Accounting 300 Chapter 3 Income Statement Lecture PDF

Good morning in class. This is accounting 300 recorded video lecture for Chapter three. Chapter three is essentially extension of the previous topic, income statement. We prepared income statement in a single step format so far. Now we expand this task and we prepare multiple step income statement a...

Good morning in class. This is accounting 300 recorded video lecture for Chapter three. Chapter three is essentially extension of the previous topic, income statement. We prepared income statement in a single step format so far. Now we expand this task and we prepare multiple step income statement and there are a few other related topics that are important for our understanding of usefulness and limitations of the income statement. Let me share the screen with presentation slides. As always, we will go over some theoretical framework for multiple step income statement. We'll take a look at important details related to preparation of the multiple step income statement. We'll talk about revenue recognition principle very briefly. I will discuss how to handle irregular items such as discontinued operations. And key to this chapter is actually practice, preparation of multiple step income statements as many times as possible. As was mentioned before, repetition is extremely important in financial accounting classes. Once we cover Chapter three, we will start preparing for our first exam. As you know, Exam one is based on the first three chapters and one of the tasks would be preparing multiple step income statement. Let's begin. Income statement is prepared a statement number one, as you know, before we continue to other statements such as retained earnings statement and classified balance sheet. In the United States for capital market participants and users of financial statements, income statement is actually a statement that is used before any other statement to evaluate past performance of a company, it also provides basis for predicting future performance. Information reported on the face of the income statement also helps investors assess the risk and uncertainty of achieving future cash flows. Although we prepare financial statements on accrual basis, which means we do not wait until cash is received or paid, we recognize revenues when performance obligations are satisfied, and we recognize expenses when they are incurred. There is still positive correlation between net income numbers reported on the accrual basis and actual cash flows and outflows. Income statement information is useful. The correlation between net income and cash flows is not necessarily 100%. It's highly positive, maybe 85% correlation, but it's not perfect because the timing is not the same. When we sell goods, perform services on account and expect clients to receive cash, there is usually two to three months gap between when we recognize revenue on account and cash received. Thus, there is an important um predictive ability that net income figures have for future profitability and cash collection of a company. But this correlation is never perfect, something to keep in mind. Allow me to continue to the next slide. Income statement, although this is the statement we look at number one for analysis purposes, also has some limitations. For example, items that cannot be reliably measured usually bypass income statement. Good examples would be reputation, change in the value of reputation of a company. For example, the society has noticed that some company reputation has improved over time. Can I recognize gain on improvement in reputation as part of the income statement? And the answer is no. No. This may be noticeable. This may generate future higher revenues, but this is something we will not record. So there are essentially certain unrealized gains and losses that bypass income statement and are not going to be part of net income for the period. Obviously we are very well aware that every company's income numbers, net income are subject to at least some manipulation, and some of that manipulation is allowed by accounting standards because accountants have discretion on which accounting approach to adopt. For example, it's a very well known fact that depending on which depreciation approach we choose for our property plan and equipment items, straight line approach, accelerated some of the digits approach. Those would be discussed in the future in Chapter ten. Our depreciation expense, one of the main line items of the income statement will go up or down depending on which approach we use that's affecting net income for the period. So there is some discretion and judgment that are allowed by accounting standards that typically allow companies or accountants to manipulate income numbers to a certain extent. Also, obviously we are aware of corporate scandals, where by management would be involved in intentional manipulation that goes beyond any accounting standards and allowed judgment. That is considered accounting fraud. Nevertheless, it's all about net income figures. We call those bottom line figures and earnings per share. EPS is an important ratio that is computed on the basis of net income. On a quarterly basis, financial analysts issue forecasts regarding what EPS will be, what net income for the period will be. Companies are extremely interested in meeting or beating analysts forecasts. Analysts expectations because it's been noticed that if a company performs better than what the analysts predict, share price will go up by a significant percentage, and then on the other hand, the company misses on analysts forecasts on net income and EPS, share price declines. That's why net income and EPS are such important business indicators. Also some income measurement, some line items on the income statement involve judgment. Like I said, example would be bed debt expense. This is a judgmental figure, but bed debt expense is always a material line item on the face of the income statement. Essentially, it allows management to report higher or lower net income for the period depending on what the purposes for the current period. What are the main elements of income statement? And by the way, income statement is prepared in what we call a condensed format. Condensed format means there is a minimal number of useful line items, essentially income statement of a large public corporation, such as Apple, Microsoft, or Amazon would feed one page or even less. So that's a very, very short or condensed format. It doesn't mean that this is not an informative format. It actually has all important intermediate components, totals and subtotals that investors would like to see. Where do we learn about how those subtotals and totals were computed? What constitutes those important intermediate components? Well, those are disclosed and provided details on in the notes to the financial statements. There will be volumes of information disclosed for each line item of the condensed income statement. But it's a generally accepted presentation order in the United States. Income statement must follow multiple step presentation format and be condensed. Obviously, the spotlight is on revenues. It's the top section of multiple step income statement to remind definition of revenue. It is an inflow or enhancement of assets of an entity or settlement of liabilities during the period. Revenues originate from producing goods, rendering services or other activities that constitute the entity's ongoing major or central operations. Examples would be sales revenue. Of course, this is line item number one. There could be other types of revenue and we'll discuss a little bit later how to report in which section of income statement to report, those other types of revenue such as interest revenue, dividend revenue, rent revenue, and some other types of revenue. Expenses must be matched with revenues. I remember our matching principle discussed in Chapter one, one of the fundamental principles we use to prepare financial statements. Expenses must be recognized in the same reports in period as revenues that they help to generate, essentially, to avoid the cutoff error. Expenses to remind represent outflows of resources as a result of settlement of liabilities or producing goods one of the major expense line items, highly material would be cost of goods sold, cost of goods sold line item should be matched with revenues. What are other expense items that are material? Those would be depreciation expense. There may be interest expense, almost always the case that companies would borrow certain amounts from financial institutions, salaries and wages expense, rent expense, and of course, income tax expense, and there may be more items in our exercises. So those are important expense items that are highly significant. But that's not all. Besides revenues and expenses, we may or may not have certain items that are non routine transactions. We call them one time or irregular items. Those are gains and losses. On the face of the multiple step income statement, gains and losses must be clearly separated from revenues and expenses and reported in the lower portion of the multiple step income statement. Gains are also increases in equity or assets or net equity or assets, but they are not result of everyday operations like revenues. Gains are one time events. And given reporting period, a company may or may not have any gains reported. So there will be some variation in the income statement because gains are not always present. Revenues are always present on the income statement, but gains are