Financial Reporting: Chapter 3

Diluted EPS

(Net Income - Preferred Dividends + adjusted for dilutive securities)/ Weighted Average # of Common Shares assuming max dilution

Unusual/ Infrequent Items

-casualty loss -impairment of assets -unusal sale *reported as a separate item in income from continuing operations or disclosed in the notes to the financial statements

Losses

-decrease in equity from an entitys peripheral or incidental transactions -also arise from all other transactions and other events and circumstances affecting the entity, except those that result from expenses or distribution to owners EX: A clothing retailer would record a loss on the sale of an investment in government bonds if these securities are sold for a price less than their carrying amount.

Restructuring Costs (operating expense)

-include costs associated with management plans to materially change the scope of main business operations -recognized in the period the exit or disposal cost obligation actually is incurred

Common Tools to Manage Earnings

-income smoothing -classification shifting -borrow

Gains

-increase in equity from an entitys peripheral or incidental transactions -also arise from all other transactions and other events and circumstances affecting the entity, except those that result from revenues or investments by owners EX: A clothing retailer sells some of its cash registers. If it sells the registers for more than their book value, then this transaction results in a gain

Revenues

-inflows of recourses resulting from providing goods or services to customers -generated from activities that constitute the entity ongoing major or central operations EX: A clothing retailer records revenue when it sells clothing to customers because this transaction is an inflow that occurs from its major operations.

single-step income statement

-lumps together all revenues and gains followed by expenses and losses -often still presents income before income taxes *benefit: straightforward; easy to understand

Error Correction

-material error corrected through a prior period adjustment -record in the period error is discovered -adjust a balance sheets account and typically RE -restate prior periods

Expenses

-outflows of resources incurred while generating revenue -used for activities that constitute the entity's ongoing major central operations EX: A clothing retailer records the cost of the clothing that it sold as an expense because this transaction is an outflow related to its major operations.

OCI represents "net income" from valuation adjustments in 4 specific sources

-pensions -unrealized holding gains/losses on certain types of debt investment -foreign currency translation adjustments

Earnings Per Share (EPS)

-ratio that indicates the amount of income earned by a company expressed on a per share basis -report for continuing op, discontinued op, and net income

Accumulated Other Comprehensive Income (AOCI)

-report OCI on a cumulative basis in the balance sheet -report as an additional component of shareholders equity -consistent with how accumulated net income is reported in the balance sheet as retained earnings

multistep income statement (used more often)

-reports several critical subtotals before getting to net income -separates into rev/gains and expenses/losses into operating and non operating *benefit: more useful information to evaluate performance

Change in Accounting Principle

-voluntary change in accounting principle -required change due to code update

Report discontinued operations when:

1. A component of an entity or groups of components has been sold, disposed of, or is considered held for sale 2. disposal represents a strategic shift that has, or will have, a major effect on a companys operations and financial results

Problem: Leigh Corp. disposed of its Knit Products Division in June of 2020 at a loss of $38,000 before tax. Prior to the sale, the division (considered a separate business component) reported a net loss from operations of $405,000 before tax. Leigh reported income from continuing operations of $900,000 before tax for 2020

1. An operating loss of $303,750, which is the $405,000 pre-tax loss less the tax benefit of $101,250 ($405,000 × 25% 2. A loss from the disposal of $28,500, which is the $38,000 pre-tax loss less the tax benefit of $9,500 ($38,000 × 25%)

Problem On Oct. 31, 2020, Leigh Corp. approved a formal plan to dispose of a separate business component. On Dec. 31, 2020, the component was held for sale and reported a net loss from operations of $505,000 before tax for the year ended Dec. 31, 2020. The component has a book value and fair value (after selling expenses) of $3,600,000 and $3,300,000, respectively. Leigh reported income from continuing operations of $900,000 before tax for 2020

1. An operating loss of $378,750, which is the $505,000 pre-tax loss less the tax benefit of $126,250 ($505,000 × 25%) 2. An impairment loss of $225,000, which is the $300,000 pre-tax loss less the tax benefit of $75,000 ($300,000 × 25%).

When the discontinued component has not been sold when the reporting period ends, the income effects are reported but modified

1. Income or loss from operations of the component from the beginning of the reporting period to the end of the reporting period 2. An impairment loss if the book value of the assets of the component is more than the fair value minus cost to sell

When the discontinued component is sold before the end of thenreporting period, the income effects will include:

1. Income or loss from operations of the component from the beginning of the reporting period to the disposal date 2. Gain or loss on the disposal of the components assets

5 Common Sections of a Multi-Step Income Statement

1. Operating 2. Non Operating 3. Income Tax Provision 4. Discontinued Operations 5. Net Income and EPS

4 Primary Elements of I/S (Continuing Operations)

1. Revenues 2. Expenses 3. Gains 4. Losses

common characteristics of OCI items:

1. low probability of cash realization in the short run 2. transitory with high volatility 3. not part of normal operations

Info in Income Statement and OCI can be presented:

1. single continuous statement of comprehensive income 2. two separate but consecutive statements (income statements and statement of comprehensive income)

Basic EPS formula

Basic EPS = (Net Income - Preferred Dividends) / Wtd. Avg. # of Shares Outstanding

Buffalo Manufacturing Company is restructuring and closing the platinum mining division. The mine will be closed and its assets sold off over the course of the next three years. When should the costs related to closing of the mine be recognized?

In the year(s) the costs are actually incurred

Component of an Entity

It is (1) a portion of the entity (2) comprising operations and cash flows (3) that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity.

Non-Operating Section

Reports the revenues and expenses related to any secondary operations of the entity; also includes net financing costs (interest expense less interest income), unusual and/or infrequent items, and other gains and losses. Arise from peripheral or incidental transaction

Operating Section

Reports the revenues and expenses related to the entity's principle operations

Classification Shifting

Shifting operating expenses to a non-operating expense classification to report fewer operating expenses and higher operating income

Change in Accounting Estimate

account for change in estimates on a prospective basis EX: -change in useful life or residual value affecting depreciation amounts -changes in net realizable value of receivables -change in warranty cost estimates

Comprehensive Income

changes in equity from transactions and events other than transactions with owners *CI = Net Income + Other Comprehensive Income

Income Smoothing

create smoother pattern in earnings over time

Borrow

from tomorrow to meet today's earnings target

Non Operating Income Section

interest Income Interest Expense Gain on Sale of Investments Income from Continuing Operations before income taxes Income Tax Expense Income from Continuing Operations

statement of stockholders' equity

presents the causes of changes to stockholders' equity during the period, including those that caused retained earnings to change

The Nature Approach

refers to classification by the source of the expense such as -payroll costs -cost of raw materials -depreciation expense

The Functional Approach

refers to classification by the use of the expense such as -cost of goods sold -sales expense -administration expenses

Earnings Quality

refers to the ability of reported earnings (income) to predict a company's future cash flows -temporary earnings -permanent earnings

Net Income and EPS

reports net income and several computations of the amount of earnings available to each shareholder in a company

Income Tax Provision

reports the income taxes related to continuing operations from all jurisdictions in which the entity operates

Discontinued Operations

reports the results of operations for a component of an entity that has been disposed of by the end of the reporting period or that is held for sale at the end of the reporting period; also includes any gain or loss from the actual disposal of the component of the entity

Income Statement

summarizes an organization's financial results - revenues and expenses - over specified period of time aka: -consolidated statement of earnings -consolidated statement of income -statement of net income