Transcript Intermediate Accounting - Mount Allison University

Intermediate Accounting
Thomas H. Beechy
Schulich School of Business,
York University
Joan E. D. Conrod
Faculty of Management,
Dalhousie University
PowerPoint slides by:
Bruce W. MacLean,
Faculty of Management,
Dalhousie University
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
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The Income Statement and the
Retained Earnings Statement
Thomas H. Beechy
Schulich School of Business,
York University
Chapter 3
Joan E. D. Conrod
Faculty of Management,
Dalhousie University
PowerPoint slides by:
Bruce W. MacLean,
Faculty of Management,
Dalhousie University
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
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3
INTRODUCTION


Return

Current profit performance
The income statement is the primary source of information.
Predicting future income and cash flows.
Financial statement readers use this and other information to
estimate the amount, timing,
Comparing Investments
and uncertainty
13%
Providing feedback:
11%
How good were predictions of
9%
prior years’ earnings?
7%
Performance evaluation.
5%
6%
7%
8%
9%
Risk
Investors look at the return and
IBM Nortel ABC
risk of their investment.

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3
NATURE OF INCOME




Change in Retained Earnings
Economic Income versus
Accounting Income
Inclusiveness of the
Income Statement
Income as a
Predictive Tool
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3
Change in Retained Earnings

there
is no new
disinvestment
by owners
TheWhen
income
statement
links investment
a company'sor
beginning
and ending
balance
the for
change
in accounting
owners' equity
from the beginning to the end of
sheets
a given
period.
the period equals net income.
Balance Sheet
31 December 20x1
Income Statement
Year ended
31 December 20x2
Balance Sheet
31 December 20x2
Liabilities
Liabilities
Assets
Assets
Owners’
equity
+
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
Owners’
equity
Revenues
 Expenses
= Net Income
=
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3



Economic Income versus Accounting Income
The term income means different things to different people.
Economist:
An economist
defines owns
a change
in wealth,
whether
Example: Suppose
that a company
a parcel
of land for
realized
not,$10,000
as income.
The
wealth
(Value>Cost)
is
which itorpaid
several
years
ago. increase
A new highway
has
called
economic
income,
and it isand
based
on individuals
an events
just been
built next
to the property,
several
approach
rather
than
on completed
transactions.
have offered
to pay
$125,000
to $150,000
for the land. The
firm has notUsing
yet agreed
to sell. cost measurement principle, an
Accountant:
the historical
accountant usually would not recognize such an increase in
wealth as income. Only if the land is sold at fair value to
another party in an arm’s-length transaction would the
accountant recognize the increase in wealth as income. This is
accounting income, based on the transactions approach.
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3

General problems with the transactions approach
to reporting income
Not all relevant information is captured by transactions
– For example, the relevant market value of the land in the above example is
excluded from recognition in the financial statements, but is of considerable
interest to a bank that uses the land as collateral for a loan.

Management makes choices about the accounting policies and
accounting estimates
– Accounting policies determine which transactions are recorded and how
their impacts are measured. Rules for estimates are flexible.

