Classification and Format in the Income Statement Essay Example for Free

Classification and Format in the Income Statement Essay Investors commonly assess a firm’s value based on the firm’s expected future sustainable earnings stream. To inform analysts and other financial statement users about sustainable earnings, firms often report income from recurring business activities separately from income effects from unusual or nonrecurring activities (such as asset impairments, restructuring, discontinued business segments, and extraordinary events). To provide more useful information for prediction, U.S. GAAP (Generally Accepted Accounting Principles) requires that the income statement include some or all of the following sections or categories depending on the nature of the firm’s income for a period: †¢Income from Continuing Operations. Reports the revenues and expenses of activities in which a firm anticipates an ongoing involvement. When a firm does not have items in the second and third categories of income in a particular year, all of its income items are related to continuing operations; so it does not need to use the continuing operations label. Firms report their expenses in various ways. Most firms in the United States report expenses by their function: cost of goods sold for manufacturing, selling expenses for marketing, administrative expenses for administrative management, and interest expense for financing. Other firms, particularly those in the European Community, tend to report expenses by their nature: raw materials, compensation, advertising, and research and development. †¢Income from Discontinued Operations. A firm that intends to remain in a line of business but decides to sell or close down some portion of that line (such as closing a single plant or dropping a line of products) generally will report any income, gain, or loss from such an action under continuing operations. On the other hand, if a firm decides to terminate its involvement in a line of business (such as selling or shuttering an entire division or subsidiary), it will report the income, gain, or loss in the second section of the income statement, labeled â€Å"Income, Gains, and Losses from Discontinued Operations.† †¢Extraordinary Gains and Losses. Extraordinary gains and losses arise from events that are (1) unusual given the nature of a firm’s activities, (2) nonrecurring, and (3) material in amount. Corporate annual reports rarely disclose such items. Many firms have reported restructuring charges and impairment losses in their income statements in recent years. Such items often reflect the write-down of assets or the recognition of liabilities arising from changes in economic conditions and corporate strategies. Because restructuring charges and impairment losses do not usually satisfy the criteria for discontinued operations or extraordinary items, firms report them in the continuing operations section of the income statement. If the amounts are material, they appear on a separate line to distinguish them from recurring income items. Income, gains, and losses from discontinued operations and extraordinary gains and losses appear in the income statement net of any income tax effects. The majority of published income statements include only the first section because discontinued operations and extraordinary gains and losses occur infrequently.