Chapter 2

CHAPTER 02
Accounting Income and Assets:

The Accrual Concept
ACTG 500 Financial Accounting

Analysis
Income Statement

Analysis
Income
Statement
Sample Income Statement
+
+/=
+/+/+/+/=
Revenues from the sales of goods and services

Other income and revenues
Operating expenses
Financing costs
Unusual or infrequent items
Pretax earnings from continuing operations
Income tax expense
Net income from continuing operations
Income from discontinuing operations
Extraordinary items (net of tax)
Cumulative effect of accounting changes (net of tax)
Net income

Analysis
Income
Book
Recommended
Format
Statement
=
+
=
=
+/=
=
+/+/+/=

Operating expenses
Operating income from continuing operations
Other income and revenue
Recurring income before interest and taxes from continuing operations
Financing charges
Recurring(pretax) inomce from continuing operations
Pretax earnings from continuing operations
Income tax expense
Net income from continuing operations
Income for discontinuing opertions (net tax)
Extraordinary items (net of tax)
Cumulative effect of accounting changes (net of tax)
Net income
Unusual or Infrequent Items:
Definition is obvious from title-these events are

either unusual or infrequent in occurrence but not
both unusual and infrequent.
E.g. includes
Gains or losses from the disposal of a portion of a

business segment
Gains or losses from the sale of assets or

investments in subsidiary
Impairments, write-offs
Analytical Implication
As an analyst, you need to review unusual or
infrequent items and THINK whether it should be
included in forecasting future income.
Management buries these items in other income or
operating expenses
A careful examination of Management Discussion &
Analysis along with footnotes should allow you to
determine these items in greater detail
Definition is similar to unusual or infrequent

items, EXCEPT extraordinary items are events
that are BOTH unusual and infrequent in
occurrence AND material in nature
Gains or losses from early retirement of debt
Uninsured losses from natural disasters that are
both unusual and infrequent
Extraordinary items are reported net of tax after
net income from continuing operations
DO are the ones which management has

decided to dispose of but either has not done
so or did so in the current year after it had
generated loss or income.
Income and losses from DO are reported net of
taxes after net income from continuing
operations
Two types:
A change in accounting principle
Change in accounting principle refers to the
change in one GAAP method to another GAAP
method.
E.g. changing inventory method from LIFO to
FIFO.
When change in accounting principle occurs,
a firm is required to restate its financial
statements.
A change in accounting estimate

Analysis
Income
Statement
EASTMAN KODAK COMPANY AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF EARNINGS
FOR THE YEAR ENDED
DECEMBER 31,
In m illions
Sales
Cost of goods sold
1998
13,406 $
7,293
1997
1996
14,538 $
7,976
Gross profit
Selling, general, and adminstration expense
Research and development costs
Purchased research and development
Restructuring costs and asset impairment
6,113
3,303
880
42
-
Earnings from operations

Interest expense
Other income (charges)
1,888
(110)
328
130
(98)
21
1,845
(83)
(206)
Earnings before income taxes

Provision for income taxes
2,106
716
53
48
1,556
545
Earnings from continuing operations

Gain on sale of discontinuing operations
1,390
-
1,011
227
5 $
1,238
Net income
1,390 $
6,562
3,912
1,044
186
1,290
15,968
8,327
7,641
4,410
1,028
358
10

Analysis
Income
Statement
Revenues fromCOMPANIES
the sales of goods and services
EASTMAN KODAK COMPANY AND SUBSIDIARY
- Operating expenses
CONSOLIDATED STATEMENT
OF EARNINGS
= Operating income from continuing operations
In m illions
Sales
Cost of goods sold
Gross profit
+ Other income and revenue

= Recurring income before interest and taxes from continuing operations
FOR THE YEAR ENDED
- Financing charges
DECEMBER
= Recurring(pretax)
inomce from 31,
continuing operations
+/- Unusual or infrequent items
1998
1997
1996
= Pretax earnings from continuing operations
13,406
$
14,538 $
15,968
- Income
tax expense
= Net7,293
income from continuing
operations
7,976
8,327
+/- Income for discontinuing opertions (net tax)
6,113 items (net of6,562
7,641
+/- Extraordinary
tax)
+/- Cumulative
3,303 effect of accounting
3,912changes (net of tax)
4,410
= Net income
880
42
-
1,044
186
1,290
1,028
358

