The most important aspect of corporate financial reporting. in the view of most investors. is the determination of periodic income. Both the market price. of common stock and the amount of cash  per share depend on the current and future earnings of the corporation.

Developing Predictive Information

Revenues are measures of the value of products and services that have been sold or otherwise provided for customers. They  the increases in the company’s assets that result from its profit-directed activities. Generally. revenues result in increases in casheir their at the time they are included in the income statement or at an earlier or later date. Expenses. on the other hand. are measures of the cost of producing and providing the  products and services that are sold to customers to produce the company’s revenues.

Expenses represent decreases In the company’s assets that result from its profit-directed activities.

They gene-ally result in decreases in cash at the time they are incurred or at an earlier or later date. As this brief description of revenues and expenses indicates. the income statement provides important information for investors and creditors in their desire to make estimates of future cash flows to them,

Because of the importance of income reporting in making  about the future, events and transactions-that are irregular-in that they do not recur often or zero different from the company’s normal. ongoing operations require careful attention in the preparation of income statement.

Investors. creditors. and other financial statement users have a need, as well as a right. to know those aspects of a company’s income that can reasonably be expected to repeat in the future and those that should not be expected to occur on a regular basis. For information about financial performance to be of maximum usefulness to investors creditors. and other financial statement users, the results of items that are unusual and not likely to recur should be presented separately from the results of the company’s normal, recurring activities.

Income from normal recurring activities should provide more useful information for predicting future earnings than income that mixes the results of normal. recurring activities with the results of unusual and. nonrecurring activities .

The need to separate types of revenue and expense transactions into two major categories-normal. recurring and’ unusual, nonrecurring-has resulted in a multiple-section income .statement that is often encountered in business today and. that we discuss in the following section.

Three categories of unusual, nonrecurring events that require special treatment are (1) the results of discontinued operations, (2) the impact  of extraordinary items, and (3) the effects of changes in accounting principles. One of the challenges that has faced the accounting profession is to define these terms with sufficient clarity so that users of financial  can reliably compare the information .provided by different companies.

Reporting Irregular Items: An Illustration To.illustrate the presentation of irregular items in an income statement. assume that Ross Corporation operates both a small chain of retail stores and two motels. Near the end of the current year, the company sells both motels to a national hotel chain. In addition, Ross Corporation reports two “extraordinary items” and changes the method it uses in
computing depreciation expense.

An income statement illustrating the correct format for reporting these events appears on the  page. Note: This income statement is designed to illustrate the  of{various irregular items. Rarely, if ever. will all these types of events appear in the income statement of one company within a single year.


Continuing Operations The first section of the income statement contains only the results of continuing business activities-that is, the retail stores. Notice that the incene taxes expense shown in this section ($300,000) relates only to continuing operations. The income taxes relating to the irregular items are shown separately in the income statement as adjustments to the amounts of these items. Income from Continuing Operations

The subtotal income from continuing operations measures the profitability of the ongoing operations. This subtotal should be helpful in making predictions of the company’s future earnings. For example, if we predict no significant change in the profitability of its retail stares. we would expect Ross Corporation to earn a net income of approximately $700,000 next year. Discontinued Operations

If management enters into a formal plan to sell or discontinue a segment of the business, the results of that segment’s operations are shown separately in the income statement. This enables users of the financial statements to better evaluate the performance of the company’s ongoing (continuing) operations. Two items are included in the discontinued operations section of the income statement: (1) the income or loss’ from operating the segment prior to its disposal and (2) the

CHAPTER 12 Income and Changes ln Retained Earnings

CHAPTER 12 Income and Changes ln Retained Earnings

gain or loss on disposal of the segment. Notice also that the income taxes relating to the discontinued operations showiness separately from the income taxes expense relating to – continuing business operations. Discontinued Operations Must Be a Segment of the Business To qualify for separate presentation in the income statement, the discontinued operations must represent an tireless
segment of the business.

A segment of a business is a separate line of business activity or an operation that services a distinct category of customers For example, Pizza Hut once was a segment of Pepsi-Co. From time to time, PepsiCo closed individual Pizza Hut stores. Such store closures did not qualify as discontinued operations, because PepsiCo remained in the pizza parlor business.

But when PepsiCo disposed of the entire Pizza Hut chain, these restaurant activities were shown in PepsiCo’s income statement as discontinued operations.

DIscontinued Operations Are Not Really Unusual In recent years, a characteristic of

the American economy has been the restructuring of many large corporations. As part of this restructuring, corporations often sell one or more segments of the-business. Thus the presence of discontinued operations is not uncommon in the income statements of large corporations.

Posted on November 21, 2015 in Income and Changes Retained Earnings

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