Advanced income statement issues



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MODULE 9
ADVANCED INCOME STATEMENT ISSUES
ADVANCED INCOME STATEMENT ISSUES


  • Irregular Items

    • Discontinued Items

    • Extraordinary Items

    • Unusual Items (Restructuring)




  • Earnings per Share

INCOME STATEMENT FORMATS

A Review
A multi-step income statement:

  • Separates operating and non-operating activities

  • Classifies expenses by function



X CORPORATION

INCOME STATEMENT
For the period ending December 31, 20XX

Sales


Operating revenues and expenses
$150,000

Cost of Goods Sold



-70,000

Gross Profit

80,000

Selling, General, and Administrative Expenses



-10,000

Income from Operations

70,000

Rent Income




Non-Operating revenues and expenses
10,000

Investment Gains

5,000

Interest Expense



-5,000

Income before Tax

80,000

Tax Expense



-25,000

Net Income

$55,000

Earnings per Share (44,000 shares outstanding)



$1.25

Operating – within corporate mission

Non-Operating – rent, interest, equipment sales
Note: Multistep income statements usually include Gross Profit (Sales – Cost of Goods Sold).

     

CONSOLIDATED STATEMENT OF EARNINGS

The Home Depot, Inc. and Subsidiaries



AMOUNTS IN MILLIONS, EXCEPT SHARE DATA





January 29,



January 28,



Amounts in millions

2012



2007


















 













NET SALES

$70,395

100.0%

$90,837

100.0%

Cost of Sales

46,133

65.5%

61,054

67.2%

GROSS PROFIT

24,262

34.5%

29,783

32.8%

Operating Expenses:













Selling, General and Administrative  

16,028

22.8%

18,348

20.2%

Depreciation and Amortization

1,573

2.2%

1,762

1.9%

Total Operating Expenses

17,601

25.0%

20,110

22.1%




 




 




OPERATING INCOME

6,661

9.5%

9,673

10.6%

Interest and Other (Income) Expense:

 

 

 




Interest and Investment Income

13

 

27



Interest Expense

-606

-0.9%

-392

-0.4%

Other

0

 

0




Interest and Other, net

-593

 

-365



















EARNINGS BEFORE TAXES

6,068

8.6%

9,308

10.2%















Provision for Income Taxes

2,185

3.1%

3,547

3.9%




 



 




EARNINGS FROM CONTINUING OPERATIONS

3,883

5.5%

5,761

6.3%



IRREGULAR ITEMS

DE” Items


In the US, two items:


  • Discontinued Operations

  • Extraordinary Items

receive special treatment.



Treatment: Show


  • near the bottom of the income statement (prior to net income)

  • net of taxes


Note:


  • DE items receive this treatment whether single or multi-step.

  • Income before DE items is referred to as “Income from Continuing Operations”

 IFRS standards do not recognize extraordinary items. INCOME STATEMENT WITH “DE” ITEMS



X CORPORATION

INCOME STATEMENT
For the period ending December 31, 20XX

Sales

$100,000


Cost of Goods Sold

-25,000

Gross Profit

75,000

Selling, General, and Administrative Expenses



-10,000

Income Before Unusual and Infrequent Items




These taxes apply to items above and not “DE” items
65,000

Unusual Item

-5,000

Infrequent Item



-5,000

Income from Cont Operations Before Tax

55,000

Tax Expense



-30,000

Income from Continuing Operations




DE items are net of tax
25,000

Discontinued Operations ($2,700 before tax effect of $700)

-2,000


Extraordinary Items (5,400 before tax effect of $1400)

-4,000

Net Income

$19,000

Earnings per Share from (10,000 shares):


Continuing Operations

$2.50


Discontinued Operations


Show separate EPS for DE items
.20

Extraordinary Items



.40

Net Income

$1.90
IRREGULAR ITEMS

Discontinued Operations
Discontinued Operations – component that (1) will be eliminated from ongoing operations, and (2) has no management involvement after disposal.
Rules: hh00207_[1]


  • a component must be a product group or division, but not a brand

  • Discontinued operations are always reported net of taxes


Reported in two parts:

  • Part 1 - Gain or loss from operations of discontinued operations

  • Part 2 - Gain or loss from the disposal (FMV – BV)


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IRREGULAR ITEMSc:\documents and settings\wipasewa\local settings\temporary internet files\content.ie5\0xpv0386\mc900038651[1].wmf

Discontinued Operations
Al Carbon’s Tacos operates Fire in the Hole Donuts (FITH), a subsidiary that management believes does not fit well in the company.
During 20X1, Al Carbon, announced a plan to sell FITH. Fire in the Hole lost $300 and $250 thousand during 20X1 and 20X2 respectively, and no buyer seemed interested in purchasing FITH. (See A)
However, in 20X3, FITH earned $100 thousand (see B) and Taco Joe agreed to purchase FITH for $500 thousand, $50 thousand more than the current net worth (see C).
The income statement disclosure related to the discontinued operation would be:
(in thousands of US$) 20X3 20X2 20X1
Income from continuing operations 3,000 2,500 2,000


