WEBVTT NOTE Preparing and interpreting the income statement 1 00:00:00.000 --> 00:00:08.874 You are listening to Reading 2-1 of the A C C 300 course reading: Preparing and interpreting the income statement. 2 00:00:08.874 --> 00:00:24.676 Follow Sable Ridge Instruments from adjusted amounts through a multiple-step income statement, compare two years of results, and distinguish net income, other comprehensive income, and accumulated O C I. 3 00:00:24.676 --> 00:00:32.616 Return to the written chapter for the interactive Northline practice and its answer-specific feedback. 4 00:00:32.616 --> 00:00:44.046 Unit 1 followed Beacon Design's transactions into adjusted balances and financial statements. You checked the accounting rules behind those statements. 5 00:00:44.046 --> 00:00:55.174 Then, in Chapter 5, you opened public filings and read reported amounts with their dates, units, and notes. Those statements were already finished. 6 00:00:55.174 --> 00:01:05.544 Unit 2 begins with the controller's work that comes before a reader can inspect the income statement: deciding where each amount belongs. 7 00:01:05.544 --> 00:01:19.654 What an income statement reports. Sable Ridge Instruments is a fictional company you will follow through Unit 2. It makes laboratory analyzers, sells supplies for those analyzers, and installs the equipment. 8 00:01:19.654 --> 00:01:32.264 At the end of 2026, its accounting staff has recorded the year's transactions and adjustments. The controller must prepare an income statement for the chief financial officer to review. 9 00:01:32.264 --> 00:01:45.761 Sable Ridge's net income is 600,000 dollars: its revenues and gains for the year exceed its expenses and losses by that amount after income taxes. That total does not show how the company earned it. 10 00:01:45.761 --> 00:01:59.734 Sales to customers, a gain on a warehouse sale, and income from investments all helped produce the result. A multiple-step statement reports those sources separately. Where did the year's income come from? 11 00:01:59.734 --> 00:02:07.437 An income statement reports the revenues, gains, expenses, and losses included in net income for a stated period. 12 00:02:07.437 --> 00:02:15.003 A multiple-step income statement groups related amounts and shows intermediate totals on the way to net income. 13 00:02:15.003 --> 00:02:29.590 The controller must classify the amounts, check the arithmetic, and prepare the statement for comparison with other periods or companies. The controller starts with adjusted account balances, as you did for Beacon. 14 00:02:29.590 --> 00:02:42.064 These are Sable Ridge's amounts for the year ended December 31, 2026. Each amount is in United States dollars. Cost of revenue is the cost of the goods and services sold to customers. 15 00:02:42.064 --> 00:02:52.152 It includes Sable Ridge's product costs and the costs of its installation work. The discontinued-operation loss has already been measured after tax. 16 00:02:52.152 --> 00:03:06.216 Adjusted amount, Instrument sales; United States dollars, 4,200,000 dollars. Adjusted amount, Consumables sales; United States dollars, 1,850,000. 17 00:03:06.216 --> 00:03:22.687 Adjusted amount, Installation and calibration revenue; United States dollars, 950,000. Adjusted amount, Cost of revenue; United States dollars, negative 3,800,000 dollars. 18 00:03:22.687 --> 00:03:41.567 Adjusted amount, Selling and marketing expense; United States dollars, negative 980,000 dollars. Adjusted amount, Research and development expense; United States dollars, negative 620,000 dollars. 19 00:03:41.567 --> 00:04:01.411 Adjusted amount, General and administrative expense; United States dollars, negative 645,000 dollars. Adjusted amount, Loss on uncollectible supplier advance; United States dollars, negative 95,000 dollars. 20 00:04:01.411 --> 00:04:17.979 Adjusted amount, Gain on sale of the Dayton warehouse; United States dollars, 180,000. Adjusted amount, Realized gain on sale of investments; United States dollars, 40,000. 21 00:04:17.979 --> 00:04:33.487 Adjusted amount, Interest and dividend income; United States dollars, 60,000. Adjusted amount, Interest expense; United States dollars, negative 140,000 dollars. 22 00:04:33.487 --> 00:04:52.560 Adjusted amount, Income tax expense; United States dollars, negative 250,000 dollars. Adjusted amount, Loss from discontinued operations, net of tax; United States dollars, negative 150,000 dollars. 23 00:04:52.560 --> 00:05:06.952 The list contains no subtotals. Deciding which items belong together is part of preparing the statement. Income-statement classification is the name for that placement decision. 24 00:05:06.952 --> 00:05:21.831 Moving an amount to another line does not change the amount itself. Step 1: Group customer revenue and its cost. Customer revenue comes from the company's sales of goods and services. 25 00:05:21.831 --> 00:05:32.808 A gain from selling an asset used by the business is a different kind of income. Sable Ridge's customer sales add to 7,000,000 dollars: 26 00:05:32.808 --> 00:05:55.689 Customer revenue calculation, United States dollars, Instrument sales; Amount, 4,200,000 dollars. Customer revenue calculation, United States dollars, Consumables sales (supplies for analyzers); Amount, 1,850,000. 27 00:05:55.689 --> 00:06:17.496 Customer revenue calculation, United States dollars, Installation and calibration; Amount, 950,000. Customer revenue calculation, United States dollars, Total customer revenue; Amount, 7,000,000 dollars. 