Chapter 3: Income Statement and Statement of Stockholders’ Equity Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall 3-1 Learning about

Chapter 3: Income Statement and Statement of Stockholders’ Equity

Copyright © 2010 Pearson Education, Inc. Publishing as

Prentice Hall3-1

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

Income Statement andStatement of Stockholders’ Equity


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Operating performance of a firm has traditionally been measured by its success generating earnings – the “bottom line.”

Annual reports include three years of income statements and stockholder’s equity.

The Income StatementAlso called the statement of earningsPresents a business firm’s

• revenues• expenses• net income• earnings per share

Reveals management’s ability to translate sales dollars into profits


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The Income StatementMultiple-step format

Intermediate profit measures include• Gross profit• Operating profit• Earnings before income taxes

This format should be used for analysis purposes.The analyst should redo an income statement that

is not already in the multiple-step format before analyzing.


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2004 2005 2006 2007 2008

$4,305 $5,506 $5,844 $6,190 $4,774

$2,741 $3,307 $3,481 $3,703 $2,841

$1,564 $2,199 $2,363 $2,487 $1,933

$1,215 $1,777 $1,782 $1,846 $1,311

$349 $422 $581 $641 $622

-$72 -$131 -$143 -$126 -$103

$31 $4 $34 $19 -$4

$308 $295 $472 $534 $515

-$95 -$50 -$82 -$4 -$102

$213 $245 $390 $530 $413

Extraordinary $17 $111 $29 $33 $25

Net Income $196 $134 $361 $497 $388

Fully Diluted EPS $5.190 $0.840 $2.080 $2.740 $2.090

Dividends per Share $1.280 $0.410 $0.640 $0.640 $0.760

$75.670 $32.190 $37.440 $51.290 $46.760

Income Statement

Year

Net Sales

Cost of Goods Sold

EBT (Earn Before Taxes)

Taxes (neg)

Gross Profit

Other Op Expenses

EBIT (Op Income)

Interest Exp (neg)

NI from Recurring Op

Stock Price (end of yr)

Interest Income

The Income StatementRegardless of format, certain special items must be disclosed separately on an income statement:

• Discontinued operations• Extraordinary transactions


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Common-Size Income Statement

Useful analytical tool to• compare firms with different levels of

sales or total assets• facilitate internal or structural analysis• evaluate trends• make industry comparisons


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Common-Size Income Statement• Expresses each income statement item

as a percentage of net sales• Shows the relative magnitude of various

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


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2004 2005 2006 2007 2008 AVG

100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

63.67% 60.06% 59.57% 59.82% 59.51% 60.53%

36.33% 39.94% 40.43% 40.18% 40.49% 39.47%

28.22% 32.27% 30.49% 29.82% 27.46% 29.65%

8.11% 7.66% 9.94% 10.36% 13.03% 9.82%

-1.67% -2.38% -2.45% -2.04% -2.16% -2.14%

0.72% 0.07% 0.58% 0.31% -0.08% 0.32%

7.15% 5.36% 8.08% 8.63% 10.79% 8.00%

-2.21% -0.91% -1.40% -0.06% -2.14% -1.34%

4.95% 4.45% 6.67% 8.56% 8.65% 6.66%

Extraordinary 0.39% 2.02% 0.50% 0.53% 0.52% 0.79%

Net Income 4.55% 2.43% 6.18% 8.03% 8.13% 5.86%

Fully Diluted EPS 0.12% 0.02% 0.04% 0.04% 0.04% 0.05%

Dividends per Share 0.03% 0.01% 0.01% 0.01% 0.02% 0.01%

1.76% 0.58% 0.64% 0.83% 0.98% 0.96%

Gross Profit

Interest Exp (neg)

NI from Recurring Op

EBIT (Op Income)

Common Size Income Statement

Net Sales

Other Op Expenses

Interest Income

EBT (Earn Before Taxes)

Taxes (neg)

Stock Price (end of yr)

Year

Cost of Goods Sold

Gross Profit (or Gross Margin)

• First step of profit measurement• Difference between net sales and COGS• Key analytical tool in assessing operating

performance• How well does management control the

expenses of production?

• Given by


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Sales

Profit Gross

Operating Profit• Second step of profit determination

– Also called earnings before interest and taxes (EBIT)

• Measures overall performance of company’s operations.– How well does management control the

expenses of running the company• apart from financing and investing activities

and separate from tax considerations


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Given bySales

EBIT

Operating ExpensesExamples

• Selling and administrative−relate to the sale of products or services−salaries, rent, insurance, utilities, supplies,

depreciation (sometimes), etc.• Advertising

−major expense when marketing is an important element of success

• Lease payments


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Earnings Before Income Taxes/Effective Tax Rate

• Earnings before income taxes is the profit recognized before deduction of income tax expense.

• Income taxes paid may differ from income tax expense (deferred taxes)

• Effective tax rate is given by


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taxes before Earnings

expensetax Income

Special Items

Often one-time items that will not recur in the future

• Discontinued operations• Occur when a firm sells or discontinues a

clearly distinguishable portion of its business• Extraordinary gains and losses

• Unusual in nature• Not expected to recur in the foreseeable

future


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Net Earnings• Also called the “bottom line”• Represents profit after consideration of all

revenue and expense• Net profit margin shows the percentage of

profit earned on every sales dollar.• Net profit margin is given by


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Sales

Income Net

Earnings Per Common Share (EPS)

• EPS is the net earnings available to common stockholders for the period divided by the average number of common stock shares outstanding.

• If a firm has “complex” capital structure, it will report basic and diluted earnings per common share.– The complexity comes from securities or

contracts that could be turned into stockCopyright © 2010 Pearson

Education, Inc. Publishing as Prentice Hall

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Comprehensive Income

Currently, there are four items that may comprise a company’s other comprehensive income:

• Foreign currency translation effects• Unrealized gains and losses• Additional pension liabilities• Cash flow hedges


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The Statement of Stockholders’ Equity

• Important link between the balance sheet and the income statement

• Documents changes in the balance sheet equity accounts from one accounting period to the next

• Can also be presented in a supplementary schedule or in a note


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The Statement of Stockholders’ EquityIncludes transactions such as• stock dividends

− issuance of additional shares of stock in proportion to current ownership

− reduce retained earnings account• stock splits

− used to lower the market price of shares to make common stock more affordable

• reverse stock splits− occurs when outstanding shares are decreased


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Buffett and Gates• Part 1 of 8

– http://www.youtube.com/watch?feature=player_detailpage&v=7zC8DjXUfgU

• Part 2 of 8– http://www.youtube.com/watch?feature=player_detailpage&v=DdLy4jeT6pc

• Part 3 of 8 – http://www.youtube.com/watch?feature=player_detailpage&v=LwB54Oz-Gs8

• Part 4 of 8– http://www.youtube.com/watch?feature=player_detailpage&v=e6tBiyDcxfU


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