1
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
The Income
Statement and
Statement of
Cash Flows
4
4-2
Learning Objectives
Explain the difference between net income and
comprehensive income and how we report
components of the difference.
4-3
Comprehensive Income
An expanded
version of income
that includes four
types of gains and
losses that
traditionally have
not been included
in income
statements.
2
4-4
Other Comprehensive Income
Statement of Financial Accounting Standards No. 130
Comprehensive income includes traditional net income
and changes in equity from nonowner transactions.
1. Changes in the market value of securities available for sale
(described in Chapter 12).

31-May
4-6
Learning Objectives
Discuss the importance of income from
continuing operations and describe its
components.
3
4-7
Expenses
Outflows of
resources
incurred in
generating
revenues.
Revenues
Inflows of
resources
resulting
from
providing
goods or
services to
customers.
Gains and
Losses
Increases or
decreases in
equity from
peripheral or
incidental

revenues and
expenses related
to peripheral or
incidental
activities of the
company
4-9
Income Statement (Single-Step)
Expenses
& Losses
{
MAXWELL GEAR COMPANY
Income Statement
For the Year Ended December 31, 2006
Revenues and gains:
Sales 573,522$
Interest and dividends 26,400
Gain on sale of opearting assets 5,500
Total revenues and gains 605,422
Expenses and losses:
Cost of goods sold 302,371$
Selling 47,341
General and administrative 24,888
Research and development 16,300
Interest 6,200
Loss on sale of investment 8,322
Income taxes 80,000
Total expenses & losses 485,422
Net income 120,000$
{

Net income 120,000$
{
Gross
Profit
{
Proper Heading
Operating
Expenses
{
4-11
Learning Objectives
Describe earnings quality and how it is
impacted by management practices to
manipulate earnings.
4-12
Earnings Quality
Earnings quality refers to
the ability of reported
earnings to predict a
company’s future.
The relevance of any
historical-based financial
statement hinges on its
predictive value.
5
4-13
Manipulating Income and Income Smoothing
“Most managers prefer to report earnings that follow a
smooth, regular, upward path.”
1

recognized in the period incurred.
Goodwill Impairment
and Long-lived Asset
Impairment
Involves asset impairment losses
or charges (discussed further in
Chapters 10 & 11).
In-process Research
and Development
Results from certain business
combinations (discussed further in
Chapter 10).
4-17
Nonoperating Income and Earnings Quality
Gains and losses from the sale of operational
assets and investments often can significantly
inflate or deflate current earnings.
Example
As the stock market boom reached its
height late in the year 2000, many
companies recorded large gains from
sale of investments that had
appreciated significantly in value.
How should
those gains be
interpreted in
terms of their
relationship to
future
earnings? Are

extraordinary items
Income tax expense
Income from continuing operations
before extraordinary items
Discontinued operations (net of $xx
in taxes)
Extraordinary
items
A third item, the
cumulative effect of
a change in
accounting
principle, was
eliminated from
separate reporting
by a new
accounting
standard in 2005.
4-20
Intraperiod Income Tax Allocation
Income Tax Expense must be associated with
each component of income that causes it.
Show Income Tax
Expense related to
Income from
Continuing
Operations.
Report effects of
Discontinued Operations
and Extraordinary Items

4-23
Discontinued Operations
Report results of operations separately if two
conditions are met:
The operations and
cash flows of the
component have been
(or will be) eliminated
from the ongoing
operations.
The entity will not have
any significant
continuing involvement
in the operations of the
component after the
disposal transaction.
4-24
Discontinued Operations
Reporting for Components Sold
Operating income or
loss of the component
from the beginning of
the reporting period to
the disposal date.
Gain or loss on the
disposal of the
component.
Reporting for Components Held For Sale
Operating income or
loss of the component

Computation of Loss from Discontinued Operations
(Net of Tax Effect):
4-27
Income from continuing operations 128,387$
Discontinued operations:
Loss from operations of discontinued
component (net of tax benefit of
$45,000) (105,000)
Loss on disposal of discontinued
component (net of tax benefit of
$30,000) (70,000)
Net loss (46,613)$
Income Statement Presentation:
Discontinued Operations Example
10
4-28
Learning Objectives
Define extraordinary items and describe the
appropriate income statement presentation for
these transactions.
4-29
p
Material events or
transactions
p
Unusual in nature
p
Infrequent in occurrence
p
Reported net of related

