Cpa Review- Far 1-2 (Income Statement)

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Income Statement- Uses

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Expenses Vs Loss
Revenue Vs Gain
Useful in determining profitability, value for investment purposes, and credit worthiness. Also useful in predicting FCF's based on past performance.

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Cost

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An amount expended for items such as capital assets, services, and merchandise received. It is the amount actually paid for something.

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Unexpired Costs

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Costs that will expire in future periods and be charged against revenues from future periods.

Examples
1. Inventory
2. Unexpired (prepaid) cost of insurance
3. NBV of fixed assets
4. Unexpired costs of patents

Hint 3

1. COGS
2. Insurance expense
3. Depreciation expense
4. Patents expense (amortization)

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Gross Concept (revenues and expenses)

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Revenues: reported at their gross amounts (less allowance for returns and discounts given)

Expenses: reported at their gross amounts

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Net Concept (gains and losses)

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Gains: reported at their net amounts (proceeds less net BV). A gain is a recognition of an asset either not in the ordinary course of business (gain on sale of fixed asset) or without the occurrence of an expense (finding gold).

Losses:reported at net amounts. Cost expiration either not in the ordinary course of business (loss on sale on investments) or w/out the generation of revenue (abandonment).

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Presentation Order of the Major Components of an I/S and R/E's Statement

(IDEA)

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1. Income (or loss) from Continuing Operations: reported before (gross) and after (net) of taxes. Include operating and non-operating activities and income taxes.

2. Income (or loss) from Discontinued Operations: reported net of tax

3. Extraordinary Items: reported net of tax, include items that are unusual and infrequent in nature.*

4. Cumulative Effect of Change in Accounting Principle: reported net of tax (general rule). Cumulative effect of a change from one acceptable method of accounting to another b/c the new method presents the financial information more fairly than the old method.**

Hint 6

*Unique to GAAP

**Reported on the Statement of Retained Earnings

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Multiple Step Income Statement

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Reports operating revenues and expenses separately from non-operating and other gains and losses. Benefit is enhanced user information w/ readily available data w/ which to calculate various analytical ratios.

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Single Step Income Statement

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Total expenses (including income tax expense) are subtracted from total revenues. Benefits are the simple design and that types of revenues/expenses don't appear as more important than others to the user.

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Discontinued Operations

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-Reported separately from continuing operations in the I/S, net of tax. The normal loss from discontinued operations can consist of an (1) impairment loss*, (2) a gain/loss from actual operations, and (3) a gain/loss on disposal.

-All of these amounts are included in discontinued operations in the period in which they occur.

Hint 9

*Carrying value is too high, above the NCV.
-When you think you're gonna have a loss, rule of conservatism, book it now.

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Component of Entity

Definition, U.S. GAAP, & IFRS

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-Is a part of an entity for which operations and cash flows can be clearly distinguished, both operationally and for financial reporting purposes, from the rest of an entity.

Under U.S. GAAP component of an entity may be- (1) an operating segment, (2) a reportable segment, (3) a reporting unit, (4) a subsidiary, or (5) an asset group.

Under IFRS may be- (1) a separate major line of business or geographical area of operations or (2) a subsidiary acquired exclusively w/ a view to resale.

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Held for Sale (& Criteria) (5)

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A component of a business (U.S. GAAP) or disposal group (IFRS) is classified as held-for-sale in the period in which ALL of the following criteria are met-
1. Management commits to a plan to sell
2. Component is available for immediate sale in its present condition
3. An active program to locate a buyer has been initiated.
4. The sale of the component is probable and expected to be within a year
5. It's unlikely that significant changes to the plan will be made or that the plan will be withdrawn.

*Difference between GAAP and IFRS

Hint 11

-IFRS: before you can classify the product line as HFS, the individual assets and liabilities have to be re-measured.

GAAP- doesn't require this

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Accounting Rules for Discontinued Operations

(Types to be considered, conditions that must be present)

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1. Results from component have to be (1) disposed of or (2) classified as held for sale to report them in discontinued operations.

-All related costs will be recognized when the obligations to others exist, not necessarily in the period of commitment to a plan.

2 Conditions that must be present- (1) Operations and CF's have been (or will be) removed from the ongoing operations, and (2) No significant continuing involvement in the operations of the component will take place after its disposal.

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Discontinued Operations Calculation

(Types of Items, Reporting, Depreciation & Amortization)

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1. 3 types of items included in Results of Discontinued Operations- (1) results of operations of the component, (2) Gain/loss on the disposal, and (3) Impairment losses (& subsequent increases in FV) of the component*

2. Results of the operations are reported in discontinued operations in the period it is disposed or classified as HFS. Results of subsequent operations of the component are reported in the period in which they occur.

