CHAPTER 4

Income Statement and Related Information

LEARNING OBJECTIVES
1. Understand the uses and limitations of an income statement.
2. Understand the content and format of the income statement.
3. Prepare an income statement.
4. Explain how to report items in the income statement.
5. Identify where to report earnings per share information.
6. Explain intraperiod tax allocation.
7. Understand the reporting of accounting changes and errors.
8. Prepare a retained earnings statement.
9. Explain how to report other comprehensive income.

Copyright © 2018 John Wiley & Sons, Inc.    Kieso Intermediate: IFRS 3e, Instructor’s Manual 4-1
CHAPTER REVIEW
1. Chapter 4 presents a detailed discussion of the concepts and techniques that underlie the
preparation of the Income Statement and Retained Earnings Statement and the reporting
of other comprehensive income. The requirements for adequate presentation of reported
net income are described and illustrated throughout the chapter.
2. (L.O. 1) The income statement helps users of financial statements (1) evaluate the past
performance of the company, (2) provide a basis for predicting future performance, and
(3) help assess the risk or uncertainty of achieving future cash flows. The limitations of
the income statement include (1) omitting items from the income statement that cannot be
measured reliably, (2) income numbers are affected by the accounting methods
employed, and (3) income measurement involves judgment.
3. Quality of earnings is important because markets are based on trust and it is imperative
that investors have faith in the numbers reported. If that trust is damaged, capital markets
will be damaged. Earnings management negatively affects quality of earnings if it distorts
the information in a way that is less useful for predicting cash flows and future earnings.
Format of the Income Statement
4. (L.O. 2) The two major elements of income statement are income and expenses. The
definition of income includes both revenues (sales, interest) and gains (gains on sale of
long-term assets). The definition of expenses includes both expenses (depreciation,
salaries) and losses (losses on sale of long-term assets).

5. Intermediate components of the income statement include some or all of the subtotals within
the income statement to arrive at net income/loss including: gross profit, income from
operations, income before income tax, and income from continuing operations.
6. (L.O. 3) The following items are required to be presented on the income statement:
(1) revenue, (2) finance costs, (3) share of profit (loss) of associates accounted for using the
equity method, (4) tax expense, (5) amounts the post-tax profit or loss of discontinued
operations and the post-tax gain or loss recognized on disposal of a discontinued operation,
and (6) net income or net loss.
7. An income statement is composed of various sections that relate to different aspects of
the earning process. Companies may prepare some or all of the following sections.
a. Sales or revenue section.

b. Cost of goods sold section.

c. Selling expenses.

d. Administrative or general expenses.

e. Other Income and Expense.

f. Financing Costs.

g. Income Tax.

4-2 Copyright © 2018 John Wiley & Sons, Inc.    Kieso Intermediate: IFRS 3e, Instructor’s Manual
 h. Discontinued Operations. Gains and losses resulting from disposal of a component
of a company.

i Non-Controlling Interest. Shows an allocation of net income to the primary

shareholders and to the non-controlling interest.

j. Earnings Per Share.

The informative content of the income statement may be further enhanced by adding
additional subsections to the above major sections.

8. A company includes only the totals of components in condensed income statements, but
prepare supplementary schedules to support the totals.

Reporting within the Income Statement

9. (L.O. 4) Companies are required to present expenses classified either by their nature
(nature-of-expense method) or their function (function-of-expense method). The function-
of-expense method is generally used in practice, but then the individual expenses are
itemized in the notes to the financial statements.

10. The IASB takes the position that both revenues and expenses and other income and
expenses should be reported as part of income from operations. Companies can provide
additional line items, headings, and subtotals when such presentation is relevant to an
understanding of the entity’s financial performance.

11. When the parent company’s interest in the subsidiary company is less than 100 percent
the ownership of the subsidiary is divided into (a) the majority interest who own the
controlling interest and (b) the non-controlling interest (the minority interest).

