3

Financial Statements — Statement of

Financial Performance (The Profit and
Loss Statement, Income Statement)

Slide
4-1
 INCOME
INCOME STATEMENT
STATEMENT
 An income statement is a financial
statement that reports a company's
financial performance over a specific
accounting period.
 Financial performance is assessed by
presenting a summary of how the
business earned its revenues and
incurred its expenses through both
operating and non-operating activities.

Slide
4-2
 INCOME
INCOME STATEMENT
STATEMENT

Usefulness
 Evaluate past performance.

 Predict future performance.

 Help assess the risk or uncertainty of

achieving future cash flows.

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4-3
 INCOME
INCOME STATEMENT
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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4-4
 INCOME
INCOME STATEMENT
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.
Slide
4-5
 FORMAT
FORMAT OF
OF THE
THE INCOME
INCOME STATEMENT
STATEMENT

Elements of the Income Statement

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.

Slide
4-6
 FORMAT
FORMAT OF
OF THE
THE INCOME
INCOME STATEMENT
STATEMENT

Elements of the Income Statement

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 revenue  Gains on the sale of long-term
 Fee revenue assets
 Interest revenue  Unrealized gains on trading
 Dividend revenue securities.
 Rent revenue
Slide
4-7
 FORMAT
FORMAT OF
OF THE
THE INCOME
INCOME STATEMENT
STATEMENT

Elements of the Income Statement

EXPENSES – 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.

Slide
4-8
 FORMAT
FORMAT OF
OF THE
THE INCOME
INCOME STATEMENT
STATEMENT

Elements of the Income Statement

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

Illustration
Includes all of the
major items in
previous list, except
for discontinued
operations.

Slide
4-11
 CONDENSED
CONDENSED
INCOME
INCOME
STATEMENT
STATEMENT
More representative of
the type found in
practice.

Company prepares
supplementary schedules to
support the totals.
Slide
4-12
 REPORTING
REPORTING WITHIN
WITHIN THE
THE INCOME
INCOME
STATEMENT
STATEMENT

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.

Slide
4-13
 REPORTING
REPORTING WITHIN
WITHIN THE
THE INCOME
INCOME
STATEMENT
STATEMENT

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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4-14
 INCOME FROM OPERATIONS
Expense Classification

Nature Function

 Cost of materials used  Employee benefits

 Direct labor incurred  Depreciation expense
 Delivery expense  Amortization expense
 Advertising expense

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4-15
 INCOME FROM OPERATIONS
Expense Classification

Nature Function

 Cost of goods sold

 Selling expenses
 Administrative
expenses

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4-16
 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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4-17
 Expense Classification

Nature-of-Expense Approach

Slide
4-18
 Expense Classification

Function-of-Expense Approach

The function-of-expense method is generally used in practice

although many companies believe both approaches have merit.
Slide
4-19
 INCOME FROM OPERATIONS

Gains and Losses

Slide
4-20
 INCOME FROM OPERATIONS

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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4-21
 INCOME FROM OPERATIONS

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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4-22
 Recoverable
Recoverable Amount
Amount
 Recoverable amount is the greater of an
asset's fair value less costs to sell, or its
value in use.
 Value in use refers to the present value of
future cash flows expected to be derived from
an asset.
 Thus, the concept essentially focuses on the
greatest value that can be obtained from an
asset, either by selling or using it.
 The recoverable amount concept is used in
the international financial reporting standards
Slide framework.
4-23
 INCOME STATEMENT REPORTING
Income before Income Tax

Illustration 4-8

Slide Financing costs must be reported on the income statement.

4-24
 INCOME STATEMENT REPORTING

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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4-25
 INCOME STATEMENT REPORTING

Allocation to 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.

