Intermediate Accounting Chapter Three PDF

Slide 4-1  PREVIEW OF CHAPTER 3 Intermediate Accounting IFRS 2nd Edition Kieso, Weygandt, and Warfield Slide 4-2  3 Income Statement and Related Information LEARNING LEARNING O...

Slide 4-1  PREVIEW OF CHAPTER 3 Intermediate Accounting IFRS 2nd Edition Kieso, Weygandt, and Warfield Slide 4-2  3 Income Statement and Related Information LEARNING LEARNING OBJECTIVES OBJECTIVES After studying this chapter, you should be able to: 1. Understand the uses and limitations 6. Explain intraperiod tax allocation. of an income statement. 7. Understand the reporting of accounting 2. Understand the content and format of the changes and errors. income statement. 8. Prepare a retained earnings statement. 3. Prepare an income statement. 9. Explain how to report other comprehensive 4. Explain how to report items in the income income. statement. 5. Identify where to report earnings per share information. Slide 4-3  INCOME INCOME STATEMENT STATEMENT The income statement is the report that measures the success of company operations for a given period of time. The business and investment community uses the income statement to determine profitability, investment value, and creditworthiness. It provides investors and creditors with information that helps them predict the amounts, timing, and uncertainty of future cash flows. Slide 4-4  INCOME INCOME STATEMENT STATEMENT Usefulness ◆ Evaluate past performance. ◆ Predict future performance. ◆ Help assess the risk or uncertainty of achieving future cash flows. Slide 4-5 LO 1  Cont…… In summary, information in the income statement:  revenues,  expenses,  gains, and  Losses helps users evaluate past performance. It also provides insights into the likelihood of achieving a particular level of cash flows in the future. Slide 4-6  Limitations of the Income Statement Because net income is an estimate and reflects a number of assumptions, income statement users need to be aware of certain limitations associated with its information. Some of these limitations include: Companies omit items from the income statement that they cannot measure reliably.  Current practice prohibits recognition of certain items from the determination of income even though the effects of these items can arguably affect the company’s performance.  Example: unrealized gains and losses on certain investment securities in income when there is uncertainty that it will ever realize the changes in value. Slide 4-7  INCOME INCOME STATEMENT STATEMENT Limitations ◆ Companies omit items that cannot be measured reliably. ◆ Income numbers are affected by the accounting methods employed. ◆ Income measurement involves judgment. Useful life, bad debt etc Slide 4-8 LO 1  Quality of Earnings So far, our discussion has highlighted the importance of information in the income statement for:  investment and credit decisions,  including the evaluation of the company and its managers. Companies try to meet or beat market expectations so that the market price of their shares and the value of management’s compensation increase. Slide 4-9  INCOME INCOME STATEMENT STATEMENT Quality of Earnings As a result companies have incentives to manage income ◆ to meet earnings targets or ◆ to make earnings look less risky. Earnings management is the planned timing of revenues, expenses, gains, and losses to smooth out earnings. Quality of earnings is reduced if earnings management results in information that is less useful for predicting future earnings and cash flows. Slide 4-10 LO 1  3 Income Statement and Related Information LEARNING LEARNING OBJECTIVES OBJECTIVES After studying this chapter, you should be able to: 1. Understand the uses and limitations of 6. Explain intraperiod tax allocation. an income statement. 7. Understand the reporting of accounting changes and errors. 2. Understand the content and format of the income statement. 8. Prepare a retained earnings statement. 3. Prepare an income statement. 9. Explain how to report other comprehensive income. 4. Explain how to report items in the income statement. 