Management can use transactions to manipulate results
– Management can enter into transactions (or avoid transactions) with the
primary purpose of affecting the reported results. .
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3
Income Statement Concepts
4. Revenues are increases in
4. An essential characteristic of a
Losses are
decreases
in equity
7. The
transaction
must
5.7.Expenses
decreases
characteristic
economicare
resources,
either 5.
byThe essential
revenue transactions
is of
that it
from
or in
incidental
not
be
one
that
meets
economic
resources,
an expense
that
itthe
must
be must
6.inGains
are(a)
increases
net assets
6. is
The
transaction
not
way peripheral
of
inflows
or
arises
from
company’s
transactions
events
affecting
characteristics
either
by way ofand
(a)
incurred
in conjunction
with
the
from
peripheral
or
bethe
one
that meets
theofand
enhancements
ofincidental
assets or
(b)
ordinary
earning
activities,
anreductions
entity
and
othercompany’s
(a) an
outflows
or reductions
ofaffecting
revenue
generating
of from
liabilities,
not from
(a)expense
capital
transactions,
transactions
and
eventsall
characteristics
of (a) a
transactions,
events,
and process.(b)Expenditures
transaction
ordo
assets
or (b)
that
not
resulting
from
the
the
settlement
of
monetary
an
entity
andincurrences
from
allordinary
other
revenue-producing
entityliabilities,
(b) a capital
transaction
of circumstances
liabilities,
resulting
as expenses
treated
activities of
anaffecting
entity,
or are
(c) or
the
salea of
transactions,
events,
and anqualify
transaction
(b)
capital
that
areordinary
given
accounting
(e.g.,
dividends
or
from
the
either as
assets
(future
normally
from
the saleanofentity
capital
assets
or economic
investment
circumstances
affecting
transaction
(e.g., capital
revenue-earning
activities
benefit assets
to beinfusion
derived),
losses
recognition
except
those
other
distributions
to
goods,
the rendering
of that
that
are given
accounting
byasthe
owners).
of result
an
entity.
(no economicowners).
benefit), or as
services,
or expenses
the use
byor
others
from
recognition
except
those
that
result
ofrevenues
entity resources
yieldingdistributions to owners.
distributions
equity.
from
orofequity
rent, interest, royalties, or
contributions.
dividends
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3
Inclusiveness of the Income Statement
Current
Operating

