F1 M1 Balance Sheet, Income Statement, and Comprehensive Income

Full set of financial statements

• statement of financial position

• statement of earnings

• statement of comprehensive income

• statement of cash flows

• statement of owner’s equity

classified balance sheet

current vs non current assets & liabilities

liquidity formula

= current assets / current liabilities

balance sheet date

cumulative “as of” certain date

contributed capital

capital stock - preferred or common

earned capital

• paid in capital in excess of par

• retained earnings

• AOCI

• Treasury stock

purposes and uses of balance sheet

• provide lists of assets & liabilities & equity

• shows types of assets & liabilities

• used to evaluate liquidity & long term solvency

balance sheet formula

Assets = Liabilities + Equity

assets

proable future economic benefit

current assets

cash and assets expected to convert to cash

examples of current assets

cash, receivables, prepaids, inventory, short-term investments

investment + funds

noncurrent, not directly used in operations

examples of investments + funds

stock/bonds in other companies

property, plant & equipment (PP&E)

tangible, long-lived, used in operations

intangibles

no physical substance, long-lived, used in operations

intangibles examples

patent, copyright, trademark, franchise

liabilities

first claim on asset, have a maturity date

current liabilities

obligations to be satisfied with current assets

long-term liabilities

obligations to be satisfied beyond one year

Limitations of the Balance Sheet

• many assets + equity issuances measured at historical cost

• some measurements are subjective

• estimates may used

Purpose of the Income Statement

• indicates its performance for a period of time

• helps determine operating risk

• provides information about its revenues, expenses, gains and losses

users of the income statement

• external users

• lenders

• internal users

external users

investors, stockholders, common or preferred stockholders to evaluate

• profitability & value

• operating income

• return on equity

• earnings per share

lenders

short-term or long-term lenders to evaluate creditworthiness

• profit margin

• earnings before interest and tax

internal users

managers use return on asset for a particular product line

operating revenues and expenses

• normal operating activities

• separate on income statement

• presented as gross amount

nonoperating revenues and expenses

• exceptional/nonoperating activities

• includes other revenues and expenses

gains and losses

non operating items reported at net amounts

period costs

expenses immediately, recurring in nature

examples of period costs

selling cost, general cost, administrative cost, research cost

unexpired cost

capitalized as an asset for future, appears on the balance sheet, expenses in future periods based on matching principle

unexpired cost → expired cost inventory

cost of goods sold

unexpired cost → expired cost prepaid insurance

insurance expense

unexpired cost → expired cost NBV Fixed Asset

depreciation expense

unexpired cost → expired cost cost of patents

amortization expense

nonoperating items on the income statement

• sale other than inventory

• write downs

• write offs

• sale of PP&E

• sale of investment in another company

• unusual operating expense

income from continuing operations formula

= operating income + non operating income

operating income

revenues & expenses

nonoperating income

gains and losses

net gain or loss formula

= (selling price / NRV) - book/carrying value

income from discontinued operations

• selling off a product line, separate division, or segment of the company’s operations

• reporting separately on the income statement

• comes after income from continuing operations in the income statement

• reported as net of tax

single step income statement formula

All revenues & gains

-All expenses & losses

= Pre tax income

-income tax expense

=net income

single step income statement benefits

• gives net income in 1 step

• simple design

• does not make one item appear more or less important than any one item

single step income statement drawback

does not distinguish between core and incidental business

multi step income statement

sales

-COGS

= Gross Profit

-operating expenses

= operating income

± nonoperating gains (losses)

= Pre tax income

-income tax expense

= Net income

± discontinued operations (net of tax)

= Net income

multi step income statement benefits

• enhances user information

• separate operating business from nonoperating

• provides readily available information for ratio analysis

• helps assess if its core business or infrequent business

• helps calculate increase in EPS because increase in net income

limitations of the income statement

• subjectivity

• management bias

• manipulation through assumptions and bias

• accrual basis vs cash basis

• classification shifting

subjectivity

• based on accounting methods including estimates

• revenues and expenses booked on accrual basis

  • revenues when earned

  • expenses when incurred

management bias

• assumptions and estimates

• LIFO vs FIFO

• straight-line vs accelerated

• useful life vs salvage value

manipulation through assumptions and bias

• aggressive

• conservative

aggressive

booking higher revenue, lower expense, higher profit

conservative

booking lower revenue, higher expense, lower profit

accrual basis

booking revenue when it is earned, gives better assessment of performance

cash basis

book revenue when cash is received, book expense when cash is paid, poor indicator of performance