5. Identify where to report earnings per share information. Slide 4-11  FORMAT FORMAT OF OF THE THE INCOME INCOME STATEMENT STATEMENT Net income results from revenue, expense, gain, and loss transactions. This method of income measurement, the transaction approach, focuses on the income- related activities that have occurred during the period. The statement can further classify income by customer, product line, or function; by operating and non-operating; and by continuing and discontinued. The two major elements of the income statement are Income and Expense. Slide 4-12  FORMAT FORMAT OF OF THE THE INCOME INCOME STATEMENT STATEMENT Elements of the Income Statement INCOME – Increases in economic benefits during the accounting period in the form of ◆ inflows or enhancements of assets or ◆ decreases of liabilities that result in increases in equity, other than those relating to contributions from shareholders. Slide 4-13 LO 2  FORMAT FORMAT OF OF THE THE INCOME INCOME STATEMENT STATEMENT Elements of the Income Statement INCOME includes both revenues and gains. ◆ Revenues - ordinary activities of a company ◆ Gains - may or may not arise from ordinary activities. Revenue Accounts Gain Accounts ◆ Sales revenue ◆ Gains on the sale of long-term ◆ Fee revenue assets ◆ Interest revenue ◆ Unrealized gains on trading ◆ Dividend revenue securities. ◆ Rent revenue Slide 4-14 LO 2  FORMAT FORMAT OF OF THE THE INCOME INCOME STATEMENT STATEMENT Elements of the Income Statement EXPENSES – Decreases in economic benefits during the accounting period in the form of ◆ outflows or depletions of assets or ◆ incurrences of liabilities that result in decreases in equity, other than those relating to distributions to shareholders. Slide 4-15 LO 2  FORMAT FORMAT OF OF THE THE INCOME INCOME STATEMENT STATEMENT Elements of the Income Statement EXPENSES include both expenses and losses. ◆ Expenses - ordinary activities of a company ◆ Losses - may or may not arise from ordinary activities. Expense Accounts Loss Accounts ◆ Cost of goods sold ◆ Losses on restructuring ◆ Depreciation expense charges ◆ Interest expense ◆ Losses on the sale of long- ◆ Rent expense term assets ◆ Salary expense ◆ Unrealized losses on trading securities. Slide 4-16 LO 2  FORMAT FORMAT OFOF 1. Sales or Revenue 2. Cost of Goods Sold THE THE INCOME INCOME Gross Profit STATEMENT STATEMENT 3. Selling Expenses 4. Administrative or General Expenses Intermediate 5. Other Income and Expense Components Income from Operations Companies generally 6. Financing costs present some or all of Income before Income Tax these sections and totals 7. Income Tax within the income Income from Continuing Operations statement. 8. Discontinued Operations Net Income 9. Non-Controlling Interest Slide 10. Earnings Per Share 4-17  3 Conceptual Framework for Financial Reporting LEARNING LEARNING OBJECTIVES OBJECTIVES After studying this chapter, you should be able to: 1. Understand the uses and limitations of an 6. Explain intraperiod tax allocation. income statement. 7. Understand the reporting of accounting 2. Understand the content and format of the changes and errors. income statement. 8. Prepare a retained earnings statement. 3. Prepare an income statement. 9. Explain how to report other comprehensive 4. Explain how to report items in the income income. statement. 5. Identify where to report earnings per share information. Slide 4-18  FORMAT FORMAT OFOF THE THE INCOME INCOME STATEMENT STATEMENT Illustration Includes all of the major items in previous list, except for discontinued operations. ILLUSTRATION 3-2 Slide Income Statement 4-19  CONDENSED CONDENSED INCOME INCOME STATEMENT STATEMENT More representative of the type found in practice. ILLUSTRATION 3-3 Condensed Income Statement Company prepares supplementary schedules to support the totals. ILLUSTRATION 3-4 Sample Supporting Slide Schedule 4-20  3 Conceptual Framework for Financial Reporting LEARNING LEARNING OBJECTIVES OBJECTIVES After studying this chapter, you should be able to: 1. Understand the uses and limitations of an 6. Explain intraperiod tax allocation. income statement. 7. Understand the reporting of accounting 2. Understand the content and format of the changes and errors. income statement. 8. Prepare a retained earnings statement. 3. Prepare an income statement. 9. Explain how to report other comprehensive 4. Explain how to report items in the income. income statement. 5. Identify where to report earnings per share information. Slide 4-21  REPORTING REPORTING WITHIN WITHIN THE THE INCOME INCOME STATEMENT STATEMENT Gross Profit ◆ Computed by deducting cost of goods sold from net sales. ◆ Provides a useful number for evaluating performance and predicting future earnings. Unusual or incidental revenues are disclosed in other income and expense. Slide 4-22 LO 4  REPORTING REPORTING WITHIN WITHIN THE THE INCOME INCOME STATEMENT STATEMENT Income from Operations ◆ Determined by deducting selling and administrative expenses as well as other income and expense from gross profit. ◆ Highlights items that affect regular business activities. ◆ Used to predict the amount, timing, and uncertainty of future cash flows. Slide 4-23 LO 4  INCOME FROM OPERATIONS Expense Classification