In addition to a statement of comprehensive income, companies are also required to present a statement of changes in equity. Equity is generally comprised of share capital—
ordinary, share premium—ordinary, retained earnings, and the accumulated balances in other comprehensive income. The statement reports the change in each equity account and in total equity for the period. The following items are disclosed in this statement.
1. Accumulated other comprehensive income for the period.
2. Contributions (issuances of shares) and distributions (dividends) to owners.
3. Reconciliation of the carrying amount of each component of equity from the begin- ning to the end of the period.
Companies often prepare the statement of changes in equity in column form. In this format, they use columns for each account and for total equity.
To illustrate, assume the same information for V. Gill as shown in Illustration 4-22 (on page 157). The company had the following equity account balances at the beginning of 2015: Share Capital—Ordinary €300,000, Retained Earnings €50,000, and Accumu- lated Other Comprehensive Income €60,000, related to unrealized gains on non-trading equity securities. No changes in the Share Capital—Ordinary account occurred during the year. Cash dividends during the period were €10,000. Illustration 4-23 shows a state- ment of changes in equity for V. Gill.
Total comprehensive income is comprised of net income of €110,000 added to retained earnings and €30,000 related to the unrealized gain. Separate columns are used to report each additional item of other comprehensive income.17 Thus, this statement is useful for understanding how equity changed during the period.
INCOME REPORTING
Evolving Issue
As indicated in the chapter, information reported in the income statement is important to meeting the objective of financial reporting. However, there is debate over income reporting practices, be it the controversy over pro forma reporting or whether to report comprehensive income in a one statement or a two statement format. In response to these debates and to differences between income reporting under U.S. GAAP and IFRS, standard-setters are working on a project to improve the usefulness of the income statement.
Work to date has resulted in two core principles for finan- cial statement presentation (for the income statement, bal- ance sheet, and the statement of cash flows) based on the objective of financial reporting:
1. Disaggregate information so that it is useful in pre- dicting an entity’s future cash fl ows. Disaggregation means separating resources by the activity in which they are used and by their economic characteristics.
2. Portray a cohesive financial picture of a company’s activities. A cohesive financial picture means that
the relationship between items across financial state- ments is clear and that a company’s financial state- ments complement each other as much as possible.
Cohesiveness will be addressed by using the same classi- fications across the three primary statements; the two classi- fications currently under consideration are referred to as business and financing. Thus, this proposal is consistent with some current income reporting practices. However, agreeing on a standard level of disaggregation in the income statement may be difficult, given the current controversies surrounding pro forma reporting, extraordinary items, and comprehensive income reporting.
The statement presentation project is currently inactive on the Boards’ joint agenda (http://www.ifrs.org/Current- Projects/IASB-Projects/Financial-Statement-Presentation/Pages/
Financial-Statement-Presentation.aspx), but it is expected to restart once the projects on financial instruments, revenue, and leases are completed.
17The other comprehensive income section shall present line items for amounts of other compre- hensive income grouped into those that, in accordance with other IFRSs, (a) will not be reclassi- fied subsequently to profit or loss, and (b) will be reclassified subsequently to profit or loss when specific conditions are met. If a company has non-controlling interest, an additional column would be added to report changes in non-controlling interest amounts. [8]
Global Accounting Insights 159
Regardless of the display format used, V. Gill reports the accumulated other compre- hensive income of €90,000 in the equity section of the statement of financial position as follows.18
By providing information on the components of comprehensive income, as well as accumulated other comprehensive income, the company communicates information about all changes in net assets.19 With this information, users will better understand the quality of the company’s earnings.
ILLUSTRATION 4-23 Statement of Changes in Equity
V. GILL INC.
STATEMENTOF CHANGESIN EQUITY
FORTHE YEAR ENDED DECEMBER 31, 2015 Accumulated
Other Share
Retained Comprehensive Capital—
Total Earnings Income Ordinary
Beginning balance €410,000 € 50,000 €60,000 €300,000 Net income 110,000 110,000
Dividends (10,000) (10,000) Other comprehensive
income Unrealized holding
gain, net of tax 30,000 30,000
Ending balance €540,000 €150,000 €90,000 €300,000
18Many companies use the term Reserve to include all items in equity except for contributed capital. Contributed capital is comprised of Share Capital (ordinary and preference) and Share Premium (ordinary and preference). Rather than the term Reserve, we use Retained Earnings and Accumulated Other Comprehensive Income because these concepts are more descriptive of the items in the equity section.
19Corrections of errors and changes in accounting principle are not considered other comprehensive income items.
