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CHAPTER 4FINANCIAL REPORTING STANDARDS
Presenters namePresenters titledd Month yyyy
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OVERVIEW
Income statement components and formatAccounting issues
- Revenue recognition
- Expense recognition
- Inventory
- Depreciation
- Nonrecurring items
Earnings per share Income statement analysis
Comprehensive income
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INCOME STATEMENT COMPONENTS
Also called the statement of earnings, statement ofoperations, and profit and loss statement (P&L)
Presents results of operations for the accounting period
RevenuesExpenses = Net income
Revenue + Other Income + GainsExpensesLosses= Net income
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INCOME STATEMENT FORMAT
Subtotals
- Gross profit (i.e., revenue less cost of sales)
- Multistep format: Income statement shows gross profitsubtotal
- Single-step format: Income statement excludes gross profitsubtotal
- Operating profit (i.e., revenue less all operating expenses)
- Profits before deducting taxes and interest expense andbefore any other nonoperating items
- Operating profit and EBIT (earnings before interest andtaxes) are not necessarily the same
Expense Grouping
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INCOME STATEMENT FORMAT: EXAMPLE 1COLGATE-PALMOLIVE COMPANY
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Colgate Annual Report
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INCOME STATEMENT FORMAT: EXAMPLE 2LOREAL GROUP
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L'Oreal's Annual Report
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INCOME STATEMENT FORMAT: EXAMPLE 3PROCTER & GAMBLE
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Proctor & Gamble Report
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GENERAL PRINCIPLES OF REVENUERECOGNITION AND ACCRUAL ACCOUNTING
Revenue recognition can occur independently of cashmovementsfor example, in the case of the
- sale of goods and services on credit or
- receipt of cash in advance of providing goods andservices
A fundamental principle of accrual accounting is thatrevenue is recognized (reported on the income statement)
in the period in which it is earned.
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WHEN TO RECOGNIZE REVENUE
IFRS specify that revenue from the sale of goods is to berecognized when the following conditions are satisfied:
- Entity has transferred to the buyer the significant risksand rewards of ownership of the goods;
- Entity retains neither continuing managerial involvementwith nor effective control over the goods sold;
- Amount of revenue can be measured reliably;
- It is probable that the economic benefits associated with
the transaction will flow to the entity; and- Costs incurred with respect to the transaction can be
measured reliably.
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WHEN TO RECOGNIZE REVENUE
U.S. GAAP specify that revenue should be recognized whenit is realized or realizable and earned. The U.S. Securitiesand Exchange Commission (SEC) provides guidance onhow to apply the accounting principles. This guidance listsfour criteria to determine when revenue is realized or
realizable and earned:
1. There is evidence of an arrangement between buyer andseller.
2. The product has been delivered, or the service has beenrendered.
3. The price is determined or determinable.
4. The seller is reasonably sure of collecting money.
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SPECIFIC REVENUE RECOGNITIONAPPLICATIONS: LONG-TERM CONTRACTS
Long-term contract:contract that spans a number ofaccounting periods.
Percentage-of-completionmethod- Use when the outcome of a contract can be measured reliably.- In each accounting period, the company estimates what
percentage of the contract is complete and then reports thatpercentage of the total contract revenue in its incomestatement.
- Contract costs for the period are expensed against therevenue.- Net income or profit is reported each year as work is
performed.
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SPECIFIC REVENUE RECOGNITION APPLICATIONS:LONG-TERM CONTRACTS EXAMPLE
Example that uses the percentage-of-completion method ofrevenue recognition: Network Construction project: bid was $5,000,000 and
estimated costs to complete were $4,000,000
- Year 1: Costs incurred of $3,000,000 (assume this mirrorsthe percentage complete)- Revenue?- Cost of revenue?
- Year 2: Job is completed with costs of $1,000,000- Revenue?- Cost of revenue?
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SPECIFIC REVENUE RECOGNITION APPLICATIONS:LONG-TERM CONTRACTS EXAMPLE
Example that uses the percentage-of-completion method ofrevenue recognition (continued): Network Construction project: bid was $5,000,000 and estimated
costs to complete were $4,000,000.
