F1-M1 Balance Sheet, Income Statement, and Comprehensive Income

Balance Sheet

• General purpose financial reporting

  • Full set of financial statements and notes to the financial statements

    • Statement of Financial Position (Balance Sheet)

    • Statement of Earnings (Income Statement)

    • Statement of Comprehensive Income 

    • Statement of Cash Flows

    • Statement of Owner’s Equity

• Classified balance sheet

  • Distinguishes current and non-current assets and liabilities

Uses of the Income Statement and Terminology

• Purpose of the Income Statement

  • Reports both income from continuing operations and discontinued operations

  • Provide information about (REGL)

    • Expenses - Uses of funds

    • Losses - Uses of funds that will never be used to earn income 

    • Revenues - Sources of funds created by those expenses

    • Gains - Sources of funds not associated with the earnings process

• Uses of the Income Statement

  • Helps determine

    • Profitability

    • Value for investment purposes

    • Creditworthiness

  • Predicts information about future cash flows from past performance 

• Terminology

  • Cost

    • Amount expended for items such as capital assets, services, and merchandise received

    • The amount actually paid for something

    • Period cost - expensed immediately and recurring in nature

  • Unexpired costs

    • Costs that will expire in future periods and be charged (allocated) against revenues from future periods

• Revenues (gross concept)

  • Reported in the gross amount of consideration to which the entity expects to be entitled in exchange for the specified goods or services transferred

• Expenses (gross concept)

  • Costs that benefit only the current period or the allocation of unexpired costs to the current period for the benefit received

• Gain (net concept)

  • Proceeds less net book value

  • Recognition of an asset either not in the ordinary course of business or without the incurrence of an expense

• Loss (net concept)

  • Proceeds less net book value

  • Cost expiration either not in the ordinary course of business or without the generation of revenue

• Treatment of unusual or infrequent items 

  • Reported separately as part of income from continuing operations

  • Nature and financial statement effects disclosed on face of I/S or footnotes

Income from Continuing Operations

• REPORTED GROSS OF TAX (ie. does not account for tax expense)

• Multiple Step Income Statement

  • Reports operating revenues and expenses separately from non-operating revenues and expenses and other gains and losses

  • Enhanced user information 

• Single Step Income Statement

  • Total expenses are subtracted from total revenues (Revenues - expenses, this is the only step!)

  • Simple design 

  • Presentation of revenues or expenses do not appear to the user to be classified as more important that others

• Operating Income vs Nonoperating Income (both are included in income from continuing operations)

Income from Discontinued Operations

• A discontinued operation may include:

  • Component of an entity

  • Group of components of an entity

  • Business or nonprofit activity 

• Reported separately from continuing operations in the income statement, after income from continuing operations, net of tax

• Items Reported within Discontinued Operations (DIO)

  • impairment loss

  • a gain or loss from actual operations

  • a gain or loss on disposal

• Types of Entities to be considered (ie. reported in discontinued operations if…)

  • Has been disposed of

  • Is classified as held for sale

• Conditions that must be present

  • Held for Sale Criteria

    • Must meet all!

      • Management commits to plan to sell the activity

      • Activity is available for immediate sale in its present condition

      • Active program to locate a buyer has been initiated

      • Sale of the activity is probable and completion of the sale is expected to occur within a year

      • Activity is being actively marketed at a reasonable price relative to its current fair value

      • Significant changes in the plan are not expected

    • What if one or more of the criteria is no longer met?

      • Reclassified as held and used

        • Held and used - default; means the company uses the assets and are not actively for sale

• Disposal of a component or group of components (STRATEGIC SHIFT)

  • Reported in discontinued operations IF disposal represents a STRATEGIC SHIFT that HAS or WILL HAVE a major effect on an entity’s operations  and financial results

  • Examples

    • Disposal of a major geographical area

    • Disposal of a major equity method investment

    • Disposal of a major line of business

• Discontinued Operations Calculation

  • Items included in Results of Discontinued Operations 

    • Results of operations of the component

    • Gain or loss on disposal of the component

    • Impairment loss (and subsequent increases in fair value) of the component 

      • Initial and Subsequent impairment losses

        • Loss is recognized for any subsequent increase in fair value minus costs to sell 

        • Any initial or subsequent write-down to fair value less costs to sell

      • Subsequent Increases in Fair Value

        • Gain is recognized for any subsequent increase in fair value minus the costs to sell

        • But not in excess of the previously recognized cumulative loss

  • Discontinued Operations Calculation - Impairment Loss of the Component - Step by Step

1. Calculate the NRV

   1. Rule of conservatism - write down the unrealized loss immediately

2. Calculate the impairment loss

   1. Impairment loss = NRV - Book Value 

• Report in the period disposed of or held for sale

  • Report in discontinued operations 

  • In the period the component is DISPOSED OF or HELD FOR SALE

  • IF HELD FOR SALE

    • There may be subsequent operations of a component that are held for sale

    • These activities are to be reported in discontinued operations in the period in which they occur

• Depreciation and Amortization

  • ONCE management DECIDES to dispose of the component they are no longer depreciated or amortized