12. (L.O. 5) In general, earnings per share represents the ratio of net income minus
preference dividends (income available to common shareholders) divided by the weighted
average number of common shares outstanding. It is considered by many financial
statement users to be the most significant statistic presented in the financial statements,
and must be disclosed on the face of the income statement. Per share amounts for
gain or loss on discontinued operations must be disclosed on the face of the income
statement or in the notes to the financial statements.

13. The IASB defines a discontinued operation as a component of an entity that either has
been disposed of or is classified as held-for-sale, and (a) represents a major line of
business or geographical area of operations, or (b) is part of a single, coordinated plan to
dispose of a major line of business or geographical area of operations, or (c) is a
subsidiary acquired exclusively with a view to resell. When an entity decides to dispose of
a component of its business, a separate income statement category for gain or loss from
disposal of a component of a business must be provided. In addition, the results of
operations of a component that has been or will be disposed of are also reported
separately from continuing operations.

Copyright © 2018 John Wiley & Sons, Inc.    Kieso Intermediate: IFRS 3e, Instructor’s Manual 4-3
14. (L.O. 6) Intraperiod tax allocation is the process of relating the income tax effect of an
unusual item to that item when it appears on the income statement. Income tax expense
related to continuing operations is shown on the income statement at its appropriately
computed amount. All other items included in the determination of net income should be
shown net of their related tax effect. The tax amount may be disclosed in the income
statement or in a footnote.

Other Reporting Issues

15. (L.O. 7) A change in accounting principle results when a company adopts a new
accounting principle that is different from the one previously used. A company recognizes a
change in accounting principle by making a retrospective adjustment to the financial
statements. Such an adjustment recasts the prior years’ statements on a basis consistent
with the newly adopted principle. The company records the cumulative effect of the change
for prior periods as an adjustment to beginning retained earnings of the earliest year
presented.

16. Accountants make extensive use of estimates in preparing financial statements. Adjustments
that grow out of the use of estimates in accounting are used in the determination of
income for the current period and future periods and are not charged or credited directly
to Retained Earnings. It should be noted that changes in estimates are not considered
errors (prior period adjustments) or extraordinary items.

17. Companies must correct errors by making proper entries in the accounts and reporting
corrections in the financial statements. Corrections of errors are treated as prior period
adjustments, similar to changes in accounting principles. Companies record an error in
the year in which it is discovered. They report the effect of the error as an adjustment to
the beginning balance of retained earnings. If a company prepares comparative financial
statements, it should restate the prior statements for the effects of the error.

18. (L.O. 8) The retained earnings statement serves to reconcile the balance of the retained
earnings account from the beginning to the end of the year. The important information
communicated by the retained earnings statement includes: (a) prior period adjustments
(income or loss related to corrections of errors in the financial statements of a prior period
net of tax), (b) changes in accounting principle, (c) the relationship of dividend distributions
to net income for the period, and (d) any transfers to and from retained earnings.

19. (L.O. 9) Items that bypass the income statement are included under the concept of
comprehensive income. Comprehensive income includes all changes in equity during
a period except those resulting from investments by owners and distributions to owners.
The IASB evaluated approaches to providing more information about other comprehensive
income items. It decided that the components of other comprehensive income must be
displayed in one of two ways: (1) a second income statement or (2) a combined statement
of comprehensive income.

20. The statement of changes in equity is required by the IASB and reports the change in
share capital, retained earnings, and the accumulated balances in other comprehensive

4-4 Copyright © 2018 John Wiley & Sons, Inc.    Kieso Intermediate: IFRS 3e, Instructor’s Manual
 items. This statement discloses comprehensive income for the period and contributions
(issuances of shares) and distributions (dividends) to owners.

LECTURE OUTLINE

The material in this chapter can be covered in two to three class sessions. Most students have
had previous exposure to the concepts presented in the chapter.

