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CHAPTER 6

Case 6-1

a. The basic markets available to Warmen Brothers are (1) domestic screening, (2)
foreign screening, (3) video rentals, (4) cable broadcasting (5) network television
stations and (6) independent television stations.

b. The entry order should be as specified in Part a because any other order would
jeopardize the maximization of revenue from each source. For example, if a film
were sold to independent television stations prior to distribution to cable and network
stations, the viewership levels of cable and network stations would decrease.

c. Revenues should be recognized from each market as they are earned under the
realization principle. Under this concept, revenue from each of the markets should
be recognized as contracts are signed or film rights are sold to each of the various
markets.

d. The matching of costs with revenues for the motion picture industry is a difficult
process. The amount of revenue available from secondary markets is highly
dependent upon the success of the film in the domestic screening market.
Consequently, holding production costs to match against secondary markets may
result in distorted net income figures. Additionally, many top film stars contracts are
based upon a percentage of total profits. A conservative method of recognizing costs
is to charge all production costs against domestic and foreign screenings, and to
charge other secondary markets only incremental costs. This is somewhat similar to
the sunk cost method of income recognition. Although this method is generally not
appropriate for most situations, the highly speculative nature of the secondary film
markets make it an acceptable practice. During the past several years some film
making companies have experienced bankruptcy partially due to faulty revenue
recognition methods. Attempting to allocate production costs across all of the
secondary markets will require estimates of the total revenues to be received from
each of those markets prior to the distribution of the film. This is a very risky
process and could lead to distorted financial statements

e. Recognizing all production costs in the period of domestic and foreign screenings
will result in conservative income figures until the secondary market revenues are
realized. This procedure might also be criticized as distorting future net income
amounts because all production costs have been recognized prior to the recognition

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 of some revenues. Never-the-less, holding production cost and matching them with
secondary market revenues is a less favorable option.

Note to the instructor:

This solution may, or may not, be chosen by the students. It is a good example of a
situation needing critical thinking skills where no clear-cut solution is available. The
development of the issues is of more importance than the final decision.

Case 6-2

The company’s primary financial statements provide information about the earnings of a
company and its present cash flows. The primary financial statements also provide
information about financial position, including assets and debt, and can use this information
to evaluate risk, such as liquidity risk.

Investors can use this information to project the amount and timing of future cash flows.
These projections are then used to value the company. Hence, the primary financial
statements meet the objectives of financial reporting found in SFAS No. 8. According to
SFAS No. 8 financial statements provide information useful for investors, creditors and other
users. They provide information useful in projecting the amount and timing of future cash
flows. They provide information about resources and claims to resources (provided by
balance sheet.) They provide information about how those resources are used and about
company performance.

Case 6-3

a. The important distinction between revenues and gains and expenses and losses is
whether or not they are associated with ongoing operations. Over the years, this
distinction has generated questions concerning the nature of income reporting desired
by various financial-statement users. Historically, two viewpoints have dominated
this dialogue and have been termed the current operating performance concept and
the all-inclusive concept of income reporting.

The proponents of the current operating performance concept base their arguments on
the belief that normal and recurring items should constitute the principal measure of
enterprise performance. That is, net income should reflect the day-to-day, profit-
directed activities of the enterprise, and the inclusion of other items of profit or loss
distort the meaning of the term net income.

On the other hand, the advocates of the all-inclusive view believe that net income
should reflect all items that affected the net increase or decrease in stockholders’
equity during the period, with the exception of capital transactions. Specifically,

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 these individuals believe that the total net income for the life of an enterprise should
be determinable by summing the periods’ net income figures.

The underlying assumption behind this controversy is that the method of presentation
of financial information is important. That is both view points agree on the
information to be presented but disagree on where to disclose different types of
revenues, expenses, gains, and losses.

b. i. Cost of goods sold is considered an expense under both the current operating
performance and all-inclusive concepts of income.

ii. Selling expenses are considered expenses under both the current operating
performance and all-inclusive concepts.

iii. Prior period adjustments are considered gains and losses under a strict
interpretation of the current operating performance concept. However, they have
been defined as nonowner changes in equity under Statement of Financial
Accounting Concepts No.5. Prior period adjustments are considered revenues
and expenses under a strict interpretation of the all-inclusive concept.

