Reading 21: Understanding Income Statements

Question 1

List 4 types of items classified as other comprehensive income.

Answer 1

Foreign currency translation adjustments.

Unrealized gains or losses on derivatives contracts accounted for as hedges.

Unrealized holding gains and losses on a certain category of investment securities, namely, available-for-sale debt securities under U.S. GAAP and securities designated as “fair value through other comprehensive income” under IFRS. (Note: IFRS, but not U.S. GAAP, also includes a category of equity investments designated at fair value through other comprehensive income.)

Certain costs of a company’s defined benefit post-retirement plans that are not recognized in the current period.

Question 2

Give the formula used to calculate diluted earnings per share for Convertible Bonds.

Answer 2

Diluted EPS with Convertible Bonds: (Net income ‒ Preferred dividends + Convertible debt interest × (1 ‒ t)) / (Weighted average number of shares outstanding + New common shares issued upon conversion)

Question 3

Give the formula used to calculate basic and diluted earnings per share for Convertible Preferred Stock.

Answer 3

Basic EPS: (Net income − Preferred dividends) / (Weighted average number of shares Outstanding)

Note: If a stock split occurs, the additional, newly granted shares are calculated as having been outstanding since the date that the original shares were outstanding.

Diluted EPS with Convertible Preferred Stock: (Net income ‒ Preferred dividends + Convertible preferred dividends) / (Weighted average number of shares outstanding + New common shares issued upon conversion)

Question 4

How are discontinued operations reported?

Answer 4

As net of tax as a separate line item after income from continuing operations.

Question 5

How are stock options and warrants accounted for in the calculation of diluted EPS?

Answer 5

These are accounted for, by using the treasury stock method (required under U.S. GAAP). This assumes that all the funds received by the company from the exercise of options and warrants are used by the company to repurchase shares at the average market price for the period.

The resulting net increase in the number of shares outstanding equals the increase in shares from the exercise of options and warrants minus the number of shares repurchased.

Question 6

Within IFRS, how are grouping of expenses allowed?

Answer 6

By nature, or by function

Question 7

How is a change in an accounting estimate applied?

Answer 7

Prospectively, and affects financial statements for only the current and future periods. No adjustments are made to prior statements, and the adjustment is not shown on the face of the income statement. Significant changes in accounting estimates should be disclosed in the footnotes.

Question 8

Identify the disclosure requirements included in the converged standards.

Answer 8

Information about contracts with customers is classified into different categories. Categories might be based on type of product, geographic region, type of customer or sales channel, type of contract pricing terms, contract duration, or timing of transfers.

Disclosed information includes:

1. The balances of any contract-related assets and liabilities
2. Significant changes in those balances
3. Remaining performance obligations
4. Transaction prices allocated to those obligations
5. Any significant judgments
6. Changes in judgments related to revenue recognition

Question 9

Explain the matching principle of the expense principle.

Answer 9

Requires that expenses be matched with associated revenues when recognizing them on the income statement. If goods bought in the current year remain unsold at the end of the year, their cost is not included in the cost of goods sold for the current year to calculate current period profits.

Question 10

Give the formula to determine ending shareholders’ equity.

Answer 10

Beginning shareholders’ equity + Net income + Other comprehensive income − Dividends declared