Reporting the Results of Operations

Accrual Accounting Adjustments – Cash basis to accrual conversion

Simple Accrued Expenses (utilities, payroll, etc…)
1. Back out wrong entry to arrive at correct beg bal (sole proprietorship)

Capital xx [use R/E if a corporation]

Utilities xx
Payroll xx
2. Book entire accrual at EOY
Utilities xx [full amt of accrued expenses, 12/31]
Payroll xx
Accrued exp payable xx

Prior Period Adjustments

Prior Period Adjustment à Restate the previously issued financial statements
• Must highlight prior period adjustment on current year Statement of R/E (net of tax)

Current year Statement of R/E

Beginning R/E as previously reported 150K
Prior Period Adjustment due to “xxx…(net of tax)” (6K)
Beginning R/E, as adjusted 144K
NI 20K
Divs paid (4K)
Ending balance of R/E 160K

What is considered a prior period adjustment?

• Errors of a material nature
• “errors, mistakes, oversights, misapplied GAAP”
• Going from unacceptable non-GAAP principle to acceptable (GAAP) principle
• Going from cash basis to accrual basis

ACCOUNTING CHANGES: 3 TYPES

1. Changes in Principle
a. Due to switch from one GAAP principle to a new GAAP for the same transactions
or set of circumstances (makes F/S inconsistent and comparability is affected)
b. Examples: LIFO à FIFO, completed contract method à % of completion method
i. With inventory change -> look at difference @ beg of period of change
ii. Amount is reported as cumulative effect on prior periods (R/E
statement)
c. ALL CHANGES IN ACCOUNTING PRINCIPLE = PRIOR PERIOD
ADJUSTMENT (restate)
d. Requires footnote disclosure stating:
i. Nature of the change
ii. Why it is justified
2. Changes in Estimate
a. Do NOT make a prior period adjustment
b. Prospective/current period only, never retroactive!!!
 c. Examples: Bad debt allowance, depreciation method/salvage/useful life),
contingent liabilities
d. Depreciation: Take BV @ date of change and remaining life to calculate new
annual depreciation amount under the new depreciation method
e. Must footnote if change in estimate has material effect on F/S

3. Changes in Entity
a. ALWAYS TREAT AS A PRIOR PERIOD ADJUSTMENT (must restate old
F/S)
b. Example: Consolidating with subsidiary
c. All about comparability

Change in Principle inseperable from Change in Estimate

• Treat as change in estimate à No PPA, apply to current year income from operations + going
forward if applicable
• Example: Switching from SL depreciation to DDB/SYD/etc…
Net Income under GAAP
1. Continuing Operations
2. Discontinued Operations
a. Report on I/S net of tax!!!
b. Income statement section used when selling off a component of a business
c. Component = lowest level where operations and cash flows are “clearly
distinguishable from the rest of the company”
d. Examples: segment, subsidiary, branch, division, product line, brand
e. Reporting: In period in which a component is disposed of or classified as held-for-
sale and sold w/in a year, the results of that loss on sale of component must be reported
under discontinued operations in period in which they occur
i. Gainsà Must wait until sale is completed to realize a gain, report gains net of
operating losses in the year of sale!!!
ii. Lossà Impairment loss, recognize as soon as probable and can
be reasonable estimated
f. Loss on operations of disposed segment: If sale is 6/1/x2, agreement is 2/1/x1, on
the year 1 I/S, recognize all losses from segment under “losses from operations” under
discontinued operations in the year which they occur.
3. Extraordinary Items
a. Must be BOTH: Unusual (very abnormal) and Infrequent (not likely to occur
again), considering the environment the entity operates in
i. Chemical spill example: Industrial firm who normally deals w/toxic waste =
ordinary; Ice cream maker = extraordinary
ii. If meeting only 1 of 2 criteria: “Infrequent charges/gains”
1. Include as separate line item in operations “other gains/losses”
NOT net of tax
b. ASSUME YES: Hurricane, earthquake, volcano
c. NEVER: Loss due to employee strike, gains/losses from FX rate fluctuations, loss
from abandoning assets, gains/losses from selling of whole component of business
(subsidiary, branch)
d. Report on I/S net of tax
Intra-Period tax allocation à Each of 3 components reported on I/S, net of tax

