Financial Statements

Question 1

Income statements may be prepared using a multiple-step or single-step form. The income (earnings) and comprehensive income statement includes separate categories for continuing operations, discontinued operations, and extraordinary items. The purpose of these separate categories is to enable users to assess future cash flows. Retrospective application is required for all changes in accounting principle. Other comprehensive income is required and may be disclosed in several methods.

Answer 1

Income and Retained Earnings Statement Formats

Question 2

An unusual or infrequent event considered to be material that does not qualify as extraordinary. Placed as part of income from continuing operations after normal recurring revenues and expenses

Answer 2

Unusual or Infrequent Items

Question 3

Results from disposal of a business component. Placed as a separate category after income from continuing operations

Answer 3

Discontinued Operations

Question 4

An unusual and infrequent nonrecurring event which has material effects. Placed as a separate category after discontinued operations

Answer 4

Extraordinary Items

Question 5

Change from one generally accepted accounting principle to another. No longer on income statement

Answer 5

Change in Accounting Principle

Question 6

A correction of a material error from a prior period. Report as prior period adjustment by restating the prior-period financial statements

Answer 6

Correction of an Error

Question 7

Items that are unusual or infrequent but not both should not be presented as extraordinary items. However, they are often presented in a separate section in the income statement above income before extraordinary items. A common example of such items is a “restructuring charge”

Answer 7

Unusual or Infrequent Items

Question 8

A restructuring is a program that is planned and controlled by management and materially changes either the scope of the business undertaken by the company, or the manner in which that business is conducted. Some examples include:

a) Sale or termination of a line of business
b) Closure of business activities in a particular location
c) Relocation of business activities from one location to another
d) Changes in management structure, or
e) Fundamental reorganizations that affect the nature and focus of operations

Answer 8

Unusual or Infrequent Items

Question 9

Another unusual or infrequent item is accounting for the costs of exit and disposal activities (which include, among other items, restructurings). A liability for a cost associated with an exit or disposable activity should be recognized and measured initially at fair value in the period in which the liability is incurred. The fair value is usually determined as the present value of the estimated future payments discounted at the credit-adjusted, risk-free rate of interest.

Answer 9

Unusual or Infrequent Items

Question 10

In the unusual circumstance when fair value cannot be reasonably estimated, the liability shall be initially recognized in the period in which fair value can be reasonably estimated. Examples of such liabilities include:

a) Onetime termination benefits provided to current employees that are involuntary terminated
b) Costs to terminate a contract that is not a capital lease
c) Costs to consolidate facilities or relocate employees

Answer 10

Unusual or Infrequent Items

Question 11

The recognition of the liability and expense for onetime termination benefits depends on whether the employees are required to provide services beyond the minimum retention period. If so, the expense is recognized over the period that the services are provided. If they are not required to provide future services, the liability is recognized when the plan is communicated to the employees.

Answer 11

Unusual or Infrequent Items

Question 12

In periods subsequent to initial measurement, changes to the liability shall be measured using the credit-adjusted risk-free rate that was used to measure the liability initially.

Answer 12

Unusual or Infrequent Items

Question 13

Costs associated with an exit or disposable activity that does not involve discontinued operations shall be included in income from continuing operations before income taxes. The footnotes to the financial statements should provide extensive disclosure of the activities.

Answer 13

Unusual or Infrequent Items

Question 14

“Discontinued operations” is broken out separately. The “Loss from discontinued operations” includes the loss or income of the component for the period, and the gain or loss on its disposal. Income taxes or tax benefit are deducted from or added to that amount to determine the gain or loss after taxes.

Answer 14

Discontinued Operations

Question 15

To qualify for treatment as discontinued operations the assets must compromise a component of the entity with operations and cash flows that are clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity. A component may be a reportable or operating segment, a reporting unit, a subsidiary, or an asset group.

Answer 15

Discontinued Operations

Question 16

To be reported as discontinued operations, two requirements must be met: (1) the operations and cash flows of the component have been (or will be) eliminated from the ongoing operations of the entity as a result of the disposal, and (2) the entity will not have any significant involvement in the operations of the component after disposal.

