Accounting

Multiple-step Income Statements: Net Income by using?

1. Net sales revenue 2. Gross profit 3. Income from operations

Multiple-step Income Statements: Sections are?

1. Operating Section. A report of the revenues and expenses of the company's principal operations. a. Sales or Revenue Section. A subsection presenting sales, discounts, allowances, returns, and other related information. Its purpose is to arrive at the net amount of sales revenue. b. Cost of Goods Sold Section. A subsection that shows the cost of goods that were sold to produce the sales. c. Selling Expenses. A subsection that lists expenses resulting from the company's efforts to make sales. d. Administrative or General Expenses. A subsection reporting expenses of general administration. 2. Non-operating Section. A report of revenues and expenses resulting from secondary or auxiliary activities of the company. In addition, special gains and losses that are infrequent or unusual, but not both, are normally reported in this section. Generally these items break down into two main subsections: a. Other Revenues and Gains. A list of the revenues earned or gains incurred, generally net of related expenses, from nonoperating transactions. b. Other Expenses and Losses. A list of the expenses or losses incurred, generally net of any related incomes, from nonoperating transactions. 3. Income Tax. A short section reporting federal and state taxes levied on income from continuing operations. 4. Discontinued Operations. Material gains or losses resulting from the disposition of a segment of the business. 5. Extraordinary Items. Unusual and infrequent material gains and losses. 6. Earnings Per Share.

Image Single step IS

4.1

Image: Summary of Irregular Items in the IS

4.12

Condensed Income Statements

4.4

Image:IS Prep of Discounted OP

4.6

Image:IS Prep of Extraordinary Items

4.8

Image: IS Prep of Unusual Charges

4.9

Question : Change in Estimate Example (7yr)

: Arcadia HS, purchased equipment for $510,000 which was estimated to have a useful life of 10 years with a salvage value of $10,000 at the end of that time. Depreciation has been recorded for 7 years on a straight-line basis. In 2012 (year 8), it is determined that the total estimated life should be 15 years with a salvage value of $5,000 at the end of that time. Questions: What is the journal entry to correct the prior years' depreciation? Calculate the depreciation expense for 2012.

Multiple-step Income Statement: (2) A Classification of Expenses By Functions.

A Classification of Expenses By Functions, Such As Merchandising (cost of Goods Sold), Selling, and Administration. This permits immediate comparison with costs of previous years and with other departments in the same year.

Multiple-step Income Statement: (1) A Separation of Operating and Nonoperating Activities of the Company.

A Separation of Operating and Nonoperating Activities of the Company. For example, companies often present income from operations followed by sections entitled "Other revenues and gains" and "Other expenses and losses." These other categories include such transactions as interest revenue and expense, gains or losses from sales of long-term assets, and dividends received.

A Separation of Operating and Nonoperating Activities of the Company.

A Separation of Operating and Nonoperating Activities of the Company. For example, companies often present income from operations followed by sections entitled "Other revenues and gains" and "Other expenses and losses." 1. These other categories include such transactions as interest revenue and expense, gains or losses from sales of long-term assets, and dividends received. 2. A Classification of Expenses By Functions, Such As Merchandising (cost of Goods Sold), Selling, and Administration. This permits immediate comparison with costs of previous years and with other departments in the same year. Companies use a multiple-step income statement to recognize these additional relationships.7 This statement separates operating transactions from nonoperating transactions, and matches costs and expenses with related revenues. It highlights certain intermediate components of income that analysts use to compute ratios for assessing the performance of the company.

A discontinued operation occurs when two things happen:

A discontinued operation occurs when two things happen: (1) a company eliminates the results of operations and cash flows of a component from its ongoing operations, and (2) there is no significant continuing involvement in that component after the disposal transaction.

earnings per share

A distilled and important income figure, calculated as net income minus preferred dividends (income available to common stockholders), divided by the weighted average of common shares outstanding. Companies must disclose earnings per share on the face of the income statement.

Prepare a Multiple-step Income Statement.

A multiple-step income statement shows two further classifications: (1) a separation of operating results from those obtained through the subordinate or nonoperating activities of the company; and (2) a classification of expenses by functions, such as merchandising or manufacturing, selling, and administration.

