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17/11/2020 03:22:43 PM

Measuring Accounting Income

Revenues (and gains) and expenses (and losses) are the two major components of accounting income. This section discusses these two components. 

a.. Revenues and Gains

Revenues are earned inflows or prospective earned inflows of cash that arise from a company’s ongoing business activities. These include cash inflows such as cash sales, and prospective cash inflows such as credit sales. Gains are earned inflows or prospective earned inflows of cash arising from transactions and events unrelated to a company’s ongoing business activities. an example of a gain-specifically, a gain on sale of a discontinued segment. The distinction between revenues and gains is based on the ongoing business activities that produce revenues. Revenues are expected to persist indefinitely for a going concern. In contrast, gains are nonrecurring. This dis­tinction is important for analysis, especially when determining sustainable income.

Revenue recognition methods can significantly affect reported income. Revenue recognition is becoming more complex, as it is increasingly linked with e-commerce activity. It is also an area with minimal guidance from accounting standards. This permits opportunities for earnings management. Accordingly, analyzing revenue recog­nition practices is crucial in financial statement analysis. For this reason we devote a section to revenue recognition later in the chapter

b.. Expenses and Losses

Expenses are incurred outflows, prospective outflows, or allocations of past outflows of cash that arise from a company’s ongoing business operations. Losses are decreases in a company’s net assets arising from peripheral or incidental operations of a company. Accounting for expenses and losses often involves assessing the amount and timing of their allocation to reporting periods. Timing is a matter of when they are incurred, often based on matching them with revenues generated.

Another important issue is that of cost deferral (or multi period allocation). Accoun­tants capitalize costs whose benefits are realized over many periods. These costs are systematically allocated to future periods. In contrast, many costs are incurred in the same period in which they are recognized. (It is not necessary that cash outflows for expenses and losses occur at the same time they are recognized.)

AMBER CORP. AND SUBSIDIARIES

Consolidated Income Statement ($ millions)

2006 2005

2004

Revenues............................................

....$14,314

$12,716

$13,033

Cost of goods sold...............................

.... (8,270)

(7,454)

(7,943)

Grass profit..........................................

.... 6,044

5,262

5,090

Expenses

Selling and administrative..................

.... (2,964)

(2,478)

(899)

(1,016)

(2,396)

(855)

Research and development..............

.... (1,234)

Restructuring charge.........................

 

Interest expense................................

.... (725)

(715)

154

(654)

1,185

(355)

Income before taxes............................

.... 1,121

Income taxes.......................................

.... (336)

(351)

Income from continuing operations.....

.... 785

(197)

830

Gain from extinguishment of debt........

38

 

—

Loss from operating discontinued segment...............................................

—

0

(23)

Gain from sale of discontinued segment...............................................

—

—

66

Net income..........................................

....$ 823

$ (197)

$ 873

Foreign currency translation adjustments.........................................

.... 82

(54)

(31)

Unrealized holding gain on available-for-sale securities................................

24

22

6

Post retirement benefits adjustment....

.... 0

(4)

—

Comprehensive income.......................

....$ 929

$ (233)

$ 848