Performance.
Items that are part of the ordinary recurring operations of the firm should be
included in earnings. Other items, for example, gains and losses that relate to
prior periods or to unusual or non-recurring activities are recorded as direct
adjustments to retained earnings. Net income” should have maximum power for
predicting operating income.
All transactions affecting the net increase or decrease in equity during the
period are included in the determination of net income, except contributions by
or distributions to owners. Decreases the probability that they will be
overlooked in a review of the operating results for a period of years. Reduce the
dangers of possible manipulation of the annual earnings figure. Assess fully the
importance of each item and its effect on operating results and cash flows.
Accounting standards in Canada generally reflect an approach that is closer to
the all-inclusive approach. Virtually all items affecting equity (other than
investment by or distributions to owners) are included in net income; the AcSB
has largely eliminated the possibility of charging or crediting items directly to
retained earnings except for corrections of errors and for restatements due to
changes in accounting policies. Separately identify and disclose the various
special non-operating items separately on the face of the income statement.
Which items affecting shareholders’ equity
should be included in the computation of net
All-Inclusiveincome and reported in the income statement?
Approach.
Current
Practice.
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The Royal Bank of Canada reported earnings of $1,169 in 1994
3 and $1,262
in 1995
in millions).
Income
as (amounts
a Predictive
Tool The increase in 1995
over 1996 was about 8%.
Based
on this data, and your understanding that the bank
 Earnings trends are important analytical tools
operated in a stable environment in 1996, what estimate could
used by investment analysts and investors in
you provide for 1996 earnings?
forecasting a company's future earnings.
Another
8% increase
would translate
 Forecasts
of future
earningsinto
area prediction
one factorof
$1,363often
($1,262
 1.08%),
not too
far off the decisions.
bank’s reported
used
in making
investment
1996 earnings of $1,430, which was an increase of about 13%
 Past trends and performance do not guarantee
over 1995.
continuation of such trends and performance in
future,
but 13%
theyincrease
are often
in get an
If youthe
predict
another
for useful
1997, you’d
prediction.
estimate
of about $1,616; actual 1997 net income was $1,679.
Well, prediction is not really that easy.
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One anomoly that might catch your eye is the fact
Goingshows
a bit further
income
statement,
that 1996
a huge up
taxCN’s
recovery
of $694,
3 one might
Exhibit
3-1
notice
something
called profitable
“special
even though operations
were modestly
EXHIBIT
EXHIBIT
3-1
3-1of Income
charges”
which, be
at $1,453,
was
fairly
instrumental
Consolidated
Statement
and
would
normally
expected
to
result
in
an
Will there be more special charges in future years? Or was these onein the
reported
In
1996,
there
was
Canadian
Canadian
National
Railway
Company
income
tax1995
expense.
The loss.
reason
can
beNational
tracedRailway
(in Company
timeRevenues
events?
Industrial
productscharge Consolidated
$Income
893
$ 851 $ 838
Consolidated
Statement
Statement
ofis
of Income
another
special
of
$381,
but
there
no
the
notes)
to
a
change
in
accounting
policy;
CN
Forest products
787 will
771help in
Yearand
ended
Year
December
endedindustry
December
31824 31
Information
from the company,
from
experts,
Grain
and grain
products
692
564
600
such
charge
in
1997.
Reference
toCanadian
theof net
notes
(not
(in millions
(in
millions
of
Canadian
dollars)
dollars)
chose
to
apply
the
AcSB’s
revised
income
tax
•
CN
reports
a
loss
of
$(1,085)
in
1995,
income
of
$805
in
1996
this assessment.
But,
taking out the non-recurring
noted601
above,
Coal, sulphur, and
fertilizers
635 items618
reproduced
here)
indicates
that
there
were1997
a776
few
Intermodal
6771995 635
accounting
rules
well
in
advance
of
their
and
net
income
of
$402
in
1997.
1997
1996
1996
1995
earnings
from
continuing
operations
would
be
as
follows:
Automotive
435
389
399
(restated)
(restated)
(restated)
(restated)
things
in
this
category,
but
the
biggest
item in
mandatory
effective
date
of
2000.
This
accounting
• It’s
hard
to
see
a
trend
based
on
bottom-line
net
income!
Other
items
97
109
110
19973,9951996
Revenues
Revenues
4,352 4,352
3,9953,9541995
3,954
1995
was
the
write
down
of
one
of
CN’s
capital
change
permitted
thehold
company
to
• What
will
1998
for CN?
Operating
Operating
expenses
expenses
3,545
3,7664,967(1,092)
4,967
Income
from
continuing
operations,
as recognize,
reported3,545 in
421 3,766 836
Operating
Operating
incomeincome
(loss) by
(loss)
807
807 229
229(1,013) (1,013)
Operating
Expenses
assets,
railthat
properties,
$1,300.
Rail
properties
1996,
aanswer
one-time
gain
of
$768
as
the
probable
Subtract
special,
nonrecurring,
income
tax
gain
(768)
• To
question,
one
would
certainly
seek
forecasts
of(198)
Interest
Interest
expense
expense
(118) (118)
Labour
and fringe
benefits
1,431(114) (114)
1,381 (198)
1,477
were
written
down
their areas
value
was
Add
back
special,
nonrecurring,
charges
Other
income
Other
income
57
57
27 1001,453
future
tax
benefits
from
past
operating
losses;
economic
activity
inbecause
CN’s
major
of
operation
–297
Material
316 27 381
318100
IncomeIncome
(loss)
from
(loss)
continuing
from
continuing
operations
operations
335
314
277
Restated
impaired:
earnings
their
from
future
continuing
cash
operations
flow
was
deemed
421
449
361
there
is Fuel
no
cash
flow
associated
with
this
gain,
at
transportation,
industrial
products,
forest
products,
mining,
etc.
before
income
before
income
taxes
taxes
746
746
142
142
(1,111)
(1,111)
Depreciation and amortization
200
194
231
insufficient
to
their
capital
cost.
1996,
taxes
186
171
192 and
Income
Income
tax
(expense)
tax gain
(expense)
recovery
recovery
least
notOperating
insectors
1996.
Ifrecover
the
had
not
been
• These
represent
major
areas
of
theInCanadian
economy,
Equipment
rentals
219 694
216 19 194 19
from continuing
from continuing
operations
operations
(325) (325)
694
the
special
charge
was
made
for
estimated
recognized,
taxcontinuing
expense
would
have
there
are
lots
offrom
sources
to consult.
NetIncome
carincome
hire
116 836
108(1,092)117
Income
(loss)
(loss)
from continuing
operations
operations
421 been
421
836
(1,092)
Purchased
services
363
348
354
Discontinued
Discontinued
operations
operations
reduction
costs
expected to be incurred
$74.workforce
Casualty
insurance
103 14
85
(net and
of applicable
(net
of applicable
income income
taxes) taxes)
(18) (18)
14
7 52 7
in 1997
(but
be (loss)
paid out over the $next
Other
273
271
302
Net income
Net to
income
(loss)
402$seven
402
$ 805$ 805
$(1,085)$(1,085)
Special charges
–
381
1,453
years).
A
little
detective
work
has
paid
off.
Earnings per
Earnings
share per
Note
share
16  Note 16
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Ryerson
Canada
ReferencesReferences
to other
disclosure
toLimited,
other notes
disclosure
have notes
been omitted.
have been omitted.
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3
Choice in Format Issues