Appropriated Retained Earnings

A retained earnings account that is restricted for a specific use, usually to comply with contractual requirements, board of directors' policy, or current necessity.

Changes in Estimate

Accounted for in the period of change and future periods. Not handled retrospectively. Not considered errors or extraordinary items. Examples include: Useful lives and salvage values of depreciable assets. Allowance for uncollectible receivables. Inventory obsolescence.

changes in estimates

Adjustments or changes that companies must make because financial circumstances did not turn out as expected. Companies account for changes in estimates in the period of change if they affect only that period, or in the period of change and future periods if the change affects both. They do not carry back such changes to prior years. Changes in estimate are not considered errors or extraordinary items.

accumulated other comprehensive income

An entry in the stockholders' equity section of the balance sheet that reports the cumulative amounts of Other Comprehensive Income. Other Comprehensive Income measures the amounts of all gains and losses in a period that bypass the income statement but affect stockholders' equity. These amounts arise from such items as unrealized gains or losses on certain investments and unrealized gains and losses on certain hedging transactions.

capital maintenance approach

An income measurement approach in which a company determines income for the period based on the change in equity, after adjusting for capital contributions or distributions (dividends). An alternative to the transaction approach for income measurement.

modified all-inclusive concept

Approach, adopted by the accounting profession, that dictates that companies record just about all items, including irregular ones, as part of net income, and that companies must highlight irregular items in the financial statements.

Identify Where to Report Earnings Per Share Information.

Because of the inherent dangers of focusing attention solely on earnings per share, the profession concluded that companies must disclose earnings per share on the face of the income statement. A company that reports a discontinued operation or an extraordinary item must report per share amounts for these line items either on the face of the income statement or in the notes to the financial statements.

Changes in Estimates Estimates are inherent in the accounting process.

Changes in Estimates Estimates are inherent in the accounting process. For example, companies estimate useful lives and salvage values of depreciable assets, uncollectible receivables, inventory obsolescence, and the number of periods expected to benefit from a particular expenditure. Not infrequently, due to time, circumstances, or new information, even estimates originally made in good faith must be changed. A company accounts for such changes in estimates in the period of change if they affect only that period, or in the period of change and future periods if the change affects both.

Classifying an event or transaction as an extraordinary item requires meeting both of the following criteria?

Classifying an event or transaction as an extraordinary item requires meeting both of the following criteria: a. Unusual Nature. The underlying event or transaction should possess a high degree of abnormality and be of a type clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the company, taking into account the environment in which it operates. b. Infrequency of Occurrence. The underlying event or transaction should be of a type that the company does not reasonably expect to recur in the foreseeable future, taking into account the

Limitations of the Income Statement (1)

Companies Omit Items From the Income Statement That They Cannot Measure Reliably. Current practice prohibits recognition of certain items from the determination of income even though the effects of these items can arguably affect the company's performance. For example, a company may not record unrealized gains and losses on certain investment securities in income when there is uncertainty that it will ever realize the changes in value. In addition, more and more companies, like Cisco Systems and Microsoft, experience increases in value due to brand recognition, customer service, and product quality. A common framework for identifying and reporting these types of values is still lacking.

Companies also use earnings management to ______ current earnings in order to _____ income in the future.

Companies also use earnings management to decrease current earnings in order to increase income in the future. The classic case is the use of "cookie jar" reserves. Companies establish these reserves by using unrealistic assumptions to estimate liabilities for such items as loan losses, restructuring charges, and warranty returns. The companies then reduce these reserves in the future to increase reported income in the future.

Explain How to Report Irregular Items.

Companies generally include irregular gains or losses or nonrecurring items in the income statement as follows: (1) Discontinued operations of a component of a business are classified as a separate item, after continuing operations. (2) The unusual, material, nonrecurring items that are significantly different from the customary business activities are shown in a separate section for extraordinary items, below discontinued operations. (3) Other items of a material amount that are of an unusual or nonrecurring nature and are not considered extraordinary are separately disclosed as a component of continuing operations. Changes in accounting principle and corrections of errors are adjusted through retained earnings.

Companies must correct errors by making?

