Income Concepts
I.
II.
Reporting Net Income—The purpose of the income statement is to provide
information about the uses of funds in the income process (expenses), the uses
of funds that will never be used to earn income (losses), the sources of funds
created by those expenses (revenues—normal), and the sources of funds not
associated with the earnings process (gains—unusual).
A. Uses of the Income Statement
1. Determine Profitability
2. Determine Value for Investment Purposes
3. Determine Credit Worthiness
4. Predicting Future Information about Future Cash Flows
B. Terms
1. Cost—an amount expended for items such as capital stock,
services, and merchandise received. Cost is the amount
actually paid for something.
2. Unexpired Costs (capitalize)—Costs that will expire in
future periods
a. Inventory (unexpired); Cost of Goods Sold
(expired)
b. Prepaid Insurance; Insurance Expense
c. NBV of fixed assets; Depreciation Expense
d. Patents; Patents Expense
3. Gross Concepts (Revenues and Expenses)
a. Revenues—reported at their gross amounts (less
returns).
b. Expenses—costs that benefit the current period or
the allocation of unexpired costs to the current
period for the benefit received are reported at their
gross amounts.
4. Net Concept (Gains and Losses)—infrequent or unusual
a. Gains—report at net (proceeds less net book value).
b. Losses—report at net (proceeds less net book
value).
Presentation Order of an Income Statement
A. Income (or Loss) from Continuing Operations (Report Gross)—
Includes operating activities (revenues, cgs, selling expenses,
administrative expenses), non-operating activities (other
revenues and gains and other expenses and losses), and income
taxes.
B. Income (or Loss) from Discontinued Operations (Report Net)—
such items are reported Net of Tax.
C. Extraordinary Items (Report Net)—items that are unusual in
nature AND occur infrequently.
D. Cumulative Effect of Change in Accounting Principle (Report
Net)—the cumulative effect (calculated as of the beginning of
the period of implementation of the new method) of a change
from one acceptable method of accounting to another (GAAP to
GAAP) because the new method presents the financial
information more fairly than the old method.
Company Name
Income Statement
For the Period Ended XXXX
Net Sales
Cost Goods Sold
Gross Profit
Selling Expense
General and Administrative Expenses
Operating Income
Other income (expense)
Interest Income (expense)
(XXX)
Gain (loss) on foreign currency trans XXX
Income before unusual items and income tax
Unusual or infrequent items
Gain on litigation settlement
XXX
Gain on sale of available-for-sale inv XXX
Income from continuing operations before income tax
Income tax
Current
XXX
Deferred
XXX
Income from Continuing Operations
XXX
(XXX)
XXX
(XXX)
(XXX)
XXX
XXX
XXX
XXX
XXX
XXX
XXX
Discontinued operations
Loss from operations of Division A
(including disposal loss of $XX and
Less income tax benefit of $XX)
(XXX)
Income (loss) before extraordinary item and
cumulative effect of accounting change
XXX
Extraordinary item [Note ___ (less applicable
income taxes of $XX)]
XXX
Cumulative effect of change in accounting
principle (less applicable income taxes of $XX)
XXX
Net Income
XXX
Note: Above the line items are reported at Gross (before tax); Below the line items are
reported at Net (after tax). The line is income from continuing operations.
Income from Continuing Operations
I.
II.
Single Step Income Statement—Total revenues are subtracted from total
expenses, thus the income statement has a single step. Benefits: simple
design and presentation of types of revenues and expenses do not appear to
the user to be classified as more important than others.
Multiple Step Income Statement—Reports operating revenues and expenses
separately from non-operating revenues and expenses and other gains and
losses. Benefits: enhanced user information.
Discontinued Operations
I.
II.
