INTERMEDIATE ACCOUNTING Chapter 5 The Income Statement and

INTERMEDIATE ACCOUNTING Chapter 5 The Income Statement and the Statement of Cash Flows © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Objectives 1. Explain the purposes of an income statement. 8. Understand basic earnings per share. 2. Understand the capital maintenance concept of income. 9. Report comprehensive income. 3. Define the elements of an income statement. 4. Describe the major components of an income statement. 5. Compute operating income and income from continuing operations. 6. Report results from discontinued operations. 7. Identify and report extraordinary items. 10. Explain the statement of cash flows and classify cash flows as operating, investing, or financing. 11. Apply financial statement analysis techniques to analyze the income statement and cash flow statement information. 12. (Appendix 5. 1) Understand segment reporting and interim reporting. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

The Importance of Earnings • While the balance sheet represents a company’s financial position at a moment in time, the income statement represents its financial performance for a defined period The income statement reports how well the organization performed in generating revenues, incurring expenses, and creating profits for investors, lenders, creditors, and other stakeholders • Stock analysts (reporting to investors) develop forecasts for quarterly and annual earnings numbers • Management faces intense pressure to generate earnings numbers that will please investors and stakeholders and is commonly compensated based on the company meeting or exceeding certain earnings targets established by the board © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. of directors •

What are the Purposes of the Income Statement? (Slide 1 of 2) • • An overall objective of financial reporting is to provide information that is useful to investors, creditors, and other external users for evaluating financial performance and assessing the amounts, timing, and uncertainty of future net cash inflows. Specifically, the objective of the income statement is to provide information about a company’s comprehensive income and its components. • Providing information about the resources generated and consumed by a company’s operations and activities during the period, in order to measure and report the amount of net profit (or loss) generated for the shareholders. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

What are the Purposes of the Income Statement? (Slide 2 of 2) • • Evaluate the profitability and assess the return on investment in the company Assess the company’s operating capability and financial performance for the current period and over time Evaluate management’s performance Predict the company’s future income and cash flows Understand the components of income Assess the company’s risk Compare performance against other companies Assess the impact of economic factors on the company © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

What is Income? • The capital maintenance concept states that a corporation’s net income for a period of time is the amount that it could distribute to shareholders without depleting the capital the shareholders have invested (not a return of capital) • Example: Layla Company had net assets of $45, 000 at the beginning and $80, 000 at the end of the year, shareholders made additional capital investments of $10, 000 during the year, and Layla distributed cash dividends of $2, 500 to shareholders during the year: © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Comprehensive Income and Net Income (Slide 1 of 2) • Both U. S. GAAP and IFRS require companies to measure and report both net income and comprehensive income • Comprehensive income is the change in equity of a company during a period from transactions, other events, and circumstances relating to nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. • Includes changes in the value of shareholders’ equity resulting from transactions, events, and circumstances that are traditionally measured and reported in net income AND changes in the values of certain types of assets and liabilities that are reported in other comprehensive income © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Comprehensive Income and Net Income (Slide 2 of 2) • In accrual accounting, a company records economic events as transactions in the periods they occur • Net income measures accomplishments (resources created) and efforts (resources used up) so that the reported net income reflects the results of the company’s income-generating activities. In the accrual approach, a corporation’s net income for a period is measured as follows: • This approach measures income based on the net assets created during the period © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

What are the Elements of the Income Statement? • The four elements of the income statement are • Revenues • Expenses • Gains • Losses • Each of these is defined in FASB Statement of Financial Accounting Concepts No. 6 © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Revenues • Revenues are increases in assets or settlements of liabilities from delivering or producing goods, rendering services, or other activities that are the company’s ongoing major or central operations • They represent increases in future economic benefits from increases in cash, accounts receivable or other types of assets, or settlements of performance obligations to customers who have paid in advance for goods or services • They measure the accomplishments of the operating activities in producing and delivering goods and services to customers • Transactions that result in revenues are varied depending on © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Revenue Recognition (Slide 1 of 2) • Revenue recognition is the process of formally measuring and reporting revenue in a company’s financial statements • Revenue recognition principles are a matter of timing. In general, revenue cannot be recognized until both: 1. it has been earned • The company has produced and delivered the goods or services to its customers and has earned the rights to the asset being created or has settled the liability to a customer 2. collection has occurred or is reasonably certain to occur • Future economic benefits associated with created assets have been realized (received cash settling accounts receivable) or © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. are reasonably certain to be realized in the future