- Year 1: Costs incurred $3,000,000 (assume this mirrors thepercentage complete)- Revenue?- Cost of revenue?
- Year 2: Job is completed with costs of $1,250,000 (a costoverrun)- Revenue?- Cost of revenue?
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SPECIFIC REVENUE RECOGNITIONAPPLICATIONS: LONG-TERM CONTRACTS
Percentage-of-completion is the preferred method under bothIFRS and U.S. GAAP
When the outcome of a contract cannot be measured reliably,there are alternatives to the percentage-of-completion method- Assuming it is probable that costs will be recovered, IFRS
permit recognition of revenue up to the amount of costsincurred.
- U.S. GAAP (but not IFRS) permit the completed contractmethod.
Company does not report any income until the contract issubstantially finished. Completed contract method is also acceptable when the
entity has primarily short-term contracts.
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SPECIFIC REVENUE RECOGNITION APPLICATIONS:LONG-TERM CONTRACTS EXAMPLE
Assume the following:- A company has a contract to build a network for a customer for a total
sales price of $10 million.- Network will take an estimated three years to build.- Considerable uncertainty surrounds total building costs because new
technologies are involved.- The outcome cannot be reliably measured, but it is probable that the
costs up to the agreed-upon price will be recovered.- Expenditures total $3 million, $5.4 million, and $6 million as of the
end of Year 1,2, and 3, respectively.
Question: How much revenue, expense (cost of construction), andincome would the company recognize each year under IFRS and,using the completed contract method, under U.S. GAAP?
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SPECIFIC REVENUE RECOGNITION APPLICATIONS:LONG-TERM CONTRACTS EXAMPLE
Question: How much revenue, expense (cost of construction), and incomewould the company recognize each year under IFRS and using the completedcontract method under U.S. GAAP?
Answer: Under IFRS, recognize revenue to the extent of contract costsincurred. Company would recognize- Year 1, $3 million construction cost, $3 million revenue, and thus, $0 income- Year 2, $2.4 million construction cost, $2.4 million revenue, and thus, $0
income- Year 3, $0.6 million construction cost, remaining $4.6 million revenue
(because the contract has been completed and the outcome is nowmeasurable), and thus, $4 million income.
Answer: With the completed contract method under U.S. GAAP, no revenue
will be recognized until the contract is complete.- Year 1, $0 million construction cost, $0 million revenue, and thus, $0 income- Year 2, $0 million construction cost, $0 million revenue, and thus, $0 income- Year 3, $6 million construction cost, $10 million revenue (because the
contract has been completed), and thus, $4 million income
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SPECIFIC REVENUE RECOGNITIONAPPLICATIONS: INSTALLMENT SALES
Installment sales: Sales in which proceeds are to be paidin installments over an extended period.
IFRS separate the installments into the sale price (presentvalue of the installment payments) and an interest
component. Revenue attributable to the sale price is recognized atthe date of sale
Revenue attributable to the interest component isrecognized over time.
International standards note, however, that the guidancefor revenue recognition must be considered in light of locallaws regarding the sale of goods in a particular country.
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SPECIFIC REVENUE RECOGNITIONAPPLICATIONS: INSTALLMENT SALES
Sale of real estate under U.S. GAAPA sale of real estate is reported at time of sale using normal revenue
recognition conditions when seller has completed the significantactivities in the earnings process and is either1) assured of collecting the selling price or
2) able to estimate amounts that will not be collected. Otherwise, defer some of the profit using
- the installment method, in which the portion of the total profitrecognized in each period is determined by the percentage of thetotal sales price for which the seller has received cash, or
- the cost recovery method, in which the seller does not report anyprofit until the cash amounts paid by the buyerincluding principaland interest on any financing from the sellerare greater than all thesellers costs of the property.
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SPECIFIC REVENUE RECOGNITIONAPPLICATIONS: EXAMPLE
Assume the following:- Sales price and cost of a property are $2,000,000 and $1,100,000,
respectively, so that the total profit to be recognized is $900,000.- Seller received a down payment of $300,000 cash, with the remainder
of the sales price to be received over a 10-year period.
- There is significant doubt about the ability and commitment of thebuyer to complete all payments.