Nature Function ◆ Cost of materials used ◆ Employee benefits ◆ Direct labor incurred ◆ Depreciation expense ◆ Delivery expense ◆ Amortization expense ◆ Advertising expense Slide 4-24 LO 4  INCOME FROM OPERATIONS Expense Classification Nature Function ◆ Cost of goods sold ◆ Selling expenses ◆ Administrative expenses Slide 4-25 LO 4  INCOME FROM OPERATIONS Expense Classification Illustration: The firm of Telaris Co. performs audit, tax, and consulting services. It has the following revenues and expenses. Slide 4-26 LO 4  Expense Classification Companies are required to present an analysis of expenses classified either by: their nature (such as cost of materials used, direct labour incurred, delivery expense, advertising expense, employee benefits, depreciation expense, and amortization expense) or their function (such as cost of goods sold, selling expenses, and administrative expenses). Slide 4-27  Expense Classification An advantage of the nature-of-expense method is that it is simple to apply because allocations of expense to different functions are not necessary. For manufacturing companies that must allocate costs to the product produced, using a nature-of expense approach permits companies to report expenses without making arbitrary allocations. Slide 4-28  Expense Classification The function-of-expense method, however, is often viewed as more relevant because this method identifies the major cost drivers of the company and therefore helps users assess whether these amounts are appropriate for the revenue generated. As indicated, a disadvantage of this method is that the allocation of costs to the varying functions may be arbitrary and therefore the expense classification becomes misleading. Slide 4-29  Expense Classification Nature-of-Expense Approach ILLUSTRATION 4-5 Slide 4-30 LO 4  Expense Classification Function-of-Expense Approach ILLUSTRATION 4-6 The function-of-expense method is generally used in practice although many companies believe both approaches have merit. Slide 4-31 LO 4  INCOME FROM OPERATIONS ILLUSTRATION 3-7 Gains and Losses Number of Unusual Items Reported in a Recent Year by 500 Large Companies Slide 4-32 LO 4  INCOME FROM OPERATIONS Gains and Losses IASB takes the position that both ◆ revenues and expenses and ◆ other income and expense should be reported as part of income from operations. Companies can provide additional line items, headings, and subtotals when such presentation is relevant to an understanding of the entity’s financial performance. Slide 4-33 LO 4  INCOME FROM OPERATIONS Gains and Losses Additional items that may need disclosure: ◆ Losses on write-downs of inventories to net realizable value or of property, plant, and equipment to recoverable amount, as well as reversals of such write-downs. ◆ Losses on restructurings of the activities and reversals of any provisions for the costs of restructuring. ◆ Gains or losses on the disposal of items of property, plant, and, equipment or investments. ◆ Litigation settlements. ◆ Other reversals of liabilities. Slide 4-34 LO 4  INCOME STATEMENT REPORTING ILLUSTRATION 3-8 Income before Income Tax Presentation of Finance Costs Illustration 4-8 Slide Financing costs must be reported on the income statement. 4-35 LO 4  INCOME STATEMENT REPORTING Net Income Represents the income after all ✔ revenues and ✔ expenses for the period are considered. Viewed by many as the most important measure of a company’s success or failure for a given period of time. Slide 4-36 LO 4  INCOME STATEMENT REPORTING Allocation to Non-Controlling Interest When a company prepares a consolidated income statement, IFRS requires that net income be allocated to the controlling and non-controlling interest. This allocation is reported at the bottom of the income statement, after net income. ILLUSTRATION 3-9 Presentation of Non-Controlling Interest (amounts given) Slide 4-37 LO 4  INCOME STATEMENT REPORTING BE4-3: Presented below is some financial information related to Volaire Group. Compute the following: Other Income and Expense Revenues €800,000 Income from continuing operations 100,000 €800,000 Comprehensive income 120,000 Net income 90,000 100,000 Income from operations 220,000 Selling and administrative expenses 500,000 120,000 Income before income tax 200,000 90,000 - Slide Advance slide in presentation mode to reveal answers. 