What we’ll cover:

1. Income Statement

2. Format of the Income Statement

3. Reporting Irregular Items

4. Special Reporting Issues

1. Income Statement

a. Usefulness

• Evaluate past performance

• Predicting future performance

• Help assess the risk or uncertainty of achieving future cash flows

b. Limitations

• Companies omit items that cannot be measured reliably

• Income is affected by the accounting methods employed

• Income measurement involves judgment

c. Quality of Earnings

• Companies have incentives to manage income to meet or beat Wall Street expectations, so that

o market price of stock increases and

o value of stock options increase.

• Quality of earnings is reduced if earnings management results in information that is less useful for predicting future earnings and cash flows.

2. Format of the Income Statement

a. Elements of the Income Statement

• Revenues – Inflows of assets or settlements of its liabilities that constitute the entity’s ongoing major or central operations. Examples of Revenue Accounts:

o Sales

o Fee revenue

o Interest revenue

o Dividend revenue

o Rent revenue

• Expenses – Outflows or other using-up of assets or incurrences of liabilities that constitute the entity’s ongoing major or central operations. Examples of Expense Accounts:

o Cost of goods sold

o Depreciation expense

o Interest expense

o Rent expense

o Salary expense

• Gains – Increases in equity (net assets) from peripheral or incidental transactions.

• Losses - Decreases in equity (net assets) from peripheral or incidental transactions.