28 00:06:17.496 --> 00:06:28.907 Gross profit is customer revenue less the cost of goods and services sold. The 180,000 dollars warehouse gain belongs outside customer revenue. 29 00:06:28.907 --> 00:06:42.312 It is neither customer revenue nor the cost of those sales, so it does not enter gross profit. Sable Ridge reports it later among other gains. Check your understanding. 30 00:06:42.312 --> 00:06:56.037 If the controller adds the warehouse gain to sales, what is wrong with the resulting 7,180,000 dollars revenue line? Pause to consider your answer. Here is the explanation. 31 00:06:56.037 --> 00:07:10.002 It includes 180,000 dollars from selling a warehouse among amounts earned from customers for Sable Ridge's products and services. The gain belongs elsewhere in this statement. 32 00:07:10.002 --> 00:07:24.125 Correcting the error changes some subtotals, but not net income. Sable Ridge uses the name cost of revenue because it sells both manufactured products and installation services. 33 00:07:24.125 --> 00:07:39.287 Cost of goods sold (cost of goods sold) names the cost of products sold; a manufacturer or retailer often uses it when reporting goods. A service company may instead report cost of services. 34 00:07:39.287 --> 00:07:55.086 A company that sells both can combine these costs under cost of revenue or present them separately. Check the company's line names and notes before comparing its gross profit with another company's. 35 00:07:55.086 --> 00:08:10.886 Gross profit shows what remains before selling, research, and general office expenses. Sable Ridge recorded 3,800,000 dollars of cost of revenue for its instruments, supplies, and installation work. 36 00:08:10.886 --> 00:08:19.344 Its gross profit is 3,200,000 dollars (7,000,000 dollars revenue minus 3,800,000 dollars cost of revenue). 37 00:08:19.344 --> 00:08:37.608 Sable Ridge sales and cost of revenue for 2026. Revenue is 7,000,000 dollars. Cost of revenue is negative 3,800,000 dollars. Gross profit is 3,200,000 dollars. 38 00:08:37.608 --> 00:08:45.502 The distinction between cost of revenue and operating expense depends on what the cost is for. 39 00:08:45.502 --> 00:09:03.307 Freight to bring inventory to Sable Ridge becomes part of inventory cost and reaches cost of revenue when that inventory is sold. Freight to deliver a finished product to a customer is normally a selling expense. 40 00:09:03.307 --> 00:09:21.279 Check your understanding. A draft includes Sable Ridge's 980,000 dollars selling and marketing expense in cost of revenue. If the controller moves it below gross profit, which total changes? Does net income change? 41 00:09:21.279 --> 00:09:36.984 Pause to consider your answer. Here is the explanation. Gross profit rises by 980,000 dollars. Net income stays the same because the expense remains on the statement and is deducted once. 42 00:09:36.984 --> 00:09:49.409 Step 2: Classify operating expenses. Operating expenses are costs of carrying out the company's business that are outside the cost of the goods and services sold. 43 00:09:49.409 --> 00:10:05.284 Their form depends on the business: a manufacturer may report research and development, selling, and administration, while a professional service firm may report staff and office costs under different names. 44 00:10:05.284 --> 00:10:14.794 The business's operating activities include producing or providing what it sells and the functions that support those sales. 45 00:10:14.794 --> 00:10:27.833 Operating income is the result from those activities after the related cost of revenue and operating expenses, before the nonoperating items and income taxes shown below. 46 00:10:27.833 --> 00:10:37.649 Sable Ridge reports selling and marketing, research and development, and general and administrative expenses after gross profit. 47 00:10:37.649 --> 00:10:47.313 The controller has determined that the 95,000 dollars loss on an uncollectible supplier advance belongs in operating expenses. 48 00:10:47.313 --> 00:10:57.360 The next chapter explains why the loss remains in continuing operations and how a material unusual or infrequent item is presented. 49 00:10:57.360 --> 00:11:11.509 Use the cost's purpose to choose the function. Classify a cost by the function that used the resource: Cost of revenue includes resources used to produce goods or perform services that the company sold. 50 00:11:11.509 --> 00:11:24.047 It can include both direct costs and a reasonable allocation of indirect production or service costs. The cost enters gross profit when the related good or service enters revenue. 51 00:11:24.047 --> 00:11:35.535 A selling expense supports marketing, obtaining sales, or distributing a finished product after it is ready for sale. It enters operating income after gross profit. 52 00:11:35.535 --> 00:11:49.123 An administrative expense supports the direction or operation of the company as a whole. It is not assigned to production, performing a service, selling, or another separately reported function. 53 00:11:49.123 --> 00:11:58.229 It also enters operating income after gross profit. This purpose test can classify a new cost without relying on a memorized list. 54 00:11:58.229 --> 00:12:08.806 For example, the salary of an employee who installs a service sold to a customer is a cost of revenue. A salesperson's commission is a selling expense. 55 00:12:08.806 --> 00:12:19.873 The salary of an employee who runs company-wide payroll is an administrative expense. Classify the cost based on the work performed, not the employee's title. 