220,000 €80,000 LO 4 4-38  INCOME STATEMENT REPORTING BE4-3: Presented below is some financial information related to Volaire Group. Compute the following: Financing Costs Revenues €800,000 Income from continuing operations 100,000 €800,000 Comprehensive income 120,000 Net income 90,000 100,000 Income from operations 220,000 Selling and administrative expenses 500,000 120,000 Income before income tax 200,000 90,000 220,00 Slide Advance slide in presentation mode to reveal answers. €20,000 LO 4 4-39  INCOME STATEMENT REPORTING BE4-3: Presented below is some financial information related to Volaire Group. Compute the following: Income Tax Revenues €800,000 Income from continuing operations 100,000 €800,000 Comprehensive income 120,000 - Net income 90,000 100,000 Income from operations 220,000 Selling and administrative expenses 500,000 120,000 Income before income tax 200,000 90,000 Slide Advance slide in presentation mode to reveal answers. 220,000 €100,000 LO 4 4-40  INCOME STATEMENT REPORTING BE4-3: Presented below is some financial information related to Volaire Group. Compute the following: Discontinued Operations Revenues €800,000 Income from continuing operations 100,000 €800,000 Comprehensive income 120,000 Net income 90,000 100,000 Income from operations 220,000 Selling and administrative expenses 500,000 120,000 Income before income tax 200,000 - 90,000 - Slide Advance slide in presentation mode to reveal answers. €10,000 LO 4 4-41  INCOME STATEMENT REPORTING BE4-3: Presented below is some financial information related to Volaire Group. Compute the following: Other Comprehensive Income Revenues €800,000 Income from continuing operations 100,000 €800,000 Comprehensive income 120,000 Net income 90,000 100,000 Income from operations 220,000 Selling and administrative expenses 500,000 120,000 Income before income tax 200,000 - 90,000 Slide Advance slide in presentation mode to reveal answers. €30,000 LO 4 4-42  Solution Solution Revenues 800,000,000 Less: Selling and administrative expenses (500,000) +_ Other income and expense X (80,000) Income from Operation 220,000 Less Finance Cost Y (20,000) Income Before income tax 200,000 Income tax I 100,000 Income from discontinued operation IDO (10,000) Net income 90,000 +_ other comprehensive income OCI 30,000 Comprehensive Income 120,000 Slide 4-43  3 Conceptual Framework for Financial Reporting LEARNING LEARNING OBJECTIVES OBJECTIVES After studying this chapter, you should be able to: 1. Understand the uses and limitations of an 6. Explain intraperiod tax allocation. income statement. 7. Understand the reporting of accounting 2. Understand the content and format of the changes and errors. income statement. 8. Prepare a retained earnings statement. 3. Prepare an income statement. 9. Explain how to report other comprehensive 4. Explain how to report items in the income income. statement. 5. Identify where to report earnings per share information. Slide 4-44  INCOME STATEMENT REPORTING Earnings per Share Net Income - Preferred Dividends Weighted Average of Ordinary Shares Outstanding ◆ A significant business indicator. ◆ Measures the dollars earned by each ordinary share. ◆ Must be disclosed on the face of the income statement. Slide 4-45 LO 5  Earnings Earnings per per Share Share Illustration: Lancer, Inc. reports net income of $350,000. It declares and pays preferred dividends of $50,000 for the year. The weighted-average number of ordinary shares outstanding during the year is 100,000 shares. Lancer computes earnings per share as follows: ILLUSTRATION 4-10 Net Income - Preferred Dividends Weighted Average of Ordinary Shares Outstanding $350,000 - $50,000 = $3.00 per share 100,000 Slide 4-46 LO 5  ILLUSTRATION 4-12 Income Statement Divide by weighted- average shares outstanding EPS Slide 4-47 Earnings Earnings per per Share Share LO 5  INCOME STATEMENT REPORTING Discontinued Operations A component of an entity that either has been disposed of, or is classified as held-for-sale, and: 1. Represents a major line of business or geographical area of operations, or 2. Is part of a single, co-coordinated plan to dispose of a major line of business or geographical area of operations, or 3. Is a subsidiary acquired exclusively with a view to resell. Slide 4-48 LO 5  INCOME STATEMENT REPORTING Discontinued Operations Companies report as discontinued operations 1. (in a separate income statement category) the gain or loss from disposal of a component of a business. 2. The results of operations of a component that has been or will be disposed of separately from continuing operations. 