ACCT 3110 1st EditionExam # 3 Study Guide Lectures: 8-9Why is the income statement useful?1. Helps evaluate the past performance of the company2. Provides a basis for predicting future performance3. Helps asses the risk or uncertainty of achieving future cash flows4. Helps to compare its performance to the performance of other companiesWhat are the limitations of an income statement?1. Companies omit items from the income statement that the cannot measure reliably2. Income numbers are affected by the accounting methods employed3. Income measurement involves judgment4. Does NOT help to evaluate financial condition, solvency or liquidity (Balance Sheet does)Why would companies want to commit fraud to manage income up?1. Achieve income levels so that management earns bonuses or stock options2. Mislead owners and potential investors to believe the company is doing better than it is so they will invest more3. Mislead banks into thinking the company is in compliance with loan covenantsWhy would a company want to commit fraud to manage income down?1. To reduce net income which reduces incomes taxes2. If the company has already reached the point where management will earn bonuses, they might try to push the income to the next year to help achieve goal for next yearHow do companies commit fraud?- Alter accounting estimates and judgmentso Reduce a balance sheet liability and increase incomeo Increase a balance sheet liability and reduce income- Keep “rainy day” reserves or liabilities and use them to smooth earnings- Accelerate or delay revenue or expense recognition (record them early or don’t record them until next period)What is the difference between revenues and gains?- Revenues are inflows from a company’s ongoing or central operations while gains are inflowsfrom peripheral or incidental activities (not from the normal operations of the company)What is the difference between expenses and losses?- Expenses are outflows from a company’s ongoing or central operations while losses are outflows from peripheral or incidental activities (not from the normal operations of the company)What are the differences between a single step and a multi step income statement?- Single step is simple, multi is more complex- Single has no classification or groupings (just all revenues all together and all expenses all together) while multi is grouped by operating and non-operating activities- Single step is not very informative but multi provides a lot of information- Single is not used often but multi is used by all public and most private companiesWhat is the format of the multi-step income statement?- 1. Operating Sectiono Revenue, COGS, Expenses- 2. Nonoperating Sectiono From peripheral activities, not core activities (gains and losses)o Ex. Subleasing part of building to another company- 3. Discontinued Operationso Stopping a product line, getting rid of a subsidiary location- 4. Extraordinary Items (net of tax)o Unusual and infrequent gain or loss- 3. Non-controlling Interestso If a subsidiary is not wholly owned then a company needs to allocate its net income between the controlling and non-controlling shareholderso Only when company owns less than 100% of it’s subsidiaryo Can put this in “Other Comprehensive Income” in a single statement with the income statement or as in a separate Comprehensive Income StatementHow are earnings per share computed?o EPS= (Net Income-Preferred Dividends)/Weighted Average # of Shareso To get weighted average number of shares add number of shares from last day of each month (including 12/31 of previous year) and divide by 13What is intraperiod tax allocation?- How the taxes get allocated between continuing operations, discontinued operations, and extraordinary itemsHow is a change in an accounting estimate accounted for?- Accounted for in the period of change- Not handled retrospectively (do NOT go back and change old financial statements)- Debit liability, credit expenseHow do you account for a change in method of accounting or an error?- Retrospectively adjust financial statements for an accounting error and for a change in accounting principles (have to go back three years for public companies)- Must include the change in footnotes- Ex. If you change from LIFO to FIFO must go back and change previous year to FIFO- A change for an error in a previous year does not affect net income if the error is in a previous