Reporting the Results of Operation Flashcards
What three things are accounting changes?
Changes in:
- accounting principle
- accounting estimates
- the reporting entity
Correction of errors in old financials is not an “accounting change”
What is restatement?
Revising old financials to correct an error
What is another term for retrospective application?
Retroactive restatement
How should prior period adjustments be reported?
Highlighted on statement of retained earnings
Shown as adjustment to beginning RE, net of tax
What is it called when prior period adjustments are reported with their net tax effect?
Intra-period tax allocation
What qualifies as a change in accounting principle?
A change between generally accepted accounting principles
-May be because old principle is no longer generally accepted (or not)
Change in method of applying a principle
What does not count as a change in accounting principle?
Adoption of principle to record transactions for first time
Adoption of principle to record effects of transactions that were previously immaterial
What is the only justification for changing accounting principles?
Required by new pronouncements
Entity can justify it by proving it is preferable
What is involved in retrospective application?
Cumulative effect of change in principle is reflected in BV of assets and liabilities at the beginning of first period presented (or earliest possible period)
Offsetting adjustment (if necessary) to opening balance of RE for that period
Financials for each presented prior period should show period-specific effects of new principle
Only direct effects of a change in principle are included
What are indirect effects of a change in accounting principle?
Changes to cash flows resulting from a change in principle
E.g. a royalty payment based on a reported amount, such as income
What happens if it is impracticable to apply principles changes to prior periods?
Principle should be applied to earliest date possible
Under what circumstances can a change in principle be deemed impracticable?
Entity has made every reasonable effort
Application requires knowledge of management’s intent that can’t be determined
Application requires estimates which cannot be objectively supported
What disclosures are needed for accounting principle changes?
(1) nature and reason for change, including method of applying it
(2) prior-period info that’s been retrospectively adjusted
(3) effect of changes on income before extraordinary items, net income, and related per-share amounts
(4) cumulative effect of change on RE or other components of equity or net assets
(5) disclosure of reasons why any application is impracticable
What happens if a change in estimate and change in principle are inseparable?
Accounted for as change in estimate
E.g. change in depreciation method to match asset’s benefits
What are examples of changes in estimates?
Useful lives and salvage values
Uncollectible receivables
Warranty costs
How should changes in estimates be reported?
In income from continuing operations
Only reported in periods that the change affects
No retrospective adjustment required
What should be disclosed for changes in estimates?
Effects on (a) income before extraordinary items, (b) net income, and (c) related per-share amounts
Should be disclosed for period of change and any future periods that are affected
What estimates do not need to be disclosed?
Estimates made in ordinary business that aren’t material or long-term (e.g. bad debt estimate)
How are changes in reporting entity reported?
Retrospectively apply changes to financials for all presented prior periods
Do NOT report (a) the effect of the change on beginning RE or (b) pro forma effects on net income and EPS
What are examples of changes in reporting entity?
Consolidated financials
Changing subsidiary companies for which consolidated financials are prepared
What should be disclosed for changes in reporting entity?
Nature and reason of change
Effect of change on (a) income before extraordinary items. (b) net income, (c) OCI, and (d) related per-share amounts
How are changes from unacceptable to generally accepted accounting principles reported?
As a correction of previous errors
NOT as change in accounting principle
How should previous errors be reported?
Reported as prior-period adjustment by restating prior period financial statements
What should be included in restatements of prior period financials for error corrections?
Cumulative effect of error should be reflected in BV of assets and liabilities
Offsetting adjustment to BRE
Corrections of period-specific effects of the error
What should be disclosed for error corrections?
- that previously issued financials have been restated
- description of error
- effect of the correction on each line item and per-share amounts affected
- cumulative effect on RE (or other relevant parts of equity or net assets)
- effects (both gross and net of tax) on net income – should be disclosed in annual report
How should accounting errors be classified?
By time of discovery, or according to effect on income statement, balance sheet, or both
What happens if an error is discovered in a different period than it occurs?