3. The effects of discontinued operations net of tax as a separate category, after continuing operations. Slide 4-49 LO 5  DISCONTINUED DISCONTINUED OPERATIONS OPERATIONS Illustration: Multiplex Inc., a highly diversified company, decides to discontinue its electronics division. During the current year, the electronics division lost £300,000 (net of tax). Multiplex sold the division at the end of the year at a loss of £500,000 (net of tax). Income from continuing operations £20,000,000 Discontinued operations: Loss from operations, net of tax 300,000 Loss on disposal, net of tax 500,000 Total loss on discontinued operations 800,000 Net income £19,200,000 ILLUSTRATION 3-11 Income Statement Presentation Slide 4-50 of Discontinued Operations LO 5  DISCONTINUED DISCONTINUED OPERATIONS OPERATIONS ILLUSTRATION 4-12 A company that reports a discontinued operation must report per share amounts for the line item either on the face of the income statement or in the notes to the financial statements. Slide 4-51  3 Conceptual Framework for Financial Reporting LEARNING LEARNING OBJECTIVES OBJECTIVES After studying this chapter, you should be able to: 1. Understand the uses and limitations of an 6. Explain intraperiod tax allocation. income statement. 7. Understand the reporting of accounting 2. Understand the content and format of the changes and errors. income statement. 8. Prepare a retained earnings statement. 3. Prepare an income statement. 9. Explain how to report other comprehensive 4. Explain how to report items in the income income. statement. 5. Identify where to report earnings per share information. Slide 4-52  INCOME STATEMENT REPORTING Companies report discontinued operations on the income statement net of tax. The allocation of tax to this item is called intra period tax allocation, that is, allocation within a period. It relates the income tax expense (sometimes referred to as the income tax provision) of the fiscal period to the specific items that give rise to the amount of the income tax provision. Intra period tax allocation helps financial statement users better understand the impact of income taxes on the various components of net Slide 4-53 income.  INCOME STATEMENT REPORTING Intraperiod Tax Allocation Relates the income tax expense to the specific items that give rise to the amount of the tax provision. On the income statement, income tax is allocated to: (1) Income from continuing operations (2) Discontinued operations “let the tax follow the income” Slide 4-54 LO 6  INTRAPERIOD TAX ALLOCATION Discontinued Operations (Gain) Illustration: Schindler Co. has income before income tax of €250,000. It has a gain of €100,000 from a discontinued operation. Assuming a 30 percent income tax rate, Schindler presents the following information on the income statement. ILLUSTRATION 4-13 Slide 4-55 LO 6  INTRAPERIOD TAX ALLOCATION Discontinued Operations (Loss) Illustration: Schindler Co. has income before income tax of €250,000. It has a loss of €100,000 from a discontinued operation. Assuming a 30 percent income tax rate, Schindler presents the following information on the income statement. ILLUSTRATION 4-14 Slide 4-56 LO 6  INTRAPERIOD TAX ALLOCATION Discontinued Operations (Loss) Companies may also report the tax effect of a discontinued item by means of a note disclosure. ILLUSTRATION 4-15 Slide 4-57 LO 6  INCOME STATEMENT REPORTING Summary ILLUSTRATION 4-16 Summary of Income Items Slide 4-58 LO 6  INCOME STATEMENT REPORTING Summary ILLUSTRATION 4-16 Summary of Income Items Slide 4-59 LO 6  INCOME STATEMENT REPORTING DIFFERENT INCOME CONCEPTS Users and preparers look at more than just the bottom line income number, which supports the IFRS requirement to provide subtotals within the income statement. Slide 4-60 LO 6  3 Conceptual Framework for Financial Reporting LEARNING LEARNING OBJECTIVES OBJECTIVES After studying this chapter, you should be able to: 1. Understand the uses and limitations of an 6. Explain intraperiod tax allocation. income statement. 7. Understand the reporting of 2. Understand the content and format of the accounting changes and errors. income statement. 8. Prepare a retained earnings statement. 3. Prepare an income statement. 9. Explain how to report other comprehensive 4. Explain how to report items in the income income. statement. 