601 final

Usefulness of the Income Statement

Evaluate past performance - by disclosing separate components of revenues and expenses, users can identify the main factors that influence performance • Provides confirmatory value (component of relevance) • Analysts care about meeting or beating earnings forecasts • Predict future performance • Provides predictive value (component of relevance) • Analyzing a trend of earnings growth - may indicate future continued growth • Assess risks or uncertainties in achieving future cash flows - some items are more persistent than others making them indicators of future cash flows • Revenues from sales versus transitory gains

Limitations of the Income Statement

Excludes certain items - companies cannot measure certain items reliably and therefore exclude them from the I/S • Unreliable information lacks faithful representation • E.g., - estimating a contingent loss reliably • Depends on accounting methods selected • Identical companies that purchase the same asset but use different depreciation methods will report different net income, impeding comparability • Requires extensive judgment and estimation • Discretion allows managers to make choices to reflect the economic reality of the transaction which enhances the usefulness of the F/S • However, managers can bias their judgments to achieve desired reporting outcomes • Different judgments reduce comparability

Determining the Estimated Percentage of Completion

Firms estimate the degree of completion by using input measures or output measures • Input measures - a common method is the cost-to-cost approach, which estimates the cumulative percentage of completion by dividing the total cost incurred to date by the total estimated costs • The estimated total cost of the project is likely to change throughout the project • Output measures include measures such as miles of highway completed or square footage completed, etc.

Percentage of Completion Method Implementation

Firms recognize revenue, expense, and gross profit in each year by: • Computing cumulative revenue by multiplying the total estimated contract revenue times the percentage complete • Revenue for the current period is cumulative revenue less revenue recognized in all prior periods • Actual costs for the period will be known or given • Computing gross profit for the year as the revenue recognized in the current period less the costs recognized in the period

Accounting for Treasury Stock (T/S) Transactions

Firms typically record T/S in a contra-stockholders' equity account and report T/S as a reduction of total stockholders' equity on the B/S • Recall from the earlier discussion that T/S reduces the shares O/S, do not have voting rights and do not receive dividends • There are two methods of accounting for T/S: • Cost method - records the acquisition of T/S at the cost of the repurchased shares • Most popular method • Par value method - records the acquisition at the par value of the repurchased shares

Constraining Estimates of Variable Consideration

For the entity to include variable consideration in the estimated transaction price (and thus the amount of revenue recognized), it has to conclude that it is probable that a significant revenue reversal will not occur in future periods

Acquisition and Disposition of Long-Term Assets

Gains or losses do not provide or use cash • The cash inflow or outflow has the gain or loss embedded in it and that is why is must come out of net income in the operating section, or it would be double- counted

Transactions with Owners

Investments by Owners - Increases in net assets of a particular enterprise resulting from transfers to it from other entities something of value to obtain or increase ownership interests (or equity) in it. Assets are most commonly received as investments by owners, but that which is received may also include services or satisfaction or conversion of liabilities of the enterprise. • Distributions to Owners - Decreases in net assets of a particular enterprise resulting from transferring assets, rendering services, or incurring liabilities by the enterprise to owners. Distributions to owners decrease ownership interests (or equity) in an enterprise.

Financing Activities

Involve the cash receipts and payments from debt and equity financing • Do not net inflows and outflows • Includes: • Cash receipts from issuing equity to owners • Cash receipts from borrowing through bonds and notes or other debt instruments (include short-term N/P) • Cash payments to repurchase equity from owners • Cash payments for principal on debt (including short-term N/P and current maturities of long term debt) • Cash payments for dividends

Percentage-of-Completion Method

Involves the following procedures throughout the year: • Accumulate construction costs by debiting an asset (inventory) account called "construction in progress" (CIP) • When the contractor sends bills to the customer throughout the project, the contractor debits A/R and credits "billings on construction in progress" (Billings), which is a contra-account to CIP • When the contractor receives cash from the customer, it debits cash and credits A/R • Involves the following procedures at year-end: • Recognize the revenue and associated costs each year, basing the amount of gross profit in a given year on the progress to date • Credit revenue, debit expense for the costs, and debit the difference (the gross profit) to the CIP account • At the completion of the project, debit Billings and credit CIP to close the accounts • At the end of each year, the contractor reports A/R and the net amount of CIP over Billings (or Billings over CIP) • CIP over Billings is a current asset; Billings over CIP is a current liability • If the company reports CIP over Billings, the contract has unbilled receivables, or an asset, giving the contractor the right to bill the buyer for work performed • If the company reports Billings over CIP, it implies that the contractor has received cash in advance (unearned revenue) and has the obligation to perform on the contract

Multiple Contracts

It is not uncommon for vendors to enter into multiple contracts with the same customer • Under certain circumstances, the seller should combine these contracts and account for them as a single contract • Specifically, if one of the following criteria is met, the seller should combine multiple individual contracts into a single contract for the purposes of determining the timing and measurement of revenue: • The contracts are negotiated as a package and have a single commercial objective • The amount of consideration to be received by the seller related to one contract depends on the price or performance of another contract • The goods or services promised in the separate contracts are all part of one performance obligation

Overview of Long-Term Contracts

Long-term contracts are a type of transaction where firms report revenue, costs, and gross profit over time, as opposed to a point in time • Prevalent in industries such as communications, construction, software development, aircraft manufacturing, and shipbuilding • There are two accounting methods for revenue recognition for long-term contracts: • Percentage-of-Completion Method - recognizes gross profit over the production period • A company should use this method when it meets one of the three criteria for goods/services transferred over time and it can reasonably measure its progress toward completion • Otherwise must use the completed contract method below • Completed Contract Method - only recognizes gross profit at the end of the contract • Total revenue and costs are the same under both methods • Difference between the methods is the timing of revenue and gross profit recognition

