Professional Documents
Culture Documents
Learning Objectives
What is revenue recognition principle under
the accrual-basis accounting?
How to apply the matching principle to
expense recognition under the accrual-
basis? .
How is income measured under the accrual-
basis?
What is the cash-basis accounting?
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Learning Objectives (Contd.)
What are the distinctions between cash-
basis and accrual-basis earnings?
Why is accrual-basis income generally a
better measure of operating performance?
Income statement format and classification.
How to report a change in accounting
principle, accounting estimate, and
accounting entity.
What is comprehensive income?
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Learning Objectives :
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Measuring Profit ( Net income) Performance:
When to recognize revenues and expenses under the
GAAP (the accrual-basis)?
Operating Cycle
Market
Step 1: Revenuer ecognition the
product
Step 2: Expense matching Receive
Collect cash order
Step 3: Income Recognition
Deliver Negotiate
product production
contract
Net income =
Revenues - Expenses Manufacture
product
Order
material
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Accrual Basis Accounting Income Measurement
Step1: Revenues are recognized (recorded)
when:
Earned: The seller has performed a service or
conveyed an asset to the buyer; and
Measurable (Realizable): The value to be
received for that service or asset can be
measured with a high degree of reliability and
the collection is reasonably assured.
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Step 1: Determine the amount of revenue to be
recorded (revenue recognition).
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Step 2: Matching expenses with revenues
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Step 2: Matching expenses with revenues
(contd.)
Traceable costs : The costs which can be
easily traced to the revenues. These traceable
costs also called product costs (i.e., the
cost of goods sold).
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Matching Traceable costs (expenses)
with Revenues: (Cory TV and Appliance )
This example illustrates how product (traceable) costs are matched with 9
revenues.
Expense Period costs when they are
consumed
Suppose Cory TV also buys radio advertising for a monthly cost of
$120 beginning in February. This is a period cost (not product cost).
Period costs are expensed in the period when they are consumed.
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Learning Objective :
What is the cash-basis accounting?
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Cash Basis Income Measurement
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Cash Versus Accrual Accounting
Carter Company has sales on account totaling
$100,000 per year for three years. Carter
collected $50,000 in the first year and $125,000
in the second and third years. The company
prepaid $60,000 for three years rent in the first
year. Utilities are $10,000 per year, but in the
first year only $5,000 was paid. In the second
year, the total of $15,000 was paid for the
utilities. Payments to employees are $50,000
per year.
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Cash Basis vs. Accrual Basis Accounting
Looking at the cash-basis and the
accrual-basis results for Carter Company,
which method would you want to use if
you were asked to make predictions about
future years operating performance?
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Cash Basis vs. Accrual Basis Accounting
Information about enterprise
earnings and its components
measured by accrual accounting
generally provides a better
indication of enterprise performance
than does information about current
cash receipts and payments.
( SFAC No. 1)
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Example: Whole Foods Market Inc.
Discrepancies between earnings (net income) and cash flows
Year Net Income Total Accruals Cash Flows
1996 -17.23 17.58 0.35
1997 26.64 11.60 38.24
1998 45.40 30.94 76.33
1999 42.16 59.78 101.93
2000 28.93 57.44 86.36
2001 51.65 97.96 149.61
2002 84.49 89.32 173.81
2003 103.69 122.85 226.53
2004 132.66 145.19 277.85
2005 136.35 150.23 286.58
2006 203.83 208.94 412.76
Note: Amounts are in millions. 19
Learning Objective :
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Income Statement
Usefulness
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LO 1 Understand the uses and limitations of an income statement.
Income Statement
Limitations
Companies omit items that cannot
be measured reliably.
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LO 1 Understand the uses and limitations of an income statement.
Single-Step Format
The single-step statement Income Statement (in thousands)
Revenues:
consists of just two Sales $ 285,000
groupings: Interest revenue 17,000
Total revenue 302,000
Expenses:
Revenues Single- Cost of goods sold 149,000
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Reporting Irregular Items other than
the Unusual Items
Discontinued Operations occurs when,
(a) company eliminates (discontinues) the
results of operations and
cash flows of a component.
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Reporting Discontinued Operations Componet
Held for sale
Two components of
discontinued operations are
reported:
Gain or loss from
operations
Impairment loss
.
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Reporting Irregular Items
Extraordinary items are nonrecurring material
items that differ significantly from a companys
typical business activities.
(2) :
Gains and losses that
occur infrequently
called:
special or unusual
items
The Line
These items are included as part of income from continuing operations before tax
(sometimes referred to as being reported above the line), they are not disclosed net of tax effects. 42
Income statement format:
Transitory items below the line
Nonrecurring items
include:
1. Special or unusual
items ( above the line)
2. Discontinued
operations
3. Extraordinary losses
and gains
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How common are nonrecurring
losses?
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Accounting Changes
Type of Accounting
Change Definition
(1)
Change in Accounting Change from one GAAP method
Principle to another GAAP method
Change in Accounting Revision of an estimate
(2) Estimate because of new information or
new experience
Change in Reporting Preparation of financial
(3) Entity statements for an accounting
entity other than the entity that
existed in the previous period
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(1) Change in Accounting Principle
(SFAS 154)
Occurs when changing from one GAAP
method to another GAAP method
For example, a change from LIFO to FIFO
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(2) Change in Accounting Estimate
Examples: Changes in the estimates of
Inventory obsolescence.
Uncollectible receivables.
Useful lives and salvage values of assets.
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Change in Accounting Estimate
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Change in Accounting Estimate:
Example:
Change in Estimate: Arcadia HS, purchased equipment for
$510,000 which was estimated to have a useful life of 10 years
with a salvage value of $10,000 at the end of that time.
Depreciation has been recorded for 7 years on a straight-line
basis. In 2010 (year 8), it is determined that the total
estimated life should be 15 years with a salvage value of
$5,000 at the end of that time.
Questions:
What is the journal entry to correct the prior
No years
Entry
depreciation? Required
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2. Change in Estimate ExampleAfter 7 years
Net book value $160,000 Depreciation
Salvage value (new) 5,000 Expense calculation
Depreciable base 155,000 for 2010.
Useful life remaining 8 years
Annual depreciation $ 19,375
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Learning Objective :
Comprehensive Income
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Comprehensive income
The change in equity excluding owner
related transactions such as investments
from owners and dividends distribution.
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Special Reporting Issues
Three approaches to reporting Comprehensive
Income (SFAS No. 130, June 1997):
1. A second separate income statement;
2. A combined income statement of
comprehensive income; or
3. As part of the statement of stockholders
equity
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Summary (contd.)
Product costs are matched to their
traceable revenues, period costs are
expensed as the assets are used up.
Multi-step income statements
highlight nonrecurring (transitory)
items.
GAAP disclosures for accounting
changes aid comparisons of
performance over time.
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Summary (contd.)
All firms must report Basic EPS, and
those with complex capital structures
must also report Diluted EPS.
Other Comprehensive Income
changes in assets and liabilities
resulting from incomplete or open
transactions that bypass the income
statement and are reported as direct
adjustments to stockholders equity.
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