not. Example, gain is a result of compensation received by a company from insurance company for some event. So this is a one time event, and let's assume that settlement was very significant, higher than what was expected by a company. So it's a positive inflow of resources, but it has nothing to do with a company selling goods or rendering services. Um, losses are very similar to gains except for the resulting outflow of resources, but they're also one time transactions. Obviously, again, there may or may not be losses reported at all in a given reporting period. Example would be lost due to an earthquake, lost due to fire as in the case of California based businesses. Not so long ago, as well as loss due to strike, employee strike whereby, significant losses are reported. Gains and losses from sale of investments, gain or loss on sale of property plan and equipment, write offs of assets due to impairment. These are rare events. At best, they happen once a year, maybe even less frequently. The bottom line is that they have to be clearly distinguished from revenues and gains and reported separately in a separate section of the multiple step income statement. Multiple step income statement separates operating transactions from non operating transactions. It closely matches revenues with related expenses. We highlight intermediate components of the income statement, such as gross profit, operating income before income tax. Those intermediate components are extremely useful for investors because they compute various ratios, financial analysts issue forecasts, not only on the bottom line, net income and EPS, but also on those intermediate components, and companies are interested to meet expectations of the Wall Street professionals on those various benchmarks. Here is a wonderful presentation of multiple step income statement and the US Gap, multiple step income statement of Cabrera Company for the year ended December 31, 2025. What are those important intermediate components? You can see that first of all, this income statement perfectly fits in the page, maybe even less than a page, and tons of details would be disclosed in the notes to the financial statements. Our main upper component of the multiple step income statement is simply revenues minus cost of goods sold. Revenues minus cost of goods sold gives us our first intermediate component, essentially gross profit for the period. Within the revenue section, we don't just report gross revenue generated, but we also report any sales discounts, sales returns and allowances. Essentially, there is always percentage of customers who would return goods to the store or request refund for quality because they would claim that goods and services were not of adequate quality. This is what we call sales returns and allowances and discounts. You can see that these items reduce gross revenue that was originally generated. Net sales is simply gross sales revenue minus any returns and allowances and discounts. Cost of goods sold is Net sales revenue minus I'm sorry, cost of goods sold is an important expense item. I would say the major expense item that must be closely matched with that net sales figure. Gross profit is simply net sales minus cost of goods sold. Here you don't see any percentages computed, but typically we look at gross profit margin as well. This is not so much of concern for our course. It's mostly for financial statements, analysis, discipline. We then report operating expenses, we call them SG&A, selling general and administrative expenses, and we'll take a look at what typically falls under this category. Again, on the face of the condensed multiple step income statement, this is all reported in a very short format. There is only one line item for selling expenses, one line item for general and administrative expenses. But those are, you know, hundreds of thousands of transactions during the reporting period. In the nos of the financial statements, typically a company, Cabrera company, would provide a breakdown for us regarding what exactly they include in selling expenses, and what's their accounting policy to recognize general and administrative expenses. Gross profit for the period minus SG&A gives us income from operations. Income from operations $186,073, in this case, is considered a second intermediate component. Again, if we wanted to, we could compute operating margins, but this is not our task. Financial analysts and investors would probably somehow analyze performance based on income from operations margin. We then continue to the lower portion of the multiple step income statement, which is those non routine items, other revenues and gains. In this case, in this example, Cabrera Company received dividend revenue, meaning that the company had investment in some other companies, share capital and there was dividend revenue received. Dividend revenue is a one time event. It's a non routine transaction. We cannot report dividend revenue after sales revenue. This is considered a revenue. Were there any gains, it looks like the company also sold equipment, liquidated property plan and equipment with a gain. A very infrequent event. We don't sell our factories, warehouses, and office buildings or machinery often. Gain on sale of equipment will be reported as other gains. What about other expenses and losses? Did company have any? Looks like there was interest received interest incurred, I'm sorry on bonds and notes, and there was loss due to flat. All of those are infrequent events that result in outflow of resources and must be reported separately from major expense items, such as cost of goods sold and operating SG&A expenses. Income before income tax is simply income from operations plus or minus those non routine items, gains and losses, other revenues and expenses. Income before income tax is 231,423. We should not forget to subtract income tax expense minus income tax expense gives us net income for the year 164,489. This is not all. It's mandatory for us to compute EPS, earnings per share of common stock is simply our net income for the period minus number of shares of common stock outstanding. Looks like the company had 100,000 shares of common stock outstanding. EPS is $1.64 per share of common stock. Do I know whether it's a good indicator or bad indicator given this company's financial statements and reporting period? Actually, I don't. I need some benchmarks. I need to know, first of all, what the financial analysts predicted regarding EPS. Was the company's reported EPS $1.64 higher than what financial analysts predicted or not? Or the company missed on predicted EPS. Did the company perform better than the industry average in terms of EPS? Did the company improve its own EPS over time, over the last three years? These are important questions that investors can learn about when they look at financial statements, not the financial statements as well as financial forecasts. Excellent format for multiple step income statement. This is what we will need to prepare in our exercises and also Exam one. Here is a good example of what would constitute SG&A, selling general and administrative expenses. Those could be dozens of line items disclosed in the notes to the financial statements. Again, on the face of the income statement, we would just report couple of line items. One for selling expenses, another one for general and administrative expenses. In the notes to the financial statements will provide a breakdown. For example, selling expenses would include sales, salaries and commissions, travel and entertainment expenditures, advertising expenses, shipping supplies and expenses. Those are very common items to be reported here. General and administrative expenses represent depreciation of administrative buildings, stationery supplies and postage, office supplies, office salaries, and other related items. All right. So we're still working with Cabrera Company, and we already looked at certain items that the company reported in the lower section of the income statement, such as gains and losses. Gains and losses to remind are unusual and infrequent in nature. This is how you recognize these items when you read the problem and you have a task of preparing multiple step income statement. These items typically have high degree of abnormality. They happen very infrequently, perhaps once a year, maybe less frequently. This is how you recognize them from the description. Again, repetition is important. Once you prepare three or five multiple step income statement, you really don't ask yourself anymore whether certain item is a major type of revenue or expense or is it actually an unusual gain or loss? Examples of unusual and infrequent items, as I mentioned, would be losses on write down or impairment of assets, such as property planning equipment, receivables, intangible assets, any restructuring charges, any effects of strike, earthquake, fires, floods, those are easily recognizable. Already. EPS, there is a formula that never changes for earnings per share, that important indicator against which we compare performance of a company for the purpose of evaluating whether or not company did better than what was predicted by financial analysts. Earnings per share is computed as net income for the period minus preferred dividends, dividends on preferred stock, if any, preferred stock is not even issued by any company. Essentially preferred stock is rare. In a problem, we need to look for information about preferred dividends. Common stock dividends are not subtracted from net income for the period, common stock dividends