Companies must correct errors by making proper entries in the accounts and reporting the corrections in the financial statements. Corrections of errors are treated as prior period adjustments, similar to changes in accounting principles. Companies record a correction of an error in the year in which it is discovered. They report the error in the financial statements as an adjustment to the beginning balance of retained earnings. If a company prepares comparative financial statements, it should restate the prior statements for the effects of the error.

Extraordinary Items: Companies must show extraordinary items net of taxes in a separate section in the income statement

Companies must show extraordinary items net of taxes in a separate section in the income statement, usually just before net income. After listing the usual revenues, expenses, and income taxes, the remainder of the statement shows the following.

Companies report as discontinued operations (in a separate income statement category) ?

Companies report as discontinued operations (in a separate income statement category) the gain or loss from disposal of a component of a business. In addition, companies report the results of operations of a component that has been or will be disposed of separately from continuing operations. Companies show the effects of discontinued operations net of tax as a separate category, after continuing operations but before extraordinary items.

Explain How to Report Other Comprehensive Income.

Companies report the components of other comprehensive income in a second statement, a combined statement of comprehensive income, or in a statement of stockholders' equity.

Explain Intraperiod Tax Allocation.

Companies should relate the tax expense for the year to specific items on the income statement to provide a more informative disclosure to statement users. This procedure, intraperiod tax allocation, relates the income tax expense for the fiscal period to the following items that affect the amount of the tax provisions: (1) income from continuing operations, (2) discontinued operations, and (3) extraordinary items.

Multiple-step Income Statements : Companies use a multiple-step income statement to recognize these additional relationships

Companies use a multiple-step income statement to recognize these additional relationships.7 This statement separates operating transactions from nonoperating transactions, and matches costs and expenses with related revenues. It highlights certain intermediate components of income that analysts use to compute ratios for assessing the performance of the company.

Corrections of Errors Errors occur as a result of ?

Corrections of Errors Errors occur as a result of mathematical mistakes, mistakes in the application of accounting principles, or oversight or misuse of facts that existed at the time financial statements were prepared. In recent years, many companies have corrected for errors in their financial statements. For example, one consulting group noted that over 1,300 companies (10 percent of U.S. public companies) reported error-driven restatements in a recent year. The errors involved such items as improper reporting of revenue, accounting for stock options, allowances for receivables, inventories, and loss contingencies.17

Problem for Correction of Error

Corrections of Errors: To illustrate, in 2013, Hillsboro Co. determined that it incorrectly overstated its accounts receivable and sales revenue by $100,000 in 2010. In 2013, Hillboro makes the following entry to correct for this error (ignore income taxes). Journal Entry: Retained earnings 100,000 Accounts receivable 100,000

prior period adjustments

Corrections of accounting errors made in previous accounting periods. Companies correct such errors by making proper entries in the accounts and reporting the corrections in the financial statements (as an adjustment to the beginning balance of retained earnings) in the year in which they are discovered. If a company prepares comparative financial statements, it should restate the prior statements for the effects of the error.

Losses.

Decreases in equity (net assets) from peripheral or incidental transactions of an entity except those that result from expenses or distributions to owners.

INCOME STATEMENT SECTIONS 4.

Discontinued Operations. Material gains or losses resulting from the disposition of a segment of the business.

INCOME STATEMENT SECTIONS 6.

Earnings Per Share.

Usefulness of the Income Statement (1):

Evaluate the Past Performance of the Company. Examining revenues and expenses indicates how the company performed and allows comparison of its performance to its competitors. For example, analysts use the income data provided by Ford to compare its performance to that of Toyota.

INCOME STATEMENT SECTIONS 5.

Extraordinary Items. Unusual and infrequent material gains and losses.

Extraordinary items are?

Extraordinary items are nonrecurring material items that differ significantly from a company's typical business activities. The criteria for extraordinary items are as follows. Extraordinary items are events and transactions that are distinguished by their unusual nature and by the infrequency of their occurrence. Classifying an event or transaction as an extraordinary item requires meeting both of the following criteria: a. Unusual Nature. The underlying event or transaction should possess a high degree of abnormality and be of a type clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the company, taking into account the environment in which it operates. b. Infrequency of Occurrence. The underlying event or transaction should be of a type that the company does not reasonably expect to recur in the foreseeable future, taking into account the environment in which the company operates.

disclosing income from operations highlights the difference between?

