CPA FAR - Module 2

Effects on Cash of Foreign Currency Translation Changes in cash caused by changes in exchange rates must be shown

"as part of the reconciliation of the change in cash and cash equivalents during the period."

Cash Flows from Investing Activities This category reports cash inflows and cash outflows that relate to

"investment" in and disposal of noncash assets.

Risks and Uncertainties Significant Concentrations The standard is concerned with "severe impacts" caused by concentrations. A severe impact is a significant financially disruptive effect on the normal functioning of the firm, where

"severe" is greater than material but less than catastrophic. Bankruptcy is considered catastrophic for example.

Management's Going-Concern Assessment There is uncertainty regarding the entity's ability to meet maturing obligations if there is

"substantial doubt" that the entity can meet its obligations as they become due

Monetary and Nonmonetary Items—Assets and liabilities are categorized as

(1) monetary or (2)nonmonetary, depending on whether the item has a fixed unchangeable value.

Different types of businesses have different risks. Knowledge of the firm's 1. 2. 3. will assist users in assessing risks concerning the firm's operations. For example, identification of competition and vulnerability to technological change are aided with this knowledge.

(1) products and services, (2) geographical locations and (3) principal markets

Effects on Cash of Foreign Currency Translation Foreign currency transactions that occur during the period and affect cash flow should be converted to their dollar equivalent using

(1) the exchange rate in effect at the date of each transaction or (2) an average exchange rate for the period, if not materially different from the specific rates in effect on the dates of the transactions.

Statement of Changes in Equity Vertical Format—Total OE is also shown as a column. This format allows a check of accuracy by comparing total OE computed as

(1) the sum of each transaction affecting OE, and (2) the sum of individual OE account balances.

Risks and Uncertainties Use of Estimates The firm must communicate that:

(1) use of estimates is inescapable in preparing financial statements that conform with GAAP, (2) the use of estimates results in approximate amounts, not certainty, and (3) estimates involve assumptions about future events.

Number of Days' Sales in Average Receivables =

(300 or 360 or 365 (or other measure of business days in a year)) / Accounts Receivable Turnover (computed above)

Number of Days' Supply in Inventory =

(300 or 360 or 365 (or other measure of business days in a year)) / Inventory Turnover

Securities Defensive-Interval Ratio =

(Cash + (Net) Receivables + Marketable Securities) / Average Daily Cash Expenditures

Acid-Test Ratio (also known as Quick Ratio) =

(Cash + (Net) Receivables + Marketable Securities) / Current Liabilities

Quick or acid-test ratio =

(Cash + Short-term investments + AR)/CL

Return on Total Assets =

(Net Income + (add back) Interest Expense (net of tax effect)) / Average Total Assets

Times Interest Earned Ratios =

(Net Income + Interest Expense + Income Tax) / Interest Expense

Return on Common Stockholders' Equity =

(Net Income—Preferred Dividend (obligation for the period only)) / Average Common Stockholders' Equity

Earnings Per Share (EPS—Basic Formula) =

(Net Income—Preferred Dividends (obligation for the period only)) / Weighted Average Number of Shares Outstanding

Accounts Receivable Turnover =

(Net) Credit Sales / Average (Net) Accounts Receivable (e.g., Beginning + Ending/2)

A discontinued operation is when a component or group of components of an entity are

1) disposed for by sale or other than sale, or classified as held-for-sale, and 2) the disposal "represents a strategic shift that has (or will have) a major effect on an entity's operation and financial results." A strategic shift includes the disposal of a major geographical area, a major line of business, a major equity method investment, or other major parts of the entity.

The following categories capture the types of exit or disposal activities:

1) those disposals that occur in the normal course of business that are disposals of individually insignificant assets, 2) disposals that meet the criteria of a discontinued operation, and 3) individually significant disposals that do not meet the criteria of a discontinued operation.

Cash Flow from Operating Activities—Accrual Reconciliation Accruals and Deferrals—Using the indirect method, net income is adjusted to derive net cash flow from operating activities by:

1. Adding back noncash charges (reductions) included in deriving net income; and 2. Subtracting out noncash credits (increases) included in deriving net income.

Accounting Cycle Review The periodic accounting process leading to the preparation of financial statements is called the accounting cycle. The cycle steps used by a firm are specific to the information technology applied. The following is a representative list, in chronological order.

1. Analyze relevant source documents and record journal entries in a journal, a temporary listing of accounts affected and the amount by which they are to be changed by transaction, event, or adjustment. 2. Post the information from the journal to the accounts in the ledger, on a periodic basis. Only after posting, the account balances are updated. 3. Record adjusting journal entries at the end of the accounting period. These journal entries record changes in resources and obligations not signaled by a new transaction or event. Examples include accrual of wages expense from the last payday to the end of the fiscal period, expiration of prepaids, and recognition of estimated expenses such as depreciation and warranty expense. These journal entries are also posted to the accounts. 4. Prepare trial balances. Some firms prepare a trial balance, which is a test of the equality of the sum of debit account balances and credit account balances, before and after adjusting journal entries. A trial balance is a quick test for the presence of an error in recording or posting. 5. Prepare the income statement, balance sheet, and statement of cash flows. The first two are prepared directly from the ledger accounts or trial balance; the cash flow statement requires additional analysis. 6. Close the temporary account balances setting them to zero, and transfer the net income amount to retained earnings.

The SCF must report information in the following categories:

1. Cash inflows and outflows from operating activities 2. Cash inflows and outflows from investing activities 3. Cash inflows and outflows from financing activities 4. Effects of foreign currency translation on cash flows 5. Reconciliation of net cash inflows/outflows with the reported change in cash, cash equivalents, and restricted on the Statement of 6. Financial Position.

Noncurrent Liability Disclosures—Companies are required to disclose the following information about liabilities:

1. Combined aggregate amount of maturities on borrowings for each of the five years following the balance sheet 2. Sinking fund requirements 3. The aggregate amount of payments for unconditional obligations to purchase fixed or minimum amounts of goods or services 4. The fair value of each financial debt instrument in the financial statements or in the notes 5. The nature of the firm's liabilities, interest rates, maturity dates, conversion options, assets pledged as collateral, and restrictions

Risks and Uncertainties Significant Concentrations The standard applies only to the following defined set of four concentrations, rather than all possible concentrations. 1. 2. 3. 4.

1. Concentrations in the volume of business with a particular customer, supplier, lender, grantor, or contributor. The loss of the relationship is an example of an event that could cause a severe impact. The standard states that it is always at least reasonably possible to lose such a customer, grantor or contributor although the impact may not be severe. 2. Concentrations in revenue from specific products, services, or fund-raising sources. A price or demand change could cause a severe impact. 3. Concentrations in specific sources (suppliers) of services, materials, labor, licenses or other rights used in operations. Losses of a key supplier or a patent are examples of events that could cause a severe impact. 4. Concentrations in the market or geographic area of operations. The standard states that it is always at least reasonably possible that operations located outside the firm's home country will be disrupted in the near term.

