Copyright © 2016 Pearson Education, Inc. - PowerPoint Presentation

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Copyright © 2016 Pearson Education, Inc. - PPT Presentation

Chapter 3 Income Statement and Statement of Stockholders Equity 3 1 Income Statement and Statement of Stockholders Equity Income Statement Also called the statement of earnings Presents a firms revenues expenses net income and earnings per share ID: 698251

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Slide1

Chapter 3Income Statement and Statement of Stockholders’ Equity

3-1Slide2

Income Statement and Statement of Stockholder’s Equity

Income StatementAlso called the statement of earningsPresents a firm’s revenues, expenses, net income, and earnings per share

Statement of Stockholder’s EquityLink between balance sheet and income statementAnnual reports include three years of income statements and stockholder’s equity information.

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The Income Statement

Comes in two basic formatsMultiple-step formatSingle-step formatMultiple-step format should be used for analysis purposes.

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The Income Statement

Multiple-step formatProvides several intermediate profit measures prior to the amount of net earnings for the periodGross profitOperating profit

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The Income Statement

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The Income Statement

Single-step formatGroups all items of revenue together, then deducts all categories of expense

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The Income Statement

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The Income Statement

Regardless of format, certain items must be disclosed separately on an income statement:Discontinued operationsExtraordinary transactions

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The Income Statement

Comprehensive IncomeChange in equity during a period from transactions, other events, and circumstances related to nonowner sources.Companies are required to report comprehensive income in one of three ways:

on the face of its income statementin a separate statement of comprehensive income, orin its statement of stockholders’ equity.

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The Income Statement

Common-Size Income StatementUseful analytical toolCompare firms with different levels of sales or total assetsF

acilitate internal or structural analysisEvaluate trendsMake industry comparisons

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The Income Statement

Common-Size Income StatementExpresses each income statement item as a percentage of net salesShows the relative magnitude of various expenses relative to sales, the profit percentages, and the relative importance of “other” revenues and expenses

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The Income Statement

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The Income Statement

Net SalesTotal sales revenue is shown net of returns and allowances.A sales return is a cancellation of a sale.A sales allowance is a deduction from the original sales invoice price.

Sales are the major revenue source for most companies.

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The Income Statement

Net SalesIf a company’s sales are increasing (or decreasing), it is important to determine whether the change is a result of price, volume, or a combination of both.The reasons for sales growth (or decline) are covered in the Management Discussion and Analysis.

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The Income Statement

Net Sales“Real” (inflation adjusted) sales growth“Nominal” (as reported) sales growthAn adjustment of the reported sales figure with the Consumer Price Index (or some other measure of general inflation) will enable the analyst to compare changes in real and nominal terms.

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The Income Statement

Cost of Goods SoldAlso called cost of salesCost to seller of products or services sold to customersAffected by cost flow assumption used to value inventory

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The Income Statement

Cost of Goods Sold PercentageRatio of cost of goods sold and net salesImportant for profit determination

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The Income Statement

Cost of Goods Sold Percentage – Sage Inc.Increased between 2014 and 2015

MD&A explains that lower prices on footwear have resulted in lower margins.

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The Income Statement

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The Income Statement

Gross ProfitAlso called gross marginDifference between net sales and cost of goods soldFirst step of profit measurement on the multi-step income statement

Key analytical tool in assessing operating performance

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The Income Statement

Gross Profit MarginRatio of gross profit to net sales (expressed as a percentage)Complement of the cost of goods sold percentage

Firms want to maintain or increase gross profit margin.Remains relatively constant in stable industriesMay change significantly in volatile industries

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The Income Statement

Gross Profit Margin – Sage Inc.

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The Income Statement

Gross Profit Margin – Multiple Revenue SourcesEach revenue is shown separately.Each revenue line will show the corresponding cost of goods sold for each revenue source.

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The Income Statement

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The Income Statement

Operating ExpenseIncludes areas in which management discretion is exercisedHas considerable impact on current and future profitabilityImportant to track trends, absolute amounts, relationship to sales, and relationship to industry competitors

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The Income Statement

Operating ExpensesSelling and administrative expensesAdvertising costsDepreciation and amortization

Repairs and maintenanceImpairment charges

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The Income Statement

Operating Expenses – Selling and Administrative ExpensesRelate to the sale of products or servicesSalaries, rent, insurance, utilities, supplies, etc.