Case 6-4

a. A change from the sum-of-the-years-digits depreciation method to the

straight-line method for fixed assets is a change in accounting principle. The concept
of consistency presumes that an accounting principle, once adopted, should not be
changed in accounting for events and transactions of a similar type. A change is
permissible only if the enterprise justifies the preferability of an alternative
acceptable accounting principle. Under the provisions of FASB ASC 250, this
accounting change requires retrospective application to prior periods as if it had
always been used.

b. If a public company obtained additional information about the service lives of some
of its fixed assets showing that the service lives previously used should be shortened,
such a change would be a change in accounting estimate. The change in accounting
estimate should be accounted for in the year of change and future years since the
change affects both. Specifically, the operating item, depreciation expense, would be
increased. In addition, the effect on net income, and related per-share amounts of the
current period should be disclosed.

c. Changing specific subsidiaries comprising the group of companies for which

consolidated financial statements are presented is an example of a change in the
reporting entity. Such a change requires that the consolidated income statements be
restated to reflect the different reporting entity.

Case 6-5

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a. Earnings per share, as it applies to a corporation with a capitalization structure
composed of only one class of common stock, is the amount of earnings applicable to
each share of common stock outstanding during the period for which the earnings are
reported. The computation of earnings per share should be based on a weighted
average of the number of shares outstanding during the period with retroactive
recognition given to stock splits or reverse splits and to stock dividends, except
relatively small nonrecurring stock dividends may be ignored.

b. Meanings of terms often used in discussing earnings per share and the types of items
to which they apply follow:

1. Senior securities are securities which have preference to before earnings are
allocated to common stock. Cumulative preferred dividends whether or not
earned should be deducted from net income except "if earned" dividends
should be deducted only to the extent earned. Preferred stock is a senior
security if it has a preference on dividends. Bonds are a senior security and
interest expense on the bonds enters into the determination of net income.

2. For purposes of computing earnings per share residual securities are those
securities deriving a major portion of their value from their right to be
converted into common stock through the exercise of an option or conversion
privilege by the owner of the security. Convertible preferred stock,
convertible debt, common stock options and common stock warrants are
examples of such securities.

c. Treatments to be given to the listed items in computing earnings per share are:

i. Dividends on preferred stock should be deducted from net income before

computing earnings per share applicable to the common stock and other
residual securities. If the preferred stock is cumulative this adjustment is
appropriate whether or not the amounts of the dividends are declared or
earned.

ii. Minor reacquisitions of outstanding common stock which are placed in the
treasury may be excluded in the computation of earnings per share.
However, in determining earnings per share during the period when a
major acquisition of treasury common stock was made, the computation
should be based on the weighted average number of shares outstanding
during the period.

iii. When the number of common shares outstanding increases as a result of a

stock split during the year, the computation should be based on shares
outstanding at year end and retroactive recognition should be given for an
appropriate number of prior years.

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 iv. The existence of a provision for a contingent liability on a possible lawsuit
created out of retained earnings will not affect the computation of earnings
per share since the appropriation of retained earnings does not affect net
income or the number of shares of stock outstanding.

v. Outstanding preferred stock with a par value liquidation right issued at a

premium, although affecting the determination of book value, will not
affect the computation of earnings per share for common stock except with
respect to the dividends as discussed in c.i. above.

vi. The exercise of a common stock option which results only in a minor
increase in the number of shares outstanding during the period may be
disregarded in the computation of earnings per share. If, however, the
exercise of a common stock option results in a major increase in the
number of shares outstanding, the computation of earnings per share
should be based on the weighted average number of shares outstanding
during the period. The exercise of a stock option by the grantee does not
affect earnings, but any compensation to the officers from the granting of
the options would reduce net income and earnings per share.

vii. The replacement of a machine immediately prior to the close of the current
fiscal year will not affect the computation of earnings per share for the year
in which the machine is replaced. The number of shares remains
unchanged and since the old machine was sold for its book value, earnings
are unaffected

Case 6-6

a .i. The term accounting change means a change in (1) an accounting principle, (2)
an accounting estimate or (3) the reporting entity.

