Ch 4 Flashcards
3 Limitations of income statement?
1 companies omit items from income statement they can’t measure reliably (ex. Company may not record unrealized gains/losses from investments b/c uncertainty of realization)
2 income #s are affected by accounting methods employed
(ex. Straight line vs accelerated depreciation)
3 income measurement involves judgement (ex. companies estimate useful life and write off values differently)
3 ways Business and investment community uses from income statement?
Helps predict amounts, timing and uncertainty of future cash flows
Earnings management
Planned timing of revenues, expenses, gains and losses
To smooth out bumps in earnings
Quality of earnings
Usefulness for predicting future earnings and cash flows
What is earnings management’s effect on quality of earnings?
Distorts information of earnings in a way that’s less useful
In predicting future earnings
Transaction approach
Focuses on income-related activities that occurred
During the period
4 Elements of income related items?
Revenues, expenses, gains, losses
Revenues
Inflows or other enhancements of assets of entity or
Settlements of liabilities during a period from delivering
Or producing goods, rendering services or other
Activities that constitute the entities central operations
Expenses
Outflows or other using up of assets or incurrences of
Liabilities during period from delivering or producing goods,
Rendering services, or carrying out other activities that
Constitute entities ongoing major or central operations
Gains
Increases in equity (net assets) from peripheral or incidental
Transactions of an entity except those that result from
Revenues or investments by owners
Losses
Decreases in equity from peripheral or incidental transactions
Of an entity except those that result from expenses or
Distributions to owners
Capital maintenance approach
Company determines income for period based on change
In equity after adjustment for capital contributions
(investments by owners) or distributions (dividends)
7 main steps in multi-step income statement?
1 operating section 2 non operating section 3 income tax 4 discontinued operations 5 extraordinary items 6 noncontrolling interest 7 earnings per share
4 parts of Operating section, define?
Report revenues and expenses of company’s principal
Operations
1 Sales and revenues
2 cost of goods sold
3 selling expenses
4 administrative or general expenses
Non operating section, define, 2 parts?
Report revenues and expenses from secondary activities
1 other revenues and gains
2 other expenses and losses
Income tax
Section reporting federal and state income taxes levied
On income from continued operations
Discontinued operations section
Material gains or losses resulting from disposition
Of component of business
Extraordinary items
Unusual and infrequent material gains and losses
Noncontrolling Interest
Allocation of income to non controlling shareholders
Single step income statement, advantage?
Consists of two groupings: revenues and expenses
Advantage is simplicity
Current operating performance approach
Most useful income measure reflects only regular
And recurring revenue and expense elements
Irregular items don’t reflect company’s future earning power
Modified all inclusive concept of income reporting
Approach where companies record most items
Including unusual and irregular ones as part of net income
However companies must highlight extraordinary items
To help users better determine long run earning power
4 general categories for unusual items on income statements?
1 unusual gains and losses
2 discontinued operations
3 extraordinary items
4 noncontrolling interest
Unusual gains and losses 6 components?
1 losses on write off of receivables, inventories, property,
plant and equipment, deferred R&D or other intangibles
2 gains or losses from currency exchange
3 restructuring charges
4 gains or losses from sale or abandonment of property,
Plant or equipment used in business
5 effects of strike including against competitors and major
Suppliers
6 adjustment of accruals on Longterm contracts
Restructuring charge , 3 examples?
Major reorganization of company affairs
Ex. Employee layoff costs, plant closing costs,
write off of asset’s
Discontinued operations 2 things?
1) company eliminates results of operations of
component of business
2) there is no significant involvement in component after
Disposal transaction
Component
Manufactures and sells consumer products
It has several product groups, each with different product
Lines and brands
Intraperiod tax allocation
Allocation of tax to item within a period
Extraordinary items 2 qualities?
Unusual nature- possess a high degree of abnormality
And unrelated to typical activities of business
Infrequency of occurrence- activity that company does not
Expect to repeat itself in the near future
Noncontrolling interest, example? Define?
The portion of equity interest in a subsidiary not attributable
to parent company
If Coca Cola acquires 70% of Koch Company
Coca Cola has the controlling interest (over 50%)
And remaining shareholders of Koch have noncontrolling
Interest
Earnings per share
Earnings per share =
(net income - preferred dividends)/
weighted avg. common shares outstanding
2 examples of changes in accounting principle?
Change in method of inventory (FIFO to avg. cost)
Change in accounting construction contracts from
Percentage of completion to completed contract method
Retrospective adjustment
Company recognizes a change in accounting principle
On financial statements
Adjustment recasts the prior years statements on newly
Adopted principle preserving comparability
Changes in accounting estimates?
Do not get carried back to financial statements
Of prior years
Corrections of errors are treated as…
Prior period adjustments, similar to changes in accounting principles
Appropriated retained earnings
Restricted retained earnings
Comprehensive income
Includes all changes in equity during period except
Those resulting from investments to owners and
Distributions to owners
Other comprehensive income
Non owner changes in equity that bypass the
income statement
One statement approach
Reports comprehensive income in single statement
Two statement approach
Two separate but consecutive statements of net income
And other comprehensive income
Statement of stockholders equity
Presents account of total stockholders equity in columnar
Form (columns)
Consists of contributed capital, retained earnings and accumulated balances in other comprehensive income
2 items disclosed in statement of stockholders equity?
1 contributions (issuances of shares) and distributions (dividends to owners)
2 reconciliation of carrying amount of each component
Of stockholders equity from beginning to end of period