56 00:12:19.873 --> 00:12:33.462 These three categories do not include every operating function. A company may report research and development or another function on a separate operating-expense line. Sable Ridge does so below. 57 00:12:33.462 --> 00:12:43.759 Some costs sit near a boundary or serve more than one function. A company must apply a reasonable classification or allocation policy consistently. 58 00:12:43.759 --> 00:12:51.744 Its business model and presentation policy can therefore produce a different answer from another company's answer. 59 00:12:51.744 --> 00:13:06.294 If the available information does not identify how the resource was used, inspect the company's accounting policy instead of assuming that one classification applies to every company. Check your understanding. 60 00:13:06.294 --> 00:13:20.566 Classify three costs: labor used to install an analyzer sold to a customer, a commission for obtaining that sale, and the salary of the company-wide human-resources director. Pause to consider your answer. 61 00:13:20.566 --> 00:13:32.470 Here is the explanation. Installation labor is cost of revenue because it performs the service sold. The commission is a selling expense because it helps obtain the order. 62 00:13:32.470 --> 00:13:40.128 The human-resources director's salary is an administrative expense because it supports the company as a whole. 63 00:13:40.128 --> 00:13:57.862 Sable Ridge operating-expense section for 2026. Begin with gross profit of 3,200,000 dollars. Selling and marketing is negative 980,000. Research and development is negative 620,000. 64 00:13:57.862 --> 00:14:12.576 General and administrative is negative 645,000. The loss on the uncollectible supplier advance is negative 95,000. Operating income is 860,000 dollars. 65 00:14:12.576 --> 00:14:26.043 Sable Ridge's operating income is 860,000 dollars. To compare it with another company's operating income, inspect the lines included in each subtotal and read the notes and accounting policies. 66 00:14:26.043 --> 00:14:37.836 If one company places a material cost above operating income and another places a similar cost below it, adjust the subtotals when the disclosures provide enough detail. 67 00:14:37.836 --> 00:14:46.488 Otherwise, state the classification difference rather than treating the two figures as equivalent. Check your understanding. 68 00:14:46.488 --> 00:15:01.421 A colleague moves the supplier-advance loss below operating income because it happened only once. What should the controller ask before accepting that change? Pause to consider your answer. Here is the explanation. 69 00:15:01.421 --> 00:15:16.563 The controller should ask what the advance was for and how Sable Ridge presents similar items. Here it supported the analyzer supply chain. An item does not move below operating income merely because it occurred once. 70 00:15:16.563 --> 00:15:31.286 Sable Ridge's adjusted results include a 150,000 dollars after-tax loss from its veterinary instruments line. For this chapter, the controller has determined that the line meets the discontinued-operations test. 71 00:15:31.286 --> 00:15:44.544 The loss belongs below the after-tax result of the activities Sable Ridge continues to run. The next chapter explains how the controller makes that determination and presents the tax effect. 72 00:15:44.544 --> 00:15:56.499 Step 3: Present nonoperating items and income tax. Nonoperating items arise outside the activities used to produce and sell the company's goods and services. 73 00:15:56.499 --> 00:16:06.779 An income statement can show nonoperating gains and income, then nonoperating expenses, as separate lines or in clearly labeled groups. 74 00:16:06.779 --> 00:16:22.008 The warehouse sale produced a gain of 180,000 dollars: proceeds less the warehouse's carrying amount, which is its recorded value after depreciation and other reductions. The gain is not the proceeds. 75 00:16:22.008 --> 00:16:37.770 Sable Ridge shows that gain, a 40,000 dollars investment gain, 60,000 dollars of income earned from investments, and 140,000 dollars of interest expense on borrowing as separate lines below operating income. 76 00:16:37.770 --> 00:16:46.984 Showing investment income and borrowing cost separately lets a reader see both sources rather than only their net effect. 77 00:16:46.984 --> 00:16:58.634 Income before income taxes, or pretax income, includes operating and nonoperating items before income tax expense. Sable Ridge reports 1,000,000 dollars. 78 00:16:58.634 --> 00:17:07.087 Some statements show another subtotal before interest expense and tax to isolate the effect of borrowing costs. 79 00:17:07.087 --> 00:17:15.387 That subtotal may still include other nonoperating items, so check its components before comparing companies. 80 00:17:15.387 --> 00:17:29.169 Income tax expense follows pretax income because it is a separate tax cost, not a cost of production, selling, or borrowing. Taxable income can differ from pretax accounting income. 81 00:17:29.169 --> 00:17:40.363 The current tax amount is based on taxable income; income tax expense on the financial statements can also include deferred tax expense or benefit. 82 00:17:40.363 --> 00:17:51.480 Do not calculate income tax expense by multiplying pretax accounting income by a tax rate unless the problem supplies that simplifying assumption. 83 00:17:51.480 --> 00:18:06.168 Income from continuing operations is the after-tax result excluding activities reported as discontinued operations. It includes both operating and nonoperating items. 