Understanding Operating Decisions in Financial Accounting
School
Wilfrid Laurier University**We aren't endorsed by this school
Course
BU 127
Subject
Accounting
Date
Dec 11, 2024
Pages
71
Uploaded by MateTeamSnail49
FINANCIAL ACCOUNTINGEighth Canadian EditionLIBBY, LIBBY, HODGE, KANAAN, STERLINGFINANCIAL ACCOUNTINGEighth Canadian EditionLIBBY, LIBBY, HODGE, KANAAN, STERLING© 2023 McGraw Hill LimitedPrepared by Shannon Butler, CPA, CA, MEdCarleton University, Sprott School of BusinessOperating Decisionsand the Accounting SystemChapter 3
3-2© 2023 McGraw Hill LimitedLearning ObjectivesLO3-1 Describe a typical business operating cycle and explain the necessity for the periodicity assumption.LO3-2 Explain how transactions arising from operating activities affect the elements of the statement of earnings.LO3-3 Explain the accrual basis of accounting and apply the revenue and expense recognition principles to measure net earnings.LO3-4 Apply transaction analysis to recognize, classify, and record the effects of transactions arising from operating activities on the financial statements.
3-3© 2023 McGraw Hill LimitedLearning Objectives ContinuedLO3-5 Prepare a classified statement of earnings.LO3-6 Compute and interpret the total asset turnover ratio and the return on assets.LO3-7Identify operating transactions and explain the difference between net earnings and cash flow from operations.SUPPLEMENTARY MATERIALLO3-S1 Explain earnings measurement and comprehensive income.
3-4© 2023 McGraw Hill LimitedThe Operating Cycle (cash-to-cash cycle) The operating (or cash-to-cash) cycle is the time it takes for a company to pay cash to suppliers, sell those goods and services to customers, and receive cash from customers.
3-5© 2023 McGraw Hill LimitedThe Periodicity AssumptionTo meet the needs of decision makers, we report financial information for relatively short time periods (monthly, quarterly, annually).Two types of issues arise in reporting periodic net earnings to users:Recognition issues.Whenshould the transactions and their effects of operating activities be recognized, classified, and recorded?Measurement issues.What amountsshould be recognized and recorded for the transactions?
3-6© 2023 McGraw Hill LimitedClassified (or Multiple-Step) Statement of EarningsRevenue– Expense= Net earningsChapter 1Statement of EarningsChapter 3 Classified Statement of EarningsNet sales– Cost of sales= Gross profit– Operating expenses= Earnings from operations+/– Non-operating income= Earnings before income taxes– Income tax expense= Earnings from continuing operations+/– Income from discontinued operations= Net earningsEarnings per shareAdditional Slide
3-7© 2023 McGraw Hill LimitedClassified Statement of EarningsThe statement of earnings includes a number of sections and subtotals to aid the user in identifying the company’s earnings from operations for the year, and to highlight the effect of other items on net earnings.Most manufacturing and merchandising companies use the following basic structure as shown on the next slide.
3-8© 2023 McGraw Hill LimitedClassified Statement of Earnings Basic Structure:Net sales− Cost of sales= Gross profit− Operating expenses= Earnings from operations+/− Non-operating revenues/expenses and gains/losses= Earnings before income taxes− Income tax expense= Earnings from continuing operations+/− Earnings/loss from discontinued operations= Net earnings
3-9© 2023 McGraw Hill LimitedClassified Statement of Earnings ContinuedThe statement of earnings includes three major sections: 1.Results of continuing operations2.Results of discontinued operations3.Earnings per shareAll companies report information for sections 1 and 3, while some companies report information in section 2, depending upon their particular circumstances. The bottom line, net earnings, is the sum of sections 1 and 2.
3-10© 2023 McGraw Hill LimitedContinuing OperationsThis section of the statement of earnings presents the results of normal or continuing operations. Revenuesare defined as increases in assets or settlements of liabilities from ongoing operationsof the business. Operating revenues result from the sale of goods or services. Expensesare decreases in assets or increases in liabilities from ongoing operations, and are incurred to generate revenues during the period.