Balance Sheet Account Types by Category Owners' equity—two main types

1. Contributed capital, treasury stock 2. Retained earnings

Structure of the Income Statement Multiple Disclosures The total income tax effect for a given year is accomplished through multiple disclosures. The items for which intraperiod tax allocation is applied include:

1. Discontinued operations 2. Other comprehensive income items 3. Adjustment for retroactive accounting principle changes 4. Prior-period adjustments

For a disposal that meets the criteria of a discontinued operation the entity must disclose the following (ASU 2014-08):

1. Fact and circumstances leading to the disposal and reasons for the strategic shift and the effect of the strategic shift on operations 2. For the initial period in which the disposal group is classified as held for sale and for all prior periods presented in the statement of financial position, a reconciliation of (1) total assets and total liabilities of the discontinued operation that are classified as held for sale in the notes to the financial statements to (2) total assets and total liabilities of the disposal group classified as held for sale that are presented separately on the balance sheet. 3. Operating and investing cash flows for the periods for which the discontinued operation's results of operations are reported in the income statement. 4. Depreciation and amortization, capital expenditures, and significant operating and investing noncash items for the periods for which the discontinued operation's results of operations are reported in the income statement. 5. Entities that have significant continuing involvement with a discontinued operation after the disposal date must provide additional disclosures regarding the nature of activities, including cash flows from or to the discontinued operation.

Cash Flows from Operating Activities—Noncash Items Equity Method Adjustments Therefore, under the equity method, only cash dividends received from the investee cause a cash flow. The adjustments to net income to get cash flow would be:

1. If an equity investment loss, add back the amount of the loss. 2. If an equity investment income, subtract out the amount recognized as income that was not received as cash dividends.

The following are separately disclosed and computed in the income statement below income from continuing operations:

1. Income-Income from the discontinued operation (DOP) for the portion of the year to disposal. 2. Gain or loss- On disposal of the operation. a. The gain or loss is the net proceeds from sale of the component less book value of the component's net assets. Net proceeds are equal to the gross amount received on sale less the cost to dispose of the assets. Thus, the cost to dispose increases a loss and decreases a gain.

Risks and Uncertainties Significant Concentrations For disclosable concentrations (those meeting the above criteria), the following is to be disclosed:

1. Information adequate to inform users about the nature of the risk associated with the concentration 2. For concentrations of labor (one of the four listed concentrations, see above) subject to collective bargaining agreements, the firm must disclose (a) the percentage of the labor force covered by the agreement, and (b) the percentage of the labor force covered by the agreement that will expire within one year. 3. For concentrations of operations located outside of the entity's home country (one of the four listed concentrations, see above), the firm also must disclose the carrying amounts of net assets and the geographic areas in which they are located.

Risks and Uncertainties Certain Significant Estimates The following are examples of assets and liabilities, related revenues and expenses, and disclosures of gain or loss contingencies that may be particularly sensitive to change in the near term:

1. Inventory subject to obsolescence 2. Equipment subject to technological obsolescence 3. Deferred tax asset valuation allowances 4. Capitalized software costs 5. Environmental remediation obligations 6. Litigation obligations 7. Obligations for defined benefit pension plans and other postemployment benefits

Cash Flows from Operating Activities—Noncash Items Equity Method Adjustments An investor that uses the equity method to account for an investment must recognize its share of the investee's net income or net loss in the period it is reported by the investee, regardless of whether any dividends are paid by the investee. Therefore, the investor would make the following entries:

1. Investee reports Net Income, Investor entry: DR: Investment in Investee CR: Equity Investment Income 2. Investee reports Net Loss, Investor entry: DR: Equity Investment Loss CR: Investment in Investee

A firm can reclassify a current liability as noncurrent if it accomplishes one of the following after the balance sheet date but before the financial statements are issued:

1. Issue stock to extinguish the debt; 2. Refinance the current liability with a non-current liability; or 3. Enter into an irrevocable agreement to refinance the current liability with a noncurrent liability.

Risks and Uncertainties Certain Significant Estimates When estimates used to value assets, liabilities, or contingencies are subject to a reasonable possibility of material change, disclosures may be required. Disclosure about an estimate is required when information available before the financial statements are issued or are available to be issued indicates that the following two criteria are met:

1. It is at least reasonably possible that an estimate will change in the near term; 2. The effect of the change would be material. a. Materiality is based on the effect of using the new estimate on the financial statements.

Cash Flow from Operating Activities—Accrual Reconciliation Under the indirect method, net income must be adjusted for the following items to get cash flow from operating activities. Below is a list of items that are typically used to reconcile accrual-based net income to cash flows from operations.

1. Items that are added back to net income are those that were deducted to derive net income, but cash was not used in the transaction. Examples of the items that are added back in the reconciliation are: a. Depreciation expense b. Amortization expense c. Depletion expense d. Losses e. Loss under equity method of accounting for Investments g. Amortization of premium on bond investment g. Amortization of discount on bonds payable h. Decreases in current assets i. Increases in current liabilities j. Increase in unearned revenue 2. Items that are subtracted from net income are those that were added to derive net income, but cash was not received in the transaction. Examples of items that are deducted in the reconciliation are: a. Gains b. Amortization of discount on bond investment c. Amortization of premium on bond payable d. Undistributed income under equity method of accounting for investments e. Increases in current assets f. Decreases in current liabilities g. Decrease in unearned revenue

Ratios can be grouped according to the major purpose or type of measure being analyzed. The major purposes or types of measures being analyzed are:

1. Liquidity/Solvency 2. Operational Activity 3. Profitability 4. Equity/Investment Leverage

There are two components of comprehensive income:

1. Net income and 2. "Other" comprehensive income. 3. It is the second category that causes comprehensive income to differ from net income. "Other" comprehensive income items are not currently recognized in net income. They are recorded directly as increases or decreases in owners' equity.

Balance Sheet Account Types by Category Cash is the only account for which the following are the same:

1. Nominal value 2. Market value 3. Realizable value 4. Present value 5. Future value

The basic purpose of the SCF is to provide information about the cash receipts and cash payments for an entity to help investors, creditors, and others assess:

1. Past ability to generate and control cash inflows and cash outflows related to operating, investing, and financing activities; 2. Probable future ability to generate cash inflows sufficient to meet future obligations and pay dividends; and 3. The likely need for external borrowing.

Exceptions—There are exceptions to all-inclusive income statements.

1. Prior-period adjustments—Prior-period adjustments are shown on the Statement of Retained Earnings and are the correction of accounting errors affecting income of prior years. 2. Other comprehensive income items (OCI) a. Foreign currency translation adjustments b. Unrealized holding gains and losses on securities available for sale c. Pension and other postretirement benefit plan cost adjustments d. Certain deferred derivative gains and losses 3. The OCI items above are disclosed in the statement of comprehensive income discussed in a later lesson. The different income amounts for a period are related as follows: 4. Retrospective changes in accounting principle affecting income. These are treated as direct adjustments to retained earnings.

