© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-1

INCOME AND CHANGES IN RETAINED EARNINGS

Chapter

12

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-2

Information about net income can be divided into two major categories

Information about net income can be divided into two major categories

Income from continuing operations.

Income from continuing operations.

1. The results of

discontinued operations

1. The results of

discontinued operations

2. The impact of

extraordinary items.

2. The impact of

extraordinary items.

3. The effects of changes in

accounting principles.

3. The effects of changes in

accounting principles.

Normal, recurring revenue and expense transactions.

Normal, recurring revenue and expense transactions.

Unusual, nonrecurring events that affect net income.

Unusual, nonrecurring events that affect net income.

Reporting the Results of OperationsReporting the Results of Operations

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-3

This tax expense does not include

effects of unusual, nonrecurring items.

This tax expense does not include

effects of unusual, nonrecurring items.

These unusual, nonrecurring items are each reported

net of taxes.

These unusual, nonrecurring items are each reported

net of taxes.

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-4

Discontinued Operations

Income/Loss from operating the segment

prior to disposal.

Income/Loss on disposal of the segment.

When management enters into a formal plan to sell or discontinue a segment of the business, the related gains and losses must be disclosed on the income statement.

When management enters into a formal plan to sell or discontinue a segment of the business, the related gains and losses must be disclosed on the income statement.

Discontinued OperationsDiscontinued Operations

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-5

A segment must be a separate line of business activity or an operation that services a distinct category of

customers.

A segment must be a separate line of business activity or an operation that services a distinct category of

customers.

When management enters into a formal plan to sell or discontinue a segment of the business, the related gains and losses must be disclosed on the income statement.

When management enters into a formal plan to sell or discontinue a segment of the business, the related gains and losses must be disclosed on the income statement.

Discontinued OperationsDiscontinued Operations

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-6

During 2003, Apex Co. sold an unprofitable segment of the company. The segment had a net loss from operations during the period of

$150,000 and its assets sold at a loss of $100,000. Apex reported income from

continuing operations of $350,000. All items are taxed at 30%.

How will this appear on the income statement?

During 2003, Apex Co. sold an unprofitable segment of the company. The segment had a net loss from operations during the period of

$150,000 and its assets sold at a loss of $100,000. Apex reported income from

continuing operations of $350,000. All items are taxed at 30%.

How will this appear on the income statement?

Discontinued Operations - ExampleDiscontinued Operations - Example

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-7

Discontinued Operations - ExampleDiscontinued Operations - Example

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-8

Income Statement Presentation:

Discontinued Operations - ExampleDiscontinued Operations - Example

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-9

Extraordinary ItemsExtraordinary Items

Material in amount.Gains or losses that

are both unusual in nature and not expected to recur in the foreseeable future.

Reported net of related taxes.

Material in amount.Gains or losses that

are both unusual in nature and not expected to recur in the foreseeable future.

Reported net of related taxes.

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-10

During 2003, Apex Co. experienced a loss of $75,000 due to an earthquake at one of its

manufacturing plants in Nashville. This was considered an extraordinary item. The

company reported income before extraordinary item of $175,000. All gains and losses are subject to a 30% tax rate.

How would this item appear on the 2003 income statement?

During 2003, Apex Co. experienced a loss of $75,000 due to an earthquake at one of its

manufacturing plants in Nashville. This was considered an extraordinary item. The

company reported income before extraordinary item of $175,000. All gains and losses are subject to a 30% tax rate.

How would this item appear on the 2003 income statement?

Extraordinary Items - ExampleExtraordinary Items - Example

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-11

Income Statement Presentation:

Extraordinary Items - ExampleExtraordinary Items - Example

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-12

Accounting ChangesAccounting Changes

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-13

Change in Accounting PrincipleChange in Accounting Principle

Occurs when changing from one GAAP method to another GAAP method.

Make a catch-up adjustment known as the cumulative effect of a change in accounting principle.

The cumulative effect is reported net of taxes and after extraordinary items.

Occurs when changing from one GAAP method to another GAAP method.

Make a catch-up adjustment known as the cumulative effect of a change in accounting principle.

The cumulative effect is reported net of taxes and after extraordinary items.

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-14

Also in 2003, Apex Co. decided to change from the double-declining balance to the straight-line

method for depreciation. The effect of this change is an increase in net income of $65,000. Apex reported income before cumulative effect of an accounting change of $122,500 during the year. All items of income are subject to a 30%

tax rate.