Non-Mandatorily Redeemed Preferred Shares

Mandatorily redeemable preferred shares are preferred shares that can be redeemed at the option of the shareholder, but that option may not be exercised with certainty • Non-mandatorily redeemable preferred shares are reported as equity because the preferred shares may not be redeemed

Other Comprehensive Income (OCI)

Nicknamed dirty surplus items • Four types: • Unrealized gains and losses on available-for-sale investments • Unrealized gains and losses on cash flow hedges • Foreign currency translation adjustments • Unrecognized pension costs (benefits) from adjustments needed to bring the accounting for the pension asset or liability to the funded status of the pension plan • OCI items have at least one of three characteristics • Low probability of cash realization in the short run • Transitory - excluding them from the I/S reduces volatility • Not part of the entity's normal operations • OCI items close to Accumulated Other Comprehensive Income (AOCI)

Purpose of the Statement of Cash Flows

Provides information to users about a firm's cash receipts and cash disbursements during a period of time • Reconciles the change in cash to the cash flows for the period and summarizes the firm's cash flows by operating, investing, and financing activities • Enables F/S users to: • Assess the entity's ability to meet its obligations and pay dividends • Determine whether the entity will require external financing • Identify the differences between net income and the associated cash receipts and payments

Expense Recognition

Recognize expense when: • The entity's economic benefits are consumed in the process of producing or delivering goods or rendering services • An asset has experienced a reduced (or eliminated) future benefit, or when a liability has been incurred or increased, without an associated economic benefit • Therefore, a company reports an expense when economic benefits are consumed. • Three main approaches to determine when to report an expense: • Match with revenues • Expense in the period incurred • Systematically allocate over periods of use

Overview of Indirect Method Adjustments - Additions

Noncash Expenses and Losses • Depreciation, depletion, and amortization expense • Impairment loss • Bad debt expense (or use net A/R) • Stock-based compensation expense • Amortization of bond discounts • Increase in DTL or decrease in DTA • Equity losses from investee and cash dividends received from investee • Loss on sale of assets • Unrealized losses on trading or FVO securities • Increases in loan loss reserves • Pension expense or payments to retirees on defined-benefit plans • Changes in Current Assets and Current Liabilities • Decreases in current assets (except for cash and short-term securities) • Increases in current liabilities

Overview of Indirect Method Adjustments - Deductions

Noncash Revenues and Gains • Amortization of bond premiums • Decrease in DTL or increase in DTA • Equity income of investee • Gain on sale of assets • Unrealized gains on trading or FVO securities • Decreases in loan loss reserves • Contributions to defined-benefit pension plan • Changes in Current Assets and Current Liabilities • Increases in current assets (except for cash and marketable securities) • Decreases in current liabilities

Significant Noncash Investing and Financing Transactions

Noncash items are not incorporated in the statement of cash flows (although some noncash items are adjustments to net income in the operating section) • Noncash items are disclosed in a separate footnote or schedule • Common significant noncash investing and financing activities include: • Assets financed with debt • Stock dividends • Bond conversions • Capital lease signing • Nonmonetary exchanges

Accounting for Common Stock Issuances

Normally firms issue common stock for cash but it can also be issued for noncash consideration • When issuing stock for cash, firms allocate the total proceeds between the par or stated value and APIC • If the shares have no par or stated value, firms record the total proceeds in the common stock account • When issuing stock for noncash consideration, the corporation should value the goods and services received at the fair value of the consideration given up in the exchange • In this case, the value given in exchange would be the fair value of the stock issued • However, if the stock does not have a reliable fair value, the corporation uses the fair value of the consideration received to value the shares issued

Change in Reporting Entity

Occurs when a company reports F/S that are, in effect, F/S for a different reporting entity • A change in reporting entity involves: • Presenting consolidated or combined F/S instead of individual F/S • Changing the specific subsidiaries that make up the group of entities for which consolidated F/S are presented • Changing the entities included in combined F/S • The acquisition of a business is not considered a change in reporting entity • Firms account for reporting entity changes using the retrospective method by adjusting all F/S presented from prior periods to reflect the change

Allocation of a Discount

Once the company has estimated all of the standalone selling prices, it allocates any discount (the amount by which the sum of the standalone prices is greater than the transaction price) to separate performance obligations on the basis of the relative standalone selling prices

Retained Earnings

dividends to shareholders • Events other than dividends, net income, or net loss can also impact retained earnings

Net income

measure of financial performance resulting from the aggregate of revenues, expenses, gains and losses that are not items of other comprehensive income

New Revenue Standard

public companies will adopt for fiscal years beginning after 12/15/18 and nonpublic companies must adopt by 12/15/19 • Overarching principle of revenue recognition is the notion of the transfer of control of the goods or services

Other comprehensive income (OCI)

revenues, expenses, gains, and losses that are explicitly excluded from net income in specific accounting standards

Comprehensive income

the change in a company's equity during a period of time resulting from transactions, events, and circumstances other than transactions with owners, Net income + Other comprehensive income

