Lecture Intermediate accounting (IFRS/e) - Chapter 4: The income statement and statement of cash flows

Chapter 4 - The income statement and statement of cash flows. This chapter has a twofold purpose: to consider important issues dealing with income statement content, presentation, and disclosure and to provide an overview of the statement of cash flows, which is covered in depth in Chapter 21.

THE INCOME STATEMENT AND STATEMENT OF

CASH FLOWS

Chapter 4

An income statement for a hypothetical manufacturing company that you can refer to as we proceed through the chapter.

Outflows of resources incurred in generating revenues.

Increases or decreases in equity from peripheral or incidental transactions

of an entity.

Income from Continuing Operations

Income Tax Expense

Because of

its importance and size, income tax expense is a separate item

Operating Income

Nonoperating

Income

Operating versus Nonoperating Income

Includes revenues and expenses directly related to the principal revenue- generating activities of the

Includes gains and losses and revenues and expenses related

to peripheral or incidental activities of the

Income Statement (Single-Step)

Income Statement (Multiple-Step)

U S GAAP vs IFRS

• Has no minimum requirements

SEC requires that expenses be

classified by function

• “Bottom line” called net income

or net loss

• Report extraordinary items

There are more similarities than differences between income statements prepared according to IFRS and

those prepared according to U.S GAAP Some

differences are highlighted below

• Specifies certain minimum information to be reported on the face of the income statement

• Allows expenses classified by function or natural description

• “Bottom line” called profit or loss

• Prohibits reporting extraordinary

Earnings Quality

Earnings quality refers to the ability of

reported earnings to predict

a company’s future earnings.

Transitory Earnings

versus Permanent Earnings

Manipulating Income and

Operating Income and Earnings Quality

Restructuring Costs

Costs associated with shutdown or

relocation of facilities or downsizing of operations are recognized in the period incurred.

Nonoperating Income and

Earnings Quality

Gains and losses generated from the sale of

investments often can significantly inflate or

deflate current earnings.

Example

As the stock market boom reached

its height late in the year 2000,

many companies recorded large

gains from sale of investments

that had appreciated significantly

in value

How should those gains be interpreted

in terms of their relationship to future earnings? Are they transitory

or permanent?

Separately Reported Items

Reported separately, net of taxes:

Discontinued operations

Intraperiod Income Tax Allocation

Income Tax Expense must be associated with each component of income that causes it.

Income Tax Expense must be associated with each component of income that causes it.

Show Income Tax Expense related to

Income from Continuing

of related income tax effect.

Report effects of Discontinued Operations net

of related income tax effect.

Reporting Discontinued Operations

The IASB and FASB have been working together to develop a common definition and a common set of

disclosures for discontinued operations.

The proposed standard defines a

discontinued operation as a “component”

that either:

1.Has been disposed of

2.Is classified as held for sale

Reporting Discontinued Operations

Reporting for Components Sold

Income or loss from operations of the component from the beginning of the reporting

period to the disposal

date

Gain or loss on the disposal of the component’s assets

Reporting for Components Held For Sale

Income or loss from operations (revenues,

expenses, gains, and losses) of the component

from the beginning of the

reporting period to the

end of the reporting

An “impairment loss” if the carrying value of the assets of the component is more than the fair value minus cost to sell

Unusual or Infrequent Items

Unusual or infrequent items that are material are included as separate component of continuing operations or disclosed in notes to financial statements

Accounting Changes

Change in Accounting Policies

• A change in accounting policy refers to a change

from one acceptable accounting method to

another.

• IFRS requires that voluntary changes in accounting

policy be accounted for retrospectively by revising prior years’ financial statements.

• For mandated changes in accounting policies,

companies are required to account for the change according to the requirements in that new or

updated standard If not specified, companies are

Change in Depreciation or Amortization

Change in Accounting Estimate

Revision of a previous accounting estimate

Use new estimate in current and future

periods Includes changes in

Correction of Accounting Errors

Errors occur when transactions are either recorded incorrectly or not recorded at all

Errors Discovered in

shareholders’ equity

Previous years’ financial statements that are incorrect as a result of the error are retrospectively restated to

Material Errors

Discovered in

Subsequent

Year

Earnings per Share Disclosure

One of the most widely used ratios is earnings per

share (EPS) , which shows the amount of income earned by a company expressed on a per share basis.

