(21) Understanding Income Statements Flashcards
LOS 24. a: Describe the components of the income statement and alternative presentation formats of that statement.
The income statement shows the entity’s revenues, expenses, gains and losses during a reporting period.
LOS 24. a: Describe the components of the income statement and alternative presentation formats of that statement.
A multi-step income statement provides a subtotal for gross profit and a single step income statement does not.
Expenses on the income statement can be grouped by the nature of the expense item or by their function, such as with expenses grouped into cost of goods sold.
LOS 24. b: Describe general principles of revenue recognition and accrual accounting, specific revenue recognition applications (including accounting for long-term contracts, installment sales, barter transactions, gross and net reporting of revenue), and implications of revenue recognition principles for financial analysis.
Revenue is recognized when earned and expenses are recognized when incurred.
LOS 24. b: Describe general principles of revenue recognition and accrual accounting, specific revenue recognition applications (including accounting for long-term contracts, installment sales, barter transactions, gross and net reporting of revenue), and implications of revenue recognition principles for financial analysis.
Methods for accounting for long-term contracts include:
Percentage-of-completion: Recognize revenues in proportion to costs incurred.
Completed contract: recognizes revenue only when the contract is complete
LOS 24. b: Describe general principles of revenue recognition and accrual accounting, specific revenue recognition applications (including accounting for long-term contracts, installment sales, barter transactions, gross and net reporting of revenue), and implications of revenue recognition principles for financial analysis.
Revenue recognition methods for installment sales are:
Normal revenue recognition at time of sale if collectability is reasonable assured
Installment sales method if collectability cannot be reasonable estimated
Cost recovery method if collectability is highly uncertain.
LOS 24. b: Describe general principles of revenue recognition and accrual accounting, specific revenue recognition applications (including accounting for long-term contracts, installment sales, barter transactions, gross and net reporting of revenue), and implications of revenue recognition principles for financial analysis.
Revenue from barter transactions can only be recognized if its fair value can be estimated from historical data on similar non-barter transactions.
LOS 24. b: Describe general principles of revenue recognition and accrual accounting, specific revenue recognition applications (including accounting for long-term contracts, installment sales, barter transactions, gross and net reporting of revenue), and implications of revenue recognition principles for financial analysis.
Gross revenue reporting shows sales and cost of goods sold, while net revenue reporting shows only the difference between sales and cost of goods sold and should be used when the firm is acting essentially as a selling agent and does not stock inventory, take credit risk, or have control over supplier and price.
LOS 24. c: Calculate revenue given information that might influence the choice of revenue recognition method. Why would a firm use aggressive revenue recognition methods? What are some examples?
A firm using a revenue recognition method that is aggressive will inflate current period earnings at a minimum and perhaps inflate overall earnings.
Because of the estimates involved, the percentage-of-completion method is more aggressive than the completed-contract method.
Also, the installment method is more aggressive than the cost recovery method.
LOS 24. d: Describe key aspects of the converged accounting standards for revenue recognition issued by the International Accounting Standards Board and Financial Accounting Standards Board in May 2014.
Converged accounting standards issued in May 2014 take a principles-based approach to revenue recognition. These standards identify a five-step process for recognizing revenue:
- Identify the contract(s) with the customer
- Identify the performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price to the performance obligations in the contract
- Recognize revenue when (or as) the entity satisfies a performance obligation
LOS 24. e: Describe general principles of expense recognition, specific expense recognition applications, and implications of expenses recognition choices for financial analysis.
The matching principle requires that firms match revenues recognized in a period with the expenses required to generate them.
LOS 24. e: Describe general principles of expense recognition, specific expense recognition applications, and implications of expenses recognition choices for financial analysis.
One application of the matching principle is seen in accounting for inventory, with cost of goods sold as the cost of units sold from inventory that are included in current-period revenue.
Other costs, such as depreciation of fixed assets or administrative overhead, are period costs and are taken without regard to revenues generated during the period.
LOS 24. e: Describe general principles of expense recognition, specific expense recognition applications, and implications of expenses recognition choices for financial analysis. Depreciation methods.
Depreciation methods:
Straight-line: Equal amount of depreciation expense in each year of the asset’s useful life.
Declining balance: apple a constant rate of deprecation to a declining book value until book value equals residual value.
LOS 24. e: Describe general principles of expense recognition, specific expense recognition applications, and implications of expenses recognition choices for financial analysis. Inventory valuation methods.
Inventory valuation methods:
FIFO: Inventory reflects cost of most recent purchases, COGS reflects cost of oldest purchases.
LIFO: COGS reflects cost of most recent purchases, inventory reflects cost of oldest purchase.
Average cost: Unit cost equals cost of goods available for sale divided by total units aviable and is used for both COGS and inventory.
Specific identification: Each item in inventory is identified and its historical cost is used for calculating COGS when the item is sold.
LOS 24. e: Describe general principles of expense recognition, specific expense recognition applications, and implications of expenses recognition choices for financial analysis. How are intangible assets with limited/indefinite lives expensed?
Intangible assets with limited lives should be amortized using a method that reflects the flow over time of their economic benefits. Intangible assets with indefinite lives (e.g., goodwill) are not amortized.
LOS 24. e: Describe general principles of expense recognition, specific expense recognition applications, and implications of expenses recognition choices for financial analysis.
Users of financial data should analyze the reasons for any changes in estimates of expenses and compare these estimates with those of peer companies.
LOS 24. h: Describe how earnings per share is calculated and calculate and interpret a company’s earning per share (both basic and diluted earnings per share) for both simple and complex capital structures.
LOS 24. h: Describe how earnings per share is calculated and calculate and interpret a company’s earning per share (both basic and diluted earnings per share) for both simple and complex capital structures.
When a company has potentially dilutive securities, it must report diluted EPS.
For any convertible preferred stock, convertible debt, warrants, or stock options that are dilutive, the calculation of diluted EPS is:
LOS 24. j: Convert income statements to common-size income statements.
A vertical common-size income statement expresses each item as a percentage of revenue. The common-size format standardizes the income statement by eliminating the effects of size. Common-size income statements are useful for trend analysis and for comparisons with peer firms.
