(C) 2007 Prentice Hall, Inc.3-1 Income Statement and Statement of Stockholders’ Equity Learning about earnings, the bottom line, Is very important most

(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.

3-3-11

Income Statement and Income Statement and Statement of Stockholders’ Statement of Stockholders’ EquityEquity

Learning about earnings, the bottom line,Is very important most of the time.

A phony number Just may encumber

Those folks trying to make more than a dime.

--A. Ormiston


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The Income StatementThe Income Statement

Also called the Statement of EarningsAlso called the Statement of Earnings

Presents:Presents:

RevenuesRevenues

ExpensesExpenses

Net IncomeNet Income

Earnings Per ShareEarnings Per Share


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The Income Statement The Income Statement (cont.)(cont.)

Comes in two basic formatsComes in two basic formats

Multiple-stepMultiple-step

Single-stepSingle-step


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The Income Statement The Income Statement (cont.)(cont.)Multiple-stepMultiple-step Provides several intermediate profit Provides several intermediate profit

measures prior to the amount of measures prior to the amount of net earnings for the period:net earnings for the period:

Gross profitGross profit Operating profitOperating profit Earnings before income taxesEarnings before income taxes

Should be used for purposes of Should be used for purposes of analysisanalysis


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The Income Statement The Income Statement (cont.)(cont.)

Single-stepSingle-step

Groups all items of revenue Groups all items of revenue together, then deducts all together, then deducts all categories of expense to arrive categories of expense to arrive at a figure for at a figure for

net income net income


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The Income Statement The Income Statement (cont.)(cont.)Regardless of format, certain special items, if Regardless of format, certain special items, if

they occur during an accounting period, they occur during an accounting period, must be disclosed separately on an must be disclosed separately on an income statementincome statement

These include. . . These include. . .

Discontinued operationsDiscontinued operations Cumulative effect of changes in Cumulative effect of changes in

accounting principles accounting principles (Extraordinary transactions(Extraordinary transactions))


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Common-Size Common-Size Income StatementIncome Statement

Useful analytical toolUseful analytical toolExpresses each income statement Expresses each income statement

item as a percentage of net salesitem as a percentage of net salesShows the relative magnitude of Shows the relative magnitude of

various expenses relative to various expenses relative to sales, the profit percentages, sales, the profit percentages, and the relative importance of and the relative importance of “other” revenues and expenses“other” revenues and expenses


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Common-Size income Common-Size income statement statement (cont.) (cont.)

Comparison of two major retail Comparison of two major retail companies*companies*Comparison using $ ($ are in millions):Comparison using $ ($ are in millions):

Retailer ARetailer A Retailer BRetailer BNet Sales Net Sales $ 287,989 $ 287,989 $ 46,839$ 46,839Cost of SalesCost of Sales 219,793 219,793 31,445 31,445Operating Expenses 51,105Operating Expenses 51,105 11,793 11,793Net IncomeNet Income 10,267 10,267 3,198 3,198

*Data from SEC website, *Data from SEC website, www.sec.govwww.sec.gov


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Common-Size income Common-Size income statementstatement (cont.) (cont.)

Comparison of two major retail Comparison of two major retail companies*companies*Comparison using common size income statement %:Comparison using common size income statement %:

Retailer ARetailer A Retailer BRetailer BNet Sales Net Sales 100.00100.00 100.00 100.00 Cost of SalesCost of Sales 76.32 76.32 67.13 67.13Operating ExpensesOperating Expenses 17.75 17.75 25.18 25.18 Net IncomeNet Income 3.573.57 6.83 6.83



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Net SalesNet SalesSales are generally reported net of sales returns Sales are generally reported net of sales returns

and sales allowances and sales allowances

A A sales returnsales return is a cancellation of a sale is a cancellation of a sale

A A sales allowancesales allowance is a deduction from the original is a deduction from the original sales invoice pricesales invoice price


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Net Sales—Related IssueNet Sales—Related Issue

Are sales growing in “real” (inflation-Are sales growing in “real” (inflation-adjusted) as well as “nominal” (as adjusted) as well as “nominal” (as reported) terms? reported) terms?

An adjustment of the reported sales An adjustment of the reported sales figure with the Consumer Price figure with the Consumer Price Index (or some other measure of Index (or some other measure of general inflation) will enable the general inflation) will enable the analyst to make a comparison of the analyst to make a comparison of the changes in real and nominal termschanges in real and nominal terms


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Cost of Goods Sold Cost of Goods Sold (COGS)(COGS) Also called “Cost of Sales”Also called “Cost of Sales” Cost to seller of products or services Cost to seller of products or services

sold to customerssold to customers Important for profit determinationImportant for profit determination Largest expense item for many firmsLargest expense item for many firms Impacted by cost flow assumption Impacted by cost flow assumption

used to value inventoryused to value inventory Cost of goods sold percentage is:Cost of goods sold percentage is:

Cost of goods soldCost of goods sold

Net salesNet sales


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Gross ProfitGross Profit First step of profit measurementFirst step of profit measurement Difference between net sales and Difference between net sales and

COGSCOGS Key analytical tool in assessing a Key analytical tool in assessing a

firm’s operating performancefirm’s operating performance Gross Profit Margin is:Gross Profit Margin is:

Gross profitGross profit

Net salesNet sales


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Operating ExpenseOperating Expense

Have considerable impact on the Have considerable impact on the firm’s current and future firm’s current and future profitabilityprofitability

Important to track carefully--trends, Important to track carefully--trends, absolute amounts, relationship absolute amounts, relationship to sales, relationship to to sales, relationship to industry competitorsindustry competitors


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Operating ProfitOperating Profit Second step of profit Second step of profit

measurementmeasurement Also called Also called EBITEBIT——EEarnings arnings

BBefore efore IInterest and nterest and TTaxesaxes Measures overall performance Measures overall performance

of company’s operations: sales of company’s operations: sales revenue less expenses revenue less expenses associated with generating salesassociated with generating sales


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Operating Profit Operating Profit (cont.)(cont.)

