Far 1 Ch 4. The Income Statement and Statement of Cash Flows

IFRS

-IFRS has a few information requirements for the income statement, GAAP does not. -Expenses can be classified by function or by natural description, SEC requires all be classified by function -IFRS uses profit or loss instead of Net income or loss -IFRS prohibits reporting extraordinary items.

Correction of accounting errors

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How to report discontinued operations when the component is considered held for sale (likely to be sold within a year)

1) Operating income or loss (revs, exps, gains and losses) 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 (Can be reported separately, net of their tax effects )(If combined, the impairment LOSS must be disclosed either parenthetically on the face of the income statement or in a disclosure note)

How to report discontinued operations when the component has been sold before the end of the accounting period

1) Operating income or loss (revs, exps, gains, losses) 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 (can be combined or reported separately, net of their tax effects) (If combined, the gain or loss component must be indicated)

Two major methods of income manipulation

1) income shifting (income smoothing) 2) income statement classification

Income Smoothing

Companies bank earning by understating them in particularly good years and use the banked profits to polish results in bad years

Transitory earnings/Separately reported items

Discontinued operations Extraordinary items

Big bath accounting

Including recurring operating expenses in special charge categories such as restructuring costs to make it look more profitable.

Separately reported items have an order that they have to be in

Income from continuing operations- Discontinued operations, net of tax Extraordinary items, net of tax

Extraordinary items

Material events and transactions that are both: 1) Unusual in nature 2) Infrequent in occurrence (Presented in the income statement below discontinued operations) (In addition, a disclosure note is necessary to descirbe the nature of the event and the tax effects, if they are not indicated on the face of the income statement)

Income Statement is also known as

Statement of operations and Statement of earnings

A change in depreciation, amortization, or depletion is considered to be

a change in accounting estimate that is achieved by a change in accounting principle and are accounted for prospectively, exactly as we would for any other change in estimate.

Discontinued operations

a component of an entity whose operations and cash flows can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity

A component of an entity is

a. an operating segment that has either been disposed of or is classied as "held for sale" b. a business that meets the criteria to be classified as held for sale on acquisition

GAAP requires that a voluntary change in accounting principle

be accounted for retrospectively by revising prior years financial statements (before, the cumulative effect on the income of previous years from having used the old method was included in the year of change income statement) Now, an adjustment is made to the beginning balance of retained earnings for the earliest period reported in the comparative statements of shareholders' equity to account for the cumulative income effect of changing to the new principle for all years prior. JEs will update the current accounts. A disclosure note provides justification for the change and indicates the effect of the change on items not reported and in the disclosure note, shows the cumulative effect on retained earnings for the earliest year reported

IASB states that Extraordinary items

cannot be put on the income statement or any notes

Restructuring costs

costs associated with shutdown of facilities or downsizing of operations

Sec 401 of Sarbanes oxley requires that pro forma earning

if included in disclosures also provide a reconciliation with earnings determined according to generally accepted accounting principles

Restructuring costs are recognized

in the period the exit or disposal cose obligation is actually incurred.

Operating income

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

A change in reporting entity

involves the preparation of financial statements for an accounting entity other than the entity that existed in the previous period

Single step income statement

lists all revenues and gains included in income from continuing operations. Then expenses and losses are grouped, subtotaled, and subtracted-in a single step

pro forma earnings

manager's view of permanent earnings in the sense of being a better long-run performance measure.

Income from continuing operations

operating transactions that probably will continue into the future. Revenues, Expenses (including income taxes), gains, and losses, excluding those related to discontinued operations and extraordinary items.

Change in Accounting Principle

refers to a change from one acceptable accounting method to another ex/ change from LIFO to FIFO.

Earnings quality

refers to the ability of reported earnings to predict future earnings.

Nonoperating income

relates to peripheral or incidental transactions of the company.

Multistep income statement

reports a series of intermediate subtotals such as gross profit, operating income, and income before taxes.

A change in accounting estimate

requires the prediction of future events, so they can be wrong. When an adjustment needs to be made, it is accounted for proespectively and if it effects many future periods, such as a change in estimated useful life, a disclosure note shows the effect of that change on the current year's income before extraordinary items, net income, and earnings per share. Not necessary for more routine changes such as revising bad debts, unless the effect is material.

GAAP states that mandated changes in accounting principles can be accounted for by

retrospecitively restating prior years statements reporting the cumulative effect on the income of previous years from having used the old method rather than the new method in the income statment of the year of change as a separately reported item below extraordinary items.

Unusual OR Infrequent items

should be included in continuing operations but reported as a separate income statement component.ex/impairment of goodwill or restructuring costs

Income statement

summarizes the profit-generating activities that occured during a particular reporting period (investors and creditors perceive it as the statement most useful for predicting future profitability

A change in accounting estimate as a result of a change in accounting principle requires

the change to be justified in a disclosure note, just like a change in accounting principle and the effect on net income and earnings per share to be noted

Intraperiod tax allocation

the process of associating income tax effects with the income statement components that cause them

A change in reporting entity requires prior years financial statements

to be revised to include the new entity as if it existed in those periods

Transitory earnings

transactions or events that are not likely to occur again in the forseeable future.