Consignment Sales

A consignment sale is an arrangement where a seller (consignor) delivers goods to a third party (consignee), who sells the goods to a customer • Determining whether a particular arrangement is a consignment arrangement is based on whether the seller passes control to the other party • If control passes, it is a normal sale • If control doesn't pass, then it qualifies as a consignment sale, i.e., the following three indicators: • The seller controls the product until a specified event occurs, such as the sale to the ultimate consumer • The seller can require that the product be returned to it or sent to another third party • The third party does not have an unconditional obligation to pay for the product • If an arrangement is classified as a consignment arrangement, the consignee does not record the inventory on its books, and the consignor does not record revenue when the goods are delivered • Rather on the delivery date, the consignor credits inventory and debits inventory on consignment while the consignee makes no entry • The consignor records revenue, along with the commission expense and receivable or cash, upon notification that the consignee has sold the inventory • The consignor will also record COGS and remove the inventory on consignment from its books • When the consignee sells the inventory, it records commission revenue and an amount that is due to the consignor for the sale

Consideration Payable to a Customer

A seller may make payments to a customer if the seller is providing incentives to entice the buyer to purchase, or continue to purchase, its goods • Unless the payment to the customer is in exchange for a distinct good or service, the seller should deduct the amount of the consideration payable to the customer from the transaction price

Identify the Performance Obligations in the Contract

A seller needs to identify the various performance obligations in a contract to allocate the transaction price to these different performance obligations and to recognize revenue when or as it satisfies each individual one • A performance obligation is a promise to transfer: • a good or service, or bundle of goods or services, that is distinct, or • a series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer • The determination of separate performance obligations starts with identifying promised goods and services • Then the seller must determine which goods and services are distinct • To be distinct, a good or service must meet two conditions: • The customer can benefit from the good or service on its own or in conjunction with other readily available resources to the customer, and • The promise of the seller to deliver that good or service is separately identifiable from other promises in the contract

Stock Splits

A stock split results in a proportionate increase in the number of equity shares and a proportionate decrease in the share's par value per share • A 2-for-1 split results in an additional share of stock being given to shareholders for each share held • 100 shares of $2 par value stock before a split becomes 200 shares of $1 par value stock after the split • Total common stock account is unchanged: (100 x $2) = (200 x $1) • Only a memorandum entry is made into the general journal • A company issues a stock split when it believes its shares are trading at a price that is too high to attract a wider ownership base

Type of Accounting Changes

Changes in accounting principle - changes from one generally accepted method to another generally accepted method • Changes in accounting estimate • Changes in reporting entity

Treasury Stock - Cost Method

Acquisition - when a firm repurchases shares, it debits T/S for the cost of the repurchased shares • The repurchase of shares does not change the common stock account or APIC - Common • The repurchased shares are still considered issued, but they are no longer O/S • Reissuance of T/S - a firm holding T/S usually reissues these shares at a selling price that is different than the acquisition cost • If the company sells the T/S at a price above cost, it classifies the excess over cost as APIC - Treasury Stock • While this excess is similar to a gain, it should not be reported on the I/S because it results from a capital transaction • If the company sells the T/S below cost, the firm reduces APIC -T/S by the amount that is below cost • If the balance of APIC - T/S is not sufficient to absorb the difference, the rest reduces R/E

Statement of Cash Flow Formats

Indirect method (reconciliation format) • Direct method (income statement format) - FASB prefers this method but it is the least popular in practice • Used by 1% of public companies • Only the operating activities differs between the two methods

New Revenue Recognition Standard

Adopts an asset-liability approach and measures revenue based on the change in asset and liability values. • Five steps are applied to determine the timing and measurement of revenue: • Identify the contract with the customer • Identify the separate performance obligations in the contract • Determine the transaction price • Allocate the transaction price to separate performance obligations • Recognize revenue when each performance obligation is satisfied

Contract criteria:

All parties to the contract have agreed to the contract and are committed to performing under the contract (can be written or oral - whichever is customary practice for that business) • Each party's rights with respect to the goods or services that are being transferred are identifiable • The payment terms for the goods or services that are being transferred are identifiable • The contract has commercial substance, meaning that the risk, timing, or amount of the entity's future cash flows is expected to change as a result of the contract • It is probable that the seller will collect the consideration to which it is entitled in exchange for the goods or services • Consider the customer's ability and intention to pay • Probably is defined as "likely to occur"

Convertible Preferred Shares

Allow the shareholder to convert its shares to common shares at a predetermined rate or exchange ratio • Convertible preferred shares carry the same preferences as non-convertible preferred stock; however, they may also convert to common shares • The conversion feature enables preferred shareholders that convert to common stock to participate in voting rights and to not be limited to the fixed dividend return of preferred shares

Amortization of Bond Discounts and Premiums

Amortization of bond discounts and premiums result in a difference between the interest expense reported in net income and the interest paid. • The amortization of a bond discount results in more interest expense than cash paid • Add amortization to net income • The amortization of a bond premium results in less interest expense than cash paid • Subtract amortization from net income • Direct method - subtract (add) bond discount (premium) amortization to reduce (increase) cash paid for interest

Contributed Capital (Paid-In Capital)

Amounts invested by shareholders (common and preferred) • Common shareholders are the residual claimants of the firm who receive dividend distributions after the company has paid all other providers of capital their return on investment • Common shareholders can be individuals, other corporations or institutions (i.e., mutual funds) • Preferred shareholders are investors holding shares in a company that have preferential rights over common shares • Includes stock sold by the entity at face or par value and amounts received above par value • Par value or stated value is an arbitrary amount that the organizers place on the stock • Additional paid-in capital (APIC) represents the amounts that common and preferred shareholders contribute in excess of par or stated value