- How much profit will be recognized attributable to the down payment if1) the installment method is used?2) the cost recovery method is used?
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SPECIFIC REVENUE RECOGNITIONAPPLICATIONS: EXAMPLE
How much profit will be recognized attributable to the down payment if theinstallment method is used?
- Installment method apportions the cash receipt between cost recovered andprofit using the ratio of profit to sales value.
- Here, the ratio of profit to sales value equals $900,000/$2,000,000 = 45%.
- Seller will recognize the following profit attributable to the down payment:45% of $300,000 = $135,000.
How much profit will be recognized attributable to the down payment if the costrecovery method is used?
- Under the cost recovery method, do not recognize any profit until cashreceived from buyer exceeds all costs.
- Here, $300,000 cash paid by the buyer is less than the sellers cost of$1,100,000.
- Seller will recognize $0 profit attributable to the down payment.
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SPECIFIC REVENUE RECOGNITIONAPPLICATIONS: GROSS VS. NET REPORTING
Merchandising companies typically sell products that they purchasefrom a supplier. To account for the sales, they
- record the amount of the sale proceeds as sales revenue and- record the cost of the products as the cost of goods sold.
Some internet-based merchandising companies sell products that
they never hold in inventory; they simply arrange for the supplier toship the products directly to the end customer. Should they recordrevenues of
- the gross amount of sales proceeds received from their customers?- the net difference between sales proceeds and their cost?
U.S. GAAP guidance- Report revenues gross if the company is the primary obligor under
the contract, bears inventory risk and credit risk, can choose itssupplier, and has reasonable latitude to establish price.
- Otherwise, report revenues net.
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SPECIFIC REVENUE RECOGNITIONAPPLICATIONS: EXAMPLE
Company OLR, an online retailer, buys tickets (airline,concert, etc.), resells them for $100, and earns a 10% fee.What is the correct accounting?
Alternative A: Gross
- Revenue $100
- Cost of goods sold $90
- Gross Profit $10
Alternative B: Net- Revenue $10
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SPECIFIC REVENUE RECOGNITIONAPPLICATIONS: EXAMPLE
We evaluate whether it is appropriate to record the gross amountof product sales and related costs or the net amount earned as
commissions. Generally, when we are primarily obligated in a
transaction, are subject to inventory risk, have latitude in
establishing prices and selecting suppliers, or have several but notall of these indicators, revenue is recorded at the gross sales price.
We generally record the net amounts as commissions earned if we
are not primarily obligated and do not have latitude in establishing
prices.
Amazon Inc. (2011), 10-K
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GENERAL PRINCIPLES OF EXPENSERECOGNITION
Fundamental principle: A company recognizes expenses inthe period in which it consumes (i.e., uses up) theeconomic benefits associated with the expenditure.
Matching principle: Costs are matched with revenues.As with revenue recognition, expense recognition can
occur independently of cash movements.
- Inventory and cost of goods sold
- Plant, property, and equipment and depreciation
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SPECIFIC EXPENSE RECOGNITIONAPPLICATIONS: INVENTORY
Goods
Purchased
Beginning
InventoryGoods
Available
for
Sale
Ending
Inventory
Cost of
Goods Sold
Balance Sheet Income Statement
Inventory CostFlow
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SPECIFIC EXPENSE RECOGNITIONAPPLICATIONS: EXAMPLE
Inventory PurchasesFirst quarter 2,000 units at $40 per unitSecond quarter 1,500 units at $41 per unitThird quarter 2,200 units at $43 per unitFourth quarter 1,900 units at $45 per unitTotal 7,600 units at a total cost of $321,600
Inventory sales during the year: 5,600 units at $50 per unit
What are the revenue and expense for these transactions during theyear?
Assume the company specifically identifies that- the 5,600 units sold were those purchased in the 1st and 2nd quarter
plus 2,100 of the units purchased in the 3rd quarter and- the 2,000 remaining units were 100 of those purchased in the 3rd
quarter plus the 1,900 purchased in the 4th quarter.
