PREVIEW OF CHAPTER 4

Financial Accounting
Lecture 2: Income Statement

FMT – HANU – DINH LE MAI

INTERMEDIATE ACCOUNTING
IFRS 2 ED Chapter 4
Intermediate Accounting
IFRS 2nd Edition
Kieso, Weygandt, and Warfield
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4-1 4-2

Income Statement and INCOME STATEMENT

4 Related Information Usefulness
 Evaluate past performance.
LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Understand the contUnderstand the uses and 6. Explain intraperiod tax allocation.  Predict future performance.
limitations of an income statement.
7. Understand the reporting of accounting
2. ent and format of the income statement. changes and errors.
3. Prepare an income statement. 8. Prepare a retained earnings statement.
4. Explain how to report items in the income 9. Explain how to report other comprehensive  Help assess the risk or uncertainty of
statement. income.
achieving future cash flows.
5. Identify where to report earnings per share
information.

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LO 1

INCOME STATEMENT INCOME STATEMENT

Limitations Quality of Earnings

 Companies omit items that cannot be Companies have incentives to manage income
measured reliably.
 to meet earnings targets or

 to make earnings look less risky.

 Income numbers are affected by the
accounting methods employed. Earnings management is the planned timing of revenues,
expenses, gains, and losses to smooth out earnings.

 Income measurement involves Quality of earnings is reduced if earnings management

judgment. results in information that is less useful for predicting future
earnings and cash flows.

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LO 1
 FORMAT OF THE INCOME STATEMENT FORMAT OF THE INCOME STATEMENT

Elements of the Income Statement Elements of the Income Statement

INCOME – Increases in economic benefits during the INCOME includes both revenues and gains.
accounting period in the form of  Revenues - ordinary activities of a company
 inflows or enhancements of assets or  Gains - may or may not arise from ordinary activities.
 decreases of liabilities
Revenue Accounts Gain Accounts
that result in increases in equity, other than those relating to  Sales revenue  Gains on the sale of long-term
contributions from shareholders.  Fee revenue assets
 Interest revenue  Unrealized gains on trading
 Dividend revenue securities.

 Rent revenue
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LO 2

FORMAT OF THE INCOME STATEMENT FORMAT OF THE INCOME STATEMENT

Elements of the Income Statement Elements of the Income Statement

EXPENSES – Decreases in economic benefits during the EXPENSES include both expenses and losses.
accounting period in the form of  Expenses - ordinary activities of a company
 outflows or depletions of assets or  Losses - may or may not arise from ordinary activities.
 incurrences of liabilities
Expense Accounts Loss Accounts
that result in decreases in equity, other than those relating to  Cost of goods sold  Losses on restructuring
distributions to shareholders.  Depreciation expense charges
 Interest expense  Losses on the sale of long-
 Rent expense term assets

 Salary expense  Unrealized losses on trading

securities.
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LO 2

1. Sales or Revenue
FORMAT OF FORMAT OF
2. Cost of Goods Sold
THE INCOME THE INCOME
Gross Profit
STATEMENT 3. Selling Expenses
STATEMENT
4. Administrative or General Expenses
Intermediate 5. Other Income and Expense
Illustration
Components Income from Operations Includes all of the
Companies generally 6. Financing costs major items in
present some or all of Income before Income Tax previous list, except
these sections and totals 7. Income Tax for discontinued
within the income Income from Continuing Operations operations.
statement. 8. Discontinued Operations
Net Income
9. Non-Controlling Interest
ILLUSTRATION 4-2
Slide 10. Earnings Per Share Slide Income Statement
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 CONDENSED REPORTING WITHIN THE INCOME
INCOME STATEMENT
STATEMENT
Gross Profit
More representative of
the type found in  Computed by deducting cost of goods sold from net
practice. sales.

 Provides a useful number for evaluating performance

ILLUSTRATION 4-3
Condensed Income
Statement
and predicting future earnings.

Unusual or incidental revenues are disclosed in other income

Company prepares and expense.
supplementary schedules to
support the totals.
ILLUSTRATION 4-4
Sample Supporting
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LO 4

REPORTING WITHIN THE INCOME INCOME FROM OPERATIONS

STATEMENT
Expense Classification
Income from Operations
 Determined by deducting selling and administrative Nature Function
expenses as well as other income and expense from gross
profit.