Finally, disclosing income from operations highlights the difference between regular and irregular or incidental activities. This disclosure helps users recognize that incidental or irregular activities are unlikely to continue at the same level. Furthermore, disclosure of operating earnings may assist in comparing different companies and assessing operating efficiencies.

Answer: Change in Estimate Example (7yr)

First, establish Net book value (NBV) at date of change in estimate. Equipment cost $510,000 Salvage value (10,000) Depreciable base 500,000 Useful life (original) / 10 years Annual depreciation = $ 50,000 x 7 years = $350,000 Depreciation Expense calculation for 2012. Net book value $160,000 Salvage value (new) (5,000) Depreciable base = 155,000 Useful life remaining / 8 years Annual depreciation $ 19,375 Journal entry for 2012 Depreciation expense 19,375 Accumulated depreciation 19,375

For further clarification, the following gains and losses are not extraordinary items.

For further clarification, the following gains and losses are not extraordinary items. a. Write-down or write-off of receivables, inventories, equipment leased to others, deferred research and development costs, or other intangible assets. b. Gains or losses from exchange or translation of foreign currencies, including those relating to major devaluations and revaluations. c. Gains or losses on disposal of a component of an entity (reported as a discontinued operation). d. Other gains or losses from sale or abandonment of property, plant, or equipment used in the business. e. Effects of a strike, including those against competitors and major suppliers. f. Adjustment of accruals on long-term contracts. [3] The above items are not considered extraordinary "because they are usual in nature and may be expected to recur as a consequence of customary and continuing business activities."

Gains and losses that bypass net income but affect stockholders' equity are referred to as?

Gains and losses that bypass net income but affect stockholders' equity are referred to as other comprehensive income.

Usefulness of the Income Statement (3)

Help Assess the Risk or Uncertainty of Achieving Future Cash Flows. Information on the various components of income—revenues, expenses, gains, and losses—highlights the relationships among them. It also helps to assess the risk of not achieving a particular level of cash flows in the future. For example, investors and creditors often segregate IBM's operating performance from other nonrecurring sources of income because IBM primarily generates revenues and cash through its operations. Thus, results from continuing operations usually have greater significance for predicting future performance than do results from nonrecurring activities and events.

Prepare a Single-step Income Statement.-

In a single-step income statement, just two groupings exist: revenues and expenses. Expenses are deducted from revenues to arrive at net income or loss—a single subtraction. Frequently, companies report income tax separately as the last item before net income.

Extraordinary Items: considerable judgment must be exercised in determining whether to report an item as extraordinary.

In addition, considerable judgment must be exercised in determining whether to report an item as extraordinary. For example, the government condemned the forestlands of some paper companies to preserve state or national parks or forests. Is such an event extraordinary, or is it part of a paper company's normal operations? Such determination is not easy. Much depends on the frequency of previous condemnations, the expectation of future condemnations, materiality, and the like.14

In determining whether an item is extraordinary, a company must consider the _____?

In determining whether an item is extraordinary, a company must consider the environment in which it operates. The environment includes such factors as industry characteristics, geographic location, and the nature and extent of governmental regulations. Thus, the FASB accords extraordinary item treatment to the loss from hail damages to a tobacco grower's crops if hailstorm damage in its locality is rare. On the other hand, frost damage to a citrus grower's crop in Florida does not qualify as extraordinary because frost damage normally occurs there every three or four years.

In summary, information in the income statement—revenues, expenses, gains, and losses—helps users evaluate past performance. It also provides insights into the likelihood of achieving a particular level of cash flows in the future.

In summary, information in the income statement—revenues, expenses, gains, and losses—helps users evaluate past performance. It also provides insights into the likelihood of achieving a particular level of cash flows in the future.

In summary, several limitations of the income statement reduce the_____ of its information for

In summary, several limitations of the income statement reduce the usefulness of its information for predicting the amounts, timing, and uncertainty of future cash flows.