Title
Fiscal Year End
Reporting Period
Length and Composition
Reporting Currency
Rounding
Language
Comparative data
Copyright 1998 McGraw-Hill Ryerson Limited, Canada




Detail
Display
Single Step Format
Multiple Step Format
–
–
–
–
Operations Section
Non-Operations Section
Other possible sections
Income tax expenses
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EXHIBIT 3-3
Cott Corporation
Consolidated Statement of Earnings
in thousands of dollars, except per share amounts
Exhibit 3-2
A multiple-step income statement as contained in
25-Jan-97
the Cott Corporation
annual 27-Jan-96
report, is28-Jan-95
presented in
Sales
$1,351,567 $1,277,393 $1,061,754
Exhibit 3-3. In this example,
the multiple-step
Cost of Goods Sold
1,135,543 1,128,596
912,143
Gross Profit
216,024
148,797
149,611
statement
presents
a
number
of
fairly
idiosyncratic
Selling, General and Administrative Expenses
102,426
103,159
70,939
subtotals:
Earnings before the Undernoted
113,598
45,638
78,672
Amortization of capital assets
25,304
17,566
10,755
Gross
profit
Amortization of goodwill, licenses and trademarks
2,745
2,044
2,540
Earnings before
the undernoted
Amortization of other assets
8,834
6,208
4,196
Interest on long-term debt
25,357
17,578
4.489
Earnings(loss)
before
income
taxes
Other interest
1,952
2,335
2,110
Interest income and other expense Earnings (loss)
-2,944
-459
-1,821
before undernoted
Restructuring costs
12,076
37,156
–
Click
on
the
Income
Statement
to
open
it
in Excel
Gain on reduction of investments in joint ventures
-2,260
–
–
Settlement of class action lawsuit
Earnings (loss) Before Income Tax
Income Taxes
Current
Deferred
Earnings (loss) Before Undernoted
Minority Interest
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
1,915
72,979
40,619
–
82,428
-36,790
–
22,269
56,403
5,554
6,367
11,921
28,698
-613
-2,487
-7,539
-10,026
-26,764
516
20,236
73
20,309
36,094
-1,538
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3
Format Issues Governed By Accounting
Standards






Required Subsections
Intraperiod Tax Allocation
Minimum Disclosure of
Continuing Operations
Discontinued Operation
Extraordinary Items
Unusual or Infrequent Gains
and Losses
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Required Subsections
 The
income statement should distinguish the
Continuing
operations
includesfollowing:
all of the revenues, expenses, gains, and losses that pertain
to those operations
thatdiscontinued
management has
decided to
– Income except
or lossthose
before
operations
and
sell or shut extraordinary
down.
items.
Discontinued
operations
– Results
of discontinued operations.
includes past and estimated future revenues, expenses, gains, and
– Income or loss before extraordinary items.
losses on those segments of the company’s business that
– Extraordinary
management
has decided toitems.
get out of.
– Netitems
income or loss for the period.
Extraordinary
includes –only
those few
andwhen
lossesand
that as
meet
the criteria for
Earnings
pergains
share,
appropriate.
classificationas
extraordinary.
[CICA
1520.02]
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3
Intraperiod Tax Allocation