84 00:18:06.168 --> 00:18:25.689 From Sable Ridge operating income to net income for 2026. Operating income is 860,000 dollars. Add the warehouse gain of 180,000, the investment gain of 40,000, and interest and dividend income of 60,000. 85 00:18:25.689 --> 00:18:42.244 Subtract interest expense of 140,000. Income before income taxes is 1,000,000 dollars. Subtract income tax expense of 250,000 for 750,000 dollars from continuing operations. 86 00:18:42.244 --> 00:18:51.144 Subtract the discontinued-operation loss of 150,000 after tax. Net income is 600,000 dollars. 87 00:18:51.144 --> 00:19:06.663 Sable Ridge reports 750,000 dollars from continuing operations and a separately presented 150,000 dollars after-tax loss from the veterinary line. Its net income is 600,000 dollars. 88 00:19:06.663 --> 00:19:14.551 Step 4: Check the completed income statement. The controller can now put the lines together. 89 00:19:14.551 --> 00:19:27.755 Read the heading before the figures: this statement covers Sable Ridge for the year ended December 31, 2026, and its amounts are in United States dollars. 90 00:19:27.755 --> 00:19:35.472 It reports activity over a year, unlike a balance sheet, which reports balances at a date. 91 00:19:35.472 --> 00:19:55.527 The complete Sable Ridge 2026 income statement. Instrument sales are 4,200,000 dollars, consumables sales are 1,850,000, and installation and calibration revenue is 950,000, for total revenue of 7,000,000. 92 00:19:55.527 --> 00:20:02.571 Cost of revenue is negative 3,800,000, giving gross profit of 3,200,000. 93 00:20:02.571 --> 00:20:23.408 Selling and marketing is negative 980,000, research and development is negative 620,000, general and administrative is negative 645,000, and the supplier-advance loss is negative 95,000, giving operating income of 94 00:20:23.408 --> 00:20:41.017 860,000. The warehouse gain is 180,000, the investment gain is 40,000, interest and dividend income is 60,000, and interest expense is negative 140,000. Pretax income is 1,000,000. 95 00:20:41.017 --> 00:20:57.648 Income tax expense is negative 250,000, giving continuing income of 750,000. The discontinued-operation loss after tax is negative 150,000. Net income is 600,000 dollars. 96 00:20:57.648 --> 00:21:12.563 The controller checks that revenue includes only sales of goods and services, cost of revenue includes the related goods and service costs, and the warehouse and investment gains appear below operating income. 97 00:21:12.563 --> 00:21:26.193 The resulting subtotals separate operating performance from the other items included in the 600,000 dollars net income. This is a teaching form. Public companies may use different line names. 98 00:21:26.193 --> 00:21:41.322 For commercial and industrial companies, the Securities and Exchange Commission's Regulation S X Rule 5-03 sets minimum income-statement captions. The company's business and notes help explain its specific lines. 99 00:21:41.322 --> 00:21:56.736 If you want another worked case before the independent problem, the lesson on building income-statement subtotals uses different company facts. The reading gives you everything needed for the Northline problem below. 100 00:21:56.736 --> 00:22:05.599 How classification errors distort income-statement subtotals. The meaning of a subtotal depends on the lines above it. 101 00:22:05.599 --> 00:22:14.313 A classification error can overstate gross profit and operating income without changing pretax income or net income. 102 00:22:14.313 --> 00:22:24.453 To evaluate any company's statement, identify what belongs in each group and trace which subtotals an incorrect placement would affect. 103 00:22:24.453 --> 00:22:39.251 The draft below makes that error: it includes Sable Ridge's 180,000 dollars warehouse gain in customer revenue instead of showing it below operating income. The controller should correct the draft. 104 00:22:39.251 --> 00:22:49.992 The transaction and tax amount do not change. The table compares the correct 2026 statement with the incorrect draft, in United States dollars: 105 00:22:49.992 --> 00:23:04.594 Income-statement line, Customer revenue; Correct statement, 7,000,000 dollars; Incorrect draft: gain in sales, 7,180,000 dollars. 106 00:23:04.594 --> 00:23:16.933 Income-statement line, Gross profit; Correct statement, 3,200,000; Incorrect draft: gain in sales, 3,380,000. 107 00:23:16.933 --> 00:23:29.498 Income-statement line, Operating income; Correct statement, 860,000; Incorrect draft: gain in sales, 1,040,000. 108 00:23:29.498 --> 00:23:43.421 Income-statement line, Income before income taxes; Correct statement, 1,000,000; Incorrect draft: gain in sales, 1,000,000. 109 00:23:43.421 --> 00:23:55.080 Income-statement line, Net income; Correct statement, 600,000; Incorrect draft: gain in sales, 600,000. 110 00:23:55.080 --> 00:24:12.376 The draft overstates revenue, gross profit, and operating income by 180,000 dollars each. It still reports 600,000 dollars of net income. The gain arose from selling a warehouse, not from selling analyzers or services. 111 00:24:12.376 --> 00:24:24.436 Checking only the final total would miss the error. The income-statement classification guide gives another placement example. Check your understanding. 112 00:24:24.436 --> 00:24:34.830 Suppose another draft incorrectly includes the 40,000 dollars investment gain in customer sales rather than below operating income. 113 00:24:34.830 --> 00:24:46.810 What would that draft report for gross profit, operating income, pretax income, and net income? Pause to consider your answer. Here is the explanation. 