Limitations of the Income Statement (3)

Income Measurement Involves Judgment. For example, one company in good faith may estimate the useful life of an asset to be 20 years while another company uses a 15-year estimate for the same type of asset. Similarly, some companies may make optimistic estimates of future warranty costs and bad debt write-offs, which result in lower expense and higher income.

Limitations of the Income Statement (2)

Income Numbers Are Affected By the Accounting Methods Employed. One company may depreciate its plant assets on an accelerated basis; another chooses straight-line depreciation. Assuming all other factors are equal, the first company will report lower income. In effect, we are comparing apples to oranges.

INCOME STATEMENT SECTIONS 3.

Income Tax. A short section reporting federal and state taxes levied on income from continuing operations.

comprehensive income

Income measure that includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. Comprehensive income includes all revenues and gains, expenses and losses reported in net income, and all gains and losses that bypass net income but affect stockholders' equity. These latter amounts arise from such items as unrealized gains or losses on certain investments and unrealized gains and losses on certain hedging transactions.

single-step income statement

Income statement format that consists of just two groupings: revenues and expenses. Expenses are deducted from revenues to arrive at net income or loss. Companies that use the single-step income statement in financial reporting typically do so because of its simplicity.

multiple-step income statement

Income statement format that separates operating transactions from nonoperating transactions, and matches costs and expenses with related revenues. It highlights certain intermediate components of income that analysts use to compute ratios for assessing the performance of the company.

current operating performance approach

Income-reporting approach that advocates reporting only regular and recurring revenue and expense elements, but not irregular items, in income.

irregular items

Income-statement components for which the FASB has established special reporting rules. These items fall into six general categories: (1) discontinued operations, (2) extraordinary items, (3) unusual gains and losses, (4) changes in accounting principle, (5) changes in estimates, and 6) corrections of errors.

Gains.

Increases in equity (net assets) from peripheral or incidental transactions of an entity except those that result from revenues or investments by owners.

Revenues

Inflows or other enhancements of assets of an entity or settlements of its liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central operations.

Irregular items fall into six general categories

Irregular items fall into six general categories, which we discuss in the following sections: 1. Discontinued operations. 2. Extraordinary items. 3. Unusual gains and losses. 4. Changes in accounting principle. 5. Changes in estimates. 6. Corrections of errors.

other comprehensive income

Measure of the amounts of all gains and losses in a period that bypass the income statement but affect stockholders' equity. These amounts arise from such items as unrealized gains or losses on certain investments and unrealized gains and losses on certain hedging transactions.

transaction approach

Method of income measurement that focuses on the income-related activities—revenue, expense, gain, and loss transactions—that have occurred during the period.

INCOME STATEMENT SECTIONS 2.

Nonoperating Section. A report of revenues and expenses resulting from secondary or auxiliary activities of the company. In addition, special gains and losses that are infrequent or unusual, but not both, are normally reported in this section. Generally these items break down into two main subsections: a. Other Revenues and Gains. A list of the revenues earned or gains incurred, generally net of related expenses, from nonoperating transactions. b. Other Expenses and Losses. A list of the expenses or losses incurred, generally net of any related incomes, from nonoperating transactions.

extraordinary items

Nonrecurring material items that differ significantly from a company's typical business activities. They are distinguished by their unusual nature and by the infrequency of their occurrence.

discontinued operation

Occurs for a company when two things happen: (1) a company eliminates the results of operations and cash flows of a component from its ongoing operations, and (2) there is no significant continuing involvement in that component after the disposal transaction. Companies report a discontinued operation (in a separate income statement category), indicating the gain or loss from disposal of a business. In addition, companies report separately from continuing operations the results of operations of a component that has been, or will be, disposed of.

statement of stockholders' equity

One of the basic financial statements, which reports the changes in each stockholders' equity account and in total stockholders' equity during the year. It typically shows balances at the beginning of the period, additions and deductions, and balances at the end of the period. Companies disclose changes in the separate accounts either in separate statements or in the basic financial statements or notes thereto.

criteria for an extra-ordinary item. Ex

Only rarely does an event or transaction clearly meet the criteria for an extra-ordinary item.13 For example, a company classifies gains or losses such as Write-down or write-off of receivables, inventories, equipment leased to others, deferred research and development costs, or other intangible assets. and Other gains or losses from sale or abandonment of property, plant, or equipment used in the business are extraordinary if they resulted directly from a major casualty (such as an earthquake), an expropriation, or a prohibition under a newly enacted law or regulation. Such circumstances clearly meet the criteria of unusual and infrequent.