Statement of Changes in Equity Other events—Other events reported in the statement of changes in equity (and columns affected) include:

1. Retrospective change in accounting principle affecting prior earnings (retained earnings and total OE) 2. Restatement of income statement for an error affecting prior earnings-prior period adjustment (retained earnings and total OE) 3. Contributed capital from conversion of bonds (contributed capital and total OE) 4. Contributed capital from stock options and stock award plans (contributed capital and total OE)

Comprehensive income does not include the following:

1. Retrospective effects of changes in accounting principle 2. Prior-period adjustments

Capital Structure Disclosures—Companies are required to provide the following information related to capital structure:

1. Rights and privileges of outstanding securities 2. The number of shares issued during the annual fiscal period and any subsequent interim period presented 3. Liquidation preference of preferred stock 4. If the liquidation value of preferred stock is considerably in excess of par value or stated value of preferred stock, this information should be disclosed in the equity section of the balance sheet. 5. Other preferred stock disclosures—The following information can be disclosed in the footnotes or in the equity section of the balance sheet: a. Aggregate or per-share amounts at which preferred stock can be called or is subject to redemption through sinking fund operations b. Aggregate or per-share amounts of arrearages for cumulative preferred stock 6. Redeemable preferred stock—For each of the five years following the balance sheet date, the amount of redemption requirements for all types of redeemable capital stock must be disclosed in the notes to the financial statements.

U.S. GAAP requires the disclosure of comprehensive income in a financial report in one of two ways:

1. Single statement of comprehensive income—This alternative presents the components of profit or loss within this single statement leading to net income as a subtotal. Displaying the other comprehensive income items leads to total comprehensive income. 2. Two statements—A separate income statement is presented immediately before the statement of comprehensive income. The net income amount resulting from the first statement is used as the beginning amount for the second statement, which then reports the other comprehensive income items leading to comprehensive income.

Special Journals Periodic posting is as follows:

1. Sum of the DR Cash column for a period is posted to the cash account; 2. Sum of the DR AR column for a period is posted to the AR control account while each individual amount in that column is posted to the appropriate AR subsidiary account; 3. Sum of the CR Sales account is posted to the sales account.

Summary of significant accounting policies—The first footnote is typically a summary of significant accounting policies—the principles and methods chosen by management where GAAP allows a choice. Such disclosure is required. Users' understanding of financial statement amounts is greatly facilitated by knowing the methods used in preparing the statements. This footnote usually includes information about the following:

1. The chosen depreciation method 2. The chosen method of valuing inventory 3. The securities classified as cash and cash equivalents 4. The basis for consolidation: a. Amortization policies b. Revenue recognition policies

Management's Going-Concern Assessment Both quantitative and qualitative information should be considered when assessing the entity's ability to meet its obligations. The look-forward period for this assessment is one year from the issuance of the financial statements. Per ASU 2014-15, the following information should be taken into consideration:

1. The company's current financial condition—Including its current liquid resources. 2. Conditional and unconditional obligations —Due or anticipated in the next year. 3. Funds necessary to maintain operations—Considering the company's current financial condition, obligations, and other expected cash flows in the next year. 4. Other conditions—That could adversely affect the company's ability to meet its obligations in the next year. For example: Negative financial trends. a. Other indications of financial difficulties b. Internal matters c. External matters

Risks and Uncertainties Significant Concentrations Disclosure of a concentration is required if all the following criteria are met. These concentrations are called disclosable concentrations.

1. The concentration exists at the balance sheet date; 2. The entity is vulnerable to the risk of a near-term severe impact because of a concentration and 3. It is at least reasonably possible that events capable of causing a severe impact will occur in the near term.

Two categories—There are two categories of subsequent events, each requiring different accounting treatment:

1. The condition leading to the subsequent event existed at the balance sheet date; 2. The condition leading to the subsequent event did not exist at the balance sheet date-the condition arose after the balance sheet date.

The period during which to evaluate subsequent events is the period between the balance sheet date, and either:

1. The date the financial statements are issued—when they are widely distributed for general use, or 2. The date the financial statements are available to be issued—when they are complete, comply with GAAP, and have all the approvals necessary for issuance.

Comparison of the Direct/Indirect Method of Determining Cash Flows from Operating Activities The direct method and the indirect method are alternative ways of developing and presenting cash flow from operating activities. The most significant aspects of the two methods are:

1. The direct method presents cash flows in terms of the specific sources from which cash was received (inflows) and to which cash was paid (outflows). 2. The indirect method develops cash flows by adjusting net income and does not (necessarily) identify the specific sources of cash inflows or outflows. 3. Under either method, the cash flow from operating activities will be the same amount. 4. Under either method, the other major sections of the statement of cash flows—investing, financing, foreign currency effects, and the reconciliation of the change in cash—will be the same. 5. The direct method is preferred (by the FASB). 6. Both methods require disclosure of Noncash Investing and Financing activities. 7. The direct method requires an additional schedule to reconcile net income to cash flow from operating activities. 8. The indirect method requires an additional disclosure of the amount (of cash) paid for interest and income taxes.

Summary of significant accounting policies Related party transactions—Companies must disclose the following information:

1. The nature of the relationship between the related entities 2. A description of all related-party transactions for the accounting years in which an income statement is presented in the financial report 3. The dollar amounts of the related-party transactions for the accounting years in which an income statement is presented in the financial report 4. In relation to related parties, any receivables or payables from or to related parties as of the date of each balance sheet presented in the financial report

Risks and Uncertainties Certain Significant Estimates The disclosures must include:

1. The nature of the uncertainty that may cause an estimate to change and a statement that it is at least reasonably possible that a change in an estimate will occur in the near term. If the estimate concerns a loss contingency, the disclosure must also include an estimate of the possible loss or range of loss, or state that such an estimate cannot be made. 2. The estimated effect of the change as of the date of the financial statements must be disclosed.

Management's Going-Concern Assessment Disclosures are required only when conditions give rise to substantial doubt about the entity's going concern. No disclosures are required if there is no going concern uncertainties. If the substantial doubt is alleviated because management developed a plan to mitigate the effects of the uncertainties, the disclosures are still needed and the disclosures would include a description of management's plans to alleviate the substantial doubt. Disclosures include:

1. The principal conditions that give rise to the uncertainties 2. Management's evaluation of these conditions 3. Management's plans to alleviate the substantial doubt

Structure of the Income Statement Continuing Operations and Other Items of Income—The income statement is divided roughly into two portions.

1. Top portion—The top portion includes routinely occurring items and other items that are appropriately included in income from continuing operations. a. The subtotal income from continuing operations is used by investors as a broad measure of operating income. b. GAAP does not prescribe the specific format in which information should be presented in the top portion of the Income Statement. c. Income from continuing operations includes all income items other than those in the bottom portion of the income statement. 2. Bottom portion—The bottom portion includes items that are specifically defined by GAAP as being unrelated to continuing operations. a. These items are not representative of the firm's ability to generate income and are unique items that will not be repeated. They are, however, components of total income. b. GAAP is very specific about the measurement and presentation of items in the bottom portion. For example, there is very specific guidance on the presentation and measurement of discontinued operations. c. Discontinued operations are required to be presented at the bottom portion of the income statement. Discontinued operations are major components of an entity that are either sold or planned to be sold and thus are no longer part of continuing operations.