If an item is shown net of related tax, it means that the tax
consequences of the item have been determined and the
reported amount is shown after these tax effects have
been adjusted for.
Determining this amount is the process of intraperiod tax
allocation. Intra means that the allocation is within the
period and within the income statement and retained
earnings statement.
Interperiod tax allocation is the allocation of tax expense
to different reporting periods, covered in depth in Chapter
16.
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3
Minimum Disclosure of Continuing
Operations


Section 1520 of the CICA Handbook specifies the
minimum information content of the income statement
included in arriving at the income or loss before
discontinued operations and extraordinary items :
Revenue items include:




revenue
investment income of various types
lease income
revenue from government assistance
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3
Minimum Disclosure of Continuing
Operations

Section 1520 list of information that the AcSB
considers desirable. Major items include:
– cost of goods sold
– major operating expenses categories, such
as selling and administrative expenses
– rental expense
– certain types of lease income
– the net amount of foreign currency gains
or losses included in income
– certain amounts relating to financial assets
and financial liabilities that are recognized
as income or expense for the period
(discussed in Chapters 13 and 15)
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3
Minimum Disclosure of Continuing
Operations

Recommended disclosures of expenses include:






depreciation and amortization
research and development expenses
interest expenses
unusual items
income taxes
non-controlling, or
minority, interest in income
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3
Discontinued Operations
 Implications for predicting future income
Examples
of segments that, if discontinued, would
cash flow.
requireand
disclosure:
In a troubled
economy,
sale or windup
of
 Amanufacturer
eliminates
a significant
and
business segments
are common
distinguishable
product line.
occurrences.
 A tobacco
and consumer products company sells its
interest
in an oil and gas
joint
venture,
its only is
 Restructuring:
If the
existing
business
investment
in the
gas industry.
changed,
butoil
theand
company
stays in the
 A food
distributor
who normally
sellsmay
its product
same
line of business,
a loss
be
directly
to restaurants sells its wholesale division,
reported.
which sold products to retail outlets
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
Discontinued Operations
Specifically, two components
of income resulting from
discontinued operations must
be disclosed separately:
– Results of operations for the
discontinued segment before
the disposal decision, net of tax.
– Gain or loss (net of tax) from
disposal of a segment of a
business, including the income
or loss from operating the
business during any phase out
period
Copyright 1998 McGraw-Hill Ryerson Limited, Canada

Full disclosure of a
discontinued operation
includes the following:
– Identification and description of the
business segment discontinued.
– The measurement date and the
actual or projected disposal date.
– The actual or expected manner of
disposition.
– A description of the assets, by major
classification, of the discontinued
segment.
– Revenue attributable to the
discontinued segment for the
reporting period.
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3
Extraordinary Items

Section 3480, the CICA Handbook – transactions or
events that have all of the following characteristics:
– They are not expected to occur frequently over several years.
– They do not typify the normal business activities of the entity.
– They do not depend primarily on decisions or determinations
by management or owners.
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3
Extraordinary Items

Section 3480 – Events which are
not extraordinary items:
 Losses and provisions for losses with
respect to bad debts and inventories.
 Gains and losses from fluctuations in
foreign exchange rates.
 Adjustments with respect to contract prices.
 Gains and losses from write-down or sale
of property, plant, equipment, or other investments.
 Income tax reductions on utilization of prior period losses or
reversal of previously recorded tax benefits. (Such reductions were
once considered extraordinary and were a common example of an
extraordinary item.)
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3
Unusual or Infrequent Gains and Losses
Some events or transactions are not extraordinary but should be
disclosed separately on the income statement to emphasize their
nature as unusual or infrequent.
 For example, assume a timber company has a material write-down
TheofCICA
Handbook
companies
its pulp
and paperrecommends
inventory andthat
timber
resourcesreport
(a capital
separately
“revenues,
expenses,
gains
or losses
resulting from
asset) due
to prevailing
low prices
in the
timber industry.