classification shifting

operating losses or expenses to nonoperating section to avoid bad news, nonoperating gains or revenues to operating to improve performance

net sales formula

= gross sales - returns and discounts

total sales formula

= net sales + service revenue + rental revenue

cost of sales formula

= cost of goods sold + cost of services sold + cost of rental income

gross profit formula

= total sales - cost of sales

total selling expenses formula

= freight out + commissions + advertising + salaries for sales people

general and administrative expense formula

= insurance expense + salaries for officers

report discontinued operations

• on the income statement

• separately from continuing operations net of tax

• below income from continuing operations before net income

continuing operations formula

= operating income + nonoperating income

operating income (loss) includes

revenues, expenses, gains & losses from core business

examples of operating income (loss)

• COGS

• selling expense

• general expense

• admin expense

• depreciation

• R&D

nonoperating income (loss) includes

other revenue, expenses, gains and losses unusual and/or infrequent items

examples of nonoperating income (loss)

• interest revenue

• interest expense

held for sale criteria

1. management commits to a plan to sell the activity

2. activity is available for immediate sale in its present condition

3. active program to locate a buyer has been initiated

4. sale of the activity is proable & completion of the sale is expected within 1 year

5. activity of being actively marketed at a reasonable sale price relative to its current fair value

6. significant changes in the plan to sell are not expected

conditions that must be presnet

• all related costs shall be recognized when the obligations to others exist, not necessarily in the period of commitment to a plan

• disposal of a component is reported in discontinued operations if it represents a strategic shift that has or will have a major effect on an entity’s operations and financial results

results of operations of the component

• product line sold during the year must be reported separately at end of the year

• all results for that period will be moved down & classified as gain or loss

gain or loss on disposal of the component

• date of product line sale does not matter as long as it was sold during the year

• gain or loss on disposal is calculated based on the selling price vs carrying value at the time of the sale

• gain or loss would be reported under discontinued operations

impairment loss of the component steps

1. calculate NRV

2. calculate impairment loss

NRV - Rule of Conservatism

write down the unrealizes loss immediately

impairment loss formula

= NRV - book value

Report in the period disposed or held for sale - multiple years

calculate

• impairment loss

• results of operations

• gain or loss on sale

depreciation and amortiziation

decision of disposal - no longer depreciate or amoritize

measurement and valuation

segement classified held for sale reported on balance sheet at lower of NRV or book value

presentation and disclosure

• presented as a separate component of income at bottom of the income statement

• presented below income from continuing operations, net of tax

• disclosed in the face or in notes of the financial statements

import purchases

accounts payable in foreign currency

export services

accounts receivable in foreign currency

foreign currency transaction gains/losses occur when

• a company buys from or sells to a foreign company with whom it has no ownership interest

• company agrees to pay or accept payment in a foreign currency

not considered foreign currency transactions

transactions between a subsidiary and a parent of a permanent financing nature `

exchange rate

price of one unit of a currency expressed in units of another currency rate on which two currencies will be exchanged at equal value

direct method

domestic price of one unit of another currency

direct method example

1 euro = $1.47

indirect method

foreign price of one unit of the domestic currency

indirect method example

0.68 euros = $1

Current exchane rate

exchange rate at the current date, immediate delivery of currency - spot rate

gain/loss exchange rate

exchange rate changes between time purchased or sale contracted & time payment is made

accounts receivable denominated in foreign currency - gain

foreign currency increase, assets increase

accounts receivable denominated in foreign currency - loss

foreign currency decrease, assets decrease

accounts payable denominated in foreign currency - gain

foreign currency increase, liabilities increase

accounts payable denominated in foreign currency - loss

foreign currency decrease, liabilities decrease

transactions not settled at balance sheet date

gain or loss in current net income must be computed at each balance sheet date on all record transactions denominated in foreign currencies not settled

valuation of assets and liabilities

assets or liabilities resulting from currency transactions should be recorded in US company’s books using exchange rate in effect at date of transaction

items on income statement - REGL

• revenues

• expenses

• gains

• losses

items not on the income statement - PUFI

• pension adjustments

• unrealized gains lor losses

• foreign currency items

• instrument specific credit risk

comprehensive income formula

= net income + other comprehensive income

other comprehensive income - PUFI

• pension adjustments

• unrealized gains lor losses

• foreign currency items

• instrument specific credit risk

pension adjustments

certain gains/losses from a defined benefit pension plan must be recognized in OCI in the year change occurs