Provides a basis for assessing the Provides a basis for assessing the success of a company apart from its success of a company apart from its financing and investing activities financing and investing activities and separate from tax and separate from tax considerationsconsiderations

Operating Profit Margin is:Operating Profit Margin is:Operating profitOperating profit

Net salesNet sales


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Other Income (Expense)Other Income (Expense)

Revenues/expenses other than from Revenues/expenses other than from operationsoperations

Dividend and interest incomeDividend and interest incomeInterest expenseInterest expense

Investment gains/lossesInvestment gains/lossesEquity earnings/lossesEquity earnings/losses

Sales of fixed assets gains/lossesSales of fixed assets gains/losses

IncludesIncludes


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Equity EarningsEquity Earnings

Two methods may be used to Two methods may be used to account for investments in account for investments in voting stock of other voting stock of other companies of less than 50%companies of less than 50%

EquityEquity

Cost Cost


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Earnings Before Income Earnings Before Income Taxes/Taxes/Effective Tax RateEffective Tax Rate Earnings before income taxes is the Earnings before income taxes is the

profit recognized before deduction profit recognized before deduction of income tax expenseof income tax expense

Remember, income taxes paid may Remember, income taxes paid may differ from income tax expense differ from income tax expense (deferred taxes)(deferred taxes)

Effective tax rate is:Effective tax rate is:

Income taxesIncome taxes

Earnings before income taxesEarnings before income taxes


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Special Items Special Items (cont.)(cont.)

• Are often one-time items that will Are often one-time items that will not recur in the futurenot recur in the future

• If companies are affected by the If companies are affected by the following three items, they must be following three items, they must be disclosed separately on the income disclosed separately on the income statement, net of income tax effects statement, net of income tax effects or retrospectively applied to prior or retrospectively applied to prior periods’ financial statements:periods’ financial statements:

• Discontinued operationsDiscontinued operations• ExtraordinaryExtraordinary items items


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Discontinued OperationsDiscontinued Operations

Occur when a firms sells or Occur when a firms sells or discontinues a clearly discontinues a clearly distinguishable portion of its distinguishable portion of its business business


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Net EarningsNet Earnings Also called the “bottom line”Also called the “bottom line” Represents the firm’s profit after Represents the firm’s profit after

consideration of ALL revenue and consideration of ALL revenue and expenseexpense

Net profit margin is: Net profit margin is:

Net earningsNet earnings

Net salesNet sales


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Earnings Per Common Earnings Per Common ShareShare

The net earnings available to The net earnings available to common stockholders for the common stockholders for the period divided by the average period divided by the average number of common stock number of common stock shares outstandingshares outstanding


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Earnings Per Common Share Earnings Per Common Share (cont.)(cont.)

If firm has “complex” capital If firm has “complex” capital structure, it will report structure, it will report basicbasic and and diluteddiluted EPS EPS

Extensively used by analysts in Extensively used by analysts in evaluating a firmevaluating a firm


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Earnings Per Common Share Earnings Per Common Share (cont.)(cont.)Examples of basic and diluted EPS data Examples of basic and diluted EPS data reported by a variety of companies*reported by a variety of companies*

Basic EPSBasic EPS Diluted Diluted EPSEPS

AirlineAirline $ .70$ .70 $ .67$ .67

Grain MillGrain Mill 3.34 3.34 3.08 3.08

RecreationRecreation 1.56 1.56 1.50 1.50

RetailerRetailer 2.45 2.45 2.43 2.43

Semicond. Mfg. Semicond. Mfg. 1.03 1.03 1.01 1.01



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Comprehensive IncomeComprehensive Income

The change in equity of a company The change in equity of a company during a period from during a period from transactions, other events, and transactions, other events, and circumstances relating to circumstances relating to nonowner sources nonowner sources


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Comprehensive Income Comprehensive Income (cont.)(cont.)

Companies are required to report Companies are required to report total comprehensive income in total comprehensive income in one of three ways:one of three ways:

1.1. On the face of the income On the face of the income statementstatement

2.2. In the statement of stockholders’ In the statement of stockholders’ equity equity

3.3. In a separate statement of In a separate statement of comprehensive incomecomprehensive income


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Comprehensive IncomeComprehensive Income (cont.)(cont.)Currently, there are four items that Currently, there are four items that

may comprise a company’s other may comprise a company’s other comprehensive income:comprehensive income:

1.1. Foreign currency translation Foreign currency translation effectseffects

2.2. Unrealized gains and lossesUnrealized gains and losses3.3. Additional pension liabilitiesAdditional pension liabilities4.4. Cash flow hedgesCash flow hedges


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The Statement The Statement of Stockholders’ Equityof Stockholders’ Equity

Details transactions that affected Details transactions that affected the balance sheet equity the balance sheet equity accounts during an accounting accounts during an accounting periodperiod


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The Statement The Statement of Stockholders’ Equity of Stockholders’ Equity (cont.)(cont.)

Basically, it simply explains how Basically, it simply explains how each account got from the each account got from the balance at the beginning of the balance at the beginning of the period to the balance at the period to the balance at the end of the period and describes end of the period and describes “events” that caused the “events” that caused the balances to change balances to change


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Documents

(C) 2007 Prentice Hall, Inc.3-1 Income Statement and Statement of Stockholders’ Equity Learning about earnings, the bottom line, Is very important most