(amounts given)
Slide
4-26
 INCOME STATEMENT REPORTING
BE3-3: Presented below is some financial information related to
Volaire Group. Compute the following: Other
Income and
Expense
Revenues €800,000
Income from continuing operations 100,000 €800,000
Comprehensive income 120,000
Net income 90,000 100,000
Income from operations 220,000
Selling and administrative expenses 500,000 120,000
Income before income tax 200,000
90,000
Slide
Advance slide in presentation mode to reveal answers. €80,000
4-27
 INCOME STATEMENT REPORTING
BE3-3: Presented below is some financial information related to
Volaire Group. Compute the following:
Financing
Costs
Revenues €800,000
Income from continuing operations 100,000 €800,000
Comprehensive income 120,000
Net income 90,000 100,000
Income from operations 220,000
Selling and administrative expenses 500,000 120,000
Income before income tax 200,000
90,000
Slide
Advance slide in presentation mode to reveal answers. €20,000
4-28
 INCOME STATEMENT REPORTING
BE3-3: Presented below is some financial information related to
Volaire Group. Compute the following:

Income Tax

Revenues €800,000
Income from continuing operations 100,000 €800,000
Comprehensive income 120,000
Net income 90,000 - 100,000
Income from operations 220,000
Selling and administrative expenses 500,000 120,000
Income before income tax 200,000
90,000
Slide
Advance slide in presentation mode to reveal answers. €100,000
4-29
 INCOME STATEMENT REPORTING
BE3-3: Presented below is some financial information related to
Volaire Group. Compute the following:
Discontinued
Operations
Revenues €800,000
Income from continuing operations 100,000 €800,000
Comprehensive income 120,000
Net income 90,000 100,000
Income from operations 220,000
Selling and administrative expenses 500,000 120,000
Income before income tax 200,000
- 90,000
Slide
Advance slide in presentation mode to reveal answers. - €10,000
4-30
 INCOME STATEMENT REPORTING
BE3-3: Presented below is some financial information related to
Volaire Group. Compute the following: Other
Comprehensive
Income
Revenues €800,000
Income from continuing operations 100,000 €800,000
Comprehensive income 120,000
Net income 90,000 100,000
Income from operations 220,000
Selling and administrative expenses 500,000 120,000
Income before income tax 200,000
- 90,000
Slide
Advance slide in presentation mode to reveal answers. €30,000
4-31
 INCOME STATEMENT REPORTING

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.

Slide
4-32
 Earnings
Earnings per
per Share
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

Slide
4-33
 Divide by
weighted-
average
shares
outstanding

EPS
Slide
4-34 Earnings
Earnings per
per Share
Share
 4
Financial Statements —
Statement of Cash Flows

Slide
4-35
 STATEMENT OF CASH FLOWS

An important element of the objective of financial

reporting is

“assessing the amounts, timing, and

uncertainty of cash flows.”

IASB requires the statement of cash flows

(also called the cash flow statement).

Slide
4-36
 STATEMENT OF CASH FLOWS

Primary Purpose: To provide relevant information about

the cash receipts and cash payments of an enterprise
during a period.

Statement provides answers to the following questions:

1. Where did the cash come from?

2. What was the cash used for?

3. What was the change in the cash balance?

Slide
4-37
 STATEMENT OF CASH FLOWS

Content and Format

Operating Investing Financing
Activities Activities Activities
Transactions that Making and Transactions
enter into the collecting loans involving liability
determination of and acquiring and and equity items
net income disposing of
investments and
property, plant,
and equipment

Slide
4-38
 CONTENT AND FORMAT

Slide
4-39
 STATEMENT OF CASH FLOWS

Preparation of the Statement of Cash Flows

Sources of Information
Information obtained from several sources:
1. comparative statements of financial position,

2. current income statement, and

3. selected transaction data.

Slide
4-40
 Preparation
Preparation of
of Statement
Statement of
of Cash
Cash Flows
Flows

Illustration: On January 1, 2015, in its first year of

operations, Telemarketing Inc. issued 50,000 ordinary shares
of $1 par value for $50,000 cash. The company rented its
office space, furniture, and telecommunications equipment and
performed marketing services throughout the first year. In June
2015, the company purchased land for $15,000.

The following Illustration shows the company’s comparative

statements of financial position at the beginning and end of
2015.