A change in accounting principle results from adoption of a generally accepted

accounting principle different from the one used previously fry reporting
purposes. The term accounting principle includes not only accounting principles
and practices but also the methods of applying them.

A characteristic of a change in accounting principle is that it concerns a choice

from among two or more generally accepted accounting principles. But neither
(1) initial adoption of an accounting principle in recognition of events or
transactions occurring for the first time or that previously were immaterial in
their effect nor (2) adoption or modification of an accounting principle
necessitated by transactions or events that are clearly different in substance from
those previously occurring is a change in accounting principle.

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 Changes in accounting principle are numerous and varied. They include, for
example, a change in the method of inventory pricing, such as from the last-in,
first-out (LIFO) method to the first-in, first-out (FIFO) method; a change in
depreciation method for previously recorded assets, such as from the double-
declining balance method to the straight-line method (other than a change to the
straight-line method at a specific point in the service life of an asset that was
planned at the time the accelerated method was adopted to fully depreciate the
cost of the asset over its estimated life); and a change in the method of
accounting for long-term construction-type contracts, such as from the completed
contract method to the percentage-of-completion method.

Changes in accounting estimates are necessary consequences of periodic

presentations of financial statements. Preparing financial statements requires
estimating the effects of future events. Examples of items for which estimates are
necessary are uncollectible receivables, inventory obsolescence, service lives and
salvage values of depreciable assets, warranty costs, periods benefited by a
deferred cost and recoverable mineral reserves. Future events and their effects
cannot be perceived with certainty; estimating requires the exercise of judgment.
Thus accounting estimates change as new events occur, as more experience is
acquired or as additional information is obtained.

Distinguishing between a change in accounting principle and a change in an

accounting estimate sometimes is difficult. For example, a company may change
from deferring and amortizing cost to recording it as an expense when incurred
because future benefits from the cost have become doubtful. The new accounting
method is adopted, therefore, in partial or complete recognition of the change in
estimated future benefits. The effect of the change in accounting principle is
inseparable from the effect of the change in accounting estimate.

Changes of this type often are related to the continuing process of obtaining
additional information and revising estimates and are therefore considered as
changes in estimates.

Changes in the reporting entity are limited mainly to (1) presenting consolidated
or combined statements in place of statements of individual companies, (2)
changing specific subsidiaries comprising the group of companies for which
consolidated financial statements are presented and (3) changing the companies
included in combined financial statements. A different group of companies
comprises the reporting entity after each change.

ii. A correction of an error in previously issued financial statements concerns

factors similar to those relating to an accounting change. Errors in financial
statements result from mathematical mistakes, mistakes in the application of

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 accounting principles or oversight or misuse of facts that existed at the time the
financial statements were prepared. In contrast a change in accounting estimate
results from new information or subsequent developments and accordingly from
better insight or improved judgment. Thus an error is distinguishable from a
change in estimate. A change from an accounting principle that is not generally
accepted to one that is generally accepted to one that is generally accepted is
considered to be a correction of an error.

b. There is a presumption that an accounting principle once adopted should not be

changed in accounting for events and transactions of a similar type. Consistent use of
accounting principles from one accounting period to another enhances the utility of
financial statements to users by facilitating analysis and understanding of
comparative accounting data.

The presumption that an entity should not change an accounting principle may be
overcome only if the enterprise justifies the use of an alternative acceptable
accounting principle on the basis that it is preferable. But a method of accounting that
was previously adopted for a type of transaction or event that is being terminated or
that was a single, nonrecurring event in the past should not be changed. For
example, the method of accounting should not be changed for a tax or tax credit that
is being discontinued or for preoperating costs relating to a specific plant. But this
does not imply that a change in the estimated period to be benefited for a deferred
cost (if justified by the facts) should not be recognized as a change in accounting
estimate. The issuance of an Accounting Standards Update by the FASB that creates
a new accounting principle that expresses a preference for an accounting principle is
sufficient support for a change in accounting principle.