The Balance Sheet and Firm Valuation There are three important valuations for a firm:

1. Total OE or net assets—This is the amount determined by current U.S. GAAP and is found in the balance sheet; 2. Market value of net identifiable assets—The amount of cash that would remain after selling all identifiable assets (including identifiable intangibles) and paying off all liabilities. This amount is also called the firm's "split up" or liquidation value. To determine this amount, the firm must have its assets appraised; 3. Total value of the firm—Its market capitalization—that is, the total value of the firm's outstanding stock. For publicly traded firms, this value can be found on Internet financial sites.

"Other" Comprehensive Income Items (OCI) The following items are items included in the second category above; that is, they are included in comprehensive income but not in income:

1. Unrealized gains and losses on debt securities classified as available-for-sale (AFS). 2. Unrecognized pension and postretirement benefit cost and gains. Currently, GAAP does not recognize all changes in these liabilities and assets immediately in income. Rather, some are recognized in other comprehensive income. 3. Foreign currency translation adjustments are changes in the value of foreign currency and accounts measured in foreign currency 4. Certain deferred gains and losses from derivatives.

Probable is the threshold associated with contingencies and is broadly interpreted to mean greater than

70% or 80% probably that the event will occur.

Cash Flows from Operating Activities—Noncash Items Depreciation/Amortization/Depletion Expenses These are noncash expenses that must be added back to net income. Often the amount of depreciation/amortization/depletion expense is not given and you need to solve for the expense:

A T-account is the best way to derive depreciation/amortization/depletion expense

Define General Prices

A market basket of items that the typical consumer purchases.

Background on the Balance Sheet It is the only statement dated as of a point in time. The title consists of three lines:

ABC Company Balance Sheet As of December 31, 20X4

Balance Sheet Account Types by Category Current liabilities—Examples are

Accounts payable, accrued liabilities, unearned revenue, income tax payable, notes payable, current portion of long-term debt

Accumulated Other Comprehensive Income (AOCI) the accumulated balances of each individual component of OCI must be reported. This information can appear in the

Balance Sheet, Statement of Owners' Equity, or footnotes.

Ratios for liquidity Current ratio =

CA/CL

Per Share Basis =

Cash Dividends per Common Share / Earnings per Common Share

Common Stock Dividends Pay Out Ratio Total Basis =

Cash Dividends to Common Shareholders / Net Income to Common Shareholder

Reconciliation of Net Cash Flow from Operating Activities with Net Income The reconciliation shows the adjustments to Net Income necessary to arrive at

Cash Flow from Operating Activities.

If the Direct Method is used to present Net Cash Flow from Operating Activities, a separate schedule must be provided that reconciles

Cash Flows from Operating Activities to Net Income.

Balance Sheet Account Types by Category Current assets-Examples include

Cash, cash equivalents, short-term investments, accounts receivable, other receivables, inventories, prepaids

Examples of monetary items—

Cash, most receivables, accounts payable, all liabilities payable in fixed dollar amounts, and certain investments in debt securities.

Book Value per Common Stock =

Common Shareholders' Equity / Number of Outstanding Common Shares

Inventory Turnover =

Cost of Goods Sold / Average Inventory

WCR =

Current Assets / Current Liabilities

Working Capital Ratio = The more common name of this ratio is "current ratio."

Current Assets / Current Liabilities

Working Capital =

Current Assets − Current Liability

Cash Flows from Operating Activities—Noncash Items Increase in accounts receivable When sales are made on account, the related entry would be:

DR: Assets Receivable CR: Sales

Cash Flows from Operating Activities—Noncash Items Amortization of discount on bonds payable—When bonds are issued for less than maturity value, a discount results. The related entry would be:

DR: Cash DR: Discount on Bonds Payable CR: Bonds Payable

Cash Flows from Operating Activities—Noncash Items Equity Method Adjustments If the investee paid a cash dividend during the period, the Investor entry would be:

DR: Cash CR: Investment in Investee

Cash Flows from Operating Activities—Noncash Items Amortization of premium on bond investment—The subsequent amortization of the premium would be recorded by a periodic entry:

DR: Interest Income CR: Premium on Bond Investment

Cash Flows from Operating Activities—Noncash Items Amortization of premium on bond investment—When bonds are purchased for more than maturity value, a premium results. The related entry would be:

DR: Investment in Bonds DR: Premium on Bond Investment CR: Cash

Cash Flows from Operating Activities—Noncash Items Increase in accounts payable When purchases are made on account, the related entry would be:

DR: Purchases CR: Account Payable

Sales journal as an example of a special journal—A sales journal for a firm might record all cash and credit sales and have the following six columns:

Date Customer Invoice # DR Cash DR AR CR Sales

Operating Number of Cycle =

Days in Operating = Number of Days' Sale in A/R + Length Cycle Number of Days' Supply in Inventory

Common Stock Yield =

Dividend per Common Share / Market Price per Common Share

Define Subsequent Events

Events or transactions that have a material effect on the financial statements. Subsequent events occur after the date of the financial statements but before the statements are issued or are available to be issued.

Define Expenses

Expenses represent decreases in net assets or incurred liabilities through the provision of goods or services. Expenses are related to the company's primary business operations. Expenses provide benefit to the firm. Losses do not.

Concepts of Income Net income for the period would include all changes in

FV of assets and liabilities during the period.

Define Gains

Gains represent increases in equity or net assets from peripheral or incidental transactions.

Control and subsidiary accounts are used for any account that consists of

Inventory, plant assets (property, plant, and equipment) and accounts payable are examples.

Examples of nonmonetary items—

Inventory, plant assets, investments in equity securities, unearned rent, and other liabilities payable in goods and services

Balance Sheet Account Types by Category Noncurrent assets-Examples include

Long-term investments, property, plant and equipment, intangibles, "other" assets (including long-term prepaids)

Define Losses

Losses represent decreases in equity or net assets from peripheral or incidental transactions. Losses do not provide value or benefit to the firm.

Price-Earnings Ratio (P/E Ratio) =

Market Price for a Common Share / Earnings per (Common) Share (EPS)

Define Liquidity Ratios (also known as Solvency Ratios)

Measure the ability of the firm to pay its obligations as they become due.

Define Constant Dollars

Measurements in the general price level as of a specific date. Constant dollar measurements reflect an adjustment for inflation and allow comparisons using dollars with the same purchasing power.

Define Nominal Dollars

Measurements in the price level in effect at a transaction date. These measurements are not adjusted for inflation.

Profit Margin (on Sales) =

Net Income / (Net) Sales

Times Preferred Dividend Earned Ratio =

Net Income / Annual Preferred Dividend Obligation

Return on Owners' (all Stockholders') Equity =

Net Income / Average Stockholders' Equity

Noncash Investing and Financing Activities If an Investing or Financing Activity involves part cash and part noncash, the cash portion should be a part of (on the face of) the SCF; the noncash portion should be disclosed in

Noncash Investing and Financing Activities.

Balance Sheet Account Types by Category Noncurrent liabilities—Examples are

Notes payable, bonds payable, lease liabilities, pension liabilities, postretirement healthcare liabilities, deferred taxes.