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The Income Statement

Operating Expenses – Advertising CostsAre or should be a major expense when marketing is an important element of success

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The Income Statement

Advertising Costs for Sage Inc.Sage Inc. spends 6 to 7 cents of every sales dollar for advertising.

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The Income Statement

Operating Expenses – Lease PaymentsCosts associated with operating rentals of leased facilities for retail outletsNote 3 to the financial statements explains the agreements that apply to the rental arrangements and presents a schedule of minimum annual rental commitments.

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The Income Statement

Operating Expenses – Depreciation and AmortizationCost of assets other than land that will benefit a business enterprise for more than a year is allocated over the asset’s service life.Cost allocation procedure is determined by the nature of the long-lived asset.

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The Income Statement

Operating Expenses – Depreciation and AmortizationDepreciation is used to allocate the cost of tangible fixed assets.Amortization is an allocation process applied

to capital leases, leasehold improvements, and cost expiration of intangible assets.Depletion is an allocation process applied to acquisition and development of natural resources.

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The Income Statement

Percentage of Depreciation and Amortization Expense for Sage Inc.

Decreased somewhat from 2015 to 2016New assets were placed in service during 2016 for only a part of the year (rendering less than full year’s depreciation and amortization).

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The Income Statement

Operating Expenses – Repairs and MaintenanceAnnual costs of repairing and maintaining PP&EShould correspond to the level of investment in capital equipment and to the age and condition of fixed assets

Inadequate allowance can impair success.Should be evaluated in relation to the firm’s investments in fixed assets

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The Income Statement

Percentage of Repairs and Maintenance Expense for Sage Inc.

Decreased from 2015 to 2016Could be a result of having newer fixed assets needing fewer repairsCould be a choice to delay repairs in order to increase operating profit in the short term

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The Income Statement

Operating Expenses – Impairment ChargesRecognized to record a decline in value of a long-term assetMay occur in connection with goodwillCan also be recognized when asset values of PP&E decrease below book value

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The Income Statement

Operating ProfitAlso called earnings before interest and taxes (EBIT)Second step of profit determination on the multi-step income statement

Measures overall performance of operationsProvides a basis for assessing success of a firm apart from financing and investing activities and separate from tax considerationsSales revenue less the expenses associated with generating sales

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The Income Statement

Operating Profit MarginRatio of operating profit to net sales

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The Income Statement

Operating Profit Margin for Sage Inc.Indicates that Sage Inc. strengthened its return on operations in 2016 after a dip in 2015

Despite the percentage increase in cost of goods sold, Sage Inc.’s percentage of selling and administrative and advertising expenses decreased enough to increase operating profit.

39Slide40

The Income Statement

Other Income (Expense)Revenues and costs other than from operationsDividend and interest incomeI

nterest expenseInvestment gains (losses)Equity earnings (loss)

ains (losses) from sale of fixed assets

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The Income Statement

Other Income (Expense)Firms that carry debt and equity securities classified as “trading securities” report these investments on the balance sheet at market value with any unrealized gains and losses included in earnings.

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The Income Statement

Other Income (Expense)In assessment of earning quality, the analyst should consider the materiality and the variability of the nonoperating items of income.Gains and losses on the sale of major capital assets

Accounting changesExtraordinary itemsInvestment income from temporary investments in cash equivalents

Investment income recognized under the equity method

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The Income Statement

Equity EarningsTwo accounting methods for investments in voting stock of other companiesEquity methodCost method

Analysts should be aware of whether a company uses the equity or cost method.

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The Income Statement

Equity Earnings – Equity MethodAllows the investor proportionate recognition of the investee’s net income, irrespective of the payment or nonpayment of cash dividendsShould be used when the investor can exercise significant influence over the investee’s operating and financing policies

Fits accrual accounting requirementsDistorts earnings when income is recognized and no cash may ever be received

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The Income Statement

Equity Earnings – Cost MethodInvestor recognizes investment income only to the extent of any cash dividends received.Allows recognition of investment income only to the extent of any cash dividends actually received

Carries an investment account at cost

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The Income Statement

Example – Assume that company A acquires exactly 20% of the voting common stock of Company B for $400,000. Company B reports $100,000 earnings for the year and pays $25,000 in cash dividends.For

company A, income recognition in the earnings statement and the noncurrent investment account on the balance sheet are different depending on the accounting method.

