1 - Cengage



Chapter 12

The Corporate Income Statement and the Statement of Stockholders’ Equity

Review of Learning Objectives

LO1  Define quality of earnings, and identify the components of a corporate income statement.

The quality of earnings refers to the substance of earnings and their sustainability into future accounting periods. The quality of a company’s earnings may be affected by the accounting methods and estimates it uses and by the gains and losses, write-downs and restructurings, and nonoperating items that it reports on its income statement.

When a company has both continuing and discontinued operations, the operating income section of its income statement is called income from continuing operations. Income from continuing operations before income taxes is affected by choices of accounting methods and estimates and may contain gains and losses on the sale of assets, write-downs, and restructurings. The income taxes expense section of the statement is subject to special accounting rules. The lower part of the statement may contain such nonoperating items as discontinued operations, extraordinary gains and losses, and effects of accounting changes. Earnings per share information appears at the bottom of the statement.

The reason for considering quality of earnings issues is to assess their effect on cash flows and performance measures. Except for possible income tax effects, gains and losses, asset write-downs, restructurings, and nonoperating items generally have no effect on cash flows. However, quality of earnings issues can affect key performance ratios like profit margin, return on assets, and return on equity.

LO2  Show the relationships among income taxes expense, deferred income taxes, and net of taxes.

Income taxes expense is the tax applicable to income from operations on an accrual basis. Income tax allocation is necessary when there is a material difference between accrual-based accounting income and taxable income—that is, between the income taxes expense reported on the income statement and actual income tax liability. The difference between income taxes expense and income taxes payable is debited or credited to an account called Deferred Income Taxes. The phrase net of taxes indicates that taxes have been taken into account in reporting an item in the financial statements.

LO3 Describe the disclosure on the income statement of discontinued operations and extraordinary items.

Because of their unusual nature, gains or losses on discontinued operations and on extraordinary items must be disclosed on the income statement separately from continuing operations and net of income taxes.

LO4 Compute earnings per share.

Readers of financial statements use earnings per share to evaluate a company’s performance and to compare it with the performance of other companies. Earnings per share of common stock are presented on the face of the income statement. The amounts are computed by dividing the income applicable to common stock by the number of common shares outstanding for the year. If the number of shares outstanding varied during the year, the weighted-average number of common shares outstanding is used in the computation. A company that has a complex capital structure must disclose both basic and diluted earnings per share on the face of its income statement.

LO5 Define comprehensive income, and describe the statement of stockholders’ equity.

Comprehensive income includes all items from sources other than stockholders that account for changes in stockholders’ equity during an accounting period. The statement of stockholders’ equity summarizes changes over the period in each component of the stockholders’ equity section of the balance sheet. This statement reveals much more than the statement of retained earnings does about the transactions that affect stockholders’ equity.

LO6 Account for stock dividends and stock splits.

A stock dividend is a proportional distribution of shares among a corporation’s stockholders. The following is a summary of the key dates and accounting treatments of stock dividends:

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