items– that
not have
the characteristics
of extraordinary
The do
write-down,
anall
impairment
of value, has been
determined by
management
but caused
by outside
events that
low market
items but
result from
transactions
or events
are notprices.
expected
– It isfrequently
certainly infrequent,
since the
company
that it isnormal
the first
to occur
over several
years,
or doreports
not typify
time in the company’s 40-year history that such a write-down has been
business
activities of the entity” [CICA 1520.03(1)].
necessary.
Such– items
should
be shown
net of
tax.
However,
risksnot
associated
with price
fluctuations
in a natural resource
market are surely a typical business risk in the timber industry.
– The item is not extraordinary.

How should the company report the asset impairment?
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3
Earnings Per Share



Public companies are required to report earnings per
share.
Earnings per share (EPS) is a summary figure that is
often quoted by analysts and investors as the primary
(and sometimes only) indication of a company’s
earnings record.
Public companies are required to report earnings per
share for both (1) income before discontinued
operations and extraordinary items, and (2) net income.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada
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3
Earnings Per Share


.
Basic earnings per share is computed by dividing reported
income available to the holders of common shares by the weighted
average number of common shares outstanding during the year.
For computation of EPS on common shares, income must be
reduced by any preferred share dividend claims since such
dividends are not available to common share owners and have not
been subtracted in computing income.
Fully diluted earnings per share shows how earnings per share
would change in the event that all common shares promised under
the terms of existing option agreements, conversion privileges on
bonds or preferred shares, etc., were actually issued. We’ll study
earnings per share in depth in Chapter 21
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3






International Perspective
Virtually every country requires an income statement of some form.
TheThe
measurement
and
measurement
vary,
but there
terms andbasis
labels
onspecific
statements
may haverules
quite
different
is always some attempt to measure the results of operations.
meanings than under GAAP. Statements prepared on the entity
Income statements in non-North American reporting environments are
basis of reporting are called value added statements:
less revealing than in Canada.
reveals much more information that is of interest to other
The biggest difficulty a reader has with international
and that
is very useful for public policy.
financialstakeholders
income statements
is understanding
theand
value
to the economy by the
what anreveals
item means
howadded
it was measured.
Virtuallyenterprise.
no other country other than Canada
andCanadians
the United States
requires separate
will recognize
the concept of value added as the
reporting
operations or effects
basis of
ondiscontinued
which the much-beloved
Goods and Services Tax
of changes in accounting policy.
(GST) is levied.
In many countries, the accounting measurement rules
are greatly influenced by tax law.
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3
Retained Earnings Statement






Error Corrections
Retroactive Effect of a
Change in Accounting Policy
Capital Transactions
Other Charges
Appropriations of and
Restrictions on Retained
Earnings
Prior Period Adjustments
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3

Retained Earnings Statement
The purpose of the
retained earnings
statement is
– to report all changes in
retained earnings during the
accounting period,
– to reconcile the beginning
and ending balances of
retained earnings, and
– to provide a connecting link
between the income
statement and the balance
sheet.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada

The major components of
a statement of retained
earnings are:
– 1. Net income or loss for the
period.
– 2. Dividends.
– 3. Error corrections.
– 4. Cumulative effect of
retroactive changes in
accounting policy.
– 5. Other changes: capital
transactions, appropriations,
and restrictions.
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3







Error Corrections
When errors are made, they must be corrected.
This sometimes involves restating the financial statements of prior years,
and thus changing prior income, which is summarized in retained earnings.
Proper disclosure of these changes is accomplished
by making an adjustment to opening retained earnings
for the cumulative impact of the change to prior income,
net of tax.
Opening retained earnings as restated are presented.
Then, the comparative financial statements are adjusted
to give effect to the error correction.
In effect, the transaction is backed out of the current
income statement and into the appropriate prior year.
A description of the error and its effect on the financial
statements must be included in the disclosure notes.
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Retroactive Effect of a Change in
Accounting Policy
3



