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TENTH CANADIAN EDITION INTERMEDIATE ACCOUNTING Prepared by: Dragan Stojanovic, CA Rotman School of Management, University of Toronto 4 CHAPTER 4 Reporting.

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Presentation on theme: "TENTH CANADIAN EDITION INTERMEDIATE ACCOUNTING Prepared by: Dragan Stojanovic, CA Rotman School of Management, University of Toronto 4 CHAPTER 4 Reporting."— Presentation transcript:

1 TENTH CANADIAN EDITION INTERMEDIATE ACCOUNTING Prepared by: Dragan Stojanovic, CA Rotman School of Management, University of Toronto 4 CHAPTER 4 Reporting Financial Performance Kieso Weygandt Warfield Young Wiecek McConomy

2 CHAPTER Copyright © John Wiley & Sons Canada, Ltd. 4 After studying this chapter, you should be able to: Understand how firms create value and manage performance. Understand how users use information about performance to make decisions. Understand the concept of and be able to assess quality of earnings/information. Understand the differing perspectives on how to measure income. Measure and report results of discontinued operations. Measure income and prepare the income statement and the statement of comprehensive income using various formats. Prepare the statement of retained earnings and the statement of changes in equity. Understand how disclosures and analysis help users of financial statements assess performance. Identify differences in accounting between IFRS and ASPE and potential changes. Reporting Financial Performance 2

3 3 Copyright © John Wiley & Sons Canada, Ltd. Reporting Financial Performance Performance Business models and industries Communicating information about performance Quality of earnings / information Statement of Retained Earnings / Changes in Equity Presentation of statement of retained earnings Presentation of statement of changes in equity Statement of Income / Comprehensive Income Measurement Discontinued Operations Presentation Disclosure and Analysis Disclosures Analysis IFRS/ASPE Comparison A comparison of IFRS and ASPE Looking ahead

4 4 Copyright © John Wiley & Sons Canada, Ltd. Business Models Business Model identifies three activities: 1.Financing Obtaining cash funding 2.Investing Use of funding to buy assets and invest in people 3.Operating Use of assets and people to generate profits Financial statements should capture these fundamental business activities

5 5 Copyright © John Wiley & Sons Canada, Ltd. Overview of the Business Model

6 6 Copyright © John Wiley & Sons Canada, Ltd. Communicating Information About Performance Income Statement helps users: 1.Evaluate past performance and profitability 2.Assist in predicting future performance 3.Assess potential risk or uncertainty in achieving future net cash inflows

7 7 Copyright © John Wiley & Sons Canada, Ltd. Limitations of Income Statement Statement of income/comprehensive income has the following limitations: Items are excluded if they cannot be measured reliably Amounts reported are affected by accounting methods used Use of estimates in measuring income Financial reporting bias GAAP shortcomings

8 8 Copyright © John Wiley & Sons Canada, Ltd. Quality of Earnings Quality of earnings refers to how solid earnings numbers are Two main aspects to consider: 1.Content Integrity of information Sustainability of earnings 2.Presentation Earnings presentation is clear and concise Easy to use and understandable

9 9 Copyright © John Wiley & Sons Canada, Ltd. Quality of Earnings Characteristics of high quality earnings: 1.Nature of Content –Unbiased and determined objectively –Represents economic reality –Reflects earnings from on-going core activities –Can be correlated with cash flows from operations –Based on sound business strategy/model 2.Presentation –Does not disguise or mislead (transparent) –Understandable –Also, information is clear and concise Earnings management decreases quality of earnings

10 10 Copyright © John Wiley & Sons Canada, Ltd. Comprehensive vs. Net Income Key question: how do we measure income? IFRS generally supports the all-inclusive approach to measuring income –This results in “comprehensive income” –Comprehensive income includes any non-shareholder transactions that causes a change in equity Example: unrealized gains/losses on revaluation of property, plant, and equipment under the revaluation model –Comprehensive Income = Net Income +/- Other Comprehensive Income (OCI) –OCI is closed to a balance sheet account called Accumulated Other Comprehensive Income (AOCI) ASPE continues to focus on net income as the measure of income

11 11 Copyright © John Wiley & Sons Canada, Ltd. Discontinued Operations Discontinued operations includes components that have been disposed of or are held for sale Components can include: ­ Under ASPE: an operating segment, reporting unit, subsidiary, asset group, or operations without assets ­ Under IFRS: separate major line of business or geographical area of operations, or a business qualifying as “held for sale” upon acquisition ­ IFRS is more restrictive

12 12 Copyright © John Wiley & Sons Canada, Ltd. Discontinued Operations A distinction made between: ­ The component’s results of operations ­ Disposal of the component’s assets The key is that the component generates its own cash flows and has its own distinct operations

13 13 Copyright © John Wiley & Sons Canada, Ltd. Discontinued Operations- Asset Held for Sale Component is held for sale if the following criteria are met: –Authorized plan to sell exists –Asset available for immediate sale –Active search for a buyer –Sale is probable within a year –Asset is reasonably priced and marketed –Unlikely that plan to sell will change

