Ch. 4 - Income Statement Flashcards
- What are the uses of an Income statement?
2 Statements
- 20 words - Hint: its for investors and creditors
- 17 words. Hint: sort of the opposite of 1
Extra: 1 - What other parties use it?
- The income statement provides investors and creditors with information that helps them predict the amounts, timing, and uncertainty of future cash flows.
- Also, the income statement helps users determine the risk (level of uncertainty) of not achieving particu- lar cash flows.
Extra:
3. It should be emphasized that the income statement is used by parties other than investors and creditors. For example, customers can use the income statement to determine a company’s ability to provide needed goods or services, unions examine earnings closely as a basis for salary dis- cussions, and the government uses the income statements of companies as a basis for formulating tax and economic policy.
- What are the limitations of an Income Statement?
3 Statements
- 20 words - Hint: Non-number related
- 8 words - Hint: non - numbers related kind of
- 6 words - Hint: Numbers related
- The statement does not include many items that contribute to general growth and well being of a company.
i. e increase in brand value - Income numbers often affected by the accounting methods used.
- Income measures are subject to estimates.
Extra:
4. Some situations in which changes in value are not recorded in income are:
(a) Unrealized gains or losses on available-for-sale investments,
(b) Changes in the fair values of long-term liabilities, such as bonds payable,
(c) Changes (increases) in value of property, plant and equipment, such as land, natural resources,
or equipment,
(d) Changes (increases) in the values of intangible assets such as customer goodwill, brand value,
or intellectual capital.
Note that some of these omissions arise because the items (e.g., brand value) are not recognized in financial statements, while others (value of land) are recorded in financial statements but meas- urement is at historical cost.
- What is transaction approach when they speak of accounting?
1 Statement
1. 50 words - Hint: The basic structure of the science of accounting.
Extra 1 - Opposite of transaction approach
- The transaction approach focuses on the activities that occurred during a given period. Instead of presenting only a net change in net assets, it discloses the components of the change. The transaction approach to income measurement requires the use of revenue, expense, loss, and gain accounts.
Extra:
2. In the capital maintenance approach, only the net change (income) is reflected whereas the transaction approach not only provides the net change (income) but the components of income (revenues and expenses). The final net income figure should be the same under either approach given the same valuation base.
- Names and define the 4 major elements of an income statement?
4 statements
- 30 words- Hint: Think of ways assets can increase
- 30 words- Hint: Think of ways we can lost money in accrual system.
- 20 words: relates to net assets
- 20 Words: relates to net assets
(1) Revenues: Inflows or other enhancements of assets of an entity or settlements of its liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations.
(2) Expenses: Outflows or other using-up of assets or incurrences of liabilities during a period from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity’s ongoing major or central operations.
(3) Gains: Increases in equity (net assets) from peripheral or incidental transactions of an entity except those that result from revenues or investments by owners.
(4) Losses: Decreases in equity (net assets) from peripheral or incidental transactions of an entity except those that result from expenses or distributions to owners.
- Describe the 2 ways of preparing an income statement?
- Hint: 1 step
- Hint: Multi Step
Extra 1 - Advantages and disadvantages of using one over the other
- In a single-step income statement, just two groupings exist: revenues and expenses. Expenses are deducted from revenues to arrive at net income or loss—a single subtraction. Frequently, companies report income tax separately as the last item before net income.
- A multiple-step income statement shows two further classifications: (1) a separation of operating results from those obtained through the subordinate or nonoperating activities of the company, and (2) a classification of expenses by functions, such as merchandising or manufacturing, selling, and administration.
Extra:
3. The advantages of the single-step income statement are: (1) simplicity and conciseness, (2) probably better understood by the layperson, (3) emphasis on total costs and expenses, and net income, and (4) does not imply priority of one revenue or expense over another. The disadvantages are that it does not show the relationship between sales revenue and cost of goods sold and it does not show other important relationships and information, such as income from operations, income before income tax, etc.
- Explain how to report various other unusual income items.