INCOME STATEMENT SECTIONS 1.

Operating Section. A report of the revenues and expenses of the company's principal operations. a. Sales or Revenue Section. A subsection presenting sales, discounts, allowances, returns, and other related information. Its purpose is to arrive at the net amount of sales revenue. b. Cost of Goods Sold Section. A subsection that shows the cost of goods that were sold to produce the sales. c. Selling Expenses. A subsection that lists expenses resulting from the company's efforts to make sales. d. Administrative or General Expenses. A subsection reporting expenses of general administration.

Intermediate Components of the Income Statement

Operating section Nonoperating section Income tax Discontinued operations Extraordinary items Earnings per share

Expenses.

Outflows or other using-up of assets or incurrences of liabilities during a period from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity's ongoing major or central operations.

Usefulness of the Income Statement (2)

Provide a Basis for Predicting Future Performance. Information about past performance helps to determine important trends that, if continued, provide information about future performance. For example, General Electric at one time reported consistent increases in revenues. Obviously past success does not necessarily translate into future success. However, analysts can better predict future revenues, and hence earnings and cash flows, if a reasonable correlation exists between past and future performance.

intraperiod tax allocation

Reporting of irregular items within an accounting period on the income statement or statement of retained earnings net of tax. Such allocation relates the income tax expense of the fiscal period to the specific items that give rise to the amount of the tax provision. It helps financial statement users better understand the impact of income taxes on the various components of net income, and it discourages statement readers from using pretax measures of performance when evaluating financial results.

Corrections of Errors

Result from: mathematical mistakes. mistakes in application of accounting principles. oversight or misuse of facts. Corrections treated as prior period adjustments. Adjustment to the beginning balance of retained earnings.

Changes in Accounting Principles

Retrospective adjustment. Cumulative effect adjustment to beginning retained earnings. Approach preserves comparability. Examples include: change from FIFO to average cost. change from the percentage-of-completion to the completed-contract method.

Multiple-Step Income Statement

Separates operating transactions from nonoperating transactions. Matches costs and expenses with related revenues. Highlights certain intermediate components of income that analysts use.

Extraordinary Items : when a company sells the only significant security investment it has ever owned

Similarly, when a company sells the only significant security investment it has ever owned, the gain or loss meets the criteria of an extraordinary item. Another company, however, that has a portfolio of securities acquired for investment purposes would not report such a sales as an extraordinary item. Sale of such securities is part of its ordinary and typical activities.

Single-step Income Statements

Single-step Income Statements In reporting revenues, gains, expenses, and losses, companies often use a format known as the single-step income statement. The single-step statement consists of just two groupings: revenues and expenses. Expenses are deducted from revenues to arrive at net income or loss, hence the expression "single-step." Frequently companies report income tax separately as the last item before net income to indicate its relationship to income before income tax. Illustration 4.1 shows the single-step income statement of Dan Deines Company.

Such earnings management ___ affects the quality of earnings if it _____ the information in a way that is ____ useful for predicting future earnings and cash flows

Such earnings management negatively affects the quality of earnings if it distorts the information in a way that is less useful for predicting future earnings and cash flows. Markets rely on trust. The bond between shareholders and the company must remain strong. Investors or others losing faith in the numbers reported in the financial statements will damage U.S. capital markets. As we mentioned in the opening story, we need heightened scrutiny of income measurement and reporting to ensure the quality of earnings and investors' confidence in the income statement.

Summary of Irregular Items The public accounting profession now tends to accept?

