Financial Statement

Analysis

Lecture (2):
Income Statement

Dr. Ahmed Abdelhady

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 Lecture (1) Questions
Solutions

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 PROBLEM 3-2

122,000

35,000

122,000 87,000

87,000
47,000

47,000 40,700

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 PROBLEM 3-5
1- The date of balance sheet should be presented as follow “at
December 31, 2012” not “For the year ended December 31,
2012”

2- “Allowance for Doubtful Account” should be presented under

Accounts Receivable in Current Assets.

3- “Treasury Stock” should be deducted from Equity under

Stockholder’s Section not Assets Section.

4- “Land & Buildings” should be separated from each other,

because Land is not subject to Depreciation.

5- “Accumulated Depreciation - Buildings” should be presented

under Buildings.
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 6- “Short Term Notes” should be presented under Current Assets
Section (Marketable Securities) not under Long Term Investment
Section.

7- “Supplies” should be presented under Current Assets not under

Long Term Assets.

8- “Liabilities” should be categorized Current Liabilities & Long Term

Liabilities.

9- Current Liabilities (Accounts Payable & Wages Payable) should be

presented before Long Term Liabilities (Bonds Payable).

10- “Redeemable Preferred Stock” should be presented under Long

Term Liabilities Section not under Stockholder’s Equity Section.

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 PROBLEM 3-8

a. Minority interest will be 20% of the total

equity of $300,000, or $60,000. To be
conservative, classify minority interest as a
liability for financial analysis.

b. The minority share of earnings will be 20%

of $50,000, or $10,000.

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 PROBLEM 3-14

a. 4 Gain from the sale of land would be on the income

statement.
b. 1 Cash restricted for the retirement of bonds would be
under other assets.
c. 3 Accounts payable is usually one of the larger current
liabilities.
d. 5 Construction in process is part of plant and equipment.
e. 4 Bonds payable is usually long term.
f. 4 Redeemable preferred stock is shown above
shareholders’ equity.

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g. 3 Accounts receivable is a current asset.

h. 1 Research and development is expensed.

i. 2 Assets $100,000 = Liabilities $60,000 + Stockholders’
Equity 40,000 .
j. 1 Inventory is a current asset.
k. 4 Pension liabilities are usually long-term.
l. 1 Unearned rent income is a current liability.
m. 3 Treasury stock represents a reduction of stockholders’
equity.

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 Chapter (4)

Income Statement

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 The Income Statement

• Dated for a period of time

– For the Year Ended...
• Multiple-step format
– Gross profit
– Operating income
– Income before taxes
– Net income
• Single-step format
– Total of all revenues and gains
– Less the total of all expenses and losses
 Multiple-Step Single Step
Multiple-Step Company Single-Step Company
Income Statement Income Statement
For the Year Ended December 31, 20XX For the Year Ended December 31, 20XX

Sales $426,426 Sales $ 426,426

Cost of Goods Sold 190,831 Interest Income 1,293
Gross Profit 235,595 Other Income 6,371
Operating Expenses:
434,090
General & Administrative $ 116,902
Costs and Expenses:
Advertising 126,120
Cost of Goods Sold $ 190,831
Uncollectible Accounts 687 243,709
General & Administrative 116,902
Operating (Loss) Income (8,114)
Advertising 126,120
Interest (Income) Expense (1,293)
Other (Revenue)Expense (net) (6,371) (7,664)
Uncollectible Accounts 687 434,540
(Loss) Income Before Taxes (450) (Loss) Income Before Taxes (450)
Income Taxes (Benefit) (666) Income Taxes (Benefit) (666)
Net Income $ 216 Net Income $ 216
Basic Elements of the Income Statement

• Net Sales (Revenues)

• Cost of Goods Sold (Cost of Sales)
• Other Operating Revenue
• Operating Expenses
• Other Income or Expense
 Net Sales

• Revenue from the sale of principal goods or

services sold to customers
• Shown net of
– Discounts
– Returns
– Allowances
 Cost of Goods Sold