Discontinued Operations
A. Follows SFAS No. 144
B. Reported separately from continuing operations in the I/S, net of
tax
C. Usually a loss is reported, i.e. impairment loss, gain or loss from
actual operations, and gain/loss on disposal
D. Reported in the period the g/l occurs.
Terminology
A. Component of an Entity—part of an entity (the lowest level) for
which operations and cash flows can be clearly distinguished,
both operationally and for financial reporting purposes, from the
rest of the entity.
1. An operating segment
2. A reportable segment (segment reporting)
3. A reporting unit
4. A subsidiary
5. An asset group
*IFRS: Under IFRS, a component of an entity may be
1. A separate major line of business or geographical area of
operation, or
2. A subsidiary acquired exclusively with a view to resale
B. Asset Group—a collection of assets to be disposed of together as
a group in a single transaction AND the liabilities directly
associated with those assets
C. Held for Sale—A component of a business 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 the component.
2. The 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 the sale is
expected to be complete within one year.
5. The sale of the component is being actively marketed.
6. Actions required to complete the sale make it unlikely that
significant changes to the plan will be made or that the plan
will be withdrawn
*Under IFRS, before a component can be classified as heldfor-sale, the individual assets and liabilities of the component
must be measured in accordance with applicable standards and
any resulting gains and losses must be recognized. After
classification as held-for-sale, the component is reported at the
lower of carrying value and fair value less costs to sell. U.S.
GAAP does not require remeasurement of individual assets and
liabilities before classification as held-for-sale, but the
classification of a component as held-for-sale does trigger an
impairment analysis of the component.
III.
Accounting Rules
A. Types of entities to be considered—Results of operations of a
component of an entity will be reported in discontinued
operations if the component
1. Has been disposed of, or
2. Is classified as held for sale
B. Conditions that must exist
1. Eliminated from Ongoing Operations—up for sale or sold
2. No significant continuing involvement—after sale, no
involvement
C. Reporting Results—report in discontinued operations in the
period the component is either disposed of or is held for sale
1. Impairment Losses—A loss is recognized for recording the
impairment of the component. CV: 4,000,000, FMV:
2,200,000, Loss: 1,800,000
2. Subsequent Increases in Fair Value—A gain is recognized
for the subsequent increase in fair value minus the costs to
sell (but not in excess of the previous recognized
cumulative loss)
3. Depreciation and Amortization—no longer
D. Anticipated Future Gains or Losses—NOT recognized until they
occur until the date of sale and not before.
E. Subsequent Adjustments to Amounts Previously Reported—
adjustments to amounts previously reported in discontinued
operations that are directly related to the disposal of a component
of an entity in a prior period are classified in the current period in
discontinued operations.
IV.
Exit or Disposal Activities—As part of its convergence with IFRS, U.S.
GAAP requires the recognition of a liability for the costs associated with an
exit or disposal activity.
A. Exit and Disposal Costs—cost associated with exit and disposal
activities.
1. Involuntary employee termination benefits
2. Costs to terminate a contract that is not a capital lease
3. Other costs, including costs to consolidate facilities or
relocate employees
B. Criteria for Liability Recognition—An entity’s commitment to
an exit or disposal plan, by itself, is not enough to result in
liability recognition. A liability associated with an exit or
disposal activity should be recognized only when all of the
following are met:
1. An obligating event has occurred,
2. The event results in a present obligation to transfer assets or
to provide services in the future, and
3. The entity has little or no direction to avoid the future
transfer of assets or providing of services.
*Future operating losses expected to be incurred as part of
an exit or disposal activity are recognized in the period(s)
incurred.
C. Liability Measurement—The liability should be measured at fair
value, determined using U.S. GAAP fair value measurement
techniques.
D. Income Statement Presentation—Costs associated with an exit or
disposal activity related to a discontinued operation will be
reported in discontinued operations. Costs associated with an
exit or disposal activity not related to a discontinued operation
will be reported in income from continuing operations.
E. Disclosure—All of the following must be disclosed in the notes
to the f/s in the period the exit or disposal activity is initiated and
all subsequent periods until the activity is completed:
1. A description of the exit or disposal activity, including the
facts and circumstances leading to the expected activity and
the expected completion date.