3. Assets w/in component are no longer depreciated or amortized.

Hint 13

*Initial and subsequent impairment losses are recognized for recording the impairment of the component (less costs to sell)

Subsequent Increases in FV: gain is recognized for any increase in FV less costs to sell (but only to the extent of the initial impairment loss)

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Discontinued Operations Calculation

(Anticipated Future Gains/Losses, Subsequent Adjustments, Measurement & Valuation, Presentation & Disclosure)

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1. Gain or loss not previously recognized that results from the sale is recognized at the date of sale. Anticipated gains/losses aren't recognized until they occur.

2. Adjustments directly related* to the disposal of a component in a prior period are classified in the current period in discontinued operations.

3. Component classified as HFS is measured at the lower of its carrying amount or FV - costs to sell.

4. Results of discontinued operations (net of tax) are presented as a separate component of income before extraordinary items. A gain/loss recognized on disposal is disclosed either on the face of the I/S or in the notes to the F/S's.

Hint 14

*Must have demonstrated a cause-and-effect relationship & occur no later than 1 year after the date of the disposal transaction.

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Exit or Disposal Activities

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-Recognition of a liability for the costs associated with an exit/disposal activity is required.

-Includes: (1) involuntary employee termination benefits, (2) costs to terminate a contract that isn't a capital lease, and (3) other costs including costs to consolidate facilities or relocate employees.

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Criteria for Liability Recognition

(Exit or Disposal Activities)

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-Commitment to exit/disposal plan by itself is not enough. All criteria must be met-
1. An obligating event has occurred (ex. payment)
2. Event results in a present obligation to transfer assets or to provide services in the future.
3. Entity has little/no discretion to avoid the future transfer of assets or providing of services.*

Hint 16

*Future operating losses expected to be incurred as part of an exit or disposal activity are recognized in the period in which they occur (not normal operating loss)

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Liability Measurement

(Exit or Disposal Activities)

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Liability should be measured at fair value. FV is determined using U.S. GAAP FV measurement techniques.

Liability may be adjusted in future periods but revisions are accounted for prospectively.

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Income Statement Presentation

(Exit or Disposal Activities)

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Costs associated with exit/disposal activity will be reported in discontinued operations.

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Disclosure (5)

(Exit or Disposal Activities)

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Following must be disclosed in the notes to the F/S's-
1. Description of exit/disposal activity and facts/circumstances leading to the expected activity and expected completion date.

2. For each major cost associate w/ the activity: (1) total amount expected to be incurred w/ the activity, total incurred in period, and cumulative amount incurred to date must be disclosed. (2) Reconciliation of beg. and ending liability balances showing changes during period for costs incurred, costs settled, and other adjustments with an explanation of the reasons.

3. Line items in the I/S where the costs are aggregated

4. For each segment, total amount of costs expected, amount incurred to date (net of adjustments) with explanations.

5. If liability for a cost isn't recognized b/c FV can't be estimated, facts and reasons should be disclosed.

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Extraordinary Items (4)

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Under U.S. GAAP are-
1. Material in nature
2. Different from typical business activities
3. Not expected to recur in future (infrequent)
4. Not normally considered in evaluating ordinary operating results.

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Extraordinary Items

Disclosures and Examples (4)

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-Must be separately disclosed in the I/S, net of any tax effects, after discontinued operations.

-Abandonment or damage to plant due to infrequent event.
-Expropriation of a plant by the gov't.
-Prohibition of a product line by a newly enacted law.
-Certain gains/losses from extinguishment of long-term debt if they are not part of the entity's recurring operations

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Examples of Non-Extraordinary Items (5)

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-Part of Continuing Operations

1. Gain or loss from abandonment/sale of PP&E used in the business.
2. Large write-down/off of receivables, inventories, intangibles, and long-term securities.
3. Gain/loss of foreign currency transactions and translations.
4. Losses from an employee strike
5. Long-term debt extinguishments that are part of a common management strategy.

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Material, Unusual, OR Infrequent Items

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-If material reported as a separate line item as part of income from continuing operations and not net of tax (in the non-operating section).

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IFRS vs. U.S. GAAP

Extraordinary Items

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No such thing as an extraordinary item under IFRS on the financial statement or in the notes.

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Accounting Changes and Error Corrections

Classified as (3)

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1. Changes in Estimate (prospective).

2. Changes in Principle (general rule- retrospective)

3. Changes in Entity (restate)

-Error Corrections are not considered accounting changes

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Changes in Accounting Estimate

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-Occurs when it's determined that the estimate previously used by the company is incorrect.

Types of Events (6)*

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1. Changes in the lives of fixed assets.
2. Adjustments of year-end accrual of officers' salaries and/or bonuses.
3. Write-downs of obsolete inventory.
4. Material nonrecurring IRS adjustments.
5. Settlement of litigation.
6. Changes in accounting principle that are inseparable from a change in estimate (ex: installment method to immediate recognition).