Reconciliation of Change in Cash The net change in Cash is the amount that must be exactly explained by the cash flows associated with

Operating, Investing, and Financing Activities plus or minus the impact of foreign currency translation.

Total assets = Total liabilities +

Owners' equity

Book Value per Preferred Share =

Preferred Shareholders' Equity (including dividends in arrears) / Number of Outstanding Preferred Stocks

Define Accounting Income

Revenues less expenses plus gains less losses.

Define Revenues

Revenues represent increases in net assets or settlements of liabilities by providing goods and services. Revenues are related to the company's primary business operations.

Noncash Investing and Financing Activities Noncash activities must be presented at the bottom of the

SCF or in a disclosure

Owners' Equity Ratio =

Shareholders' Equity / Total Assets

Define Cash Equivalents

Short-term, highly liquid investments that are readily convertible to known amounts of cash. Cash equivalents are sufficiently close to maturity so that the risk of changes in value due to changes in interest rate is insignificant.

Reconciliation of Net Cash Flow from Operating Activities with Net Income The schedule that presents the reconciliation is identical to the Cash Flow from Operating Activities section in the

Statement of Cash Flows presented using the Indirect Method.

Exam Tip

The CPA Exam may ask the effect of certain transactions on ratios. Analyze the effect by determining whether the numerator or denominator has experienced the greater percentage change.

Define Measurement Base

The attribute of an account being measured and reported

Define Economic Income

The change in the net worth of a business enterprise during an accounting period.

Define Specific Price Change

The change in the price of a specific good or service over a period of time.

Define Financial Statement Ratio Analysis

The development of quantitative relationships between various elements of a firm's financial statements.

Define Inflation

The increase in general prices for a period of time; deflation is the decrease in general prices. When inflation is 4%, there has been a 4% increase in the general price level index.

Define Purchasing Power

The purchasing power of an asset is the amount of goods and services that can be obtained by transferring the asset to another party.

Define Comprehensive Income

The sum of (1) net income and (2) other comprehensive income. CI = NI + OCI

Structure of the Income Statement Presentation Requirements

There is no prescribed way of displaying the items above income from continuing operations

Debt to Equity Ratio =

Total Debt (Liabilities) / Owner's Equity

Debt Ratio =

Total Liabilities / Total Assets

If the actual disposal loss is different from the estimated loss recognized previously, then in the period of disposal the difference is recognized as

a gain or loss

Factors Limiting the Interpretation of Balance Sheet Information Consolidation of subsidiaries compounds the difficulties with interpretation of account balances when the parent and subsidiaries use different

accounting methods

The entity should disclose its policy for designating items as cash equivalents and restricted cash. A change in policy for designating cash equivalents or restricted cash is a change in

accounting principle

If the disposal takes place in the year the decision is made, then the disposal loss reported is the

actual amount

Cash Flows from Operating Activities—Noncash Items Losses/Gains - These are noncash deductions or additions in computing net income that must be

added back to or subtracted from net income

Concepts of Income Any investments by owners would be ________ and any dividends paid or treasury stock purchased would be ___________, when making this calculation.

added; subtracted

IFRS does not require adjustment to the balance sheet for share splits or reverse splits occurring

after the reporting date but before the financial statements are issued.

Subsequent Events—Conditions Existed at the Balance Sheet Date—The financial statements should reflect all information regarding these events up to the balance sheet date. This category of subsequent events requires recognition in the financial statements and includes

all events that provide evidence about conditions existing at the balance sheet date including estimates used in the process of preparing the statements. Footnotes may be included to supplement and explain the recognition.

To derive net cash provided by operating activities using the direct method, each item in the income statement is adjusted from

an accrual basis to cash basis.

Gain contingencies (are/are not) recognized

are not

Refinancing current debt Stock dividends and splits after the balance sheet date are treated as if they occurred

as of the balance sheet date.

Profitability Ratios—These measure

aspects of a firm's operating (income/loss) results on a relative basis.

Operating number of cycle measures the

average length of time to invest cash in inventory, convert the inventory to receivables, and collect the receivables; it measures the time to go from cash back to cash.

Number of days' sales in average receivables measures the

average number of days required to collect receivables; it is a measure of the average age or receivables.

The statement of financial position is another name for the

balance sheet

Factors Limiting the Interpretation of Balance Sheet Information Assets and liabilities are acquired at different times and are not affected in the same way by inflation and specific price-level changes. This causes the recorded value of these accounts to

be different from their current or real value and makes comparisons difficult.

The SCF must explain all of the changes in cash, cash equivalents, and restricted cash between the

beginning and end of the reporting period on the Balance Sheet.

Accumulated other comprehensive income (AOCI) is the amount

carried over from the previous period and then either increased or decreased during the current period.

Reconciliation of Change in Cash The net effect of operating, investing, financing cash flows and the net effect of foreign currency translation will be the difference between

cash at the beginning and end of the period.

The SCF also provides information about investing and financing activities that do not involve

cash inflows (receipts) or outflows (payment)

Reconciliation of Change in Cash The beginning and ending Cash would include

cash, cash equivalents, and restricted cash reported on the respective (1/1/X2 and 12/31/X2) Balance Sheets.

Factors Limiting the Interpretation of Balance Sheet Information Several different measurement bases are used (historical cost, depreciated historical cost, market (fair) value, realizable value, present value) which compromises the

comparability characteristic of accounting information.

Risks and Uncertainties Significant Concentrations Susceptibility to risk and uncertainty increases when diversification is lacking −when the firm has

concentrations in various aspects of its business. Examples of concentrations include excessive reliance on one customer, having one product or service account for most of the firm's revenues, and reliance on one or a small number of suppliers.

Valuation accounts Not all contra or adjunct accounts are valuation accounts, but all valuation accounts are

contras or adjucts

Illegal Acts—Examples include illegal

contributions and bribes

Investments in equity securities cannot be cash equivalents because they are not

convertible to a known amount of cash.

Effects on Cash of Foreign Currency Translation The SCF also shows the effect on the change in cash that results from changes in

currency exchange rates between the U.S. dollar and foreign currencies.

Working capital: Measures the extent to which

current assets exceed current liabilities and, thus, are uncommitted in the short term.

The times interest earned ratio measures the ability of

current earnings to cover interest payments for a period.

The times preferred dividend earned ratio measures the ability of

current earnings to cover preferred dividends for a period.

Classification of Assets and Liabilities—Assets and liabilities are classified as ______ or _________

current or noncurrent

IFRS does not consider refinancing, amendments or waivers when determining the classification of debt as

current or noncurrent.

The present value is the measure of current sacrifice when extinguishing the

debt at the balance sheet date

If the WCR exceeds 1.00: Equal increases in current assets and liabilities _______ the WCR.

decrease

A decrease in current assets (alone) __________ the WCR.

decreases

An increase in current liabilities (alone) _______ the WCR.

decreases

During inflation, the purchasing power of an asset having a fixed unchangeable value

decreases

If the WCR is less than 1.00: Equal decreases in current assets and liabilities ________ the WCR.

decreases

Two Formats Allowed by GAAP The operating section of the SCF can be presented using either the

direct or the indirect format.