• The cost of goods that were sold to earn

revenue
Retailer Manufacturer
Beginning Inventory Beginning Inventory
+ Purchases + Cost of Goods
Manufactured
– Ending Inventory
– Ending Inventory
= Cost of Goods Sold
= Cost of Goods Sold
 Other Operating Revenue

• Reflects the nature of the business

• Examples
– Lease revenue
– Royalty revenue
– Finance charges
– Commission revenue
 Operating Expenses

• Selling expenses
– Result from the company’s effort to create sales
– Examples
• Advertising
• Sales commissions
• Sales supplies used
• Administrative expenses
– Relate to the general administration of the
company’s operation
– Examples
• Salaries
• Insurance
• Bad debt expense
 Other Income or Expense

• Secondary activities not directly related to

operations
– Dividend income
– Interest income
– Gains (losses) from sale of assets
– Interest expense
 Special Income Statement Items

• Unusual or Infrequent Items Disclosed

Separately
– Included with normal recurring revenues and
expenses
– If material, disclosed separately, before income
taxes
– Relate to operations
– Treatment for analysis
• Primary analysis: include
• Supplementary analysis: exclude
Special Income Statement Items (cont’d)

• Equity in Earnings of Nonconsolidated

Subsidiaries
– The investor’s proportional share of the investee’s
net income
– Does not represent cash flow to the investor
• Cash dividends received represent cash flow
– Analysis issues:
• Investor’s net income includes revenue of other entity
• May distort ratios
• Presented before tax; tax consequences typically
immaterial
Special Income Statement Items (cont’d)

• Extraordinary Items
– Unusual and infrequent
– Reported net of income tax
– Analysis issues:
• Exclude from primary analysis
• Include for supplementary analysis
Special Income Statement Items (cont’d)

• Cumulative Effect of a Change in Accounting

Principle
– For fiscal years beginning before 12/15/05
• Cumulative effect of the change shown net of tax on the
income statement of the period in which change was
made
• Earlier statements not restated to reflect application of the
new principle
– Effective for fiscal years beginning after 12/15/05
• All comparative statements are retrospectively restated to
reflect application of the new accounting principle
• The cumulative effect on income of earlier years is shown
as a net-of-tax adjustment to the beginning Retained
Earnings balance of the earliest period presented
Special Income Statement Items (cont’d)

• Minority Share of Earnings

– Earnings of a partially-owned consolidated
subsidiary that would accrue to the minority owners
– Presentation may be either pre-tax or net-of-tax
• Earnings per Share
Net income ÷ W.A. of Number of shares
outstanding
Reconciliation of Retained Earnings

Reported as part of the Statement of Stockholders’

Equity or combined with the Income Statement

Beginning of year balance of retained earnings

+ Prior period adjustments (net of tax)
± Cumulative effect of a change in accounting
principle (net of tax)
= Beginning balance as adjusted
+ Net income
– Dividends
= End-of-year balance of retained earnings
 Retained Earnings

• The accumulated undistributed earnings of the

corporation reported on the balance sheet
• Appropriated
– Restricted by law, contract, or management
decision (reserves)
– Not available for dividends
• Unappropriated
– Available for dividends
– Does not represent cash or any other asset
 Stock Dividends
• Dividends are declared only for the Outstanding Shares not
for the Issued Shares (Authorized Shares), because
Treasury Shares have no right in the dividends.
• Cash dividends
– Date of declaration: create liability and reduce retained
earnings
– Date of payment: reduce liability and cash
• Stock dividends
– Small (less then 25%): capitalize the market value of the
stock
– Material: capitalize the par value of the stock
– Total equity is unaffected by a stock dividend
– Analysis issues:
• Restate share quantities to reflect stock dividend activity
 Stock Dividend Example