Effect of error is recorded as direct adjustment to BRE
What happens if an error is discovered in the same period as it occurs?
Directly corrected with a JE
What happens if revenues or expenses are misclassified on the income statement?
Net income wouldn’t be affected, so no correction is necessary
Restatement of comparative financials is still required
What are counterbalancing errors?
Errors in both the balance sheet and income statement that offset each other over two consecutive accounting periods
E.g. if accrued wages are not charged at the end of the fiscal year, they will be charged to the next year
The required method for reporting income involves a compromise between which two concepts?
Current operating concept – income should reflect ordinary operations
All-inclusive concept – income should reflect even the unusual items
How is the compromise between the two main income concepts reached?
All regular items, including unusual and infrequent ones, are included in net income
Income from discontinued operations and extraordinary items are reported separately
Prior period adjustments are adjustments to BRE, not income
How are unusual or infrequent items reported?
As a separate component of income from continuing operations
BOTH unusual and infrequent items are extraordinary items
How should taxes on income from continuing operations be presented?
As a single line item
What is included in discontinued operations?
Not only components that have been disposed, but still-operating components that are subject to a formal plan for disposal
What qualifies as a separate component of an entity?
A segment, reporting unit, or asset group whose operations and cash flows are clearly distinguished – both operationally and in the financials
What are examples of non-component disposals?
Selling restaurants to franchisees
Closing stores to open (fewer) superstores in same area
How are disposals of non-component assets reported?
Gains/losses reported in income from continuing operations
If disposal will occur after 12 months, then discount costs to sell to PV
When are operations deemed to be discontinued?
If operations and cash flows are (or will be) removed
If the entity no longer has significant involvement in the component’s operations
How are component assets presented if held as available for sale?
Valued at current FV less cost to sell
Assets and related liabilities are NOT netted, but reported separately
How are future operating losses for discontinued components reported?
No liability for them is recognized
For component assets of discontinued operations that are held for sale, which expenses are recognized?
Interest and rent expenses
NOT depreciation or amortization expenses
For component assets of discontinued operations that are held for sale, which future liabilities must be recognized?
Lease termination costs
Employee severance costs
How are changes to previously reported discontinued operations amount reported?
In current period statements (as discontinued operations)
How are expected gains on the sale of discontinued-component assets reported?
Not reported until realized
When should extraordinary items be included in the income statement?
If material – considered individually, not in aggregate
Presented separately and net of tax
What are not extraordinary items?
- Gains/losses on disposal of segment
- Gains/losses from abandonment of property
- Effects of a strike
Exception: many gains/losses which are usually ordinary can be extraordinary if caused by an extraordinary event
What is the multiple-step format for income statements?
Net Sales - COGS = Gross Margin - Operating Exp. = Operating Income \+/- Other Rev/Exp/Gain/Loss = Income from Continuing Operations Before Taxes - Income Taxes = Income from Continuing Operations \+/- Gains/Losses from Discontinued Operations \+/- Extraordinary Gain/Loss = Net Income
In the multi-step method, how is COGS calculated?
Beg. Inv. \+ Net Purchase \+ Freight-in = GAFS - End Inv. = COGS
In the multi-step method, what is included in operating expenses?
Selling expenses and general & administrative expenses
In the multi-step method, what is included in “other revenue/expenses/gains/losses”?
Rent and interest income/expenses
Capital gains/losses
What is the single-step for income statements?
Total Revenues - Total Expenses = Income from Continuing Operations Before Taxes - Income Tax = Income from Continuing Operations \+/- Extraordinary Gain/Loss = Net Income
Tax might be included in “Total Expenses”
What is comprehensive income?
All changes in equity besides contributions from owners and distributions to owners
Divided into net income and OCI
What are the different classifications of OCI?
Foreign currency items
Pension adjustments
Unrealized gains/losses on securities
Gains/losses on cash flow hedging derivatives
What is included in foreign currency items?
