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Unformatted text preview: CHAPTER 4 Reporting Earnings and Financial Position THINKING BEYOND THE QUESTION How do we report earnings and financial position to stockholders? Using common rules and formats is important so that decision makers can compare results across companies and so they will have faith in the reliability of the information. If each company selected its own rules, the cost of comparisons would be extremely high as stakeholders would need to adjust each company’s information to some common standard. Unless the rules used by companies are known, decision makers cannot determine whether reported information faithfully represents the com- panies underlying economic activities or not. If investors, creditors, and other stakeholders cannot evaluate how well companies are performing, they will not provide financial resources to the companies or will demand high rates of return to compensate them for the high risk associated with their investments. Strong accounting regulations are essential to creat- ing efficient capital markets. Countries without these regulations either have planned economies or underdeveloped ones. QUESTIONS Q4-1 Dividends are NEVER an expense. Dividends are a distribution of income, not a component of it. Q4-2 Q4-3 g. Does this company have significant investments as of the balance sheet date? h. What long-term liabilities does this firm have at the balance sheet date? Q4-4 The primary reason is to maximize the amount of profit-related information conveyed to users. By breaking the information into separate and distinct categories, additional information is conveyed. Consider the opposite situation. At the extreme, one could report a one-section or even a one-line income statement. It would only report net income with no supporting detail. This would not be very useful because it would not provide any information as to the components of income. 91 92 Chapter 4 The different sections of the income statement provide insight into the sources of revenue and causes of expense. Revenues and expenses dir- ectly related to the primary activities of the firm are reported near the top of the income statement. Other revenues and expenses from nonprimary activities are given less prominence lower down the statement. Firms usually report gross profit because it is a key measure of efficiency. It is computed by deducting cost of goods sold (often the largest expense a company has) from sales. Income statements have many sections to maximize the information provided. Q4-5 The purpose of consolidated financial statements is to report combined financial information of the parent and its subsidiaries as if they were all the same organization. Legally, they are separate corporations. But, because the parent company has voting control over the subsidiaries, the assets of the parent and subsidiaries are generally managed as one large integrated entity. Accordingly, consolidated financial statements are prepared to report on that same basis. This allows investors to make are prepared to report on that same basis....
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This note was uploaded on 06/18/2011 for the course ACC 300+ taught by Professor Gh during the Spring '11 term at Saint Joseph's University.
- Spring '11