2.2 Factors Affecting profitability

Question 1

Factors Involved in measuring Profitability

Answer 1

Analysis answers questions re:
1. Relevant income Measure

Persistence of Income

Quality of Income

Earnings Power

Question 2

Revenue Assessment evaluation by?

Answer 2

Trend percentage Analysis

Management MD&A

Question 3

Profitability

Recognition: expense involves these 

Answer 3

Pervasive Expense recognition principles:

Cause and effect is associated

Systematic and Rational Allocation

Immediate Recognition

Question 4

Profitability

Revenue Recognition

Answer 4

Revenue is recognized when:

• Realized or realizable AND
• Earned

Realizable: goods exchange for assets that can be converted to cash or claims to cash

Earned: earnings processes substantially complete. Entity is entitled to resulting benefits

The conditions are usually met when goods delivered services rendered

Question 5

5 step model for Reveenue Recognition

Answer 5

1. Identify the Contract
2. Identify the Performance Obligations
3. Determine the Transaction Price
4. Allocate the transaction price to the performance obligations
5. RECOGNIZE when or as Performance obligation is satisfied

Question 6

When to Immediately recognize Revenue

Answer 6

1. Costs can’t be directly or feasibly traced

BENEFITS are used up in period incurred

I.e. Utilities

Question 7

Expense Recognition

Answer 7

NOT subject to Realization criteria

• When CONSUMPTION of benefits occurs OR
• when ABiLITY of assets to provide FUTURE benefits impaired
• also, Expense or Loss incurred when liability incurred / increased without receipt of corresponding benefits

Ie a estimable Contingent Loss

Systematic and Rational Allocation process does NOT tie Revenue to Costs.

Causal relationship identified

• asset has useful life
• asset is “used up”

Usual example is Depreciation

Question 8

Major Categories of Expenses

Answer 8

-Selling
—-sales Salaries, collection costs, bad debt, freight out

-General and Admin
( not selling or depreciation)
-Depreciation 
- Maintenance/repair (varies w Plant. Does not vary Directly w income. It is Discretionary. Relates to Earnings Quality)
- Interest (effective interest used)
- Amortization (intangiblesi
- Income tax Expense

Effective tax rate = Tax Expense/ pretax income

Question 9

Expects of Accounting Changes

Principle

Answer 9

• Principle
• Estimate
• Entity

Principle:

• change in GAAP used
• change in Method applying GAAP
• Change caused by old GAAP not accepted

Retrospective (if practical). All Assets, Liability’s, and Retained Earnings at Beginning of first period adjusted for Cumulative effect of All Periods NOT reported. Those REPORTED, individually adjusted for Period Specific

Question 10

Effects of Accounting Changes

Change in Estimate

Answer 10

Prospective application

From New info and reassessment If future benefits and obligations (represented by assets /liabilities)

Effect recorded only in period of change and future periods

*** if change in Principle inseparable from change in Estimate >
(Ie change in method of depreciation = change in Estimate

Question 11

Change in Entity

Answer 11

Reported retrospectively. Yo interim and annual

This is not a business combination

Question 12

Accounting Changes

Error

Answer 12

Math error, error in applying GAAP, to GAAP

Prior period is RESTATED using prior period adjustments (same adjustments as retrospective)