A company must eventually pay for environmental

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a company must eventually pay for environmental liabilities, and numerous other estimates. All of these estimates and assumptions affect both reported net income and the balance sheet. Judgments affect all financial statements. This is an important by-product of accrual account- ing. We discuss these estimates and assumptions, and their effects on financial statements, throughout the book. 2-13 Module 2 I Overview of Business Activities and Financial Statements Taxexpense applies to income from continuing operations Transitory items are those not expected to recur ANALYSIS DECISION You Are the CFO Assume that you learn of the leakage of hazardous waste from your company's factory. It is esti- mated that cleanup will cost $10 million. Part 1: What effect will recording this cost have on your company's balance sheet and its income statement? Part 2: Accounting rules require you to record this cost if it is both probable and can be reliably estimated. Although the cleanup is relatively cer- tain, the cost is a guess at this point. Consequently, you have some discretion whether to record it. Discuss the parties that are likely affected by your decision on whether or not to record the liability and related expense, and the ethical issues involved. [Answer 2-341 Reporting of Transitory Items To this point, we have only considered income from continuing operations and its components. A more complete income statement format is in Exhibit 2.6. The most noticeable difference involves two additional components of net income located at the bottom of the statement. These two components are specifically segregated from the "income from continuing operations" and are defined as follows: 1. Discontinned operations Gains or losses (and net income or loss) from business segments that are being sold or have been sold in the current period. 2. Extraordinary items Gains or losses from events that are both unusual and infrequent and are, therefore, excluded from income from continuing operations. _ General Income Statement Format Sales - Cost of goods sold Gross profit - Operating expenses - Nonoperating expenses (+ Nonoperating revenues) I •. - Taxexpense ----~~-------------------------- Income from continuing operations I •• [::!: Discontinued operations, net of tax ::!: Extraordinary items, net of tax Net income These two components are segregated because they represent transitory items, which reflect trans- actions or events that are unlikely to recur. Many readers of financial statements are interested in future company performance. They analyze current-year financial statements to gain clues to better predict future performance. (Stock prices, for example, are based on a company's expected profits and cash flows.) Transitory items, by definition, are unlikely to arise in future periods. Although transitory items can help us analyze past performance, they are largely irrelevant to predicting future per- formance. This means that investors and other users tend to focus on income from continuing
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