are simply ignored. For the purpose of this formula. In the denominator, we have either end of year number of common stock outstanding shares outstanding, or weighted average number of common stock shares outstanding, if that number changed. In this case, it would be simply the average of opening balance and closing balance number of shares of common stock outstanding. Example of computation of EPS for our Cabrera corporation, it had 100,000 shares of common stock outstanding, and there were no preferred stock dividends declared. So what would be EPS? Net income minus zero preferred stock dividends divided by 100,000 shares of common stock outstanding. $1.64. What if the number of shares of common stock changed during the period? Well, let's take a look. Cabrera has 100,000 shares of common stock outstanding on January 1, and issues another 100,000 shares on July 1. What would be the weighted average number of shares of common stock during the calendar year? Well, it's simply the average of what the company had at the beginning of the year 100,000 and what it had at the end of the year, 200,000 shares of common stock in total. Thus weighted average number of shares of common stock is 150,000. EPS changes. It goes down to $1.10 if additional shares of common stock were issued during the reporting period. Another example of EPS computation, the company reports net income of 350,000. Preferred dividends were declared in the amount of 50,000. Number of shares of common stock didn't change. It was 100,000 shares. How do we compute EPS? Well, the only difference with the previous example is that we shouldn't forget to subtract preferred dividends of 50,000. EPS of Lancer corporation is $3 per share of common stock. Now, what is the difference between a single step income statement that we prepared before and multiple step income statement? Single step income statement is unlikely to be used by large public companies, but small businesses, so proprietorships, partnerships are very welcome to use the simplified format. Single step income statement does not imply that one type of revenue or expense has priority over another one. Basically, all we do is we take all the revenues, regardless of the nature, subtract all the expenses to compute net income for the period. This is single step income statement of the same company, Cabrerav Corporation. Keep in mind that net income does not change. It's the same number, just like EPS, regardless of which format the company uses. You're simply relocating revenues and expenses to different sections, but net income is still the same. Net income is still all the revenues minus all the expenses, gains and losses. It doesn't matter which format we use. Format does not give us any opportunity to manipulate net income for the period and show higher all over net income based on the format. EPS is still $1.64. This is just a simple review question. Separation of operating and non operating activities exists in which type of income statement. Both multiple step income statement, a multiple step, but not a single step income statement is obviously the correct answer. What are other unusual or infrequent items that we may or may not report if there is such information presented in a problem, then we need to think about how to report those items. Those would be discontinued operations. Discontinued operations typically represent highly material or significant items that cannot be ignored. In a problem, if we have information about discontinued operations, then we have to prepare essentially another section, extra section in the lower portion of the income statement. Discontinued operations occur when two things happen. First of all, a company eliminates the results of operations of a component of the business. Example would be selling a foreign subsidiary producing unique goods. That would be considered discontinued operations. And the elimination of a component of business represents strategic shift, having major effect on the company's operations and financial results. If these two conditions are met, then we have to recognize discontinued operations as a separate section in the multiple step income statement. We will simply insert another section in the lower portion of it. Discontinued operations, reported net of tax, whether those are gains or losses. Let's take a look at an example and then we'll practice. Multiplex Products, highly diversified company decides to discontinue its electronic division. It means that the company decided to sell its electronics division. During the current year, the division generated a loss. That's a result generated by discontinued operation, 300,000 net of tax. The company was able to sell this division at the end of the year at a loss of half 1 million net of tax. Keep in mind that both of these numbers could be gain. A discontinued division could have generated gain. Company could have generated gain from selling of discontinued division. In this case, we had both of those amounts reported as losses. Multiplex determines that the electronics division discontinuation means strategic shift criteria. Thus, we have to create separate section in the financial statements, and its assets are highly significant, 20% of total company's assets. So yes, it's an important business event that doesn't happen often. What do we know about this company? Well, income from continuing operations was 20 million. What would the income statement look like? The lower portion of the income statement? What would be your advice to Multiplex corporation regarding how to report discontinued operations? This is how we would do that. We would report income from continuing operations. This is, by the way, partial income statement, only the lower portion of the income statement. Income from continuing operations, $20 million as given. I would insert an extra section called discontinued operations. I would report gain or loss from discontinued operations net of tax. In this case, we had losses, 300,000. I would also report gain or loss from disposal or selling that electronics division net of tax half 1 million. There was total loss due to discontinued operations of 800,000. My net income for the period is no longer just 20 million. It's 20 million minus net result. From discontinued operations, 800,000. Net income would be $19.2 million. Here is where I would see my discontinued operations in the multiple step income statement. The upper portion is what we've seen before for Cabrera company. Now it's a different company, but nevertheless, income statement, upper portion looks very similar to what we saw for Cabrera Corporation. We have sales revenue, net sales revenue minus cost of goods sold gives us the first intermediate component called gross profit. Minus SG&A, selling general administrative expenses gives us income from operations, half 1 million. That's our upper portion. Looks like the company had other items infrequent and nature, other revenues and gains, other expenses and losses. Thus, income before income tax was 460,000 after we consider those infrequent items. Income tax should be subtracted, which gives us income from continued operations of 276,000. Now I will have to insert extra section called discontinued operations, where I would report those gains or losses due to discontinued operations, and my net income for the period is 240,000. I will have to compute EPS several times. If I have discontinued operations. If I only have net income without discontinued operations, then there will be only one EPS. Information for per share of common stock is my EPS disclosure. I would compute EPS based on income from continuing operations. What is that component, 276,000. Then I would compute my EPS based on discontinued operations, and finally, the very bottom EPS would be based on net income for the period. We'll practice. Don't worry. We'll take a look at how to compute those various EPS components. Alright. There could be different situations with discontinued operations, as we mentioned. There could be gain situations, there could be loss situations. Let's take a look at the gain situation once again. Beasley Enterprises has income before income tax of 250,000. It has a gain of 100,000 from a discontinued operations, and income tax is 30%. Advise the company what the lower portion of the income statement will look like. That's a partial income statement that we are preparing. Income before income tax, 250,000 -30% of that amount. 