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Reporting a Change in Estimate (2)

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1. Accounted for prospectively, do not affect previous periods.

2. If it affects several future periods, the effect on income before extraordinary times, net income, and related per share info for the current year should be disclosed in the notes.*

Hint 27

*Changes usually made each period (ex: uncollectible amounts) don't have to be disclosed in the notes unless they are material.

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Changes in Accounting Principle

Rule of Preferability and Nonrecurring Changes

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Change in accounting from one acceptable principle to another acceptable principle. The general rule is that they require retrospective adjustments.

1. Principle may be changed only if required by GAAP/IFRS or if alternative is preferable and more fairly presents the info.

2. Shouldn't be made for a transaction/event in the past that has been terminated or is nonrecurring.

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Changes in Accounting Principle

Effects of a Change (3)

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1. Direct Effects: are adjustments that would be necessary to restate the F/S's of prior periods.

2. Indirect Effects: differences in non-discretionary items based on earnings that would have occurred if the new principle had been used in prior periods (ex: bonuses)

3. Cumulative Effects: if (1) Non-comparitive F/S*- effect equals difference between the amount of beg. retained earnings in the period of change and what retained earnings would have been if change was retrospectively applied. If (2) Comparative F/S**- equals difference between beg. retained earnings in the 1st period presented and what retained earnings would have been if the new principle had been applied to all prior periods.

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*Non-Comparative: compares beginning R/E's using old method to beginning R/E's had you always used the new method.

**Comparative: have to go back and change all the beginning R/E's amounts for all the years being compared (earliest year presented)

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Reporting Changes in an Accounting Principle

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General rule is to recognize by adjusting beginning retained earnings in the earliest period presented for the cumulative effect of the change, and, if prior periods are presented, they should be restated (retrospective application)

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IFRS vs. U.S. GAAP

Reporting Changes in an Accounting Principle

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Under IFRS, if comparative information is being displayed, entity must at a minimum present 3 balance sheets* and two of each other financial statement**. Cumulative effect adjustment would be shown as an adjustment to the beginning retained earnings on the balance sheet for the beginning of the prior period.

GAAP doesn't have a 3 BS requirement

Hint 31

*End of current period, end of prior period, and beginning of prior period.

**End of current period and prior period

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Reporting Changes in an Accounting Principle

Exceptions to the General Rule (2)

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1. Impracticable to Estimate- if it is considered "impractical" to estimate prior periods, then the change is handled prospectively (ex: changing inventory cost from FIFO to LIFO

2. Change in Depreciation Method- or amortization/depletion is both a change in accounting principle and a change is estimate. They should be considered changes in estimate and handled prospectively.*

Hint 32

*New depreciation method should be used as of beginning of the year of the change in estimate and should start w/ the current book value of the underlying asset. No retrospective calculations should be made and no adjustment should be made to retained earnings.

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Reporting Changes in an Accounting Principle

Applications of the General Rule

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1. Amount of cumulative effect to be reported on R/E's is difference between:
(1) R/E's at the beginning of the earliest period presented
(2) R/E's that would have been reported at the beginning of the earliest period presented if the new accounting principle had been applied retrospectively for all prior periods, by recognizing only the direct effects and related income tax effect.

2. The new accounting principle is used for all periods presented.

3. If principle isn't material in year of change but is reasonably expected to become material in later periods, it should be disclosed in year of change.

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Change in Accounting Entity

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Occurs when the entity being reported on has changed composition.

Examples: Consolidated/Combined F/S's presented in place of statements of the individual companies and changes to the companies included in the consolidated/combined F/S's from year to year.

1. Restatement to Reflect Information for the New Entity (if comparative F/S's are presented)
2. Full Disclosure- of the cause and nature of change should be made including changes in income before extraordinary items, net income, and R/E's.

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IFRS vs. U.S. GAAP

Change in Accounting Entity

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IFRS does not include the concept of a change in accounting entity.

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Error Correction

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-Prior period adjustment, restate.

Include: (1) corrections of errors in recognition, measurement, presentation, and disclosure in the F/S's. (2) Changes from non-GAAP/IFRS methods of accounting to a GAAP/IFRS method of accounting.

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Error Correction

Comparative Financial Statements Presented

Not Presented (Side 3)

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-Correct the information if the year is presented.
-Adjust beginning R/E's of the earliest year presented (net of tax) if the year containing the error is not presented.

Hint 37

-The error correction should be reported as an adjustment to the opening balance of retained earnings (net of tax).

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IFRS vs. U.S. GAAP

Error Correction

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IFRS- when its impracticable to determine the period-specific or cumulative effect of an error, the entity is required to restate information prospectively from the earliest date that is practicable.

-U.S. does not have an impracticality exception from error corrections.