Intermediate Accounting Exam 2

Three Major Components of the Multistep Income Statement

1) Operating Income

2) Nonoperating Income

3) Income Tax Expense

Earnings Quality

The ability of reported earnings to predict a company’s future earnings

Classification Shifting

Misclassifying operating expenses as nonoperating expenses to affect the appearance of earnings

Discontinued Operations

components sold, disposed of, or held for sale

Restatement Approaches

1) Retrospective Approach

2) Modified Retrospective

3) Prospective Approach

Retrospective Approach

New standard applied to all periods presented (change last 3 years)

Modified Retrospective

New standard applied to adoption period only (prior periods not restated)

Prospective Approach

Change implemented in the current and future periods (estimate change)

Statement of Cash Flows

provides information about cash receipts and cash disbursements, inflows, and outflows

Sections of the Statement of Cash Flows

1) Operating Activities

2) Investing Activities

3) Financing Activities

Operating Activities

Activities reported on the income statement

Operating Activities methods

1) Direct

2) Indirect

Direct Method

Reports each cash flow seperately

Indirect Method

Starts with net Income and converts to cash basis

Investing Activities

Buying and selling long-lived assets (PP&E) and investments

Financing Activities

External financing

• Debt

  • Noncurrent liabilities (ex: loans)

• Equity

  • dividends

Noncash Investing and Financing

On the statement of cash flows or disclosure notes (ex: purchase of PP&E with note payable)

Profit Margin

A profitability ratio that shows the % of a sale that becomes profit

• Net income/net sales

Receivables Turnover

How quickly the company turns receivables into cash (# of days)

• Net sales/Average AR

• If short on cash, increase discount (ex: 2/10 n 30)

Inventory Turnover

# of times the average inventory balance is sold during a reporting period

• COGS/average inventory

Asset Turnover

Efficiency of using assets

• Net sales/average total assets

• Trending up is good

Activity Ratios

1) Receivables Turnover

2) Inventory Turnover

3) Asset Turnover

Time value of money

Money invested today will grow to a larger amount in the future

Simple Interest

Multiply the initial investment by the interest rate and the period of time

Compound Interest

Money remains invested for multiple periods and the previous periods interest earns interest

Effective Rate

rate that which money will actually grow during a full year

Future Value of a Single Amount

The amount of money that a dollar will grow to at some point in the future

• FV=I(1+i)^n

  • I= amount invested

  • i= interest rate

  • n= # of compounding periods

Present Value of a Single Amount

Today’s equivalent to a particular amount in the future

• PV=FV/(1+i)^n

Ordinary Annuity

Cash payments at the END of each period

Annuity Due

Cash payments at the BEGINNING of each period

FV of Ordinary Annuity

• 1st investment compounds 2 periods

• 2nd investment compounds once

• 3rd has no compounding

FV of an Annuity Due

• 1st investment compounds for 3 periods

• 2nd investment compounds twice

• 3rd compounds once

PV of Ordinary Annuity

Multiply each payment by the corresponding PV factor of each year (or use table)

PV of Annuity Due

No interest on the first payment since made on the first day

Deferred Annuities

first cash flow occurs more than one year after the date of the agreement

Revenue Recognition Steps (5)

1) Identify the contract with a customer

2) Identify the performance obligation(s) in the contract

3) Determine the transaction price

4) Allocate the transaction price to each PO

5) Recognize revenue when (or as) each PO is satisfied

Core Revenue Recognition Principle

Companies recognize revenue when goods or services are transferred to customers for the amount the company expects to be entitled to receive in exchange for those goods or services

Recognizing Revenue over time: requirements

• Single PO and known transaction price if:

  • Customer consumes the benefit of the seller’s work as it is performed

  • Customer controls the asset as it is created

  • Seller is creating an asset that has no alternative use to the seller (ex: customized)

Recognizing Revenue over time: When to recognize

• Recognize in proportion to the amount of PO that has been satisfied

  • Recorded as deferred or unearned revenue

Recognizing Revenue over time: Progress Completion Methods

• Output Method

• Input Method

Output Method

Proportion of goods/services that have been transferred to date

Input Method

Proportion of effort expended thus far relative to the total effect expected to satisfy PO

Distinct Goods and Services

1) must be separately identifiable from other goods or services in the contract

2) could be used on its own or in combination with goods or services obtained elsewhere

Stand-Alone Selling Prices

Amount at which a good or service is sold separately under similar circumstances

Stand-Alone Selling Price Approaches

1) Adjusted Market Assessment Approach

2) Expected Cost and Margin Approach

3) Residual Approach

Adjusted Market Assessment Approach

Seller considers what it could sell the product for in the market in which it normally conducts business

Expected Cost and Margin Approach

Seller estimates its costs of satisfying a PO and then adds an appropriate profit margin

Residual Approach

Last Resort: only allowed when the stand-alone selling price is highly uncertain

The seller estimates an unknown stand-alone selling price by subtracting the sum of the known/estimated stand-alone selling prices of other goods in the contract from the total transaction price of the contract

Gift Card Revenue

• Deferred Revenue when sold

• Breakage- unused portion of gift cards

Consignment Sales

• Recognize revenue upon sale to end customer

• The owner retains rights to the product until sold or returned to them (seller doesn’t have right to product)

Bill-and-Hold Arrangement

• Customer purchases goods but requests seller retain possession until a later date

• Recognize revenue at delivery

Operating Income Includes

Normal day to day income and expenses

• Revenue, Utilities, Rent, etc

Non Operating Income includes

Income from secondary activities

• interest, gains, etc