The burden of justifying other change rests with the entity proposing the change. The
nature of and justification for a change in the method of inventory pricing should be
disclosed in the financial statements for the period the change was adopted; the
change should be justified on the basis that the new method is more appropriate than
the old. In addition, the effect of the change on net income and the related per share
amounts should be disclosed for all periods presented. This disclosure may be on the
face of the income statement or in the notes. Financial statements of subsequent
periods need not repeat the disclosures.

In one specific situation the application of these provisions may result in financial
statement presentations of results of operations that are not of maximum usefulness
to intended users. For example, a company owned by a few individuals may decide to
change from one acceptable inventory method to another in connection with a
forthcoming public offering of shares of its equity securities. The potential investors
may be better served by the statements of income for a period of years reflecting the
use of the newly adopted accounting principle because it will be the same as that
expected to be used in future periods. In recognition of this situation, financial

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 statements for all prior periods presented may be restated retroactively when a
company first issues its financial statements for any one of the following purposes:
(1) obtaining additional capital from investors, (2) effecting a business combination
or (3) registering securities. This exemption is available only once for changes made
at the time a company's financial statements are first used for any of the purposes and
is not available to companies whose securities currently are widely held. Under
these specific circumstances the company should disclose in financial statements
issued the nature of the change in accounting principle and the justification for it.

c & d. The general conclusion of APB Opinion No. 20 was that previously issued financial
statements need not be revised for changes in accounting principles. However, the
FASB revisited this issue and in May 2005 issued SFAS No. 154, “Accounting
Changes and Error Corrections—A Replacement of APB Opinion No. 20 and FASB
Statement No. 3,” now contained at FASB ASC 250-10. This pronouncement
required retrospective application to prior periods’ financial statements of changes in
accounting principles. Retrospective application is defined at FASB ASC 250-10-20
as:

“The application of a different accounting principle to one or more previously

issued financial statements, or to the statement of financial position at the
beginning of the current period, as if that principle had always been used, or a
change to financial statements of prior accounting periods to present the financial
statements of a new reporting entity as if it had existed in those prior years.”

When it is impracticable to determine the period-specific effects of an accounting

change on one or more prior periods presented, or the cumulative effect FASBASC
250-10, requires that the new accounting principle be applied to the balances of the
appropriate assets and liabilities as of the beginning of the earliest period for which
retrospective application is practicable and that a corresponding adjustment be made
to the opening balance of retained earnings for that period rather than being reported
in an income statement. Finally, FASB ASC 250-10 requires that a change in
depreciation, amortization, or depletion method for long-lived, nonfinancial assets be
accounted for as a change in accounting estimate (discussed below) effected by a
change in accounting principle.

Case 6-7

Situation 1

a. A change in the depreciable lives of fixed assets is a change in accounting

estimate.

b. In accordance with generally accepted accounting principles, the change in

estimate should be reflected in the current period and in future periods.

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 c. This change in accounting estimate will affect the statement of financial position
in that the accumulated depreciation in the current and future years will increase
at a different rate than previously reported, and this will also be reflected in
depreciation expense in the earnings statement in the current and future years.

d. A footnote should disclose the effect of the change in accounting estimate on net
income, and related per-share amounts for the current period.

