Ch. 4 Flashcards
Income statement
Report that measure s the success of company operations for a given period of time.
The business and investment community uses the income statements for?
To determine profitability, investment value and creditworthiness.
Income statement provides investors and creditors with information that helps them predict what
Amounts, timing and uncertainty of future cash flows.
Investors and creditors use income statement info for
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- Evaluate the past performance of the company
- Provide a basis for predicting future performance
- Help assess the risk or uncertainty of achieving future cash flows.
Net income is what?
An estimate and reflects an number of assumptions.
What are the limitations of the income statement
- Companies omit items from the income statement that they cannot measure reliably.
- Income numbers are affected by the accounting methods employed.
- Income measurement involves judgment.
SEC has taken decisive action to prevent the practice of what?
Earnings management
What is earnings management
Is defined as the planned timing of revenues, expenses, gains, and losses to smooth out bumps in earnings.
What did the companies use the earnings management for?
Used to decrease current earnings in order to increase income in the future.
The classic case is the use of “cookie jar” reserves which is
Where companies established these reserves by using unrealistic assumptions to estimate liabilities for such items as loan losses, reconstructions charges and warranty returns.
Then the companies reduce these reserves in the future to increase reported income in the future.
These earnings negatively affects what? Oh
Quality of earnings because if it distorts the information in a way that is less useful for predicting future earnings and future cash flows.
Net jncome results from?
Revenue, expense, gain and loss transactions.
Transaction approach
Focuses on income related activities that have occurred during the period.
Revenues take many forms
Sales, Fees, interest, dividends and rents
Expenses take many forms
Cogs Depreciation Interest Rent Salaries and wages Taxes
Gains and losses are many types
Sale of investments or plant assets
Settlement of liabilities
Write offs of assets due to impairments or casualty
Mists decisions find the ______ of the financial statement to be more useful than the whole.
Part
Multi step income statement
Operating section
- sales or revenues
- cogs
- selling expenses
- administrative expenses
Nonoperating section
Rev and exp result from secondary activities of company. Special gains and losses that are infrequent or unusual are reported in this section
• other revenues and gains
• other expenses and losses
Income tax
Discontinued operations
- material gains or losses resulting from the disposition of component of bus.
No controlling interest
Allocation of income to nongontrolling share holders
Earnings per share: a measure of performance over reporting period.
The reporting of gross profit shows
A useful number for evaluating performance and predicting future earnings.
Statement readers may study the trend in gross profits because
To determine how successfully a company uses it resources .
Understand how ckmpetitiv pressure affected profit margins
Single step income statement
Into
Condensed income statement
Includes only totals of expenses
Single step income statement
Consists only of expenses and revenues
What is the primary advantage of the single step?
Format lies in its simple presentation and the absence of any implication that one type of revenue or expense item has priority over another
What format elongates potential classification problem?
Single step
FASB developed specific guidliens in two important areas
- What to include in income
2. And how to report certain unusual or infrequent items
Some users advocate a current operating performance approach
To income reporting.
Some argued that the most useful income measure reflects only regular and recurring revenue and expenses elements.
Some unsusal or infrequent items do not reflect a company’s future earning power.
Some argue that
The focus on operating income potentially misses important info about a company’s performance. Any loss or gain by company contributes to long run profitability
Accounting profession adopted a modified all inclusive concept
Records most items including unusual or infrequent ones as part of net income.
Are companies required to disclose any unusual or infrequent gains and losses or both in the statement or notes to financial?
Yes!!
Why is additional disclosure often needed?
In the notes so that users of the income statement understand the effect of these gains or losses on net income and future cash flows
Gains or losses are identified as
A) unusual : high degree of abnormality and clearly unrelated to or only incidentally related to ordinary and typical acitivites
B) infrequency of occurrence: Transaction that is not reasonably expected to recur in the foreseeable future.
What are the common unusual or infrequent gains and losses?
Losses on write down of receivables; inventories; property, plant and equipment; goodwill or other untangle assets
Restructuring charges
Other gains and losses from sale or Abandobment of property plant and equipment .
Effects of a strike
Gainsandlosses on extinguishment of debt obligations
Gains and losses related to casualties such S fires floods and earthquicks
Gain or losses on the Sale of invesntment securities
The most common type of unusual gains reported in survey of 500 companies
Reconstructuring charges (202–more than 40%)
Write downs, gains/losses on asset sales (289– nearly 60%)
Gains and losses from unusual or infrequent gains or losses are not reported of net of tax.
T or F
True
Unusual or infrequent gains or losses or both should be itemized and reported as what?6
Other revenues and gains section
Or
Other expenses and loses section
Gains and losses should be considered
Material and unusual or infrequent or both
Discontinued operations occurs when?