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SPECIFIC EXPENSE RECOGNITIONAPPLICATIONS: EXAMPLE SOLUTION
Revenue = $280,000(5,600 units times $50 per unit)
Cost of Goods SoldThe 5,600 units that were sold were specifically identified
as follows:From 1st quarter: 2,000 units at $40 per unit $80,000From 2nd quarter: 1,500 units at $41 per unit $61,500From 3rd quarter: 2,100 units at $43 per unit $90,300Total cost of goods sold $231,800
Ending inventoryFrom the 3rd quarter: 100 units at $43 per unit $4,300From the 4th quarter: 1,900 units at $45 per unit $85,500Total remaining (or ending) inventory cost $89,800
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Total availablefor sale
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SPECIFIC EXPENSE RECOGNITIONAPPLICATIONS: EXAMPLE
Inventory PurchasesFirst quarter 2,000 units at $40 per unitSecond quarter 1,500 units at $41 per unitThird quarter 2,200 units at $43 per unitFourth quarter 1,900 units at $45 per unit
Total 7,600 units at a total cost of $321,600
Inventory sales during the year 5,600 units at $50 per unit.
Revenue and expense for these transactions during the year?
Assume the company does not specifically identify the units, but insteaduses the weighted average cost method of inventory costing.
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SPECIFIC EXPENSE RECOGNITIONAPPLICATIONS: EXAMPLE SOLUTION
Revenue = $280,000(5,600 units times $50 per unit)
Average cost per unit =Total cost of goods available divided by total units available =
$321,600/7,600 units = $42.3158 per unit
Cost of goods sold =5,600 units at $42.3158 per unit $236,968
Ending inventory =2,000 units at $42.3158 per unit $84,632
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Total availablefor sale
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SPECIFIC EXPENSE RECOGNITIONAPPLICATIONS: EXAMPLE
Inventory PurchasesFirst quarter 2,000 units at $40 per unitSecond quarter 1,500 units at $41 per unitThird quarter 2,200 units at $43 per unitFourth quarter 1,900 units at $45 per unit
Total 7,600 units at a total cost of $321,600
Inventory sales during the year: 5,600 units at $50 per unit.
What are the revenue and expense for these transactions during the
year?
Assume the company does not specifically identify the units, but insteaduses the FIFO (first in, first out) method of inventory costing.
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SPECIFIC EXPENSE RECOGNITIONAPPLICATIONS: EXAMPLE SOLUTION
Inventory PurchasesFirst quarter 2,000 units at $40 per unitSecond quarter 1,500 units at $41 per unitThird quarter 2,200 units at $43 per unitFourth quarter 1,900 units at $45 per unit
Total 7,600 units at a total cost of $321,600
Using the FIFO method of inventory costing:
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FIFO to determine COGS: 2,000 from 1st quarter at $40 perunit + 1,500 from 2nd quarter at $41 per unit + 2,100 from
3rd quarter at $43 per unit
COGS = $231,800
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SPECIFIC EXPENSE RECOGNITIONAPPLICATIONS: EXAMPLE SOLUTION
Inventory PurchasesFirst quarter 2,000 units at $40 per unitSecond quarter 1,500 units at $41 per unitThird quarter 2,200 units at $43 per unitFourth quarter 1,900 units at $45 per unit
Total 7,600 units at a total cost of $321,600
Using the LIFO method of inventory costing:
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LIFO to determine COGS: 1,900 from 4th quarter at $45 perunit + 2,200 units at $43 per unit + 1,500 units at $41 per unit
COGS = $241,600
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SUMMARY TABLE ON INVENTORYCOSTING METHODS
Method Description
COGS whenprices are risingrelative to theother twomethods
Ending Inventorywhen prices arerising relative to theother two methods
FIFO Assumes that earliest
items purchased weresold first
Lowest Highest
LIFO Assumes most recentitems purchased weresold first
Highest* Lowest*
AverageCost
Averages total costsover total units available
Middle Middle
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*Assumes no LIFO layer liquidation. LIFO layer liquidation occurs when the volume of sales exceeds thevolume of other purchases in the period so that some sales are assumed to be from existing, relatively low-pricedinventory rather than from more recent purchases.
