Additional Dimensions of Financial Reporting

1. Additional Dimensions of Financial Reporting Chapter 14

2. Comprehensive Income • GAAP mandate that certain changes in the value of assets and liabilities be excluded from net income.

3. Comprehensive Income • Many readers of financial statements believe the exclusion of this information reduces the usefulness of the net income figure.

4. Comprehensive Income • As a result, the FASB now requires firms to report comprehensive income.

5. Comprehensive Income • Comprehensive income is net income plus revenues, expenses, gains, and losses that are excluded from net income.

6. Accounting Changes • There are three types of accounting changes: • A change in accounting principle • A change in accounting estimate • A change in reporting entity

7. Change in Accounting Principle • A company should be consistent from period to period in principles used, but firms do sometimes change from one principle to another.

8. Change in Accounting Principle • The general rule requires a cumulative effect adjustment.

9. Change in Accounting Principle • In the year of change, account balances are restated to show those amounts that would have appeared if the new method had been used all along.

10. Change in Accounting Principle • A common example is in the area of depreciation.

11. Change in Accounting Principle • Assume that a company has used sum-of-the-years'-digits depreciation for two years, resulting in a total in the Accumulated Depreciation account of $5,000

12. Change in Accounting Principle • At the beginning of year three, the company decides to switch to straight-line for the asset.

13. Change in Accounting Principle • If the company had used straight-line for the first two years, then the total in the Accumulated Depreciation account would have been $2,000.

14. Change in Accounting Principle • Remember that Depreciation Expense reduces Retained Earnings; so, Retained Earnings in our example is $3,000 ($5,000 - $2,000) too low, and Accumulated Depreciation is $3,000 too high.

15. Change in Accounting Principle • To adjust in the year of the change, the firm will record a $3,000 increase in the account titled "Cumulative Effect of Change in Accounting Principle" (which will increase Retained Earnings) and a $3,000 decrease in Accumulated Depreciation.

16. Change in Accounting Principle • The "Cumulative Effect..." account will appear as the last item at the bottom of the income statement.

17. Change in Accounting Principle • GAAP requires note disclosure of what net income would have been in the current and prior years had the new method been used, referred to by most accountants as pro forma amounts.

18. Change in Accounting Principle • There is an exception to the general rule.

19. Change in Accounting Principle • Some changes are accounted for retroactively, meaning that prior years' financial statements are restated to reflect the use of the new method.

20. Change in Accounting Principle • Remember that with the general rule, only the current year's statements are restated.

21. Change in Accounting Principle • Restating prior years' statements is done sparingly because the appearance of different sets of numbers may erode public confidence in financial reporting.

22. The retroactive approach is used in the cases: • A change from LIFO to another inventory method.

23. The retroactive approach is used in the cases: • A change in the method of accounting for long-term construction contracts.

24. The retroactive approach is used in the cases: • A change to or from the full-cost method by firms in the extractive industries.

25. The retroactive approach is used in the cases: • A change made by a firm issuing financial statements to the public for the first time.

26. The retroactive approach is used in the cases: • When required as part of the transition process for a new FASB method.

27. Change in Accounting Estimate • Changes in accounting estimates are accounted for currently and prospectively, meaning that they are included in the year of the change and future years, if appropriate.

28. Change in Accounting Estimate • Changes in accounting estimates are accounted for currently and prospectively, meaning that they are included in the year of the change and future years, if appropriate.

29. Change in Accounting Estimate • Prior years' statements are NOT restated.

30. Change in Accounting Estimate • There are so many estimates used in accounting that restating every time a change in estimate occurred would be a nightmare.

31. Change in Accounting Estimate • The effects of changes in accounting estimates on net income must be disclosed in the notes to the financial statements.

32. Change in Accounting Estimate • There are so many estimates used in accounting that restating every time a change in estimate occurred would be a nightmare.

33. Change in Accounting Estimate • If there is a change in an estimate which is part of the depreciation calculation, then the new depreciation expense is calculated by doing the following.

34. Change in Accounting Estimate • Salvage value is subtracted from the book value of the asset, and the difference is divided by the remaining estimated useful life.

35. Change in Reporting Entity • A change in reporting entity occurs when a firm changes the specific subsidiaries included in its consolidated financial statements.

36. Change in Reporting Entity • Such changes are accounted for retroactively, meaning that prior years' financial statements are restated, thus ensuring comparability of the financial statements.

37. Segment Reporting • All publicly held corporations are required to report certain disclosures about segments in notes to the financial statements.

38. Segment Reporting • An industry segment is a component of a firm that provides a product or service, or a group of related products or services, to unaffiliated customers.

39. Segment Reporting • In identifying segments, factors to consider include the underlying nature of the product or service, the production process, markets, and the marketing process.

40. Segment Reporting • Segment data can help users of financial statements to assess risk and future trends.

41. Operating Segments • An operating segment is a component of a firm that does the following: • Engages in business activities from which it can earn revenues and incur expenses. • Has operating results that are regularly reviewed by the firm’s chief operating decision maker. • Has financial information available.

42. For each major segment, firms must report: • Operating profit or loss, calculated by subtracting a segment's operating expenses from its revenue. • This does not include an allocation of general corporate expenses.

43. For each major segment, firms must report: • Identifiable assets, which are assets used exclusively by the segment and a share of the assets used jointly with other segments.

44. For each major segment, firms must report: • Other disclosures, including revenue from external customers and depreciation expense.

45. Geographic Areas • A firms' foreign operations consist of those revenue-producing activities located outside the firm's home country.

46. Geographic Areas • Disclosure of revenue, operating profit or loss, and identifiable assets must be made for both foreign and domestic operations.

47. Geographic Areas • Information about foreign operations and export sales is particularly helpful in assessing a firm's risk.

48. Major Customers • Firms are required to disclose if sales to a single customer exceed 10% of revenue.

49. Major Customers • The customer's industry must be disclosed.

50. A firm's annual report includes these elements: • An introductory letter written by the chief executive officer • A review of the firm's types of businesses