5. Identify where to report earnings per share information. Slide 4-61  Other Other Reporting Reporting issues issues Accounting Changes and Errors Changes in Accounting Principle One type of accounting change results when a company adopts a different accounting principle Changes in accounting principle include:  a change in the method of inventory pricing from FIFO to average-cost, or  a change in accounting for construction contracts from the percentage-of-completion to the completed- contract method Slide 4-62  A company recognizes a change in accounting principle by making a retrospective adjustment to the financial statements. Such an adjustment recasts the prior years’ statements on a basis consistent with the newly adopted principle. The company records the cumulative effect of the change for prior periods as an adjustment to beginning retained earnings of the earliest year presented. Slide 4-63  OTHER OTHER REPORTING REPORTING ISSUES ISSUES Accounting Changes and Errors Changes in Accounting Principle ◆ Retrospective adjustment. ◆ Cumulative effect adjustment to beginning retained earnings. ◆ Approach preserves comparability across years. ◆ Examples include: ► Change from FIFO to average-cost. ► Change from the percentage-of-completion to the completed-contract method. Slide 4-64 LO 7  Accounting Accounting Changes Changes Change in Accounting Principle: Gaubert Inc. decided in March 2015 to change from FIFO to weighted-average inventory pricing. Gaubert’s income before taxes, using the new weighted-average method in 2015, is $30,000. ILLUSTRATION 4-17 Pretax Income Data Calculation of a Change in Accounting Principle ILLUSTRATION 4-18 Income Statement Presentation of a Change in Accounting Principle (Based on 30% tax rate) Slide 4-65 Advance slide in presentation mode to reveal answers. LO 7  Accounting Accounting Changes Changes Change in Accounting Estimates ◆ Accounted for in the period of change or the period of and the future periods if the change affects both. ◆ Not handled retrospectively. ◆ Not considered errors. ◆ Examples include: ► Useful lives and residual values of depreciable assets. ► Uncollectible receivables. ► Inventory obsolescence. Slide 4-66 LO 7  Change Change in in Accounting Accounting Estimates Estimates Change in Estimate: Arcadia HS, purchased equipment for $510,000 which was estimated to have a useful life of 10 years with a residual value of $10,000 at the end of that time. Depreciation has been recorded for 7 years on a straight-line basis. In 2015 (year 8), it is determined that the total estimated life should be 15 years with a residual value of $5,000 at the end of that time. Questions: ◆ Does prior years’ depreciation need to be restated? ◆ Calculate the depreciation expense for 2015. Slide 4-67 LO 7  After Change Change in in Accounting Accounting Estimates Estimates 7 years Equipment cost $510,000 First, First,establish establishNBV NBV Residual value 10,000 at atdate dateofofchange changein in Depreciable base 500,000 estimate. estimate. Useful life (original) 10 years Annual depreciation $ 50,000 x 7 years = $350,000 Balance Sheet (Dec. 31, 2014) Fixed Assets: Equipment $510,000 Accumulated depreciation 350,000 Net book value (NBV) $160,000 Slide 4-68 LO 7  After Change Change in in Accounting Accounting Estimates Estimates 7 years Net book value $160,000 Depreciation Depreciation Residual value (new) 5,000 Expense Expensecalculation calculation Depreciable base 155,000 for for2015. 2015. Useful life remaining 8 years Annual depreciation $ 19,375 Journal entry for 2015 Depreciation Expense 19,375 Accumulated Depreciation 19,375 Slide 4-69 LO 7  Accounting Accounting Changes Changes and and Errors Errors Corrections of Errors ◆ Result from: ► mathematical mistakes. ► mistakes in application of accounting principles. ► oversight or misuse of facts. ◆ Corrections treated as prior period adjustments. ◆ Adjustment to the beginning balance of retained earnings. ◆ If a company prepares comparative financial statements, it should restate the prior statements for the effects of the error. Slide 4-70 LO 7  Accounting Accounting Changes Changes and and Errors Errors Corrections of Errors: In 2015, Tsang Co. determined that it incorrectly overstated its accounts receivable and sales revenue by NT$100,000 in 2014. In 2015, Tsang makes the following entry to correct for this error (ignore income taxes). Retained Earnings 100,000 Accounts Receivable 100,000  Retained Earnings is debited because sales revenue, and therefore net income, was overstated in a prior period.  Accounts Receivable is credited to reduce this Slide 4-71 overstated balance to the correct amount. LO 7  Accounting Accounting Changes Changes and and Errors Errors ILLUSTRATION 4-19 Summary Summary of Accounting Changes and Errors Type of Situation Changes in Accounting Principle Criteria Change from one generally accepted accounting principle to another. Examples Change in the basis of inventory pricing from FIFO to average-cost. Placement on Recast prior years’ income statements on the same Income basis as the newly adopted principle. Statement Slide 4-72 LO 7  Accounting Accounting Changes Changes and and Errors Errors ILLUSTRATION 4-19 Summary Summary of Accounting Changes and Errors Type of Situation Changes in Accounting Estimate Criteria Normal, recurring corrections