Answer 16

Discontinued Operations

Question 17

Many of the assets disposed of as discontinued operations are long-lived assets. Accordingly, the component is classified as discontinued operations in the first period that it meets the criteria as being “held for sale”

Answer 17

Discontinued Operations

Question 18

The conditions are:

1) Management commits to a plan of disposal
2) The assets are available for sale
3) An active program to locate a buyer has been initiated
4) The sale is probable
5) The asset is being actively marketed for sale at a fair price.
6) It is unlikely that the disposal plan will significantly change

Answer 18

Discontinued Operations

Question 19

Long lived assets classified as “held for sale” are reported at the lower of their carrying amounts or fair values less costs to sell. Therefore, the gain or loss on disposal of discontinued operations is the actual gain or loss if disposal occurs in the same period that the component meets the criteria to be classified as “held for sale”

Answer 19

Discontinued Operations

Question 20

If the criteria to classify the component as “held for sale” is met in a period before it is disposed of, the amount of the loss (if applicable) on disposal is an estimated loss resulting from the write-down of the group of assets to their estimated fair valued. Estimated gains cannot be initially recognized.

Answer 20

Discontinued Operations

Question 21

However, if the component is held for sale over several reporting periods, estimated gains can be recognized based on the new information but are limited to the amount of losses previously recognized. Thus, the assets can be written up but not above their carrying amounts when they met the criteria as being held for sale.

Answer 21

Discontinued Operations

Question 22

When “discontinued operations” are disclosed in a comparative income statement, the income statement presented for each previous year must be adjusted retroactively to enhance comparability with the current year’s income statement. Accordingly, the revenues, cost of goods sold, and operating expenses (including income taxes) for the discontinued component are removed from the revenues, cost of goods sold, and operating expenses of continuing operations and are netted into one figure, that is, “Income (loss) from discontinued operations”

Answer 22

Discontinued Operations

Question 23

Comprehensive income is the sum of net earnings (loss) and other comprehensive income. It requires disclosure of changes during a period of the following components of other comprehensive income: unrealized gains and losses on available-for-sale investments and foreign currency items, including any reclassification adjustments and any adjustments necessary to recognize the funding status of pension plans or other postemployment benefits

Answer 23

Comprehensive Income

Question 24

This standard allows the management of an enterprise two choices for presenting other comprehensive income.

Answer 24

Comprehensive Income

Question 25

The first choice: At the bottom of income statement, continue from net income to arrive at a comprehensive income. An entity shall present in the following:

1) A total amount for net income and its components
2) A total amount for other comprehensive income and its components
3) Total comprehensive income

Answer 25

Comprehensive Income

Question 26

The second choice: In a separate statement that may start with net income, and that directly follows statement of income. An entity shall present the following:

1) Net income and it’s components in the statement of net income
2) Comprehensive and its components along with total comprehensive income

Answer 26

Comprehensive Income

Question 27

The accumulated (total) comprehensive income shall be presented separately from retained earnings and additional paid in capital in the statement of financial position. The changes in the accumulated balances are to be presented in the notes to the financial statements or on the face of the financial statements.

Answer 27

Comprehensive Income

Question 28

As unrealized gains (losses) recorded and reported in other comprehensive income for the current or prior periods are later realized, they are recognized and reported in net income. To avoid double counting it is necessary to reverse the unrealized amounts that have been recognized.

Answer 28

Comprehensive Income

Question 29

Accumulated other comprehensive income is reported in the stockholders’ equity section of the balance sheet. When an entity has components of other comprehensive income, the total of these is closed to the balance sheet account entitled accumulated other comprehensive income, not retained earnings.

Answer 29

Comprehensive Income

Question 30

Balance sheets or statements of financial position present assets, liabilities, and stockholders’ equity. The balance sheet reports the effect of transactions at a point in time, whereas the statement of earnings (income) and comprehensive income, statement of retained earnings, and statement of cash flows report the effect of transactions over a period of time.

Answer 30

Balance Sheets(Statements of Financial Position)

Question 31

Distinction between current and noncurrent assets and liabilities is almost universal.

1) Current assets - Current assets is used to designate cash and other assets or resources commonly identified as those that are reasonably expected to be realized in cash or sold or consumed during the normal operating cycle of the business.
2) Current liabilities - Current liabilities is used principally to designate obligations whose liquidation is reasonably expected to require the use of existing resources properly classifiable as current assets, or the creation of other current liabilities

Answer 31

Balance Sheets(Statements of Financial Position)

Question 32

Related party disclosures are covered by ASC Topic 850 (SFAS 57). Additional disclosures required for specific situations were specified at the end of most pronouncements.

