Chapter 14 Notes

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University of Toronto Scarborough
Financial Accounting
Liang Chen

Chapter 14 Performance Measurement Notes Sustainable Earnings N sustainable earnings likely level of earnings to be obtained in future, determined by adjusting net earnings for irregular items N differ from actual net earnings by amount of irregular (non-typical) revenues, expenses, gains, losses included in net earnings N users are interested in sustainable earnings because amount helps estimate future earnings without noise of irregular items N to help determine sustainable earnings, irregular items are reported separately on the financial statements Discontinued Operations N discontinued operations the disposal, or availability for sale, of an identifiable operating segment of the business N operating segment can be subsidiary company or operating division within company, as long as it is separate business unit with its own financial elements (e.g., revenues, expenses, and cash flows) that can be clearly distinguished from rest of company N whether operating segment has been disposed of (sale, abandonment, spin-off), or classified as held for sale, it is expected that: 1. operations and cash flows have been eliminated from ongoing operations of company as result of disposal transaction 2. the company will have no continuing involvement after the disposal transaction Balance Sheet N assets (net of any related liabilities) that are held for sale as discontinued operations are valued and reported on the balance sheet at the lower of their carrying amount and fair value (less any anticipated costs of selling) N they retain their original classification as assets or liabilities, and are reported as current or noncurrent N once an asset has been classified as held for sale, no additional depreciation is recognized N of course, assets that have already been disposed of are no longer recorded or reported on the balance sheet Statement of Earnings N when a company disposes of one of its operating segments, the disposal is reported separately on the statement of earnings as an irregular item called discontinued operations N the discontinued operations item consists of two parts: the earnings (loss) from the discontinued operations and the gain (loss) on the disposal of the segment; of course, if the segment has not yet been disposed of and is being held for sale, only the first part (earnings or loss from discontinued operations) will be segregated and reported on statement until the actual disposal occurs N like all irregular items, discontinued operations are reported net of income tax, that is, the applicable income tax expense or tax savings is shown for earnings before income tax and for each component that is reported for discontinued operations N in addition, on its statement of earnings, earnings per share are reported separately for continuing operations and for discontinued operations so that investors can clearly see the impact of this decision on the company N the impact of the discontinued operations on cash flow must also be reported separately on the cash flow statement N in general, in evaluating a company it makes sense to eliminate irregular items such as discontinued operations from the analysis Change in Accounting Principle N change in accounting principle use of unlike accounting principle in current year compared to what was used in past year N to ensure the comparability of financial statements from year to year, accounting principles should be applied consistently from period to period, however, this does not mean that changes can never be made N when a change is made, it is classified as either voluntary or mandatory N a voluntary change in accounting principle is allowed when management can show that the new accounting principle results in a more reliable and relevant presentation of events or transactions in the financial statements N a mandatory change in accounting principle is one that is required by standard-setters N changes in accounting principles affect financial reporting in four ways: 1. The cumulative effect of the change in accounting principle should be reported (net of income tax) as an adjustment to opening retained earnings. Since prior-period earnings are affected, a change in accounting principle must be reported in the retained earnings section of the statement of shareholders equity (or in the statement of retained earnings), rather than in the current periods statement of earnings. 2. The new principle should be used for reporting the results of operations in the current year. 3. All prior-period financial statements should be restated to make comparisons easier. 4. The effects of the change should be detailed and disclosed in a note. N ideally, all accounting changes are applied retrospectivelythis means that a financial statement from any prior year that is represented for comparative purposes must be restated as if the new accounting principle had been used in the past Comparative Analysis N in assessing financial performance, investors and creditors are interested in the sustainable earnings of a company N in addition to this, they are also interested in making comparisons from period to period N there are three types of comparisons to improve the usefulness of financial information for decision-making: 1. Intracompany basis: This basis compares an item or financial relationship inside a company within the current year or with one or more prior years. Comparisons within a company are often useful to detect changes in financial relationships and significant trends. 2. Intercompany basis: This basis compares an item or financial relationship of one company with the same item or relationship in one or more competing companies. Comparisons with other companies give insight into a companys competitive position. 3. Industry averages: This basis compares an item or financial relationship of a company. Comparisons with industry give information about a companys relative position within the industry.
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