Accounting: The Language of Business - Vol. 2 (Intermediate: Part 52)

Capitalism is in crisis both morally, due to widening disparities of income and wealth and disclosures of abusive practices, and ecologically, due to its refusal to make business adjustments in accounting procedures that pass the consequences of emissions to the public and the future.

Richard A. Falk

Statements of Net Income and Comprehensive Income (Part J)

by

Charles Lamson

Income from Continuing Operations

In this section, we review several line items from a multi-step income statement.

Income from continuing operations is income from portions of the business that are expected to continue into the future. Therefore, income from continuing operations does not include discontinued operations, which are portions of a company that have been disposed of or that are held for sale. Firms typically calculate income from continuing operations as the sum of three income statement items:

1. Operating income (Operating income is often referred to as "earnings before interest and taxes" or EBIT.)

2. Non-operating items of non-operating revenue/gains and expenses/losses

3. Income tax provision

 We discuss each of these items in the following sections. 

Operating Income

Operating income includes revenues and expenses from the entity's principal operations. Exhibit 5.12 presents a typical operating income section of the income statement.

EXHIBIT 5.12 The Operating Section of the Statement of Net Income

*Net sales revenue equals sales net of sales discounts and estimated returns and allowances.

Gross profit, net sales revenue less cost of goods sold, represents the amount of sales revenue available to cover operating and other expenses and contributes to overall net income that can potentially be distributed to shareholders. Financial statement users analyze the firm's gross profit to assess trends and profit margins.

Operating income is gross profit less all operating expenses [(i.e., selling expenses and general and administrative expenses) (U.S. GAAP do not define operating income.)]. Operating income is a key financial performance measure because it:

1. Reflects the results of the core operations of the business.

2. Assists a financial statement user in comparing different firms' operations before considering sources of financing and their costs.

3. Provides a measure of income available to all outside stakeholders. The entity's stakeholders are the providers of capital (both debt and equity holders) and the government (through taxation).

Non-Operating Income

Non-operating income items include gains and losses along with revenues and expenses resulting from a company's peripheral activities. Non-operating income items are less useful than operating income items for predicting future earnings. Consequently, companies separate non-operating income items from the operating items on the statement of net income. For example, a gain or loss on the sale of a specialized piece of equipment is not likely to reoccur and is not part of the core operations of the business.

Specific non-operating items include interest revenue, interest expense, dividend revenue, and gains and items within unusual nature and/or infrequency and occurrence. Items with an unusual nature are transactions or events possessing a high degree of abnormality and unrelated---or only remotely related---to the company's ordinary activities. Items that are infrequent in occurrence are transactions or events not reasonably expected to reoccur in the foreseeable future. If a gain or loss results from a transaction that is either unused in nature and/or infrequent in occurrence, then companies report the event as a separate line item within income from continuing operations or disclose the item in the notes. Examples of transactions or events that are unusual or infrequent include:

• Restructuring charges.

• Losses on impairments.

• Gains and losses on disposals of assets.

• Losses due to natural disasters such as an earthquake or hurricane.

Typically, companies sum operating expense income with the non-operating items to determine income before tax.

 

Income Tax Provision

The income tax provision reports the tax expense determined by considering the income tax effects of operating in all jurisdictions. Specifically, it includes U.S. federal, state, local, and foreign income taxes.

The income tax provision does not include other types of taxes. For example, payroll tax and property taxes are included in operating expenses. Also, note that companies report discontinued operations net of tax. Consequently, companies do not report the income tax expense associated with discontinued operations in the income tax provision.

Companies deduct the income tax provision from income before taxes to report net income. For many companies, net income is the final line on the income statement. As we address in the sections that follow, if companies report any discontinued operations, they include these gains, losses, and income following net income. As a result, income after the income tax provision is then called income from continuing operations, and the line item before income tax expense is called income from continuing operations before tax.

*GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 184-187*

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