Interest expense
1,888
(110)
328
130
(98)
21
1,845
(83)
(206)

2,106
716
53
48
1,556
545

1,390
-
1,011
227
5 $
1,238
Net income
1,390 $
11

Analysis
Income
Statement

COMPANIES
Revenues from the
sales of goods and services
Operating
expenses
In m illions
Sales
Cost of goods sold
Gross profit

FOR
THE
YEAR
ENDED
= Recurring
income
before
interest
and taxes from continuing operations
- Financing charges
DECEMBER 31,
= Recurring(pretax) inomce from continuing operations
+/Unusual or infrequent1997
items
1998
1996
13,406 $
14,538 $
15,968
- Income tax expense
7,976
8,327
= Net7,293
operations
6,113
6,562
7,641
+/- Extraordinary items (net of tax)
4,410
+/- Cumulative
= Net income
880
1,044
1,028
42
-
186
1,290
358

Interest expense
1,888
(110)
328
130
(98)
21
1,845
(83)
(206)

2,106
716
53
48
1,556
545

1,390
-
1,011
227
5 $
1,238
Net income
1,390 $
12

Analysis
Income
Statement

COMPANIES
Revenues from the
Operating
expenses

FOR
THE
YEAR
ENDED
= Recurring
income
before
interest
- Financing charges
DECEMBER 31,
items
1998
1996
13,406 $
14,538 $
15,968
7,976
8,327
= Net7,293
operations
6,113
6,562
7,641
4,410
+/- Cumulative
= Net income
880
1,044
1,028
In m illions
Sales
Cost of goods sold
$
In analyzing
income statements, the goal is to
determine future cash flow. Therefore, the income
Gross profit
statements is looked at as a predictor of future
income, which in general it is not. However, the income
42 have predictive
186
statement must
value.Restructuring costs and asset impairment
1,290
358

Interest expense
1,888
(110)
328
130
(98)
21
1,845
(83)
(206)

2,106
716
53
48
1,556
545

1,390
-
1,011
227
5 $
1,238
Net income
1,390 $
13

Analysis
Income
Statement

COMPANIES
Revenues from the
Operating
expenses

FOR
THE
YEAR
ENDED
= Recurring
income
before
interest
- Financing charges
DECEMBER 31,
items
1998
1996
13,406 $
14,538 $
15,968
7,976
8,327
= Net7,293
operations
6,113
6,562
7,641
4,410
+/- Cumulative
= Net income
880
1,044
1,028
In m illions
Sales
Cost of goods sold
$
In analyzing
income statements, the goal is to
Gross profit
income, which is general it is not. The income
42 have predictive
186
statement must
value.Restructuring costs and asset impairment
Recurring
Interest expense
1,290
358
1,888 items must

130 be analyzed.
1,845
versus non-recurring
(110)
328
(98)
21
(83)
(206)

2,106
716
53
48
1,556
545

1,390
-
1,011
227
5 $
1,238
Net income
1,390 $
14

Analysis
Statement
Income
EASTMAN
KODAK COMPANY AND SUBSIDIARY
COMPANIES
from the sales of goods and services
CONSOLIDATED STATEMENT Revenues
OF EARNINGS
In m illions
Sales
Cost of goods sold
+ Other FOR
income THE
and revenue
YEAR ENDED
DECEMBER 31,
- Financing charges
=1998
Recurring(pretax) inomce
1997from continuing operations
1996
13,406 $
14,538 $
15,968
7,293
7,976
8,327
- Income
tax expense
= Net income from continuing operations
6,113
6,562
7,641
4,410
+/- Extraordinary
tax)
+/- Cumulative
880 effect of accounting
1,028
= Net income
In analyzing income statements, the goal is to

