Chapter 6 - Analyzing operating activities. This chapter extends our analysis to operating activities. We analyze accrual measures of both revenues and expenses in determining net income. Understanding recognition methods for both revenues and expenses is emphasized. We also interpret the income statement and its components for financial analysis. | Financial Statement Analysis . Subramanyam Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 6 CHAPTER Analyzing Operating Activities Economic Income Equals net cash flows + the change in the present value of future cash flows Includes both recurring and nonrecurring components— rendering it less useful for forecasting future earnings potential Permanent Income Also called sustainable earning power, or sustainable or normalized earnings Estimate of stable average income that a company is expected to earn over its life Reflects a long-term focus Directly proportional to company value Income Measurement Concepts of Income 2 2 Based on accrual accounting Suffers from measurement error, arising because of accounting distortions Accounting Income consists of: Permanent Component--the recurring component expected to persist indefinitely Transitory Component--the transitory (or non-recurring) component not expected to persist (Note: The concept of economic income includes both permanent and transitory components.) Value Irrelevant Component--value irrelevant components have no economic content; they are accounting distortions Income Measurement Concepts 2 2 Income Measurement Measurement Two main components of accounting income: Revenues (gains) Expenses (losses) 2 2 Revenues and Gains • Revenues are earned inflows or prospective inflows of cash from operations* • Gains are recognized inflows or prospective inflows of cash from non-operations** * Revenues are expected to recur **Gains are non-recurring Income Measurement Measurement 2 2 Expenses and Losses • Expenses are incurred outflows, prospective outflows, or allocations of past outflows of cash from operations • Losses are decreases in a company’s net assets arising from non-operations Expenses and losses are resources consumed, spent, or lost in pursuing revenues and gains Income . | Financial Statement Analysis . Subramanyam Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 6 CHAPTER Analyzing Operating Activities Economic Income Equals net cash flows + the change in the present value of future cash flows Includes both recurring and nonrecurring components— rendering it less useful for forecasting future earnings potential Permanent Income Also called sustainable earning power, or sustainable or normalized earnings Estimate of stable average income that a company is expected to earn over its life Reflects a long-term focus Directly proportional to company value Income Measurement Concepts of Income 2 2 Based on accrual accounting Suffers from measurement error, arising because of accounting distortions Accounting Income consists of: Permanent Component--the recurring component expected to persist indefinitely Transitory Component--the transitory .