Revenues

Inflows or other enhancements of assets of an entity or settlement of its liabilities (or a combination of both) during a period from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central operations

Overview of Common Stock

Authorized shares are the total number of shares that the firm can legally issue • The state attorney general (of the state of incorporation) approves the authorization • Number of authorized shares is included in the articles of incorporation filed with the state • Issued shares are the number of shares sold or otherwise distributed to shareholders • Unissued shares are shares that are authorized but not issued • Treasury shares are the corporation's own shares repurchased by the corporation and held for some future use • Reacquired shares can also be retired rather than held in treasury • Outstanding shares are the number of shares still in the hands of the stockholders, computed as issued shares less than treasury shares • EPS and book value/share use the number of outstanding shares in their calculations • Cash dividends are only paid on outstanding shares • Only outstanding shares have voting rights

Channel Stuffing

Channel stuffing (also referred to as trade loading) is a practice in which a company induces wholesale distributors to buy more inventory than they can sell in the current period with increased discounts or liberal return policies • If the distributors cannot sell the inventory in the next period, they return the goods to the seller • Channel stuffing inflates sales in the current period, thus making the seller's F/S look better • Firms should not recognize revenue from a channel stuffing arrangement because the risks and rewards of ownership have not passed to the buyer, given the buyer's ability to return the product

Net Accounts Receivable and Bad Debt Expense

Bad debt expense is a non-cash expense • Under the indirect method, we adjust net income for the change in A/R • Quickest way to deal with bad debt expense is to use the change in net A/R • Under the direct method, A/R is an adjustment to sales revenue to arrive at cash collected from customers

Indirect Method

Begins with net income and reconciles it to net cash generated from operating activities • Two groups of reconciling items: • Adjustments for noncash items • Additions • Depreciation, depletion or amortization expense • Bad debt expense (or can handle by using net amounts below) • Loss on sale of assets • Unrealized losses on trading securities and certain other investments • Deductions • Gain on sale of assets • Unrealized gains on trading securities and certain other investments • Changes in operating assets and liabilities • Additions • Decreases in current assets (exclude cash and short-term investments) • Increases in current liabilities • Deductions • Increases in current assets (exclude cash and short-term investments) • Decreases in current liabilities

Changes in Accounting Principle

Changes in accounting principle may be mandatory or voluntary • Newly issued accounting standards are mandatory changes • Voluntary changes can be made if the firm can justify the new principle on the basis that it more accurately portrays its financial position and performance • Firms are required to use the retrospective approach except for two cases: • If a new accounting standard, follow the guidance in the standard (retrospective or prospective) • If it is impractical to use the retrospective method; must meet any one of the following criteria: • F/S effects of the retrospective application are not determinable • Retrospective application requires speculation about manager's intent in prior periods • Retrospective application requires significant estimates for prior period and the information needed cannot be objectively verified

Bill-and-Hold Transactions

Bill-and-hold arrangements are transactions where a buyer accepts title and billings but delays the physical receipt of the goods • The buyer may request a delay in delivery for several reasons: a temporary shortage of warehouse space, current excess inventory levels, a significant backlog in the production cycle, or the construction of a new facility • If the seller has transferred control of the goods to the buyer, then the seller can recognize revenue at the point of sale • The seller determines if it has transferred control by considering the normal indicators of control • In addition, the seller must meet all of the following four criteria to claim that it has transferred control to the buyer • The reason for the bill-and-hold must be substantive (i.e., customer requested it) • The product must be separately identifiable as belonging to the customer • The product must be ready for physical transfer to the customer • The entity cannot have the ability to use the product in any way, including delivering it to another customer • If the seller meets all four of these conditions, it can recognize revenue at the time of the sale, otherwise the seller must wait until it meets the conditions or it delivers the goods to the buyer

Comprehensive Income

Change in equity (net assets) of an entity during a period from transactions and other events and circumstances from non-owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners.

Discontinued Operations

Characteristics of a discontinued operation • A portion of the entity comprising operations and cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity • Can be a reportable segment, an operating segment, a reporting unit, a subsidiary, or an asset group • If operations do not meet this definition, then their sale is treated as an asset disposal and reported in non-operating income and loss • Three main types of income, gain or loss: • Income or loss from operations of discontinued entity, net of tax • If company has sold the operations, include income or loss from beginning or year to date of disposal • If company is holding for sale, include income or loss from the entire period • Gain or loss on remeasurement of net assets held for sale to fair value less disposal costs, net of tax • Gain or loss on disposal of assets, net of tax • After a company reports a component as a discontinued operation, it must separately report the results of the discontinued component in the comparative I/S for all prior periods

Losses

Decreases in equity (net assets) from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity during a period except those that result from expenses or distributions to owners

Recognize Revenue When, or As, Each Performance Obligation is Satisfied

Companies determine when to recognize revenue based on when the goods or services are transferred to the customer • A good or service is transferred when the customer obtains control • A customer has control of an asset if it has the ability to direct the use of the asset and receives all (or substantially all) of the remaining benefits of owning the asset • Goods and services may be transferred to a customer over time or at a point in time • If over time, then the seller recognizes revenue over that time period • If at a point in time, then the recognizes revenue at that point in time