Gross profit
income, which is42general it is
186not. The income
have predictive
value.
Restructuring costs and asset impairment statement must
1,290
358
Interest expense
Recurring
versus
1,888
non-recurring
(110)
328
items
Earnings beforeThus,
income
taxes
look
for above the line 2,106
and
716
below the line nonEarnings from continuing operations
recurring items
1,390
-
Net income
1,390 $
130
must
(98) be
21
1,845
analyzed.
(83)
(206)
53
48
1,556
545
1,011
227
5 $
1,238
15

Analysis
Income
Statement

COMPANIES
Revenues from the
Operating
expenses
In m illions
Sales
Cost of goods sold
Gross profit

FOR
THE
YEAR
ENDED
= Recurring
income
before
interest
- Financing charges
DECEMBER 31,
+/Unusual or infrequent
items
1998
1997
1996
13,406 $
14,538 $
15,968
7,976
8,327
= Net7,293
operations
6,113
6,562
7,641
4,410
+/- Cumulative
= Net income
880
1,044
1,028
42
-
186
1,290
358

Interest expense
1,888
(110)
328
130
(98)
21
1,845
(83)
(206)

2,106
716
53
48
1,556
545

1,390
-
1,011
227
5 $
1,238
Net income
1,390 $
16

Analysis
Income
Statement

COMPANIES
= Operating
income from continuing operations
OF EARNINGS
In m illions
Sales
Cost of goods sold
Gross profit
Interest expense
880
42
-
1,888
$
1,888 $

Net income

FOR
THE YEAR ENDED
- Financing
charges
= Recurring(pretax)
inomce from 31,
DECEMBER
=1998
Pretax earnings from1997
continuing operations 1996
13,406 $
14,538 $
15,968
7,293
7,976 (net tax)
8,327
+/- Income
for discontinuing opertions
6,113
6,562
7,641
+/- Cumulative effect of accounting changes (net of tax)
3,912
4,410
= Net3,303
income
1,028
358
1,888
(110)
130
328
130
(98)
1,845
21
1,845
(83)
(206)
2,106
1,420
716
53
2,203
48
1,556
545
1,290
1,390
$
1,044
186
1,290
1,390 $
358
5
5 $
1,011
227
1,238
17

Analysis
Income
Statement

COMPANIES
= Operating
income from continuing operations
OF EARNINGS
Other non-recurring items may

be hidden
In m illions
Sales
Cost of goods sold
Gross profit

FOR
THE YEAR ENDED
- Financing
charges
= Recurring(pretax)
inomce from 31,
DECEMBER
=1998
Pretax earnings from1997
continuing operations 1996
13,406 $
14,538 $
15,968
7,293
7,976 (net tax)
8,327
+/- Income
6,113
6,562
7,641
+/- Cumulative effect of accounting changes (net of tax)
3,912
4,410
= Net3,303
income
880
42
-
1,044
186
1,290
1,028
358

Interest expense
1,888
(110)
328
130
(98)
21
1,845
(83)
(206)

2,106
716
53
48
1,556
545

1,390
-
1,011
227
Net income
1,390 $
5 $
1,238
18

Analysis
Income
Statement

Operating expenses
COMPANIES
OF EARNINGS
- Financing charges
FOR THE YEAR ENDED
DECEMBER
+/- Unusual or infrequent
items 31,
In m illions
1998
1997
1996
Sales
$ = Net
13,406
$ continuing
14,538
$
15,968
income from
operations
+/- Income
Cost of goods sold
7,293
7,976 (net tax)
8,327
Gross profit
7,641
+/- Cumulative
= Net3,303
income
3,912
4,410

be hidden

Above
the
880
1,044
42
186
- Items 1,290
Line
1,028
358

Interest expense
1,888
(110)
328
130
(98)
21
1,845
(83)
(206)

2,106
716
53
48
1,556
545

1,390
-
1,011
227
5 $
1,238
Net income
1,390 $
19

Analysis
Income
Statement
Revenues from the

COMPANIES
OF EARNINGS

be hidden
In m illions
Sales
Cost of goods sold
Gross profit

FOR THE YEAR ENDED
- Financing charges
DECEMBER
= Recurring(pretax)
inomce from 31,
1998
1997
1996
13,406
$
14,538 $
15,968
- Income
tax expense
= Net7,293
operations
7,976
8,327
7,641
+/- Extraordinary
tax)
+/- Cumulative
4,410
= Net income
880
42
-
1,044
186
1,290
1,028
358

