Chapter 4 (The Income Statement, Comprehensive Income, and The Statement of Cash Flows)

What 3 categories do accounting changes fall into?

1. A change in an accounting principle 2. A change in estimate 3. A change in reporting entity

What is considered cash inflows for operating activities?

1. Customers from the sale of goods or services 2. Interest and dividends from investments

What events require separate reporting below income and continuing operations as well as separate disclosure if they have a material effect?

1. Discontinued operations 2. Extraordinary items

The information in the income statement and other comprehensive income items can be presented in what 2 ways?

1. In a single, continuous statement of comprehensive income 2. In two separate, but consecutive statements, an income statement and a statement of comprehensive income

Where must OCI be reported?

1. In the current reporting period 2. On a cumulative basis in the balance sheet

When a discontinued component is sold before the end of the reporting period, the reported income effects of a discontinued operation will include what?

1. Income or loss form operations of the component from the beginning of the reporting period to the disposal date 2. gain or loss on disposal of the component's assets

What three categories are transactions classified in the statement of cash flows?

1. Operating activities 2. Investing activities 3. Finaning activities

What are cash outflows of investing activities?

1. Owners in the form of dividends or other distributions 2. Owners for the reacquisition of shares previously sold 3. Creditors as repayment of the principal amount of debt (excluding trade payables that relate to operating activities)

What is considered cash outflows for operating activities?

1. The purchase of inventory 2. Saleries, wages, and other operating expenses 3. Interest on debt 4. Income taxes

How do managers manipulate income?

1. income shifting 2. income statement classifications

What is considered a discontinued operation?

A segment of a company's business that has been sold, disposed of or abandoned

Why may the amounts differ from sales and investment income reported in the income statement?

Because in the income statement sales revenues is measured on the accrual basis (which means it reflects revenue earned during the period and not the cash actually collected)

What are restructuring costs?

Costs associated with shutdown or relocation of facilities or downsizing of operations

What must happen when a voluntary change in accounting principles happen?

GAAP requires that voluntary accounting changes be accounted for retrospectively. that is, we recast prior years' financial statements when we report those statements again to appear as if the new accounting method had been used in those periods

the single step format

Groups all revenues and gains together and all expenses and losses together

How are accounting errors corrected?

If an error is discovered in a year subsequent to the year the error is made, the accounting treatment depends on whether or not the error is material with respect to its effect on the financial statements. If it is material, it requires a prior period adjustment. If it is not material, they can be corrected in the year discovered

Which statement is the most useful for predicting future profitability

Income statement

What are operating activities?

Inflows and outflows of cash related to the transactions entering into the determination of net operating income

What are financing activities?

Involve cash inflows and outflows from transactions with creditors (excluding trade creditors) and owners

What are investing activities?

Involve the acquisition and sale of (1) long-term assets used in the business and (2) non operating investment assets

What does the statement of cash flow report?

It is a change statement, disclosing the events that caused cash to change during the period

where is the change in accounting estimate reflected at?

It is reflected in the financial statements of the current period and future periods

How are unusual or infrequent items presented in the income statement?

It is reported as a separate component of continuing operations

How must the income statement be displayed?

No specific standards dictate how income from conniving operations must be displayed, so companies have considerable latitude in how they present the components of income from continuing operations

What is earnings quality?

Refers to the ability of reported earnings to predict a company's future earnings

the multiple step format

Reports a series of intermediate subtotals such as group profit, operating income, and income before taxes before arriving at income from continuing operations

What is operating income?

Revenues and expenses directly related to the primary revenue-generating activities of the company

What is Earnings per share (EPS)?

Shows the amount of income earned by a company expressed on a per share basis

What does diluted eps reflect?

The potential dilution that could occur for companies that have certain securities outstanding that are convertible into common shares or stock options that could create additional common shares if the options were exercised

What is intraperiod tax allocation?

The process of associating income tax (not an issue of measurement but an issue of presentation)

What is comprehensive income? (OCI)

The total change in equity for a reporting period other than from transactions with owners

How are extraordinary items presented in the income statement?

