CH. 3 income statement, related info & rev rec ACCT 320

this occurs from peripheral or incidental transactions

gain on the sale of equipment

in the single-step income statement…

just two groupings exist- revenues and expenses

the income statement helps investors and creditors predict amounts, timing, and uncertainty of future cash flows

true

the single-step income statement differentiates between operating and nonoperating activities

false

i/s items found on a multi step income statement include all of the following except

prepaid expenses

the income statement helps users of financial statements…

1. evaluate the past operating performance of the company

2. predict a basis for predicting future performance

3. help assess the risk or uncertainty or achieving future cash flows

(recurring transactions v. one-time transactions)

limitations of the income statement

1. companies omit items from the income statement that they cannot measure reliably.

2. income numbers are affected by the accounting method used

3. income measurement involves judgement

companies omit items from the income statement that they cannot measure reliably such as…

brand recognition, product quality, human capital.

income numbers are affected by the accounting method used such as…

depreciation and inventory cost flow

income measurment involves judgement (estimates) on things like…

bad debt expense, warrenty expense, depreciation expense

format of the income statement

revenues, expenses, gains, and losses

multi step v. single step i/s

multi splits operating + non operating activities and includes several steps to calculate net income. single just subtracts all expenses from all revenues to arrive at net income.

income from continuing operations (after tax)

net income THE LINE

quality of earnings

the financial press focuses a lot of attention on a company’s earnings! the SEC is concerned that short-term market pressures drive companies to make decisions that are not in the best interest for the long-term.

two types of quality of earnings

1. earnings management

2. non-gaap reporting

earnings management

planned timing of revenues, expenses, gains, and losses to smooth out the bumps in earnings. making financial decisions that it wouldn’t otherwise make to alter financial or operating results.

non-gaap reporting

providing financial measures/results to users that are not aligned with gaap (adjusted EBITDA). companies must label such measures as non-gaap for transparency

unusual gains and losses

if a material financial statement event is unusual or infrequent or both, companies will often report it seperately in the income from continuing operations section of the income statement

unusual gains and losses example

natural disasters, imparements, reconstructing costs

discontinued operations

result from the sale or disposal of a component of a business. a component is a part of an entity for which operations and cash flows are clearly distinguishable from the rest of the entity. the disposal of the component also represents a strategic shift in the company’s operations and financial results

examples of disposals of components

yum disposing of pizza hut

disposals that aren’t disposals of components

yum stops selling pasta

closing 50 restaurant locations

target not selling clorox product line anymore

results of the disposable are reported in two phases

1. income or loss from operation of the discontinued component for the entire year, net of tax

2. gain or loss from disposal of the discontinued component, net of tax

intraperiod tax allocation

the process of associating income tax expense with related income for the current period, or “letting the tax follow the income” companies allocate tax expense to the various components of net income which helps users to better predict the amount, timing, and future cash flows.

example of intraperiod tax allocation

cost - benefit + cost = total cost

EPS

earnings per share

importance of earnings per share in the financial press

widely used measure of business performance. Market pressure to meet wallstreet earnings expectations can be significant. These short-term pressures can drive companies to “manage” earnings.

basic EPS calculation

(net income - preferred dividends) / (weighted-average common shares outstanding)

preferred dividends

earnings available to common shareholders

change in accounting estimate

a change in an amount a company expects (estimate) because new information or circumstances have become available (fix it and move forward)

in a change in accounting etimate do not

restate the prior period financials

examples of changes in accounting estimate

change in depreciation of useful life, salvage value, bad debt, sales returns and allowances, warranties, etc.