114 00:24:46.810 --> 00:25:01.409 Gross profit would be 3,240,000 dollars and operating income 900,000 dollars, both 40,000 dollars too high. Pretax income would remain 1,000,000 dollars and net income 600,000 dollars. 115 00:25:01.409 --> 00:25:17.674 The gain is still counted once, but it is in the wrong group. Compare income statements across years. The controller prepares a two-year statement for the chief financial officer (chief financial officer). 116 00:25:17.674 --> 00:25:28.464 The 2025 adjusted amounts below show the source of the earlier column. Both years are for the same company and in United States dollars. 117 00:25:28.464 --> 00:25:49.102 Sable Ridge, year ended December 31, 2025, Instrument sales; United States dollars, 3,900,000 dollars. Sable Ridge, year ended December 31, 2025, Consumables sales; United States dollars, 1,650,000. 118 00:25:49.102 --> 00:26:00.777 Sable Ridge, year ended December 31, 2025, Installation and calibration revenue; United States dollars, 850,000. 119 00:26:00.777 --> 00:26:12.243 Sable Ridge, year ended December 31, 2025, Cost of revenue; United States dollars, negative 3,520,000 dollars. 120 00:26:12.243 --> 00:26:24.959 Sable Ridge, year ended December 31, 2025, Selling and marketing expense; United States dollars, negative 900,000 dollars. 121 00:26:24.959 --> 00:26:37.988 Sable Ridge, year ended December 31, 2025, Research and development expense; United States dollars, negative 580,000 dollars. 122 00:26:37.988 --> 00:26:51.226 Sable Ridge, year ended December 31, 2025, General and administrative expense; United States dollars, negative 700,000 dollars. 123 00:26:51.226 --> 00:27:13.428 Sable Ridge, year ended December 31, 2025, Interest and dividend income; United States dollars, 55,000. Sable Ridge, year ended December 31, 2025, Interest expense; United States dollars, negative 155,000 dollars. 124 00:27:13.428 --> 00:27:27.604 Sable Ridge, year ended December 31, 2025, Income tax expense on continuing operations; United States dollars, negative 150,000 dollars. 125 00:27:27.604 --> 00:27:40.008 Sable Ridge, year ended December 31, 2025, Income from the veterinary line, net of tax; United States dollars, 135,000. 126 00:27:40.008 --> 00:27:53.358 The controller groups the 2025 amounts under the same line names used for 2026. The completed statement lets the chief financial officer compare each line and subtotal directly. 127 00:27:53.358 --> 00:28:05.953 The veterinary-line result is shown as discontinued operations in both income-statement years so the continuing-operations columns describe the same set of activities. 128 00:28:05.953 --> 00:28:15.456 The next chapter explains the classification test and how earlier income statements are presented after a qualifying disposal. 129 00:28:15.456 --> 00:28:38.575 Sable Ridge comparative income statements for 2025 and 2026. Revenue rises from 6,400,000 dollars to 7,000,000, a 600,000 dollar increase. Gross profit rises from 2,880,000 to 3,200,000, an increase of 320,000. 130 00:28:38.575 --> 00:28:57.400 Operating income rises from 700,000 to 860,000, an increase of 160,000. Pretax income rises from 600,000 to 1,000,000, and continuing income rises from 450,000 to 750,000. 131 00:28:57.400 --> 00:29:16.005 The discontinued result changes from positive 135,000 to negative 150,000, a decline of 285,000. Net income therefore rises only 15,000, from 585,000 to 600,000 dollars. 132 00:29:16.005 --> 00:29:26.904 The written statement shows every revenue, expense, gain, and loss line supporting these subtotals. 133 00:29:26.904 --> 00:29:35.410 Revenue rose by 600,000 dollars, gross profit by 320,000 dollars, and operating income by 160,000 dollars. 134 00:29:35.410 --> 00:29:49.453 Net income rose by only 15,000 dollars because the 300,000 dollars increase in continuing income was largely offset by a 285,000 dollars decline in the veterinary-line result. 135 00:29:49.453 --> 00:29:53.385 A dollar change shows how much an amount changed. 136 00:29:53.385 --> 00:30:11.039 Percentage growth compares that change with the earlier amount: Percentage growth equals (Current amount minus Earlier amount) divided by Earlier amount Sable Ridge's revenue grew by 9.4 percent: (7,000,000 dollars minus 137 00:30:11.039 --> 00:30:28.051 6,400,000 dollars) divided by 6,400,000 dollars. Its operating income grew by 22.9 percent: (860,000 dollars minus 700,000 dollars) divided by 700,000 dollars. Operating income therefore grew faster than revenue. 138 00:30:28.051 --> 00:30:41.693 That comparison measures the relative growth of two statement amounts; it does not explain what caused either amount to change. A profit margin asks a different question. 139 00:30:41.693 --> 00:30:55.656 It expresses a statement subtotal as a share of revenue for the same period. Percentage growth follows one amount across years; a margin compares two amounts within one year. 140 00:30:55.656 --> 00:31:06.168 Each margin uses a different income-statement subtotal in the numerator, so each shows what remains after a different set of costs: 141 00:31:06.168 --> 00:31:30.330 Rate and what it includes, Gross profit rate (gross margin): revenue left after cost of goods and services sold; 2025 calculation, 2,880,000 dollars divided by 6,400,000 dollars = 45.0 percent; 2026 calculation, 142 00:31:30.330 --> 00:31:37.430 3,200,000 dollars divided by 7,000,000 dollars = 45.7 percent. 