Importance of income from continuing operations
The need to provide information to help analysts predict future cash flows emphasizes the importance of properly reporting the amount of income from the entity's continuing operations
Describe components of income from continuing operations
Revenues, expenses (including income taxes), gains, losses, excluding those related to discontinued operations and extraordinary items
Describe earnings quality and how it is impacted by management practices to manage/manipulate earnings
Earnings quality refers to the ability of reported earnings (income) to predict a company's future earnings. To enhance predictive value, analysts try to separate a company's transitory earnings effects from its permanent earnings. It's a mistake to assum
Why might managers prefer "smooth" earnings? What are methods they can use to achieve smooth earnings patterns?
Executives prefer to report earnings that follow a smooth, regular, upward path. They hate to report declines, but they also want to avoid increases that vary wildly. As a result, some companies "bank" earnings by understating them in particularly good ye
Explain intraperiod tax allocation
Intraperiod tax allocation allocates income tax expense or benefit with each major component of income that causes it. Income tax is allocated to income from continuing operations and each of the two separately reported items
When an item qualifies for extraordinary item reporting
Material events and transactions that are both
1. Unusual in nature
2. Infrequent in occurrence
Know how financial statement reporting is impacted by changes in accounting principle, changes in accounting estimates and prior period adjustments
Changes in accounting principle: make a retroactive adjustment such that prior years' statements are recast on a basis consistent with the newly adopted principle
Ex: FIFO to LIFO
Changes in estimates: only affect current and future periods' accounting; n
Explain the difference between net income and comprehensive income and why unrealized holding gains (losses) on securities available for sale are included in comprehensive income
The calculation of net income omits certain types of gains and losses that are included in comprehensive income.
Comprehensive income includes net income and other items that bypass the income statement and are reported directly in owners' equity (such as
3 indicators that suggest a firm should report revenues gross as the principal
- The Entity Is the Primary Obligor in the Arrangement
- The Entity Has General Inventory Risk
- The Entity Has Latitude in Establishing Price
Describe the installment sales and cost recovery methods of recognizing revenue for installment sales and explain the unusual conditions under which these methods might be used
Installment sales method: Recognizes revenue and costs only when cash payments are received; 2 components = a partial recovery of the cost of the item sold and a gross profit component
Cost recovery method: Defers all gross profit recognition until cash e
Explain/provide factors that would indicate that the % of completion method of accounting for long term contracts is appropriate
- Reasonable estimates can be made of revenues and costs.
- The contract specifies the parties' rights, consideration to be paid, and payment terms.
- Both the purchaser and the seller have the ability and expectation to fulfill their obligations under th
Present Value of a Lump Sum
PV of $1 = $1/(1+i)^n
i = interest rate
n = # of periods
Simple interest
Computes interest on the principal amount only, not on any accrued interest.
Compound interest
Involves calculating interest on interest.
Ordinary annuity
a flow of cash payments of equal amounts paid at the end of each period for a certain number of periods.
Annuity due
a flow of cash payments of equal amounts paid at the beginning of each period for a certain number of periods.
Operating Activities
Inflows of cash:
- received from customers
- interest on receivable!!
- dividend from investments!!
Outflows of cash:
- purchase of inventory
- interest on liabilities!!
- income taxes
- salaries and wages
Investing Activities
Inflows of cash:
- disposal of property
- disposal of investments
- collection of loans
Outflows of cash:
- purchase of property
- purchase of investments
- loans to others
- purchase of intangibles
Financing Activites
Inflows of cash:
- issuing equity securities
- issuing long-term debt
Outflows of cash:
- retire stock or acquire treasury stock
- repay debt
- pay dividends to owners
Gross as the principal
The gross amount billed to a customer because it has earned revenue (as a principal) from the sale of the goods or services
Net as the agent
The net amount retained (that is, the amount billed to the customer less the amount paid to a supplier) because it has earned a commission or fee as an agent.