V. GILL INC.
STATEMENTOF FINANCIAL POSITION
ASOF DECEMBER 31, 2015 (EQUITY SECTION) Equity
Share capital—ordinary €300,000
Retained earnings 150,000
Accumulated other comprehensive income 90,000
Total equity €540,000
ILLUSTRATION 4-24 Presentation of Accumulated Other Comprehensive Income in the Statement of Financial Position
Standards issued by the FASB (U.S. GAAP) are the pri- mary global alternative to IFRS. As in IFRS, the income statement is a required statement for U.S. GAAP. In ad- dition, the content and presentation of the U.S. GAAP
income statement is similar to the one used for IFRS. A number of U.S. GAAP standards have been issued that provide guidance on issues related to income statement presentation.
INCOME STATEMENT
GLOBAL ACCOUNTING INSIGHTS
Following are the key similarities and differences between U.S. GAAP and IFRS related to the income statement.
Similarities
• Both U.S. GAAP and IFRS require companies to indicate the amount of net income attributable to non-controlling interest.
• Both U.S. GAAP and IFRS follow the same presentation guidelines for discontinued operations, but IFRS defi nes a discontinued operation more narrowly. Both standard- setters have indicated a willingness to develop a similar defi nition to be used in the joint project on fi nancial state- ment presentation.
• Both U.S. GAAP and IFRS have items that are recognized in equity as part of other comprehensive income but do not affect net income. Both U.S. GAAP and IFRS allow a one statement or two statement approach to preparing the statement of comprehensive income.
Differences
• Presentation of the income statement under U.S. GAAP follows either a single-step or multiple-step format. IFRS does not mention a single-step or multiple-step approach.
In addition, under U.S. GAAP, companies must report an
item as extraordinary if it is unusual in nature and infrequent in occurrence. Extraordinary-item reporting is prohibited under IFRS.
• The U.S. SEC requires companies to have a functional presentation of expenses. Under IFRS, companies must classify expenses by either nature or function. U.S.
GAAP does not have that requirement.
• U.S. GAAP has no minimum information requirements for the income statement. However, the U.S. SEC rules have more rigorous presentation requirements. IFRS identifi es certain minimum items that should be presented on the in- come statement.
• U.S. SEC regulations defi ne many key measures and pro- vide requirements and limitations on companies report- ing non-U.S. GAAP information. IFRS does not defi ne key measures like income from operations.
• U.S. GAAP does not permit revaluation accounting.
Under IFRS, revaluation of property, plant, and equip- ment, and intangible assets is permitted and is reported as other comprehensive income. The effect of this differ- ence is that application of IFRS results in more transac- tions affecting equity but not net income.
Relevant Facts
The terminology used in the IFRS literature is some- times different than what is used in U.S. GAAP. For
example, here are some of the differences related to this chapter.
About the Numbers
IFRS U.S. GAAP
Equity or shareholders’ equity Shareholders’ equity or stockholders’
equity Share capital—ordinary Common stock Share capital—preference Preferred stock Ordinary shares Common shares Preference shares Preferred shares
Share premium—ordinary Premium on common stock or Paid-in capital in excess of par—common Share premium—preference Premium on preferred stock or Paid-in
capital in excess of par—preferred Reserves Retained earnings and accumulated
other comprehensive income Statement of financial Balance sheet or Statement of financial
position position
Profit or loss Net income or Net loss
The IASB and FASB are working on a project that would re- work the structure of fi nancial statements. One stage of this project will address the issue of how to classify various items in the income statement. A main goal of this new approach is
to provide information that better represents how businesses are run. In addition, this approach draws attention away from just one number—net income.
On the Horizon
Summary of Learning Objectives 161
1 Understand the uses and limitations of an income statement. The in- come statement provides investors and creditors with information that helps them pre- dict the amounts, timing, and uncertainty of future cash flows. Also, the income state- ment helps users determine the risk (level of uncertainty) of not achieving particular cash flows. The limitations of an income statement are as follows. (1) The statement does not include many items that contribute to general growth and well-being of a company.
(2) Income numbers are often affected by the accounting methods used. (3) Income mea- sures are subject to estimates.
2 Understand the content and format of the income statement. Net in- come results from revenue, expense, gain, and loss transactions. This method of income measurement, the transaction approach, focuses on the income-related activities that have occurred during a given period. Instead of presenting only a net change in net assets, it discloses the components of the change.
The following sections are generally shown on an income statement: sales or revenue, cost of goods sold, selling expense, administrative or general expense, financing costs, and income tax. If present, a company also reports discontinued operations (net of tax). Earn- ings per share is reported, and an allocation of net income or loss to the non-controlling interest is also presented, where applicable.