3-11© 2023 McGraw Hill LimitedPrimary Operating Expenses Part 1The following are primary operating expenses for most merchandising companies: 1. Cost of salesis the cost of products sold to customers. In companies with a manufacturing or merchandising focus, the cost of sales (also called cost of goods sold) is usually the most significant expense. The difference between sales—net of sales discounts, returns, and allowances—and cost of sales is known as gross profit (or gross margin).2. Selling and distribution expensesinclude the salaries of all personnel who support the sales effort.3. Administrative expensesinclude a variety of expenses related to salaries of administrative personnel, legal counsel, accountants, and computer technicians, travel, and telecommunications services, among others.
3-12© 2023 McGraw Hill LimitedPrimary Operating Expenses Part 24. Gains (orlosses) on disposal of assets.Companies dispose of (either sell or abandon) property and equipment from time to time to maintain modern facilities. Gains(with an account called gain on disposal of assets) are increases in assets or decreases in liabilities that result when assets other than investments are sold for more than their cost. Lossesare decreases in assets or increases in liabilities resulting from the sale of assets other than investments for less than their cost.Earnings (loss) from operations, also called operating income, equals net sales less cost of sales and operating expenses.
3-13© 2023 McGraw Hill LimitedPrimary Operating Expenses Part 3
3-14© 2023 McGraw Hill LimitedNon-Operating ItemsNot all activities affecting a statement of earnings are central to continuing operations. Any revenues, expenses, gains, or losses that result from these other activities are not included as part of earnings from operations but instead categorized as other income or expenses. These typically include:Interest income, financing costs, gains or losses on sale of investments. The non-operating items that are subject to income taxes are added to or subtracted from earnings from operations to obtain the earnings before income taxes(or pretax earnings).
3-15© 2023 McGraw Hill LimitedIncome Tax ExpenseIncome tax expense is the last expense listed on the statement of earnings. All for-profit corporations are required to compute income taxes owed to federal, provincial, and foreign governments. Income tax expense is calculated as a percentage of earnings before income taxes, reflecting the difference between income, which includes revenues and gains, and expenses and losses. It is determined by using applicable tax rates.
3-16© 2023 McGraw Hill LimitedDiscontinued OperationsCompanies may dispose of a major line of business or a geographical area of operations during the accounting period, or decide to discontinue a specific operation in the near future. The net earnings or loss from that component, as well as any gain or loss on subsequent disposal, are disclosed separately on the statement of earnings as discontinuedoperations. Because of their non-recurring nature, the financial results of discontinued operations are not useful in predicting future recurring net earnings.
3-17© 2023 McGraw Hill LimitedEarnings (Loss) per ShareCorporations are required to disclose earnings (loss) per share on the statement of earnings or in the notes to the financial statements. This ratio is widely used in evaluating the operating performance and profitability of a company. Simple earnings per share can be calculated as net earnings divided by the average number of shares outstanding during the period. The calculation of the ratio is actually more complex and beyond the scope of this course.
3-18© 2023 McGraw Hill LimitedHow Are Operating Activities Recognized and Measured? Many local retailers and other small businesses use cash basis accounting, in which revenues are recorded when cash is received and expenses are recorded when cash is paid, regardless of when and revenues are earned or the expenses are incurred. A cash basis is often quite adequate for these small businesses, which usually do not have to report to external users.
3-19© 2023 McGraw Hill LimitedCash Basis AccountingFinancial statements created under cash basis accounting normally postpone or accelerate recognition of revenues and expenses long after or before goods and services are produced and delivered (when cash is received or paid).The cash basis also does not necessarily reflect all assets and liabilities of a company on a particular date. Cash basis financial statements are not very useful to external decision makers. IFRS therefore require accrual basis accounting for financial reporting purposes.
3-20© 2023 McGraw Hill LimitedAccrual AccountingIn accrual basis accounting, revenues and expenses are recognized when the transaction that causes them occurs, not necessarily when cash is received or paid.
