ACIS3115 Chapter 4 - Chapter 4 Income Statement and Related...

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1 Chapter 4 Income Statement and Related Information
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2 Income Statement Usefulness Limitations Quality of Earnings Format of the Income Statement Reporting Irregular Items Special Reporting Issues Intraperiod tax allocation Earnings per share Retained earnings statement Comprehensive income Discontinued operations Extraordinary items Unusual gains and losses Changes in accounting principles Changes in estimates Corrections of errors Income Statement and Related Information Elements Single-step Multiple-step Condensed income statements
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3 Income Statement Report that measures the success of company operations for a given period of time.
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4 Usefulness of Income Statement Evaluate the past performance of the company. Provide a basis for predicting future performance. If a reasonable correlation exists between past and future performance, we can better predict future earnings and cash flows. Help assess the risk or uncertainty of achieving future cash flows. Recurring items are more certain in the future.
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5 Limitations of the Income Statement Companies omit items from the income statement. GAAP prohibits recognition of certain items: Example: unrealized gains and losses on certain investment securities Brand value Income numbers are affected by the accounting methods. Straight-line method vs. Accelerated method FIFO vs. LIFO Income measurement involves judgment. Estimate useful life of an asset Estimate bad debt write-offs Estimate warranty returns
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6 Quality of Earnings Earnings Management Planning timing of revenues, expenses, gains, and losses to smooth out bumps in earnings. Example: recognize sales before earned to boost earnings Quality of earnings Earnings management negatively affects the quality of earnings. It distorts the information in a way that is less useful for predicting future earnings and cash flows. If investors lose faith in the numbers reported in the F/S, U.S. capital market will be damaged.
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Evidence of Earnings Management Source: Burgstahler and Dichev, Journal of Accounting & Economics, 1997 Distribution of earnings
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Evidence of Earnings Management Source: Burgstahler and Dichev, Journal of Accounting & Economics, 1997 Distribution of changes in earnings
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9 Income Statement Usefulness Limitations Quality of Earnings Format of the Income Statement Reporting Irregular Items Special Reporting Issues Intraperiod tax allocation Earnings per share Retained earnings statement Comprehensive income Discontinued operations Extraordinary items Unusual gains and losses Changes in accounting principles Changes in estimates Corrections of errors Income Statement and Related Information Elements Single-step Multiple-step Condensed income statements
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10 Elements of the Income Statement Revenues – Inflows or other enhancements of assets or settlements of its liabilities that constitute the entity’s ongoing major or central operations.
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