75,000 gives us income from continued operations after tax, 175,000. Total again on discontinued operations, 100,000 minus related tax effect. These operations are reported net of tax, gives us net gain on discontinued operations of 70,000. Finally, net income for the period is income from continued operations after tax, 175,000 plus gain on discontinued operations, net of tax, 70,000 gives us 245,000. What if a company reported loss instead of gain, how would the presentation of the lower portion of the multiple step income statement change? The only difference would be that we would subtract 70,000. Nevertheless, losses on discontinued operations must be also reported net of their tax effect. If total loss due to discontinued operations was 100,000, I would need to subtract a related income tax effect of 30,000 given a 30% income tax rate. Loss on discontinued operations, net of tax effect would be 70,000. That's the only difference between how you report gain or losses. All right, comprehensive income. Let's take a look at, you know, a different topic, but is nevertheless reported to usefulness of income statement. Comprehensive income represents not only all the revenues, expenses, gains and losses, but it also represents gains and losses that are not part of income statement. They bypass income statement. We call these items or elements other comprehensive income items. So how since they bypass income statement and are not part of computation of net income for the period, do we need to report or disclose those items to our investors? And the answer is, yes, we should because some of those items are highly material in nature. I mean, the total dollar values are really significant. Although they are not part of net income computation, investors would like to see what those unrealized gains and losses are that bypass income statement, that may potentially become realized gains and losses. And we have a couple of choices. It's choice, it's up to a company, it's up to its accounting policy, how to report such items. We can prepare one combined statement where we show unrealized gains and losses after computation of net income for the period. Or we can simply prepare two different statements. One would be our regular multiple step income statement finishing with EPS, and another one would be the one showing unrealized gains and losses that bypass income statement. All right, so this was our income statement that we saw before, sales revenue minus cost of goods sold, minus operating expenses, gives us net income for the period. Up until this line item, it's our multiple step income statement prepared in a very condensed format. And then the company, if it had any unrealized gains and losses, would prepare a separate statement. Net income for the period plus or minus unrealized gains and losses gives us total comprehensive income. What are the examples of unrealized gains and losses? Well, let's assume a company purchased Investments, shares of common stock of another company for 100,000 during the year. Investments are allowed to be recognized at market value. This is the only departure from historical cost accounting. All right, so we spent 100,000 on investments. We purchase shares of common stock of another company that is performing very well. We anticipate that share price goes up, so our investment will increase in value. Indeed, at the end of the reporting period, we realize that market value of those shares of common stock of another company is 130,000. Thus, there was gain of 30,000 generated for those investments, but I haven't sold investments yet. Can I report gain or loss as part of the multiple step income statement? No. In the face of the multiple step income statement, we only realized gains and losses, realized gains and losses are the ones that have happened during the reporting period. I haven't sold my investments yet. I still keep them on the balance shere, but I have to somehow show to my investors that market value went up, my investments appreciate it, and I have the right to recognize them at market value at 130,000. So what should I do with this gain of 30,000 in value of marketable securities? I will recognize them as other gains, 30,000. Alrighty. A little bit more about retain earnings. Retained earnings question was discussed before. It's essentially our opening balance plus net income for the period minus dividends declared, if any, gives us closing balance. All right, this is what we discussed up to date or so far in Chapters one and two. Now, we will need to expand this topic a little bit. Retained earnings balances may be affected by some other irregular items or events that are also infrequent in nature. So our task is now to take a look at the fifth line of the retained earnings statement that may or may not be there because it all depends on what happened during the reporting period. Here is the retained earnings statement before any unusual items. Let's take a look. The company prepares retained earnings statement before it discovered any mistake. Opening balance was 1,050,000 plus net income for the period minus any dividends declared. CAR dividend stock dividends gives us closing balance as of December 31 of 1,110,000. And then it says that the company discovered a mistake. And let's assume it's a material mistake. $50,000 related to inventory recording was discovered. The mistake was a prior period mistake. How do I know that? Well, a written earnings statement on this slide is for 2025, and it says the mistake was actually 2024 mistake. This is what we call prior period error. What was the impact of this error on financial statements? As a result of this error, cost of goods sold were higher and net income was lower in 2024. Once the mistake is corrected, net income should be higher and cost of goods sold should be lower. So how do I correct this prior period mistake? I don't have to go back and restate my income statement and cost of goods sold for 2024. No, that's not uh required. Unless you have numerous prior period mistakes, you don't have to restate your prior period financial statements. Instead, you would have to adjust opening balance for retained earnings. This figure 1,050,000 because it already incorporates net income for 2024. So how do I do that? The correction of prior period mistake will require adjustment of the opening balance for retained earnings in the period in which mistake was discovered. I will simply subtract $50,000 and restate or adjust my opening balance for retained earnings. Oh, I'm sorry, I would add, net income should have been higher. My apologies. So my restated opening balance retained earnings is no longer 1,000,050, it's 1.1 million. Everything else stays the same. I would add net income for the period and subtract two types of dividends the company declared, namely cash dividends and stock dividends. So my closing balance for restated retained earnings is 50,000 higher than it was before I discovered prior period mistake. All right, statement of stockholders' equity. When we prepared classified balance sheet in Chapter two, we looked at a very simple presentation of stockholders equity section. We only had common stock and retained earnings closing balance. Back then, when we covered that chapter, I said, Well, for now, let's focus on these two components of a classified balance sheet. But that's not all that a company may potentially report. What else would you see in stockholder securities section of the balance sheet? Well, potentially, you would see those unrealized gains and losses that bypass our income statement. In my example, those were marketable securities that appreciated in value over the reporting period by $30,000. They are unrealized gains and losses. They bypass income statement, but they still have to be credited to something other than gains. What we credit is actually stockholder securities section of the balance sheet. If we have such unrealized gains and losses, then we need to create an extra line item in the equity section. It's no longer just common stock and retained earnings closing balance. It would be other comprehensive income items where we would report any changes in those gains and losses during the period. You can see how this was done. Unrealized gain was 60,000. At the beginning of the year, marketable security is further appreciated by 40,000. So the unrealized losing balance gain is 100,000. So that's just a generic example given this problem on the slide. Thus, for this company off brand incorporation, equity section of the balance sheet will look a little bit different than what we've seen before. It would have common stock of 300,000 reported, closing balance for retain earnings, 160,000 reported, and it will also have other comprehensive income at the closing balance of 100,000. It's just a departure from the previous presentation of the equity section of the balance sheet that we've seen in Chapter two. All right, here's what the balance sheet will look like, common stock, retain earnings closing balance, accumulated other comprehensive income, which is those unrealized gains and losses, 100,000. Although they bypass income statement, these items cannot be ignored. These items cannot be ignored. They're still part of our reporting process and of our financial statements. But instead of crediting gains, because we haven't sold those investments, we cannot credit gains. This is not a realized gain yet. We will credit equity section of the balance sheet, particularly an account that is called other comprehensive income items. All right. Just a couple of items regarding our revenue recognition principle, we now have a new standard, beginning from 2018 onwards, companies were given five years to apply a new standard. There is a converge standard between IFRS and USGAP, meaning that we now recognize revenue transactions in a universal way almost globally, revenue from contracts with customers is the title of the standard. You work a lot in detailed manner with the standard in intermediate accounting, too. Of course, which is why I'm not spending tons of time in intermediate accounts in one. We just need to mention a few items from the previous chapters. First of all, revenue is recognized when performance obligation is satisfied. Regardless of cashes received or not from a client, we typically give our customers two to three months to deliver cash in exchange for accounts receivable. Also, there remain five steps identified in revenue with Contracts from contracts with customers, a new standard. We need to identify the contract in a written form. That contract has to be broken down into different performance obligations. Step number three is very challenging. For