Chapter 13: Appendix

Form and Content of a Complete Income Statement An income statement, also known as the statement of earnings or profit and loss statement, provides a detailed summary of a company's revenues, expenses, gains, and losses over a specific period. It is used to assess profitability, operational performance, and the company’s ability to generate sustainable income. Below, we outline the key components of a complete income statement and assess their content. Key Sections of a Complete Income Statement 1. Continuing Operations: o Definition: This section includes revenues and expenses from the company’s core, ongoing business activities. It is the most critical part of the income statement as it reflects the income that is expected to persist in the future. o Components:  Revenues (Sales): The income generated from the primary business activities.  Cost of Goods Sold (COGS): Direct costs attributable to the production or purchase of goods sold.  Gross Profit: Calculated as revenues minus COGS.  Operating Expenses: Includes selling, general, and administrative expenses (SG&A), research and development, and other costs associated with operations.  Operating Income: Gross profit minus operating expenses.  Other Income/Expenses: Includes interest income, interest expense, and gains or losses from investments. o Assessment: The focus on continuing operations allows stakeholders to assess the company’s core profitability and operational efficiency, providing a basis for forecasting future performance. 2. Unusual and Infrequent Gains and Losses: o Definition: Gains and losses that are not part of the company’s ordinary business activities but are not considered extraordinary. Examples include asset impairments, litigation settlements, or damage due to natural disasters. o Reporting: These are reported as part of continuing operations but are typically shown after operating income to distinguish them from the core business results. o Assessment: Separating these items helps users evaluate the recurring earnings of a company, while still recognizing the impact of one-time events on overall performance. 3. Discontinued Operations: o Definition: This section reports results from business segments that the company has decided to sell or shut down. A business segment could be a division that is geographically separate or offers distinct products or services. o Components:  Income from Discontinued Operations: Includes the income or loss from the segment's operations up to the date of disposal.  Gain or Loss on Disposal: Represents the financial impact of selling or winding down the segment, such as losses from asset sales.  Tax Effects: Tax impacts are shown separately to provide a clearer view of the effects on after-tax income. o Assessment: Including discontinued operations separately ensures that users can distinguish between the results of ongoing operations and those that will not affect future performance. 4. Earnings per Share (EPS): o Definition: EPS measures the portion of a company's profit allocated to each outstanding share of common stock. It is a key metric for investors, as it reflects profitability on a per-share basis. o Components:  Basic EPS: Calculated by dividing net income by the weighted average number of shares outstanding.  Diluted EPS: Takes into account potential shares from stock options, convertible securities, and other instruments that could increase the total share count.  EPS for Continuing Operations and Discontinued Operations: When both exist, EPS figures are provided for each, offering a detailed view of the sources of earnings. o Assessment: EPS allows investors to gauge the profitability available to each share, making it easier to compare performance across companies of different sizes. 5. Changes in Accounting Principles: o Definition: Occurs when a company adopts a different accounting method for financial reporting, such as changing how inventory is valued (e.g., from FIFO to LIFO). o Retrospective Application: Requires restating prior period financials as if the new method had always been used. This ensures that financial results across periods are comparable. o Assessment: By applying changes retrospectively, stakeholders can make better comparisons between historical and current results, leading to more accurate trend analysis. 6. Comprehensive Income: o Definition: Comprehensive income includes all changes in equity during a period except those resulting from investments by and distributions to shareholders. o Components:  Net Income: As reported in the income statement. Other Comprehensive Income (OCI): Items such as unrealized gains or losses on available-for-sale securities, foreign currency translation adjustments, and changes in pension plan values. Assessment: Including comprehensive income provides a fuller picture of all changes in equity, beyond those reflected in net income. It is essential for understanding how factors like market fluctuations affect the company's overall value.  o Assessing the Income Statement: Focus on Sustainable Income The goal of organizing the income statement into these sections is to highlight sustainable income, which is the level of income likely to continue into the future. Sustainable income focuses on continuing operations because it represents the core business activities that are expected to generate earnings consistently over time. By separating out the effects of discontinued operations and unusual events, analysts can better understand a company’s regular earnings power. • Why It Matters: Investors and analysts use sustainable income to value a company, as it reflects the earnings base that will continue into the future. For example, if a significant portion of a company’s income comes from a one-time gain (like the sale of a business unit), that gain is not sustainable and should not influence expectations for future profitability. Example: Reporting Sustainable Income An example of a complete income statement for a corporation like ComUS might include the following structure: • • • • Continuing Operations: o Revenues: $10,000,000 o COGS: $6,000,000 o Gross Profit: $4,000,000 o Operating Expenses: $2,000,000 o Operating Income: $2,000,000 o Other Gains: $100,000 (e.g., gain from sale of an asset) o Net Income from Continuing Operations: $2,100,000 Discontinued Operations: o Loss from Discontinued Segment: ($200,000) o Gain on Disposal of Segment: $150,000 o Net Income from Discontinued Operations: ($50,000) Net Income: $2,050,000 Earnings per Share: o Basic EPS from Continuing Operations: $2.10 o Basic EPS from Discontinued Operations: ($0.05) o Total Basic EPS: $2.05 This structure clearly differentiates income that will likely recur (continuing operations) from one-time items (discontinued operations), allowing stakeholders to focus on the company’s core earnings potential. Conclusion A well-organized income statement provides transparency about a company’s earnings, helping users understand the sources of income and which parts of that income are sustainable. By separating continuing operations, discontinued segments, and one-time events, the income statement ensures that stakeholders can make informed decisions based on a clear understanding of the company’s ongoing financial health and performance.