Revenue Recognition (Slide 2 of 2) • A study by the SEC indicated that overstating revenue and recognizing revenue too soon are involved in over half of the financial reporting frauds in the United States • Therefore, in Staff Accounting Bulletin No. 104 (SAB 104), the SEC provided additional authoritative guidance on revenue recognition issues. It emphasized four criteria for revenue recognition, which are consistent with the US GAAP criteria: • • Persuasive evidence of a sales arrangement must exist Delivery has occurred or services have been rendered The seller’s price to the buyer is fixed or determinable Collectability is reasonably assured © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Real Report: Revenue Recognition (Slide 1 of 2) © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Real Report: Revenue Recognition (Slide 2 of 2) Question: 1. What criteria does Coca-Cola use to determine when revenue can be recognized? • Coca-Cola’s revenue recognition criteria are almost identical to the SEC’s guidelines. Coca-Cola implements those guidelines by recognizing revenue when title (ownership) to products transfers to bottling partners, resellers, or other customers, either upon shipment or receipt, depending on the specific terms of the sales transactions. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Revenue Recognition Relative to Cash Flows © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Real Report: Revenue Recognition (Slide 1 of 2) © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Real Report: Revenue Recognition (Slide 2 of 2) Question: 1. How does Starbucks describe the differences in revenue recognition policies across the retail, specialty, and stored value card revenues? • Starbucks recognizes revenue using very different policies across the retail, specialty, and stored value cards. Starbucks recognizes retail revenues at point of sale when customers tender payment. Specialty revenues consist of product sales to customers (licensees, grocery store chains, foodservice distributors) as well as royalties and fees from licensees. Starbucks recognizes specialty revenues from product sales (coffee, tea, and related products) upon shipment. Starbucks recognizes revenues from stored value cards either when tendered or redeemed for products. Until then, the outstanding balances are included in the deferred revenue liability on the © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Expenses • According to FASB’s Statement of Concepts No. 6, expenses arise from outflows or using up assets or incurring liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities that are the company’s ongoing major or central operations • Within accrual accounting, expenses are measured and recognized in the period in which the resources are used up, the outflows of assets occur, or the liabilities are incurred, even though the cash outflows may occur in a different period (expense recognition) • The FASB has identified the following expense recognition principles: • Association of Cause and Effect • Systematic and Rational Allocation © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Expenditure: Asset or Expense? © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Gains and Losses • Gains and losses are components of net income. They are reported “net” and generally in the period the event occurred. • Gains are increases in the equity (net assets) of a company from peripheral or incidental transactions… not revenue or equity investments • Losses are decreases in the equity (net assets) of a company from peripheral or incidental transactions… not expenses or dividends • Revenues and expenses relate to a company’s major operating activities while gains and losses relate to peripheral activities (selling fixed assets for more or less than book value) or to the effects of other events and circumstances, some of which may be beyond its control © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

What Are the Major Components of the Income Statement? • Although the form of the income statement may differ from company to company, its content is relatively standard. The major components and items are: • Revenues • Cost of goods sold, Operating expenses, Other operating income items (gains and losses) • Operating income • Interest expense, Interest and dividend income, Unusual and nonrecurring gains and losses, Income taxes associated with continuing operations • Income from continuing operations • Results from discontinued operations, Income (loss) from operations of discontinued components (net of income taxes), Gain (loss) from disposals of discontinued components (net of income taxes) • Extraordinary items (net of income taxes) • Net income © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Single-Step and Multiple-Step Formats • Under the single-step income statement format, a company classifies items into two groups, revenues and expenses • Although the single-step format is simple and flexible, the number of companies using it is only about 15% of surveyed companies [Accounting Trends and Techniques (New York: AICPA, 2010), p. 317. ] • The multiple-step income statement presents income from continuing operations using various categories and subtotals such as gross profit, operating income, and income from continuing operations © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Example: Single-Step Income Statement © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Example: Multiple-Step Income Statement © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