Basic EPS

Net income less preference dividends

Weighted-average number of ordinary

Diluted EPS

Reflects the potential dilution that could occur for companies that have certain securities outstanding that are convertible

Earnings per Share Disclosure

Report EPS data separately for:

1 Income (loss) from continuing

Comprehensive Income

An expanded version of income that includes gains and losses that traditionally have not been included

in income statements.

Other Comprehensive Income

Comprehensive income includes traditional net income

as well as additional gains and losses that change

shareholders’ equity.

1 Net unrealized gains (losses) from investments (net of tax)

2 Gains and losses due to reviewing assumptions or market returns

differing from expectations and prior service cost from amending the postretirement benefit plan

3 When a derivative designated as a hedging instrument for a cash

flow hedge is adjusted to fair value, the gain or loss is deferred as a component of comprehensive income and included in earnings later,

at the same time as earnings are affected by the hedged transaction

4 Gains or losses from changes in foreign currency exchange rates

The amount could be an addition to or reduction in shareholders’ equity (This item is discussed elsewhere in your accounting

U S GAAP vs IFRS

• Similar OCI items as IFRS

Both IFRS and U.S GAAP allow companies to report income and other comprehensive income items in either a single, continuous statement of comprehensive income or in two separate, but consecutive statements (an income statement

and a statement of comprehensive income)

• Similar OCI items as U.S

GAAP

• Additional OCI item: changes

in revaluation surplus, from the

Accumulated Other Comprehensive Income

In addition to reporting OCI that occurs in the current reporting period, U.S GAAP requires companies to report OCI on a cumulative basis in the statement of financial position IFRS does not require companies to report accumulated other comprehensive income (AOCI).

In addition to reporting OCI that occurs in the current reporting period, U.S GAAP requires companies to report OCI on a cumulative basis in the statement of financial position IFRS does not require companies to report

accumulated other comprehensive income (AOCI).

The Statement of Cash Flows

• Provides relevant information about a company’s

cash receipts and cash disbursements.

• Helps investors and creditors to assess

 future net cash flows

 liquidity

 long-term solvency.

• Required for each income statement period

reported.

Operating Activities

Cash Flows from Operating Activities

Cash Flows from Operating Activities

Inflows from:

 sales to customers.

 interest and dividends

received from investments.

Inflows from:

 sales to customers.

 interest and dividends

received from investments +

Direct and Indirect Methods of

Reporting

Two Formats for Reporting Operating Activities

Reports the cash effects of

each operating

activity

Direct Method

Starts with accrual net income and converts to cash basis Indirect Method

Direct Method

Under the direct method, the cash effect of each operating activity is reported directly in the

statement.

Indirect Method

By the indirect method, we arrive at net cash flow from operating activities indirectly by starting with reported net income and working backwards to convert that amount to a

cash basis.

Cash Flows from Investing Activities

Cash Flows from Investing Activities

 sale of investment securities

(shares and bonds).

 collection of nontrade receivables.

 interest or dividends received from

 purchase of investment securities

(shares and bonds).

 loans to other entities.

Outflows for:

 purchase of long-lived assets used

in the business.

 purchase of investment securities

(shares and bonds).

 loans to other entities.

Cash Flows from Financing Activities

+

_

Financing Activities

Inflows from:

 sale of shares to owners.

 borrowing from creditors

through notes, loans, mortgages, and bonds.

Outflows for:

 owners for the repurchase or reacquisition

of shares previously sold.

 owners in the form of dividends or other distributions

ALC’s Statement of Cash Flows

Noncash Investing and Financing

Activities

Significant investing and financing transactions not involving cash

also are reported.

Acquisition of equipment (an investing activity) by issuing a long-term note

payable (a financing activity).

Both U.S GAAP and IFRS require a statement of cash flows and classify cash flows as operating, investing, or financing

U S GAAP vs IFRS

• Operating Activities

– Dividends Received

– Interest Received– Interest Paid

Typical Classification of Cash Flows from

Interest and Dividends

U S GAAP vs IFRS The FASB and IASB are working together on a project, Financial Statement Presentation, to establish a common

standard for presenting information in the financial

statements.

End of Chapter 4