4 Statements:
- Hint: Unusal or nonrecurring
- Hint Discontinued
- Hint: Unusual and nonrecurring
- Hint: Noncontrolling interest
Companies generally include irregular gains or losses or nonrecurring items in the income statement as follows. (1) Other items of a material amount that are of an unusual or nonrecurring nature and are not considered extraordinary are separately disclosed as a component of continuing operations.
(2) Discontinued operations of a component of a business are classified as a separate item, after continuing operations.
(3) The unusual, material, nonrecurring items that are significantly different from the customary business activities are shown in a separate section for extraordinary items, below discontinued operations.
(4) If a company holds a noncontrolling interest in a subsidiary company, it must present an allocation of net income or loss that is attributable to the noncontrolling interest.
- Identify where to report earnings per share information
1 Statement
Because of the inherent dangers of focusing attention solely on earnings per share, the profession con- cluded that companies must disclose earnings per share on the face of the income state- ment. A company that reports a discontinued operation or an extraordinary item must report per share amounts for these line items either on the face of the income statement or in the notes to the financial statements.
- Understand the reporting of accounting changes in principles, estimates, and errors.
2 Statements
- Hint: Principles and corrections
- Hint: Estimates
- Changes in accounting principle and corrections of errors are adjusted through retained earnings.
- Changes in estimates are a normal part of the accounting process. The effects of these changes are handled prospectively, with the effects recorded in income in the period of change and in future periods without adjustment to retained earnings.
- Prepare a retained earnings statement.
1 Statement
1: Hint: a few elements
- The retained earnings statement should disclose net income (loss), dividends, adjustments due to changes in accounting principles, error corrections, and restrictions of retained earnings.
- Explain how to report other comprehensive income.
1 statement
1. Hint: 2 ways
- Companies report the components of other comprehensive income in one of two ways: (1) a single state- ment of comprehensive income (one statement format) or (2) in a second statement (two statement format).
1b. Some situations in which application of different accounting methods or estimates lead to comparison problems include?
6 Statements:
- Hint: Inventory
- Hint: Real Assets
- Hint: Contracts
- Hint: Real Assets
- Hint: Receivables
- Hint: Sold goods
(a) Inventory methods—LIFO vs. FIFO,
(b) Depreciation Methods—straight-line vs. accelerated,
(c) Accounting for long-term contracts—percentage-of-completion vs. completed-contract,
(d) Estimates of useful lives or salvage values for depreciable assets,
(e) Estimates of bad debts,
(f) Estimates of warranty costs.
What is earnings management? And how does it negatively impact the f/s?
1 Statement
- 70 words : Hint: planned timing
- 60 words: Hint: Not as useful
Earnings management is often defined as the planned timing of revenues, expenses, gains and losses to smooth out bumps in earnings. In most cases, earnings management is used to increase income in the current year at the expense of income in future years. For example, companies prematurely recognize sales in order to boost earnings. Earnings management can also be used to decrease current earnings in order to increase income in the future. The classic case is the use of “cookie jar” reserves, which are established by using unrealistic assumptions to estimate liabilities for such items as loan losses, restructuring charges and warranty returns.
Earnings management has a negative effect on the quality of earnings if it distorts the information in a way that is less useful for predicting future cash flows. Within the Conceptual Framework, useful information is both relevant and representationally faithful. However, earnings management reduces the reliability of income, because the income measure is biased (up or down) and/or the reported income is not representationally faithful to that which it is supposed to report (e.g., volatile earnings are made to look more smooth).
Why should caution be exercised when using the net income figure in the income statement?
1 statement
1: 55 words: Hint Assumptions and estimates
Caution should be exercised because many assumptions and estimates are made in accounting and the net income figure is a reflection of these assumptions. If for any reason the assumptions are not well-founded, distortions will appear in the income reported. The objectives of the application of generally accepted accounting principles to the income statement are to measure and report the results of operations as they occur for a specified period without recognizing any artificial exclusions or modifications.