and adjustments. Examples Changes in the realizability of receivables and inventories; changes in estimated lives of equipment, intangible assets; changes in estimated liability for warranty costs, income taxes, and salary payments. Placement on Show change only in the affected accounts (not shown Income net of tax) and disclose the nature of the change. Statement Slide 4-73 LO 7  Accounting Accounting Changes Changes and and Errors Errors ILLUSTRATION 4-19 Summary Summary of Accounting Changes and Errors Type of Situation Corrections of Errors Criteria Mistake, misuse of facts. Examples Error in reporting income and expense. Placement on Restate prior years’ income statements to correct for Income error. Statement Slide 4-74 LO 7  3 Conceptual Framework for Financial Reporting LEARNING LEARNING OBJECTIVES OBJECTIVES After studying this chapter, you should be able to: 1. Understand the uses and limitations of an 6. Explain intraperiod tax allocation. income statement. 7. Understand the reporting of accounting 2. Understand the content and format of the changes and errors. income statement. 8. Prepare a retained earnings 3. Prepare an income statement. statement. 4. Explain how to report items in the income 9. Explain how to report other comprehensive statement. income. 5. Identify where to report earnings per share information. Slide 4-75  OTHER OTHER REPORTING REPORTING ISSUES ISSUES Retained Earnings Statement Increase Decrease ◆ Net income ◆ Net loss ◆ Change in accounting ◆ Dividends principle ◆ Change in accounting ◆ Prior period principles adjustments ◆ Prior period adjustments Slide 4-76 LO 8  OTHER OTHER REPORTING REPORTING ISSUES ISSUES Retained Earnings Statement ILLUSTRATION 3-20 Retained Earnings Statement Slide 4-77 LO 8  Retained Retained Earnings Earnings Statement Statement Before issuing the report for the year ended December 31, 2015, you discover a ₩50,000 error (net of tax) that caused 2014 inventory to be overstated (overstated inventory caused COGS to be lower and thus net income to be higher in 2014). Would this discovery have any impact on the reporting of the Statement of Retained Earnings for 2015? Slide 4-78 LO 8  Retained Retained Earnings Earnings Statement Statement Slide Advance slide in presentation 4-79 mode to reveal answers. LO 8  Retained Retained Earnings Earnings Statement Statement Restrictions on Retained Earnings Disclosed ◆ In notes to the financial statements. ◆ As Appropriated Retained Earnings. Slide 4-80 LO 8  3 Conceptual Framework for Financial Reporting LEARNING LEARNING OBJECTIVES OBJECTIVES After studying this chapter, you should be able to: 1. Understand the uses and limitations of an 6. Explain intraperiod tax allocation. income statement. 7. Understand the reporting of accounting 2. Understand the content and format of the changes and errors. income statement. 8. Prepare a retained earnings statement. 3. Prepare an income statement. 9. Explain how to report other 4. Explain how to report items in the income comprehensive income. statement. 5. Identify where to report earnings per share information. Slide 4-81  OTHER OTHER REPORTING REPORTING ISSUES ISSUES Comprehensive Income All changes in equity during a period except those resulting from investments by owners and distributions to owners. Includes: ◆ all revenues and gains, expenses and losses reported in net income, and ◆ all gains and losses that bypass net income but affect equity. Slide 4-82 LO 9  Comprehensive Comprehensive Income Income Net Income Other Comprehensive + Income ◆ Unrealized gains and losses on non-trading equity securities. ◆ Translation gains and losses on foreign currency. ◆ Plus others Reported in Equity Slide 4-83 LO 9  Comprehensive Comprehensive Income Income Question Gains and losses that bypass net income but affect equity are referred to as a. comprehensive income. b. other comprehensive income. c. prior period income. d. unusual gains and losses. Slide 4-84 LO 9  Comprehensive Comprehensive Income Income Companies must display the components of other comprehensive income in one of two ways: 1. A single continuous statement (one statement approach) or 2. two separate, but consecutive statements of net income and other comprehensive income (two statement approach). Slide 4-85 LO 9  Comprehensive Comprehensive Income Income One Statement Approach ILLUSTRATION 4-21 One Statement Format: Comprehensive Income Advantage – does not require the creation of a new financial statement. Disadvantage - net income buried as a subtotal on the statement. Slide 4-86 LO 9  Comprehensive Comprehensive Income Income Two Statement Illustration 4-19 Approach ILLUSTRATION 4-22 Two Statement Format: Comprehensive Income Slide 4-87  OTHER OTHER REPORTING REPORTING ISSUES ISSUES Statement of Changes in Equity Required, in addition to a statement of comprehensive income. ◆ Generally comprised of ► Share capital—ordinary, ► Share premium—ordinary, ► Retained earnings, and the ► Accumulated balances in other comprehensive income. Slide 4-88 LO 9  Statement Statement of of Changes Changes in in Equity Equity Reports the change in each equity account and in total equity for the period. Includes the following: 1. Accumulated other comprehensive income for the period. 