The income statement measures the success of a business over a period of time. It assesses revenues earned and expenses incurred. However, income totals can be affected by accounting methods used and involve judgement in some cases. Determining what is included in net income, such as irregular gains and losses, is an issue because it impacts the portrayal of a company's performance. There are debates around whether irregular items should impact net income or be directly reflected in retained earnings.

1. I
INCOME STATEMENT
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The income statement measures the success of
enterprise operations for a given period of time.
Economist J.R.Hicks' income definition: the
maximum value an entity can consume during
a period and still be as well-off at the end as at
the beginning.
What was your income for last Year?
Suppose that you worked in the summer and
earned $4,200.
Because you paid taxes and incurred tuition
and living expenses for the school, your
income statement may show a loss for the year.
But have you sustained a loss?

2. 2
How do you value the education obtained
during this year?
One interpretation of Hicks's definition states
that you would measure not only monetary
income but also psychic income("well-
offiress").
Psychic income is a measure of increase in net
wealth arising from qualitative factors.
Inspite of the usefulness of the recognition of
psychic income, it has been discarded by
accountants in determining net income due to
measurement problems.
ltems that cannot be quantified with any
degree of reliability are discarded from
i,
oeterTnlnlng lncome.
On the other hand, income totals are not
uniform and precrse.

3. Income totals are affected by the accountmg
rr.itt"Ot employed (stralght-line vs'
accelerated meihods of depreciation) '
Companies that use liberal (aggressive)
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policies report higher income
numbers in the short run'
In such cases, the quallty of earnings is low'

4. 4
Is income sustainable?
X corp reported earnings of $4.77 per share,
supposedly a 20 % increase over the prior
year's $3.99 per share earnings.
However,
- $2.2 per share was earned from the sales
of certain lines of business.
- S0.17 per share resulted from a
nonoperating tax forgiveness granted to
encourage exports.
- An additional $0.19 per share of income
resulted from a nonrecurring transaction.
So, how real was the 20oh increase?
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5. The past decade has witnessed an exceptional
degree of attention on subtotals that make up
the income statement.
The opportunistic use of income statement to
alter earnings performance is also important.
Earnings management can be performed by
accelerating or decelerating the recognition of
revenue or gains and expenses or losses.
Earnings can be shifted among different
peri ods(interperiod version).
Different classification or disclosure of items
within the income statement of a single period
may also lead to earnings management.
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6. 6
If earnings perfonnance were assesed by net
income- the bottom line of the income
statement, intra-income statement creativity
would be fruitless.
However, in the past decade, there has been a
strong shift away from a primary emphasis on
the bottom line of the income statement.
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7. 'l
Usefulness of the Income Statement
I ) Evaluate the past performance of the
enterprise.
By examining revenues and expenses, you
can tell how the company performed and
compare its perfoffnance to its competitors.
2)Provide a basis for predicting future
performance.
Information about past performance can be
used to determine imporlanl trends that, if
continued, provide information about
future performance.
3)Information about various components of
income - revenues, expenses, gains and
losses-highlights the relationship among
them and can be used to assess the risk of
not achieving a particular level of cash
flows in the future.

8. The results from continuing operations
usually have greater significance for
predicting future performance than do the
results from non-recurring events.
Limitations of the fncome Statement
I ) Items that cannot be measured reliabl y are
not reported in the income statement.
Ex: increases in value due to brand
recognition, customer service, and product
quality.
2) Income numbers are affected by the
accounting methods employed.
3) Income measurement involves judgement.
Ex: determination of useful lives of fixed
assets can change between companies.
Similarly, companies may make overly
optimistic estimate of bad-debt write-offs.

9. Reporting lrregular Items
- What should be included in net income?
- What should be done with irregular gains
and losses and corrections of revenues
and expenses of prior Years?
- Should they be closed directlY to
Retained Earnings (not reported in net
income)
Or
- Should they be first presented in the
income statement and then carried to
Retained Earnings along with the net
income or loss for the Period.
9

10. l0
Carrent operating performonce concept:
- net income should show only the regular,
recurring earnings.
- irregular gains and losses do not reflect
an enterprise's fufure earnings power.
- irregular gains and losses should not be
included in computing net income.
- irregular gains and losses should be
carried directly to Retained Earnings as
special items.

11. 11
All-inclusive concept:
- irregular items must be included in net
income.
- irregular items contribute to the long-run
profitability of the business entity.
- irregular items can be separated from the
results of regular operations to arrive at
income from operations.
- However, net income should include all
transactions.
I - When judgement is allowed to determine
irregular items, a danger of manipulating
income dataarises.

12. l2
Ex: At one time, American Standard
wrote-off directly to Retained Earnings
$17.9 million of losses from discontinued
operations.
This enabled the company to report
earnings per share of $1.01.
If the write-off had been charged to
expense, American Standard would have
reported a loss of 78 cents per share.
It could be to the advantage of the firm to run
one time losses through Retained Earnings ,
but gains through income which leads to poor
financial reporting practices.