Slide
4-41
Slide
4-42
 Preparation of Statement of Cash Flows

Preparing the Statement of Cash Flows

Determine:
1. Net cash provided by (or used in) operating activities.

2. Net cash provided by (or used in) investing and financing

activities.

3. Determine the change (increase or decrease) in cash during

the period.

4. Reconcile the change in cash with the beginning and the

ending cash balances.

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4-43
 Preparing the Statement of Cash Flows

Net cash provided by operating activities

 Excess of cash receipts over cash payments from operating
activities.
 Determined by converting net income on an accrual basis to
a cash basis.
 Add to or deduct from net income those items in the income
statement that do not affect cash.
 Requires an analysis of the current year’s income statement,
comparative statements of financial position and selected
transaction data.
Slide
4-44
 Increase in accounts receivable
reflects a non-cash increase of
$41,000 in revenues.

Cash provided by operating activities ILLUSTRATION 5-22

Slide
4-45
 Increase in accounts payable
reflects a non-cash increase of
$12,000 in expenses.

Cash provided by operating activities ILLUSTRATION 5-22

Slide
4-46
 Preparing the Statement of Cash Flows

Telemarketing Inc.’s investing and financing activities.

 Purchased land for $15,000.
 Issued ordinary shares for $50,000.
 Paid $14,000 in dividends.

Slide
4-47
Investing
and
Financing
Activities

Purchased land
for $15,000
(Investing)

Slide
4-48
Investing
and
Financing
Activities

Issued ordinary
shares for
$50,000
(Financing)

Slide
4-49
Investing
and
Financing
Activities

Paid $14,000 in
dividends
(Financing)

Slide
4-50
 Preparation of Statement of Cash Flows

BE 4-12: Keyser Beverage Company reported the following

items in the most recent year.
Activity
Net income $40,000 Operating
Dividends paid 5,000 Financing
Increase in accounts receivable 10,000 Operating
Increase in accounts payable 7,000 Operating
Purchase of equipment 8,000 Investing
Depreciation expense 4,000 Operating
Issue of notes payable 20,000 Financing

Required: Determine if each item should be classified as an

operating, investing, or financing activity.
Slide
4-51
 BE 4-12 Net income of $40,000

Statement of Cash Flow (in thousands)

Operating activities
Net income $ 40,000
Increase in accounts receivable (10,000)
Increase in accounts payable 7,000
Depreciation expense 4,000
Net cash provided by operating activities 41,000
Investing activities
Purchase of equipment (8,000)
Financing activities
Dividends paid (5,000)
Proceeds from notes payable 20,000
Net cash provided by financing activities 15,000
Increase in cash $ 48,000
Slide
4-52
 BE 4-12 Dividends paid $5,000

Statement of Cash Flow (in thousands)

Operating activities
Net income $ 40,000
Increase in accounts receivable (10,000)
Increase in accounts payable 7,000
Depreciation expense 4,000
Net cash provided by operating activities 41,000
Investing activities
Purchase of equipment (8,000)
Financing activities
Dividends paid (5,000)
Proceeds from notes payable 20,000
Net cash provided by financing activities 15,000
Increase in cash $ 48,000
Slide
4-53
 BE 4-12 Increase in accounts receivable of $10,000

Statement of Cash Flow (in thousands)

Operating activities
Net income $ 40,000
Increase in accounts receivable (10,000)
Increase in accounts payable 7,000
Depreciation expense 4,000
Net cash provided by operating activities 41,000
Investing activities
Purchase of equipment (8,000)
Financing activities
Dividends paid (5,000)
Proceeds from notes payable 20,000
Net cash provided by financing activities 15,000
Increase in cash $ 48,000
Slide
4-54
 BE 4-12 Purchase equipment for $8,000

Statement of Cash Flow (in thousands)

Operating activities
Net income $ 40,000
Increase in accounts receivable (10,000)
Increase in accounts payable 7,000
Depreciation expense 4,000
Net cash provided by operating activities 41,000
Investing activities
Purchase of equipment (8,000)
Financing activities
Dividends paid (5,000)
Proceeds from notes payable 20,000
Net cash provided by financing activities 15,000
Increase in cash $ 48,000
Slide
4-55
 BE 4-12 Increase in accounts payable of $7,000