How would this item appear on the income statement?

Also in 2003, Apex Co. decided to change from the double-declining balance to the straight-line

method for depreciation. The effect of this change is an increase in net income of $65,000. Apex reported income before cumulative effect of an accounting change of $122,500 during the year. All items of income are subject to a 30%

tax rate.

How would this item appear on the income statement?

Change in Accounting Principle Example

Change in Accounting Principle Example

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-15

Income Statement Presentation:

Computation:

Change in Accounting Principle Example

Change in Accounting Principle Example

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-16

Change in EstimatesChange in Estimates

Revision of a previous accounting estimate.

The new estimate should be used in the current and future periods.

The prior accounting results should not be disturbed.

Revision of a previous accounting estimate.

The new estimate should be used in the current and future periods.

The prior accounting results should not be disturbed.

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-17

On January 1, 2000, we purchased equipment costing $30,000, with a useful

life of 10 years and no salvage value. During 2003, we determine that the

remaining useful is 5 years (8-year total life). We use straight-line depreciation.

Compute the revised depreciation expense for 2003.

On January 1, 2000, we purchased equipment costing $30,000, with a useful

life of 10 years and no salvage value. During 2003, we determine that the

remaining useful is 5 years (8-year total life). We use straight-line depreciation.

Compute the revised depreciation expense for 2003.

Change in Estimates - ExampleChange in Estimates - Example

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-18

Record depreciation expense of $4,200 for2003 and subsequent years.

Change in Estimates - ExampleChange in Estimates - Example

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-19

Let’s move on to a few

final topics.

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-20

Often, the Price-Earnings Ratio is used to evaluate the reasonableness of a company’s stock price.

Often, the Price-Earnings Ratio is used to evaluate the reasonableness of a company’s stock price.

Let’s examine this further.

Let’s examine this further.

Price-earnings Ratio (P/E)Price-earnings Ratio (P/E)

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-21

A measure of the company’s profitability and earning power for the period.

A measure of the company’s profitability and earning power for the period.

Based on the number of shares issued and the length of time

that number remained unchanged.

Based on the number of shares issued and the length of time

that number remained unchanged.

Earnings Per Share (EPS)Earnings Per Share (EPS)

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-22

Remember that Apex Co. income from continuing operations of $350,000. The

after-tax loss from discontinued operations was $175,000. The extraordinary loss was

$52,500 and the cumulative effect of accounting changes was a gain of $45,500.

Assume that Apex has weighted average shares outstanding of 156,250. Prepare a partial income statement showing the EPS

for Income from Operations and for the other special items.

Remember that Apex Co. income from continuing operations of $350,000. The

after-tax loss from discontinued operations was $175,000. The extraordinary loss was

$52,500 and the cumulative effect of accounting changes was a gain of $45,500.

Assume that Apex has weighted average shares outstanding of 156,250. Prepare a partial income statement showing the EPS

for Income from Operations and for the other special items.

Earnings Per Share (EPS) -Partial Income Statement

Earnings Per Share (EPS) -Partial Income Statement

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-23

* Rounded.

Earnings Per Share (EPS) -Partial Income Statement

Earnings Per Share (EPS) -Partial Income Statement

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-24

If preferred stock is present, subtract preferred dividends from net income prior to computing EPS.

If preferred stock is present, subtract preferred dividends from net income prior to computing EPS.

EPS is required to be reported in the income statement.

Earnings Per Share (EPS)Earnings Per Share (EPS)

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-25

Declared by board of directors.

Declared by board of directors.

Not legally required.

Not legally required.

Creates liability at declaration.

Creates liability at declaration.

Requires sufficient Retained Earnings

and Cash.

Requires sufficient Retained Earnings

and Cash.

Accounting for Cash DividendsAccounting for Cash Dividends

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-26

Date of Declaration Board of directors declares the dividend. Record a liability.

Date of Declaration Board of directors declares the dividend. Record a liability.

Dividend DatesDividend Dates

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-27

Ex-Dividend Date The day which serves as the ownership cut-off

point for the receipt of the most recently declared dividend.

Ex-Dividend Date The day which serves as the ownership cut-off

point for the receipt of the most recently declared dividend.