2. For each major cost associated with an activity:
a. The total amount expected to be incurred in
connection with the activity, the amount incurred in
the period, and the cumulative amount incurred to
date.
b. A reconciliation of the beginning and ending
liability balances showing the changes during the
period for costs incurred, costs paid or otherwise
settled, and any other adjustments with an
explanation of the reasons.
3. The line item(s) in the income statement in which the costs
are aggregated.
4. For each reportable segment, the total amount of costs
expected to be incurred, the amount incurred in the period
and incurred to date, net of any adjustments with an
explanation of the reasons.
5. If a liability for a cost associated the activity is not
recognized because fair value cannot be reasonably
estimated, the fact and reasons for that should be disclosed.
Extraordinary Items
I.
II.
III.
IV.
Defined—Unusual and Infrequent
A. Material in nature
B. Significantly different from the typical business activities
C. Not expected to recur
D. Not considered ordinary part of operations
Disclosure
A. Separately on the income statement
B. Net of tax effects
C. After discontinued operations before cumulative effect of change
in accounting principle
Examples of Extraordinary Items
A. Abandonment of a plant due to an infrequent earthquake or flood
B. Expropriation of a plant by the government
C. Prohibition of a product line by a newly enacted law or
regulation
Examples of Non-Extraordinary Items
A. Gain/loss from sale or abandonment of PPE used in the business
B. Write-downs or write-offs of:
1. receivables
2. inventories
3. intangibles
4. long-term securities
C. G/L from foreign currency transactions or translation
D. Loss from major strike
Note: Income items that are either unusual OR infrequent are NOT extraordinary (e.g.
gain on sale of a factory building). If material, report as a separate line item as part of
income from continuing operations (and not net of tax).
*IFRS prohibits the reporting of any amount as extraordinary on the income statement or
in the notes to the financial statement.
Accounting Changes and Prior Period Adjustments
I.
II.
Accounting changes include:
A. Changes in accounting principle—cumulative/retrospective
approach
B. Changes in accounting estimate—prospective
C. Changes in entity—restat
D. Prior Period Adjustments are NOT accounting changes
Changes in Accounting Principle—cumulative; A change from one acceptable
method of GAAP (IFRS) to another acceptable method of GAAP (IFRS)
(GAAP to GAAP; IFRS to IFRS)
A. Rule of Preferability—such change may be made only if
the alternative principle is preferable and more fairly
presents the financial inforation.
B. Nonrecurring changes—an accounting change should not
be made for a transaction or event in the past that has been
terminated or is nonrecurring.
C. Effects of a change
a. Direct Effects—retroactive adjustments that would
be necessary to restate the financial statements of
prior periods
b. Indirect Effects—differences in nondiscretionary
items based on earnings (like bonuses) that would
have occurred if the new principle had been used in
prior periods.
c. Cumulative Effect—is equal to the difference
between the amount of beginning retained earning
in the period of change and what the retained
earnings would have been if the accounting change
had been retroactively applied to all prior affected
periods.
D. Reporting Changes in Accounting Principle—such changes
should be recognized by including the cumulative effect in
the net income of the period of change; prior period f/s are
not restated (usually).
*Under IFRS, when an entity disclosing comparative
information applies an accounting principle retroactively or
makes a retrospective restatement of items in the F/S, the entity
must (at a minimum) present three B/Ss (end of current period,
end of prior period, and beginning of prior period) and two of
each other F/S (current period and prior period). The
cumulative effect adjustment would be shown as an adjustment
of the beginning R/E on the B/S for the beginning of the prior
period. U.S. GAAP does not have a three B/S requirement.
III.
IV.
V.
Changes in Accounting Estimate—prospectively; occurs when it is
determined that the estimate previously used by the company is incorrect.
