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SOC100H5 (538)
Chapter 4

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Department
Sociology
Course
SOC100H5
Professor
Nathan Innocente
Semester
Winter

Description
Mon, jan 13 Chapter 4: Income statement Usefulness of Income Statement • Income statement is a report that measures the success of company operations for a given period of time. [It contains information such as revenues, expenses, gains and losses] • Usefulness of Income Statement o Evaluates past performance (e.g., to assess profitability, investment value, credit- worthiness, and compare companies) o Helps in predicting future performance (e.g., timing, amounts of future cash flows) o Helps in assessing the risk and uncertainty of achieving future cash flows • Recurring items are more certain to occur in future. One-time items are transitory. E.g., revenues and expenses vs. Gains and losses. Limitations of Income Statement • Companies omit items that they cannot measure reliably o E.g., Change in values due to brands, customer service, R&D etc. • Income numbers are affected by the accounting methods employed o E.g., LIFO vs FIFO inventory valuation; accelerated vs straight line depreciation • Income measurement involves judgment o Estimates for allowance for doubtful debt, asset write-offs • Reporting Bias • Shortcomings of GAAP 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 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 Mon, jan 13 • Based on sound business strategy/model 2.Presentation • Does not disguise or mislead (transparent) • Understandable • Also, information is clear and concise • Quality of Earnings • Companies have incentives to manage income to meet or beat Wall Street expectations, so that • market price of stock increases and • value of stock options increase • Quality of earnings is reduced if earnings management results in information that is less useful for predicting future earnings and cash flows Class discussion: Read the “Numbers Game” speech by former SEC Chairman Arthur Levitt, pages 3 to 5 (the sections titled “the pressure to manage numbers” and “Accounting Hocus Pocus” Income statement format 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) Mon, jan 13 - OCI is closed to a balance sheet account called Accumulated Other Comprehensive Income (AOCI) 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 Comprehensive Income Statement Example of a combined income and comprehensive income statement: Sales 800,000 Cost of goods sold 600,000 Gross profit 200,000 Operating expenses 90,000 Net income 110,000 Other comprehensive income Unrealized holding gain, net of tax 30,000 Comprehensive income 140,000 Other comprehensive income OCI • IFRS only • IAS 1.7 - Changes in revaluation surplus - Actuarial gains/losses on pension plans - Gains/losses arising from translation of foreign operations - Gains/losses on available for sale investments - Gains/losses from hedging instruments if using hedge accounting 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) Mon, jan 13 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 Mon, jan 13 Condensed Income Statements • Sometimes, it is not possible to report all the desired expense detail on the face of the income statement. GAAP allows the reporting the totals on the income statement, supported with supplementary schedules Presenting Expenses: Nature versus Function • Under IFRS, analysis of expenses must be presented based on either: Mon, jan 13 - 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 Discontinued Operations • Discontinued operations includes components that have been disposed of or are held for sale • Components can include: o Under previous ASPE: an operating segment, reporting unit, subsidiary, asset group, or operations without assets o Under IFRS: separate major line of business or geographical area of operations, or a business qualifying as “held for sale” upon acquisition (IFRS 5.31
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