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The Income Statement

Cost MethodAllows recognition of investment income only to the extent of any cash dividends actually received:

$25,000 x 0.20 = $5,000Investment account is carried at cost.

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The Income Statement

Equity MethodPermits the investor to count as income the percentage interest in the investee’s earnings.

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The Income Statement

Equity MethodInvestment account is increased by the amount of investment income recognized and is reduced by the amount of cash dividends received.

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The Income Statement

Equity MethodDistorts earningsIncome is recognized even though no cash may ever be received.Assumes that the investor could cause the investee to pay dividends (which may not be true)

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The Income Statement

Earnings Before Income Taxes / Effective Tax RateEarnings before income taxes is the profit recognized before the deduction of income tax expense.Income taxes paid may differ from income tax expense.

Effective tax rate is the ratio of income taxes to earnings before income taxes.

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The Income Statement

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The Income Statement

Earnings Before Income Taxes / Effective Tax RateNoteworthy items that may affect the effective tax rate are net operating losses (NOLs) and foreign taxes.

Users of financial statements need to distinguish between earnings increasing due to core operations versus items such as tax rate deductions.

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The Income Statement

Special ItemsOften one-time items that will not recur in the futureDiscontinued operations

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The Income Statement

Net EarningsAlso called the “bottom line”Represents profit after consideration of all revenue and expense

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The Income Statement

Net Profit MarginRatio of net earnings to net sales (expressed as a percentage)Shows the percentage of profit earned on every sales dollar

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The Income Statement

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The Income Statement

Earnings per Common ShareNet earnings available to common stockholders for the period divided by the average number of common stock shares outstandingFirms with complex capital structure report basic and diluted earnings per common share.

Analysts should consider material changes in the number of common stock shares outstanding.

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The Income Statement

Comprehensive IncomeReported in one of three waysOn the face of the income statementIn a separate statement of comprehensive income

In the statement of stockholders’ equity

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The Income Statement

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The Income Statement

Comprehensive IncomeForeign currency translation effectsUnrealized gains and lossesAdditional pension liabilities

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The Income Statement

Comprehensive Income – Foreign Currency Translation EffectsArise from changes in equity of foreign subsidiariesOccur as a result of changes in foreign currency exchange rates

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The Income Statement

Comprehensive Income – Unrealized Gains and LossesCumulative net unrealized gains and losses

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The Income Statement

Comprehensive Income – Additional Pension LiabilitiesReported when accumulated benefit obligation is greater than the fair market value of plan assets less the balance of the accrued pension liability account or plus the balance in the deferred pension asset account

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The Income Statement

Comprehensive Income – Cash Flow HedgesDerivatives designated as hedging the exposure to variable cash flows of a forecasted transactionCompanies using cash flow hedges must initially report any gain or loss in other comprehensive income and subsequently reclassify the amount into earnings when the forecasted transaction affects earnings.

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Statement of Stockholders’ Equity

Important link between the balance sheet and the income statementDocuments changes in the balance sheet equity accountsAnnual reports include three years of stockholders’ equity information

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Statement of Stockholders’ Equity

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Statement of Stockholders’ Equity

Stock dividendsIssuance of additional shares of stock in proportion to current ownershipReduce retained earnings account

Stock splitsUsed to lower the market price of shares to make common stock more affordableReverse stock splitsOccurs when outstanding shares are decreased

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Earnings Quality, Cash Flow, and Segmental Accounting

Assessment of the quality of reported earnings is an essential element of income statement analysis.Cash flow from operations is a key ingredient in analyzing operating performance.

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Earnings Quality, Cash Flow, and Segmental Accounting

Segmental data include revenue, operating profit or loss, assets, depreciation and amortization, and capital expenditures by industry components.These disclosures facilitate analysis of operating performance and contribution by each segment.

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All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.

Copyright © 2016 Pearson Education, Inc. - PowerPoint Presentation

Copyright © 2016 Pearson Education, Inc. - PPT Presentation

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