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INVENTORY METHOD: EXAMPLE DISCLOSURE
Inventory Valuation Inventories are valued at the lower of costor market value. Product related inventories are primarily
maintained on the first-in, first-out method. Minor amounts of
product inventories, including certain cosmetics and commodities,
are maintained on the last-in, first-out method. The cost of spare
part inventories is maintained using the average cost method.
Procter & Gamble (2011), Annual Report
Inventoriesare valued at the lower of cost or net realizable value.Cost is calculated using the weighted average cost method.
LOreal Group (2011), Registration Document
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INVENTORY METHOD: EXAMPLE DISCLOSURE
Inventories. Inventories are stated at the lower of cost or market. The
cost of approximately 80% of inventories is determined using the first-in, first-out (FIFO) method. The cost of all other inventories,
predominantly in the U.S. and Mexico, is determined using the last-in,
first-out (LIFO) method.
Colgate-Palmolive (2011), Annual Report (Note 2)
Inventories valued under LIFO amounted to $271 and $263 at
December 31, 2011 and 2010, respectively. The excess of current cost
over LIFO cost at the end of each year was $30 and $52, respectively.
The liquidations of LIFO inventory quantities had no material effect onincome in 2011, 2010 and 2009.
Colgate-Palmolive (2011), Annual Report (Note 16)
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SPECIFIC EXPENSE RECOGNITIONAPPLICATIONS: DEPRECIATION
Depreciation: Process of systematically allocating costs of long-livedassets over the period during which the assets are expected to provideeconomic benefits.
- Depreciation: term commonly applied for physical long-lived assets,
such as plant and equipment (NOT land)- Amortization:Term commonly applied to this process for intangible
long-lived assets with a finite useful life
DepreciationMethods:
- Straight line
- Accelerated (i.e., diminishing balance)
- Units of production
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SPECIFIC EXPENSE RECOGNITIONAPPLICATIONS: DEPRECIATION EXAMPLE
Equipment cost = $9,000. Estimated residual = $0. Useful life = 3 years. Annual depreciation expense = (Cost Residual value)/Useful life.
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Cost of equipment $9,000
Less Year 1 depreciation expense 3,000
Book value at end of Year 1 $6,000
Less Year 2 depreciation expense 3,000
Book value at end of Year 2 $3,000
Less Year 3 depreciation expense 3,000
Book value at end of Year 3 $0
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SPECIFIC EXPENSE RECOGNITIONAPPLICATIONS: DEPRECIATION EXAMPLE
Judgments and estimates needed in depreciation:- estimated salvage value- estimated useful life
For example, given a purchase price of $10,000, what isthe annual straight-line depreciation expense- if estimated salvage value = $5,000 and useful life = 10
years?- if estimated salvage value = $0 and useful life = 2 years?
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SPECIFIC EXPENSE RECOGNITIONAPPLICATIONS: DEPRECIATION EXAMPLE
Diminishing Balance Depreciation Determine straight-line rate (100%/Useful life) Determine acceleration factor (e.g., 1.5 or 2) Depreciation rate = (Straight-line rate x acceleration factor) Depreciation expense = Net book value (NBV) x Depreciation
rate Discontinue depreciation when net book value = Salvage value
Example: What is the annual depreciation expense each year?Asset cost: $11,000Estimated salvage value: $1,000Estimated useful life: 5 yearsAcceleration factor: 2
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SPECIFIC EXPENSE RECOGNITION APPLICATIONS:DEPRECIATION EXAMPLE SOLUTION
Year
NBVBeginning of
YearDepreciation
ExpenseAccumulatedDepreciation
NBV End ofYear
1 11,000 4,400 4,400 6,600
2 6,600 2,640 7,040 3,960
3 3,960 1,584 8,624 2,376
4
2,376 950 9,574 1,426
5 1,426 426 10,000 1,000
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NONRECURRING ITEMS AND CHANGES INACCOUNTING STANDARDS
Separating nonrecurring from recurring items of incomeand expense can help an analyst assess a companysfuture earnings.