143 00:31:37.430 --> 00:32:01.592 Rate and what it includes, Operating margin: revenue left after operating expenses too; 2025 calculation, 700,000 dollars divided by 6,400,000 dollars = 10.9 percent; 2026 calculation, 860,000 dollars divided by 144 00:32:01.592 --> 00:32:05.371 7,000,000 dollars = 12.3 percent. 145 00:32:05.371 --> 00:32:29.648 Rate and what it includes, Net profit margin: revenue left after all items in net income; 2025 calculation, 585,000 dollars divided by 6,400,000 dollars = 9.1 percent; 2026 calculation, 600,000 dollars divided by 146 00:32:29.648 --> 00:32:33.312 7,000,000 dollars = 8.6 percent. 147 00:32:33.312 --> 00:32:47.946 For each dollar of 2026 revenue, Sable Ridge kept about 46 cents of gross profit and 12 cents of operating income. Its operating margin rose even though net profit margin fell. 148 00:32:47.946 --> 00:33:02.912 The veterinary-line loss helps explain that difference. Gross margin can change because of prices, product mix, costs, or cost classification; the rate alone cannot identify which. 149 00:33:02.912 --> 00:33:17.878 Before comparing companies, check that their revenue and cost groups are comparable. These are income rates, not measures of cash available to pay a debt. Check your understanding. 150 00:33:17.878 --> 00:33:33.759 If someone says Sable Ridge's operating income rose by 160,000 dollars only because it sold more, which 2025 and 2026 amounts would you inspect first? Do these statements establish the cause? 151 00:33:33.759 --> 00:33:44.318 Pause to consider your answer. Here is the explanation. Compare revenue, cost of revenue, and operating expenses in both years. 152 00:33:44.318 --> 00:33:53.215 Revenue rose 600,000 dollars, gross profit rose 320,000 dollars, and operating income rose 160,000 dollars. 153 00:33:53.215 --> 00:34:03.192 The figures measure changes; they do not establish what caused more sales, different costs, or different expense levels. 154 00:34:03.192 --> 00:34:18.386 Limits of income-statement comparisons. The statements show that reported continuing income rose by 300,000 dollars. They do not show whether prices, sales volume, product mix, or costs caused the increase. 155 00:34:18.386 --> 00:34:33.212 To investigate, the chief financial officer needs sales and cost detail and the relevant notes. To assess debt payments, a lender also needs cash flows, collection and payment patterns, and debt terms. 156 00:34:33.212 --> 00:34:49.218 Income from continuing operations includes the warehouse and investment gains. A reader assessing the business's ongoing earning power should identify those gains and examine whether similar transactions are expected. 157 00:34:49.218 --> 00:34:56.815 The reported increase alone cannot establish future income or available cash. Check your understanding. 158 00:34:56.815 --> 00:35:12.305 A lender says the 300,000 dollars rise in continuing income proves Sable Ridge has 300,000 dollars more cash for debt payments. Which part of that statement is measured, and what would the lender need to check? 159 00:35:12.305 --> 00:35:23.590 Pause to consider your answer. Here is the explanation. The rise in reported continuing income is measured. It is not a cash balance or cash-flow change. 160 00:35:23.590 --> 00:35:32.736 The lender needs cash collections and payments, the statement of cash flows, and debt terms before making the payment claim. 161 00:35:32.736 --> 00:35:46.868 Other comprehensive income and accumulated O C I. Net income is one measure of the period's performance, but some recognized gains and losses bypass net income under specific accounting rules. 162 00:35:46.868 --> 00:36:00.190 Those items enter other comprehensive income (O C I). Comprehensive income is net income plus O C I for the period. Owner investments and dividends are neither net income nor O C I. 163 00:36:00.190 --> 00:36:10.716 To determine whether an item enters O C I, identify the item and its accounting classification, then apply the specific guidance for that item. 164 00:36:10.716 --> 00:36:26.835 Common O C I categories include changes from translating a foreign operation's statements into the reporting currency, certain gains and losses on cash flow hedges, some changes in employee retirement plans, and holding 165 00:36:26.835 --> 00:36:40.378 gains and losses on available-for-sale debt securities. A company can designate a financial contract as a cash flow hedge when it offsets changes in expected cash receipts or payments. 166 00:36:40.378 --> 00:36:46.487 A debt security is an investment that gives its holder a right to receive payments. 167 00:36:46.487 --> 00:37:00.987 For one classified as available for sale, a change in its fair value, or current market-based value, can enter O C I while the company holds it. A gain or loss recognized on sale enters net income. 168 00:37:00.987 --> 00:37:09.231 Other classifications can produce different treatment, so do not classify a gain from the word unrealized alone. 169 00:37:09.231 --> 00:37:22.701 A S C Topic 220, Subtopic 10, Section 45, paragraph 10A identifies the O C I categories; other accounting guidance supplies the recognition and measurement requirements for each item. 170 00:37:22.701 --> 00:37:27.264 Sable Ridge's securities are classified as available for sale. 171 00:37:27.264 --> 00:37:43.616 During 2026, their value increases, producing an 80,000 dollars holding gain before tax, or 60,000 dollars after tax, in O C I. Sable Ridge also sells a security with a gain that had previously entered O C I. 172 00:37:43.616 --> 00:37:57.216 The 40,000 dollars pretax gain enters net income when recognized on sale. A 30,000 dollars after-tax reclassification adjustment removes the related earlier gain from O C I. 173 00:37:57.216 --> 00:38:13.096 The adjustment keeps that gain from remaining in both net income and current O C I. This adjustment follows the accounting rule for a sale; the earlier warehouse-in-sales example was an incorrect draft. 