Completed Contract Method

Companies use the completed contract method when they do not meet the criteria required to use percentage-of-completion • Under the completed contract method, the firm reports income from the contract only in the final year of the project • The only procedures that differs between the percentage-of-completion and completed contract method is the recognition of revenue and expense • Rules effective 12/15/16 require a cost recovery approach that recognizes revenue each period to the extent that costs are incurred, but no gross profit is recognized until the end of the contract

Transfer Over Time

Considered over time if meet any of the following three criteria: • The customer receives and consumes the benefits of the goods/services simultaneously (e.g., health club memberships and magazine subscriptions) • The customer controls the asset as the seller creates it or enhances it over time (e.g., software updates) • The asset the seller is creating does not have an alternative use to the seller, and the seller has an enforceable right to payment for the performance completed to date • If a good/service is transferred over time, then the seller recognizes revenue over the same time period, based on the progress that it has made toward completion • If the seller does not have a reasonable way to measure its progress toward completion, then it should not recognize any revenue until it can reasonably estimate progress • Progress toward completion can be measured using either output or input methods • Example of output methods include units produced or delivered, progress such as floors or miles completed, and time elapsed • Example of input methods include labor hours expended, machine hours used, and costs incurred

Other Principal-Agent Transactions

Consignment sales are one form of principal-agent transactions • Consignor is the principal; consignee is the agent • Other examples include travel agency transactions, transactions related to advertisements and mailing lists, and auction transactions • Ex: Assume a travel agent books a flight for a client. There are two options for recognizing the revenue: • Record the total amount of the ticket (gross amount) as revenue and recognize the cost of sales for the amount remitted to the airline • Record only the net fee - that is, the amount billed to the customer less the amount paid to the airline for the tickets (net revenue approach) • If an entity obtains control of the product before passing it to the consumer, it is the principal and should use the gross revenue reporting approach • If it never obtains control, then it is the agent and should use the net revenue reporting approach • Gross profit is the same under both approaches, but companies are often evaluated on revenues, of which the two approaches differ greatly

Participating Preferred Shares

Contain a provision requiring that preferred shareholders share ratably in distributions with common shareholders • The additional dividends distributed from the participation occur most often when the dividends to common shareholders exceed the percentage stated for the preferred shares • Ex: If a company has 6% participating preferred shares and the company pays common shareholders a dividend of 8% of common par value, it must also distribute an additional dividend to the preferred shareholders equal to 2% of preferred par

Cumulative Preferred Stock

Contain a provision stipulating that if the board of directors does not declare a dividend, the dividends accumulate • Accumulated dividends are referred to as dividends in arrears • The firm cannot pay dividends to common shareholders until it has paid all preferred dividends in arrears plus the current year preferred dividends • Companies do not consider dividends in arrears a liability on the B/S because the dividends only become a legal liability when they are declared • However the company must disclose any arrearage in the notes to the F/S

Disaggregation of Revenue.

Disclose disaggregated revenue information in categories that depict how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors. Reconcile disaggregated revenue to revenue for reportable segments.

Reconciliation of Contract Balances

Disclose opening and closing balances of contract assets (e.g., unbilled receivables) and liabilities (e.g., unearned revenue) and provide a qualitative description of significant changes in these amounts. Disclose the amount of revenue recognized in the current period relating to performance obligations satisfied in a prior period (e.g., from contracts with variable consideration). Disclose the opening and closing balances of trade receivables if not presented elsewhere.

Other Qualitative Issues

Disclose significant judgments and changes in judgments that affect the amount and timing of revenue from contracts with customers. Disclose how management determines the minimum amount of revenue not subject to the variable consideration constraint.

Remaining Performance Obligations.

Disclose the amount of the transaction price allocated to remaining performance obligations not subject to significant revenue reversal. Provide a narrative discussion of potential additional revenue in constrained arrangements.

Costs to Obtain or Fulfill Contracts.

Disclose the closing balances of capitalized costs to obtain and fulfill a contract and the amount of amortization in the period. Disclose the method used to determine amortization for each reporting period.

Types of Dividends

Dividends represent a return to shareholders on their investment in the corporation • Cash dividends - most common form of dividend • Stock dividends - distributions in the form of the company's own shares • Property dividends - distributions firms make of any asset other than cash (e.g., inventory or investments in shares of other companies) • Liquidating dividends - distributions that the firm pays from contributed capital instead of from retained earnings

New Revenue Recognition - Analysis

Does the new standard adhere to the conceptual framework? • The new revenue recognition standard states that the overarching principle of revenue recognition is the notion of the transfer of control of the goods or services. • In contrast, the conceptual framework does not mention transfer of control, but rather states that a company recognizes revenue when it is realizable and earned. • While transfer of control often occurs simultaneously with the culmination of the earnings process, there are scenarios where they do not align. • FASB is in the process of rewriting the conceptual framework and it is expected that this inconsistency will be rectified.