Statement of Changes in Equity Vertical Format—Each column reconciles the beginning and ending account balance for one account by

disclosing all the changes in the account during the period.

The gain or loss recognized for individual assets is included in income from continuing operations whereas the gain or loss from DOP is reported as

discontinued operations below income from continuing operations.

Measurement Bases for Balance Sheet Valuation Present value—The present value of a future cash flow is its

discounted value

Cash Flow from Operating Activities—Accrual Reconciliation Accruals and Deferrals—Under GAAP, net income is based on accrual accounting, which recognizes

economic events through accruals and deferrals which means many items used in determining net income do not reflect cash flows

Operational Activity Ratios—These measure the

efficiency with which a firm carries out its operating activities.

Exit or Disposal Activity in the Ordinary Course of Business If the asset is abandoned or there is an involuntary conversion because the asset is destroyed, then no cash is received and the gain or loss

equals the net book value of the asset on the date of the abandonment or conversion.

Current asset (CA) For most firms the operating cycle is less than one year, but some firms, such as construction and engineering companies, have operating cycles

exceeding one year. Construction in process, an inventory account found in construction firms' balance sheets, is a current asset even though the constructed asset may require several years to complete.

Balance Sheet Account Types by Category Noncurrent assets Goodwill is by far the largest intangible in terms of dollar amount for many firms and equals the

excess of the purchase price paid for another business over the market value of its net assets. Only when a firm is purchased by another is goodwill recognized in the balance sheet of the purchaser. Internally, generated goodwill is expensed.

Effects on Cash of Foreign Currency Translation Companies that have transactions in foreign currencies or convert financial statements expressed in a foreign currency to statements expressed in dollars may incur a change in the dollar value of cash simply because of

exchange rate changes

Per share basis measures the

extent (percentage) of earnings distributed to common shareholders.

Current liability (CL) A liability expected to be

extinguished through the use of current assets or by the incurrence of other current liabilities.

The gain or loss from the discontinued operation is presented on the

face of the income statement as income (loss) from discontinued operation (net of tax).

Management's Going-Concern Assessment Management must assess the entity's ability to continue as a going concern. Management's assessment should be based on

facts and circumstances that are "known or reasonably knowable" as of the date the financial statements are issued.

Concepts of Income The net worth of a business enterprise is described as the

fair value (FV) of net assets

When the BV of the net assets of the component exceeds the component's fair value less cost of disposal at year-end, then the component assets are written down to

fair value less cost of disposal.

Statement of Cash Flows—Requirements and Purpose Statement Requirement—A Statement of Cash Flows (SCF) is required for all business enterprises that report both

financial position (Balance Sheet) and results of operations (income statement) for a period.

Under IFRS, the cut-off date for subsequent events is the date the

financial statements are considered authorized for issuance.

Period of evaluation for subsequent events All other entities use the available to be issued date. These entities are not required to evaluate subsequent events after the point of availability. However, a non-SEC filer must also disclose the date through which the subsequent events were evaluated and whether that date is the date the

financial statements are issued or available to be issued.

Under U.S. GAAP, the cut-off date for subsequent events is when the

financial statements are issued or available to be issued.

The balance sheet provides information useful in assessing the entity's

financial strengths and weaknesses, especially risk, and the allocation of assets.

Publicly held firms are required to include the MD&A in the annual report. It provides management's discussion about the operations of the

firm, its liquidity, and capital resources.

Management's Discussion and Analysis (MD&A) Forward-looking information is provided that is not reflected in the financial statements. This includes management's general prognosis about

future sales, effects of competition, and expected effects of general macroeconomic conditions.

All assets and liabilities of the discontinued operation for all comparative periods are presented separately on the balance sheet. These assets and liabilities cannot be presented as a net single amount; rather the

gross amount of assets and liabilities must be shown.

Restricted cash is identified by the entity as the cash that is

held for a specific purpose and is not available for the company to freely use.

The acid-test ratio measures the quantitative relationship between

highly liquid assets and current liabilities in terms of the "number of times" that cash and assets that can be converted quickly to cash cover current liabilities

The securities defensive-interval ratio measures the quantitative relationship between

highly liquid assets and the average daily use of cash in terms of the number of days that cash and assets can be quickly converted to support operating costs

Purchasing power gain—A purchasing power gain results from

holding monetary assets during deflationary times or having monetary liabilities during inflationary times.

Purchasing power loss—A purchasing power loss results from

holding monetary assets during inflationary times or having monetary liabilities during deflationary times.

Cash flows from financing activities This category reports cash inflows and cash outflows that relate to

how the entity is financed.

Statement of Changes in Equity Horizontal Format—Alternatively, the statement can be presented in horizontal format. Each account is explained from beginning balance to ending balance

in one set of rows, one account schedule on top of another

Formats Leading to Income from Continuing Operations Multiple-Step Format—The multiple-step format involves a presentation of

income from continuing operations that includes multiple comparisons of revenues, expenses, gains, and losses. In doing so, the reader is provided with the operating margin of the company, which is the excess of operating revenues over operating expenses.

Formats Leading to Income from Continuing Operations Single-Step Format—The single-step format involves a presentation of

income from continuing operations that is largely based on a single comparison. Total revenues and gains are compared with total expenses and losses in the single-step format.

The income of a discontinued operation, and any gain or loss from its disposal, are separated from

income from continuing operations, for all periods presented, even though in previous periods the income from the segment was part of continuing operations.

Structure of the Income Statement Income Tax Expense—Income tax expense is attributable only to

income from continuing operations. The tax effects of items below continuing operations are shown along with the item itself in a process called "intraperiod tax allocation."

Current operating performance income statement Due to enhanced opportunities to manipulate net income, the all-inclusive approach was selected over the current operating approach for

income statement presentation purposes

Current operating performance income statement At the other end of the spectrum is the current operating performance approach to income statement preparation, which would limit the

income statement to normal, recurring items.

If the WCR exceeds 1.00: Equal decreases in current assets and liabilities ________ the WCR.

increase

If the WCR is less than 1.00: equal increases in current assets and liabilities ______ the WCR.

increase

Reporting Within the Balance Sheet Valuation accounts A valuation account is one used to

increase or decrease the book value of an item to a measure of current value.

A decrease in current liabilities (alone) _________ the WCR.

increases

An increase in current assets (alone) ______ the WCR.

increases

Cash Flows from Operating Activities—Noncash Items Losses/Gains - If the amount of a loss or gain is not provided, it must be derived from

information that is given

Cash payments to suppliers—Cost of Goods Sold on an income statement may include changes in

inventory and/or changes in accounts payable.

Measurement Bases for Balance Sheet Valuation Market value, a type of current value—Examples include

investments in marketable securities for which the holding firm does not have significant influence and does not intend to hold to maturity

The Balance Sheet and Firm Valuation The total owners' equity of most publicly traded firms (also known as net assets or A − L) is significantly less than the market value of the firm because

investors place a higher value on firms that include the investors' expectation of future earnings. Firms are usually worth much more than the sum of their individual net assets, even at market value.