174 00:38:13.096 --> 00:38:24.888 These amounts are supplied for presentation practice. A S C Topic 220, Subtopic 10, Section 45, paragraph 15 explains the reclassification adjustment. 175 00:38:24.888 --> 00:38:44.389 Sable Ridge statement of comprehensive income for 2026. Net income is 600,000 dollars. An unrealized holding gain after tax adds 60,000. A reclassification adjustment after tax subtracts 30,000. 176 00:38:44.389 --> 00:38:52.632 Other comprehensive income is 30,000, and comprehensive income is 630,000 dollars. 177 00:38:52.632 --> 00:39:12.505 Accumulated other comprehensive income (AO C I) is the cumulative O C I balance reported in equity, separately from retained earnings. Sable Ridge began the year with 45,000 dollars of AO C I. 178 00:39:12.505 --> 00:39:27.720 Its 30,000 dollars of current-year O C I brings ending AO C I to 75,000 dollars. O C I is a change during 2026; AO C I is a balance at December 31. 179 00:39:27.720 --> 00:39:45.020 Net income and O C I reach different equity balances. Sable Ridge's 600,000 dollars of 2026 net income closes to retained earnings before dividends or other changes. 180 00:39:45.020 --> 00:39:57.288 Its 30,000 dollars of 2026 O C I is added to beginning A O C I of 45,000, producing ending A O C I of 75,000 dollars. 181 00:39:57.288 --> 00:40:12.963 Check your understanding. Is Sable Ridge's 75,000 dollars of ending AO C I another asset? Can you add it to 2026 comprehensive income? Pause to consider your answer. Here is the explanation. No. 182 00:40:12.963 --> 00:40:28.800 AO C I is an equity balance, not an asset or another gain for 2026. Current O C I of 30,000 dollars is already included in the 630,000 dollars comprehensive-income total. Check your understanding. 183 00:40:28.800 --> 00:40:44.557 Which amount is a change during 2026: 30,000 dollars of O C I or 75,000 dollars of ending AO C I? What date does the other amount describe? Pause to consider your answer. Here is the explanation. 184 00:40:44.557 --> 00:41:01.767 The 30,000 dollars O C I is the change during 2026. The 75,000 dollars AO C I is the equity balance at December 31, 2026, after adding that change to the 45,000 dollars beginning balance. Check your understanding. 185 00:41:01.767 --> 00:41:16.796 A company holds a debt security whose classification sends fair-value holding changes to net income. Does a holding gain enter O C I merely because the company has not sold the security? 186 00:41:16.796 --> 00:41:30.856 What fact would you need to check? Pause to consider your answer. Here is the explanation. No. Check the security's accounting classification and the rule that applies to it. 187 00:41:30.856 --> 00:41:44.592 Sable Ridge's example uses available-for-sale debt securities, whose holding gains normally enter O C I. A different classification can send a holding gain to net income. 188 00:41:44.592 --> 00:41:54.799 End-of-chapter practice. Prepare a statement for Northline. Northline Components reports six 2026 activities in Step 1 below. 189 00:41:54.799 --> 00:42:09.824 Each amount is in United States dollars and belongs in the income statement for the year ended December 31, 2026. Northline also reports income tax expense of 225,000 dollars for 2026. 190 00:42:09.824 --> 00:42:27.543 Use that supplied expense to calculate net income. There is no discontinued operation. First decide where each amount enters the statement and which subtotal it can change. The facts are not listed in statement order. 191 00:42:27.543 --> 00:42:45.017 Then calculate the 2026 subtotals and rates. The feedback points to the placement or amount that needs another look. The land gain and borrowing cost both follow operating income, but they belong on separate lines. 192 00:42:45.017 --> 00:42:59.144 Now test the effect of putting the 200,000 dollars land gain in sales. Which subtotals would be overstated if the gain were counted only once? Compare Northline's two years. 193 00:42:59.144 --> 00:43:16.128 Northline also supplies its 2025 amounts below. These are for the same company, for the year ended December 31, 2025, in United States dollars. There was no land-sale gain or discontinued operation that year. 194 00:43:16.128 --> 00:43:42.185 2025 item, Net sales; Amount, 8,400,000 dollars. 2025 item, Cost of goods sold; Amount, negative 5,040,000 dollars. 2025 item, Selling expenses; Amount, negative 1,400,000 dollars. 195 00:43:42.185 --> 00:44:10.992 2025 item, Administrative expenses; Amount, negative 1,100,000 dollars. 2025 item, Interest expense; Amount, negative 260,000 dollars. 2025 item, Income tax expense; Amount, negative 150,000 dollars. 196 00:44:10.992 --> 00:44:22.682 Calculate the 2025 subtotals and rates in Step 3. Then use the two-year table in Step 4 to test what changed in dollars and what changed as a share of sales. 197 00:44:22.682 --> 00:44:32.586 In Step 5, use the accounting classification given in each separate case to decide whether a gain or loss enters net income or O C I. 198 00:44:32.586 --> 00:44:47.627 Before opening the worked answer, write one claim the Northline statements support and one question they cannot answer. Could a lender treat either year's net income as cash available for debt payments? 