How Do Income Statements Report Operating Income and Income from Continuing Operations? • Operating income (loss) includes sales revenue, the various expenses related to these sales and business activities, and other income items related to operating activities. • Income from continuing operations reports the company’s income from ongoing, recurring business activities • It includes operating income plus (or minus) income items associated with financing and investing activities (such as interest expense and interest income); gains and losses that are not part of normal, ongoing operating activities; and income taxes • It excludes the income effects of items that are not continuing, either because they are components of the business that are © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Sales Revenue • Gross sales revenues (or gross revenues) are total increases in assets or settlements of liabilities from delivering or producing goods, rendering services, or other activities that are the company’s ongoing major or central operations • Net sales revenues (or net revenues) are the gross sales revenues minus any sales returns or allowances and any sales discount given to customers (or reasonably estimated) • Net sales amounts typically exclude any sales taxes or value added taxes the company may have collected from customers because the company will have to remit them to the taxing authority. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Cost of Goods Sold • Cost of goods sold is the cost of the inventory items sold to customers during the period. • In a perpetual inventory system, the cost of goods sold is recorded at the time of each sale and reports the total for the period on its income statement • In a periodic inventory system, the cost of goods sold is based on a physical inventory taken at the end of each period (cost of goods available – ending inventory) • Example: © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Operating Expenses • Operating expenses are those primary recurring costs incurred to generate sales revenues and conduct business operations • Typically classified according to functional categories… for example selling expenses separated from general and administrative expenses • Because of their significance, depreciation, amortization, research and development expenses may also be shown as a separate categories © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Example: Operating Expenses © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Other Operating Income And Expense Items • Gains and losses from asset sales, inventory write-downs, impairment charges, restructuring charges, or other types of gains and losses that are a consequence of normal operating activities are included in operating income • Significant recurring items of income and expense, as well as gains and losses, which are not directly related to the primary operations but result from the financing and investing activities • Financing expenses commonly include interest expense on the company’s short-term and long-term debt. Investing income includes dividend income, interest income, and realized gains or losses from sales of investment securities • Gains and losses that are unusual and nonrecurring “nonextraordinary” and not a consequence of normal operating activities • Examples include, for example, the loss from a flood or a fire, or the gain © 2013 Cengage Learning. All Rights Reserved. not be scanned, copied or or loss from the. May extinguishment ofduplicated, debt or posted to a publicly accessible website, in whole or in part.

Income Taxes • Pretax income from continuing operations is reported before income tax expense • Operating income plus or minus interest expense, interest and dividend income, other gains and losses, and any unusual or nonrecurring gains and losses • Income tax expense related to continuing operations represents an accrued expense for the total amount of income tax (federal, state, and foreign) that a corporation will ultimately have to pay on the income generated during the period • Interperiod tax allocation involves assigning a corporation’s tax obligation as an expense across various accounting periods because of temporary (timing) differences between its taxable income and pretax financial income • Intraperiod tax allocation involves apportioning a corporation’s total income tax expense for a period to the various components © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. of its net income and other comprehensive income items (if any)

Example: Intraperiod Allocation of Income Tax Expense © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Net Income Attributable to Noncontrolling Interests • Noncontrolling interests only arises when a parent company owns a majority of the common shares of a subsidiary company but does not own 100% of the shares. In a situation like this, the parent company will consolidate 100% of the subsidiary company’s income statement with its own income statement, including all of the revenues, expenses, and net income of the subsidiary. However, the noncontrolling shareholders are entitled to a minority portion of the subsidiary’s earnings. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