The retroactive effect of a change in
accounting policy is also reflected on the
retained earnings statement.
When an accounting policy is changed,
the comparability of the financial
statements is compromised unless all
comparative numbers, including prior
years’ net incomes, are restated using
the newly adopted principle.
This change in prior years’ income also
changes opening retained earnings as
previously reported.
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3
Capital Transactions




The retained earnings statement contains other increases
and decreases in equity caused by capital transactions. Most
capital transactions are share transactions.
Since a corporation is dealing with itself (its owners) in share
transactions, gains and losses caused by these transactions
are not shown on the income statement because they are not
arm’s-length transactions.
Gains normally create contributed capital  separate
shareholders’ equity accounts  and losses reduce retained
earnings.
We’ll study these more carefully in Chapter 14.
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3
Other Charges

Other charges to retained
earnings result from:
– share issue expenses incurred on
the issuance of new shares,
– taxes resulting from a change in
control or triggered by dividend
payments to shareholders,
– and adjustments to retained
earnings caused by a
reorganization.
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3
Appropriations of and Restrictions on
Retained Earnings
Appropriations of and restrictions on retained earnings limit the availability of retained
earnings to support dividends.
Restrictions result from legal requirements, such as a statutory requirement that
retained earnings be restricted for dividend purposes by the cost of any treasury stock
held, or contractual agreements, such as a bond agreement (i.e., indenture) requiring
that retained earnings of a specified amount be withheld from dividend purposes until
the bonds are retired.
Copyright 1998 McGraw-Hill Ryerson Limited, Canada

Appropriations of retained earnings
result from formal decisions by the
corporation to set aside, or appropriate, a
specific amount of retained earnings
(temporarily or permanently). The effect of
an appropriation is to remove the
specified amount of retained earnings
from dividend availability.
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3
Prior Period Adjustments





In the past, another category of items, called prior period adjustments
were also charged to opening retained earnings, and shown net of tax
on the retained earnings statement with full retroactive restatement.
These items, such as lawsuits decided in one year but pertaining to
events of a prior year, or a tax reassessment related to a prior year, fit
established criteria in order to qualify them for exclusion from the
income statement.
The most stringent requirements were that the items had to be the
result of decisions by someone other that owners or managers, and had
to relate to specific prior periods.
However, in line with the all-inclusive concept of income, the AcSB
decided that these items were, in fact, related to normal operations and
should be recorded on the face of the income statement.
Thus, the category no longer exists.
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3
Review Problem
1. Single-step income statement:
Killian Corporation
Click on the Statement
to Open in Excel
Income Statement
for the Year Ended 31 December 20x5
2. Multiple-step income statement:
Click on the Statement to Open in Excel
Killian Corporation
Income Statement
for the Year Ended 31 December 20x5
Revenues and gains:
Sales revenue
$1,000,000
Sales revenue
$1,000,000
Service revenue
200,000
Cost
of
goods
sold
600,000
Interest revenue
30,000
Gross
margin
400,000
Gain on sale of operational asset
10,000
Operating
expenses:
Total revenue and gains
1,330,000
Selling, general and administrative expenses
$150,000
Expenses and losses:
Depreciation
expense
50,000
200,000
Cost of goods sold
600,000
Income
from
operations
200,000
Selling, general and administrative expenses
150,000
Other
revenues
and
gains:
Depreciation
50,000
Service revenue
200,000
Interest expense
20,000
Interest
revenue
30,000
Loss on sale of long-term investment
10
Gain
on
sale
of
operational
asset
100,000
330,000
Income tax expense [see computations below]
200,000
Other
expenses
and
losses:
Total expenses and losses
1,030,000
Interest expense
20,000
Income from continuing operations
300,000
Loss on sale of long-term investment
10,000
30,000
Discontinued operations:
Net other items
300,000
Loss from discontinued operations, net of tax of $4,000
($6,000)
Income from continuing operations before income tax
500,000
Loss on disposal
of business
segment, net of tax of $24,000 -36,000
-42,000
Computation
of income
tax expense:
Income
tax
expense
200,000
Income
before extraordinary item
258,000
Total revenues
$1,330,000
Income
from
continuing
operations
300,000
Extraordinary
item:
Expenses before
income taxes :
Discontinued operations:
Loss of
from
earthquake
damage, net of tax benefit of $80,000 $600,000 -120,000
Cost
goods
sold
Loss from discontinued operations, net of tax of $4,000
-6,000
Net
income
Selling,
general and administrative expenses
150,000 $138,000
Loss
on
disposal
of
business
segment,
net
of
tax
of
$24,000
-36,000
-42,000
Capital cost allowance (equal to depreciation)
50,000
Income
before
extraordinary
item
258,000
Interestper
expense
20,000
Earnings
share:
Extraordinary
item:
Loss
onfrom
sale continuing
of long-term
investment
10,000
830,000
Income
operations
$3.00
Loss
from
earthquake
damage, net of tax effects of $80,000
-120,000
Taxable
income
500,000
Net income
$1.38
Copyright
1998
McGraw-Hill
Ryerson
Limited,
Canada
Net
income
$138,000
b
a
c
k
next
h
o
m
e
Tax rate
40%
Computation of Taxable Income
Click on the Statement to Open in Excel
3
Summary of Key Points