Items that are material and are either
unusual or infrequent—but not both—
are included as a separate item in
continuing operations.
4-33
Type of Accounting
Change Definition
Change in Accounting
Principle
Change from one GAAP method
to another GAAP method
Change in Accounting
Estimate
Revision of an estimate
because of new information or
new experience
Change in Reporting
Entity
Preparation of financial
statements for an accounting
entity other than the entity that
existed in the previous period
Accounting Changes
12
4-34
Learning Objectives
Describe the measurement and reporting
requirements for a change in accounting
principle.
4-35

changes in depreciation,
amortization, and
depletion methods
4-38
Change in Accounting Estimate Example
On January 1, 2003, we purchased
equipment costing $30,000, with a useful
life of 10 years and no salvage value.
During 2006, we determine that the
remaining useful is 5 years (8-year total
life). We use straight-line depreciation.
Compute the revised depreciation
expense for 2006.
4-39
Asset cost 30,000$
Accumulated depreciation
12/31/05 - ($3,000 × 3 years) (9,000)
Remaining to be depreciated 21,000
Remaining useful life ÷ 5 years
Revised annual depreciation 4,200$
Record depreciation expense of $4,200 for
2006 and subsequent years.
Change in Accounting Estimate Example
GENERAL JOURNAL
Page: 180
Date Description PR Debit Credit
4,200
Accumulated Depreciation 4,200
Depreciation Expense
14

net of income taxes
Prior Period Adjustments
15
4-43
Prior Period Adjustments Example
While reviewing the depreciation entries for
2002-2007, the controller found that in 2006
depreciation expense was incorrectly debited
for $150,000 when in fact it should have been
debited $125,000. (Ignore income taxes.)
Prepare the necessary journal entry in 2007 to
correct this prior period error.
GENERAL JOURNAL
Page: 180
Date Description PR Debit Credit
12/31/06 Depreciation Expense 150,000
Accumulated Depreciation 150,000
4-44
GENERAL JOURNAL
Page: 180
Date Description PR Debit Credit
Accumulated Depreciation 25,000
Retained Earnings 25,000
2007 Entry
Prior Period Adjustments Example
4-45
Learning Objectives
Define earnings per share (EPS) and explain
required disclosures of EPS for certain income
statement components.

17
4-49
The Statement of Cash Flows
p
Provides relevant information about a
company’s cash receipts and cash
disbursements.
p
Helps investors and creditors to assess
n
future net cash flows
n
liquidity
n
long-term solvency.
p
Required for each income statement period
presented.
4-50
Learning Objectives
Identify and describe the various classifications
of cash flows presented in a statement of cash
flows.
4-51
Operating Activities
Cash
Flows
from
Operating
Activities

converts to cash
basis
Indirect Method
4-53
Direct and Indirect Methods
Cash flows from Operating Activities
Cash received from customers 78$
Cash paid for administrative expenses (25)
Net cash flows from operating activities 53$
ARLINGTON LAWN CARE
Statement of Cash Flows
For the Year Ended December 31, 2006
($ in thousands)
Direct
Method
Cash flows from Operating Activities
Net income 35$
Adjustments for noncash effects:
Depreciation expense 8$
Increase in accounts receivable (12)
Increase in accounts payable 7
Increase in income taxes payable 15 18
Net cash flows from operating activities 53$
ARLINGTON LAWN CARE
Statement of Cash Flows
For the Year Ended December 31, 2006
($ in thousands)
Indirect
Method
4-54

Cash
Flows
from
Financing
Activities
+
_
Financing Activities
Inflows from:
l
Sale of shares to owners.
l
Borrowing from creditors
through notes, loans,
mortgages, and bonds.
Outflows
to:
Outflows to:
l Owners in the form of dividends
or other distributions.
l
Owners for the reacquisition of
shares previously sold.
l
Creditors as repayment of the
principal amounts of debt.
4-56
Noncash Investing and Financing Activities
Significant investing and financing
transactions not involving cash also