Intermediate Accounting (Chapters 4-6)

What is the purpose of the income statement

To report a company’s revenues, expenses, gains, losses, and net income or loss for a period.

What is the basic income statement relationship

Revenues and gains minus expenses and losses equals net income or net loss.

What is income from continuing operations

Income from the company’s ongoing business activities, separate from discontinued operations.

What are operating expenses

Costs incurred in the normal activities of running the business, such as selling, general and administrative, and research and development expenses.

What is operating income

Income from operating activities before nonoperating items and income taxes.

What are nonoperating items

Revenues, expenses, gains, or losses not directly related to the company’s main operations, such as interest expense or a gain on an investment sale.

What are discontinued operations

A component of a business that has been disposed of or is classified as held for sale and meets the required criteria for separate reporting.

How are discontinued operations reported

Separately from income from continuing operations, generally net of related income tax effects.

What is earnings per share (EPS)

The amount of net income attributable to each share of common stock.

What is the basic EPS formula

Income available to common shareholders ÷ weighted-average common shares outstanding.

What is diluted EPS

EPS adjusted for the potential effects of dilutive securities that could become common shares.

Why is diluted EPS often lower than basic EPS

Potential common shares increase the share count and can reduce earnings per share.

What is comprehensive income

The change in equity during a period from nonowner transactions; it includes net income and other comprehensive income.

What is other comprehensive income (OCI)

Certain gains and losses excluded from net income but included in comprehensive income.

How can comprehensive income be presented

In one continuous statement of comprehensive income or in two consecutive statements: an income statement and a statement of comprehensive income.

Where does accumulated OCI appear

As a separate component of shareholders’ equity on the balance sheet.

What is the purpose of the statement of cash flows

To report cash receipts and cash payments during a period and help users assess liquidity, profitability, and long-term solvency.

What does cash include on the statement of cash flows

Cash, cash equivalents, and restricted cash.

What are the three statement of cash flows categories

Operating activities, investing activities, and financing activities.

What are operating cash flows

Cash inflows and outflows related mainly to activities reported in the income statement and the company’s principal operations.

What are investing cash flows

Cash flows from acquiring and selling long-term assets and investments not treated as cash equivalents.

What are financing cash flows

Cash flows related to borrowing, repaying debt, issuing shares, repurchasing shares, and paying dividends.

Why can net income differ from operating cash flow

Net income uses accrual accounting, while operating cash flow reflects cash received and paid; noncash items and timing differences cause differences.

What is earnings quality

The extent to which reported earnings faithfully reflect sustainable performance and help predict future results and cash flows.

What is income smoothing

Using accounting choices or estimates to reduce fluctuations in reported earnings across periods.

What is classification shifting

Moving items between income statement categories to make operating performance appear stronger without changing total net income.

Why should investors review unusual or nonrecurring items

They may not reflect performance that is likely to continue in future periods.

What is the time value of money

The idea that money available today can earn interest and grow to a larger amount in the future.

What is interest

The amount paid or received for the use of money over time.

What is simple interest

Interest calculated only on the original principal.

What is compound interest

Interest calculated on the original principal and on interest accumulated from prior periods.

What is present value (PV)

The value today of a future cash amount or series of cash flows, discounted at an appropriate interest rate.

What is future value (FV)

The amount to which money invested today will grow after earning interest for a specified period.

What is the future value formula for a single amount

FV = PV × (1 + i)^n.

What is the present value formula for a single amount

PV = FV ÷ (1 + i)^n, or FV × the present value factor.

What does i represent in time value of money formulas

The interest rate per compounding period.

What does n represent in time value of money formulas

The number of compounding periods.

What happens to future value when the interest rate increases

Future value increases, assuming the same present value and number of periods.

What happens to present value when the discount rate increases

Present value decreases, assuming the same future cash flow and timing.

What is an annuity

A series of equal payments made or received at regular intervals.

What is an ordinary annuity

An annuity with payments at the end of each period.

What is an annuity due

An annuity with payments at the beginning of each period.

How does the present value of an annuity due compare with an ordinary annuity

The annuity due has a higher present value because each payment occurs one period earlier.

How does the future value of an annuity due compare with an ordinary annuity

The annuity due has a higher future value because each payment earns interest for one additional period.

What is the present value of an ordinary annuity

The value today of equal payments received or paid at the end of each period, discounted at the applicable rate.

What is the future value of an ordinary annuity

The accumulated value of equal end-of-period payments after earning interest over the specified periods.

What is a deferred annuity

An annuity whose payments begin at a future date rather than immediately or at the end of the next period.

How can the present value of a deferred annuity be calculated

First calculate the annuity’s value at the beginning of its payment period, then discount that amount back to today.

What are the four common variables in an annuity problem

Present value or future value, payment amount, number of periods, and interest rate.

What should you do when payment periods differ from annual periods

Convert the annual interest rate and total time into the rate and number of periods that match the payment frequency.

How is the present value of a bond generally calculated

Add the present value of the periodic interest payments to the present value of the maturity value, using the market rate per period.

What determines a bond’s issue price

The present value of its promised interest payments and principal repayment discounted at the market interest rate at issuance.