14 14 Copyright © John Wiley & Sons Canada, Ltd. Discontinued Operations Measurement & Presentation Depreciation is not recognized for held for sale assets Remeasured at lower of carrying value and fair value net of cost to sell Once asset is written down, subsequent gains can be recognized only up to the amount of original loss Presented separately on balance sheet –Under ASPE, held for sale asset retains original classification as current or non-current –Under IFRS, held for sale assets generally classified as current

15 15 Copyright © John Wiley & Sons Canada, Ltd. Discontinued Operations– Statement Presentation Income from continuing operations (net of tax) $xx,xxx Discontinued Operations: Income (Loss) from operations (net of tax) $xx,xxx Gain (Loss) on disposal (net of tax) xx,xxx xx,xxx Net Income $xx,xxx Earnings per share from continuing operations $ x Earnings per share from discontinued operations x Earnings per share on net income $ x

16 16 Copyright © John Wiley & Sons Canada, Ltd. Presentation of Performance Under IFRS, the statement of comprehensive income can be presented either: as a single combined statement, or as two separate statements Companies can present income using either –Single-step income statement, or –Multiple-step income statement

17 17 Copyright © John Wiley & Sons Canada, Ltd. Comprehensive Income Statement Example of a combined income and comprehensive income statement: Sales800,000 Cost of goods sold600,000 Gross profit200,000 Operating expenses90,000 Net income110,000 Other comprehensive income –Unrealized holding gain, net of tax30,000 Comprehensive income140,000

18 18 Copyright © John Wiley & Sons Canada, Ltd. Single-Step Income Statement Presents only two groupings before Income before Discontinued Operations: 1.Revenues (includes gains) 2.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: –Oversimplification –Less detail (e.g. operating and non-operating activities reported together and cannot be distinguished)

19 19 Copyright © John Wiley & Sons Canada, Ltd. Single-Step Income Statement 19 – = Revenues Net Sales Other Revenues (e.g. Dividend, Rental) Expenses Cost of Goods Sold Selling Expenses Administrative Expenses Interest Expense Income Tax Expense Net Income Any Gains/Losses from Discontinued Operations must be disclosed separately from Continuing Operations Earnings per Share

20 20 Copyright © John Wiley & Sons Canada, Ltd. 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

21 21 Copyright © John Wiley & Sons Canada, Ltd. Multiple-Step Income Statement Continuing Operations Operating section Nonoperating section Income tax Discontinued Operations Income/Loss from operations Gain/Loss from disposition Both reported net of taxes Other Comprehensive Income Includes other gains/losses not included in net income

22 22 Copyright © John Wiley & Sons Canada, Ltd. Continuing Operations–Detail Operating Section Net Sales Cost of Goods Sold Selling Expenses Administrative or General Expenses Nonoperating Section Other Revenues and Gains Other Expenses and Losses Income Tax Separate income tax section on Income from Continuing Operations only

23 23 Copyright © John Wiley & Sons Canada, Ltd. 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 An example of trade-off between understandability and full disclosure Reduces “information overload”

24 24 Copyright © John Wiley & Sons Canada, Ltd. 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.) Choice should result in information that is more reliable and relevant No similar guidance under ASPE

25 25 Copyright © John Wiley & Sons Canada, Ltd. Intraperiod Tax Allocation Refers to the allocation of income taxes within a fiscal period Certain irregular items on the income statement are reported net of tax Specifically, income tax expense (or benefit) is calculated and presented separately for the following: 1.Income from continuing operations 2.Discontinued operations 3.Other comprehensive income

26 26 Copyright © John Wiley & Sons Canada, Ltd. 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 EPS based on earnings before discontinued operations and EPS based on net income must be shown on the face of the income statement EPS based on discontinued operations may be disclosed in the notes to the financial statements

27 27 Copyright © John Wiley & Sons Canada, Ltd. Earnings Per Share Calculated as: Net Income less Preferred Dividends Weighted Average of Common Shares Outstanding Earnings per share is subject to dilution (reduction) if issue of additional shares is possible in the future For such situations, both Basic EPS and Diluted EPS are presented

28 28 Copyright © John Wiley & Sons Canada, Ltd. Retained Earnings Statement Retained earnings increases by net income and decreases by net loss and declared dividends (both cash and share dividends) for the year Correction of errors in prior periods and effects to prior periods from accounting policy changes are treated as prior period adjustments They adjust (net of tax) beginning retained earnings; also prior years’ financial statements are restated Under IFRS, a Statement of Changes in Equity is presented in lieu of a retained earnings statement.

29 29 Copyright © John Wiley & Sons Canada, Ltd. Statement of Changes in Equity This statement is required under IFRS and presents the following: 1.Total comprehensive income 2.For each component of equity, the effects of retrospective application/restatement 3.Reconciliation between the carrying amount of each component of equity at the beginning and end of the period. 29

30 30 Copyright © John Wiley & Sons Canada, Ltd. Looking Ahead IASB and FASB are preparing a converged standard on “Financial Statement Presentation” –Working principles state that financial statements should: Provide a cohesive financial picture of an entity Provide information to help users assess the liquidity of an entity Separate financing activities from other activities Provide information about measurement of assets and liabilities, and Disaggregate information and present subtotals and totals IASB and FASB are also working on redefining the meaning of “component” for discontinued operations

31 31 Copyright © John Wiley & Sons Canada, Ltd. COPYRIGHT Copyright © 2013 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein.


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