Summary of Irregular Items The public accounting profession now tends to accept a modified all-inclusive income concept instead of the current operating performance concept. Except for changes in accounting principle and error corrections, which are charged or credited directly to retained earnings, companies close all other irregular gains or losses or nonrecurring items to Income Summary and include them in the income statement. Of these irregular items, companies classify discontinued operations of a component of a business as a separate item in the income statement, after "Income from continuing operations." Companies show the unusual, material, nonrecurring items that significantly differ from the typical or customary business activities in a separate "Extraordinary items" section below "Discontinued operations." They separately disclose other items of a material amount that are of an unusual or nonrecurring nature and are not considered extraordinary. Because of the numerous intermediate income figures created by the reporting of these irregular items, readers must carefully evaluate earnings information reported by the financial press. Illustration 4.12 summarizes the basic concepts that we previously discussed. Although simplified, the chart provides a useful framework for determining the treatment of special items affecting the income statement.

quality of earnings

The extent to which earnings is useful to investors and creditors in making resource allocation decisions, generally in terms of predicting future earnings and cash flows. Thus, higher-quality earnings exhibit higher levels of relevance and faithful representation. Earnings of high quality boost investors' confidence in the financial statements. Earnings management negatively affects the quality of earnings when it distorts the information in a way that does not accurately predict future earnings and cash flows.

income statement

The financial report that measures the success of company operations for a given period of time. It is also often called the statement of income or statement of earnings.

The income statement is the report that measures the ____of company _____ for a given _____ of time.

The income statement is the report that measures the success of company operations for a given period of time. (It is also often called the statement of income or statement of earnings. 1) The business and investment community uses the income statement to determine profitability, investment value, and creditworthiness. It provides investors and creditors with information that helps them predict the amounts, timing, and uncertainty of future cash flows.

Understand the Uses and Limitations of An Income Statement.

The income statement provides investors and creditors with information that helps them predict the amounts, timing, and uncertainty of future cash flows. Also, the income statement helps users determine the risk (level of uncertainty) of not achieving particular cash flows. The limitations of an income statement are: (1) The statement does not include many items that contribute to general growth and well-being of a company. (2) Income numbers are often affected by the accounting methods used. (3) Income measures are subject to estimates.

earnings management

The planned timing of revenues, expenses, gains, and losses to smooth out bumps in earnings.

Prepare a Retained Earnings Statement.

The retained earnings statement should disclose net income (loss), dividends, adjustments due to changes in accounting principles, error corrections, and restrictions of retained earnings.

The transaction approach

The transaction approach focuses on the activities that occurred during a given period. Instead of presenting only a net change in net assets, it discloses the components of the change. The transaction approach to income measurement requires the use of revenue, expense, loss, and gain accounts.

A separation of operating and non operating activities of a company exists in

a multiple-step but not a single-step income statement

A natural expense classification.

a natural expense classification. Manufacturing concerns and merchandising companies in the wholesale trade commonly use this

functional expense: classification of operating expenses for retail stores, uses a functional expense classification for?

classification of operating expenses, recommended for retail stores, uses a functional expense classification of administrative, occupancy, publicity, buying, and selling expenses.

Condensed Income Statements

statement is a condensed version of the more detailed multiple-step statement presented earlier. It is more representative of the type found in practice.

earnings management

the planned timing of revenues, expenses, gains, and losses to smooth out bumps in earnings. In most cases, companies use earnings management to increase income in the current year at the expense of income in future years. For example, they prematurely recognize sales (i.e., before earned) in order to boost earnings. As one commentator noted, "... it's like popping a cork in [opening] a bottle of wine before it is ready."

the primary advantage of the single-step format

the primary advantage of the single-step format lies in its simple presentation and the absence of any implication that one type of revenue or expense item has priority over another. This format thus eliminates potential classification problems.

the reporting of gross profit ?

the reporting of gross profit provides a useful number for evaluating performance and predicting future earnings. Statement readers may study the trend in gross profits to determine how successfully a company uses its resources. They also may use that information to understand how competitive pressure affected profit margins. panies and assessing operating efficiencies.

the transaction approach

the transaction approach, focuses on the income-related activities that have occurred during the period.4 The statement can further classify income by customer, product line, or function, or by operating and nonoperating, continuing and discontinued, and regular and irregular categories.5 The following lists more formal definitions of income-related items, referred to as the major elements of the income statement.