B

A

Discontinued operations

Gain(Loss) from discontinued operations 100 (250) (300)

Gain on sale of discontinued operations 50 -- –




C

Net income $3,150 $2,250 $1,700



DISCONTINUED OPERATIONS EXAMPLE

On December 22, 2003 GM completed a series of transactions that resulted in the split-off of Hughes from GM and the simultaneous sale of GM’s approximately 19.8% economic interest in Hughes to the News Corporation.



gm cars corporate website

GENERAL MOTORS CORP. & SUBSIDIARIES

Consolidated Statements of Income

Years ended December 31

(Dollars in millions) 2004 2003 2002
Net sales $193,517 $185,837 $177,867
Cost of sales and other expenses 159,951 152,435 147,192

Selling, general, and administrative expenses 20,394 20,957 20,834

Interest expense 11,980 9,464 7,503

Total costs and expenses 192,325 182,856 175,529


Income before income taxes 1,192 2,981 2,338
Income tax (benefit) expense (911) 731 644

Equity income and minority interests 702 612 281

Income from continuing operations 2,805 2,862 1,975
Discontinued operations

(Loss) from discontinued operations (219) (239)

Gain on sale of discontinued operations 1,179 –
Net income $2,805 $3,822 $1,736

Part 2 – GM sold Hughes in 2003 at a gain of $1.179 billion.

Part 1 – Hughes lost $458 million over 2002-2003.
IRREGULAR ITEMS

Extraordinary Items
Extraordinary Item – non recurring material items that differ from the entity’s business activities.
They are both:


  • Unusual in Nature – possess a high degree of abnormality




  • Infrequent in Occurrence – not reasonably expected to recur in the foreseeable future

The following are not extraordinary:




It’s unusual.

It’s infrequent.

It’s highly extraordinary my dear Watson.
Corporate restructuring


  • Effects of a strike

  • Early extinguishment of debt

  • Immaterial items

 IFRS standards do not recognize extraordinary items.



IRREGULAR ITEMS

Restructuring Charges
Attention should be paid to items that may be unusual or infrequent, but not both. Restructuring charges are a common example. coљ絤ą
Restructuring charges – usually relate to activities such as layoffs, closings, asset impairments.
Some companies report restructuring charges as unusual items (“other losses” or “other expenses”).
Restructuring charges are NOT “DE” items and should NOT be shown net of taxes.

RESTRUCTURING EXAMPLE

ronald mcdonald


McDonald’s Corporation

Consolidated Statement of Income

(In millions, except per share data)


Years ended December 31, 1999 1998 1997

Revenues from Company-operated restaurants $ 9,512.5 $ 8,894.9 $ 8,136.5

Revenues from franchised restaurants 3,746.8 3,526.5 3,272.3

Total revenues 13,259.3 12,421.4 11,408.8

Operating costs and expenses

Food and packaging 3,204.6 2,997.4 2,772.6

Payroll and employee benefits 2,418.3 2,220.3 2,025.1

Occupancy and other operating expenses 2,206.7 2,043.9 1,851.9

Total Company-operated restaurant expenses 7,829.6 7,261.6 6,649.6

Franchised restaurants--occupancy expenses 737.7 678.0 613.9

Selling, general and administrative expenses 1,477.6 1,458.5 1,450.5

Other operating (income) expense (124.1) (60.2) (113.5)

Made for You costs 18.9 161.6 0

Special charge 0 160.0 0

Total operating costs and expenses 9,939.7 9,659.5 8,600.5



Operating income 3,319.6 2,761.9 2,808.3

Interest expense 396.3 413.8 364.4

Nonoperating (income) expense 39.2 40.7 36.6

Income before provision for income taxes 2,884.1 2,307.4 2,407.3

Provision for income taxes 936.2 757.3 764.8



Net income $ 1,947.9 $ 1,550.1 $ 1,642.5



Why did income go down in 1998?
Made for You – a new food preparation system that allows us to serve fresher, better-tasting food at high speed. The system supports future growth because it can more easily accommodate an expanded menu.
Special Charge – comprised of employee severance, lease cancellation and write-off of capitalized technology made obsolete.
 How do we distinguish between restructuring and items that should have been normal expenditures in past years?

DICK’S SPORTING GOODS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

     

   February 2, February 3, January 28,



 Fiscal Year Ended 2008  2007 2006

(Amounts in thousands, except per share data)

Net sales $3,888,422 $3,114,162 $2,624,987

Cost of goods sold, 2,730,359 2,217,463 1,887,347

GROSS PROFIT 1,158,063  896,699 737,640  

Selling, general and administrative expenses 870,415  682,625 556,320

Merger integration and store closing costs —  — 37,790

Pre-opening expenses 18,831  16,364 10,781

INCOME FROM OPERATIONS 268,817 197,710 132,749
Gain on sale of investment —  — (1,844)

Interest expense, net 11,290 10,025 12,959

INCOME BEFORE INCOME TAXES 257,527 187,685 121,634
Provision for income taxes 102,491 75,074 48,654

NET INCOME $155,036 $112,611 $72,980


EARNINGS PER COMMON SHARE:

Basic $1.42 $1.10  $0.73

Diluted $1.33 $1.02  $0.68

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:

Basic 109,383 102,512 99,584

Diluted 116,504 110,790 107,958  dicks

In Notes:  Merger integration and store closing costs associated with the purchase of Galyan’s of $37.8 million were recognized in 2005. The cost relates primarily to closing Dick’s stores in overlapping markets and advertising the re-branding and re-grand opening of the former Galyan’s stores.


