SEC requires that expenses be classified by function . (e.g., selling expenses not salaries, advertising, etc.)
“ Bottom line” called net income or net loss.
Report extraordinary items separately.
Allows expenses classified by function or natural description .
“ Bottom line” called profit or loss.
Prohibits reporting extraordinary items.
There are more similarities than differences between income statements prepared according to U.S. GAAP and those prepared applying IFRS. Some differences are highlighted below.
Earnings Quality / Manipulating Income (page 175) Earnings quality: if good quality, reported earnings helps to predict a company’s future earnings. Transitory Earnings versus Permanent Earnings (examples: next slide)
Three “non-permanent” items that may appear in Operating Income
(see JDS example on page 177)
Impairment of Goodwill
Impairment of Long-Lived assets
“ Proforma Earnings” (page 179)
Google example – January 2009
Fourth quarter income = $382 million ($1.21 EPS)
Proforma income = $1.62 billion, which excluded:
Loss on settlement of copyright infringement lawsuit
Separately Reported Items (text pages 180-187) Reported separately, net of taxes: 1) Discontinued operations 2) Extraordinary items 3) A third separately reported item, the cumulative effect of a change in accounting principle, might be included for certain mandated changes in accounting principles .
Intraperiod Income Tax Allocation (text pages 180-182) Income Tax Expense must be associated with each component of income that causes it. Show Income Tax Expense related to Income from Continuing Operations. Report effects of Discontinued Operations and Extraordinary Items net of related income tax effect .
Numbers on the Income Statement for “Discontinued Operations”? (pgs.182-185)
Meaning of “operation”
When the operation (component of business) has already been sold
Illustr 4-4 – page 184 (note the “gain on disposal”
When the decision to sell has been made, but the sale has not yet taken place
Illus 4-5 – page 185 (note the “impairment loss”)
Graphic 4-6: Balance Sheet “assets / liabilities held for sale’
An extraordinary item is a material event or transaction that is both:
Unusual in nature, and
Infrequent in occurrence
Extraordinary items are reported net of related taxes
Extraordinary Items (text pages 186-187)
U. S. GAAP vs. IFRS
Report extraordinary items separately in the income statement.
Prohibits reporting extraordinary items in the income statement or notes.
A BIG difference! But, the desire to converge U.S. and international accounting standards could guide FASB to eliminate the extraordinary item classification.
Unusual or Infrequent Items Items that are material and are either unusual or infrequent— but not both —are included as separate items in continuing operations.
Accounting Changes in: principles, estimates or entity (text pages 188-191)
Change in Accounting Principle
Example: change from LIFO to FIFO
GAAP requires that most voluntary accounting changes be accounted for retrospectively by revising prior years’ financial statements.
For mandated changes in accounting principles, the FASB often allows companies to choose to account for the change retrospectively or as a separately reported item below extraordinary items.
Change in Depreciation, Amortization, or Depletion Method … is treated the same as a change in accounting estimate ( not as a change in principle)
Change in Accounting Estimate (review Illustr. 4-6 on page 190) If the company revises an accounting estimate made in a prior period (say, last year) …. … we use the new estimate in current and future periods That is, you do not “correct” previously reported numbers!
Change in Reporting Entity: two examples with very different answers a) New rule: you must consolidate financial subsidiaries b) prior-period financials should be restated to appear as if the “new entity” existed in those periods.
When one company acquires another one, the financials of the acquirer include the acquiree as of the date of acquisition
prior-period financial statements are not restated .
Correction of Accounting Errors (page 192) Errors occur when transactions are either recorded incorrectly or not recorded at all. Errors Discovered in Same Year Reverse original erroneous journal entry and record the appropriate journal entry. Record a prior period adjustment to the beginning retained earnings balance Previous years’ financial statements are retrospectively restated to reflect the correction. Material Errors Discovered in Subsequent Year
Earnings per Share Disclosure (text pages 192-193) earnings per share (EPS) shows the amount of income earned by a company expressed on a per share basis. Basic EPS Net income less preferred dividends Weighted-average number of common shares outstanding for the period Diluted EPS Reflects the potential dilution (reduction in EPS) that could occur for companies that have convertible securities that that could create additional common shares if the conversions took place.
Earnings per Share Disclosure
Report EPS data separately for:
Income or Loss from Continuing Operations
Separately Reported Items
Net Income or Loss
Comprehensive Income (text pages 194-197) An expanded version of income that includes four gains and losses that are not included in the traditional income statement.
Comprehensive income includes traditional net income AND four additional gains and losses that change shareholders’ equity.
Some unrealized holding gains (losses) from investments.
Some gains and losses - postretirement benefit plans.
Some derivatives - gain or loss is deferred
Some gains or losses -foreign currency exchange
Accumulated Other Comprehensive Income We report other comprehensive income on a cumulative basis in the balance sheet as an additional component of shareholders’ equity.
The Statement of Cash Flows (text pages 198-207)
Three categories are presented:
Required for each income statement period reported.
Operating Activities Cash Flows from Operating Activities
sales to customers.
interest and dividends received.
purchase of inventory.
salaries, wages, and other operating expenses.
interest on debt.
Two Acceptable Methods of Reporting the Operating Activities Reports the cash effects of each operating activity Direct Method Starts with accrual net income and converts to cash basis Indirect Method
Direct Method – pages 201-202
Indirect Method (text page 203) We start with reported net income and work backwards to convert that amount to a cash basis .
sale of long-lived assets used in the business.
sale of investment securities (stocks and bonds).
collection of nontrade receivables.
Cash Flows from Investing Activities + _
purchase of long-lived assets used in the business.
purchase of investment securities (stocks and bonds).
loans to other entities.
sale of shares to owners.
borrowing from creditors through notes, loans, mortgages, and bonds.
Cash Flows from Financing Activities +
owners in the form of dividends or other distributions.
owners for the reacquisition of shares previously sold.
creditors as repayment of the principal amounts of debt.
ALC’s complete (3 categories) Statement of Cash Flows (page 204)
Noncash Investing & Financing Activities … . THAT DO NOT INVOLVE CASH are reported eithe r in the Cash Flow Statement or in a Note EXAMPLE: Acquisition of equipment (an investing activity) by issuing a long-term note payable (a financing activity).