KIESO WEYGANDT WARFIELD YOUNG WIECEK - MCCONOMY
INTERMEDIATE
ACCOUNTING
VOLUME 1
ELEVENTH CANADIAN EDITION
Prepared by:
Darrin Ambrose CPA, CMA, MBA
University of Calgary
CHAPTER 4:
REPORTING FINANCIAL
PERFORMANCE
Chapter 4: Reporting Financial Performance
After studying this chapter, you should be able to:
1. Understand how firms create value and manage performance.
2. Understand how users use information about performance to make decisions.
3. Understand the concept of and be able to assess quality of earnings/information.
4. Understand the differing perspectives on how to measure income.
5. Measure and report results of discontinued operations.
6. Measure income and prepare the income statement and the statement of
comprehensive income using various formats.
7. Prepare the statement of retained earnings and the statement of changes in equity.
8. Understand how disclosures and analysis help users of financial statements assess
performance.
9. Identify differences in accounting between IFRS and ASPE and potential changes.
After studying Appendix 4A, you should be able to:
10. Explain the differences between the cash basis of accounting and the accrual basis of
accounting
Reporting Financial Performance
Business Models
The basic business model identifies three activities:
1. Financing
Obtaining cash funding
2. Investing
Use of funding to buy assets and invest in people
3. Operating
Use of assets and people to generate profits
Financial statements should capture these
fundamental business activities
5
Overview of the Business Model
Communicating Information
About Performance
Income Statement helps users:
1. Evaluate past performance and profitability
2. Provide a basis for predicting future performance
3. Help assess the risk of not achieving future net
cash inflows
Limitations of Income Statement
Statement of income/comprehensive income has
the following limitations:
Items are excluded if they cannot be measured
reliably
Amounts reported are affected by accounting
methods used
Use of estimates in measuring income
Financial reporting bias
GAAP shortcomings
8
Quality of Earnings
Quality of earnings refers to how solid earnings
numbers are
Two main aspects to consider:
1. Content
Integrity of information
Sustainability of earnings
2. Presentation
Earnings presentation is clear and concise
Easy to use and understandable
Quality of Earnings
Characteristics of high quality earnings:
1.
Nature of Content
2.
Unbiased and determined objectively
Represents economic reality
Reflects earnings from on-going core activities
Can be correlated with cash flows from operations
Based on sound business strategy/model
Presentation
Does not disguise or mislead (transparent)
Understandable
Also, information is clear and concise
Earnings management decreases quality of earnings
10
Comprehensive vs. Net Income
Key question: how do we measure income?
IFRS generally supports the all-inclusive approach to measuring
income
This results in comprehensive income
Comprehensive income includes any non-shareholder transactions
that causes a change in equity
Example: unrealized gains/losses on revaluation of property, plant, and
equipment under the revaluation model
Comprehensive Income = Net Income +/- Other Comprehensive
Income (OCI)
OCI is closed to a balance sheet account called Accumulated Other
Comprehensive Income (AOCI)
ASPE continues to focus on net income as the measure of income
11
Discontinued Operations
Discontinued operations includes components
that have been disposed of or are held for sale
Components can include:
Under ASPE: an operating segment, reporting unit,
subsidiary, asset group, or operations without
assets
Under IFRS: separate major line of business or
geographical area of operations, or a business
qualifying as held for sale upon acquisition
IFRS is more restrictive
12
Discontinued Operations
A distinction made between:
The components results of operations
Disposal of the components assets
The key is that the component generates
its own cash flows and has its own distinct
operations
13
Discontinued OperationsAsset Held for Sale
Component is held for sale if the following
criteria are met:
Authorized plan to sell exists
Asset available for immediate sale
Active search for a buyer
Sale is probable within a year
Asset is reasonably priced and marketed
Changes to the plan are unlikely
14
Discontinued Operations
Measurement & Presentation
Depreciation is not recognized for held for sale assets
Remeasured at lower of carrying value and fair value
net of cost to sell
Once asset is written down, subsequent gains can be
recognized only up to the amount of original loss
Presented separately on balance sheet
Under ASPE, held for sale asset retains original
classification as current or non-current
Under IFRS, held for sale assets generally classified as
current
15
Discontinued Operations
Statement Presentation
Income from continuing operations (net of tax)
$xx,xxx
Discontinued Operations:
Income (Loss) from operations (net of tax) $xx,xxx
Gain (Loss) on disposal (net of tax)
xx,xxx xx,xxx
Net Income
$xx,xxx
Earnings per share from continuing operations
Earnings per share from discontinued operations
Earnings per share on net income
x
x
x
16
Presentation of Performance
Under IFRS, the statement of comprehensive
income can be presented either:
as a single combined statement, or
as two separate statements
Companies can present income using either
Single-step income statement, or
Multiple-step income statement
17
Comprehensive Income Statement
Example of a combined income and comprehensive income
statement:
Sales 800,000
Cost of goods sold
600,000
Gross profit 200,000
Operating expenses
90,000
Net income 110,000
Other comprehensive income
Unrealized holding gain, net of tax
30,000
Comprehensive income 140,000
18
Single-Step Income Statement
Presents only two groupings before Income before Discontinued
Operations:
1.
Revenues (includes gains)
2.
Expenses (includes losses)
Income tax expense often reported separate from expenses as the last
line item in determining net income
Advantages:
Simplicity
Eliminates classification problems for revenues and expenses
Disadvantage:
.