Definition of Equity

Equity, or net assets, is the difference between assets and liabilities • This residual interest in a company's assets remains after the claims of creditors have been satisfied and therefore represents the ownership interest • The amount of equity is the cumulative result of investments by owners, comprehensive income, and distributions to owners

Noncash Consideration

In some contracts, instead of paying cash for the good or service, customers compensate the seller with goods, services or other noncash items, such as shares of stock in the customer's corporation • In this case, the transaction price should be measured at the fair value of the noncash consideration received by the seller • If the seller cannot reasonably estimate the fair value of the noncash consideration received, then it should measure the transaction price at the standalone selling price of the goods or services promised to the customer

Operating Activities

Includes cash receipts and disbursements related to the production and delivery of goods and services that are reported on an accrual basis on the I/S • Firm must have a positive net operating cash flow over the long run to sustain operations • Analyzing operating activities enables users to assess the firm's ability to generate future cash flows from the normal earnings cycle • Cash flows from operating activities include: • Cash receipts from customers • Cash receipts from interest and dividends • Cash payments for the purchase of goods for resale or for use in production • Cash payments to suppliers and employees • Cash-based gains or losses from disposal of discontinued operations • Cash payments for taxes • Cash payment for interest

Statement of Stockholders' Equity

Includes changes in the following accounts: • Contributed capital (e.g., common stock, preferred stock, and additional paid-in capital in excess of par) related to investments by owners • Retained earnings, including net income (loss) and distributions to owners (dividends) • Accumulated other comprehensive income • Treasury stock • Noncontrolling interest • The B/S reports the final balances in these accounts, but the Statement of S/E provides an analysis of the changes in these accounts • Non-public companies are not required to include this statement (but most do)

Gains

Increases in equity (net assets) from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity during a period except those that result from revenues or investments by owners

Multiple-Step Income Statement

Operating section - revenues and expenses related to operations • Non-operating section - revenues and expenses related to secondary operations • Includes restructuring charges (unless serial restructurer), net financing costs, unusual and/or infrequent items, other gains and losses from peripheral transactions • Income tax provision • Includes U.S. federal, state, local and foreign income taxes • Excludes payroll and property taxes (included under operations) and taxes attributable to discontinued operations • Discontinued operations - results of operations and of disposal (both elements net of tax) • Share of net income of equity investees • Consolidated net income • Net income - noncontrolling interest • Net income attributable to company and related earnings per share • Other comprehensive income (OCI) - can be in a separate statement • Comprehensive income

Expenses

Outflows or other using up of assets or incurrences of liabilities (or a combination of both) during a period from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity's ongoing major or central operations

Fixed-Dividend Preferred Shares

Preferred shares where the dividend is fixed and the payment is required • Fixed dividend is a contractual obligation to pay cash (or some other asset) to the holder • Even though fixed-dividend preferred shares have characteristics of both debt and equity, the entire proceeds are treated as equity at issuance

Preferred Stock Versus Debt Financing

Preferred stock dividends are usually fixed in amount • The fixed dividend payment and absence of voting rights make preferred shares similar to debt • Preferred stock provides advantages over debt and common equity for the corporation such as: • Corporations that are closely held (a few shareholders) issue nonvoting preferred stock to raise private equity capital without giving up control of the corporation • Preferred stock is less risky than debt for the issuing corporation because the corporation is not required to pay dividends, but interest payments are mandatory to avoid default • Preferred stock is not advantageous from a tax standpoint • Preferred dividends are not tax-deductible but interest expense is

Preferred Stock

Preferred stock is an equity security that has preferences over common stock • Preferred stockholders have the right to claim assets over common stockholders in the event of a liquidation • Most preferred stock is non-voting • Dividend preference - firms must pay preferred shareholders before declaring any dividends to common shareholders • However, preferred shareholders have no right to dividends if the firm does not declare dividends for a given period • There is never a legal liability for the corporation to pay dividends unless the board of directors declares a dividend

Preferred Stock

Preferred stock par values are higher than those used for common stock because they usually pay dividends as a fixed percentage of par • Features of preferred stock • Cumulative • Participating • Convertible • Callable • Redeemable • Fixed Dividend

Investing Activities

Relate to the acquisition and disposition of productive property, investments in debt and equity securities, and making and collecting loans • Do not net inflows and outflows • Include • Cash receipts from the collection or sale of notes receivable (short and long term) from lending to others • Cash receipts from the sale of debt and equity securities of other entities (including short term or marketable securities) • Cash receipts from the sale of productive assets • Cash payments for extending credit to others • Cash payments for investments of debt and equity securities of other entities (including short term or marketable securities) • The exception is trading securities in which transactions are considered operating activities due to their short duration (i.e., nearness to cash) • Cash payments for property, plant and equipment and other productive assets

Stock Issue Costs

Related to legal and underwriting fees • Attorneys assist in the filing process with the SEC and the state of the incorporation • Underwriting fees are paid to investment banks or other financial institutions for the risk assumed by purchasing the securities directly from the issuing corporation • Underwriter buys the shares from the issuer net of the fee and then sells the shares in the market

Methods for Reporting Accounting Changes

Retrospective change - restate all prior-year F/S as if the newly adopted principle had always been used • Restated F/S adjust opening B/S accounts for the cumulative effect of applying the new principle in all prior years and present all subsequent F/S as if the policy had always been used. Specifically: • Assets and liabilities as of the beginning of the first period presented reflect the cumulative effect of the change on periods prior to those presented • R/E is adjusted for the beginning of the first period presented to reflect the cumulative effect of the change on reported income for periods prior to those presented • F/S for each period presented reflect the effects of the change • Prospective change - make the change in the current year and all future years • Does not change any previously issued F/S

Complexities in Determining Cash Flows

Several issues complicate the preparation of the statement of cash flows: • Acquisition and disposition of long-term assets • Deferred income taxes • Net accounts receivable and bad debt expense • Unrealized gains and losses on fair value adjustments • Equity method investments • Share-based compensation • Pension adjustments • Amortization of bond discounts and premiums

Share-Based Compensation and Pension Adjustments

Share-based compensation expense is a noncash expense • Pension expense consists of service cost, amortization of prior service costs, interest on the PBO, and the expected return on plan assets • However, pension expense is a noncash expense • Instead, the cash flow effect of a pension plan is the amount funded and the amount paid out to retirees