3-21© 2023 McGraw Hill LimitedAccrual Accounting, Important TipAccrual accounting, in short:•Recognize revenues when EARNED(goods delivered, services performed)•Recognize expenses when INCURRED(resources used or debts incurred to generate revenues in the same period)The revenue recognition principleand the expenserecognition principledetermine when revenues and expenses are to be recorded under accrual basis accounting.
3-22© 2023 McGraw Hill LimitedCash-basis vs Accrual-basis Accounting—ExampleAdditional SlideThe company sold and delivered its products to a customer in the current month and allowed the customer to make a payment of $1,000 next month. The customer made the full payment next month as promised.Delivered the productReceived $1,000 cashCurrent MonthNext MonthUnder cash-basis accounting, the sales revenue of $1,000 should be recorded next month (upon cash receipt).Under accrual-basis accounting, the sales revenue of $1,000 should be recorded in the current month (upon delivery).
3-23© 2023 McGraw Hill LimitedThe Revenue Recognition PrincipleThe revenue recognition principlespecifies both the timing and amount of revenue to be recognized during an accounting period. It requires that a company recognize revenuewhen goods and services are transferred tocustomers in an amount it expects to be entitled toreceive.There are five steps to follow for recognizing revenue, especially when a sales contract is more complex.These five steps are on the next slide.
3-24© 2023 McGraw Hill LimitedRevenue Recognition, Five StepsStep 1: Identify the contract (written, verbal, or implied agreement) between the company and customer.Step 2: Identify the seller’s performance obligations (promised goods and services).Step 3: Determine the transaction price (the amount the seller expects to be entitled to receive from the customer).Step 4: Allocate the transaction price to the performance obligations.Step 5: Recognize revenue when each performance obligation is satisfied (or over time if a service is provided over time).
3-25© 2023 McGraw Hill LimitedRecording Revenues versus Cash ReceiptsThe critical point for revenue recognition under the five-step model is when goods or services are delivered, not when cash is received from customers. Cash can be received from customers (1) in a period beforedelivery, (2) in the sameperiod as delivery, or (3) in a period afterdelivery.
3-26© 2023 McGraw Hill LimitedRecording Revenues vs Cash Receipts – Scenario 1The simplest scenario—cash received during the same period of delivery of goods/servicesCash ReceivedRecord REVENUE hereDELIVERYTIMECash xxxSales revenue xxxAdditional Slide
3-27© 2023 McGraw Hill LimitedRecording Revenues vs Cash Receipts – Scenario 2Cash received before delivery of goods/servicesCash ReceivedRecord REVENUE hereDELIVERYTIMECash xxxSales revenue xxxDeferred revenue xxxDeferred revenue xxx(Note: “Deferred Revenue” is also known as “Unearned Revenue”.)Additional Slide
3-28© 2023 McGraw Hill LimitedRecording Revenues vs Cash Receipts – Scenario 1The simplest scenario—cash received during the same period of delivery of goods/servicesCash ReceivedRecord REVENUE hereDELIVERYTIMECash xxxSales revenue xxxAdditional Slide
3-29© 2023 McGraw Hill LimitedTIMERecording Revenues vs Cash Receipts – Scenario 3Cash received after delivery of goods/servicesCash ReceivedRecord REVENUE hereDELIVERYCash xxxSales revenue xxxAccounts receivable xxxAccounts receivable xxxAdditional Slide
3-30© 2023 McGraw Hill LimitedRevenue Recognition – Example 1Cash is receivedbefore the goods or services aredelivered.On receipt of a $1,000 cash depositDebitCreditCash (+A)1,000Deferred revenue (+L)1,000On deliveryof ordered goodsDeferred revenue (−L)1,000Sales revenue (+R, +SE)1,000
3-31© 2023 McGraw Hill LimitedRevenue Recognition – Example 2Cash is receivedin the same period as the goods orservices are delivered.On deliveryof purchased goods for $300 cashDebitCreditCash (+A)300Sales revenue (+R, +SE)300
3-32© 2023 McGraw Hill LimitedRevenue Recognition – Example 3Cash is receivedafter the goods or services are delivered.On deliveryof purchased goods for $500 on accountDebitCreditAccounts receivable (+A)500Sales revenue (+R, +SE)500On receipt of cash after deliveryCash (+A)500Accounts receivable (−A)500
3-33© 2023 McGraw Hill LimitedExpense Recognition Principle Part 1The expense recognition principle requires that expenses be recorded in the same period when incurred in earning revenue.In other words, all of the resources consumed in earning revenues during a specific period must be recognized in that same period, a matching of costs with benefits.
