chapter+4+note+with+answers

chapter+4+note+with+answers - Chapter 4 Reporting financial...

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Chapter 4: Reporting financial performance In-class exercises:E4-6, E4-16, E4-17, P4-14 1
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Practice exercises:P4-3, P4-4, P4-8, P4-13, P4-15USEFULNESS & LIMITATIONS OF I/S USES OF THE I/S - evaluate mgt performance & firm performance during period - helps in predicting future cash flows of firm - helps in assessing risk of firm LIMITATIONS OF THE I/S - must use estimates eg in estimating bad debt exp - doesn’t show all changes in value in firm because we wait for transaction with outside party before recording revenue - items are omitted because we can’t measure them with enough certainty 2
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- variations allowed under GAAP make it hard to compare across firms QUALITY OF EARNINGS WHAT FACTORS WOULD YOU CONSIDER IN ASSESSING THE “QUALITY OF EARNINGS” OF A FIRM? ie. what causes one firm’s earnings to be “higher quality” than another? - economic environment in which firm operates (sound business) - credibility of company compared to its former performance & other similar companies - most inc is from continuing operations (recurring) - high correlation between inc & cash flows from operations - conservative choice in actg policies & estimates - reliability of earnings – auditor’s report, unbiased, verifiable, representational faithfulness of earnings - earnings are not managed to achieve a certain result - presentation is transparent & understandable 3
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Single-Step Income Statement Presents only two groupings before Income before Discontinued Operations: Revenues (includes gains) Expenses (includes losses) Income tax expense often reported separate from expenses as the last line item in determining net income Advantages: Simplicity Eliminates classification problems for revenues and expenses Disadvantage: Operating and non-operating activities reported together Multiple-Step Income Statement Operating and non-operating activities are separated Advantages: Highlighting regular and irregular activities allows for greater predictive value (assess future earnings) and feedback value (assess past earnings) Provides better detail to compare companies Allows for ratio analysis used to assess performance 4
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Presenting Expenses: Nature versus Function Under IFRS, analysis of expenses must be presented based on either: Nature of expenses (e.g. purchase of materials, transportation costs, employee benefits, depreciation, etc) Function of expenses (e.g. cost of sales, administrative costs, etc) If expenses are presented by function, nature of expenses must also be disclosed No similar requirement under private entity GAAP Condensed Income Statement Expenses are reported on the income statement in group totals Details of the expense groups are included on supplementary schedules Provides the advantage of a concise, understandable income statement 5
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Earnings per Share Earnings per share (EPS) is considered one of the most significant business indicators Indicates dollars earned per common share; it does not report the dollars paid (or to be paid) per common share
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