Nonrecurring items:
- discontinued operations
- extraordinary items (not permitted under IFRS)
- unusual or infrequent items
Changes in accounting standards
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EPS: EXAMPLE 1
Basic EPS- Earnings available to common shareholders divided by weighted
average number of shares outstanding
Basic EPS = (Net incomePreferred dividends)Weighted average number of shares outstanding
Assume the following:
- Company had net income of $2,431 million for the year,
- 488.3 million weighted average number of common shares outstanding
- No preferred stock, no convertible securities, no options
What was the companys basic EPS?
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Colgate's Annual Report
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EPS: EXAMPLE 1 SOLUTION
Assume the following:- Company had net income of $2,431 million for the year
- 488.3 million weighted average number of common shares outstanding
- No preferred stock, no convertible securities, no options
What was the companys Basic EPS?
Basic EPS
= (Net incomePreferred dividends)/Weighted average number of
shares outstanding= ($2,431$0)/488.3
= $4.98
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Colgate's Annual Report
http://localhost/var/www/apps/conversion/tmp/scratch_8/Ch4_Colgate_2011_AR.pdfhttp://localhost/var/www/apps/conversion/tmp/scratch_8/Ch4_Colgate_2011_AR.pdf8/11/2019 IFSA 4
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EPS: EXAMPLE 2WEIGHTED AVERAGE NUMBER OF SHARES
Calculate(1) the weighted average number of shares outstanding
(2) the companys basic EPS
Assume the following:Company had net income of $2,500,000 for the year and paid $200,000of preferred dividends.
1,000,000 Shares outstanding on 1 January 20XX
200,000 Shares issued on 1 April 20XX(100,000) Shares repurchased on 1 October 20XX
1,100,000 Shares outstanding on 31 December 20XX
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EPS: EXAMPLE 2 SOLUTIONWEIGHTED AVERAGE NUMBER OF SHARES
Weighted average number of shares outstanding1,000,000 (3 months/12 months) Jan, Feb, Mar
+ 1,200,000 (6 months/12 months) AprilOct
+ 1,100,000 (3 months/12 months) Oct, Nov, Dec
= 1,125,000 Weighted average number of shares outstanding
Basic EPS
= (Net incomePreferred dividends)/Weighted average numberof shares outstanding
= ($2,500,000$200,000)/1,125,000
= $2.04
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EPS: EXAMPLE 3
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EPS: EXAMPLE 3IF-CONVERTED METHOD FOR CONVERTIBLE
PREFERRED STOCK
Assume a company has the following:- net income of $1,750,000
- an average of 500,000 shares of common stock outstanding
- 20,000 shares of convertible preferred outstanding
- no other potentially dilutive securitiesEach share of preferred pays a dividend of $10 per share, and eachis convertible into five shares of the companys common stock.
Calculate the companys basic and diluted EPS.
Diluted EPS
= Net income/(Weighted average number of shares outstanding+ New shares issued at conversion)
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EPS: EXAMPLE 3
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EPS: EXAMPLE 3IF-CONVERTED METHOD FOR CONVERTIBLE
PREFERRED STOCK SOLUTION
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Basic EPSDiluted EPS Using
If-Converted Method
Net income $1,750,000 $1,750,000
Preferred dividend 200,000 0
Numerator $1,550,000 $1,750,000
Weighted average number of shares
outstanding 500,000 500,000
If converted 0 100,000
Denominator 500,000 600,000
EPS $3.10 $2.92
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EPS: EXAMPLE 4IF-CONVERTED METHOD FOR CONVERTIBLE DEBT
Assume a company has the following:- net income of $750,000
- an average of 690,000 shares of common stock outstanding
- $50,000 of 6% convertible bonds outstanding that are convertible into atotal of 10,000 shares
- no other potentially dilutive securities
- An effective tax rate is 30%
Calculate the companys basic and diluted EPS.