Interest expense
1,888
(110)
328
130
(98)
21
1,845
(83)
(206)

2,106
716
53
48
1,556
545

1,390
-
1,011
227
5 $
1,238
Net income
1,390 $
20

Analysis
Statement
EASTMAN
KODAK COMPANY AND SUBSIDIARY COMPANIES
Income
CONSOLIDATED STATEMENT Revenues
OF EARNINGS
from the sales of goods and services

be hidden
In m illions
Sales
Cost of goods sold
Gross profit
YEAR ENDED
+ Other FOR
income THE
and revenue
= Recurring income
before interest
DECEMBER
31,and taxes from continuing operations
- Financing charges
1997from continuing operations
1996
=1998
Recurring(pretax) inomce
+/- Unusual
items
13,406or infrequent
$
14,538 $
15,968
7,293
7,976
8,327
= Net6,113
operations
6,562
7,641
3,303
3,912
4,410
880 effect of accounting
1,028
+/- Cumulative
= Net income
42
186
-
1,290
358
130
(98)
Line
21
1,845
(83)
(206)

Interest expense
1,888
(110)
Below
328

2,106
716
53
48
1,556
545

1,390
-
1,011
227
5 $
1,238
Net income
1,390 $
the
21

Analysis
Income
Statement

COMPANIES
Revenues from the
Operating
expenses
In m illions
Sales
Cost of goods sold
Gross profit

FOR
THE
YEAR
= Recurring
income
before
interestENDED
- Financing charges
DECEMBER 31,
+/-1998
1997
1996
13,406 $
14,538 $
15,968
8,327
= Net 7,293
income from continuing7,976
operations
6,113
6,562
7,641
3,303effect of accounting
3,912
4,410
+/- Cumulative
changes (net of tax)
= Net income
880
1,044
1,028
42
-
186
1,290
358

Interest expense
1,888
(110)
328
130
(98)
21
1,845
(83)
(206)

2,106
716
53
48
1,556
545

1,390
-
1,011
227
5 $
1,238
Net income
1,390 $
22

Analysis
Income
Statement

COMPANIES
Revenues from the
Operating
expenses
In m illions
Sales
Cost of goods sold
Gross profit

FOR
THE
YEAR
= Recurring
income
before
interestENDED
- Financing charges
DECEMBER 31,
+/-1998
1997
1996
13,406 $
14,538 $
15,968
8,327
= Net 7,293
income from continuing7,976
operations
6,113
6,562
7,641
3,303effect of accounting
3,912
4,410
+/- Cumulative
changes (net of tax)
= Net income
880
1,044
1,028
42
-
186
1,290
358

Interest expense
1,888
(110)
328
130
(98)
21
1,845
(83)
(206)

2,106
716
53
48
1,556
545

1,390
-
1,011
227
5 $
1,238
Net income
1,390 $
23

Analysis
Income
Statement
Revenues from the

COMPANIES
OF EARNINGS
In m illions
Sales
Cost of goods sold
Gross profit

FOR THE YEAR ENDED
- Financing charges
DECEMBER
= Recurring(pretax)
inomce from 31,
1998
1997
1996
13,406
$
14,538 $
15,968
- Income
tax expense
= Net7,293
operations
7,976
8,327
7,641
+/- Extraordinary
tax)
+/- Cumulative
4,410
= Net income
880
42
-
1,044
186
1,290
1,028
358

Interest expense
1,888
(110)
328
130
(98)
21
1,845
(83)
(206)

2,106
716
53
48
1,556
545

1,390
-
1,011
227
5 $
1,238
Net income
1,390 $
24

Analysis
Income
Statement
Recurring operating activities is the best indicator of future income

The concept of recurring income is similar to permanent or
sustainable income in the sense that it is persistent.
With recurring income, the level or rate
of growth is relatively more predictable.
25