Situation 2

a. The change from reporting the investment in Allen using the cost method to
using a consolidated financial statement basis is a change in reporting entity. The
change in reporting entity is actually a change in accounting principle, but the
APB Opinion No. 20 excluded this change from the general category to give it
special reporting procedures.

b. A change in reporting entity is effected and disclosed by restating all prior-period

financial statements in accordance with the method of presenting the current
financial statements of the new reporting entity. In the initial set of financial
statements occurring after the change, the nature of and reason for the change
must be disclosed by footnote, but subsequent financial statements need not
repeat the disclosures.

c. The statement of financial position will be affected by this change in that the
investment account of the parent and the equity section of the subsidiary will be
eliminated, intercompany accounts will be eliminated, and a goodwill account as
well as a minority interest account may arise. The income statement will be
affected in that intercompany transactions will be eliminated and a minority
interest in earnings will be shown. Also, if goodwill has been created, the income
statement may disclose an expense for goodwill impairment.

d. The financial statements of the period of the change in the reporting entity should
describe by footnote disclosure the nature of the change and the reason for it. In
addition, the effect of the change in net earnings, and related per-share amounts
should be disclosed for all periods presented. Financial statements of subsequent
periods need not repeat the disclosures.

Situation 3

a. The change in the method of computing depreciation for all fixed assets
(previously recorded and future acquisitions) represents a change in an
accounting estimate.

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 b. Accordingly, the effect of the change should be reflected in the current-year
future financial statements.
c. As a result of the change to straight line, current and future depreciation charges
will differ from what they might have been under the accelerated method, the
direction of this difference will depend on the life of the individual assets.
d. The nature of and justification for the change should also be disclosed in the
footnotes to the financial statements.

Case 6-8

a. Morgan should recognize the change in depreciation method as a change in

accounting estimate

b. The effects of the hailstorm should be reported as a separate item of continuing

operations in the income statement according to the provisions of ASU 2015-01
because it is unusual in nature and infrequent in occurrence, taking into account the
environment in which the entity operates.

Case 6-9

a. Under the current operating performance concept of income, only changes and events
under the control of management that result from current period decisions should be
included in income. Normal and recurring items should constitute the basis for
evaluating current period performance.

b. Earnings as defined under SFAC No. 5 reflect the current operating performance
concept because it excludes cumulative effects of changes in accounting principles.
These effects are the accumulation of differences in earnings of prior periods that
would have occurred had the new method been used in the past rather than the old
one. Because cumulative effects relate to the past, they are not relevant in assessing
current operating performance and as such should be excluded from the current
period measurement of income.

c. Under the all-inclusive concept of income, net income would reflect all items that
affected the net increase or decrease in equity (net assets) during the accounting
period, with the exception of capital transactions (investments by owners and
distributions to owners).

d. The definition of comprehensive income is that it is the change in net assets

occurring during the accounting period from non-owner sources. Since it would
therefore include the effects of all items that affected the net increase or decrease in
equity during the accounting period exclusive of transactions with owners, this
definition essentially reflects the all-inclusive concept of income.

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e. Under the financial capital maintenance concept of income, income is the change in
the recorded (monetary) values of net assets occurring during the accounting period
which do not result from investments by owners or distributions to owners. These
changes would include recorded changes due to changes in price level (holding gains
and losses) as well as changes due to the cumulative effect of accounting changes.
Hence, comprehensive income, which purports to measure these changes in net assets
relies upon the financial capital maintenance concept and hence is consistent with it.

f. For financial reporting practices to be consistent with the concept of physical capital
maintenance, assets would need to be measured at current replacement values and
holding gains and losses would be removed from the income statement and treated as
equity adjustments. Current practice for recording net assets is slowly evolving in
this direction. For example, investments in equity securities with readily
determinable fair values and investments in debt instruments are reported at fair
value, a current value measure. Moreover, the gains and losses resulting from
revaluing investments in securities that are classified as available for sale are
excluded from net income and treated as adjustments to equity. Accounting for
impaired loans and impaired fixed assets also results in the recording of fair value
when impairment occurs.

FASB ASC 6-1 Comprehensive Income

Reporting Comprehensive Income is contained in sections FASB ASC 220-10-45. It

is found by searching comprehensive income or by cross referencing SFAS No. 130.

FASB ASC 6-2 Net Income

Found by searching net income

205-10 and 220-10

FASB ASC 6-3 APB Opinion No. 9

Found by cross reference to APB No. 9.

225-10-05-05

FASB ASC 6-4 Discontinued Operations

Search discontinued operations.