A. Events causing estimate changes
a. Changes in the lives of fixed assets
b. Adjustment of year-end accrual of officers’ salaries
c. Write-downs of obsolete inventory
d. Material IRS adjustments
e. Settlement of litigation
f. Changes in accounting principle that are inseparable
from a change in estimate
B. Reporting a change in estimate
a. Prospectively
b. Changes in estimate affecting future periods should
be disclosed in the notes to the f/s
Changes in Accounting Entity—restatement; the entity being reported on has
changed composition. Example: consolidated or combined f/s that are
presented in place of statement of the individual companies
A. Restatement to reflect information for the new entity (if
comparative f/s are presented): If a change in accounting
entity occurs in the current year, all previous f/s that are
presented in comparative f/s along with the current year
should be restated to reflect the information for the new
reporting entity.
B. Full Disclosure: Full disclosure of the cause and nature of
the change should be made
*IFRS does not include the concept of change in accounting
entity.
Prior Period Adjustment—restatement
A. Examples:
a. Corrections of errors in f/s of prior periods
b. Retroactive restatements required by new GAAP
c. Changes from non-GAAP to GAAP
B. Accounting for
a. Comparative F/S presented
i. Correct the information if the year is
presented
ii. Adjust beginning retained earning of the
earliest year presented if the year is not
presented
b. Comparative F/S not presented—adjust the opening
balance of retained earning (net of tax).
*Under IFRS, when it is impracticable to determine the
cumulative effect of an error the entity is required to restate
information prospectively from the earliest date that is
practicable. U.S. GAAP does not have an impracticality
exemption for error corrections.
Treatment of Accounting Changes
Estimate
Principle
Entity
Yes
Cumulative
Effect
No
Retroactively
Restate
No
Prior Period
Adjustments
Error
Correction
No
No
No
Yes
Yes
No
No
N/A
Yes
No
Yes
No
No
Prospectively
Adjust accounts
so that only
current and
subsequent i/s
will be affected
If comparative
F/S, restate
Prior F/S
If not
comparative
F/S, restate R/E
only
Cumulative
Effect of
change of
GAAP should
be shown in I/S
only in the
period the
change is made
Comprehensive Income
I.
II.
III.
Defined—Change in equity (net assets) of a business from transactions and
events from nonowner sources. It includes all changes in equity during a
period except those resulting from investment by owners and distributions to
owners.
Net Income
a. Income from continuing operations
b. Discontinued operations
c. Extraordinary items
d. Cumulative effect of changes in accounting principle
Other Comprehensive Income—Revenues, expenses, gains, and losses that are
excluded from net income
a. Pension minimum liability adjustment
b. Unrealized gains and losses
c. Foreign currency items
d. Effective portion of cash flow hedges
e. Revaluation Surplus (IFRS only)
IV.
V.
Accumulated other comprehensive income—a component of equity that
includes the total of other comprehensive income for the period and previous
periods
Note: At the end of each accounting period, all components of comprehensive
income are closed to the balance sheet. Net income is closed to R/E and other
comprehensive income is closed to accumulated other comprehensive income.
Financial Reporting
a. NOT reported on a per share basis
b. Below the total for Net Income
c. In a separate statement that begins with Net Income
d. In a statement of changes in equity
Revenue Recognition
I.
II.
Revenue is recognized when a “SALE” takes place
a. Delivery of good or setting aside of goods ordered
b. Transfer of title
c. Objectivity is a legitimate reason to delay recognition
Exceptions and Special Accounting Treatment
a. Deferred Credits—Unearned Revenue recognized as income through the
passage of time
i. Interest income
ii. Rental income
iii. Royalty income
b. Installment Sales—recognized as collections are made
c. Cost Recovery Method—no profit is recognized on a sale until all costs
have been recovered
d. Non-Monetary Exchanges—depends upon the type of exchange (similar
or dissimilar)
e. Involuntary Conversions—fire, theft. Conversion of a non-monetary asset
to cash would result in a g/l for financial accounting purposes
f. Net Method of Accounting for Trade (Sales) Discounts—Sales are
recorded net of any discounts; therefore, A/R at year end does not include
the discount offered. If the sales discount amount is not earned, the sales
discount amount is recorded as “other income,” and cash or A/R is debited
g. Percentage of completion Contract Accounting—Revenue is recognized as
“production takes place” for long-term construction contracts having costs
that can be reasonably estimated. If costs cannot be reasonably estimated,
then the “completed contract method must be used.
