Chapter 4

| You Will Learn...

1. To define the concept of income.

C Income is a return over and above the investment of the owners.

C Two concepts can be used to measure well-offness: financial capital maintenance and physical capital maintenance.

2. To explain why an income measure is important.

C The recognition, measurement, and reporting of income is considered to be among the most important tasks performed by accountants.

C These measures are used to make business and economic decisions that result in the allocation of resources.

3. To explain how income is measured, including the revenue recognition and expense-matching concepts. The basic explanation is:

C Income is measured as the difference between resource inflows and outflows over a period of time.

C Revenues are recognized when the earnings process is substantially complete.

C Expenses are matched against revenues directly or are immediately recognized as a period expense.

4. To understand the format of an income statement. Remember:

C The income statement may be presented in a single- or multiple-step form.

C Regardless of the form, irregular and extraordinary items are disclosed separately to determine net income.

5. To describe the specific components of an income statement. They include:

C Most companies will report on some or all of the following income statement components:

< Net sales, cost of goods sold, gross profit, operating expenses, operating income, other revenues and gains, other expenses and losses, income from continuing operations before income taxes, income taxes on continuing operations, income from continuing operations, discontinued operations, extraordinary items, and cumulative effect of changes in accounting principles.

6. To compute comprehensive income and prepare a statement of stockholders’ equity. Some helpful facts to keep in mind:

C Comprehensive income reflects all changes in equity during a period except those resulting from investments by owners and distributions to owners.

C Comprehensive income is the number used to reflect an overall measure of change in a company’s wealth during the period.

7. To construct simple forecasts of income for future periods.

C An important use of an income statement is to forecast income in future periods.

C Most financial statement forecasts start with a forecast of sales. Many expenses maintain a constant relationship with sales.

| Important Points

Conceptual Framework of Income Measurement

An important objective of this chapter is to introduce a conceptual approach to alternative income measurement theories. Review the capital maintenance and transactions approaches as alternatives. Also, remember that the FASB must make choices among alternative theories or schools of thought. Finally, understand that income measurement principles that are currently GAAP are only compromises of the attributes of relevance and verifiability.

Income Measurement and Objectives of Financial Reporting

You will better understand the underlying rationale of income measurement if you relate elements of income to the objective of providing information for assessing cash flow prospects—amount, timing, and uncertainty. Specifically pay attention to the information content of elements such as operating and other income, extraordinary items, discontinued segments, cumulative effects of accounting changes, and prior period adjustments.