Diluted EPS
= (Net income + After-tax interest on convertible debtPreferreddividends)/(Weighted average number of shares outstanding + Additionalcommon shares that would have been issued at conversion)
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EPS: EXAMPLE 4
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EPS: EXAMPLE 4IF-CONVERTED METHOD FOR CONVERTIBLE DEBT
SOLUTION
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Basic EPS Diluted EPS UsingIf-Converted Method
Net income $750,000 $750,000
After-tax cost of interest 0 2,100
Preferred dividend 0 0
Numerator $750,000 $752,100
Weighted average number of shares
outstanding 690,000 690,000
If converted 0 10,000
Denominator 690,000 700,000
Earnings per share (EPS) $1.09 $1.07
EPS EXAMPLE
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EPS: EXAMPLE 5TREASURY STOCK METHOD FOR STOCK OPTIONS
Assume a company reported net income of $2.3 million for the
year ended 30 June 2005 and has the following:- an average of 800,000 common shares outstanding
- 30,000 options with an exercise price of $35 outstanding
- no other potentially dilutive securitiesOver the year, its market price averaged $55 per share.
Calculate the companys basic and diluted EPS.
Diluted EPS
= (Net IncomePreferred dividends)/(Weighted averagenumber of shares outstanding + New shares issued at optionexerciseShares that could have been purchased with cashreceived upon exercise)
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EPS: EXAMPLE 5
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EPS: EXAMPLE 5TREASURY STOCK METHOD FOR STOCK OPTIONS
SOLUTION
800,000 Weighted average number of shares outstanding
+ 30,000 New shares issued at option exercise
19,091
Shares that could be purchased with cash receivedupon exercise, calculated as $1,050,000 ($35 foreach of the 30,000 options exercised) divided byaverage market price of $55 per share = 19,091shares
= 810,909 Shares
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Calculate Denominator
30,00019,091 = 10,909
EPS: EXAMPLE 5
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EPS: EXAMPLE 5TREASURY STOCK METHOD FOR STOCK OPTIONS
SOLUTION
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Basic EPS
Diluted EPS Using
Treasury Stock
Method
Net income $2,300,000 $2,300,000
Numerator $ 2,300,000 $2,300,000
Weighted average number
of shares outstanding 800,000 800,000
If exercised and treasury
shares purchased 0 10,909Denominator 800,000 810,909
EPS $2.88 $2.84
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COMMON-SIZE INCOME STATEMENTS
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Panel B: Common-Size Income Statements for Companies A, B, and C
A B C
Sales 100% 100% 100%
Cost of sales 30 75 30
Gross profit 70 25 70
Selling, general, andadministrative expenses 10 10 10
Research and development 20 0 20
Advertising 20 0 20Operating profit 20 15 20
Each line item is expressed as a percentage of thecompanys sales.
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COMPREHENSIVE INCOME
Beginning Equity + or
Change = Ending EquityRetained earnings + Net income
DividendsRetained earnings
Accumulated othercomprehensive income
+ Other comprehensiveincomeOther comprehensiveloss
Accumulated othercomprehensive income
Stock + IssuancesRepurchases
Stock
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1. Foreign currency translation adjustments
2. Unrealized gains or losses on derivatives contracts accounted for ashedges
3. Unrealized holding gains and losses on available-for-sale securities4. Certain costs of a companys defined benefit post-retirement plans that
are not recognized in the current period
COMPREHENSIVE INCOME:
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COMPREHENSIVE INCOME:EXAMPLE
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Assume the following about a company:- beginning shareholders equity is 200 million
- net income for the year is20 million
- cash dividends for the year are3 million
- no issuance or repurchase of common stock.
- actual ending shareholders equity is 227 million.
What amount has bypassed the net income calculation bybeing classified as other comprehensive income?
What is the companys comprehensive income?
COMPREHENSIVE INCOME:
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COMPREHENSIVE INCOME:EXAMPLE SOLUTION
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Assume the following about a company:
- beginning shareholders equity is 200 million
- net income for the year is20 million
- cash dividends for the year are3 million
- no issuance or repurchase of common stock- actual ending shareholders equity is 227 million
What amount has bypassed the net income calculation by being
classified as Other comprehensive income?Answer:10 million.
What is the companys total comprehensive income?
Answer:30 million
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SUMMARY
Income statement shows how much revenue the company
generated during a period and what costs it incurred inconnection with generating that revenue.
Accounting issues relate primarily to timing (revenue recognition,expense recognition, nonrecurring items).
The income statement also presents EPS (earnings per share),an important metric.
Tools for income statement analysis include common-sizeanalysis and profitability ratios.
Comprehensive income includes net income and othercomprehensive income.