Oversimplification
Less detail (e.g. operating and non-operating activities reported
together and cannot be distinguished)
19
Single-Step Income Statement
Revenues
Expenses
=
Net Income
Earnings per
Share
Revenues
Net Sales
Other Revenues
(e.g. Dividend, Rental)
Expenses
Cost of Goods Sold
Selling Expenses
Administrative Expenses
Interest Expense
Income Tax Expense
Any Gains/Losses from
Discontinued Operations must be
disclosed separately from
Continuing Operations 20
20
Single-Step Income Statement
21
Multiple-Step Income Statement
Operating and non-operating activities are
separated
Advantages:
Highlighting regular and irregular activities allows for
greater predictive value (assess future earnings) and
feedback value (assess past earnings)
Provides better detail to compare companies
Allows for ratio analysis used to assess performance
22
Multiple-Step Income Statement
Continuing Operations
Discontinued Operations
Other Comprehensive Income
Operating section
Nonoperating section
Income tax
Income/Loss from operations
Gain/Loss from disposition
Both reported net of taxes
Includes other
gains/losses not included
in net income
23
Multiple-Step Income Statement
24
Multiple-Step Income Statement
25
Continuing OperationsDetail
Net Sales
Operating Section
Cost of Goods Sold
Selling Expenses
Administrative or General Expenses
Nonoperating Section
Income Tax
Other Revenues and Gains
Other Expenses and Losses
Separate income tax section on
Income from Continuing Operations
only
26
Condensed Income Statement
Expenses are reported on the income statement
in group totals
Details of the expense groups are included on
supplementary schedules
Provides the advantage of a concise,
understandable income statement
An example of trade-off between
understandability and full disclosure
Reduces information overload
27
Condensed Income Statement
28
Presenting Expenses:
Nature versus Function
Under IFRS, analysis of expenses must be
presented based on either:
Nature of expenses (e.g. purchase of materials,
transportation costs, employee benefits, depreciation,
etc.)
Function of expenses (e.g. cost of sales,
administrative costs, etc.)
Choice should result in information that is more
reliable and relevant
No similar guidance under ASPE
29
Intraperiod Tax Allocation
Refers to the allocation of income taxes within a
fiscal period
Certain irregular items on the income statement are
reported net of tax
Specifically, income tax expense (or benefit) is
calculated and presented separately for the
following:
1. Income from continuing operations
2. Discontinued operations
3. Other comprehensive income
30
Earnings per Share
Earnings per share (EPS) is considered one of
the most significant business indicators
Indicates dollars earned per common share; it
does not report the dollars paid (or to be paid)
per common share
EPS based on earnings before discontinued
operations and EPS based on net income must
be shown on the face of the income statement
EPS based on discontinued operations may be
disclosed in the notes to the financial statements
31
Earnings Per Share
Calculated as:
Net Income less Preferred Dividends
Weighted Average of Common Shares Outstanding
Earnings per share is subject to dilution (reduction)
if issue of additional shares is possible in the future
For such situations, both Basic EPS and Diluted
EPS are presented
32
Retained Earnings Statement
Retained earnings increases by net income and
decreases by net loss and declared dividends (both
cash and share dividends) for the year
Correction of errors in prior periods and effects to
prior periods from accounting policy changes are
treated as prior period adjustments
They adjust (net of tax) beginning retained earnings;
also prior years financial statements are restated
Under IFRS, a Statement of Changes in Equity is
presented in lieu of a retained earnings statement.
33
Statement of Changes in Equity
This statement is required under IFRS and
presents the following:
1. Total comprehensive income
2. For each component of equity, the effects of
retrospective application/restatement
3. Reconciliation between the carrying amount of
each component of equity at the beginning
and end of the period.
34
34
Looking Ahead
IASB and FASB are preparing a converged standard on
Financial Statement Presentation
At the time of printing, the project was on hold.
IASB was in discussion on financial performance
reporting and was in the research project stage.
An exposure draft has been prepared on the Conceptual
Framework which proposes to relabel the statement of
comprehensive income as the statement of financial
performance.
35
Appendix 4A Cash Basis versus Accrual
Basis
Most companies use accrual basis of accounting
Recognize revenue in the period it is earned and expenses
in the period when they are incurred.
Cash received does not play a factor in recognizing the
transaction
Small companies may use the cash basis of accounting
Recognize revenue only when the cash is received, and
expenses are recorded only when the cash is paid
Income is determined based solely on the actual collection
of cash and the payment of expenses.
Cash basis financial statements do not conform with GAAP
36
Appendix 4A Conversion from Cash Basis
to Accrual Basis
Service Revenue Calculation
The changes in accounts receivable and unearned
revenues during the year must be considered
Accounts Receivable: Represents amounts that
were earned last year but collected this year
Unearned Revenue: Represents amounts that were
collected last year but have not been earned until
this year
37
Appendix 4A Conversion from Cash Basis
to Accrual Basis
38
Appendix 4A Conversion from Cash Basis
to Accrual Basis
Operating Expense Calculation
The changes in prepaid expenses and accrued liabilities
during the year must be considered
Prepaid Expenses: Beginning prepaid expenses balance is
added to cash paid for operating expenses to arrive at
operating expense on an accrual basis
Accrued Liabilities: Beginning accrued liabilities are
deducted and ending accrued liabilities are added to cash
paid for expenses to arrive at expenses on an accrual
basis
39
Appendix 4A Conversion from Cash Basis
to Accrual Basis
40
Appendix 4A Conversion from Cash Basis
to Accrual Basis
41
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