3-34© 2023 McGraw Hill LimitedExpense Recognition Principle Part 2The costs of generating revenue include expenses incurred, such as:Salaries to employees who workedduring the period(wages expense)Utilities for the electricity usedduring the period(utilities expense)Inventory items (e.g., T-shirts, legwear, pants and shorts) that are sold during the period(cost of sales)Facilitiesrentedduring the period(rent expense)Useof buildings and equipment for production purposes during the period(depreciation expense)
3-35© 2023 McGraw Hill LimitedMore Examples of ExpensesSalaries to employees who worked during the period (wages expense)Utilities (electricity, gas, water, phone, etc.) used during the period (utilities expense)Inventories (ready-for-sale goods) sold during the period (cost of sales)Use of properties rented during the period (rent expense)Use of self-owned buildings and equipment during the period (depreciation expense)Use of supplies during the period (supplies expense)Use of borrowed money during the period (interest expense)Use of purchased TV ads time slots during the period (advertising expense)Use of insurance during the period (insurance expense)Additional Slide
3-36© 2023 McGraw Hill LimitedRecording Expenses versus Cash PaymentsAs with revenues and cash receipts, expenses are recorded as incurred, regardless of when cash is paid. Cash may be paid (1) before, (2) during, or (3) after an expense is incurred. An entry is made on the date the expense is incurred and another one on the date of the cash payment, if at different times.
3-37© 2023 McGraw Hill LimitedRecording Expenses vs Cash Payments – Scenario 1The simplest scenario—cash paid during the same period of expense incurredCash PaidRecord EXPENSE hereINCURREDTIMEXX expense xxxCash xxxAdditional Slide
3-38© 2023 McGraw Hill LimitedRecording Expenses vs Cash Payments – Scenario 2Cash paid before expense incurred (e.g., prepaid rent, prepaid insurance)Cash PaidRecord EXPENSE hereINCURREDTIMECash xxxXX expense xxxPrepaid expense xxxPrepaid expense xxxAdditional Slide(Note: More specific account titles such as “Prepaid Insurance” or “Prepaid Rent” can be used.)
3-39© 2023 McGraw Hill LimitedRecording Expenses vs Cash Payments – Scenario 1The simplest scenario—cash paid during the same period of expense incurredCash PaidRecord EXPENSE hereINCURREDTIMEXX expense xxxCash xxxAdditional Slide
3-40© 2023 McGraw Hill LimitedTIMERecording Expenses vs Cash payments – Scenario 3Cash paid after expense incurred (e.g., unpaid utilities, unpaid wages)Cash paidRecord EXPENSE hereINCURREDCash xxxXX expense xxxXX payable xxxXX payable xxxAdditional Slide
3-41© 2023 McGraw Hill LimitedRecording Expenses vs Cash Payments – Tricky Examples2.In Nov, Dell paid technicians $500 for their work in Oct. Dell prepares the J/E for Nov.1.In Nov, Dell paid technicians $500 for their work in Nov. Dell prepares the J/E for Nov.3.In Nov, Dell’s technicians earned $500 for their work. Dell will pay them in Dec. Dell prepares the J/E for Nov.Wages expense500Cash500Oct’s wages expense. In Oct, Dell must have Dr. Wages expense 500 & Cr. wages payable 500. In Nov, the Oct payable is paid.Cash paid in the same month (Nov) of wages expense incurredNov’s wages expense. Cash to be paid next monthAdditional SlideWages payable500Cash500Wages expense500Wages payable500
3-42© 2023 McGraw Hill LimitedExpense Recognition Principle– Example 1, Part 1Cash is paidbefore the expense is incurred to generaterevenue.Companies purchase many assets that are used to generate revenues in future periods. Examples include buying insurance for future coverage, paying rent for future use of space, and acquiring supplies and equipment for future use. When revenues are generated in the future, the company records an expense for the portion of the cost of the assets used.