How Do Income Statements Report Results from Discontinued Operations? • To enhance the usefulness of a company’s income statement, it is important for the company to report separately the results of its continuing and discontinuing operations and also to highlight the material aspects involving the sale of a discontinued component. A company reports results from discontinued operations when: • operations and cash flows of the component have been eliminated • company will have no significant continuing involvement in the operations of the component after the disposal © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Real Report: Discontinued Operations (Slide 1 of 4) © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Real Report: Discontinued Operations (Slide 2 of 4) © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Real Report: Discontinued Operations (Slide 3 of 4) Questions: 1. What components of its operations did Talbots dispose of in fiscal year 2008 (which ended January 31, 2009) and fiscal year 2009 (which ended January 30, 2010)? • In fiscal 2008, Talbots discontinued the Talbots Kids, Mens, and U. K. businesses. In fiscal 2009, Talbots sold the J. Jill business. 2. What was the income or loss from operations of the discontinued businesses in fiscal 2008 and fiscal 2009? Why does it appear that Talbots sold these businesses? • The loss from operations in fiscal 2008 from discontinued operations was $(416, 138). In fiscal 2009, the loss from operations was $(3, 818). A company may dispose of components of its business for several reasons. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Real Report: Discontinued Operations (Slide 4 of 4) 3. What amount of the loss from operations in fiscal 2008 involved impairment charges? • Of the $416. 1 million loss from discontinued operations in fiscal 2008, $318. 4 million (over 76%) is attributable to an impairment charge to the assets of the J. Jill business. 4. Which income amounts are financial statement users more likely to use in projecting Talbots’s future profitability and cash flows for fiscal 2011? • External users are concerned with predicting the amounts, timing, and uncertainty of a company’s future earnings and cash flows. Because discontinued operations will not be present in the © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Determining a Component of a Company • A component of a company involves operations and cash flows that can be distinguished, operationally and for financial reporting purposes, from the rest of the company. • A company must distinguish (based on management’s judgment) the sale of a component from the sale of other assets, as well as from other activities related to restructuring or changing the company’s business, such as phasing out a product line, shifting service activities, or changing the manufacturing process. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Example: Determining a Component of a Company • Diviney Company manufactures and sells consumer products and has several product groups, each with different product lines. For Diviney, a product group is the lowest level at which the operations and cash flows can be clearly distinguished from the rest of the company. Therefore, each product group is a component of the company. Diviney has had operating losses for certain brands in its beauty care group. • A. Sale of a component. Diviney decides to exit the beauty care business and sells the product group. • B. Not a sale of a component. Diviney decides to stay in the beauty care business but to sell the brands that are generating operating losses. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Operating Income (or Loss) of a Discontinued Operation • When a component of a company operates during part of a year and then is sold before the end of the year, it has operating income or an operating loss for part of the year • This must be distinguished separately from the income from continuing operations of the rest of the company © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Gain or Loss on Sale of a Discontinued Operation (Slide 1 of 2) • When the sale occurs in the same accounting period that management decided to sell the component, the calculation of the pretax gain (loss) is determined by subtracting the book value of the net assets (assets minus liabilities) of the component from the net proceeds received (selling price minus any selling costs). • A company classifies a component as held for sale at the end of the current accounting period when all of the following criteria are met: • Management has committed to a plan to sell the component, the component is available for immediate sale in its present condition, management has begun an active program to locate a buyer, the sale is probable within one year, the component is being offered for sale at a price that is reasonable in relation to the component’s current fair value and it is unlikely that © 2013 Cengage Learning. All Rights Reserved. will May notmake be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. management significant changes to the plan

Gain or Loss on Sale of a Discontinued Operation (Slide 2 of 2) • A component classified as held for sale is reported on its balance sheet at the lower of (1) its book value (book value of assets minus book value of liabilities) or (2) its fair value minus any costs to sell. If the fair value (minus any costs to sell) is less than the book value, the company records a loss and adjusts the book values of the assets of the component. • The loss (after taxes) is reported in the results from discontinued operations section of its income statement. It reports the assets and the liabilities in the respective sections of its ending balance sheet. • When the company actually completes the sale of a held-forsale component, it computes any additional gain (loss) on the sale by subtracting the adjusted net book value of the component from the net proceeds received. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Disclosures • A company is also required to disclose certain information about the sale (or classification as held for sale) of a discontinued component in the notes to its financial statements. This information includes: • a description of the facts and circumstances leading up to the sale and, if held for sale, the expected manner and timing of the sale • the revenues and pretax income (loss) of the component included in its operating income (loss) reported in the results from discontinued operations section of the company’s income statement • if not separately reported on its income statement, the gain (loss) on the sale and the caption on the income statement that includes the gain (loss) if not separately reported on orits balance the book © 2013 Cengage • Learning. All Rights Reserved. May not be scanned, copied duplicated, or postedsheet, to a publicly accessible website, values in whole or inof part.

