Book cover for Intermediate Accounting

Intermediate Accounting

Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield

ISBN #9780470374948

13th Edition

695 Questions

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7,109 Students Helped

Homework Questions

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Summary
Learning Objectives
Key Concepts
Example Problems
Explanations
Common Mistakes

Summary

Chapter 4 delves into the construction and interpretation of the income statement, emphasizing the differences between single?step and multiple?step formats, and addressing the handling of irregular items, intraperiod tax allocation, and EPS reporting. It also covers the preparation of the retained earnings statement, reporting of other comprehensive income, and the use of pro forma reporting practices. The chapter underscores the importance of these reporting adjustments in providing stakeholders with a clear and comprehensive understanding of a company’s operational performance beyond conventional GAAP figures.

Learning Objectives

1

Describe the purpose and structure of the income statement and its role in financial reporting.

2

Differentiate between single?step and multiple?step income statement formats and explain their respective advantages.

3

Explain the treatment of irregular items and the methods for intraperiod tax allocation in financial statements.

4

Demonstrate the preparation of the retained earnings statement and the reporting of other comprehensive income.

5

Analyze pro forma reporting practices and understand how they provide additional insight beyond GAAP figures.

Key Concepts

CONCEPT

DEFINITION

Income Statement

A financial statement that reports a company's financial performance over a specific accounting period, detailing revenues, expenses, and profits or losses.

Single-Step Format

An income statement presentation that aggregates all revenues and then deducts all expenses to arrive at net income in one step.

Multiple-Step Format

An income statement layout that separates operating revenues and expenses from non-operating items, offering detailed subtotals like gross profit.

Irregular Items

Non-recurring or unusual transactions such as extraordinary gains or losses that require separate disclosure on the income statement.

Intraperiod Tax Allocation

The process of allocating income tax expense among continuing operations, discontinued operations, extraordinary items, and other components in a reporting period.

Earnings per Share (EPS)

A financial metric that divides net income available to common shareholders by the weighted average number of common shares outstanding.

Retained Earnings Statement

A financial statement detailing the changes in retained earnings over an accounting period, reflecting the accumulated profits reinvested in the business.

Other Comprehensive Income (OCI)

Components of total comprehensive income that are not included in the net income, such as unrealized gains and losses on certain investments.

Pro Forma Reporting

Financial statements that present a company’s performance with certain adjustments to provide a clearer view of ongoing operations, beyond GAAP figures.

Example Problems

Example 1

Give an example of a transaction that results in: (a) A decrease in an asset and a decrease in a liability (b) A decrease in one asset and an increase in another asset. (c) A decrease in one liability and an increase in another liability. (c) A prospective employee is interviewed.

Example 2

Do the following events represent business transactions? Explain your answer in each case. (a) A computer is purchased on account. (b) A customer returns merchandise and is given credit on account. (c) A prospective employee is interviewed. (d) The owner of the business withdraws cash from the business for personal use. (e) Merchandise is ordered for delivery next month.

Example 3

Name the accounts debited and credited for each of the following transactions. (a) Billing a customer for work done. (b) Receipt of cash from customer on account. (c) Purchase of office supplies on account. (d) Purchase of 15 gallons of gasoline for the delivery truck.

Example 4

Why are revenue and expense accounts called temporary or nominal accounts?

Example 5

Andrea Pafko, a fellow student, contends that the double-entry system means that each transaction must be recorded twice. Is Andrea correct? Explain.
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Step-by-Step Explanations

QUESTION

How do you calculate the basic Earnings per Share (EPS) from a given net income and weighted average common shares outstanding?

STEP-BY-STEP ANSWER:

Step 1: Identify net income from the income statement, ensuring that any dividends on preferred stock are subtracted if applicable.
Step 2: Determine the weighted average number of common shares outstanding during the period.
Step 3: Divide the adjusted net income (after subtracting any preferred dividends) by the weighted average number of common shares.
Step 4: Report the result as the basic EPS.
Final Answer: Basic EPS = (Net Income - Preferred Dividends) / Weighted Average Common Shares Outstanding.

Calculating EPS (Earnings per Share)

QUESTION

What steps are involved in preparing a retained earnings statement?

STEP-BY-STEP ANSWER:

Step 1: Begin with the opening balance of retained earnings from the previous accounting period.
Step 2: Add net income (or subtract net loss) for the current period as reported on the income statement.
Step 3: Subtract any dividends declared and paid during the period.
Step 4: Arrive at the ending balance of retained earnings, which will be reported on the balance sheet.
Final Answer: Ending Retained Earnings = Beginning Retained Earnings + Net Income (or - Net Loss) - Dividends Declared.

Preparing the Retained Earnings Statement

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Common Mistakes

  • Confusing the single?step and multiple?step income statement formats, leading to misinterpretation of operating versus non-operating activity.
  • Overlooking the impact of irregular items and failing to adjust them correctly, which can distort performance analysis.
  • Incorrectly applying intraperiod tax allocation, particularly when dealing with extraordinary items or discontinued operations.
  • Miscalculating EPS by not properly considering weighted average shares or by failing to subtract preferred dividends.
  • Assuming that pro forma reports are GAAP-compliant without recognizing the adjustments made for non-recurring items.