.
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FRA – Chapter 2- Income statement
EXAMPLE 1:
The following information for Decher Automotives covers the year ended 2008:
Administrative expense $ 62,000
Dividend income 10,000
Income taxes 100,000
Interest expense 20,000
Merchandise inventory, 1/1 650,000
Merchandise inventory, 12/31 440,000
Flood loss (net of tax) 30,000
Purchases 460,000
Sales 1,000,000
Selling expenses 43,000
Required:
a. Prepare a multiple-step income statement.
b. Assuming that 100,000 shares of common stock are outstanding, calculate the earnings
per share before extraordinary items and the net earnings per share.
Solution
(a)
Decher Automotives
Income Statement
For the Year Ended December 31, 2008
Sales $1,000,000
Cost of goods sold:
Beginning inventory $ 650,000
Purchases 460,000
Merchandise available for sale $ 1,110,000
Less: Ending inventory (440,000)
Cost of goods sold 670,000
Gross profit 330,000
Operating expense:
Selling expenses $ 43,000
Administrative expenses 62,000 105,000
Operating income 225,000
Other income:
Dividend income 10,000
Other expense:
Interest expense (20,000)
Income before taxes 215,000
Income taxes (100,000)
Income from continuing operations 115,000
Extraordinary items:
Flood loss, net of tax (30,000)
Net income $ 85,000
(b)
Earnings per share:
Income from continuing operations $ 1.15
Extraordinary items (loss) (0.30)
Net income $ 0.85
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FRA – Chapter 2- Income statement
EXAMPLE 2:
The accounts of Consolidated Can contain the following amounts at December 31, 2008. Assume
a flat 20% corporate tax rate on all items:
Cost of products sold $410,000
Dividends 3,000
Extraordinary gain (pretax) 1,250
Income taxes 9,300
Interest expense 8,700
Rental income 1,600
Retained earnings, 1/1 270,000
Sales 480,000
Selling and administrative expense 42,000
Common stock (30,000 shares outstanding) 150,000
Required: Prepare a multiple-step income statement combined with a reconciliation of retained
earnings for the year ended December 31, 2008.
Consolidated Can
Income Statement
For the Year Ended December 31, 2008
Sales $ 480,000
Cost of products sold (410,000)
Gross profit 70,000
Operating expenses:
Selling and Administrative expenses (42,000)
Operating income 28,000
Other income:
Rental income 1,600
Other expense:
Interest expense (8,700)
Income before tax 20,900
Income tax (9,300)
Income from continuing operations 11,600
Extraordinary gain, net of tax (1,250 x 80%) 1.000
Net income $ 12,600
Earnings per share:
Income from continuing operations $ 0.39
Extraordinary items (loss) 0.03
Net income $ 0.42
Retained Earnings Statement
Retained earnings 1/1 $270,000
Net income 12,600
Less: dividends (3,000)
Retained earnings 12/31 $ 279,600
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