205-20

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FASB ASC 6-5 Accounting Changes

Search accounting changes

250-10

FASB ASC 6-6 Earnings Per Share

Search earnings per share

260-10

Room for Debate

Debate 6-1 Comprehensive Income

Team 1 Defend comprehensive income

1. Comprehensive income is the change in net assets during the period, excluding
transactions with owners. Thus it is consistent with the all-inclusive concept of
income and provides income measures which are closer to economic (real) income
than is provided by net income, and with the financial capital maintenance concept of
income.

In 1936, the AAA stated that income should reflect all revenue properly given
accounting recognition and all costs written off during the accounting period
regardless of whether or not they are the results of operations in that period. Such
inclusion is needed to determine those amounts that are available for distribution to
stockholders. It thus provides an appropriate measure of the change in wealth
(income) of the enterprise and the change in wealth provided by the enterprise to its
owners.

2. Comprehensive income would include changes due to price level, holding gains,
which under GAAP are excluded from net income. These changes provide
information on the effectiveness of the company’s investment strategies and the
changes in wealth resulting from those strategies.

3. Comprehensive income includes the effects of all non-owner changes that previously
were reported as separate adjustment to equity. Their inclusion in comprehensive
income is preferable because these are non-owner changes, and hence affect owner’s
wealth during the accounting period. As such they affect enterprise performance
during the period are properly included as components of income.

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4. Comprehensive income is consistent with the concept of financial capital
maintenance because it includes all reported items that affect net assets during the
accounting period. It does not strictly follow historical cost, but it does include
holding gains and losses in the computation of income.

Team 2 Oppose comprehensive income

1. Comprehensive income should not be reported because it is not consistent with the
current-operating performance concept of income and it represents a departure from
the realization principle

2. For the most part, net income includes the results of transactions and events on the
performance of the company for the period. It is historical in nature and provides
accounting information which is relevant, objective and reliable. It provides
information to investors on how their monetary investments were used to generate
dollars for the enterprise and to increase investor wealth.

3. Because net income is primarily based on the current-operating concept of income, it

provides predictive ability regarding future performance of the company. It shows
the amount of revenues realized or realizable during the accounting period. These
amounts can be extrapolated into the future. It shows the expenses associated with
generating those revenues. These too can be extrapolated.

1. Comprehensive income includes items which do not have predictive ability. It includes
the effects of price level adjustments and foreign currency translation adjustments.
Including holding gains and losses obscures the measure of income available for
distribution to stockholders. Holding gains have not been realized and are not yet
available for distribution. Foreign currency translation adjustments are bookkeeping
“plugs” that result from using the average exchange rate for income statement
adjustments and the current rate for balance sheet adjustments. They are not realized
and do not affect the amount of dollars that are currently.

Debate 6-2 Income Concepts

Comprehensive Income

Issues about income reporting have been characterized broadly in terms of a contrast
between the current operating performance and the all-inclusive income concepts.
Although the FASB generally has followed the all-inclusive income concept, as
introduced in Chapter 5, it has made some specific exceptions to that concept.
Several accounting standards require that certain items that qualify as components of
comprehensive income bypass the income statement. Other components are required
to be disclosed in the notes. The rationale for this treatment is that the earnings
process is incomplete. Examples of items currently not disclosed on the traditional
income statement and reported elsewhere are unrealized gains and losses on available

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 for sale securities and certain foreign currency gains and losses.
Current operating performance concept (COPC): The application of this concept is
one of the two main approaches to measuring earnings. The concept is explained in
International Accounting Standard No.8, “Unusual and Prior Period Items and
Changes in Accounting Policy”. When earnings are measured on the basis of this
concept, such earnings consist of income from normal enterprise operations before
non-recurring items (such as write-offs) and capital gains and losses are accounted
for.

This latter concept would require the income statement to be designed on what might
be called a ‘current operating performance’ basis, because its chief purpose is to aid
those primarily interested in what a company was able to earn under the operating
conditions of the period covered by the statement.”