When is a bond issued at a discount

When its issue price is below face value, usually because its stated rate is below the market rate.

When is a bond issued at a premium

When its issue price is above face value, usually because its stated rate is above the market rate.

What is the key difference between PV and FV

PV discounts future cash flows to today; FV compounds current money forward into the future.

What is revenue

Inflows or other enhancements of assets, or settlements of liabilities, from delivering goods, providing services, or other central business activities.

What two questions must revenue recognition answer

How much revenue to recognize and when to recognize it.

What is the core revenue recognition principle

Recognize revenue when or as the company satisfies a performance obligation by transferring control of a promised good or service to the customer.

What are the five steps of revenue recognition

1. Identify the contract. 2. Identify performance obligations. 3. Determine the transaction price. 4. Allocate the transaction price. 5. Recognize revenue when or as each performance obligation is satisfied.

What is a contract for revenue recognition purposes

An agreement between a company and a customer that creates enforceable rights and obligations.

When does a contract generally exist under the revenue model

When the parties approve the agreement, rights and payment terms can be identified, the arrangement has commercial substance, and collection is probable.

What is a performance obligation

A promise to transfer a distinct good or service to a customer.

When is a promised good or service distinct

When the customer can benefit from it on its own or with readily available resources and it is separately identifiable from other promises in the contract.

What is the transaction price

The amount of consideration the company expects to be entitled to for transferring promised goods or services.

What is variable consideration

Consideration that can change because of discounts, rebates, refunds, incentives, penalties, bonuses, or similar factors.

How is variable consideration included in the transaction price

Estimate the amount using an appropriate method and include it only to the extent it is probable that a significant revenue reversal will not occur.

What is the expected-value method

A probability-weighted estimate that sums possible outcomes and their probabilities.

What is the most-likely-amount method

The single most likely amount from a range of possible outcomes.

How is the transaction price allocated to multiple performance obligations

Generally in proportion to each obligation’s relative standalone selling price.

What is a standalone selling price

The price at which a company would sell a promised good or service separately to a customer.

When is revenue recognized at a point in time

When control of the promised good or service transfers to the customer at a specific time.

What are common indicators that control has transferred

The customer has a present right to payment, legal title, physical possession, significant risks and rewards, or accepted the asset, as relevant to the arrangement.

When is revenue recognized over time

When the customer receives and consumes benefits as the company performs, the customer controls the asset as it is created or enhanced, or the asset has no alternative use and the company has an enforceable right to payment for work completed.

How is progress measured for an over-time performance obligation

Using a method that faithfully depicts progress, such as an output method or an input method.

What is an output method

A method that measures progress based on results delivered to the customer, such as units delivered or milestones achieved.

What is an input method

A method that measures progress based on inputs used, such as labor hours or costs incurred, relative to total expected inputs.

How are sales with a right of return accounted for

Recognize revenue for the amount expected to be kept, a refund liability for expected refunds, and an asset for the right to recover returned products, subject to the applicable measurement rules.

What is the difference between a principal and an agent

A principal controls the specified good or service before transfer and generally reports gross revenue; an agent arranges for another party to provide it and generally reports its fee or commission as revenue.

How is a significant financing component treated

Separate the cash selling price from the financing effect, recognizing interest income or expense over time when required.

What practical expedient applies to a financing component

A company may assume there is no significant financing component if the period between transfer and payment is one year or less.

How are customer prepayments generally recorded before goods or services are provided

As a contract liability, often called deferred revenue, until the company satisfies the related performance obligation.

What is a contract asset

A right to consideration for goods or services already transferred when that right is conditional on something other than the passage of time.

What is a receivable

A right to consideration that is unconditional except for the passage of time before payment is due.

How are warranties treated for revenue recognition

A warranty that only assures the product meets specifications is generally accounted for as a cost/accrual; a warranty that provides an additional service is generally a separate performance obligation.

How are customer options for additional goods or services treated

They are a separate performance obligation when they provide a material right the customer would not receive without the contract.

How are gift cards accounted for when sold

Cash is received and a contract liability is recorded; revenue is recognized when the card is redeemed or when qualifying breakage is recognized.

What is bill-and-hold accounting

A situation in which a customer has purchased a product but asks the seller to hold it for later delivery; revenue is recognized only if the applicable control-transfer criteria are met.

What is a consignment arrangement

An arrangement where goods are delivered to another party for sale but the seller generally retains control until a specified event, such as sale to an end customer.

What is a contract modification

A change in the scope or price of a contract that must be assessed to determine whether it is a separate contract or part of the existing contract.

How is revenue recognized on a long-term contract that qualifies for over-time recognition

Revenue is recognized over time based on the measure of progress toward satisfying the performance obligation.

What is the cost-to-cost input method

A method that measures progress by comparing costs incurred to date with total estimated costs.

What is the formula for percentage of completion using cost-to-cost

Costs incurred to date ÷ total estimated costs.

How is revenue to date calculated using a cost-to-cost progress measure

Percentage complete × total transaction price, less revenue recognized in prior periods.

Why must total estimated contract costs be updated

Changes in expected costs affect the measure of progress and the amount of revenue and profit recognized.