3-43© 2023 McGraw Hill LimitedExpense Recognition Principle– Example 1, Part 2Cash is paidbefore the expense is incurred to generaterevenue.On payment of $200 cash for office suppliesDebitCreditOffice supplies (+A)2,000Cash (−A)2,000On subsequent use of half of the suppliesSupplies expense (+E, −SE)1,000Office supplies (−A)1,000
3-44© 2023 McGraw Hill LimitedExpense Recognition Principle– Example 2Cash is paidin the same periodas the expense is incurredto generate revenue.Expenses are sometimes incurred and paid for in the period in which they arise. An example is paying for repairs on sewing machines the day of the service. On payment of $500 cashfor using a repair serviceDebitCreditRepairs expense (+E, −SE) 500Cash (−A) 500
3-45© 2023 McGraw Hill LimitedExpense Recognition Principle– Example 3, Part 1Cash is paidafter the cost is incurred to generaterevenue.Although rent and supplies are typically purchased before they are used, many costs are paid after goods or services have been received and used. Examples include using electric and gas utilities in the current period that are not paid for until the following period, using borrowed funds and incurring interest expense to be paid in the future, and owing wages to employees who worked in the current period.
3-46© 2023 McGraw Hill LimitedExpense Recognition Principle– Example 3, Part 2Cash is paidafter the cost is incurred to generaterevenue.On the use of $4,000 employees’ services during the periodDebitCreditSalaries expense (+E, −SE)4,000Salaries payable (+L)4,000On payment of cash after using employees’ servicesSalaries payable (−L)4,000Cash (−A)4,000
3-47© 2023 McGraw Hill LimitedCombined Rules (Extremely Important)Debit is left, and credit is right. (Always!)Asset and Expense accounts increase on the left (debit) side and normally have debit balances, while others increase on the right (credit) side and normally have credit balances.Revenue and expense T-accounts have zero beginning balances.Additional Slide
3-48© 2023 McGraw Hill LimitedCombined Rules (Extremely Important)In a journal entry:1.Both debit and credit must appear. In other words, if we debit something, we must credit something else.2.Total debits must equal total credits.As long as these conditions are met, the basic accounting equation A = L + SE will always hold true.Additional Slide
3-49© 2023 McGraw Hill LimitedExpanded Transaction Analysis Model
3-50© 2023 McGraw Hill LimitedTransaction Analysis Rules Part 1All accounts can increase or decrease, although revenues and expenses tend to increase throughout a period as transactions occur. For accounts on the left side of the accounting equation, the increase symbol, +, is written on the left side of the T-account. For accounts on the right side of the accounting equation, the increase symbol, +, is written on the right side of the T-account, except for expenses, which increase on the leftside of the T-account.
3-51© 2023 McGraw Hill LimitedTransaction Analysis Rules Part 2Debits (dr) are written on the left side of each T-account and credits (cr) are written on the right.Total debits equal total credits when changes arising from each transaction are recognized, classified, and recorded in the proper accounts.Every transaction affects at least two accounts.
3-52© 2023 McGraw Hill LimitedTransaction Analysis Rules Part 3When a revenue or expense is recorded, either an asset or a liability will be affected as well:Revenues increase net earnings, retained earnings, and shareholders’ equity. Revenues have creditbalances; that is, to increase a revenue account, you credit it, which increases net earnings and retained earnings. Recording revenue results in either increasing an asset (such as cash or accounts receivable) or decreasing a liability (such as deferred subscriptions revenue).