How Do We Report Extraordinary Items on the Income Statement? (Slide 1 of 2) • U. S. GAAP establishes very narrow criteria that must be met for an event to be classified as extraordinary. IFRS do not permit gains or losses to be labeled extraordinary. An extraordinary item is an event or a transaction that is unusual in nature and infrequent in occurrence. • Both of the following criteria must be met • Unusual in nature—the underlying event or transaction is highly abnormal and is clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the company, taking into account the environment in which the company operates. • Infrequent in occurrence—the underlying event or transaction is not reasonably expected to recur in the foreseeable future, taking into account the environment in which the company © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

How Do We Report Extraordinary Items on the Income Statement? (Slide 2 and 2) • U. S. GAAP establishes very narrow criteria that must be met for an event to be classified as extraordinary. IFRS do not permit gains or losses to be labeled extraordinary. An extraordinary item is an event or a transaction that is unusual in nature and infrequent in occurrence. • Both of the following criteria must be met • Unusual in nature—the underlying event or transaction is highly abnormal and is clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the company, taking into account the environment in which the company operates. • Infrequent in occurrence—the underlying event or transaction is not reasonably expected to recur in the foreseeable future, taking into account the environment in which the company © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Reporting Gains or Losses in Income © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Real Report: Extraordinary Items (Slide 1 of 5) © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Real Report: Extraordinary Items (Slide 2 of 5) © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Real Report: Extraordinary Items (Slide 3 of 5) 1. Huntsman’s extraordinary gain arose from a business acquisition it completed in 2006. How did the fair value of the net assets Huntsman acquired in the transaction compare to the purchase price Huntsman paid? (This is what gave rise to the original extraordinary gain from the acquisition. ) • Huntsman discloses that the fair value of net assets acquired exceeded the purchase price paid. Even after assigning no basis to property, plant, and equipment acquired or any other noncurrent nonfinancial assets, Huntsman still had excess fair value over purchase price. The remaining excess was recorded as an extraordinary gain. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Real Report: Extraordinary Items (Slide 4 of 5) 2. Why did Huntsman recognize additional extraordinary items in 2010, 2009, and 2008 pertaining to the acquisition that occurred 2006? • Huntsman recognized additional extraordinary items in 2010, 2009, and 2008 relating to various settlements of contingent amounts from this acquisition, specifically, the extraordinary items related to settlement of contingent purchase price consideration, the reversal of accruals for certain restructuring and employee termination costs recorded in connection with the acquisition, and a reimbursement of certain costs pursuant to the acquisition agreements. 3. What were the results of discontinued operations in 2010, 2009, and 2008? • In 2010, 2009, and 2008, Huntsman recognized income (loss) from discontinued operations amounting to $42 million, $(19) million, and $84 million, respectively. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Real Report: Extraordinary Items (Slide 5 of 5) 4. What amounts of net income (loss) were attributable to noncontrolling interests in 2010, 2009, and 2008? • In 2010, 2009, and 2008, Huntsman recognized net income (loss) attributable to noncontrolling interests in the amounts of $(5) million, $2 million, and $(1) million, respectively. 5. What was comprehensive income (loss) attributable to Huntsman Corporation in 2010, 2009, and 2008. • In 2010, 2009, and 2008, comprehensive income (loss) attributable to Huntsman Corporation amounted to $17 million, $316 million, and $(137) million, respectively. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

How Does Net Income Affect Retained Earnings? • Retained earnings is the link between a corporation’s income statement and its balance sheet • Although not a required financial statement, an organization may include a schedule in its financial statements that reconciles the beginning retained earnings balance with the ending retained earnings balance • Example: © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

How Do We Compute and Report Earnings Per Share? • Earnings per share (EPS) is an important ratio in financial statement analysis because investors and analysts often analyze it relative to the current market price per share of a company’s stock to determine the relative market price of the company’s earnings • Basic earnings per share is computed as follows: • Companies with dilutive securities (convertible preferred stock and bonds, options) are required to disclose diluted earnings per share information © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Real Report: Earnings Per Share (Slide 1 of 2) © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Real Report: Earnings Per Share (Slide 2 of 2) 1. By how much did basic and diluted earnings per share differ for the year ended October 3, 2010? What is the primary cause of this difference? • Starbucks’s basic and diluted earnings per share amounts for the year ended October 3, 2010, were $1. 27 and $1. 24, respectively. The difference is $0. 03, which is primarily attributable to the difference in the number of shares used to compute basic (744. 4 million shares) versus diluted (764. 2 million shares) earnings per share. 2. What caused the difference in the weighted average number of shares in the calculation of basic versus diluted earnings per share? • The difference in Starbucks’s weighted average number of shares in the calculation of basis versus diluted earnings per share is attributable to the dilutive effect of common stock equivalents consisting of certain shares subject to stock options and RSUs (restricted stock units). © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