The Balance Sheet and Firm Valuation The difference between a firm's market capitalization and the market value of net identifiable assets

is goodwill—an amount that cannot be identified with any individual recorded asset. However, goodwill is recorded for accounting purposes only when one firm purchases all or a controlling interest of another firm.

The reporting principles for contingent liabilities are similar to those of subsequent events and in some cases overlap. However, for recognized contingencies, the event confirming the loss, reduction in asset, or recognition of liability need not take place before the

issuance of the financial statements.

Period of evaluation for subsequent events Public entities or any entities that widely distribute their financial statements use the _________ date.

issued

Substantial doubt means that

it is probable that the entity will be unable to meet its obligations.

Measurement Bases for Balance Sheet Valuation Historical cost or other historical value—Some accounts are measured and reported at a fixed, unchanging historical amount. Examples include

land, some investments, cash, prepaids, many current liabilities, contributed capital accounts, and treasury stock.

Examples of subsequent events include

lawsuits, changes in corporate structure, issuances of debt and equity securities, major acquisitions, and significant gains and losses.

In addition, for contingent liabilities, the quality that distinguishes recognition from footnote disclosure only is the

likelihood of the future event and whether the economic sacrifice is estimable.

A classified balance sheet distinguishes current and noncurrent assets and liabilities which helps users assess

liquidity

The Statement of Changes in Equity effectively expands the OE section of the balance sheet by

listing all the changes in those accounts, explaining how the beginning balance increased or decreased in deriving the ending balance

The measurements for the DOP disposal loss is the same as for individual impaired assets held for disposal. The only difference is the

location on the income statement the gain or loss is reported.

Concepts of Income Investments with readily determinable market values are an exception. These investments are reported at

market value. Moreover, inventories are written down to lower of cost or market.

Balance Sheet Account Types by Category For balance sheet reporting, assets and liabilities are typically reported in order from

most liquid to least liquid. For example, current assets begin with cash and cash equivalents, then short-term investments, receivables, inventories and finally prepaids.

For all restricted cash, the entity must disclose the

nature of the restriction.

All items reported for discontinued operations are _____ of tax

net

Comprehensive income was designed to report the change in

net assets during the period from all sources other than from transactions with owners acting as owners.

Reconciliation of Change in Cash The difference between beginning and ending Cash is the

net change (increase or decrease) in Cash.

Net income is not replaced by comprehensive income. The purpose of requiring the reporting of comprehensive income is to report the

net change in equity in a single amount and to provide a more complete picture of the total earnings of the firm for a period. This reporting contributes to the objective of reporting an "all-inclusive" income amount.

An item recognized in OCI one year may be recognized in ____________ in a later year.

net income

Actual gains on disposal are recognized but estimated gains are not. A gain occurs when the

net proceeds from the sale of the component exceed the BV (book value) of the net assets of the component.

Profit margin (on sales) measures the

net profitability on sales (revenue).

Financial statement amounts are measured in

nominal dollars

Illegal Acts-The nature and impact of illegal acts on the financial statements should be disclosed fully in the

notes

Number of days' supply in inventory measures the

number of days inventory is held before it is sold or used. Indicates the efficiency of general inventory management.

Accounts receivable turnover measures the

number of times that accounts receivable turnover (are incurred and collected) during a period. Indicates the quality of credit policies (and the resulting receivables) and the efficiency of collection procedures.

Inventory turnover measures the

number of times that inventory turnover (is acquired and sold or used) during a period. Indicates over or under stocking of inventory or obsolete inventory.

Constant dollar adjustments allow comparisons of dollar amounts for transactions occurring

on different dates

All-inclusive income statement—The current income statement under GAAP is mostly an all-inclusive one in which essentially all revenues, expenses, gains, and losses are shown

on the income statement and included in the net income calculation.

Structure of the Income Statement Intraperiod Tax Allocation—Pertains to the tax effects for

only one year

Advantages of special journals The number of postings also is reduced because

only the sum of the changes in the special journal accounts for the period need to be posted to the respective accounts.

Two Formats Allowed by GAAP The direct method reports the actual operating cash inflows and outflows in the

operating section

Two Formats Allowed by GAAP The indirect method reports the reconciliation of net income and net operating cash flow in the

operating section

Reporting Within the Balance Sheet A contra account has a balance

opposite that of the associated account in terms of debit and credit. Contras can be debit or credit balances, and can be considered valuation accounts or merely accumulations of items such as depreciation and amortization over time

Exit or Disposal Activity in the Ordinary Course of Business The loss on abandonment or conversion is an

ordinary loss and part of continuing operations on the income statement.

Investments usually are considered cash equivalents only when the

original maturity is three months or less (

Accumulated Other Comprehensive Income (AOCI) This total is the running total of

other comprehensive income items through the Balance Sheet date.

Current operating performance income statement Many other items would be run through ____________ and thus escape the attention of financial statement users who rely more heavily on the income statement.

owners' equity

AOCI is an ______________ account.

owners' equity (OE)

Book value per common stock measures the

per share amount of common shareholders' claim to assets.

Book value per preferred share measures the

per share amount of preferred shareholders' claim to assets.

Summary of significant accounting policies—This summary must include information about all significant accounting policies but is not required in interim statements if the

policies have not changed.

Control and Subsidiary Accounts The accounts reside in the ledger. The general ledger contains all accounts to be used in

preparing the balance sheet. Some of these accounts are called control accounts because they report the aggregate balance of several subsidiary accounts.

OCI items are typically reported net of tax. Alternatively, firms may report each item on a ____________ with the net aggregate income tax effect reported as a separate item.

pretax basis

For disposal of an individually significant component that does not meet the definition of a discontinued operation, the entity must disclose

pretax profit or loss reported in the income statement for the period in which the disposal group is sold or is classified as held for sale.

The price-earnings (P/E) ratio measures the

price of a share of common stock relative to its latest earnings per share. Indicates a measure of how the market values the stock, especially when compared with other stocks.

Measurement Bases for Balance Sheet Valuation Depreciated, amortized, or depleted historical cost—Other accounts reflect the remaining portion of a fixed unchanging historical amount. In some cases, the original cost or other relevant amount is maintained in one account, with a contra or adjunct account being subtracted from or added to that account for the purpose of reporting net book value. Examples include

property, plant and equipment; intangibles; natural resources.

The debt ratio measures the

proportion of assets provided by creditors. Indicates the extent of leverage in funding the entity.

The owners' equity ratio measures the

proportion of assets provided by shareholders.

Market Capitalization—The market capitalization is generally many times recorded OE in amount. The purpose of the balance sheet is not to provide a firm's market value, but rather to

provide information that is a starting point for valuing a firm and assessing its riskiness.

Current asset (CA) The operating cycle is the period of time from

purchasing inventory to paying for the payable incurred on inventory purchase to the sale of goods to the collection of receivable and then to purchasing inventory all over again.

Debt Disclosures—These are perhaps the most important items found in the balance sheet, dollar for dollar. They indicate a

quantifiable financial risk faced by the firm in the future.

Return on owners' (all stockholders') equity measures the

rate of return (earnings) on all stockholders' investment.