some industries and businesses, we have to take the total price for products or services we charge our clients and apportion it or divide it in a certain proportion across different performance obligations. So that's not very straightforward task. And then we would recognize revenue, step number five for different obligations separately. That is, although you sell one product or one type of services, but there are multiple components to a contract, you'd have to make several journal entries for revenue, and those could be of different timing as well. Example would be airline industries that sell airline tickets to us and there are some bonus points attached. While a company would have to perform some kind of airline company would perform some kind of estimate for the probability of those bonus points to be redeemed future for a ticket, and they will not recognize revenue in total immediately. They will wait until future reporting period. So some part of your price you pay for air ticket will have to be apportioned to those bonus points and will be recognized in a later reporting period when bonus points actually expire. Quality of earnings is very important. Like I said, the income statement statement number one that is scrutinized or analyzed for a potential performance and future cash flow and profitability of a company by a financial analyst, investors, credit providers, and other interested parties. We know it's not a secret that every company would be involved in some earnings management. Managing income, managing earnings is the same thing, meaning that companies would try to overstate their revenues and understate their expenses to show higher net income for the period. Why is this the case? Well, there is almost perfect positive correlation between those net income and EPS figures and share price. The company shows growing net income for the period, meets analysts expectations, meets or bids, analysts expectations on EPS ratio, there will be share price increase. Otherwise, there will be a share price decline. Well, earnings quality is reduced when there is substantial amount of earnings management. Information becomes less useful for predicting future earnings and cash flows. Earnings management is very difficult to detect in accounting research. We have some models. You don't need to know about those. We use econometric techniques. We call them accrual based models to detect presence of earnings management on average across a sample of companies. But for a given specific company, it's very difficult to do. Unless the extent of earnings management is so obvious that it's clear for everyone it's actually accounting fraud. Alright, so earnings management is not just an accounting technique. There is something that we call real earnings management, which is simply planning planned timing of revenues, expense, gain and loss activities to smooth earnings, to smooth earnings and achieve certain targets. So it's not necessarily accounting techniques that companies use to manipulate net income for a given period. For example, I can defer shipment or ordering supplies, you know, into January from the previous December. That will give me lowers, you know, a supplies expense, potentially, or I can defer some other types of expenses. I can also relax my credit policies and more goods will be purchased, meaning higher revenue. Relaxing credit policies means there will be more bad debt expense as well, but that would be in the future period, not in the current reporting period. So essentially, companies use variety of techniques to somehow alter their net income for the period. There are three other items we need to take a look at that may or may not affect our income statement as well as retain earnings statement. They are not to be confused with each other. The first one is called changing accounting principle. Changes in accounting principles are rare, they are suspicious and they raise red flags. They are not always unjustified. So essentially, initially, they may raise red flag, but the company has to explain to market participants why they change their policies. Changing accounting principle is also called changing accounting method. Example would be a company changing depreciation approach after a number of years from straight line to accelerated. That would completely change presentation of the income statement on the part of depreciation expense, and presentation of balance sheet on the part of property plan and equipment or asset section. So that's suspicious. Why would you do that? If it changes your financial statements, makes them inconsistent, incomparable, throws you out of the balance. You have to explain in the notes to the financial statements or somehow else as a company, why you're doing that. From the accounting standpoint, how do we treat changes in accounting principles? They require retrospective adjustment, but you don't have to go back to all the previous periods where you used an old method once you switch to a new method and restate your financial statements. No, we will simply compute the cumulative effect of the switch from the old standard to the new standard, and we will restate our opening balance of retained earnings for the cumulative effect of the change or switch from one approach to another one. Besides depreciation, good examples would be changing cost flow assumption for inventory items. For example, from FIFO to average cost approach. We discussed inventory in the third part of our course so don't worry too much about what that means. I'm just letting you know that presentation of financial statements on the part of inventory would be very different and cost of goods sold figure will also be affected in a particular way, changing our net income computation, as well as rise to a different EPS than would be predicted otherwise. Change from percentage of completion to completed contract method for revenue recognition is also problematic. The point is that companies shouldn't make such changes very often. Switching back and forth from one approach to another one is a huge red flag. Companies do that rarely. It doesn't mean that it's unjustified. You have to explain why you are doing that and make an appropriate accounting adjustment. Here is a good example. Company changed its inventory method. Guber decided in March 2025 to change the method of recording inventory and related cost of goods sold from five foot to weighted average inventory pricing. Income before taxes under the new approach in 2025 is 30,000. Mm hmm. All right. So under the old approach, which was 54, what would be the impact the income? It would have been 40,000 in 2023 and 30,000 in 2024. In this case, when we switch in March 2025, we only have two prior periods, 2023 and 2024. Obviously, in real life, there could have been more. What's the cumulative effect of switch from five foot to weighted average when it concerns income? Well, the cumulative effect is 8,000. Given the tax rate of 30,000, what kind of um essentially impact would we have. We would have higher net income, obviously under 54, but we don't have to go back and restate financial statements for 2023, 2024. Instead, we'll have to make adjustment to opening balance of retained earnings for the cumulative effect of switch, which is 8,000. That just shows us what net income essentially would have been. Another item that is not to be confused with change in accounting principle that we just discussed, change in accounting estimate. It's a different item. It's also one time item or infrequent event that doesn't happen every year. For example, I changed my um, estimated useful life for property plan and equipment. Or I changed estimated salvage value for property plan and equipment. I changed allowance for uncolectible receivables. So this is not the approach or method. It's actually my judgmental figure that changes. What should I do? What's the accounting treatment? First of all, what's the market reaction to change accounting estimate? I would say it's less adverse and less suspicious than changing accounting principle, but it's still a little bit problematic. Again, a company would have to disclose in the nos the financial statements what causes such a revision in estimated useful life of equipment, salvage value or anything else. Why are you changing the numbers so much? What's the accounting treatment for changing accounting estimate? There is no requirement to go back and restate prior period financial statements or retain earnings balances. You don't have to do anything retrospectively. Prospective we will simply recalculate our net income figures I'm sorry, based on new numbers. Let's take a look at a good example related to change in accounting estimate. DuPage materials corporation consistently estimated, but that expands as 1% of receivables. Essentially, based on the prior history, the company believed that 1% of receivables would not be collected in cash. In 2025, the company determined it must revise upward the estimate of but that's for accounts receivable and it's now 2%. All right, so it means that more cash will not be collected in the future. Revision is made by a chief accountant based on their best judgment. They decided that more customers will not be delivering cash in exchange for accounts receivable. There is a big question, why you double your estimate for uncolectb debt? I have no idea. As an investor, this is not explained in any way. I'm looking for some kind of explanation. First of all, but that expense is a significant or material line item on the multiple step income statement. Now