The lecture and assigned problems should be directed toward two areas of concentration:

1. An understanding of each of the intermediate components of income and other unusual

items, including prior period adjustments, discontinued operations etc. Students should be
able to: (1) recognize these items when encountered in problem material, and (2) identify
the proper accounting and disclosure procedure for each of them.
2. An understanding of proper format for income (including comprehensive income) and
retained earnings statements. Given transaction data or account balances, students should
be able to prepare detailed and condensed income statements, retained earnings state-
ments, comprehensive income statements, combined statements of comprehensive income,
and a statement of changes in equity.

The material in the chapter can be presented with the following lecture outline:

A. (L.O. 1) Usefulness of the Income Statement.

1. Income information helps interested parties predict the amounts, timing, and uncertainty
of future cash flows. Income information is useful:
a. for evaluating past performance.
b. for predicting future performance.
c. for assessing the risk (uncertainty) of achieving future cash flows. Infor-
mation about the various components of income—revenues, expenses, gains, and
losses—is helpful for assessing the risk of not achieving a particular level of cash
flows in the future.

B. Limitations of the Income Statement.

1. Companies omit items from the income statement that they cannot measure
reliably. For example:

a. Unrealized gains and losses on certain investment securities.

b. The value of brand recognition, customer service, and product quality.

2. Income numbers are affected by the accounting methods employed. Discuss the
concept of the quality of earnings.

a. Discuss how earnings management can effect the quality of earnings.

Copyright © 2018 John Wiley & Sons, Inc.    Kieso Intermediate: IFRS 3e, Instructor’s Manual 4-5
 3. Income measurement involves judgment. Discuss this in terms of bad debt expense
and depreciation expense.

C. Quality of Earnings

1. Earnings management distorts current earnings to the detriment of future earnings.

2. Quality of Earnings provides full and transparent information that will not confuse or
mislead financial statement users.

D. (L.O. 2) Income Statement Format: Disclosure of the Intermediate Components of Income.

1. Review the definitions of the elements of income on text page 139: Income and
expenses.

2. Presentation of income statement items.

a. Income statement components.

b. (L.O. 3) Condensed format.

c. IFRS permits either the detailed or condensed format.

E. (L.O. 4) Reporting within the Income Statement.

1 Companies may prepare a condensed income statement with details on various com-
ponents presented in the notes to the financial statements.
2. Companies are required to present an analysis of expenses classified either by their
nature or their function.
a. The nature-of-expense method uses a natural expense approach (such as direct
labor incurred) without having to make arbitrary allocations.

b. The function-of-expense method identifies the major cost drivers of a company

(such as cost of goods sold and administrative expenses).

3. The IASB takes the position that both revenues and other income and expense should
be reported as part of income from operations.

4. When the parent company’s share interest is less than 100%, the subsidiary is only
partially owned. Under this arrangement, the subsidiary’s ownership is divided into (1)
the majority interest represented by the controlling interest, and (2) the non-controlling
interest (minority interest) represented by shareholders, who are not part of the
controlling group.

F. (L.O. 5) Earnings Per Share—a widely used measure of business performance.

4-6 Copyright © 2018 John Wiley & Sons, Inc.    Kieso Intermediate: IFRS 3e, Instructor’s Manual
 1. Discuss the importance of EPS in the financial press using examples from The Wall
Street Journal.

2. EPS is equal to
Net income – Preference Dividends
Net Income – Preference Dividends
Weighted Average Capital Shares Outstanding

3. Per share figures must be disclosed in the income statement for the following
amounts:

a. Income from continuing operations.

b. Discontinued operations.

c. Net income.

4. Discontinued operations. Disposals of a component are reported net of tax in the

income statement immediately below income from continuing operations. Results of
the disposal are reported in two amounts.

a. Income or loss from operation of the discontinued component up to the

measurement date, net of tax.

b. Gain or loss from disposal of the discontinued component, net of tax.

G. (L.O. 6) Intraperiod Tax Allocation—the process of associating income tax expense with
related income. The principle is “let the tax follow the income.”