Team 1

As advocates of the all-inclusive concept of income (sometimes called clean surplus),

we hold that net income should reflect all items that affected the net increase or
decrease in stockholders’ equity during the period, with the exception of capital
transactions. We believe that the total net income for the life of an enterprise should
be determinable by summing the periodic net income figures.

We advocate the all-inclusive income statement because we feel that it is more

transparent to have everything clearly disclosed in the income statement, and that to
put items directly into retained earnings does not meet the criterion of full disclosure.
Further, we believe that the all-inclusive concept of income aids in the avoidance of
biased reporting, where management might be able to pick and choose what to report
in the income statement.

The FASB noted in SFAC No. 5 that the all-inclusive income statement is intended to
avoid discretionary omissions from the income statement, even though “inclusion of
unusual or non-recurring gains or losses might reduce the usefulness of an income
statement for one year for predictive purposes.” The FASB has also stated that
because the effects of an entity’s activities vary in terms of stability, risks, and
predictability, there is a need for information about the various components of
income.

Consistent with the above, the FASB now requires that companies report
Comprehensive income – the change in net assets that do not result from transactions
with owners. Comprehensive income includes earnings (net income) plus all other
changes in net assets from non-owner events or transactions. For example,
translation adjustments and changes in the value of investments in available-for-sale
securities are not included in net income, but are included in comprehensive income.

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Team 2

Members of our team are proponents of the current operating performance concept
of income. We base our arguments on the belief that only changes and events
controllable by management that result from current-period decisions should be
included in income. This concept implies that normal and recurring items should
constitute the principal measure of enterprise performance. That is, net income
should reflect the day-to-day, profit-directed activities of the enterprise, and the
inclusion of other items of profit or loss distorts the meaning of the term net income.
We believe that income statements that report only the current operating performance
of the company provide an appropriate basis for comparing one firm with another and
for comparing what a company does from one year to the next. A purpose of
financial reports is to provide users with a means of predicting future cash flows. If
so, a current operating performance measure of income is more relevant for decision-
making. It would not include non-recurring items. So, it could be more readily
relied upon as a basis for prediction. This helps fulfill the concept of relevance
because it would provide predictive and feedback value.

WWW

Case 6-10

The company’s primary financial statements provide information about the earnings of a
company and its present cash flows. The primary financial statements also provide
information about financial position, including assets and debt, and can use this information
to evaluate risk, such as liquidity risk.

Investors can use this information to project the amount and timing of future cash flows.
These projections are then used to value the company. Hence, the primary financial
statements meet the objectives of financial reporting found in SFAS No. 8. According to
SFAS No. 8 financial statements provide information useful for investors, creditors and other
users. They provide information useful in projecting the amount and timing of future cash
flows. They provide information about resources and claims to resources (provided by
balance sheet.) They provide information about how those resources are used and about
company performance.

Case 6-11

1. No disclosure is required. The error has “washed out”; that is, subsequent income
statement compensated for the error. However, prior year income statements should
be restated.

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2. Should be reported as depreciation expense in body of income statement, based on
the new useful life. Changes in the estimated useful life of assets are changes in
estimates that are reported in the current and future periods.
3. No separate disclosure is generally required. This is a change in estimate that is
considered part of normal business activity.
4. Report in the body of the income statement, possibly as an unusual item.
5. Adjustment to the beginning balance of retained earnings. A change in inventory
methods is a change in accounting principle and prior periods are adjusted.
6. Report in body of the income statement, possibly as an unusual item.
7. Report in body of the income statement, possibly as an unusual item.
8. Prior period adjustment, adjust beginning retained earnings. Corrections of errors are
shown as prior period adjustments.
9. Discontinued operations. The division’s assets, results of operations, and activities
are distinguishable physically, operationally, and for financial reporting purposes.