 Highlights items that affect regular business activities.  Cost of materials used  Employee benefits
 Used to predict the amount, timing, and uncertainty of  Direct labor incurred  Depreciation expense
future cash flows.  Delivery expense  Amortization expense
 Advertising expense

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LO 4

INCOME FROM OPERATIONS INCOME FROM OPERATIONS

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

 Cost of goods sold

 Selling expenses
 Administrative
expenses

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 Expense Classification Expense Classification

Nature-of-Expense Approach Function-of-Expense Approach

ILLUSTRATION 4-5 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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LO 4 4-20
LO 4

INCOME FROM OPERATIONS INCOME FROM OPERATIONS

ILLUSTRATION 4-7
Gains and Losses Number of Unusual Items
Reported in a Recent Year
Gains and Losses
by 500 Large Companies
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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LO 4

INCOME FROM OPERATIONS INCOME STATEMENT REPORTING

ILLUSTRATION 4-8

Gains and Losses Income before Income Tax Presentation of

Finance Costs

Additional items that may need disclosure:

 Losses on write-downs of inventories to net realizable value or of
Illustration 4-8
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.

Slide Slide Financing costs must be reported on the income statement.

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 INCOME STATEMENT REPORTING INCOME STATEMENT REPORTING

Net Income Allocation to Non-Controlling Interest

Represents the income after all When a company prepares a consolidated income statement,
IFRS requires that net income be allocated to the controlling
 revenues and
and non-controlling interest. This allocation is reported at the
 expenses bottom of the income statement, after net income.
for the period are considered. ILLUSTRATION 4-9
Presentation of Non-Controlling Interest

Viewed by many as the most important measure of a company’s

success or failure for a given period of time.

(amounts given)
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LO 4

INCOME STATEMENT REPORTING INCOME STATEMENT REPORTING

BE4-3: Presented below is some financial information related to BE4-3: Presented below is some financial information related to
Volaire Group. Compute the following: Other Volaire Group. Compute the following:
Income and Financing
Expense Costs
Revenues €800,000 €800,000 Revenues €800,000 €800,000
Income from continuing operations 100,000 100,000 Income from continuing operations 100,000 100,000
Comprehensive income 120,000 120,000 Comprehensive income 120,000 120,000
Net income 90,000 90,000 Net income 90,000 90,000
Income from operations 220,000 - 220,000 Income from operations 220,000 220,000
Selling and administrative expenses 500,000 - 500,000 Selling and administrative expenses 500,000 500,000
Income before income tax 200,000 200,000 Income before income tax 200,000 - 200,000
€80,000 €20,000
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INCOME STATEMENT REPORTING INCOME STATEMENT REPORTING

BE4-3: Presented below is some financial information related to BE4-3: Presented below is some financial information related to
Volaire Group. Compute the following: Volaire Group. Compute the following:
Discontinued
Income Tax Operations
Revenues €800,000 €800,000 Revenues €800,000 €800,000
Income from continuing operations 100,000 - 100,000 Income from continuing operations 100,000 100,000
Comprehensive income 120,000 120,000 Comprehensive income 120,000 120,000
Net income 90,000 90,000 Net income 90,000 - 90,000
Income from operations 220,000 220,000 Income from operations 220,000 220,000
Selling and administrative expenses 500,000 500,000 Selling and administrative expenses 500,000 500,000
Income before income tax 200,000 200,000 Income before income tax 200,000 200,000
€100,000 - €10,000
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 INCOME STATEMENT REPORTING INCOME STATEMENT REPORTING
BE4-3: Presented below is some financial information related to
Volaire Group. Compute the following:
Earnings per Share
Other
Comprehensive
Income Net Income - Preferred Dividends
Revenues €800,000 €800,000 Weighted Average of Ordinary Shares Outstanding
Income from continuing operations 100,000 100,000
Comprehensive income 120,000 120,000  A significant business indicator.
Net income 90,000 - 90,000
 Measures the dollars earned by each ordinary share.
Income from operations 220,000 220,000
Selling and administrative expenses 500,000 500,000  Must be disclosed on the face of the income statement.
Income before income tax 200,000 200,000
€30,000
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LO 5

ILLUSTRATION 4-12

Earnings per Share Income Statement

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:
ILLUSTRATION 4-10
Divide by
Net Income - Preferred Dividends weighted-
average
Weighted Average of Ordinary Shares Outstanding
shares
outstanding
$350,000 - $50,000
= $3.00 per share
100,000 EPS

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LO 5 Slide
4-34 Earnings per Share LO 5

INCOME STATEMENT REPORTING INCOME STATEMENT REPORTING

Discontinued Operations Discontinued Operations

A component of an entity that either has been disposed of, or Companies report as discontinued operations
is classified as held-for-sale, and:
1. (in a separate income statement category) the gain or loss
1. Represents a major line of business or geographical area of from disposal of a component of a business.
operations, or
2. The results of operations of a component that has been or
2. Is part of a single, co-coordinated plan to dispose of a will be disposed of separately from continuing operations.
major line of business or geographical area of operations, 3. The effects of discontinued operations net of tax as a
or separate category, after continuing operations.
3. Is a subsidiary acquired exclusively with a view to resell.

