FRC Final
Why did the Board decide to continue to use the treasury stock method?
1. It is fairly simple to implement; 2. It was currently being used; 3. It does not contain any subjective elements; 4. It was the approach used in IFRS
Why did the FASB choose income from continuing operations as opposed to net income?
1. Net losses are more likely to occur at the net income level than the income from continuing operations level. The EPS for net income should include the potential common shares even though their effect would be antidilutive on net income (but dilutive on income from continuing operations). 2. EPS will be more comparable over time if income from continuing operations is used.
What are the arguments for supporting retrospective treatment on the indirect effect?
1. No difference between direct and indirect effects since they are both results of the change in principle. 2. May result in more consistent trend information, thus providing better information to the users of the financial statements
The Board concluded that the retrospective method is the correct approach to use for changes in accounting principles. Why did FASB reach this conclusion?
1. Retrospective approach would provide greater consistency across periods; thus, enhance the usefulness of the financial statements. 2. It would convergence between U.S. GAAP and IFRS.
What are the arguments for supporting prospective treatment on the indirect effect?
1. The change in principle is the past event that gives rise to the current period recognition of the indirect effect. 2. More practical to recognize the indirect effects in the current period.
What were the Board's primary concerns with the treasury stock method?
1. This method understates the possible dilutive effect of options and warrants because if the exercise price exceeds the average market price, the securities are not included in the computation of diluted EPS. However, they could certainly be dilutive in the future (if market price increases). 2. The method assumes a hypothetical purchase of treasury stock when, in fact, issuers might reinvest the proceeds from the exercise in a large number of different ways.
Name one of the two reasons firms may not retrospectively report the direct effect of a change in accounting principle.
1. Treatment specified for a mandatory change 2. It is impractical to use the retrospective approach
Provide one of the three conditions that make it impractical to apply the retrospective approach for a change in accounting principle.
1. indeterminable financial statement effects; 2. requires assumptions about management's intent in a prior period; 3. requires significant estimates for a prior period and availability of info needed to determine these estimates cannot be objectively verifiable
In a study cited in the article I sent you, ____% of CFOs would take a value-decreasing action to smooth earnings.
78%
How do we adjust the denominator of basic EPS to get diluted EPS when there is convertible preferred stock in the capital structure?
Add back additional shares with preferred stock conversion
How do we adjust the numerator of basic EPS to get diluted EPS when there is convertible debt in the capital structure?
Add back interest expense x (1-tax rate)
How do we adjust the numerator of basic EPS to get diluted EPS when there is convertible preferred stock in the capital structure?
Add back preferred dividends avoided on convertible preferred stock
What do we add to weighted-average common shares outstanding to get the denominator of diluted EPS when a company has convertible debt in its capital structure?
Additional shares on debt conversion
What do we add to the numerator of diluted EPS when a company has convertible debt in its capital structure?
After Tax Interest Expense
Describe the treasury stock method.
Assumes companies use proceeds from exercised options/warrants to buy its own shares
What share price do we use in the treasury stock method?
Average market price
Almost all errors will eventually correct themselves except for...
Balance sheet errors
Why did the Board decide to require an antidilution sequence that considers securities in the order of most dilutive to least dilutive?
Because it maximizes the dilution of earnings per share
A change in the depreciable life of an asset is an example of what type of change?
Change in accounting estimate
Which is more common - a change in accounting principle or a change in accounting estimate?
Change in accounting estimate
What type of change is a change from straight-line to declining balance depreciation?
Change in accounting estimate effected from a change change in accounting principle
What type of change is a change from LIFO to FIFO?
Change in accounting principle
A change in depreciation method is an example of what type of change?
Change in an accounting estimate effected by a change in accounting principle
What is a change in an estimate that is inseparable from the effect of a related change in accounting principle?
Change in an accounting estimate effected by a change in accounting principle
What are the three types of accounting changes?
Change in principle Change in estimate Change in reporting entity
What is it called when a company reports financial statements that are, in effect, financial statements for a different reporting entity?
Change in reporting entity
What enhancing qualitative characteristic from the conceptual framework is most impacted by accounting changes?
Comparability
Give 3 example of potentially dilutive securities.
Convertible Debt; Convertible Preferred Stock; Options / Warrants
Give an example of a potentially dilutive security.
Convertible debt; Convertible preferred stock; Options/warrants
Why don't we consider the tax rate in the numerator of diluted EPS when there is convertible preferred stock in the capital structure?
Dividends are not tax deductible
What does EPS stand for?
Earnings per Share
What is an unintentional mistake called?