- A company eliminates the results of operations of a component of the business.
- Eliamtion of a component that represents a strategic shift, having s major effect on the company’s operations and financial results.
Strategic shift includes?
A major line in business
Major geographical area
Major equity method investment
Companies reported discontinued operations (in sep income statement categories) the ….
Gain or loss from disposal of a component of a business
Will companies report the results of operations of a component that has been or will be disposed sepearately from contininuing operations
True and
When do companies use the phrase “income from continuing operations”
Only when gains or losses on discontinued operations occur
When a company reports discontinued operations where must I report?
On the face of the income statement the per share effect of income from continuing operations and net income.
Companies report discontinued operations on??
Income statement of tax
Intraperiod allocation
Allocation within income statement of the period.
How does intraperiod tax allocation help?
It helps financial statement users better understand the impact of income taxes on the various components of net income
Does intraperiod allocation help users predict amount timing and uncertainty of future cash flows?
Yes
Jnterperiod tax allocation discourages what
Statement readers from using pretax measur s of performance when evaluating financial results and thereby recognizes that income tax expense is a real cost.
When is intraperiod tax allocation on income stamens used for?
Income from continuing operations
Discontinued operations
Let tax follow income
:)
How to compute income tax from continuing operations
Income tax is computed related to both revenue and expense transactions as well as other income and expense used in determine income subtotal
Companies then associate what with discontinued operations
Separate tax effect
Non controlling interest
Portion of equity (net assets) interest in a subsidiary not attributable to parent company
Earnings per share
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Is net income - preferred dividends/ weighted average of common shares outstanding
EPS measures what
The number of dollars earned by each share of common stock
Where is EPS disclosed
On the face of income statement
Changes in acct principle
Include a change in the method of inventory pricing from FIFO to average cost or change in accounting for construction contracts from the percentage of completion to the completed contract method .
How do company’s recognize a change in accounting principle
By making a retrospective adjustment the financial statements
Changes in accounting estimate s
Inherent in accounting processes
A company accounts for such changes in estimates in the period of change if they
Affect only that period or in the period of change and future periods if the change affects both
Companies do not handle changes in estimate _______
Retrospectively , which means changes are not carried back to adjust prior years.
Changes in estimates are not considered what?
Errors
How do companies correct errors?
By making proper entries in the accounts and reporting corrections in financial statements
How are correction of errors treated as?
Prior period adjustments
They report error in the financial stayents as an?
Ajdjjstmnet to the beginning balance of retained earnings
What increases retained earnings?
Net income
What decreases retained earnings?
Net loss
What may increase or decrease retained earnings?
Changes in accounting principles and prior period adjustments
How do companies charge or credit these adjustments?
To the opening balance of retained earnings
Why do companies restrict retained earnings?
To comply with contractual requirements, board of directions policy or current necessity.
Where do companies disclose information of the amounts of restricted retained earnings
Notes in the financial statements
Appropriated retained earnings
Is where some companies transfer the amounts of retained earnings restricted
Retained earnings may include two separate amounts
Unrestricted (free)
Restricted (appropriated)
The total of these amounts equals the total of retained earnings
The use of what for measuring assets and liabilities have increased?
Fair value
What has placed a Strain on income reporting?
Reporting of gains and losses related to changes in fair values
Why
Fair values are constantly changing and some argue that recognizing gains and losses on net income is misleading.
FASB agrees to?
Limit the number of transactions that are reported in other comprehensive income
The aggregate amount of other comprehensive income is reported in?
Stockholders equity as accumulated other comprehensive income
Comprehensive income
Includes all changes in equity during a period except those result from investments by owners and distributions to owners
What does comprehensive income include?
Revenues and gains
Expenses and losses reported on net income
And all gains and losses that bypass net income but affects stockholders equity
Other comprehensive income
Non owner changes in equity that bypasses the income statement
Companies must display the components of other comprehensive income in two ways
Single continuous statement
(1 statement approach)
Two separate but consecutive statements of net income and other comprehensive income
One statement approach referred as
Statement of comprehensive income
Two statement approach
Uses income statement for the first statement and the comprehensive income statement for second statement
Statement of stockholders equity
This statement reports the changes in each stockholders equity account and in total stockholders equity during the year.
What do companies often prepare in columnar form?
The statement of stockholders equity
What is disclosed in equity statement
Contribution (issuance of shares) and distributions (dividends) to owners
Reconciliation of the carrying amount of each component of stockholders equity from the beginning to end of period.
By providing information on the components of comphrensive income as well as accumulated other comprehensive income the company communications info about what?
All changes in net assets and with this information users will better understand the quality of company’s earnings