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LO 5
 DISCONTINUED OPERATIONS DISCONTINUED OPERATIONS
ILLUSTRATION 4-12
Illustration: Multiplex Inc., a highly diversified company, A company that
decides to discontinue its electronics division. During the current reports a
year, the electronics division lost £300,000 (net of tax). Multiplex discontinued
sold the division at the end of the year at a loss of £500,000 (net operation must
of tax). report per share
Income from continuing operations £20,000,000 amounts for the
line item either on
Discontinued operations:
the face of the
Loss from operations, net of tax 300,000 income statement
Loss on disposal, net of tax 500,000 or in the notes to
Total loss on discontinued operations 800,000 the financial
statements.
Net income £19,200,000
ILLUSTRATION 4-11
Income Statement Presentation
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of Discontinued Operations LO 5 4-38

INCOME STATEMENT REPORTING INTRAPERIOD TAX ALLOCATION

Intraperiod Tax Allocation Discontinued Operations (Gain)

Relates the income tax expense to the specific items that give Illustration: Schindler Co. has income before income tax of
rise to the amount of the tax provision. €250,000. It has a gain of €100,000 from a discontinued
operation. Assuming a 30 percent income tax rate, Schindler
On the income statement, income tax is allocated to:
presents the following information on the income statement.
(1) Income from continuing operations ILLUSTRATION 4-13

(2) Discontinued operations

“let the tax follow the income”

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INTRAPERIOD TAX ALLOCATION INTRAPERIOD TAX ALLOCATION

Discontinued Operations (Loss) Discontinued Operations (Loss)

Illustration: Schindler Co. has income before income tax of Companies may also report the tax effect of a discontinued
€250,000. It has a loss of €100,000 from a discontinued item by means of a note disclosure.
operation. Assuming a 30 percent income tax rate, Schindler ILLUSTRATION 4-15

presents the following information on the income statement.

ILLUSTRATION 4-14

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LO 6
 INCOME STATEMENT REPORTING INCOME STATEMENT REPORTING

Summary ILLUSTRATION 4-16

Summary of Income Items
Summary ILLUSTRATION 4-16
Summary of Income Items

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OTHER REPORTING ISSUES Accounting Changes

Accounting Changes and Errors Change in Accounting Principle: Gaubert Inc. decided in March
2015 to change from FIFO to weighted-average inventory pricing.
Changes in Accounting Principle Gaubert’s income before taxes, using the new weighted-average
method in 2015, is $30,000.
 Retrospective adjustment.
ILLUSTRATION 4-17
Pretax Income Data
 Cumulative effect adjustment to beginning retained earnings. Calculation of a Change in
Accounting Principle

 Approach preserves comparability across years.

 Examples include:
► Change from FIFO to average-cost.
ILLUSTRATION 4-18
Income Statement
► Change from the percentage-of-completion to the Presentation of a Change
in Accounting Principle
completed-contract method. (Based on 30% tax rate)

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Accounting Changes Change in Accounting Estimates

Change in Accounting Estimates Change in Estimate: Arcadia HS, purchased equipment for
$510,000 which was estimated to have a useful life of 10 years
 Accounted for in the period of change or the period of
with a residual value of $10,000 at the end of that time.
and the future periods if the change affects both.
Depreciation has been recorded for 7 years on a straight-line
 Not handled retrospectively. basis. In 2015 (year 8), it is determined that the total estimated
 Not considered errors. life should be 15 years with a residual value of $5,000 at the
end of that time.
 Examples include:
► Useful lives and residual values of depreciable assets. Questions:

► Uncollectible receivables.  Does prior years’ depreciation need to be restated?

► Inventory obsolescence.  Calculate the depreciation expense for 2015.
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LO 7
 After After
Change in Accounting Estimates 7 years Change in Accounting Estimates 7 years

Equipment cost $510,000 First, establish NBV Net book value $160,000 Depreciation
Residual value - 10,000 at date of change in Residual value (new) 5,000 Expense calculation
Depreciable base 500,000 estimate. Depreciable base 155,000 for 2015.
Useful life (original) 10 years Useful life remaining 8 years
Annual depreciation $ 50,000 x 7 years = $350,000 Annual depreciation $ 19,375

Balance Sheet (Dec. 31, 2014) Journal entry for 2015

Fixed Assets:
Equipment $510,000 Depreciation Expense 19,375
Accumulated depreciation 350,000 Accumulated Depreciation 19,375
Net book value (NBV) $160,000

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Accounting Changes and Errors Accounting Changes and Errors

Corrections of Errors Corrections of Errors: In 2015, Tsang Co. determined that

it incorrectly overstated its accounts receivable and sales
 Result from:
revenue by NT$100,000 in 2014. In 2015, Tsang makes the
► mathematical mistakes. following entry to correct for this error (ignore income taxes).
► mistakes in application of accounting principles.
Retained Earnings 100,000
► oversight or misuse of facts.
Accounts Receivable 100,000
 Corrections treated as prior period adjustments.