3 Prepare an income statement. Companies determine net income by deduct- ing expenses from revenues but also classify various revenues and expenses in order to report useful subtotals within the income statement. These subtotals are gross profit, income from operations, income before income tax, and a final total, net income.
4 Explain how to report items in the income statement. Companies gener- ally provide some detail on revenues and expenses on the face of the income statement but may prepare a condensed income statement with details on various components presented in the notes to the financial statements. Companies are required to classify expense either by nature or by function. Unusual and non-recurring items should be reported in income from operations, but financing costs are reported separate from operating revenues and expenses. Companies report the effects of discontinued opera- tions of a component of a business as a separate item, after income from continuing operations.
5 Identify where to report earnings per share information. Companies must disclose earnings per share on the face of the income statement. A company that reports a discontinued operation must report per share amounts for these line items either on the face of the income statement or in the notes to the financial statements.
6 Explain intraperiod tax allocation. Companies should relate the tax expense for the year to specific items on the income statement to provide a more informative disclosure to statement users. This procedure, intraperiod tax allocation, relates the in- come tax expense for the fiscal period to the following items that affect the amount of the tax provisions for (1) income from continuing operations and (2) discontinued operations.
7 Understand the reporting of accounting changes and errors. Changes in accounting principle and corrections of errors are adjusted through retained earn- ings. Changes in accounting estimates are a normal part of the accounting process.
The effects of these changes are handled prospectively, with the effects recorded in income in the period of change and in future periods without adjustment to retained earnings.
KEY TERMS accumulated other
comprehensive income, 159
Appropriated Retained Earnings, 156 capital maintenance
approach, 138 (n) changes in accounting
estimates, 154 changes in accounting
principle, 153 comprehensive income,
156
discontinued operation, 148
earnings management, 137
earnings per share, 148 function-of-expense
method, 143 income statement, 136 intraperiod tax allocation,
150
nature-of-expense method, 143 other comprehensive
income, 156 Other income and
expense, 146
prior period adjustments, 154
quality of earnings, 137 statement of changes
in equity, 158 statement of
comprehensive income, 136 (n) transaction approach, 138
SUMMARY OF LEARNING OBJECTIVES
8 Prepare a retained earnings statement. The retained earnings statement should disclose net income (loss), dividends, adjustments due to changes in accounting principles, error corrections, and restrictions of retained earnings.
9 Explain how to report other comprehensive income. Companies report the components of other comprehensive income in one of two ways: (1) a combined statement of comprehensive income (one statement format) or (2) in a second statement (two statement format).
AUTHORITATIVE LITERATURE
Authoritative Literature References
[1] The Conceptual Framework for Financial Reporting, “Chapter 4: The Framework (1989): The Remaining Text” (London, U.K.: IASB, 2010), par. 4.25.
[2] International Accounting Standard 1, Presentation of Financial Statements (London, U.K.: IASB, 2007), par. 82.
[3] International Accounting Standard 33, Earnings per Share (London, U.K.: IASB, 2003).
[4] International Financial Reporting Standard 5, Non-current Assets Held for Sale and Discontinued Operations (London, U.K.: IASB, 2004).
[5] International Accounting Standard 33, Earnings per Share (London, U.K.: IASB, 2003).
[6] International Accounting Standard 8, Accounting Policies, Changes in Accounting Estimates and Errors (London, U.K.:
IASB, 2003).
[7] International Accounting Standard 1, Presentation of Financial Statements (London, U.K.: International Accounting Standards Committee Foundation, 2007), paras. 90–91.
[8] International Accounting Standard 1, Presentation of Financial Statements (London, U.K.: International Accounting Standards Committee Foundation, 2007), paras. 81–82.
IFRS
1. What kinds of questions about future cash flows do inves- tors and creditors attempt to answer with information in the income statement?
2. How can information based on past transactions be used to predict future cash flows?
3. Identify at least two situations in which important changes in value are not reported in the income statement.
4. Identify at least two situations in which application of dif- ferent accounting methods or accounting estimates results in difficulties in comparing companies.
5. Explain the transaction approach to measuring income.
Why is the transaction approach to income measurement preferable to other ways of measuring income?
6. What is earnings management?
7. How can earnings management affect the quality of earnings?
8. Why should caution be exercised in the use of the net income figure derived in an income statement? What are the objectives of IFRS in their application to the income statement?
9. A Wall Street Journal article noted that MicroStrategy (USA) reported higher income than its competitors by using a more aggressive policy for recognizing revenue on future upgrades to its products. Some contend that MicroStrategy’s quality of earnings is low. What does the term “quality of earnings” mean?