3-53© 2023 McGraw Hill LimitedTransaction Analysis Rules Part 4When a revenue or expense is recorded, either an asset or a liability will be affected as well:Expenses decrease net earnings, thus decreasing retained earnings and shareholders’ equity. Expenses have debitbalances (opposite of the balance in retained earnings); that is, to increase an expense, you debit it, which decreases net earnings and retained earnings.Recording an expense results in either decreasing an asset (such as supplies when used) or increasing a liability (such as wages payable when money is owed to employees).
3-54© 2023 McGraw Hill LimitedTransaction Analysis Rules Part 5When revenues exceed expenses, the company reports net earnings, increasing retained earnings and shareholders’ equity. When expenses exceed revenues, a net loss results that decreases retained earnings and, thus, shareholders’ equity.
3-55© 2023 McGraw Hill LimitedSummaryREVENUESEXPENSES•Increase net earnings and shareholders’ equity•Decrease net earnings and shareholders’ equity•↑ with credits•↑ with debits•Accounts have credit balances•Accounts have debit balancesExpensesincrease on the left side (the debit side) of the T-account to reduce net earnings, retained earnings, and shareholders’ equity.
3-56© 2023 McGraw Hill LimitedTransaction Analysis Steps:Step 1: Ask → Was a revenue earned by delivering goods or services?•If so:•Debit the appropriate account for what was received, and •Credit the revenue account.•or Ask → Was an expense incurred to generate a revenue in the current period?•If so:•Debit the expense account, and •Credit the appropriate account for what was given.•or Ask → If the transaction resulted in no revenue earned or expense incurred, what was received and given?•Debit the appropriate account for what was received, and •Credit the appropriate account for what was given.Step 2: Verify → Is the accounting equation in balance? (A = L + SE)
3-57© 2023 McGraw Hill LimitedHow is the Statement of Earnings Prepared and Analyzed Part 1?First determine that the debits equal credits after all of the transactions from the period by generating a trial balance.Accounts are listed in a specific order: assets, liabilities, and shareholders’ equity accounts are reported on the statement of financial position, followed by revenues/gains, and expenses/losses that are reported on the statement of earnings. The ending account balances that did not change as a result of the transactions are taken from the beginning trial balance from the period.
3-58© 2023 McGraw Hill LimitedHow is the Statement of Earnings Prepared and Analyzed Part 2?The accounts that did change due to transactions arising from operating activities, their ending balances are taken from the T-accounts. There may also be new accounts that are added from the previous list of accounts.End-of-period adjustments have to be made to reflect all revenues earned and expenses incurred during the period.Chapter 4 will describe the adjustment process to update the accounting records.
3-59© 2023 McGraw Hill LimitedKey Ratio Analysis Part 1TOTAL ASSET TURNOVER RATIOANALYTICAL QUESTION→ How effective is management at generating sales from assets (resources)?RATIO AND COMPARISONS→ The total asset turnover ratio is useful in answering this question. It is computed as follows:*Average total assets = (Beginning total assets + Ending total assets) ÷ 2.Total AssetTurnoverRatioSales (or Operating) RevenuesAverage Total Assets*=
3-60© 2023 McGraw Hill LimitedKey Ratio Analysis Interpretation Part 1TOTAL ASSET TURNOVER RATIO INTERPRETATIONThe total asset turnover ratio measures the sales generated per dollar of assets. A high total asset turnover ratio signifies efficient management of assets; a low total asset turnover ratio signifies less-efficient management. Stronger operating performance improves the total asset turnover ratio. Creditors and security analysts use this ratio to assess a company’s effectiveness at controlling current and non-current assets.
3-61© 2023 McGraw Hill LimitedKey Ratio Analysis Part 2RETURN ON ASSETS (ROA)ANALYTICAL QUESTION→ How well has management used the total investment in assets financed by both debtholders and shareholders during the period? RATIO AND COMPARISONS→ Analysts refer to the return on assets (ROA) as a useful measure, computed as follows:Return on AssetsNet Earnings Average Total Assets=
3-62© 2023 McGraw Hill LimitedKey Ratio Analysis Interpretation Part 2RETURN ON ASSETS INTERPRETATIONROA measures how much the firm earned for each dollar of investment in assets. It is the broadest measure of profitability and management effectiveness, independent of financing strategy. ROA allows investors to compare management’s investment performance against alternative investment options. Firms with higher ROA are doing a better job of selecting new investments, all other things being equal.
