Zubair Ashraf

1. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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2-1
INCOME AND CHANGES
IN RETAINED EARNINGS
Chapter
12

2. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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2-2
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

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

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

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

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

7. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Discontinued Operations - ExampleDiscontinued Operations - Example

8. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Income Statement Presentation:
Discontinued Operations - ExampleDiscontinued Operations - Example

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

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

11. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Income Statement Presentation:
Extraordinary Items - ExampleExtraordinary Items - Example

12. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Accounting ChangesAccounting Changes

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

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

15. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Income Statement Presentation:
Computation:
Change in Accounting Principle
Example
Change in Accounting Principle
Example

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

17. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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2-17
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

18. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Record depreciation expense of $4,200 for
2003 and subsequent years.
Change in Estimates - ExampleChange in Estimates - Example

19. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Let’s move
on to a few
final
topics.

20. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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2-20
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)

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

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

23. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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* Rounded.
Earnings Per Share (EPS) -
Partial Income Statement
Earnings Per Share (EPS) -
Partial Income Statement

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

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

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

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

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

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

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

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

32. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Small Stock
Dividend
Large Stock
Dividend
Stock Splits
Total
Stockholders'
Equity
No Effect No Effect No Effect
Common Stock Increases Increases No Effect
Paid-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

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

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

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

36. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Hang in there!
We’re coming down
the home stretch!
Yeah, that’s
easy for you
to say!
End of
Chapter
12