NO ENTRY

Dividend DatesDividend Dates

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-28

X

Date of Record Stockholders holding shares on this date

will receive the dividend. (No entry)

Date of Record Stockholders holding shares on this date

will receive the dividend. (No entry)

Dividend DatesDividend Dates

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-29

Date of Payment Record the payment of the dividend to

stockholders.

Date of Payment Record the payment of the dividend to

stockholders.

Dividend DatesDividend Dates

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-30

On June 1, 2003, a corporation’s board of directors declared a dividend for the 2,500 shares

of its $100 par value, 8% preferred stock. The dividend will be paid on July 15. Which of the following will be included in the July 15 entry?

a. Debit Retained Earnings $20,000.

b. Debit Dividends Payable $20,000.

c. Credit Dividends Payable $20,000.

d. Credit Preferred Stock $20,000.

On June 1, 2003, a corporation’s board of directors declared a dividend for the 2,500 shares

of its $100 par value, 8% preferred stock. The dividend will be paid on July 15. Which of the following will be included in the July 15 entry?

a. Debit Retained Earnings $20,000.

b. Debit Dividends Payable $20,000.

c. Credit Dividends Payable $20,000.

d. Credit Preferred Stock $20,000.

$100 × 8% = $8 dividend per share

$8 × 2,500 = $20,000 total dividend

$100 × 8% = $8 dividend per share

$8 × 2,500 = $20,000 total dividend

Dividend Dates - QuestionDividend Dates - Question

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-31

All stockholders retain same percentage ownership.

All stockholders retain same percentage ownership.

No change in total stockholders’ equity.

No change in total stockholders’ equity.

No change in par values.

No change in par values.

Distribution of additional shares of stock to stockholders.

Distribution of additional shares of stock to stockholders.

Accounting for Stock DividendsAccounting for Stock Dividends

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-32

Small Stock Dividend

Large Stock Dividend

Stock Splits

Total Stockholders'

EquityNo Effect No Effect No Effect

Common Stock Increases Increases No EffectPaid-in Capital Increases No Effect No Effect

Retained Earnings Decreases Decreases No Effect

Number of Shares Outstanding

Increases Increases Increases

Par Value per Share

No Effect No Effect Decreases

Small Stock Dividend

Large Stock Dividend

Stock Splits

Total Stockholders'

EquityNo Effect No Effect No Effect

Common Stock Increases Increases No EffectPaid-in Capital Increases No Effect No Effect

Retained Earnings Decreases Decreases No Effect

Number of Shares Outstanding

Increases Increases Increases

Par Value per Share

No Effect No Effect Decreases

Summary of Effects of Stock Dividends and Stock Splits

Summary of Effects of Stock Dividends and Stock Splits

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-33

Adjust retained earnings retroactively.

Adjust retained earnings retroactively.

The adjustment should be disclosed

net of any taxes.

The adjustment should be disclosed

net of any taxes.

The correction of an error identified as affecting net income in a prior period.

The correction of an error identified as affecting net income in a prior period.

Prior Period AdjustmentsPrior Period Adjustments

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-34

Normally, there are 3 ways that financial position can change.

Normally, there are 3 ways that financial position can change.

Issuance of new shares of stock.

Issuance of new shares of stock.

Net Income or Net Loss

Net Income or Net Loss

Payment of Dividends

Payment of Dividends

GAAP excludes some unrealized items from income, such as the change in market value of available-for-sale debt and equity investments.

GAAP excludes some unrealized items from income, such as the change in market value of available-for-sale debt and equity investments.

Comprehensive IncomeComprehensive Income

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-35

GAAP requires that unrealized items that are normally reported on the balance sheet be added back to compute

“Comprehensive Income.”

GAAP requires that unrealized items that are normally reported on the balance sheet be added back to compute

“Comprehensive Income.”

As a second Income statement.

As a second Income statement.

Combined with Net Income on the

Income Statement.

Combined with Net Income on the

Income Statement.

As an element of Stockholders’

Equity.

As an element of Stockholders’

Equity.

The accumulated amount of changes affecting

Comprehensive Income is reported in equity.

The accumulated amount of changes affecting

Comprehensive Income is reported in equity.

There are 3 options for reporting Comprehensive

Income.

There are 3 options for reporting Comprehensive

Income.

Comprehensive IncomeComprehensive Income

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Slide 12-36

Hang in there! We’re coming down the home stretch!

Yeah, that’s easy for you

to say!

End of Chapter

12