this line item will be double the principal amount. It's now 2%, but that expense reduces net income for the period significantly. Do I have to go back and restate financial statements before 2025 as if I had 2% of receivables non collectible? And the answer is no, you don't have to do anything with respect to prior periods when you change your estimate based on the judgment. However, my bet debt expense will now be different. It would be 2% of receivables outstanding for 2025 and what would be the journal entry I would make? Debit debt expense, credit allowance, doubtful accounts, our adjustinentr from Chapter 240,000 based on the new estimate of 2% of receivables. Do I have to make a change for the prior period? Absolutely not. Don't bother correcting financial statements for prior periods or don't correct retain earnings opening balance. You apply those changes in estimates prospectively from the period when they occur. Here period in which it occur is 2025. I'm essentially just recalculating but debt expense based on my new estimate of 2% of accounts receivable and it says it's 240,000. Alrighty. Correction of errors is the third unusual item. Again, that doesn't happen often that we discover mistakes related to prior periods, but it does happen. We only correct material errors, those that give us substantial difference to our decision making ability and presentation of financial statements. Mathematical mistakes could be one reason. There could be misapplication of judgment, misunderstanding of the accounting standard, the way it works, or oversight or misuse of facts, and there could be intentional mistake, of course, but this is very hard to prove that somebody made an intentional mistake. Nevertheless, how do we treat prior period mistakes once they discovered? Do we have to restate prior period financial statements that relate to that mistake? Not necessarily, but we have to make an adjustment to retain earnings opening balance for the period in which the error was discovered. Hillsborough in 2026, which is the current reporting period, determined that it incorrectly overstated receivables and revenue in 2025. For the purpose of 2026, 2025 is considered prior period. Do I have to go back and restate, you know, reaudit? I have financial statements reaudited for 2025. I'm not going to do that. So what happened? Revenue was overstated in 2025. Now I have to make a correction in 2026. Let's assume it's a material amount. But revenue from 2025 is part of retained earnings opening balance for 2026. So how do I make the correction for 2025? I will reduce retained earnings opening balance, Dabit retained earnings, 100,000 credit accounts receivable. Receivables were overstated in 2025. To bring them down by 100,000, I have to credit accounts receivable. This is how we correct prior period mistake. We don't have to restate income statement for 2025. In 2026, we will make this journal entry. Retrospective adjustment as required. Charge the impact of an error to opening balance retained earnings. Dabit retained earnings 100,000 credit accounts receivable. Let me stop sharing, and then let's take a look at what we have in the textbook. All right. So to summarize, Chapter three is an important chapter where we cover multiple step income statement. That includes several irregular items that we haven't seen before in Chapters one and two. What are those irregular items? Those are other gains and losses, other gains and losses, and discontinued operations, essentially. In Exam one, you can expect there is a whole problem that requires you to prepare multiple step income statement with discontinued operations. Plus, you need to know how to compute EPS earnings per share of common stock. While homework for Chapter three is extremely useful in this regard because we have those types of tasks assigned as well. But of course, we need to practice. We need to practice. Let's pick some exercises from Chapter three. Let's take a look at our textbook first. All right. Now I'm sharing my Wi plus account and I need my e book. Looks like I am on Chapter three, end of Chapter Practice resources. I have revision questions followed by brief exercises. Brief exercises are good for a start of practice if students feel completely lost. They don't see the difference between single step income statement, multiple step income statement. I would definitely begin with brief exercise 3.1 and continue down the list until your understanding improves. Solutions are posted on DTL for all of these exercises. Instead, let me move forward a little bit, a little bit to medium difficulty exercises such as exercise 3.5, preparation of multiple step income statement. Since this is our main topic in Chapter three in our main task, let's practice preparation of multiple step income statement. The way I will prepare it is I will basically type it in the Word document as I did before. But let's read the problem together. Let's see what's given and then we'll prepare multiple step income statement. 3.5. Two accountants for the firm of Elvis and Wright are arguing about the merits of presenting income statement in multiple step versus single step format. What is given, let's see, administrative expenses, office salaries and depreciation. Those are included in administrative expenses, cost of goods sold, rent revenue, selling expenses, breakdown is provided. We have delivery expense, sales commission, and depreciation of sales equipment. We also have information about sales revenue, income tax expense, and interest expense. Obviously, there are two related tasks. Prepare income statement in a single step format versus multiple step format, a multiple step format. We are all interested in a multiple step format. All right, so I'm going to stop sharing. Let me try to copy this, but I'm not sure if it will work into Word document because there are some restrictions that the publisher puts on how much you can copy. Let me try. No, it's not working. All right, so I will simply assume that students have exercise 3.5 in front of them. I'm going to share my Word document, a blank Word document. This is exercise 3.5. Multiple step income statement. Preparation and this is a common task for our Exam one, obviously. As before, headings and subheadings are very important. Essentially, presentation of financial statements gives us bonus points on the exam. This is bright company. Income statement is what we are preparing and what's the period? The period is the year ended, year ended as of December 31, 2025. Just to remind us we prepare income statement for the period of time, not as a certain date balance sheet, but for the period of time. All right. What do I see in this exercise if I look at it? I'm looking for all types of revenue, transactions and I see there is not transactions, I'm sorry line items. There is something that is called sales revenue. I will start with sales revenue. There is given in the problem. 96,500 straight from the problem. I'm looking for any information on cost of goods sold. I remember revenues minus cost of goods sold gives us gross profit for the period. This is what the upper portion of any multiple step income statement would look like. Cost of goods sold. It's actually the very uh important expense line item that has to be closely matched with revenues. And here comes my first intermediate component that I cannot skip no matter what, gross profit for the period, which is simply sales revenue. I'm going to help you with computation since it's our first practice example, sales revenue minus cost of goods sold. All right, so gross profit for the period is 35,930. I hope you agree with me. You're welcome to check, of course. All right. Sales minus cost of goods so gives me gross profit for the period. This is my very first intermediate component of the multiple step inical statement. Now I will continue to operate in expenses called SG&A. I'm looking for information about selling, general and administrative expenses. So I think I have some important breakdown of selling expenses provided in a problem and Wa those sales commissions, 7,980. So I'm just copying those numbers, not inventing anything. What else constitutes my selling expenses, depreciation of sales equipment? 6,480, if I'm not mistaken. And there was another line item, delivery expense. 2690. All right, so I would definitely compute total selling for investors' attention for them to perform some kind of analysis of those G&A items, total selling expenses, 17,150. What about general and administrative expenses? I see something that is called administrative expenses given in a problem and I have officers salaries 4,900 and another item here, depreciation of office equipment. And furniture. Let me just put depreciation of office equipment and furniture, 3,960. Okay, total administrative. Total administrative expenses, 8,860. All right. So what do I have? I have gross profit. Going to highlight. I have total selling. I have total administrative expenses. Those are important components I will need. I can now compute income from operations. I do not see any discontinued operations, by the way, so I can continue to income from operations, which would be my gross profit for the period, 35,930 minus SG&A, income from operations, 9,920. Let me just double check. We need a calculator, but it should be a very simple calculator. As mentioned before, all we do in accounting, at least in this class is adding or subtracting simple numbers and rarely multiplying numbers. That's all we do. All right, so gross profit, 35,903. I'm checking my computations minus total selling expenses, 17,150 minus total administrative expenses, 8,860 gives me 9,920 of income from operations. All right. Now I'm continuing to those rare or infrequent items. I'm looking for any information about other revenues and gains. If any, if any, such items, looking for this type of information. I don't see any gains, but I see rent revenue. It means that the company is subleasing maybe or leasing some properties to someone else. Company for a company, it's not the main type of business, it's just they have extra vacant property and they decided to lease it rent revenue. What about other expenses and losses? Any such items? Let me see. I don't see any losses, but I see interest expense. Interest expense, only one item to be reported here. I don't see any losses. 