Ch. 4 Flashcards
Income statement
Report that measure s the success of company operations for a given period of time.
The business and investment community uses the income statements for?
To determine profitability, investment value and creditworthiness.
Income statement provides investors and creditors with information that helps them predict what
Amounts, timing and uncertainty of future cash flows.
Investors and creditors use income statement info for
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- Evaluate the past performance of the company
- Provide a basis for predicting future performance
- Help assess the risk or uncertainty of achieving future cash flows.
Net income is what?
An estimate and reflects an number of assumptions.
What are the limitations of the income statement
- Companies omit items from the income statement that they cannot measure reliably.
- Income numbers are affected by the accounting methods employed.
- Income measurement involves judgment.
SEC has taken decisive action to prevent the practice of what?
Earnings management
What is earnings management
Is defined as the planned timing of revenues, expenses, gains, and losses to smooth out bumps in earnings.
What did the companies use the earnings management for?
Used to decrease current earnings in order to increase income in the future.
The classic case is the use of “cookie jar” reserves which is
Where companies established these reserves by using unrealistic assumptions to estimate liabilities for such items as loan losses, reconstructions charges and warranty returns.
Then the companies reduce these reserves in the future to increase reported income in the future.
These earnings negatively affects what? Oh
Quality of earnings because if it distorts the information in a way that is less useful for predicting future earnings and future cash flows.
Net jncome results from?
Revenue, expense, gain and loss transactions.
Transaction approach
Focuses on income related activities that have occurred during the period.
Revenues take many forms
Sales, Fees, interest, dividends and rents
Expenses take many forms
Cogs Depreciation Interest Rent Salaries and wages Taxes
Gains and losses are many types
Sale of investments or plant assets
Settlement of liabilities
Write offs of assets due to impairments or casualty
Mists decisions find the ______ of the financial statement to be more useful than the whole.
Part
Multi step income statement
Operating section
- sales or revenues
- cogs
- selling expenses
- administrative expenses
Nonoperating section
Rev and exp result from secondary activities of company. Special gains and losses that are infrequent or unusual are reported in this section
• other revenues and gains
• other expenses and losses
Income tax
Discontinued operations
- material gains or losses resulting from the disposition of component of bus.
No controlling interest
Allocation of income to nongontrolling share holders
Earnings per share: a measure of performance over reporting period.
The reporting of gross profit shows
A useful number for evaluating performance and predicting future earnings.
Statement readers may study the trend in gross profits because
To determine how successfully a company uses it resources .
Understand how ckmpetitiv pressure affected profit margins
Single step income statement
Into
Condensed income statement
Includes only totals of expenses
Single step income statement
Consists only of expenses and revenues
What is the primary advantage of the single step?
Format lies in its simple presentation and the absence of any implication that one type of revenue or expense item has priority over another
What format elongates potential classification problem?
Single step
FASB developed specific guidliens in two important areas
- What to include in income
2. And how to report certain unusual or infrequent items
Some users advocate a current operating performance approach
To income reporting.
Some argued that the most useful income measure reflects only regular and recurring revenue and expenses elements.
Some unsusal or infrequent items do not reflect a company’s future earning power.
Some argue that
The focus on operating income potentially misses important info about a company’s performance. Any loss or gain by company contributes to long run profitability
Accounting profession adopted a modified all inclusive concept
Records most items including unusual or infrequent ones as part of net income.
Are companies required to disclose any unusual or infrequent gains and losses or both in the statement or notes to financial?
Yes!!
Why is additional disclosure often needed?
In the notes so that users of the income statement understand the effect of these gains or losses on net income and future cash flows
Gains or losses are identified as
A) unusual : high degree of abnormality and clearly unrelated to or only incidentally related to ordinary and typical acitivites
B) infrequency of occurrence: Transaction that is not reasonably expected to recur in the foreseeable future.
What are the common unusual or infrequent gains and losses?
Losses on write down of receivables; inventories; property, plant and equipment; goodwill or other untangle assets
Restructuring charges
Other gains and losses from sale or Abandobment of property plant and equipment .
Effects of a strike
Gainsandlosses on extinguishment of debt obligations
Gains and losses related to casualties such S fires floods and earthquicks
Gain or losses on the Sale of invesntment securities
The most common type of unusual gains reported in survey of 500 companies
Reconstructuring charges (202–more than 40%)
Write downs, gains/losses on asset sales (289– nearly 60%)
Gains and losses from unusual or infrequent gains or losses are not reported of net of tax.
T or F
True