Analysis
Accounting Income: Revenue and

Expense Recognition
26
Cash Accounting is that revenue or income that

is recognized when cash is received, and
expenses are recognized when firm pays out cash
Firms cash flow is measured as cash in less cash
out
Results in highly volatile, less predictable cash
flows and income streams
Not desirable for firms with complex operation
and financing strategies.
Accrual accounting allows us to allocate revenues

and expenses to time periods other than those in
which cash flows occurred.
One result is smoothed earnings streams
Empirical evidence highlights two benefits
Enhanced predictability of future cash flows
Given cash flow from operations, accrual accounting
provides incremental information to a firms profitability
However, accrual accounting can be confusing
Accounting for revenues and expenses is based on

matching principle
Means that revenues and expenses incurred to generate
those revenues must be accounted for in the same time
period.
When accrual accounting is used to prepare financial
statements, two revenue and expense recognition issues
must be addressed:
Timing: When should revenue and expense be recognized?
Measurement: How much revenue and expense should be
recognized?

Analysis
Accounting Income: Revenue and Expense Recognition
When accrual accounting is used to prepare financial statements,

two revenue and expense recognition issues must be addressed:
Timing
Measurement
When?
How much?
30

Analysis

In Practice:
Management has discretion with respect
to both revenue and expense recognition.
31

Analysis

In Practice:
Management has discretion with respect
to both revenue and expense recognition.
Remember: It must be consistent!
32

Analysis
Recognition and measurement of financial statements:

Two conditions must be met for revenue recognition:
1. Completion of the earnings process
The Work was gone; Product Delivered; Service Competed
Under specific contracts: Portion recognized when condition met
2. Assurance of payment
Payment is expected
Do not recognize if customer is insolvent and payment not expected
33

Analysis
Recognition and measurement of financial statements:

Two conditions must be met for revenue recognition:
1. Completion of the earnings process
The Work was gone; Product Delivered; Service Competed
Under specific contracts: Portion recognized when condition met
2. Assurance of payment
Revenue
recognition
includes the concept of realization:
Payment
is expected
Revenue, measured as the amount expected to be collected, can
Do not when
recognize
if customer
is insolvent
payment
not expected
be recognized
goods
or services
haveand
been
provided
and
their cost can be reliably determined
34
NOTE: If a firm recognizes REVENUE

prior to fulfilling the two conditions of
revenue recognition, then its current
asset will be overstated. Due to
overstatement of A/R at sales price
LESS understatement of inventory at
cost.
Similarly, RETAINED EARNINGS will be
overstated by the NET INCOME that
should not have been recorded.

Analysis
Revenue Recognition Methods or Income Determination Methods:

1. Sales basis (most common)
2. Percentage of completion
3. Completed contract method
4. Installment method
Accounting Method
5. Cost recovery method
Under accrual accounting, revenue is generally recognized
at the point of sales.
Criteria for use of basis:
- Exchange has taken place
- Earnings process is (virtually) complete
36
Sales basis method: goods or services are

provided when the sale is made, and the sale
is for cash or credit to a customer with a high
probability of repayment
If cash is received before goods or services

are provided, the revenue is not recognized
until it is earned for e.g.
Rev from sale of magazines is not recognized until delivery
Credit card fees received in advance are not revenue until time
passes

Analysis
Exceptions to Revenue Recognition Methods or Income Determination Methods:

Criteria for the use of basis:
5. Cost recovery method- Long-term construction, property, or service
- Dependable estimates of estimate of extent of progress and cost

to complete
- Reasonable assurance of collectibility of contract price
Reasons for departing from sales basis:
- Availability of evidence of ultimate proceeds
- Better measure of periodic income
- Avoidance of fluctuations in revenues in revenue, expenses,
and income
38
Percentage-of-completion method: Used for long

term projects when there is a contract and there are
reliable estimates of the revenues, costs and
completion time.
Recognize revenues and corresponding costs in
proportion to work completed
Two methods to measure the proportion of work
completed
An engineering estimate
Ratio on incurred cost to total estimated costs

Analysis
General formula:
Goods and services provided to date
Total goods and Services to be provided X Total expected
revenue
E.g.: Contract to construct building for $10,000,000. It is estimated to cost $5,600,000
to build. At the fiscal year, $1,300,000 was expended. Revenue recognized:
$1,300,000 x $10,000,000 = $2,321,429