Statement of Cash Flow (in thousands)

Operating activities
Net income $ 40,000
Increase in accounts receivable (10,000)
Increase in accounts payable 7,000
Depreciation expense 4,000
Net cash provided by operating activities 41,000
Investing activities
Purchase of equipment (8,000)
Financing activities
Dividends paid (5,000)
Proceeds from notes payable 20,000
Net cash provided by financing activities 15,000
Increase in cash $ 48,000
Slide
4-56
 BE 4-12 Proceeds from notes payable of $20,000

Statement of Cash Flow (in thousands)

Operating activities
Net income $ 40,000
Increase in accounts receivable (10,000)
Increase in accounts payable 7,000
Depreciation expense 4,000
Net cash provided by operating activities 41,000
Investing activities
Purchase of equipment (8,000)
Financing activities
Dividends paid (5,000)
Proceeds from notes payable 20,000
Net cash provided by financing activities 15,000
Increase in cash $ 48,000
Slide
4-57
 BE 4-12 Depreciation expense of $4,000

Statement of Cash Flow (in thousands)

Operating activities
Net income $ 40,000
Increase in accounts receivable (10,000)
Increase in accounts payable 7,000
Depreciation expense 4,000
Net cash provided by operating activities 41,000
Investing activities
Purchase of equipment (8,000)
Financing activities
Dividends paid (5,000)
Proceeds from notes payable 20,000
Net cash provided by financing activities 15,000
Increase in cash $ 48,000
Slide
4-58
 BE 4-12
Statement of Cash Flow (in thousands)
Operating activities
Net income $ 40,000
Increase in accounts receivable (10,000)
Increase in accounts payable 7,000
Depreciation expense 4,000
Net cash provided by operating activities 41,000
Investing activities
Purchase of equipment (8,000)
Financing activities
Dividends paid (5,000)
Proceeds from notes payable 20,000
Net cash provided by financing activities 15,000
Increase in cash $ 48,000
Slide
4-59
 Preparation of Statement of Cash Flows

Question
In preparing a statement of cash flows, which of the following
transactions would be considered an investing activity?
a. Sale of equipment at book value
b. Sale of merchandise on credit
c. Declaration of a cash dividend
d. Issuance of bonds payable.

Slide
4-60
 Preparation of Statement of Cash Flows

Significant Non-Cash Activities

Reported in a separate note to the financial statements.

Examples include:
 Issuance of ordinary shares to purchase assets.
 Conversion of bonds into ordinary shares.
 Issuance of debt to purchase assets.
 Exchanges on long-lived assets.

Slide
4-61
Slide
4-62
 Usefulness of Statement of Cash Flows

Without cash, a company will not survive.

Cash flow from Operations:

 High amount - able to generate sufficient cash from
operations to pay its bills without further borrowing.
 Low or negative amount - may have to
► borrow or
► issue equity securities.

Slide
4-63
 Usefulness of Statement of Cash Flows

Financial Liquidity

Net Cash Provided by

Current Cash Operating Activities
Debt Coverage =
Ratio Average Current Liabilities

Ratio indicates the ability to pay off current liabilities from

operations.
Ratio near 1:1 is good.

Slide
4-64
 Usefulness of Statement of Cash Flows

Financial Flexibility

Net Cash Provided by

Cash Debt Operating Activities
Coverage =
Ratio Average Total Liabilities

Ratio indicates the ability to repay liabilities from net cash

provided by operating activities, without having to liquidate
assets employed in operations.

Slide
4-65
 Usefulness of Statement of Cash Flows

Free Cash Flow

Indicates the amount of discretionary cash flow available.

Slide
4-66
 Usefulness of Statement of Cash Flows

Question
The current cash debt coverage ratio is often used to
assess
a. financial flexibility.
b. liquidity.
c. profitability.
d. solvency.

Slide
4-67