Lecture 3: The Income Statement Professor Carolyn Levine The Income Statement is a very useful statement to provide information to the investors in order for them to figure out important information about the future of that specific company. There are limits to the Income Statement. Fox example, things that cannot be reliably measured cannot be part of the statement even though they might be an important financial aspect of the company. Revenues, Expenses, Gains and Losses are different things that will be found on an Income Statement, and these subjects are also discussed in depth in this video. There are great exercises in this video to aid in learning. The income statement is useful because it provides information about past performance and judges whether or not top executives have made good decisions. Information about income allows us to forecast future income (since the past is a good indicator of future), forecast future cash flows (income is calculated using accrual accounting and helpful for predicting future cash flows) which is the driver of value, and also helps us evaluate risks and uncertainty. However, there are limits to its usefulness. If the information is insufficiently imprecise, it is omitted from the income statement. This can be the exclusion of revenue that cannot be reliably measured or expenses that cannot be measured. There is also the fact that there is a lot of flexibility and different judgement and perspectives about accounting. Different methods of accounting can result in different reported income. Earnings is the most forecasted, discussed, and disclosed value. Princes move when firms meet, beat, or miss Wall Street consensus forecasts (i.e. analysts predictions). Options are based on stock prices, and bonuses are awarded directly on earnings. This, unfortunately, gives the less ethical managers incentives to manipulate income via earnings management, earnings smoothing, and manipulating downward (to have a "cookie jar reserve" in case they run into a bad period in the future). Revenues are inflows of assets, or reduction in liabilities generated through central, ongoing operations such as sales, fees, interest, dividends, and rent revenues. Gains increase net assets from peripheral activities, such as sale of investments or plant assets, settlement of liabilities, favorable litigation awards, and gains on sales of marketable securities. Expenses are outflows of assets or incurrences of liabilities generated by central, ongoing operations such as cost of goods sold, depreciation expense, interest expense, rent expense, and salary expense. Losses decrease net assets from peripheral activities, such as sale of PPE or investments, sale of marketable securities, unfavorable litigation judgment, natural disaster, early extinguishment of debt, and asset impairment. The single step income statement shows that revenues less expenses equals net income. Revenues and gains are lumped together, while expenses and losses are lumped together. There is no distinction between operating (core) and non-operating (non-core) events. There is no distinction between recurring and one-time events, either. The multistep income statement is more useful than the single step income statement. It separates operating transactions from non-operating transactions. It begins with the core, recurring activities and followed by non-core and non-recurring activities. It matches costs and expenses with related revenues, and for each revenue item, associated expenses follow directly. It highlights certain intermediate components of income that analysts use, such as gross margin, operating income, EBITDA, EBIT, and EBT. It has an operating section, a nonoperating section, and an income tax section. . Income Statement Usefulness 0:46 Limitations to usefulness 5:19 Importance of Earnings (Earnings Per Share) 9:02 What is found on the Income Statement? 19:33 Revenues vs. Gains 22:25 Apple example 29:43 Expenses vs. Losses 34:46 Single-Step Income Statement 45:00 Example of Single-Step Income Statement 50:20 Going over example 53:00 Multi-Step Income Statement 1:02:44

• published: 22 Jul 2013
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