They are presented net of tax below the discontinued operations

When is a statement of cash flows required?

for each income statement period

What are extraordinary items?

material gains and losses that are both unusual in nature and infrequent in occurrence ("red flagged" in an income statement by being reported separately, net of tax, and appropriately labeled)

What is non-operating income?

relates to peripheral or incidental activities of the company

What does the income statement report?

the changes in shareholders' equity (retained earnings) that occurred during the reporting period as a result of revenues, expenses, giant and losses

How must these two elements be reported?

they can be combined or reported separately, net of their tax effects. If combined, the gain or loss component must be indicated

How can the predictive value of earnings quality be enhanced?

Analysts try to separate a company's transitory earnings effects from its permanent earnings

What is a tax benefit?

the extraordinary loss decreased the amount of tax the company otherwise would have had to pay

Why do managers manipulate income?

to polish reports in the bad years to make the overall view look better

What is the indirect method of reporting?

Cash flow from operating activities is derived indirectly by starting with reported net income and adding or subtracting items to convert that amount into a cash basis

When an item is considered held for sale, what are the effects of the income statement?

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 carrying value (book value) of the assets of the component is more than fair value minus cost to sell

What are cash inflows of investing activities?

1. Owners when shares are sold to them 2. Creditors when cash is borrowed through notes, loans, mortgages, and bonds

What are the cash outflows from investing activities?

1. The purchase of long-lived assets used in the business 2. The purchase of investment securities like stocks and bonds of other entities (other than those classified as cash equivalents and trading securities) 3. Loans to other entities

What are the cash inflows from investing activities?

1. The sale of long-lived assets used in the business 2. The sale of investment securities (other than cash equivalents and trading securities) 3. The collection of a non trade receivable (excluding the collection of interest, which is an operating activity)

2 general approaches to the income statement format

1. The single-step 2. The multiple-step

How can comprehensive income be reported?

1. in a single, continuous statement of comprehensive income 2. In two separate but consecutive statements (an income statement and a statement of comprehensive income that begins with net income and then reports OCI items to combine for comprehensive income)

What should resources allocated to private enterprises do?

1. provide the goods and services our society desires 2. At the same time provide a fair rate of return to those who supply the resources

What does a income statement display?

A company's operating performance (its net profit or loss, during the reporting period)

Are non cash investing and financing activities reported?

Any significant non cash investing and financing activities (that is, non cash exchanges) are reported either on the face of the SCF or in a disclosure note

When are restricting costs recognized?

In the period the exit or disposal cost obligation actually is incurred

What is does a statement of cash flow show?

It shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing and financing activities. (it is a change statement)

What are pro forma earnings?

Managements view of permanent earnings in the sense of being a better long-run performance measure (controversial because determining which items to exclude is at the discretion of management)

What is the direct method of reporting?

The cash effect of each operating activity is reported directly in the statement of cash flows

When is an item considered "held for sale"?

The company has decided to discontinue a component but when the reporting period ends, the component has not yet been sold

How should a an estimate change be dealt with for reconstructing costs?

The company should record the effect of the change in the period the estimate is changed rather than restating prior years' financial statements to correct the estimate

how is an extraordinary item identified?

The determination of whether an item is unusual and infrequent should consider the environment in which the company operates

Should restructuring costs be considered part of a company's permanent earnings stream?

The more frequently the unusual charges occur, the more appropriate it is that analysts include them in the company's permanent earnings stream

What do gains and losses from the sale of investments do to current earnings?

They can significantly inflate or deflate current earnings

What is the purpose of the statement of cash flows?

To provide information about the cash receipts and cash disbursements of an enterprise that occurred during a period (provides valuable information about the operating, investing, and financing activities that occurred during the period)

What is the purpose of the income statement?

To summarize the profit-generating activities that occurred during a particular reporting period

When are expenses reported in the income statement?

if causally can be determined, expenses are reported in the same period that the related revenue is recognized. if a casual relationship cannot be established, we relate the expense to a particular period, allocate it over several periods, or expense it as insured

how is EPS computed?

income available to common shareholders (net income less any preferred stock dividends)/ weighted-average number of common shares outstanding (weighted by time outstanding) for the period

how is income tax expense reported in the income statement?

it always is reported as a separate expense in a corporate income statement

What is taxable income?

revenues, expenses, gains and losses as measured according to the regulations of the appropriate taking authority

What does income from continuing operations include?

revenues, expenses, gains and losses that will probably continue in future periods