2. Contributions (issuances of shares) and distributions (dividends) to owners. 3. Reconciliation of the carrying amount of each component of equity from the beginning to the end of the period. Slide 4-89 LO 9  Statement Statement of of Changes Changes in in Equity Equity ILLUSTRATION 4-23 Statement of Changes in Equity Slide 4-90 LO 9  Statement Statement of of Changes Changes in in Equity Equity Regardless of the display format used, V. Gill reports the accumulated other comprehensive income of €90,000 in the equity section of the statement of financial position as follows. ILLUSTRATION 4-24 Presentation of Accumulated Other Comprehensive Income in the Statement of Financial Position Slide 4-91 LO 9  GLOBAL ACCOUNTING INSIGHTS INCOME STATEMENT Standards issued by the FASB (U.S. GAAP) are the primary global alternative to IFRS. As in IFRS, the income statement is a required statement for U.S. GAAP. In addition, the content and presentation of the U.S. GAAP income statement is similar to the one used for IFRS. Slide 4-92  GLOBAL ACCOUNTING INSIGHTS Relevant Facts Following are the key similarities and differences between U.S. GAAP and IFRS related to the income statement. Similarities Both U.S. GAAP and IFRS require companies to indicate the amount of net income attributable to non-controlling interest. Both U.S. GAAP and IFRS follow the same presentation guidelines for discontinued operations, but IFRS defines a discontinued operation more narrowly. Both standard-setters have indicated a willingness to develop a similar definition to be used in the joint project on financial statement presentation. Slide 4-93  GLOBAL ACCOUNTING INSIGHTS Relevant Facts Similarities Both U.S. GAAP and IFRS have items that are recognized in equity as part of other comprehensive income but do not affect net income. Both U.S. GAAP and IFRS allow a one statement or two statement approach to preparing the statement of comprehensive income. Differences Presentation of the income statement under U.S. GAAP follows either a single-step or multiple-step format. IFRS does not mention a single-step or multiple-step approach. In addition, under U.S. GAAP, companies must report an item as extraordinary if it is unusual in nature and infrequent in occurrence. Extraordinary-item reporting is prohibited under IFRS. Slide 4-94  GLOBAL ACCOUNTING INSIGHTS Relevant Facts Differences The U.S. SEC requires companies to have a functional presentation of expenses. Under IFRS, companies must classify expenses by either nature or function. U.S. GAAP does not have that requirement. U.S. GAAP has no minimum information requirements for the income statement. However, the U.S. SEC rules have more rigorous presentation requirements. IFRS identifies certain minimum items that should be presented on the income statement. U.S. SEC regulations define many key measures and provide requirements and limitations on companies reporting non-U.S. GAAP information. IFRS does not define key measures like income from operations. Slide 4-95  GLOBAL ACCOUNTING INSIGHTS Relevant Facts Differences U.S. GAAP does not permit revaluation accounting. Under IFRS, revaluation of property, plant, and equipment, and intangible assets is permitted and is reported as other comprehensive income. The effect of this difference is that application of IFRS results in more transactions affecting equity but not net income. Slide 4-96  GLOBAL ACCOUNTING INSIGHTS About The Numbers The terminology used in the IFRS literature is sometimes different than what is used in U.S. GAAP. For example, here are some of the differences. Slide 4-97  GLOBAL ACCOUNTING INSIGHTS On the Horizon The IASB and FASB are working on a project that would rework the structure of financial statements. One stage of this project will address the issue of how to classify various items in the income statement. A main goal of this new approach is to provide information that better represents how businesses are run. In addition, this approach draws attention away from just one number—net income. Slide 4-98