How Do Companies Report Comprehensive Income? (Slide 1 of 2) • A company’s comprehensive income consists of two parts: net income and other comprehensive income. • Under U. S. GAAP, there are four items of other comprehensive income: • unrealized increases (gains) or decreases (losses) in the fair value of available-for-sale investment securities • certain types of gains, losses, and prior service cost adjustments to net pension plan assets and liabilities • gains and losses on derivative financial instruments that hedge future cash flows • translation adjustments from converting the financial statements of foreign subsidiaries into U. S. dollars © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

How Do Companies Report Comprehensive Income? (Slide 1 of 2) • Under U. S. GAAP and IFRS, a company can report its comprehensive income (or loss) under two alternatives: • present net income and comprehensive income in a single continuous performance statement OR • present net income on the income statement and present comprehensive income on a separate, but consecutive, statement of comprehensive income © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

The Relationships between Shareholders’ Equity, Net Income and Comprehensive Income © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

How Do Companies Report the Statement Of Cash Flows? • External users are very interested in how a company generates and uses cash… How much cash flow is the company generating from its operations? From what sources? How much cash did the company invest to grow? How was the growth financed? • Both U. S. GAAP and IFRS require a statement of cash flows for the accounting period along with its income statement © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Overview and Uses of the Statement of Cash Flows (Slide 1 of 2) • One of the specific objectives of financial reporting is to provide information to help financial statement users predict the amounts, timing, and uncertainty of a company’s future cash flows. Together with the balance sheet and income statement, the statement of cash flows is useful in meeting this objective. • When used with a company’s other financial statements, the statement of cash flows helps external users assess the company’s: • ability to generate positive future cash flows from operations • ability to meet its obligations • use of cash for capital expenditures and investments © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Overview and Uses of the Statement of Cash Flows (Slide 2 of 2) • When used with a company’s other financial statements, the statement of cash flows helps external users assess the company’s: • capital raised from external financing sources and repayments of external financing • differences between the company’s net income and associated cash receipts and payments • sources of cash from issuing shares and uses of cash to pay dividends and repurchase © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Reporting the Statement of Cash Flows • Both U. S. GAAP and IFRS require that a company provide a statement of cash flows to report on a company’s cash inflows, cash outflows, and net change in cash from its operating, investing, and financing activities during the accounting period, in a manner that reconciles the beginning and ending cash balances (from the balance sheet). • Three major sections: • Operating activities include all the transactions and other events related to its primary business activities, such as those involved in purchasing, producing, selling, and delivering goods for sale, as well as providing services. • Investing activities include transactions involving buying and selling property, plant, and equipment and intangible assets; buying and selling long-term investments; and lending money and collecting on the loans. • Financing activities include transactions involved in obtaining resources from owners and paying dividends and repurchasing shares, as well as © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. obtaining resources from lenders and repaying the amounts borrowed.

Operating, Investing and Financing Activity Cash Flows © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Operating Activities: Indirect Method • The Operating Activities section reports the cash receipts and payments from the operating activities of the company. • The most common way to prepare this section is called the indirect method. • Net income is listed first and then adjustments (additions or subtractions) are made: • Reverse out the effect of certain non-cash transaction, such as depreciation expense and amortization expense, that were included in net income • Include the cash flow effects triggered by changes in the period in current assets (other than cash) and current liabilities © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Investing Activities and Financing Activities • The Investing Activities section includes all the cash inflows and outflows involved in the investing activities of the company • Receipts from selling and payments for purchasing property, plant, and equipment • Receipts from selling and payments for purchasing investments in stocks and debt securities • The Financing Activities section includes all the cash inflows and cash outflows involved in the financing activities of the company • Receipts from the issuance of debt securities (e. g. , bonds, mortgages, notes) and cash disbursement to repay debt obligations Receipts from. Maythe shares payments toin whole or in part. © 2013 Cengage • Learning. All Rights Reserved. not beissuance scanned, copied orof duplicated, or postedand to a publicly accessible website,

Example: Statement of Cash Flows © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Operating Activities: Direct Method • While the FASB encourages use of the direct method, relatively few companies use this method. • This method separates operating cash inflows from operating cash outflows, which may be useful in estimating future cash flows. • The most common cash inflows and outflows for operating activities are: • operating cash inflows • collections from customers • interest and dividends collected • operating cash outflows • payments to suppliers and employees • payments of interest and income taxes © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

