ACCT 3723 1st Edition Exam 2 Study Guide Chapter 4 1 Understand the Uses and Limitations of an Income Statement a Usefulness i Evaluate past performance ii Predicting future performance iii Help assess the risk or uncertainty of achieving future cash flows b Limitations i Companies omit items that cannot be measured reliably ii Income is affected by the accounting methods employed iii Income measurement involves judgment 2 Describe the Content and Format of the Income Statement a Revenues i EX Sales fee dividend rent and interest b Expenses i EX Cost of goods sold depreciation rent interest salaries and wages and taxes c Gains and Losses i These can result from 1 Sale of investments or plant assets 2 Settlement of liabilities 3 Write offs of assets 3 Prepare an Income Statement a Single Step Income Statement i Revenues Expenses Net Income b Multiple Step Income Statement i Separates operating transactions from non operating transactions ii Matches costs and expenses with related revenues iii Three parts 1 Operating Section 2 Non operating 3 Income Tax 4 Explain How to Report Various Income Items a Companies are required to report unusual and irregular items as part of net income b These income items fall into four categories i Unusual Gains and Losses 1 Unusual or infrequent but not both 2 Reported right above Income from Continuing Operations Before Income Taxes ii Discontinued Operations 1 Occurs when company eliminates the results of operations of a component of the business and there is no significant involvement in that component after the disposal transaction 2 Amounts reported Net of tax 3 Intraperiod Tax Allocation a Helps users understand the impact of income taxes on the various components of net income b Used for i Income from continuing operations ii Discontinued operations iii Extraordinary items iii Extraordinary Items 1 Reoccurring material items that differ significantly from a company s typical business activities 2 MUST be BOTH unusual AND infrequent 3 Reported net of tax iv NonControlling Interest 1 If a company owns less than 50 in another company GAAP requires both companies to consolidate together one set of financials 5 Identify Where to Report Earnings per Share Information a EPS Net Income Preferred Dividends Weighted Average Commons Shares Outstanding i Measures the dollars earned by each share of common stock ii Must be disclosed in the income statement 6 Understand the Reporting of Accounting Changes and Errors a Retrospective adjustment b Cumulative effect adjustment to beginning retained earnings c Approach preserves comparability across years d Change in Accounting Estimates i Accounted for in the period of change or the period of and the future periods if the change affects both ii Not handled retrospectively iii Not considered errors e Corrections of Errors i Result from 1 Mathematical mistakes 2 Mistakes in application of accounting principles 3 Oversight or misuse of facts ii Corrections treated as prior period adjustments iii Adjustment to the beginning balance of retained earnings 7 Prepare a Retained Earnings Statement a Increase i Net Income ii Change in Accounting Principle iii Prior Period Adjustments b Decrease i Net loss ii Dividends iii Change in accounting principle iv Prior period adjustments c Restrictions on Retained Earnings i Disclosed 1 In notes to the financial statements 2 As appropriated retained earning 8 Explain How to Report Other Comprehensive Income a All changes in equity during a period except those resulting from investments by owners and distributions to owners b Includes i All revenues and gains expenses and losses reported in net income and all gains and losses that bypass net income but affect stockholders equity c Companies must display the components of other comprehensive income in one OR two ways i A single continuous statement 1 Advantage a Does not require the creation of a new financial statement 2 Disadvantage a Net income buried as a subtotal on the statement ii Two separate but consecutive statements of net income and other comprehensive income d Statement of Stockholders Equity i Reports the changes in each stockholders equity account and total equity for the period Chapter 5 1 Explain the Uses and Limitations of a Balance Sheet a Balance sheet is also referred to as the statement of financial position b Usefulness i Computing rates of return ii Evaluating the capital structure iii Assess risk and future cash flows iv Analyzes the company s 1 Liquidity 2 Solvency 3 Financial Flexibility c Limitations i Assets and liabilities are Historical Costs ii Many items of financial value are omitted 2 Identify the Major Classifications of the Balance Sheet a Assets future economic benefits i Current Assets 1 EX Cash 2 Short term investments a Held to Maturity i Debt amortized debt current or noncurrent b Trading i Debt Equity Fair Value Current c Available for Sale i Debt Equity Fair Value Current Non 3 Receivables a A company should clearly identify i Anticipated loss due to uncollectibles ii Amount and nature of any nontrade receivables iii Receivables used as collateral 4 Inventories a Disclose i Basis of valuation ii Cost flow assumption EX FIFO or LIFO 5 Prepaid expenses a Cash payment BEFORE expense recorded ii Non Current Assets 1 Long Term Investments a Securities i EX Bonds common stock long term notes b Tangible Fixed Assets c Special Funds i EX Sinking funds pension funds etc d Non Consolidated Subsidiaries Affiliated Companies 2 Property Plant and Equipment a Long term tangible assets i EX Land machinery building etc b Intangible Assets i EX Goodwill patents trademark franchises copyright 3 Other Assets a Can include i Long term prepaid expenses ii Non current receivables iii In special funds iv Deferred income taxes v Property held for sale vi Restricted cash or securities b Liabilities future economic sacrifices 3 4 5 6 i Current Liabilities 1 Notes Payable 2 Accounts Payable 3 Accrued Compensation 4 Unearned Revenue 5 Income Tax Payable 6 Current Maturities ii Long Term Liabilities 1 Long term debt 2 Obligations capital lease 3 Deferred income taxes c Equity Residual interest i Capital Stock ii Additional Paid in Capital iii Retained Earnings iv Non controlling Interest Prepare a Classified Balance Sheet Using the Report and Account Formats a Account Form lists assets on left side and liabilities and equities on the right i Disadvantage 1 Must have a lot of space to do side by side b Report Form