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OVERVIEW
Income statement components and format
Accounting issues
- Revenue recognition
- Expense recognition
- Inventory
- Depreciation
- Nonrecurring items
Earnings per share
Income statement analysis
Comprehensive income
Copyright 2013 CFA Institute
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$100
$90
- Gross Profit
$10
Alternative B: Net
- Revenue
$10
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Balance Sheet
Goods
Available
for
Sale
Ending
Inventory
Cost of
Goods Sold
Income Statement
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Total available
for sale
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Total available
for sale
$236,968
Ending inventory =
2,000 units at $42.3158 per unit
$84,632
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Method
Description
FIFO
LIFO
Average
Cost
Ending Inventory
when prices are
rising relative to the
other two methods
Highest
Lowest*
Middle
*Assumes no LIFO layer liquidation. LIFO layer liquidation occurs when the volume of sales exceeds the
volume of other purchases in the period so that some sales are assumed to be from existing, relatively low-priced
inventory rather than from more recent purchases.
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Cost of equipment
$9,000
3,000
$6,000
3,000
$3,000
3,000
$0
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Year
NBV
Beginning of
Year
Depreciation
Expense
Accumulated
Depreciation
NBV End of
Year
11,000
4,400
4,400
6,600
6,600
2,640
7,040
3,960
3,960
1,584
8,624
2,376
2,376
950
9,574
1,426
1,426
426
10,000
1,000
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EPS: EXAMPLE 1
Basic EPS
- Earnings available to common shareholders divided by weighted
average number of shares outstanding
Basic EPS =
(Net income Preferred dividends)
Weighted average number of shares outstanding
Assume the following:
- Company had net income of $2,431 million for the year,
- 488.3 million weighted average number of common shares outstanding
- No preferred stock, no convertible securities, no options
What was the companys basic EPS?
Colgate's Annual Report
Copyright 2013 CFA Institute
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EPS: EXAMPLE 2
WEIGHTED AVERAGE NUMBER OF SHARES
Calculate
(1) the weighted average number of shares outstanding
(2) the companys basic EPS
Assume the following:
Company had net income of $2,500,000 for the year and paid $200,000
of preferred dividends.
1,000,000
200,000
(100,000)
1,100,000
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= 1,125,000
Basic EPS
= (Net income Preferred dividends)/Weighted average number
of shares outstanding
= ($2,500,000 $200,000)/1,125,000
= $2.04
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EPS: EXAMPLE 3
IF-CONVERTED METHOD FOR CONVERTIBLE PREFERRED
STOCK
Assume a company has the following:
- net income of $1,750,000
- an average of 500,000 shares of common stock outstanding
- 20,000 shares of convertible preferred outstanding
- no other potentially dilutive securities
Each share of preferred pays a dividend of $10 per share, and each is
convertible into five shares of the companys common stock.
Calculate the companys basic and diluted EPS.
Diluted EPS
= Net income/(Weighted average number of shares outstanding
+ New shares issued at conversion)
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EPS: EXAMPLE 3
IF-CONVERTED METHOD FOR CONVERTIBLE PREFERRED
STOCK SOLUTION
Basic EPS
Net income
Preferred dividend
$1,750,000
200,000
$1,750,000
0
Numerator
$1,550,000
$1,750,000
500,000
0
500,000
500,000
100,000
600,000
$3.10
$2.92
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EPS: EXAMPLE 4
IF-CONVERTED METHOD FOR CONVERTIBLE
DEBT
Assume a company has the following:
- net income of $750,000
- an average of 690,000 shares of common stock outstanding
- $50,000 of 6% convertible bonds outstanding that are convertible into a total of
10,000 shares
- no other potentially dilutive securities
- An effective tax rate is 30%
Calculate the companys basic and diluted EPS.