Return on common stockholders' equity measures the

rate of return (earnings) on common stockholders' investment.

Common stock yield measures the

rate of return (yield) per share of common stock.

Return on total assets measures the

rate of return on total assets and indicates the efficiency with which invested resources (assets) are used.

Current asset (CA) An asset expected to be

realized in cash or to be consumed or sold during the normal operating cycle, or within one year of the balance sheet date, whichever is longer.

Since the components of cash, cash equivalents, and restricted cash may be reported on separate lines on the statement of financial position, the entity must disclose how the change in cash presented on the SCF

reconciles to the components of cash presented on the statement of financial position. This reconciliation can be on the face of the SCF or in the notes to the financial statements.

Advantages of special journals Special journals simplify the

recording of journal entries because each recording affects the same accounts each time. Your check register is an example; it is a cash receipts/payments journal. Each entry you make always affects cash, and you need only write into the register the other item affected

Current liability (CL) The incurrence of other CL part of the definition means that CL that are continuously

refinanced (rolled over) by replacing them with other CL due later (but within one year of the balance sheet date) must still be classified as CL, even though no CA will be used to extinguish them in the year after the balance sheet date.

The debt to equity ratio measures

relative amounts of assets provided by creditors and shareholders.

Equity/Investment Leverage Ratios—These provide measures of

relative sources of equity and equity value

In order to convert revenue and expense items on the accrual-based income statement to the amount of cash they generated or used, the effects of accruals and deferrals must be

removed

To avoid double counting in OE, the OCI item from the previous year is

removed from AOCI.

Unusual or Infrequent Income Items GAAP requires that unusual or infrequent items be separately

reported if material, as a component of income from continuing operations or alternatively, disclosed in notes to financial statements.

After the disposal of an operation is completed, there may be adjustments to amounts previously reported in the DOP section of the income statement. These adjustments might stem from

resolution of contingencies, settlement of pension obligations, and others that occur after disposal. Such adjustments are reported in the DOP section of the income statement in the year they occur.

Both net income and OCI items occur each year and together yield comprehensive income. Net income is closed to _____________ and OCI is closed to _________ each year.

retained earnings; AOCI

Measurement Bases for Balance Sheet Valuation Aggregate of more than one valuation basis—Retained earnings-net income reflects all measurement bases through

revenue and expense recognition.

Exit or Disposal Activity in the Ordinary Course of Business A company may voluntarily sell, dispose or abandon plant assets that are individually insignificant to the operations of the business. These disposals occur and are not the primary source of

revenue for the entity, but are incidental to operations. In the case of fire, flood or other event, the plant asset may be destroyed involuntarily. In either case, the asset must be depreciated up to the date of the disposal. The first thing that must be done before recording an exit or disposal activity is to record depreciation.

Formats Leading to Income from Continuing Operations—Income from continuing operations includes the

revenues, expenses, gains, and losses that are normal and recurring.

Cash payments for operating expenses—Expenses on an income statement may include accruals and/or deferrals. To derive cash paid for operating expenses these accruals/deferrals must be

reversed

Statement of Changes in Equity Vertical Format—In this format, each OE account is reported in a

separate column of a spreadsheet-type document. The following is an example of this format for a single period.

Two Formats Allowed by GAAP The direct method reports the reconciliation of net income to cash flows from operations in a

separate schedule

Statement of Changes in Equity Vertical Format—The statement of comprehensive income is presented either in a

separate statement or in a combined statement with net income.

Presentation of Comprehensive Income under U.S. GAAP is aligned with IFRS. Both U.S. GAAP and IFRS required that comprehensive income is presented either in a

separate statement or in the statement of income.

Accumulated Other Comprehensive Income (AOCI) Irrespective of the reporting option chosen for comprehensive income, U.S. GAAP requires that the total of other comprehensive income be

separately displayed in the owners' equity section of the Balance Sheet in an account with a title such as AOCI.

Formats Leading to Income from Continuing Operations Formats in Practice Two formats have become accepted in practice:

single-step and multiple step statements. There are many variants of each. 1. Both formats provide the same information although the multiple-step format provides more subtotals and organization. 2. Income from continuing operations and net income are the same amounts regardless of the format used. 3. The format differences affect only the ordering in calculating income from continuing operations.

Purchasing Power Gains and Losses—The change in the purchasing power of an item due to a change in the general price level is measured only for monetary items because the

specific price of nonmonetary items can change.

Effects on Cash of Foreign Currency Translation Cash balances held in foreign currency at period-end should be converted to dollars using the

spot (current) exchange rate at the date of the Balance Sheet.

Statement of Changes in Equity Comparative Statements—The comparative multiyear display for the vertical format for single year statements results in the statements of three years

stacked one on top of the other. This type of display, thus, is vertical within each year and horizontal across years.

Frequently, restricted cash is reported on a separate line item on the

statement of financial position.

Refinancing current debt The recognition (change in classification to noncurrent) takes place during the

subsequent event period, but it can be argued that the decision was made to effect the reclassification after the balance sheet date.

The recognition and disclosure requirements for subsequent events apply to both annual and interim financial statements but do not apply to

subsequent events or transactions that are governed by other applicable GAAP.

Concepts of Income For many assets and liabilities, changes in market value are not recognized until

substantiated by a transaction between willing parties.

Exit or Disposal Activity in the Ordinary Course of Business Sale of a plant asset requires removing

the asset and accumulated depreciation, recording the receipt of cash and recognition of the gain or loss on the sale. When the cash received from the sale exceeds the assets net book value, then a gain is recognized. When the cash received is less than the assets net book value, then a loss is recognized. The gain or loss on the disposal of an asset is reported on the income statement with other items from customary business activities.

Advantages of special journals Separation of duties for improved internal control is fostered with the use of special journals. Only particular individuals may be authorized to access the sales journal for example, but not

the cash receipts journal, or the general journal.

Measurement Bases for Balance Sheet Valuation Net realizable value—This is another type of current value but one that is less in amount than the historical value. Net realizable value is the amount

the firm expects to receive from the sale or collection of the item. Examples include accounts receivable and inventories.

Earnings per share (EPS—basic formula) measures

the income earned per (average) share of common stock. Indicates ability to pay dividends to common shareholders.

Subsequent Events—Conditions Did Not Exist at the Balance Sheet Date—This category of subsequent event requires only footnote disclosure of events that have material effects on the financial statements. The footnote disclosures include a description of

the nature of the event and an estimate of the financial effect, or a statement that an estimate cannot be made. Recognition is inappropriate because the condition existed after the balance sheet date

Reporting Within the Balance Sheet An adjunct account has a balance that is

the same as that of the associated account in terms of debit and credit. An adjunct can have either a debit or a credit balance. An adjunct account is added whereas a contra is subtracted

Concepts of Income accounting income reflects recorded

transactions, events, and adjustments.

Statement of Changes in Equity Comparative Statements—The comparative multiyear display for the horizontal format for single year statements adds

two more sets of columns, one for each year shown comparatively. This type of display, thus, is horizontal within each year and vertical across years.

Statement of Changes in Equity Format of the Statement—The most common formats encountered are the

vertical and horizontal formats.