Mandatorily Redeemed Preferred Shares

Shareholders can redeem redeemable preferred shares at certain dates or upon the occurrence of certain events • Mandatorily redeemable preferred shares are preferred shares for which redemption is certain at a specified price on a specified date • Here the certain event is the passage of time or upon the occurrence of a specific event (i.e., death of a corporate officer) • Mandatorily redeemable shares are treated as a liability • Definition of liability is a probably future sacrifice of economic benefits arising from a present obligation to transfer assets or provide services in the future as a result of past transactions or events • Similarly mandatorily redeemable shares contain a contractual obligation to disburse cash resulting from the right of the holder to demand payment and the fact that the exercise of the right is certain to occur

Callable Preferred Shares

Shares for which the issuing entity has the right to call (in essence, buy back) the shares at a specified price and future date • Firms account for callable preferred shares in the same way as non-callable preferred shares • When a firm calls the shares, it must pay any dividends in arrears to the preferred shareholders • Because the company has the right to call the shares, callable preferred shares are classified as equity rather than debt • This is because the payment is under the control of the issuing corporation

Consolidated Statement of Cash Flows

The consolidated Statement of Cash Flows is not the sum of the Statement of Cash Flows across companies in the consolidated group. • Rather, it is prepared from the consolidated I/S and B/S in the same way you'd prepare it for a single company. • Consequently, all intercompany transactions have been eliminated and the additional depreciation/amortization expense relating to AAP has been included. • Additional considerations: • Need to add back the noncash expense relating to the depreciation and amortization of the AAP • In the year of acquisition: • The net cash paid for an acquisition (cash paid less cash on the investee's B/S) is recorded in the investing section • To the extent that the acquisition is affected by a stock-for-stock exchange, no cash outflow is recognized since no cash has been paid. • The changes in current assets and current liabilities are computed based on amounts excluding the effects of the acquisition. • Example: If A/R increase by $100 year-over-year, but the parent acquired $30 of A/R in the acquisition, only $70 of the increase is included as an outflow in the operating section. • The $30 related to the sub is already included in the cash paid for the acquisition in the investing section or excluded all together if it was a stock-for-stock exchange.

Expected-Value Approach

The entity sums the probability-weighted amounts in a range of possible consideration amounts • Best suited when the entity has a large number of contracts with similar characteristics

Direct Method

The following t-accounts model the cash components of each major type of operating cash flow • Plug in the beginning and ending B/S balances • Plug in the income statement effect (expense or revenue) • Solve for cash

Determine the Transaction Price

The third step in the revenue recognition process is to determine the transaction price • The transaction price is the amount of consideration that the entity expects to be entitled to as a result of providing goods or services to the customer • Not necessarily the price stated in the contract - rather it's the amount the seller expects to receive • The transaction price does not include amounts collected that will be remitted to third parties (i.e., sales tax) • Sellers consider a number of different factors when determining the transaction price, including: • Variable consideration and constraining estimates of variable consideration • Any significant financing component in the contract • Noncash consideration • Consideration payable to a customer

Unrealized Gains and Losses on Fair Value Adjustments

The treatment of unrealized gains or losses depends on the classification of the security • If trading securities or the fair value option, then gains and losses are in net income • Needs to adjust for gains and losses when using the indirect method • If AFS, then gains and losses are in OCI • These gains and losses have no cash flow effects - so no implications for the statement of cash flows • Equity method investments - equity income is a non-cash item so it must be adjusted • Cash dividends received must be added to the operating section

Failure to Meet Contract Criteria

Then should recognize revenue when: • The seller has no remaining obligations to transfer goods or services and substantially all (or all) of the consideration has been received by the seller and is nonrefundable, or • The contract has been terminated and any consideration already received from the customer is nonrefundable • Note: If the seller receives cash before the appropriate time to recognize revenue, it should report the consideration as a liability. Also, the entity should not remove the inventory from its B/S.

Standalone Selling Price Determination Methods

Three suggested methods • Adjusted market assessment approach - focuses on the amount that the seller believes that customers are willing to pay for the good or service by evaluating the market • Might include using prices from the seller's competitors and adjusting those prices as necessary • Expected-cost-plus-a-margin approach - focuses on internal factors by forecasting the costs associated with providing the gods or services and adding an appropriate profit margin • Residual approach - allows a company to estimate one or more, but not all, of the standalone selling prices, and then allocate the remainder of the transaction price (the residual amount) to the goods or services for which it does not have a standalone selling price

Allocate the Transaction Price to the Performance Obligations

To allocate the transaction price, the company first determines the standalone selling price of the goods or services related to each performance obligation • Then if the sum of the standalone selling prices > transaction price, the seller allocates the discount to separate performance obligations on the basis of their relative standalone selling prices • The standalone price of each performance obligation is the price the seller would charge for the same goods or services if it sold them on a standalone basis to similar customers under similar circumstances • If the seller does not sell the goods or services on a standalone basis, it must estimate the standalone price • Authoritative literature states the company must use a method that maximizes the use of observable inputs • Once chosen, the same method should be used consistently in similar circumstances