10. What is the major distinction between income and expenses under IFRS?
11. Do the elements of financial statements, income and expense, include gains and losses? Explain.
12. What are the sections of the income statement that com- prise (1) gross profit and (2) income from operations?
13. Ahold (NLD), in its consolidated income statement, reported “settlement of securities class action” €803 million loss. In what section of the income statement is this amount reported?
14. Explain where the following items are reported on the income statement: (1) interest expense and (2) income tax.
15. Explain the difference between the “nature-of-expense”
and “function-of-expense” classifications.
Q U E S T I O N S
Questions 163 16. Discuss the appropriate treatment in the income statement
for the following items:
(a) Loss on discontinued operations.
(b) Non-controlling interest allocation.
(c) Earnings per share.
(d) Gain on sale of equipment.
17. Discuss the appropriate treatment in the financial state- ments of each of the following.
(a) Write-down of plant assets due to impairment.
(b) A delivery expense on goods sold.
(c) Additional depreciation on factory machinery because of an error in computing depreciation for the previous year.
(d) Rent received from subletting a portion of the office space.
(e) A patent infringement suit, brought 2 years ago against the company by another company, was settled this year by a cash payment of NT$725,000.
(f) A reduction in the Allowance for Doubtful Accounts balance, because the account appears to be consider- ably in excess of the probable loss from uncollectible receivables.
18. Indicate where the following items would ordinarily ap- pear on the financial statements of Boleyn, Inc. for the year 2015.
(a) The service life of certain equipment was changed from 8 to 5 years. If a 5-year life had been used previ- ously, additional depreciation of £425,000 would have been charged.
(b) In 2015, a flood destroyed a warehouse that had a book value of £1,600,000.
(c) In 2015, the company wrote off £1,000,000 of inventory that was considered obsolete.
(d) Interest expense for the year was £45,000.
(e) In 2012, a supply warehouse with an expected useful life of 7 years was erroneously expensed.
(f) Boleyn, Inc. changed from weighted-average to FIFO inventory pricing.
19. Indicate the section of an income statement in which each of the following is shown.
(a) Loss on inventory write-down.
(b) Loss from strike.
(c) Bad debt expense.
(d) Loss on disposal of a component of the business.
(e) Gain on sale of machinery.
(f) Interest expense.
(g) Depreciation expense.
(h) Interest revenue.
20. Santo Corporation has eight expense accounts in its gen- eral ledger which could be classified as selling expenses.
Should Santo report these eight expenses separately in its income statement or simply report one total amount for selling expenses? Explain.
21. Cooper Investments reported an unusual gain from the sale of certain assets in its 2015 income statement. How does intraperiod tax allocation affect the reporting of this unusual gain?
22. What effect does intraperiod tax allocation have on re- ported net income?
23. Neumann Company computed earnings per share as follows.
Net income
Shares outstanding at year-end
Neumann has a simple capital structure. What possible errors might the company have made in the computation?
Explain.
24. How should a loss on the disposal of a component of a business be disclosed in the income statement?
25. Qualls Corporation reported 2014 earnings per share of
€7.21. In 2015, Qualls reported earnings per share as follows.
On income from continuing operations €8.00 On loss on discontinued operations .88
On net income €7.12
Is the decrease in earnings per share from €7.21 to €7.12 a negative trend? Explain.
26. What is meant by “tax allocation within a period”? What is the justification for such a practice?
27. When does tax allocation within a period become neces- sary? How should this allocation be handled?
28. Linus Paper Company decided to close two small pulp mills in Conway, New Hampshire, and Corvallis, Oregon.
Would these closings be reported in a separate section entitled “Discontinued operations after income from con- tinuing operations”? Discuss.
29. How should corrections of errors be reported in the finan- cial statements?
30. Explain how a change in accounting principles affects the current year’s net income.
31. What major types of items are reported in the retained earnings statement?
32. IFRS usually requires the use of accrual accounting to
“fairly present” income. If the cash receipts and disburse- ments method of accounting will “clearly reflect” taxable income, why does this method also not usually “fairly present” income?
33. What are two ways that other comprehensive income may be displayed (reported)?
34. Gribble Company reported the following amounts in 2015:
Net income, €150,000; Unrealized gain related to revalua- tion of buildings, €10,000; Unrealized loss related to non- trading equity securities, €(35,000). Determine Gribble’s total comprehensive income for 2015.
35. What are U.S. GAAP’s requirements with respect to expense classification?
36. Bradshaw Company experienced a loss that was deemed to be both unusual in nature and infrequent in occurrence.
How should Bradshaw report this item in accordance with U.S. GAAP?
37. Explain the U.S. GAAP reporting guidelines for items rec- ognized in comprehensive income that do not affect net income.