Inter-Period tax allocation à Related to deferred tax assets/liabilities due to book/tax differences

COMPREHENSIVE INCOME

• FASB 130- All companies must report total comprehensive income

• Anything that affects S/E… except
• Equity issues & capital investment
• Dividend payments
• OCI items require “intra-period tax allocation” = reported NET OF TAX

Components
1. Net income
2. OCI

Other comprehensive Income components

• Unrealized gains/losses from AFS securities or Cash Flow hedge security
• Unrealized “translation” gain/loss arising from translating foreign F/S
• Unrealized gains/losses from hedging foreign operations
• Total Obligation: Defined benefit pension plan

OCI Presentation
• Must be displayed prominently within a financial statement in a full set of general-purpose
F/S
• Must be shown on face of at least 1 F/S, not just in the notes
• Choice of formats to display
1. Included in a combined statement of income and comprehensive income
2. Reported on a separate statement
3. Reported within the statement of S/E

Approaches to Reporting Total Comprehensive Income

1. One-Statement approach

• Puts OCI items after NI on the income statement

[normal I/S to arrive @ NI]

(+/-) OCI items
Total Comprehensive Income

2. Two-Statement approach
• I/S and separate statement of comprehensive income
• Separate Statement format: NI from I/S (+/-) OCI items
 3. Third approach “separate statement”

• Shows changes in each S/E account

C/S APIC R/E Accum OCI TCI
Beg bal x x x x
NI X x
OCI items x X
Divs paid X x
Ending bal X X X X X

SEGMENT REPORTING
• Besides core business, a company is involved in several industry segments (conglomerate)
• Required: Disclose information about operating segments as follows…(YEARLY +
INTERIM)
• Assets by segment
• Sales by segment
• Results of operations by segment
• Reconciliation where company reconciles all profits and losses to the firm as a whole
• Not required to disclose:
• Liabilities by segment
• Cash flows by segment
Operating Segment = Segment with own results of operations which can then be reported to a decision
maker (“management approach”)
• 10 segments or less should be reported!!!

10% Test to Identify operating segment is “reportable segment”

• If segment’s assets OR sales are => 10% of combined assets/sales from all segments
• Applying for Sales: Count BOTH sales to outsiders and inter-segment sales
• If segment’s profits OR losses [absolute amounts of total profits for segments that did not
report a loss] are => 10%
• Must also report to decision maker for enterprise (CEO, CFO, president, etc…) – MGT
approach
75% sufficiency test (secondary to 10% test)
• Keep identifying segments until the make up 75%+ of outsider sales

Cash vs. Accrual Adjustment

Cash income
(+) Increase in A/R
(+) Decrease in A/P
Accrual Income

Cash Basis of Accounting

• Capital Account = (capital investment – draws) + (cash income transactions) – (cash exp
transaction)

OCBOA: Acceptable Methods other than GAAP

 • Basis used to comply w/ regulatory requirements
• Basis used for tax purposes
• Cash Basis
• Definite set of criteria having substantial support (e.g. “price-level basis of accounting”)

Interim Financial Reporting

Effective Tax Rate à Use “best estimate” of ETR for full fiscal year must be made @ end of each
interim period. Should reflect foreign tax rates, % depletion, capital gains rates, other available tax
planning alternatives.

Inventory losses from Market Declines à Recognize full loss in interim period which decline occurs (if
decline is not reasonably expected to reverse later in the fiscal year).
Inventory recovery à If within same fiscal year, may recognize gain in later period. Such gains should
NOT exceed previously recognized inventory losses

Extraordinary Items à Do not prorate over remainder of fiscal year, recognize in interim period in
which they occur
Expenses w/expected benefits for rest of year = prorate over rest of fiscal year
Property taxes = prorate over entire fiscal year.

Start-up Costs, including Organizational Costs = Expense as incurred for financial reporting
purposes

Related Party Disclosures

• Include: Loans to officers, royalties paid to major shareholders, another related party
transactions except….
• Exclude: Intercompany sales (if eliminated for consolidated F/S), ordinary business items,
compensation arrangements, expense allowances