199 00:44:47.627 --> 00:45:02.892 Check Northline's statement Northline's income statement below shows each calculation. The land sale happened outside Northline's ordinary sales, so its 200,000 dollars gain appears below operating income. 200 00:45:02.892 --> 00:45:11.976 The 225,000 dollars tax expense is supplied; the exercise does not determine it from Northline's pretax accounting income. 201 00:45:11.976 --> 00:45:29.921 Northline Components worked income statement for 2026. Net sales are 9,000,000 dollars and cost of goods sold is negative 5,400,000, giving gross profit of 3,600,000. 202 00:45:29.921 --> 00:45:51.649 Selling expense is negative 1,500,000 and administrative expense is negative 1,100,000, giving operating income of 1,000,000. Add the land-sale gain of 200,000 and subtract interest expense of 300,000. 203 00:45:51.649 --> 00:46:03.432 Pretax income is 900,000. Subtract the supplied income tax expense of 225,000. Net income is 675,000 dollars. 204 00:46:03.432 --> 00:46:20.017 If Northline put the land gain in net sales and removed it from other income, sales would be 9,200,000 dollars and gross profit 3,800,000 dollars. Each would be 200,000 dollars too high. 205 00:46:20.017 --> 00:46:31.966 Operating income would rise to 1,200,000 dollars. Pretax income would stay 900,000 dollars, and net income would stay 675,000 dollars. 206 00:46:31.966 --> 00:46:45.698 The gain is counted once, but the wrong placement makes operating performance look stronger. The 2025 costs produce the subtotals in the comparison below. 207 00:46:45.698 --> 00:46:52.296 Use the supplied 150,000 dollars tax expense to calculate 2025 net income. 208 00:46:52.296 --> 00:47:08.594 Northline subtotal, United States dollars, Net sales; 2025, 8,400,000 dollars; 2026, 9,000,000 dollars; Change, 600,000 dollars. 209 00:47:08.594 --> 00:47:25.275 Northline subtotal, United States dollars, Gross profit; 2025, 3,360,000 dollars; 2026, 3,600,000 dollars; Change, 240,000 dollars. 210 00:47:25.275 --> 00:47:42.210 Northline subtotal, United States dollars, Operating income; 2025, 860,000 dollars; 2026, 1,000,000 dollars; Change, 140,000 dollars. 211 00:47:42.210 --> 00:48:00.164 Northline subtotal, United States dollars, Income before income taxes; 2025, 600,000 dollars; 2026, 900,000 dollars; Change, 300,000 dollars. 212 00:48:00.164 --> 00:48:16.080 Northline subtotal, United States dollars, Net income; 2025, 450,000 dollars; 2026, 675,000 dollars; Change, 225,000 dollars. 213 00:48:16.080 --> 00:48:34.968 Sales rose 600,000 dollars and gross profit rose 240,000 dollars. The gross profit rate was 40.0 percent in both years (3,360,000 dollars divided by 8,400,000 dollars and 3,600,000 dollars divided by 9,000,000 dollars). 214 00:48:34.968 --> 00:48:48.078 Operating margin rose from 10.2 percent (860,000 dollars divided by 8,400,000 dollars) to 11.1 percent (1,000,000 dollars divided by 9,000,000 dollars). 215 00:48:48.078 --> 00:49:06.017 Sales grew 7.1 percent (600,000 dollars divided by 8,400,000 dollars), while operating income grew 16.3 percent (140,000 dollars divided by 860,000 dollars). Operating income therefore grew faster than sales. 216 00:49:06.017 --> 00:49:22.231 The 300,000 dollars rise in pretax income consists of that 140,000 dollars operating increase, a 200,000 dollars land gain that 2025 did not have, and 40,000 dollars more interest expense. 217 00:49:22.231 --> 00:49:38.101 The latter reduces, rather than adds to, the change. Net income rose 225,000 dollars. A sound measured claim is that reported operating income rose by 140,000 dollars, or 16.3 percent. 218 00:49:38.101 --> 00:49:53.280 The statements do not explain whether prices, volume, product mix, or costs caused the change. The lender cannot treat either year's net income as cash ready for debt payments. 219 00:49:53.280 --> 00:50:10.443 Northline may still be waiting to collect some sales, and the statements do not show debt principal due or other cash needs. The lender needs the cash-flow statement and debt terms for that question. 220 00:50:10.443 --> 00:50:21.742 For Step 5, the land-sale loss and the gain recognized when the company sells an available-for-sale debt security enter net income. 221 00:50:21.742 --> 00:50:31.833 The holding gain on an available-for-sale debt security and the foreign-operation translation adjustment enter O C I. 222 00:50:31.833 --> 00:50:42.096 A sale of the debt security can also require a reclassification adjustment to remove a related earlier gain from O C I. 223 00:50:42.096 --> 00:50:58.146 Use the supplied accounting classification and the type of event to apply the appropriate presentation rule. The absence of a cash receipt does not, by itself, place a gain in O C I. Sources. 224 00:50:58.146 --> 00:51:06.381 S E C Regulation S X Rule 5-03, income-statement captions for commercial and industrial companies. 225 00:51:06.381 --> 00:51:23.439 A S C Topic 220, Subtopic 10, Section 45, paragraph 10A, categories of other comprehensive income; A S C Topic 220, Subtopic 10, Section 45, paragraph 15, reclassification adjustments. FASB Statement No. 226 00:51:23.439 --> 00:51:34.530 130, historical introduction of comprehensive-income reporting. Return to the written chapter for the Northline Components practice. 227 00:51:34.530 --> 00:51:50.496 Prepare its 2026 multiple-step statement, compare it with 2025, calculate the rates, and decide which claims the reported amounts support. Attempt each step before opening the worked answer.