1. Intraperiod tax allocation involves a breakdown of total income tax expense into
separate components which are disclosed on different portions of the financial
statements. Intraperiod tax allocation is applied to:

a. Income from continuing operations.

b. Discontinued operations.

2. Use the income statement from Illustration 4.11 on text page 4-15 to demonstrate
intraperiod tax allocation. Ask students to compute the total tax expense for 2019. It is
$167,800, disclosed for accounting purposes as follows:

Tax associated with continuing operations.............................................. R$184,000

Tax on operations of discontinued division.............................................. 24,800
Reduction of tax due to loss on disposal of
discontinued division...........................................................................    (41,000)
Total tax expense.............................................................................. R$167,800

Copyright © 2018 John Wiley & Sons, Inc.    Kieso Intermediate: IFRS 3e, Instructor’s Manual 4-7
 Without intraperiod tax allocation, total tax expense would merely be reported as
R$167,800 and financial statement users would not be able to assess the tax conse-
quences of operations or of special items.

3. Point out that the net-of-tax amount of an item is calculated by multiplying the item by
(1 minus the tax rate).

H. (L.O. 7) Changes in Accounting Principle—adoption of an accounting method that is

different from the one previously used.

1. Examples:

a. Change from FIFO to average cost.

b. Change from percentage-of-completion to the completed-contract method for

construction contracts.

2. Discuss the distinction between a change in accounting principle and a change in

accounting estimate.

3. Recast prior years’ statements to reflect new principle.

4. Point out that it is the cumulative effect of the change on prior years’ income that is
disclosed as an adjustment to beginning retained earnings for the earliest year presented.

I. Changes in Estimates (Normal, Recurring Corrections and Adjustments)—

adjustments that result from periodic revisions in estimates.

1. Examples.

a. Changes in the estimated lives or salvage values of depreciable assets.

b. Changes in estimated collectibility of receivables.

c. Adjustment of inventory costs or estimated realizability.

2. These adjustments are not treated as errors. Students frequently misunderstand this.
They erroneously believe that special journal entries or separate disclosures must be
made.

J. Correction of errors.

1. Examples.

a. Mathematical mistakes.

b. Mistakes in application of accounting principles.

c. Oversight or misuse of facts that existed at the time financial statements were
prepared.

2. Reported as a prior period adjustment.

4-8 Copyright © 2018 John Wiley & Sons, Inc.    Kieso Intermediate: IFRS 3e, Instructor’s Manual
K. (L.O. 8) Retained Earnings Statement—a summary disclosure of the changes in the
balance of the Retained Earnings account from the beginning to the end of the year. The
following items are disclosed in the retained earnings statement:

1. Prior period adjustments. Adjustments to the beginning balance of retained earnings.

a. Transactions that are accounted for as prior period adjustments:

(1) Correction of errors in financial statements of prior periods.

(2) Changes in accounting principle.

b. The entry to record a prior period adjustment usually involves the following types
of accounts:

(1) The Retained Earnings account.

(2) A balance sheet account (e.g., Accumulated Depreciation, Inventory, etc.).

2. Dividends and net income.

3. Restrictions of retained earnings.

L. (L.O. 9) Comprehensive Income—includes all changes in equity during a period except

those resulting from investments by owners and distributions to owners.

1. Other comprehensive income—includes those gains and losses that bypass net
income but affect stockholders’ equity (i.e., unrealized gains and losses on available-
for-sale securities).

2. IASB requires that the components of other comprehensive income be reported in one
of two ways.

a. A separate income statement.

b. A combined income statement of comprehensive income.

3. Statement of changes in equity—reports the change in share capital, retained earnings

and the accumulated balances in other comprehensive items.

The following items are disclosed:

a. Comprehensive income for the period.

b. Contributions (issuances of shares) and distributions to owners.

c. Reconciliation of the carrying amount of each component of equity from the

beginning to the end of the period.

Copyright © 2018 John Wiley & Sons, Inc.    Kieso Intermediate: IFRS 3e, Instructor’s Manual 4-9