Chapter 4

Reporting Financial Performance

Prepared by:
Patricia Zima, CA
Mohawk College of Applied Arts and Technology
 Reporting Financial Performance

Income Format of the Reporting Special Reporting Appendix 4A –

Statement Income Irregular Items Issues Cash Basis vs.
•Usefulness Statement •Discontinued •Intraperiod tax Accrual Basis
•Limitations •Elements operations allocation Earnings
•Quality of •Single-step •Extraordinary •Earnings per share •Differences
earnings •Multiple-step items •Retained earnings between cash
•Intermediate •Unusual gains statement and accrual basis
components and losses •Comprehensive •Conversion from
•Condensed •Changes in income cash to accrual
income estimates •Perspectives basis
statement •International •Theoretical
weaknesses of
cash basis

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 Financial Reporting
• Business Model identifies three activities:
1. Financing
• Obtaining cash funding
2. Investing
• Use of funding to obtain resources
3. Operating
• Use of resources to generate profits

• Financial statements should capture these

fundamental business activities
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 Financial Reporting

1. Balance Sheet
• Reports financing and investing activities
2. Income Statement
• Reports operating and performance
related activities
3. Statement of Cash Flows
• Reports interrelationship between all
three activities

4
 Uses and Limitations of the
Income Statement
Uses: Limitations:
• Evaluate past • Items are excluded if
performance and they cannot be
profitability measured reliably
• Assist in predicting • Amounts reported are
future performance affected by
• Assess potential risk accounting methods
or uncertainty in used
achieving future cash • Use of estimates in
flows measuring income

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 Quality of Earnings
• The reliability of the information presented is
dependent on the quality of earnings
• Characteristics of high quality earnings:
1. Nature of Content
• Unbiased and determined objectively
• Represents economic reality
• Reflects earnings from ongoing operations
• Can be correlated with cash flows from operations
• Based on sound business strategy/model
• Presentation
• Does not disguise or mislead (transparent)
• Information presented is understandable
• Also, information is clear and concise 6
 Single-Step Income Statement
• Presents only two groupings before Income before
Discontinued Operations and Extraordinary Items:
1. Revenues (includes gains)
2. Expenses (includes losses)
• Income tax expense often reported separate from
expenses as the last line item in determining net income
• Advantages:
– Simplicity
– Eliminates classification problems for revenues and
expenses
• Disadvantage:
– Operating and non-operating activities reported
together 7
Single-Step Income Statement
Revenues
Net Sales
Revenues Other Revenues
(e.g. Dividend, Rental)
– Expenses
Cost of Goods Sold
Expenses Selling Expenses
Administrative Expenses
= Interest Expense
Income Tax Expense
Net Income
Any Gains/Losses from
Discontinued Operations or
Earnings per Extraordinary Items must be
Share disclosed separately from
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Continuing Operations
 Multiple-Step Income Statement
• Operating and non-operating activities are
separated
• Expenses are classified by function (e.g. Selling
and Administrative Expenses, Cost of Goods
Sold)
• Advantages:
• Highlighting regular and irregular activities
allows for greater predictive value (assess
future earnings) and feedback value (assess
past earnings)
• Provides better detail to compare companies
• Allows for ratio analysis used to assess
performance 9
 Multiple-Step Income Statement
•Operating section
Continuing Operations •Nonoperating section
•Income tax

•Income/Loss from operations

Discontinued Operations •Gain/Loss from disposition
•Both reported net of taxes

•Material gains/losses
Extraordinary Items •Reported net of taxes

•Includes other
Other Comprehensive Income gains/losses not
included in net income
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 Continuing Operations–Detail
•Net Sales
•Cost of Goods Sold
Operating Section •Selling Expenses
•Administrative or General Expenses

•Other Revenues and Gains

Nonoperating Section •Other Expenses and Losses

•Separate income tax section on

Income Tax Income from Continuing
Operations only

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 Condensed Income Statement

• Expenses are reported on the income

statement in group totals
• Details of the expense groups are included
on supplementary schedules
• Provides the advantage of a concise,
understandable income statement
• An example of tradeoff between
understandability and full disclosure
• Reduces “information overload”

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 Reporting Irregular Items
• Income measurement currently follows a
modified all-inclusive approach
• Most irregular items included in income
except for the following:
1. Prior years’ income errors
2. Retroactive changes in accounting
policies
• The above exceptions are recorded as
adjustments (reported net of tax) on the
Statement of Retained Earnings
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 Reporting Irregular Items-
Discontinued Operations
• Discontinued operations includes components
that have been disposed of or are held for sale
• Components include:
- An operating segment - A reporting unit
- A subsidiary - An asset group
• A distinction made between:
- The component’s results of operations
- Disposal of the component’s assets
• The key is that the component generates its own
cash flows and has its own distinct operations

