2. Module 9: Elements of Financial Statments

Question 1

What are the elements of the financial statements under US GAAP?

Answer 1

US GAAP F/S have 10 elements:
1- Assets
2- Liabilities
3- Equity
4- Investments by owners
5- Distributions
6- Comprehensive Income
7- Revenues
8- Expenses
9- Gains
10- Losses

Question 2

What are the elements of the financial statements under IFRS?

Answer 2

IFRS F/s has 5 elements:
1- Assets
2- Liabilities
3- Equity
4- Income (revenues + gains)
5- Expenses

Question 3

How is Net Income computed?

Answer 3

I Income (or loss) from continuing operations (gross of tax)
D Income (or loss) from discontinued operations (net of tax)
E Extraordinary items (net of tax) – unusual and infrequent
Reported on statement of retained earnings
A Cumulative effect of change in accounting principle (net of tax)

Question 4

Define Discontinued Operations

Answer 4

Discontinued operations (net of tax) - include assets/operations already disposed or being held for sale and the entity is actively searching for a buyer.
2 conditions:
(1) The operations & cash flows of the component have been eliminated as the result of the disposal
(2) The entity will not have any significant involment in the component after disposal

Question 5

Define Extraordinary Items

Answer 5

Extraordinary Items (net of tax)
• Must be both unusual and infrequent
• Examples: An expropriation (foreign govt seizes your business, nationalism), infrequent earthquake.
So hurricanes in Florida are not considered and extraordinary item because they occurs all the time

Question 6

What are the methods used to prepare an income statement?

Answer 6

2 methods:
• Multiple steps- normal setting
• Single step- (Add all revenues+ Other income+ Gains) less (All expenses)

Question 7

Define Cumulative effect of change in Account principle

Answer 7

Cumulative effect of change in accounting principle are:
• Change in accounting estimate
• Change in accounting principle
• Change in accounting entity

Question 8

Describe a change in Accounting Estimate

Answer 8

Change in accounting estimate
• Apply prospectively – do not restate prior periods
• Affects current and future periods
Examples
o Change in fixed asset useful life
o Adjustments of year-end accrual of officers’ salaries and bonuses
o Write-downs of obsolete inventory
o Material non-recurring IRS adjustments
o Settlement of litigation
o Change from instalment method to immediate recognition because uncollectible accounts can now be estimated

Question 9

Describe a change in Accounting Principle

Answer 9

Change in accounting principle
• Apply retroactively – restate prior periods’ financial statements
• Can change accounting principle only if the alternative principle is preferable and more fairly presents the information
• Indirect effects – are reported only in period of change
• Direct effects – are recognized in prior periods (deferred taxes)

Question 10

What is a change in reporting entity?

Answer 10

Change in reporting entity is a change that results in the financial statements representing a different entity.
• Retrospective application-report FS of ALL periods

Question 11

What is an error correction?

Answer 11

An error correction is an error in recognition, measurement, presentation, or disclosure in financial statements.
• Retroactive restatements: Treated as a prior period adjustment by restating the prior year financials
• Cumulative effect of error is reflected in carrying value of assets and liabilities at the beginning of the first period presented
Example:
 Change from non-GAAP to GAAP
 Cash basis to accrual basis

Question 12

What is the cumulative effect of error?

Answer 12

Cumulative effect – difference between the amount of beginning retained earnings in the period of change and what retained earnings would have been if the accounting change had been retroactively applied.

Question 13

What do inventory errors affect?

Answer 13

Inventory errors have an impact on BOTH the balance sheet and the income statement.

Question 14

What does error in classification affect?

Answer 14

Error in classification affect only ONE period

Example: Sales expense instead of R&D expense

Question 15

What are Nonsystematic errors? And what do they affect?

Answer 15

• Non-systematic errors in adjusting entries (error in ending inventory in one period) affect two periods
• They are known as self-correcting (counterbalancing) errors; i.e they correct themselves after 2 periods.

Question 16

What are the components of Comprehensive Income?

Answer 16

Comprehensive Income = Net income + Other comprehensive income PUFE

• Include all changes in equity during a period except those resulting from investments by owners and distributions to owners (dividends)
• Other comprehensive income includes those items excluded from net income
P Pension minimum liability adjustment
U Unrealized gains/losses on Available-4-Sale investments
F Unrealized gains/loss on Foreign currency
E Effective portion of cash flow hedge

Question 17

What is a Reclassification Adjustment?

Answer 17

Reclassification adjustment – items once displayed as other comprehensive income but now displayed as part of net income

Question 18

What is Accumulated Other Comprenhensive Income?

Answer 18

Accumulated other comprehensive income – includes the total of other comprehensive income for the period and previous periods.
• Reported in in stockholders equity’s section of balance sheet

Question 19

What are the assumptions of Fair Market Measurements?

Answer 19

FMV assumes that:
•	The asset or liability is sold or transferred in the principal market or the most advantageous market (market that maximizes price received for asset or minimizes the amount paid for the liability)
•	Market participants must:	
	Be independent
	Be knowledgeable
	Able to transact
	Willing to transact (not forced)
•	FMV assumes also the highest and best use of the nonfinancial asset

Question 20

What are the valuation techniques?

Answer 20

The market approach – uses prices & info from market transactions for identical or comparable assets & liabilities
The income approach – converts future amounts to a single current (discounted) amount.
The cost approach – relies on current replacement cost to replace the asset with a comparable asset adjusted for obsolence.

Question 21

What is the purpose of Comprehensive Income?

Answer 21

The Purpose of Comprehensive Income is:

- to report a measure of the overall enterprise performance.