Answer 32

Other Financial Statement Concepts

Question 33

Accounting principles must be set forth as the initial ootnote to the statements. Disclosures are required of

1) Accounting principles used when alternatives exist
2) Principles peculiar to a particular industry
3) Unusual or innovative applications of accounting principles

Answer 33

Other Financial Statement Concepts

Question 34

Subsequent events are those occurring after the balance sheet date but before the financial statements are issued or available to be issued. Financial statements are issued when they are distributed to shareholders and other users. Financial statements are “available to be issued” when they are in a form and format that is complete and complies with GAAP and all necessary approvals for issuance have been obtained

Answer 34

Other Financial Statement Concepts

Question 35

An entity that is an SEC filer or is a conduit bond obligor for conduit debt securities traded in a public market must evaluate subsequent events through the date that the financial statements are available to be issued. There are two types of subsequent events: recognized and nonrecognized

Answer 35

Other Financial Statement Concepts

Question 36

Recognized events include an estimate for warranty liability, an estimate of a contingent liability due to a lawsuit, or an estimate of allowance for uncollectible accounts

Answer 36

Other Financial Statement Concepts

Question 37

If a recognized subsequent event is settled after the balance sheet date but before the financial statements are issued or available to be issued, then the settlement amounts should be used as the liability in the balance sheet

Answer 37

Other Financial Statement Concepts

Question 38

A nonrecognized subsequent event is one in which the condition did not exist at the balance sheet date, but arose after the balance sheet date. In such cases, the event is not recognized in the financial statements. However, if the event is such that the financial statements would be misleading, then a footnote disclosure should be made indicating the nature of the event and an estimate of the financial statement effects.

Answer 38

Other Financial Statement Concepts

Question 39

An entity that is an SEC filer is not required to disclose the date through which subsequent events are evaluated. However, a non-SEC filer must also disclose the date through which the subsequent events were evaluated and whether that date is the date the financial statements are issued or available to be issued. The provisions of ASC Topics 855 apply both interim and annual reports for all subsequent events that are not addressed by other areas of the Codification

Answer 39

Other Financial Statement Concepts

Question 40

Fair value measurements are required for certain assets and liabilties (investments, derivatives, asset impairments, asset retirement obligations, goodwill, business combinations, troubled debt restructuring)

Answer 40

Fair Value Measurements

Question 41

Applying the fair value measurement approach involves the following six steps:

1) Identify the asset or liability to be measured
2) Determine the principal or most advantageous market
3) Determine the valuation premise
4) Determine the appropriate valuation technique (market, income, or cost approach)
5) Obtain inputs for valuation (Level 1, Level 2, or Level 3)
6) Calculate the fair value of the asset

Answer 41

Fair Value Measurements

Question 42

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (at exit price) under current market conditions. An orderly transaction is a transaction that allows for normal marketing activities that are usual and customary. In other words, it is not a forced transaction or sale

Answer 42

Fair Value Measurements

Question 43

The fair value measurement assumes that the asset or liability is sold or transferred in the principal market, or if no principle market exists, the most advantageous market. The principal market is a market in which the greatest volume and level of activity occurs. The most advantageous market maximizes price received for the asset or minimizes the amount paid to transfer the liability. Market participants in the principal or morst advantageous market must have the following characteristics:

1) Be independent of the reporting entity (not related parties)
2) Be knowledgeable
3) Able to transact, and
4) Willing to transact (i.e., motivated, but not compelled to transact)

Answer 43

Fair Value Measurements

Question 44

The price in principal or most advantageous market shall not be adjusted for transaction costs, such as costs to sell. However, the cost to sell is used to determine which market is the most advantageous. If location is a characteristic of the asset or liability, the price is adjusted for costs necessary to transport the asset or liability to market.

Answer 44

Fair Value Measurements

Question 45

Fair value measurement also assumes the highest and best use of the nonfinancial asset. For financial assets and financial liabilities, the highest and best use concept is not relevant since they do not have alternative uses and their fair values do not depend upon their use within a group

Answer 45

Fair Value Measurements