Part A: The Income Statement

1. Comprehensive Income
   1. The purpose of the income statement is to summarize the profit-generating activities that occurred during a particular reporting period.
   2. Comprehensive income is the total change in equity for a reporting period other than from transactions with owners.
   3. The presentation of comprehensive income can be included as an extension to the income statement, reported (exactly the same way) as a separate statement of comprehensive income, or included in a statement of changes in equity. Note that the Arden Group presents  comprehensive income as an extension of its income statement.
   
   
2. Income from Continuing Operations
   1.  Income from continuing operations includes the revenues, expenses, gains, and losses that will probably continue in future periods.
      1. Income tax expense always is shown as a separate expense.
      2. A distinction often is made between operating and nonoperating income.
      3.  A single-step income statement format groups all revenues and gains together and all expenses and losses together.
      4.  A multiple-step income statement format includes a number of intermediate subtotals before arriving at income from continuing operations.
   
   
3. Earnings Quality
   1.  Earnings quality refers to the ability of reported earnings (income) to predict a company's future earnings.
      1. To enhance predictive value, analysts try to separate a company's transitory earnings effects from its permanent earnings.
      2. Many believe that corporate earnings management practices reduce the quality of earnings. Two major methods used by managers to manipulate income are (1) income shifting and (2) income statement classification. Here is an article on  abusive earnings management that discusses different types of earnings management and ways to detect earnings management.
       This Real-World, Real-Time Electronic Case addresses this issue of earnings management.
   2. Not all items included in operating income should be considered indicative of a company's permanent earnings.
      1. Restructuring costs include costs associated with shutdown or relocation of facilities or downsizing of operations. Prior to 2003, these costs were recognized (expensed) in the period the decision to restructure was made, not in the period or periods in which the actual activities took place. SFAS No. 146 now requires these costs to be expensed in the period(s) incurred.
      2.  Here is an article provided by KPMG that summarizes No. 146.
      3. Asset impairment losses, inventory write-down charges, and in-process research and development are other operating expenses that call into question the issue of earnings quality.
      4. Earnings quality is affected by revenue issues as well.
   3. Some  nonoperating items have generated considerable discussion with respect to earnings quality, notably gains and losses generated either from the sale of operational assets or from the sale of investments.
   
   
4. Separately Reported Items  Here is a summary.
   1.  Intraperiod tax allocation associates tax expense or tax benefit with continuing operations and any item reported below continuing operations.
   2.  Discontinued operations involve the disposal or planned disposal of a component of an entity whose operations and cash flows can be clearly distinguished from the rest of the entity.
      1. When the component has been sold, the income effects of a discontinued operation includes (1) the operating income or loss of the component from the beginning of the reporting period to the disposal date, and (2) the gain or loss on disposal.
          Illustration
      2. When the component is considered held for sale, the income effects of a discontinued operation includes (1) operating income or loss of the component from the beginning of the reporting period to the end of the reporting period, and (2) an impairment loss if the carrying value (book value) of the assets of the component is more than fair value minus cost to sell.  Illustration

3.  Extraordinary items are material gains and losses that are both unusual in nature and infrequent in occurrence.
   1. Extraordinary gains and losses are presented, net-of-tax, in the income statement below discontinued operations.
   2. A material gain or loss that is either unusual or infrequent should be reported as a separate component of continuing operations.


5. Accounting Changes
   1. Accounting changes fall into one of three categories: (1) a change in an accounting principle, (2) a change in estimate, or (3) a change in reporting entity.
   2. Most voluntary changes in accounting   principles are accounted for retrospectively by revising prior years' financial statements.
      1. The comparative financial statements are revised.
      2. The appropriate accounts are adjusted.
      3. A disclosure note provides clear justification that the change is appropriate. The note also indicates the effects of the change on items not reported on the face of the primary statements, as well as any per share amounts affected for the current period and all prior periods presented.
   3. A change in depreciation, amortization, or depletion method is considered to be a change in accounting estimate that is achieved by a change in accounting principle. These changes are accounted for prospectively, exactly as we would account for any other change in estimate.
   4. A change in accounting estimate is reflected in the financial statements of the current period and future periods.
       Illustration
   5. A change in reporting entity requires that financial statements of prior periods be retrospectively restated.

6. Correction of Accounting Errors
   1. Errors discovered in the same year they are made are simply corrected by journal entry.
   2. Treatment of errors discovered in a year subsequent to the year the error is made depends on whether the error is material.
      1. If the error is not material, it is simply corrected in the year discovered.
      2. If the error is material, the correction is considered a prior period adjustment which requires an addition to or reduction in beginning retained earnings and a restatement of previous years' financial statements.
          Illustration

7. Earnings per Share Disclosures
   1. Earnings per share (EPS) is the amount of income achieved during a period for each share of common stock outstanding.
   2. All corporations whose common stock is publicly traded must disclose EPS.
   3. The EPS for income from continuing operations, and for each item below continuing operations, must be disclosed.
       Comprehensive income statement illustration. Answer.

Part B: The Statement of Cash Flows

1. Usefulness of the Statement of Cash Flows
   1. The purpose of the statement of cash flows (SCF) is to provide information about cash receipts and cash disbursements that occurred during a period.
   2. A SCF is presented for each period in which results of operations are provided.
   
   
2. Classifying Cash Flows
   1. The SCF classifies all transactions affecting cash into one of three categories:
      1.  Operating activities are inflows and outflows of cash related to the transactions entering into the determination of net operating income.
         1. The Direct Method
         2. The Indirect Method
      2.  Investing activities involve the acquisition and sale of (1) long-term assets used in the business and (2) nonoperating investment assets.
      3.  Financing activities involve cash inflows and outflows from transactions with creditors (excluding trade creditors) and owners.
          Illustration
   2. Significant investing and financing transactions not involving cash also are reported.

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