$5,600,000
40

Analysis
Exception to Revenue Recognition Methods or Income Determination Methods:

Completed Contract Method

- Recognition of revenue and profit at contract
completion. All related costs are deferred until completion and
then matched to revenues.
41
Completed Contract Method: Used for long

term projects, when there is NO contract or
estimates of revenues and costs are
UNRELIABLE.
Rev and Exps are not recognized until
entire project is completed

Analysis
General formula:
revenue
E.g.: Contract to construct building for $10,000,000. It is estimated to cost $5,600,000
to build. At the fiscal year, $1,300,000 was expended. Revenue recognized:
No Revenue and expense recognized

until contract completed
43

Analysis
Various Revenue Recognition Methods or Income Determination Methods:

- Absence of a reasonable basis for estimating degree of
collectability.
44
Installment Sales Method: Used when

there is no way to estimate the
likelihood of collecting the sales
proceeds, but the costs of
goods/services are known
Recognizes sales and COGS as
proportions of cash collected each
period, based on GPM

Analysis
General formula:
revenue
E.g., The magazine company sold a 1-year magazine subscription
for $50.00. How much revenue should be recognized each month?
1-month
12-months
$50.00 = $4.17
46

Analysis


collectability.
47
Cost Recovery Method: Used when costs to

provide goods or services are not known or
when there are uncertanities surrounding
collection of proceeds from the sale.
Sales are recognized when cash is received
But no gross profit is recognized until the
sellers COGS is fully recovered by buyers
cash payment.

Analysis


collectibility.
Reason for departure from sales basis:

- Level of uncertainty with respect to collection
of the receivable preclude recognition of gross
profit before cash is received
49

Analysis


collectibility.
Reason for departure from sales basis:

- Level of uncertainty with respect to collection
Gross profit is deferred, until the of the receivable preclude recognition of gross
profit before cash is received
cumulative cash receipts exceeds
the costs.
50
End of Chapter!!
Jazak-um-Allah-al-Khair

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Chapter 2

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Format Tersedia

CHAPTER 02

Accounting Income and Assets:

ACTG 500 Financial Accounting

ACTG 500 Financial Accounting

Sample Income Statement

Revenues from the sales of goods and services

ACTG 500 Financial Accounting

Sample Income Statement

Revenues from the sales of goods and services

Unusual or Infrequent Items:

Definition is obvious from title-these events are

Gains or losses from the disposal of a portion of a

Gains or losses from the sale of assets or

Definition is similar to unusual or infrequent

DO are the ones which management has

ACTG 500 Financial Accounting

EASTMAN KODAK COMPANY AND SUBSIDIARY COMPANIES

Earnings from operations

Earnings before income taxes

Earnings from continuing operations

ACTG 500 Financial Accounting

Sample Income Statement

+ Other income and revenue

Earnings from operations

Earnings before income taxes

Earnings from continuing operations

ACTG 500 Financial Accounting

Sample Income Statement

EASTMAN KODAK COMPANY AND SUBSIDIARY

= Operating income from continuing operations

Earnings from operations

Earnings before income taxes

Earnings from continuing operations

ACTG 500 Financial Accounting

Sample Income Statement

EASTMAN KODAK COMPANY AND SUBSIDIARY

= Operating income from continuing operations

Earnings from operations

Earnings before income taxes

Earnings from continuing operations

ACTG 500 Financial Accounting

Sample Income Statement

EASTMAN KODAK COMPANY AND SUBSIDIARY

= Operating income from continuing operations

1,888 items must

Earnings before income taxes

Earnings from continuing operations

ACTG 500 Financial Accounting

In analyzing income statements, the goal is to

ACTG 500 Financial Accounting

Sample Income Statement

EASTMAN KODAK COMPANY AND SUBSIDIARY

= Operating income from continuing operations

Earnings from operations

Earnings before income taxes

Earnings from continuing operations

ACTG 500 Financial Accounting

Sample Income Statement

Revenues from the sales of goods and services

EASTMAN KODAK COMPANY AND SUBSIDIARY

Earnings from continuing operations

+ Other income and revenue

ACTG 500 Financial Accounting