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 Discontinued Operations-
Asset Held for Sale
• Component is held for sale if the following criteria
are met:
– Authorized plan to sell exists
– Asset available for immediate sale
– Active search for a buyer
– Sale is probable within a year
– Asset is reasonably priced and marketed
– Unlikely that plan to sell will change
• These assets carried at lower of carrying value
and fair value (net of cost to sell)
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 Discontinued Operations– Statement
Presentation
Income from continuing operations (net of tax) $xx,xxx
Discontinued Operations:
Income (Loss) from operations (net of tax) $xx,xxx
Gain (Loss) on disposal (net of tax) xx,xxx xx,xxx
Net Income $xx,xxx
Earnings per share from continuing operations $ x
Earnings per share from discontinued operations x
Earnings per share on net income $ x

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 Extraordinary Items
• Presented separately on the income statement
(net of tax); generally following discontinued
operations
• Characteristics:
– Material amounts
– Non-recurring items
– Differ significantly from the typical business
activities
• Three qualifying criteria (all three must be met):
1. Infrequent
2. Atypical of normal business activities
3. Not primarily dependent on decisions made by
management (or owners) 17
 Extraordinary Items
• CICA Handbook, Section 3480 specifies that
the following gains and losses are not
extraordinary items:
1) Losses or loss provisions from bad debts
and inventories
2) Foreign exchange gains and losses
3) Contract price adjustments
4) Gains and losses from investment write
downs
5) Income tax adjustments
6) Income tax rate or law changes
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 Unusual Gains and Losses
• Include gains and losses that do not qualify
as an extraordinary item but are material in
amount
• If they are material, they are disclosed
separately on the income statement (before
extraordinary items)
• If they are not material, they are shown with
the normal revenues and expenses

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 Changes in Estimates
• Examples of change in estimates are: change
in useful lives and salvage values of capital
assets, estimate of bad debts
• Accounted for in the current period
• No adjustment is made retroactively (i.e. prior
years are not adjusted)
• If change affects future periods, change is
accounted for in those periods as well

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 Intraperiod Tax Allocation
• Refers to the allocation of income taxes
within a fiscal period
• Certain irregular items on the income
statement are reported net of tax
• Specifically, income tax expense (or benefit)
is calculated and presented separately for
the following:
1. Income from continuing operations
2. Discontinued operations
3. Extraordinary items
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 Earnings per Share
• Earnings per share (EPS) considered one of the
most significant business indicators
• Indicates dollars earned per common share; it does
not report the dollars paid (or to be paid) per
common share
• EPS based on earnings before discontinued
operations and extraordinary items and EPS based
on net income must be shown on the face of the
income statement
• EPS based on discontinued operations and EPS
based on extraordinary items may be disclosed in
the notes to the financial statements-see HB
3500.60 and 3500.61
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 Earnings per Share
• Calculated as:
Net Income less Preferred Dividends*
Weighted Average of Common Shares Outstanding
• *Preferred dividends are those dividends that have
been declared (for non-cumulative) or one year’s
fixed dividend amount (for cumulative)
• Earnings per share is subject to dilution (reduction) if
issue of additional shares is possible in the future
•For such situations, both Basic EPS and Diluted
EPS are presented

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 Retained Earnings Statement
• Retained earnings increases by net income and
decreases by net loss and declared dividends (both
cash and stock dividends) for the year
• Correction of errors in prior periods and effects to
prior periods from accounting policy changes are
treated as prior period adjustments
• They adjust (net of tax) beginning retained earnings;
also prior years’ financial statements are often
restated
• Must disclose any part of retained earnings
appropriated (restricted) for a specific purpose
(e.g. contractual obligation, corporate policy)
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 Comprehensive Income
• Includes any item that causes a change in equity
except for investments by owners and distributions
to owners
• Under all-inclusive income approach, the following
items are included as other comprehensive income:
– Unrealized gains/losses on available-for-sale
securities
– Certain translation gains/losses on foreign
currency
– Unrealized gains/losses on certain hedging
transactions

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 Comprehensive Income
• Separate disclosure of these equity items would:
1. Highlight the impact on net income of fair
value fluctuations
2. Inform users of potential gains/losses
• AcSB disclosure for other comprehensive income
items requires:
– Expanded income statement or the
statement of shareholders’ equity, or adding
another statement
– Comprehensive EPS not required to be
disclosed
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 International Issues
• The IASB involved in “Financial Statement
Presentation” project which consists of three
phases:
1. Phase A - What constitutes a complete set
of financial statements
2. Phase B - Presentation of information on the
face of the statements
3. Phase C - Interim financial reporting

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 COPYRIGHT

Copyright © 2007 John Wiley & Sons Canada, Ltd.

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