Would have been 4.22% without merger costs
Net income as a percent of sales for each of the years was:
2008  2007 2006

3.99% 3.62% 2.78%


What is the reason for a significantly lower percentage during 2006?
Are you willing to “excuse” Dick’s Sporting Goods for this reason?

EARNINGS PER SHARE
Earnings per share are required at the bottom of the income statement.
The Basic EPS Calculation:


EPS

=

Earnings (or loss) for period  earnings applicable to senior securities*

Weighted average number of shares of CS



* for example, preferred stock dividends
The denominator is weighed to prevent end of year manipulation.

Diluted EPS must also be shown if the company has

  • stock options,

  • convertible bonds and preferred stock, or

  • other agreements that potentially reduce common stockholders earnings



NI – PS Div

# shares
Did you know: EPS is the only ratio GAAP tells us how to calculate?
 IFRS and US GAAP calculate basic and diluted EPS similarly.

Earnings per Share Example

Walmart


(in millions except per share data)

2003

2002

2001

Sales

$ 244,524

$ 217,799

$ 191,329

Other income-net

2,001

1,873

1,787

Cost of sales

191,838

171,562

150,255

Selling and administrative expenses

41,043

36,173

31,550

Interest costs:

 

 

 

  Debt

803

1,083

1,104

  Capital leases

260

274

279

  Interest income

(138)

(171)

(188)

Provision for income taxes

4,487

3,897

3,692

Minority interest

(193)

(183)

(129)

Net income

8,039

6,671

6,295

 

 

 

 

Per share of common stock:

 

 

 

  Basic net income

1.81

1.49

1.41

  Diluted net income

1.81

1.49

1.40

  Dividends

0.30

0.28

0.24

wal-mart®



Earnings per share are required on the face of the income statement for all publicly-traded companies.



Discussion Question: Does Walmart use a single step or multistep income statement?
Thought question: If Company A has an EPS of $5, and Company B has an EPS of $4, which has higher profitability?
ANALYSIS OF AN INCOME STATEMENT
McCormick & Co.

Consolidated Statement of Income mccormick

(millions except per share data)



 

for the year ended November 30 

2007

2006

 

 

 

Net sales

$2,916.2

$2,716.4

Cost of goods sold

1,724.4

1,601.8




1,191.8

X










Selling, general and administrative expense

806.9

772.6

Restructuring charges

30.7

72.4

Operating income

354.2

269.6










Interest expense

60.6

53.7

Other income, net

8.8

7.1

Income from consolidated operations before income taxes

302.4

223.0










Income taxes

92.2

64.7

Net income from consolidated operations

210.2

158.3










(Loss) gain on sale of unconsolidated operations

(.8)

26.8

Income from unconsolidated operations

21.4

19.9

Minority interest

.7

2.8

Net income

$X

$202.2

 

 

 

Earnings per share – basic

$1.78

$1.53

Earnings per share – diluted

$1.73

$1.50

Does McCormick use a single step or multi-step income statement?


Multi-step – Non operating is shown separately.
What is the gross profit of McCormick for 2006?
$2,716.4 – 1,601.8 = $1,114.6
What is net income for McCormick in 2007?
$210.2 – 0.8 + 21.4 + 0.7 = 230.1
What is the number of shares outstanding for McCormick in 2007?
Basis EPS = $230.1 million / Shares = $1.78 ; Shares = 129.3 million

PROFITABILITY RATIOS

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1. Profit Margin on Sales


Indicates: The relation of profits to sales.


Profit

Margin


=

Net Income

Sales



Interpretation:
Higher - less sales are needed to generate a desired level of profit.

How is the ratio improved? Hint: The denominator is the top of the IS and the numerator is the bottom of the IS. What is in between?

2. Return on Assets
Indicates: How assets are utilized to achieve a profit.


Return

on Assets



=

Current Year Net Income

Average Total Assets




Options: Some add interest expense to the numerator to put leveraged and unleveraged entities on equal basis.
Interpretation:

Higher - greater ability to produce profits.

3. Return on Stockholders' Equity


Indicates: The degree of profitability attributable to stockholders. Differs from ROA to extent that the entity is leveraged (has debt).


Return

on Equity



=

Current Year Net Income

Average Stockholders’ Equity




Options: Some subtract PS dividends from numerator to evaluate only amounts available to CS.
Interpretation:
Higher - a greater degree of profits available to stockholders.


Advanced Income Statement


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