• Measurement and Valuation 

  • Classified as held for sale 

    • Measured at the LOWER OF its carrying amount OR fair value less costs to sell

    • Costs to sell - incremental direct costs to transact the sale

• Presentation and Disclosure

  • Present as a Separate Component of Income

    • Results of discontinued operations are reported net of tax

    • As a separate component of income

    • Below income from continuing operations 

  • Disclose in face or in notes

    • Gain or loss recognized on disposal shall be disclosed either on the face of I/S or in the notes to the F/S

Foreign Currency Transactions

• FCT G/Ls occur when 

  • A company buys from or sells to a foreign company with whom it has no ownership interest and agrees to pay or accept payment in a foreign currency

Foreign Currency Terminology

• Exchange rate

  • Price of one unit of a currency expressed in units of another currency

  • The rate at which two currencies will be exchanged at equal value

  • Direct Method - domestic price of one unit of another currency

    • Example - One euro costs $1.47

  • Indirect Method - foreign price of one unit of the domestic currency

    • Example - 0.68 euro buys $1.00

• Current exchange rate 

  • Aka Spot Rate

  • The exchange rate at the current date

• Denominated or Fixed in a Currency

  • Used to negotiate and settle the transaction

Changes in Exchange Rate

• Foreign Exchange Transaction Gain or Loss occurs when

  • Exchange rate changes between the time a purchase or sale in foreign currency is CONTRACTED FOR and the time ACTUAL PAYMENT is made

  • Change in rate between sale and payment

Transaction not settled at Balance Sheet Date

• Unrealized gain or loss 

  • Change in rate used in recording the transaction and the exchange rate at the balance sheet date

Valuation of Assets and Liabilities

• Should reflect exchange rate at date of transaction 

Statement of Comprehensive Income

Definitions

• Comprehensive income - change in equity (net assets) of a business enterprise during a period from transactions and other events and circumstances from nonowner sources 

  • Nonowner sources - all changes in equity EXCEPT those resulting from investments by owners and distributions to owners

• Net Income 

  • Income from continuing operations and income from discontinued operations

• Other Comprehensive Income (PUFI)

  • REGL items included in comprehensive income but EXCLUDED from net income under US GAAP

  • PUFI

    • Pension Adjustments (defined benefit pension plan accounting not tested on CPA anymore)

      • Certain gains and losses from defined benefit pension plan recognized in OCI in year of changes

      • Remain in OCI income until recognized as pension expense on I/S

    • Unrealized Gains and Losses (AFS Debt Securities and Hedges)

      • Remain in OCI until securities are sold or until cash flows associated with the hedged item are realized

      • Unrealized holdings gains and losses on AFS debt securities

      • Unrealized holdings gains and losses that result from debt security being transferred in the AFS category from HTM

      • Subsequent decreases or increases in the FV of AFS debt securities previously written down as impaired

      • Gains or losses on derivative instruments that are designated as, and qualify as, cash flow hedges

    • Foreign Currency Items

      • Foreign currency translation adjustments and gains and losses on foreign currency transactions that are designated as economic hedges of a net investment of a foreign entity 

    • Instrument Specific Credit Risk

      • For liabilities for which the fair value option is elected

      • Changes in fair value that are attributable to instrument specific credit risk

        • Changes in fair value occur as a result of market fluctuations

Reclassification Adjustments

• Move OCI items from ACOI to the I/S

Accumulated Other Comprehensive Income (AOCI)

• Component of equity that includes the total of OCI for the current and all previous periods

Financial Statement Reporting

• Two methods of presenting comprehensive income and its components

  • Single statement of comprehensive income (single statement approach)

  • Income statement followed by a separate statement of comprehensive income that begins with net income (two statement approach)

• Single Statement Approach

  • Displays OCI items individually and in total

  • Below net income

• Two-Statement Approach

  • Displays comprehensive income as a separate statement that immediately follows the income statement

Other Reporting Issues

• Other comprehensive Income

  • Reported net of tax or before related tax effects

• Income Tax Expense or Benefit

  • Disclosed either on the face of the statement or notes to the F/S

• Interim Reporting Period

  • Total for comprehensive income shall be reported in condensed financial statements of interim periods issued to shareholders

• Required Disclosures

  • Tax effects of each component included in (current) other comprehensive income

    • Part of statement presentation or notes to the F/S

  • Changes in AOCI components

    • Face of F/S or notes to F/S

  • Total accumulated OCI in the BS as an equity item

  • Reclassification of adjustments

  • Amounts of OCI component 

    • Net of tax; or,

    • Before-tax 

Summary

• Carrying value - AKA book value, the net value of an asset or liability

  • Carrying Value = Original Cost - accumulated depreciation, amortization, or impairment charges

  • Represents asset’s value for internal reporting as opposed to market value (what it could sell for)

• Fair Market Value - estimated price an asset would sell for in an open, competitive market between a willing buyer and a willing seller, neither acting under compulsion and both having reasonable knowledge of relevant facts

• Net gain or loss = selling price/net realizable value - book/carrying value