Case 6-12

The new proposed income statement has separate categories for the disclosure of a
company’s operating business, its financing activities, investing activities, and tax payments.
Each category also contains an income subtotal. The proposal adopts a single statement of
comprehensive income format that combines income statement elements and components of
other comprehensive income into a single statement. Items of other comprehensive income
are to be presented in a separate section following the income statement elements. This
presentation format includes a subtotal of net income and a total of comprehensive income in
the period. The Boards the eliminated the current alternative presentation format that allows
items of other comprehensive income to be presented either: (1) On a separate statement, (2)
On a combined statement of comprehensive income, or (3) On the statement of stockholder’s
equity because research studies suggested that investors and other users’ ability to process the
information will be enhanced if a uniform format of comprehensive income statement is
presented.

According to the proposal, all income and expense items will be classified into operating,
investing, and financing categories. Within those categories, an entity will disaggregate line
items by function. Within those functions, an entity should further disaggregate line items by
nature when such presentation will enhance the usefulness of the information in predicting
future cash flows. Function refers to the primary activities in which an entity is engaged. For
example, an entity’s operating activities consist of selling goods, marketing or administration.
Nature refers to the economic characteristics or attributes that distinguish assets, liabilities,
and income and expense items that do not respond equally to similar economic events.
Examples of disaggregation by nature include disaggregating total sales into wholesale and
retail or disaggregating total cost of sales into materials, labor, transport, and energy costs.
The desegregations will result in more subtotals than current income statement therefore
facilitate the comparison of effects across financial statement.

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Another difference between the proposed format and current practice is in the treatment of
foreign currency transaction gains and losses. Currently, these gains and losses are reported
in the income statement at a net amount. Under the proposal, individual foreign currency
transactions gains or losses are to be included in the same category as the related asset or
liability on the balance sheet. Gains or losses may also arise when a company remeasures its
subsidiary’s financial statements from the local currency to its functional currency. The
proposal requires companies to identify the components of gains or losses from
remeasurement and classify them into the operating, investing or financing categories
accordingly.

The Boards agreed on retaining the current intraperiod tax allocation method. The Boards did
not support allocation of income tax expense or benefit to the operating, investing, financing
asset, or financing liability categories because they determined that the cost of doing so
would exceed the benefit. Similarly, were are no proposed changes in the then current
reporting format for discontinued operations, extraordinary items and changes in accounting
principles. The exposure draft didn’t provide guidance on which items should be included in
the comprehensive income because they are discussed in other exposure drafts.

Case 6-13

IAS No. 8 indicates that in making that judgment, the following sources should be considered
in descending order:

 The requirements and guidance in IASB standards and interpretations dealing with
similar and related issues; and
 The definitions, recognition criteria and measurement concepts for assets, liabilities,
income and expenses in the Framework for the Presentation of Financial Statements.
 The most recent pronouncements of other standard-setting bodies that use a similar
conceptual framework to develop accounting standards.
 Other accounting literature and accepted industry practices, to the extent that these do
not conflict with the sources in paragraph.

Case 6-14

a. The objective of IAS 1 is to prescribe the basis for presentation of general-purpose

financial statements, to ensure comparability both with the entity’s financial
statements of previous periods and with the financial statements of other entities.
b. IAS No. 1 indicates that a complete set of financial statements should include a
statement of comprehensive income for the period (or an income statement and a
statement of comprehensive income).
c. An entity has the choice of presenting a single statement of comprehensive income or
two statements: an income statement displaying components of profit or loss and a
statement of comprehensive income that begins with profit or loss and displays
components of other comprehensive income. It requires that as a minimum, the
statement of comprehensive income include line items that present the following
amounts for the period: revenue, finance costs, share of the profit or loss of associates
and joint ventures accounted for using the equity method, tax expense, a single

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 amount comprising the total of the post-tax profit or loss of discontinued operations,
and the post-tax gain or loss recognized on the measurement to fair value less costs to
sell or on the disposal of the assets or disposal group(s) constituting the discontinued
operation, profit or loss, each component of other comprehensive income classified
by nature, share of the other comprehensive income of associates and joint ventures
accounted for using the equity method, and total comprehensive income.

Case 6-15

The solution to this case depends upon the companies selected. Requiring the students to
print the relevant information from the financial statements is a good method to use to check
their answers.

Financial Analysis Case

Solution will depend on the companies selected to analyze.

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