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the Income Statement

The income statement summarizes the revenues and expenses generated by the company over the entire reporting period. It is the report that measures the success of a company's operations for a given period of time. It is used to determine profitability, investment value, and creditworthiness of a business. It also helps predict the amounts, timing, and uncertainty of future cash flows.

The income statement is also called: statement of income, statement of earnings, statement of operations, statement of operating results, profit and loss statement, statement of revenue and expense.

Income Statement Usefulness

  • Evaluating performance
  • Predicting performance
  • Assessing the risk of future cash flows

The income statement equation

Revenues - Expenses = Net Income

Elements of the Income Statement

  • Revenues
  • Expenses
  • Gains
  • Losses

Single-Step Income Statement

Multiple-Step Income Statement

Condensed Income Statement

Quality of Earnings

A company’s officers have motivation to meet or beat Wall Street expectations which affect stock prices and thus the value of their options. Thus the pressure to manage results can get ratcheted up to manipulate results. When good business practices are overridden to achieve numbers this negatively affects the quality of earnings, reducing the usefulness of financial statements.

Irregular Items

Discontinued Operations

Discontinued operations is a component of a company's business that has been (or will be) sold, disposed or abandoned, and there is no significant continuing involvement with that component afterwards. Discontinued operations can range from a product line to an entire line of business. Discontinued operations are listed separately on the income statement, making it less likely to mislead as to the source of a company's profit; it is reported on the income statement less tax and after income from continued operations.

Extraordinary Items

Gains or losses included in a company's financial statements, which are infrequent and unusual in nature. They are usually accounted for separately so they don't improperly reflect on the company's regular earnings. If and only if an event meets both test, it is listed net of tax in its own section usually just before net income.

Unusual Gains and Losses

Gains and losses that are either unusual or infrequent, but not both are not reported as extraordinary items. These are presented with normal recurring revenues, expenses, gains and losses. If they are material they should be disclosed separately; if immaterial they should be combined with other items.

Changes in Accounting Principles

When an entity adopts an accounting principle different from the previous used such as switching from LIFO to FIFO, it needs to recognize a change in accounting principles. Past statements need to be reworked using the new principle, and any cumulative effects of the change prior to the restated statement should be reflected in the retained earnings of the earliest year restated. Accounting changes require full disclosure in the footnotes of the financial statements to describe the justification and financial effects of the change.

Changes in Estimates

Accountant make many estimates such as the useful life of machinery and sometimes those estimates change, such as realizing that machine has useful life of 10 rather than 4 years. A change in accounting estimate does not need to be restated. Accounting changes require full disclosure in the footnotes of the financial statements to describe the justification and financial effects of the change.

Corrections of Errors

Entities must correct errors in the year in which they are discovered Corrections of errors are treated as prior period adjustments that are reflected in retained earnings to balance the correcting entry. All comparative financial statements for which the error effects, should be restated.

Intraperiod Tax Allocation

Intraperiod tax allocation is the process of communicating the income tax effect of an unusual item on the income statement. All items other than continuing operations should be displayed net of tax.

Earnings per Share

Earnings per share (EPS) is considered by most investors to significant statistic presented. EPS is calculated by subtracting preferred dividends from net income then dividing by the weighted average number of common shares outstanding. Per share amounts for gain or loss on discontinued or extraordinary items must be presented on the face of the income statement, or in disclosure notes.