Translation adjustments
Gains/losses on foreign currency transactions designated as hedges of a foreign investment
What is included in unrealized gains/loss on securities?
Unrealized gains/losses on AFS securities
Unrealized gains/losses resulting from transfer of AFS security to HTM
Change in market value of a futures contract serving to hedge an asset reported at FV
What is a purpose of reclassification adjustments?
To avoid double counting in OCI and net income
Which OCI classifications needs reclassification adjustments?
All except for minimum pension liability adjustments, which should be shown net
Where should Accumulated OCI be presented?
In the equity section independently of RE, stock, and APIC
Balances for each OCI classification could be disclosed
How should tax be reported for OCI?
Either:
(a) Each component of OCI is reported net of tax
(b) Each OCI item is reported pre-tax, with one line showing the total tax cost (but then per-item taxes should still be disclosed)
How should comprehensive income be displayed in the financials?
Cannot be merely disclosed
- One-statement approach
- Two-statement approach
What is the one-statement approach?
Just like income statement, but adds OCI
…
= Net Income
+ OCI
= Comprehensive Income
What is the two-statement approach?
Statement of Comprehensive Income should immediately follow the Income Statement
Net Income
+ OCI
= Comprehensive Income
What is the effective tax rate?
The tax rate used to estimate accrued tax expenses in interim statements
What should be excluded from estimates for the effective tax rate?
Estimates for taxes on extraordinary items (which are reported separately and net of tax)
Unusual OR infrequent items should be excluded too, though they are included in determining interim income
How might inventory estimates be different for interim reports?
Some companies must estimate gross profit to report EI and COGS
If any different method is used for the interim, it must be disclosed
How might LIFO estimates be different for interim reports?
The liquidation of a base-year layer of inventory, if it is expected to be replaced by year-end, should not be done
How should gains/losses from lower-of-cost-or-market be reported in interim reports?
Non-temporary losses should be reported in interim statements, and gains should be reported only to the extent that they make up previous losses for interims in the same fiscal year
How should companies using standard costing report variances on interims?
Variances which are planned and expected to be absorbed year-end are deferred until year-end
Unplanned variances are reported on interims
If costs are incurred in an interim period but cannot be identified with other particular periods, how should it be reported?
Charged to the interim period in which it was incurred
How should interim statements report year-end adjustments?
They should report a “reasonable portion” of them
E.g. inventory shrinkage, allowance for uncollectible accounts
How do seasonal variations affect interim reporting?
The seasonal nature of activities should be disclosed
These companies can possibly supplement their interims with twelve-month information up to the interim date
How should the tax effects of losses be reported in interim statements?
Should be recognized only when tax benefits are expected during the year or as a deferred tax asset at year-end
Which kinds of accounting changes should be reported in interim statements?
Differences from:
- the same interim period of the previous year
- the previous interim period
- the previous annual report
Companies are encouraged to adopt accounting changes at the beginning of a fiscal year
How should an error be reported if it is material to the interim period but not to the estimated year-end income?
Should be separately disclosed
What is the purpose of disclosure requirements for interim statements?
To benefit investors in publicly-traded companies
If a company expects a loss on the future sale of discontinued assets, when is the loss recorded?
When it is expected (not sold), since that would mean the asset is impaired at that point
Expected gains are not recognized until realized
What is a general emphasis of interim statements?
Timeliness over reliability
What are the only situations where prior period adjustments arise?
Error corrections
make sure this is correct
Do errors in OCI require prior period adjustments?
No
PPAs are designed to correct income errors, not OCI
What are examples of items that aren’t extraordinary?
(1) gains/losses from selling PP&E
(2) gains/losses from foreign currency exchanges or translation
(3) any write-down of assets (receivables, inventory, intangibles)
How do interim periods report discontinued operations or extraordinary items?
Reported entirely within the interim period when they occur – not spread out