How Do We Analyze the Information in Income Statements and Cash Flow Statements? • Intracompany comparisons (evaluating a company over time) • Intercompany comparisons (comparing two or more companies, either at a point in time or over time) • Common-size analysis of an income statement expresses all of the amounts in terms of percentages of Net revenues • Gross profit margin (gross profit divided by total revenues) indicates a company’s ability to generate revenues and control the costs of producing and delivering its products and services. • Operating margin (operating income divided by total revenues) indicates a company’s ability to generate a profit © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible in whole or in part. from its operating activities after covering all of its website, operating

Common Size and Profit Margin Analysis of Starbucks Corporation’s Income Statement © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Rate of Change Analysis and Ratio Analysis • Rate of change analysis is frequently used to compute growth rates by comparing subsequent periods to a base period. • Ratios capture relationships between and among items on financial statements. • Coverage ratios provide insights about a company’s risk and financial flexibility because they measure the ability to cover the interest charges associated with debt. It is computed as: • Return on common equity, which measures the profitability of the company relative to the amount of equity capital invested by the common shareholders. It is computed as: © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Rate of Change Analysis of Starbucks Corporation’s Income Statements © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Earnings Quality and Earnings Management • Earnings quality (undefined by IFRS and FASB) refers to the extent to which a company’s reported earnings are relevant and faithful representations of financial performance for the current period and enable financial statement users to develop reasonable expectations of future earnings • Earnings management has been defined in many ways. One definition is: “When managers use judgment in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of the company or influence contractual outcomes that depend on reported accounting numbers” Paul Healy and James © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Wahlen (1999)

Segment And Interim Reporting (Slide 1 and 2) • A company that has subsidiaries prepares its financial statements on a “consolidated” (aggregated) basis. • Disaggregation of total financial data also can be important in financial analysis because the level of risk, return on investment, and expected future earnings and cash flows may differ significantly across a company’s different operating segments. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Segment And Interim Reporting (Slide 2 and 2) • The FASB, therefore, requires that a company’s financial statements include certain disaggregated information about its operating segments. • A component of a company is an operating segment if it: • engages in business activities to earn revenues and incur expenses • generates operating results regularly reviewed by the company’s chief operating decision maker to make decisions about allocating resources to the segment and assessing its performance • has discrete financial information available © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Reportable Segments (Slide 1 of 2) • An operating segment is significant and is a reportable segment if it passes any of the three following tests: 1. Revenue Test. Its reported revenues (including sales to external customers and intersegment sales) are 10% or more of the combined revenues of all the company’s operating segments. 2. Profit Test. The absolute amount of its profit (loss) is 10% or more of the combined reported profits of all operating segments that did not report a loss. 3. Asset Test. Its segment assets are 10% or more of the combined assets of all operating segments. Generally, a company's profit (or loss) is pretax. Also, if the combined losses of all operating segments that reported a loss exceed the combined profits as calculated earlier, the combined loss amount is used for this 10% test. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Reportable Segments (Slide 2 of 2) • There is also an overall materiality test, which requires that the reportable segments must be disclosed if their combined revenues are at least 75% of the entire company revenues. The remaining, less significant operating segments are combined and disclosed in an “all other” segment category. • If a company has only one operating segment, it does not have disaggregated information to report. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Information Reported (Slide 1 of 2) • General. A company must (a) identify how it is organized (e. g. , by product lines or geographic areas) and what factors were used to identify its operating segments and (b) describe the types of products and services from which each reportable segment earns its revenues. • Profit or Loss. A company must report its profit or loss for each reportable segment. • Information about Assets. A company must report the total assets of each reportable segment. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Information Reported (Slide 2 of 2) • Reconciliations. A company must reconcile the reportable segments’ total revenues, total profit or loss, and total assets to the corresponding company totals. • Company-Wide Disclosures. A company must disclose (a) its revenue from external customers and (b) information about geographic areas including (1) revenues from external customers and long-lived assets in and out the United States and in individual foreign countries and If a company’s revenues from a single external customer are 10% or more of the company’s total revenues © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Components of Comprehensive Income and Cash Flow (Slide 1 of 2) © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Components of Comprehensive Income and Cash Flow (Slide 2 of 2) © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Interim Financial Reports • Interim financial statements are reports for periods of less than a year. The SEC requires registrants to file interim reports on a quarterly basis (using Form 10 -Q). • The current GAAP focuses primarily on the following income statement items: • • • Revenues Operating expenses Income taxes Extraordinary items and discontinued operations Earnings per share © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.