100,000 shares outstanding; $1 par; $5 market

10% stock dividend 40% stock dividend
Before effect of dividend balance after effect of dividend balance after
Common stock par value $1.00 $1.00 $1.00
Shares outstanding 100,000 issue 10,000 sh 110,000 issue 40,000 sh 140,000
Total par value $100,000 10,000 $110,000 40,000 $140,000
Additional paid-in capital 750,000 40,000 790,000 750,000
Total paid-in capital 850,000 900,000 890,000
Retained earnings 1,000,000 (50,000) 950,000 (40,000) 960,000
Total stockholders' equity $1,850,000 $1,850,000 $1,850,000

10% stock dividend 40% stock dividend

on 100,000 shares: on 100,000 shares:
issue 10,000 issue 40,000
additional shares additional shares
recorded at $5 per recorded at $1 per
share share
 Stock Splits

• 2-for-1 split
– Doubles the quantity of stock
– Par or stated value is halved
• No effect on retained earnings, additional paid-
in capital, or capital stock accounts
• Analysis issues:
– Restate share quantities to reflect split activity
 Comprehensive Income

Net income
+ The period’s change in accumulated other comprehensive income
= Comprehensive income

• Foreign currency translation adjustments

• Unrealized holding gains and losses on
available-for-sale marketable securities
 Comprehensive Income (cont’d)

• Required disclosures
– Comprehensive income
– Other comprehensive income from each category
– Reclassification adjustments for each category of
other comprehensive income
– Tax effects for each category of other
comprehensive income
– Balances for each category of other comprehensive
income
 Comprehensive Income (cont’d)

• Presentation
– In a separate financial statement
– Combined with the income statement
– As part of the schedule of changes in stockholders’
equity
 Comprehensive Income –
Separate Statement
XYZ Corporation
Statement of Comprehensive Income
For the Year Ended December 31, 20XX

Net income $ 34,000

Other comprehensive income
Available-for-sale security adjustment, net of tax 5,500
Minimum pension liability adjustment, net of tax 3,500
Foreign currency transaction adjustment, net of tax (5,000)
Total other comprehensive income 4,000
Comprehensive income $ 38,000
 Comprehensive Income –
Combined with Income Statement
XYZ Corporation
Statement of Income and Comprehensive Income
For the Year Ended December 31, 20XX

Sales $ 230,000
Cost of goods sold 140,000
Gross profit 370,000
Operating expenses 40,000
Operating income 330,000
Other income 4,000
Income before income taxes 326,000
Income taxes 20,000
Net income 306,000
Other comprehensive income
Available-for-sale security adjustment, net of tax 5,500
Minimum pension liability adjustment, net of tax 3,500
Foreign currency transaction adjustment, net of tax (5,000)
Other comprehensive income 4,000
Comprehensive income $ 310,000

Earnings per share (for net income only) $ 2.80

Comprehensive Income – As Part of the
Statement of Stockholders’ Equity
XYZ Corporation
Statement of Changes in Stockholders' Equity
For the Year Ended December 31, 20XX

Accumulated
Other
Retained Comprehensive Common Stock
Total Earnings Income Amount Shares
Beginning Balance $180,000 $60,000 $10,000 $110,000 55,000
Net Income 34,000 34,000
Available-for-sale
security adjustment,
net of tax 5,500 5,500
Minimum pension
liability adjustment, net
of tax 3,500 3,500
Foreign currency
transaction adjustment,
net of tax (5,000) (5,000)
Comprehensive income 38,000
Ending Balance $218,000 $94,000 $14,000 $110,000 55,000
 Comprehensive Income (cont’d)

• Analysis issues:
– Typically more volatile than net income
– A better indication of long-run profitability
 Questions on Lecture (2)

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Copyright 2009 South-Western, a part of Cengage Learning. All rights reserved. Chapter 7, Slide #36
Copyright 2009 South-Western, a part of Cengage Learning. All rights reserved. Chapter 7, Slide #38
Copyright 2009 South-Western, a part of Cengage Learning. All rights reserved. Chapter 7, Slide #39
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