Diluted EPS
= (Net income + After-tax interest on convertible debt Preferred dividends)/
(Weighted average number of shares outstanding + Additional common shares
that would have been issued at conversion)
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EPS: EXAMPLE 4
IF-CONVERTED METHOD FOR CONVERTIBLE DEBT
SOLUTION
Diluted EPS Using
Basic EPS If-Converted Method
Net income
After-tax cost of interest
Preferred dividend
$750,000
0
0
$750,000
2,100
0
Numerator
$750,000
$752,100
690,000
0
690,000
690,000
10,000
700,000
$1.09
$1.07
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EPS: EXAMPLE 5
TREASURY STOCK METHOD FOR STOCK OPTIONS
Assume a company reported net income of $2.3 million for the
year ended 30 June 2005 and has the following:
- an average of 800,000 common shares outstanding
- 30,000 options with an exercise price of $35 outstanding
- no other potentially dilutive securities
Over the year, its market price averaged $55 per share.
Calculate the companys basic and diluted EPS.
Diluted EPS
= (Net Income Preferred dividends)/(Weighted average
number of shares outstanding + New shares issued at option
exercise Shares that could have been purchased with cash
received upon exercise)
Copyright 2013 CFA Institute
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EPS: EXAMPLE 5
TREASURY STOCK METHOD FOR STOCK OPTIONS
SOLUTION
Calculate Denominator
800,000 Weighted average number of shares outstanding
+ 30,000 New shares issued at option exercise
Shares that could be purchased with cash received
upon exercise, calculated as $1,050,000 ($35 for
19,091 each of the 30,000 options exercised) divided by
average market price of $55 per share = 19,091
shares
= 810,909 Shares
30,000 19,091 = 10,909
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EPS: EXAMPLE 5
TREASURY STOCK METHOD FOR STOCK OPTIONS
SOLUTION
Net income
Numerator
Weighted average number
of shares outstanding
If exercised and treasury
shares purchased
Denominator
EPS
Copyright 2013 CFA Institute
800,000
800,000
0
800,000
10,909
810,909
$2.88
$2.84
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$10,000,000
$10,000,000
$2,000,000
Cost of sales
3,000,000
7,500,000
600,000
Gross profit
7,000,000
2,500,000
1,400,000
1,000,000
1,000,000
200,000
2,000,000
400,000
Advertising
2,000,000
400,000
Operating profit
2,000,000
1,500,000
400,000
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100%
30
70
100%
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25
100%
30
70
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20
20
20
10
0
0
15
10
20
20
20
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COMPREHENSIVE INCOME
Beginning Equity
+ or Change
= Ending Equity
Retained earnings
+ Net income
Dividends
Retained earnings
Accumulated other
comprehensive income
+ Other comprehensive
income
Other comprehensive
loss
Accumulated other
comprehensive income
Stock
+ Issuances
Repurchases
Stock
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COMPREHENSIVE INCOME:
EXAMPLE
Assume the following about a company:
- beginning shareholders equity is 200 million
- net income for the year is 20 million
- cash dividends for the year are 3 million
- no issuance or repurchase of common stock.
- actual ending shareholders equity is 227 million.
What amount has bypassed the net income calculation by
being classified as other comprehensive income?
What is the companys comprehensive income?
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COMPREHENSIVE INCOME:
EXAMPLE SOLUTION
Assume the following about a company:
- beginning shareholders equity is 200 million
- net income for the year is 20 million
- cash dividends for the year are 3 million
- no issuance or repurchase of common stock
- actual ending shareholders equity is 227 million
What amount has bypassed the net income calculation by being
classified as Other comprehensive income?
Answer: 10 million.
What is the companys total comprehensive income?
Answer: 30 million
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SUMMARY
Income statement shows how much revenue the company
generated during a period and what costs it incurred in
connection with generating that revenue.
Accounting issues relate primarily to timing (revenue recognition,
expense recognition, nonrecurring items).
The income statement also presents EPS (earnings per share),
an important metric.
Tools for income statement analysis include common-size
analysis and profitability ratios.
Comprehensive income includes net income and other
comprehensive income.
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