Module05 - Module 5 Reporting and Analyzing Operating...

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1 Module 5 Reporting and Analyzing Operating Income Roadmap ± Purpose of Income Statement ± The need for Classification ± Revenue Recognition Issues ± Expense Matching ± Research and development Conundrum ± Restructuring Charges and Big Bath ± Tax Expense ± Below the Line Items ± Earnings per Share ± Estimation of stock prices entails forecasts of future earnings and cash flows. ± Core earnings and cash flows have the greatest persistence or predictive power and are, therefore, most useful for stock price estimation. ± Our goal is to identify core earnings and cash flows of the company.
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2 Classification of Income Statement Items Non-operating Operating Non-recurring Recurrent Operating and Nonoperating Items in the Income Statement Home Depot’s Operating Items
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3 Operating and Nonoperating Components in the Income Statement Revenue Recognition ± Revenue recognition criteria 1. realized or realizable , and 2. earned ± Realized or realizable means that the seller’s net assets (assets less liabilities) increase. ± Earned means that the seller has performed its duties under the terms of the sales agreement. Arguments Against Revenue Recognition ± Rights of return exist ± Consignment sales ± Continuing involvement by seller in product resale ± Contingency sales
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4 Pfizer’s Revenue Recognition Policy ± Revenue Recognition—we record revenue from product sales when the goods are shipped and title passes to the customer. At the time of sale, we also record estimates for a variety of sales deductions, such as sales rebates, discounts and incentives, and product returns. Risks of Revenue Recognition ± Case 1: Channel stuffing ± Case 2: Barter transactions ± Case 3: Mischaracterizing transactions as arm’s-length ± Case 4: Pending execution of sales agreements ± Case 5: Gross versus net revenues ± Case 6: Sales on consignment ± Case 7: Failure to take delivery ± Case 8: Nonrefundable fees
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5 Percentage-of-Completion ± The percentage-of-completion recognizes revenue by the proportion of costs incurred to date compared with total estimated costs. ± Assume that Abbott Construction signs a $10 million contract to construct a building. Abbott estimates construction will take two years and will cost $7,500,000. This means the contract yields an expected gross profit of $2,500,000 over two years. ± The following table summarizes construction costs
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This note was uploaded on 05/12/2010 for the course ACG 5065 taught by Professor Asare during the Spring '08 term at University of Florida.

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Module05 - Module 5 Reporting and Analyzing Operating...

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