Purpose of Share Repurchases

Treasury shares are used in stock option plans, stock bonus plans, and employee stock purchase plans • Treasury shares are used in exchange for another firm's voting shares in a merger or acquisition • Repurchased transactions are used to support the market price of the stock • By buying shares back from the market, there are fewer shares O/S, raising price per share and EPS • Repurchase transactions are used to prevent takeover attempts • When shares are repurchased, the market price of the stock rises, increasing the costs of a takeover • In addition, if a sufficient number of shares are acquired, major shareholders have enough voting rights to control the corporation and directly prevent a takeover • Repurchase transactions distribute cash to shareholders without formally increasing the cash dividend • A formal dividend increase would be expected to continue in the future to avoid adverse stock effects if discontinued or cut

Deferred Income Taxes

Under the indirect method, the firm treats the changes in the deferred tax accounts like any other asset or liability • Under the direct method, it may be more helpful to use a formulaic approach: cash paid for income taxes = income tax expense + decrease in income taxes payable - increase in income taxes payable + decrease in DTL or increase in DTA- increase in DTL or decrease in DTA

Most-Likely Amount Approach

Uses the single most likely amount in a range of possible consideration amounts as the estimate • Best suited when there are only two possible outcomes

Right-to-Return Sales

When a company makes a right-to-return sale, it is giving customers the ability to return a product that has been transferred to them • The right of return does not represent a separate performance obligation, but rather should be treated as a component of variable consideration • The company recognizes the amount of expected returns as a refund liability • Represents the company's obligation to stand ready to receive the returned product and refund the customer's consideration (or provide credit toward a different good or service) • The seller does not recognize revenue for the amount of expected returns until the amounts are no longer subject to the constraint (i.e., the end of the return period) • In addition to recording a refund liability, the seller must reduce the COGS by the amount of costs attributable to the products that it expects will be returned

Legal Issues: Par and Stated Values

When a corporation is formed, the organizers designate the stock's par value, usually setting an immaterial amount such as one cent per share • Par value dates back to when all firms were required to maintain a minimum amount of capital that they could not distribute to shareholders • Maintaining assets equal to the par value of its shares protected creditors in the event of liquidation • Many states have repealed minimum legal capital laws and permit the issuance of no par stock • Older issues with par values are still widely traded

Accounting for Share Retirements

When companies choose to retire their T/S, the shares are still considered authorized but now are classified as unissued • The number of common shares are retired at par and the average APIC related to the retired shares is eliminated • If the repurchase price is less than the original amount paid in, the firm credits the difference to APIC - Retired Shares • Conversely, if the repurchase price is greater than the original issue proceeds, the firm debits APIC - Retired Shares • If this account is reduced to zero, it debits the remainder to R/E

Significant Financing Component

When the delivery of goods or services occurs in advance of the payment, the seller is providing financing to the buyer • Alternatively, when delivery occurs well after payment, the buyer is providing financing to the seller • When the time lapse between payment and delivery is more than one year, companies are required to separate the revenue generated from the contract from the financing component (if the financing component is significant at the individual contract level) • Rationale - the seller should recognize revenue at the amount that properly reflects the price that a buy would pay if the payment occurred on the same date as delivery • To determine whether a financing components exists, consider three factors: • The difference between the contract price and the cash selling price of the goods or services • The length of time between delivery and payment • The prevailing interest rate in the market • Once a company concludes that there is a significant financing component, it determines the transaction price by using time value of money techniques: • If the delivery occurs before payment, the entity discounts the promised consideration amount back to the present value, using the same discount rate it would use if it entered into a separate financing arrangement • If the delivery occurs after payment, the entity determines the future value of the payment, using the same discount rate it would use if it entered into a separate financing arrangement

Standalone Selling Price Exceptions

While the general rule is that the transaction price should be allocated based on the relative standalone selling prices, there are two possible exceptions: • When the contract includes variable consideration • The seller should allocate variable consideration to one or more, but not all, performance obligations if two criteria are met: • The terms of the variable amount relate to one or more, but not all, of the specific performance obligations • Allocating the variable amount entirely to one or more, but not all, or the specific performance obligations is consistent with the objective of performing the allocation in a way that reflects a reasonable allocation of the transaction price on the basis of the standalone selling prices (sorry guys .. This is from the exposure draft ... messy, I know) • When the discount is not related to all of the contract's performance obligations • Typically, any discount should be allocated proportionately to the performance obligations based on the relative standalone selling prices • If the following criteria are met, then the seller should allocate the discount to one or more, but not all, of the performance obligations: • The entity regularly sells the goods/services in the contract on a standalone basis • The entity regularly sells a bundle of some of the goods/services at a discount to the sum of the standalone goods/services • The discount in the bundle of goods/services described above is basically the same as the discount in the contract

Accumulated Other Comprehensive Income (AOCI)

You may need to analyze this account to determine the effect of unrealized holding gains or losses, pension adjustments, foreign currency gains or losses using the current rate method, and some gains and losses due to derivatives.

Variable Consideration

when the payment received for providing a good or service is not a fixed amount • May vary due to price concessions, performance bonuses or penalties, discounts, refunds, rebates, and incentives • Elements may be stated explicitly or implicitly in the contract • Ex: a discount for early payment is considered an element of variable consideration, even though it may not be specified explicitly in the contract • If variable consideration is included in the contract, then the entity must estimate the consideration that expects to receive using one of two approaches (using the approach that provides the best estimate): • Expected-value approach • Most-likely amount approach

Accumulated Other Comprehensive Income (AOCI)

• Accumulated other comprehensive income (AOCI) includes the cumulative amount of items such as unrealized gains and losses on available-for-sale securities, foreign currency translation adjustments, and certain pension cost adjustments