1860. No, discontinued operations, meaning that I can continue to the next line item, income before income tax. Which is simply my income from operations from above 9,920 plus any other revenues and gains. I have only one item to report minus any expenses and losses, other expenses and losses. 25,290, please double check. Yeah, I think this is the case. Let's not forget about income tax income tax expense is given in this problem. Income tax. It says income tax expense is 9,070. And finally, my bottom line, net income for the period is income before income tax, minus income tax expense. 25,290 minus this income tax expense above gives me net income for the period of 16,220. This is my bottom line. Take a look and let me know by email if you have any questions. Net income for the period is 16,220. Perfect format for a condensed multiple step income statement. We had some infrequent and unusual items such as other revenues and expenses. We did not have any gains and losses. We did not have any discontinued operations either. Are we done? I don't think so. We need to compute EPS earnings per share of common stock. I will use the same formula as was given in the book, just to remind you, net income. Minus preferred dividends, if any, look for this information in a problem. Number of shares of common stock. Outstanding. No preferred stock, just common stock. All right, net income was just computed above 16,220, I do not see any information about preferred dividends declared, I assume those are zero, which do not subtract anything and number of shares of common stock outstanding. Let me check what it says in the book. All right. It says number of shares of common stock outstanding was 40,550. We do not consider preferred stock here in the denominator, only number of shares of common stock outstanding. So EPS is $0.40 per share of common stock. All right, so this is an excellent practice problem. You can skip single STEP income statement, which is part B, I think in this exercise. The bottom line is that when you prepare single step income statement, your net income should still be 16,220, and your EPS is also $0.40. The presentation will be different in that you would simply list all the revenues and subtract all the expenses, but net income and EPS do not change as a result of changing the format. All right. So let's just continue to the next page. I'm going to stop sharing. Let me get to our textbook. We are done with Exercise 3.5. Excellent practice problem. I would definitely prepare as many multiple step income statements at home as possible if I were a student preparing for Exam one. Now 3.6 is an excellent practice probably with few more items with few more items. So let's take a look at this one. Definitely, we'll have to consider additional items when prepare multiple step income statement, which is excellent because it's additional practice for us. Let's take a look at what's given interest revenue. We also have number of items that will not be part of the income statement because they don't belong there. They belong to the balance sheet. It's just given to confuse us. Cash is obviously not part of income statement. We have sales revenue. That's income statement, accounts receivable, balance sheet, prepaid insurance, balance sheet, sales returns and allowances. This is part of the income statement. Allows for doubtful accounts, that's balance sheet, sales discounts, income statement, land equipment and building, balance sheet, cost of goods sold, income statement. Depreciation, balance sheet, notes receivable, balance sheet, selling expenses, income statement, accounts payable, bonds payable, that's liability balance sheet, SG&A, administrative and general expenses, income statement. Accrued liabilities, that would be balance sheet, interest expense, income statement, notes payable, that's balance sheet, loss from earthquake damage, that's income statement, other losses, common stock outstanding. This is balance sheet, but we might use it to compute EPS, retain earnings. That's actually balance sheet. I assume total tax rate is 20%. Prepare multiple step income statement, 100,000 shares of common stock or outstanding. Similar task to the previous exercise except for we have more items. Why don't we prepare this Useful income statement together. I'm back to my working Word document. I'm just continuing to the next page. This is exercise 3.6. Again, multiple step income statement. But there are more items than what we've seen in the previous problem. I'm sorry. This is 3.6, not 3.5. 3.5 was solved above. What is the company's title, Alons corporation. We prepare income statement. Um, for the year ended December 31, 2025. All right. Again, I'm beginning with revenues, except for I have some other items to consider besides just gross sales revenue. Mm hmm. So let me start with revenues. I have sales revenue given. So all these numbers are straight from the problem that is given. Sales revenue 1,380,000. However, I need to consider sales discounts as well as sales returns and allowances. So I need to subtract any sales returns and allowances. Because they represent claims from investors. I'm sorry, from customers buy the return the goods. All right, sales returns and allowances, reduce our revenue by 150,000, and I can also see that there were sales discounts given. Sales discounts also represent reduction in originally recognized gross revenue. All right. So let me compute net sales revenue. Which is gross revenue above minus sales returns and allowances and minus discounts. 1 million 185,000. Net sales revenue, total sales revenue or gross sales revenue minus returns and allowances and discounts. All right, so net sales revenue. Now I'm looking for my main line item called Cost of Goods Sold. Where is it? I can see it. Cost of what sold is given as 621,000. And now I'm computing my very first intermediate component, gross profit for the period as net sales revenue above 1,185,000. Net sales revenue minus cost of goods sold. All right, so gross profit for the period is 564,000. Let me highlight it because I will use this further to compute net income. Gross profit. Next, operating expenses, SG&A. Let me give it a heading. SG&A, selling general administrative expenses. I see information about selling expenses as one line item, 194,000 and in general. These are all given. We are not inventing anything here, 97,000. Income from operations is my gross profit for the period above minus SG&A. All right. So income from operations is 273,000. Wonderful. We are done with the upper portion of the income statement, income from operations is gross profit for the period minus selling general and administrative expenses, 273,000. Now I'm continuing to the next portion, which is those unusual and infrequent items. ARN revenues and gains, looking for this information in a problem. Let me create this subsection A revenues and gains. If any such items were present during the reporting period, looks like I see one interest revenue. 86,000, so let's recognize this. I don't see any gains in a problem. How about other expenses and losses. Loss from earthquake damage. Is given as 150,000. Anything else? I see interest expense. That typically falls under the other expenses line item. I don't see anything else. So there was one additional revenue, interest revenue, and there were two outflows of resources loss from earthquake damage and interest expense. I can now compute I don't see any discontinued operations, by the way, so it's a good news for this exercise. Income before income tax. Is simply my income from operations, minus expenses, other expenses and losses, plus other revenues and gains. Income before income tax. What I have, you're welcome to check is 149,000. Again, this is income from operations, 273,000 plus other revenues and gains minus other expenses and losses. Income tax, don't forget about income tax. It's not given as a number, but we know what the income tax rate is, so we can compute it. It's 149,000 multiplied by 20%. It says income tax rate is 20%. 29,800 is income tax expense. And finally, net income for the period. Income before income tax minus related 20% tax expense gives us net income of 119,200. This is positive, which is good news. The company generated revenues. Mm hmm. I'm sorry, profits. Profits, not losses. All right, so another good quality exercise related to our exam one, obviously, and we should not forget about EPS. I'm using the same formula as before, net income for the period minus any preferred dividends divided by number of shares of common stock outstanding. Net income for the period. I don't see any preferred dividends, so I assume they are zero. Number of shares of common stock outstanding, the problem suggests was 100,000 shares outstanding. All right. So EPS is $1.19 per share of common stock. I would not round it further. I would just leave it like that. Two numbers after the dot, basically is what we typically need for the purpose of presentation of financial statements. Again, if there are no preferred dividends, do not subtract anything in the denomraator. On the other hand in the denominator, we have a number of shares of common stock outstanding, not preferred stock, not common plus preferred, common stock outstanding. We follow the formula for EPS precisely. We do not invent anything. All right. Let me stop sharing the screen with working and let me get back to our textbook. 