Financial Performance and Income Statements Quiz

Chapter 4: Reporting Financial Performance

• Harjot Mehmi teaches AFA300, Section 011
• Email: [email protected]
• Office: YDI 1066, 1 Dundas St W
• Office hours: Mondays, 1–3 PM
• Course week: September 30, 2024

In-Class Questions

• Solutions for in-class questions E4.16, P4.1, P4.2, P4.3, and P4.7 are posted on D2L.
• Solutions to textbook brief exercises are already available on D2L.
• Solutions to other textbook questions are not shared online.
• Students can get help with other questions by visiting the instructor during office hours.

Statement of Financial Performance

• Measures a company's operational success over a specific period.
• ASPE (Accounting Standards for Private Enterprises) refers to the income statement.
• IFRS (International Financial Reporting Standards) uses a statement of financial performance or separates profit/loss and comprehensive income statements.
• Statements of financial performance incorporate revenues, expenses, gains, losses, net income, and other comprehensive income.
• Statements of profit or loss include revenues, expenses, gains, and losses.

Other Comprehensive Income (OCI)

• Composed of unrealized gains/losses on securities, foreign exchange, and other gains/losses (IFRS-defined).
• OCI = Comprehensive Income – Net Income
• OCI is recorded as Accumulated Other Comprehensive Income (AOCI) on the statement of financial position (SFP).

Communicating Information About Performance

• The income statement is used for evaluating past performance and profitability, and for predicting future performance.
• Past success does not guarantee future success.
• Separating recurring income (continuing operations) from non-recurring income (e.g., discontinued operations) adds clarity.
• Results from continuing operations are more valuable for predicting future performance than those from discontinued operations.

Quality of Earnings/Information

• Income statements may omit items not reliably measured (e.g., contingent gains).
• Accounting methods (e.g., depreciation) and estimation (e.g., asset use) can impact reported figures.
• Financial reporting bias sometimes stems from financial pressures.
• Generally accepted accounting principles (GAAP) might not always be ideal.

Quality of Earnings

• How well reported earnings show the sustainability of earnings and business fundamentals without bias.
• Net income from continuing operations is considered more credible than net income from discontinued operations.
• High-quality earnings are unbiased, objectively determined, reflect economic reality, and relate to core activities and cash flow from operations.
• High-quality earnings are transparent and understandable.

Earnings Management

• Used to boost current earnings by reducing future earnings, or to decrease current earnings to boost future earnings.
• Results in lower quality (not sustainable and biased) earnings.
• Targeting earnings levels and then making adjustments to arrive at those targets requires thoughtful accounting policy choices (like slower asset depreciation).
• It involves using aggressive assumptions/estimates and unnecessary transactions to attain desired goals.
• Used by companies to satisfy investor expectations.

Types of Income

• Net income: Revenues less expenses (including gains and losses), excluding those under IFRS as OCI.
• Comprehensive income: Net income plus OCI.
• Operating income: Ongoing revenue less expenses, excluding irregular items like gains/losses, discontinued operations, or OCI.

Discontinued Operations

• Operations that have been sold, abandoned, or are formally planned for disposal.
• Component of an enterprise: part of an entity being disposed of.
• Distinction is made based on its cash flows and financial statements.
• It has its separate assets, liabilities, and cash flows, generating its own net cash flows.
• Usually comprises a major line of business or geographical area.
• It is displayed separately (net of tax) on the statement of financial performance and the statement of cash flows.

Assets Held for Sale

• If a business component hasn't yet been disposed of, it can still be classified as held for sale as part of discontinued operations if appropriate.
• Criteria for a component to be considered held for sale:
  • A formal plan for its sale exists.
  • Available for sale in its current state.
  • An active search for a buyer.
  • Probable sale within a year.
  • Reasonably priced and actively marketed, with unlikely changes to the plan.

Assets Held for Sale: Measurement & Presentation

• If an asset's value increases after it has been written down, the gain can only be recognized up to the amount of the original loss.
• Depreciation is not applied to held-for-sale assets.
• Held-for-sale assets are presented separately in the balance sheet.
• Under ASPE, held-for-sale assets retain their original classification as current or non-current.
• Under IFRS, held-for-sale assets are usually classified as current.

Presentation of Discontinued Operations

• Income/loss from discontinued operations can be presented separately on the income statement or rolled into one single line, with more details provided in the notes.
• Separate presentation is important on the statement of financial position that showcases discontinued operations' assets.

Ordinary versus Peripheral Activities

• Revenues/expenses: everyday business activities
• Example: McDonald's burger sales.
• Gains/losses: infrequent or peripheral business activities
• Example: McDonald's deep fryer sales—gain if selling price exceeds book value.

Earnings Per Share (EPS)

• Key performance indicator.
• Measures dollars earned per common share (based on net income, not comprehensive income).
• Doesn't report dividend payments to shareholders.
• EPS = (Income available to common shareholders) / (Weighted average number of common shares outstanding).

EPS Presentation

• Public companies are required to include EPS on their income statements.
• Companies showing discontinued operations must report related EPS before and after such operations.
• EPS is typically less consequential for private companies whose shares are tightly held.

Statement of Retained Earnings (ASPE)

• Reconciles the retained earnings balance at the start and end of a reporting period.
• Net income/loss is recorded for the period.
• Accumulated income/loss and distributions to shareholders are explained.
• Retrospectively adjusts accounting policies and corrects errors.
• Changes in accounting estimates are reflected on the income statement and not in the retained earnings statement.

Statement of Changes in Equity (IFRS)

• Reconciles beginning/end balances of retained earnings, common shares, and other shareholders' equity accounts.
• Shows changes within each shareholders' equity account and changes to total shareholders' equity.
• Details the effects of retrospective reporting changes, comprehensive income, and OCI for each equity component.
• Includes OCI analysis details in the statement or notes.

Multiple-Step Income Statement

• Separates operating and non-operating transactions for each activity
• Aligns income/expenses with revenue sources.
• Shows intermediate steps like gross profit and operating income for better ratio analysis.

Single Step Income Statement

• Simplifies, presenting incomes and expenses collectively.
• Lists all incomes first, then expenses to get to net income/loss.
• Discontinued operations' income/loss is shown separately before tax.
• Only two categories: revenues/gains and expenses/losses
• Less detail than multiple-step statements, sacrificing some depth.

This quiz explores key concepts related to financial performance, income statements, and comprehensive income under accounting standards such as ASPE and IFRS. Test your knowledge on the components, definitions, and characteristics of financial reporting, as well as the implications of income measurement for stakeholders.