Accounting income is the result of recording transactions in
accordance with established measurement rules. Accounting
income suffers from its reliance on transactions, which ignore
economic events that indicate wealth
increases. Accounting income may
also be affected by the nature of
accounting policies chosen, which
determines the quality of earnings.

Net income must have some degree of predictive and/or feedback
value for users engaged in earnings predictions. Various items on
the income statement, as well as outside
sources, must be carefully evaluated in
the prediction process.
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3



Summary of Key Points
Many format issues are not governed by accounting
pronouncements, and the company must make
choices to create an income statement that is
useful to financial statement users. Minimum
disclosures are recommended by the CICA
Handbook; additional note disclosures and format
decisions are important for full disclosure.
Two general formats for presenting income statement information not
specifically regulated by accounting pronouncements are the single-step
and the multiple-step formats.
The single-step format uses only two broad classifications in its
presentation: a revenues and gains section and an expenses and losses
section. Total expenses and losses are deducted from total revenues
and gains in a single computation to determine the net income
(earnings) amount.
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3
Summary of Key Points



The multiple-step format income statement
presents intermediate subtotals, designed
to emphasize important relationships in the
various revenue and expense categories.
Extraordinary items
result from transactions
or events that are
infrequent,not normal business
activities, and dependent on the decision of an outsider. They are
required to be reported, net of income tax effects, as a separate
component of income, positioned after income
from continuing operations.
Unusual or infrequent items should be shown
separately on the income statement, before tax.
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3
Summary of Key Points



The gains or losses resulting from the sale or abandonment of a
business segment, whose activities represent a separate major line of
business or class of customer, must be reported, net of income tax
effects, as a separate component of income, positioned after income
from continuing operations and before extraordinary items. Gains or
losses have two components: the operating results from the “decision
day”, and the gain or loss on sale, which includes the actual asset sale
plus operating results after the date of the decision to sell.
Earnings per share amounts relate earnings
to common shares outstanding.
The statement of retained earnings reports all
changes in retained earnings during the period,
including net income or loss, dividends declared,
and capital transactions.
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3


Summary of Key Points
Error correction that affect the financial statements of
prior periods are recorded (net of tax) as a change to
opening retained earnings, and comparatives are
restated.
A change in accounting principle is to be applied
retroactively, with the cumulative effect of the change
shown as an adjustment to opening retained earnings.
Comparative financial statements should be restated. If
this treatment is not possible, only the cumulative
effect is shown on the retained earnings statement.
In certain circumstances, the change in principle is
reflected prospectively. An accounting estimate is
changed prospectively.
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