3.6 has just been solved. 3.7, please attempt this problem on your own with a closed book. Format, layout of presentation of financial statements is extremely important. Obviously, on exam Wondra always bonus points given for professional presentation of financial statements. All those total subtotals, headings and subheadings and allocating items to the correct portion of multiple income statement are extremely important. Computation of EPS, you also need to know how to do that. 3.8, if you would like to practice further, income statement and EPS. That would be for your review at home. 3.9 is another excellent problem. I would definitely take a look at 3.10 at home. This is computation of EPS given preferred stock and common stock dividends. Practice that one, and I would like to continue to our topic which is discontinued operations. We haven't really practiced yet, so let me find some exercise. Discontinued operations. I think I've just seen this. All right. 3.8, income statement and EPS. Let's do it together rather than at home because it has some discontinued operations. There may be some things that trick you. Presented below is financial information for the year 2025 of Tucker Corporation. Let me see what I have cash administrative expenses, selling expenses, net sales. Most of goods sold, CARS dividends declared, CARS dividends paid, discontinued operations, discontinued operations, loss before income tax, 40,000, depreciation expense, not recorded in 2024, 30,000, retained earnings, effective tax rate, 20%, compute net income for 2025 and most importantly, part B, prepare partial income statement. Looks like we are preparing lower portion of multiple step income statement, beginning with a line called income from continued operations before income tax. And also include information about EPS. Assume that 10,000 shares of common stock were outstanding during 2025. This is also a typical candidate for the first exam, this type of problem, whereby you are given information about items, and you need to prepare partial income statement that has discontinued operations. So don't ignore this exercise. Partial income statement. With discontinued operations and multiple EPS numbers. Now that we have discontinued operations, we compute more than one EPS. That's what the textbook suggests we will have to compute EPS separately for discontinued operations. Let's take a look. All right. So this would be partial income statement. What's the title of the corporation? Let me see. Tucker Corporation. Mm hm. Tucker Corporation. It is a partial income statement. For the year ended, I believe it was 2025. Partial income statement means I need to somehow skip the upper portion of the income statement because this is not the topic that is tested, essentially. Let's take a look what's given. All right, so income from continuing operations. Operations before tax. This is a starting point. This is the lowest portion of the income statement. This is a starting point for this solution as suggested. All right. So income from continuing operations before income tax. I have to go back to the problem and compute this with you. Income from continuing operations before tax would be, let me grab my calculator. It's not given we have to compute it ourselves. Net sales, 540,000, minus cost of goods sold 210. I'm sorry, 210 minus G&A. I have administrative expenses, 100,000 and I have selling expense 80,000. All right. So my income from continued operations before income tax is 150,000. I'm going to explain this once again once I get to my working. All right. So I'm skipping upper portion of the income statement, but I still need to compute income from continued operations before tax based on that information provided. So this would be revenues minus cost of goods sold minus SG&A, selling general administrative expenses, based on the information that is given. This is 540,000 revenues -210,000 cost of goods sold, minus selling expenses, 100,000 minus general and administrative expenses, 80,000. All right. So income from continued operations before income tax is 150,000. Revenues, minus cost of goods sold, minus as GR. Now, I need to compute income tax for those continued operations, income tax income tax rate is given. This is what a multiple step income statement lower portion would look like if we have discontinued operations. 12% gives me 30,000. 30,000. Income tax on continuing operations only income from continuing operations. After income tax or simply after tax is 120,000. Before tax amount -30,000. All right. Now, I need to insert an extra section called discontinued operations. Discontinued operations. If any, and in this case, I do have discontinued operations. The problem says loss on discontinued operations was let me see. I think it was 40,000. Loss before income tax, 40,000. Mm hmm. But the textbook indicates I need to report all of these amounts, net of related tax effect. So if loss was 40,000, 20% tax effect would be 8,000. That is a loss net of tax effect is 32,000. I'm showing you how I computed this net of related tax effect, which is 20%. Total loss is 32,000 net of tax effect. And finally, I can compute my net income for the period, which is this income from continuing operations after tax. Minus loss on discontinued operations. So my net income for the period is 88,000. All right. This is what the lower portion of the income statement would look like if we have discontinued operations. Again, every single line item, the order of presentation, the way it's computed are extremely important, for example, and just in general, of course. And now I need to compute my EPS numbers. And because I have discontinued operations, I will have three EPS numbers. My EPS one would be based on income from continued operations after tax. My EPS two will be based on total net result of discontinued operations, and my EPS three will be based on net income for the period after everything after discontinued operations. All right. So EPS EPS one based on income from continued operations after tax, the same formula is followed. Net income. Sorry, this is net income, this is income. So I'm just repeating the formula. Be careful here. Here is the trick. I'll show you. All right, income minus preferred dividends, number of outstanding of common stock. So that would be 120,000. A no preferred dividends. So they are zero. Number of shares of common stock outstanding is 10,000, so EPS one is $12. Huge EPS, but who knows? $12. No sense. Just $12 per share of common stock. All right, EPS two. Here is what you need to remember. For EPS, that is based on discontinued operations, EPS, we do not subtract preferred dividends. That's just a departure from the formula for discontinued operations. Even if they were given, we would not subtract those preferred dividends. That's just mathematically correct. I'm just not going to rule it here. All right, so there is total loss on discontinued operations after tax 38,000 divided by number of shares of common stock outstanding gives us negative $3.20 because we generated loss on discontinued operations. And EPS three, again, I have to subtract preferred dividends. So don't forget. For the purpose of your voluto works, as well as exam one, we do not subtract preferred dividends when we compute EPS based on discontinued operations. All right, so net income was 80,000. No preferred dividends, number of shares of common stock outstanding is 10,000. So EPS three is equal to $8.80 per share of common stock. All right. So that's a requirement. We have to compute these three EPS. Figures per US GAAP requirements as well as for your exam. If not computing EPS or incorrectly computing EPS, computing one EPS instead of three, if you have discontinued operations, is a huge deal because it's the main financial result metric that market participants use to scrutinize performance of companies. How would you check yourself? That's just a hint for you. EPS three must be equal to EPS one minus EPS two. That's also mathematically. You can check that $12 minus plus or minus. Let me say plus or minus depending on whether you had losses or gains due to discontinued operations. Yeah. That's your check. That's how you check yourself. Yeah. All right. This is another excellent exercise for multiple step income statement. That includes discontinued operations, tax effect, as well as three EPS numbers. Excellent, perhaps problem. All right. For this particular topic, I'm going to save this and file, and slides are available on CTL, but I'll save the file with my workings. For this particular topic, what's important is practice. Solving as many problems at home from the textbook, pay attention to Wali homework that contains very similar exercises. Prepare multiple step income statement with discontinued operations, other gains and losses, other revenues and expenses and EPS. All right, please let me know if you have any questions, guys. Otherwise, good luck with Chapter three. Bye bye.