Matching of Revenue and Expenses
I.
Terminology
a. Assets—resources with potential future value
b. Liabilities—debt
c. Revenues—increases of assets or reductions of liabilities that stem from
rendering of services, delivering of good, etc. Under U.S. GAAP, revenue
should be recognized when it is
i. Realized (or realizable)
ii. When it is earned
1. Revenue from sales of products or disposal of assets is
recognized on the date of sale of the product.
2. Revenue that stems from allowing others to use the entity’s
assets (interest, royalty, rental) is recognized when the
assets are used (as time passes).
3. Revenue from the performance of services is recognized in
the period the services have been rendered and are able to
be billed by the entity.
iii. All four of the following criteria must be met for each element of
the contract before any revenue can be recognized
1. Persuasive evidence of an arrangement exists
2. Delivery has occurred or services have been rendered
3. The price is fixed and determinable; and
4. Collection is reasonably assured.
iv. IFRS Revenue Recognition—revenue transactions are divided into
four categories, each having its own revenue recognition rules.
1. Sale of Goods—revenue recognized when
a. Revenue and costs incurred for the transaction can
be measured reliably
b. It is probable that economic benefits from the
transaction will flow to the entity
c. The entity has transferred to the buyer the
significant risk and rewards of ownership
d. The entity does not retain managerial involvement
to the degree associated with ownership or control
over the goods.
2. Rendering of Services—recognize revenue using the
percentage of completion method when the outcome of the
transaction can be estimated reliably, which can happen
when:
a. Revenue and costs incurred for the transaction can
be measured reliably
b. It is probable that economic benefits from the
transition will flow to the entity
d.
e.
f.
g.
h.
i.
j.
k.
l.
c. The stage of completion of the transaction at the
end of the reporting period can be measured
reliably
3. Revenue from Interest, Royalties, and Dividends
a. Revenue can be measured reliably
b. It is probable economic benefits from the
transaction will flow to the entity
c. Interest is recognized using effective interest
method
d. Royalties are recognized using the accrual basis
e. Dividends are recognized when the shareholders’
right to receive payment is established
4. Construction Contracts—revenue recognized as revenue
and expenses using the percentage of completion method
when the outcome of the construction contract can be
estimated reliably
a. The contract revenue and contracts cost attributable
to the transaction can be measured reliably
b. It is probable that economic benefits from the
transaction will flow to the entity.
c. Both the contract costs to complete the contract and
the state of contract completion at the end of the
reporting period can be measured reliably.
d. An expected loss on a construction contract is
recognized immediately as an expense.
Expenses—reductions of assets or increases of liabilities during a period
of time that stem from the rendering of services, delivery of goods, etc.
Should be recognized according to the matching principle
Realization—obtains cash
Recognition—book g/l to F/S
Matching Principle—expenses must be recognized in the same period in
which the related revenue is recognized.
Accrual—the process of employing the matching principle to the
recognition of revenues and expenses. Record transactions and events as
they occur, not when cash is received or expended. Recognize revenue
when it is earned and expenses when they are incurred.
Deferral—occurs when cash is received or expended but is not
recognizable for f/s purposes. Liabilities and PP expenses.
Accrued Assets—Interest Receivable
Accrued Liabilities—Interest/P, wages/p, etc
Unearned Revenue—revenue received in advance is recorded as a liability