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4 Reporting Financial Performance

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2 4 Reporting Financial Performance
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.

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

4 Business Models Business Model identifies three activities:
Financing Obtaining cash funding Investing Use of funding to buy assets and invest in people Operating Use of assets and people to generate profits Financial statements should capture these fundamental business activities LO1

5 Overview of the Business Model

6 Communicating Information About Performance
Income Statement helps users: Evaluate past performance and profitability Assist in predicting future performance Assess potential risk or uncertainty in achieving future net cash inflows L02

7 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 L02

8 Quality of Earnings Quality of earnings refers to how solid earnings numbers are Two main aspects to consider: Content Integrity of information Sustainability of earnings Presentation Earnings presentation is clear and concise Easy to use and understandable L03

9 Quality of Earnings Characteristics of high quality earnings:
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 Presentation Does not disguise or mislead (transparent) Understandable Also, information is clear and concise Earnings management decreases quality of earnings L03

10 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 L04

11 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 L05

12 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 L05

13 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 L05

14 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 L05

15 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 L05

16 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 L06

17 Comprehensive Income Statement
Example of a combined income and comprehensive income statement: Sales ,000 Cost of goods sold ,000 Gross profit ,000 Operating expenses 90,000 Net income ,000 Other comprehensive income Unrealized holding gain, net of tax 30,000 Comprehensive income 140,000 L06

18 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: Oversimplification Less detail (e.g. operating and non-operating activities reported together and cannot be distinguished) L06

19 Single-Step Income Statement
Revenues Net Sales Other Revenues (e.g. Dividend, Rental) Revenues Expenses Cost of Goods Sold Selling Expenses Administrative Expenses Interest Expense Income Tax Expense Expenses = L06 Net Income Any Gains/Losses from Discontinued Operations must be disclosed separately from Continuing Operations Earnings per Share

20 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 L06

21 Multiple-Step Income Statement
Operating section Nonoperating section Income tax Continuing Operations Income/Loss from operations Gain/Loss from disposition Both reported net of taxes Discontinued Operations L06 Includes other gains/losses not included in net income Other Comprehensive Income

22 Continuing Operations–Detail
Net Sales Cost of Goods Sold Selling Expenses Administrative or General Expenses Operating Section Other Revenues and Gains Other Expenses and Losses Nonoperating Section L06 Separate income tax section on Income from Continuing Operations only Income Tax

23 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” L06

24 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 L06

25 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: Income from continuing operations Discontinued operations Other comprehensive income L06

26 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 L06

27 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 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. L07

29 Statement of Changes in Equity
This statement is required under IFRS and presents the following: Total comprehensive income For each component of equity, the effects of retrospective application/restatement Reconciliation between the carrying amount of each component of equity at the beginning and end of the period. L07 29

30 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 L09

31 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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