 Adjustment to the beginning balance of retained earnings.

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Accounting Changes and Errors Accounting Changes and Errors

ILLUSTRATION 4-19 ILLUSTRATION 4-19
Summary Summary of Accounting
Changes and Errors Summary Summary of Accounting
Changes and Errors

Type of Type of
Situation
Changes in Accounting Principle Situation
Changes in Accounting Estimate
Criteria Change from one generally accepted accounting Criteria Normal, recurring corrections and adjustments.
principle to another.
Examples Changes in the realizability of receivables and
Examples Change in the basis of inventory pricing from FIFO to
inventories; changes in estimated lives of equipment,
average-cost.
intangible assets; changes in estimated liability for
Placement on Recast prior years’ income statements on the same warranty costs, income taxes, and salary payments.
Income basis as the newly adopted principle.
Statement Placement on Show change only in the affected accounts (not shown
Income net of tax) and disclose the nature of the change.
Statement

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 Accounting Changes and Errors OTHER REPORTING ISSUES
ILLUSTRATION 4-19
Summary Summary of Accounting
Changes and Errors Retained Earnings Statement
Type of
Corrections of Errors
Situation Increase Decrease
Criteria Mistake, misuse of facts.
 Net income  Net loss
Examples Error in reporting income and expense.  Change in accounting  Dividends
principle  Change in accounting
Placement on Restate prior years’ income statements to correct for
Income error.  Prior period principles
Statement adjustments  Prior period
adjustments

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LO 8

OTHER REPORTING ISSUES Retained Earnings Statement

Woods, Inc.
Retained Earnings Statement ILLUSTRATION 4-20 Statement of Retained Earnings
Retained Earnings
Statement
For the Year Ended December 31, 2015

Balance, January 1 ₩1,050,000

Net income 360,000
Dividends (300,000)
Balance, December 31 ₩1,110,000

Before issuing the report for the year ended December 31, 2015, you
discover a ₩50,000 error (net of tax) that caused 2014 inventory to be
overstated (overstated inventory caused COGS to be lower and thus net
income to be higher in 2014). Would this discovery have any impact on the
reporting of the Statement of Retained Earnings for 2015?

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Retained Earnings Statement Retained Earnings Statement

Woods, Inc.
Statement of Retained Earnings Restrictions on Retained Earnings
For the Year Ended December 31, 2015
Disclosed
Balance, January 1 ₩1,050,000
 In notes to the financial statements.
Prior period adjustment - error correction (50,000)
Balance, January 1 (restated) 1,000,000
 As Appropriated Retained Earnings.
Net income 360,000
Dividends (300,000)
Balance, December 31 ₩1,060,000

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 OTHER REPORTING ISSUES Comprehensive Income

Comprehensive Income Net Income

Income Statement (in thousands)
All changes in equity during a period except those resulting Other Comprehensive
from investments by owners and distributions to owners.
Sales
Cost of goods sold
$ 285,000
149,000
+ Income
Gross profit 136,000
 Unrealized gains and
Operating expenses:
Includes: Selling expenses 10,000
losses on non-trading
Administrative expenses 43,000 equity securities.
 all revenues and gains, expenses and losses reported in net Total operating expense 53,000  Translation gains and
income, and Income from operations 83,000
Other revenue (expense):
losses on foreign
Interest revenue 17,000 currency.
 all gains and losses that bypass net income but affect Interest expense (21,000)  Plus others
equity. Total other (4,000)
Income before taxes 79,000
Income tax expense 24,000 Reported in Equity
Net income $ 55,000

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OTHER REPORTING ISSUES Statement of Changes in Equity

Statement of Changes in Equity Reports the change in each equity account and in total
equity for the period. Includes the following:
Required, in addition to a statement of comprehensive
income. 1. Accumulated other comprehensive income for the period.

 Generally comprised of 2. Contributions (issuances of shares) and distributions

► Share capital—ordinary, (dividends) to owners.

► Share premium—ordinary, 3. Reconciliation of the carrying amount of each component

► Retained earnings, and the of equity from the beginning to the end of the period.

► Accumulated balances in other comprehensive

income.

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Statement of Changes in Equity Statement of Changes in Equity

ILLUSTRATION 4-23
Statement of Changes in Equity Regardless of the display format used, V. 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
Presentation of Accumulated Other Comprehensive
Income in the Statement of Financial Position

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