Error
In the basis for conclusions "Statement of Cash Flows" which parties preferred the indirect method for preparing the cash flow statement?
Financial Statement Preparers
What assumption do we use for the denominator if bondholders actually convert the bond during the year?
If-converted assumption
What convention do we use that assumes that conversion occurs at the later of the beginning of the year and the issued date of the security?
If-converted assumption
The test for dilutions only includes the incremental income per share effects on _______.
Income from Continuing Operations
Why do we multiply interest expense by (1 - tax rate) in the numerator?
Interest expense is tax deductible
Does a change in accounting principle involve a voluntary or mandatory change?
It can be either mandatory or voluntary
To compute diluted EPS, when do we assume the convertible shares are converted?
Later of beginning of the year or the issue date
How do we weight the additional shares dues to convertible debt that are added to the denominator of diluted EPS?
Later of the beginning of the year or when the debt is issued
Diluted EPS is always equal to or ___________ than basic EPS.
Less
What is the numerator for basic earnings per share?
NI available to common shareholders (NI - preferred dividend requirements)
What is the formula for diluted EPS with convertible preferred stock in the capital structure?
NI-Preferred Dividend Requirements + Preferred Dividend Avoided / WASO + Additional Shares on Conversion
Do errors that only impact the income statement affect net income?
No
What is a simple capital structure?
No dilutive securities
What adjustment do we make to the numerator of basic EPS to get diluted EPS when the company's capital structure includes options?
None
What should we do when we discover an error after the books are closed that only impacts the income statement.
Nothing except restate comparative financial statements
If beginning inventory is understated, cost of goods sold will be...
Overstated
If ending inventory is understated, cost of goods sold will be...
Overstated
Which accounting firm was responsible for hosts announcing the wrong movie for best picture at the 2017 Academy Award?
PWC
What method do firms use to report a change in accounting estimate?
Prospective
What method do we most often use to report the indirect effects of a change in accounting principle?
Prospective
What method is used to account for a change in accounting estimate effected by a change in accounting principle?
Prospective
Which type of method for dealing with accounting changes does NOT involve restating all prior-year financial statements that are presented in the annual report?
Prospective
What assumption do we use for stock splits and stock dividends?
Retroactive Assumption
What method do we most often use to report the direct effects of a change in accounting principle?
Retrospective
What method do we use to account for errors?
Retrospective
Which type of method for dealing with accounting changes involves restating all prior-year financial statements that are presented in the annual report?
Retrospective
What are the two approaches to dealing with accounting changes?
Retrospective and Prospective
What are potentially dilutive securities?
Securities that aren't currently common stock, but could be through conversion or exercise
What do we call errors that will correct themselves over two accounting periods?
Self-correcting errors
How do we compute the incremental shares on option/warrant exercise?
Shares issued on assumed exercise less treasury shares assumed purchased
What is the if-converted assumption?
The assumption that dilutive securities convert at the later of the beginning of the year and the issued date of the security.
What should we do when we discover an error after the books are closed that only impacts the balance sheet.
The items should be reclassified and comparative financial statements should be restated.
What line items could appear on an income statement after income from continuing operations, but before net income?
The line item that now may appear in this section of the income statement is discontinued operations.
in computing the denominator for basic EPS, we weight each change by _______________________.
The percentage of the total year the shares are outstanding
What is the difference between options and warrants in the calculation of diluted EPS?
There is no difference.
What method do we use to estimate the cash proceeds the company would receive from the assumed exercise of options or warrants?
Treasury Stock Method
What are the two exceptions for reporting the direct effect of a change in accounting principle retrospectively?
Treatment specified for a mandatory change and if it is impractical to use the retrospective approach
Why do we subtract preferred dividends from net income in the numerator for basic EPS?
We want Net Income available to Common Shareholders
What is the denominator of basic EPS?
Weighted Average Number of Shares Outstanding
When are options dilutive?
When they are in the money.
Did the constituents who wrote comment letters about the exposure draft of Statement of Financial Accounting Standards No. 128 agree with the use of income from continuing operations as opposed to net income as the control number for the determination of which securities are dilutive?
Yes, generally the respondents agreed with this
Which accounts (opening balance) must be adjusted for the cumulative effect of the new principle under the retrospective approach?
all balance sheet accounts
Almost all errors will eventually correct themselves, except...
balance sheet errors
What type of change is a change in the salvage value of a depcriable asset?
change in accounting estimate
If ending inventory is overstated in year 1, retained earning in year 2 will be...
correct
Antidilution sequencing results in including potentially dilutive securities in rank order, from the _____ dilutive to the ______ dilutive.
from the most dilutive to the least dilutive.