3-63© 2023 McGraw Hill LimitedFocus on Cash Flows – Operating Activities Part 1In this chapter, we focus on cash flows from operating activities: cash fromoperating sources, primarily customers, and cash tosuppliers and others involved in operations. The accounts most often associated with operating activities are current assets—such as accounts receivable, inventories, and prepaid expenses—and current liabilities, such as accounts payable, wages payable, and deferred revenue.
3-64© 2023 McGraw Hill LimitedFocus on Cash Flows – Operating Activities Part 2Companies report cash inflows and outflows over a period of time in their statement of cash flowsthat is divided into three categories:Operating activitiesInvesting activitiesFinancing activitiesOnly transactions affecting cash are reported on the statement. An important step in constructing and analyzing the statement of cash flows is identifying the various transactions as operating, investing, or financing.
3-65© 2023 McGraw Hill LimitedFocus on Cash Flows – Operating Activities Part 3To remain in business in the long run, companies must generate positive cash flows from operations. When cash from operations is negative over a period of time, the only other ways to obtain the necessary funds are to:(1) sell non-current assets, which reduces future productivity;(2) borrow from creditors at increasing interest rates to compensate for the increased risk of default on the debt; and(3) issue additional shares, where investor expectations about poor future performance drive the stock price down. There are clearly negative implications associated with generating funds through sources not directly related to operating activities.
3-66© 2023 McGraw Hill LimitedAppendix 3A: Earnings MeasurementThe following table summarizes the valuation bases that are currently permitted by IFRS for the reporting of asset and liability values on the statement of financial position:The concepts of amortized cost, net realizable value, and recoverable amount are discussed in later chapters.Asset or Liability GroupValuation BasisFinancial assets (e.g., investment in shares of other corporations, trade receivables, notes receivable)Amortized cost or fair valueInventoriesLower of cost and net realizable valueProperty, plant, and equipmentDepreciated cost or recoverable amountInvestment properties (e.g., commercial real estate properties)Depreciated cost or fair valueIntangible assetsAmortized cost or fair valueGoodwillCost or fair valueFinancial liabilitiesAmortized cost or fair value
3-67© 2023 McGraw Hill LimitedAppendix 3A: Statement of Comprehensive Income Part 1The statement of earnings includes the results of operations for a specific accounting period as well as the effects of discontinued operations. Publicly accountable enterprises are now required to disclose additional information in a statement of comprehensive income. The additional components of income reflect the financial effect of events that cause changes in shareholders’ equity, other than investments by shareholders or distributions to shareholders.
3-68© 2023 McGraw Hill LimitedAppendix 3A: Statement of Comprehensive Income Part 2The additional components of income, or othercomprehensive income, include unrealized gains and losses on certain financial instruments, as well as other items discussed in advanced accounting courses. The net earnings and other comprehensive income totals are then combined to create a final total called comprehensive income (the bottom line for this statement).
3-69© 2023 McGraw Hill LimitedEnd of Chapter Summary Part 1Elements on the classified statement of earnings are as follows:a.Revenues are increases in assets or settlements of liabilities from ongoing operations.b.Expenses are decreases in assets or increases in liabilities from ongoing operations.c.Gains are increases in assets or settlements of liabilities from activities not central to the core business operations. d.Losses are decreases in assets or increases in liabilities from activities not central to the core business operations.
3-70© 2023 McGraw Hill LimitedEnd of Chapter Summary Part 2When applying accrual accounting concepts, revenues are recognized (recorded) when earned and expenses are recognized when incurred.Based on the revenue recognition principle, we recognize revenues (1) when the company transfers promised goods or services to customers (2) in the amount it expects to be entitled to receive. Based on the expense recognition principle, we recognize expenses when incurred in generating revenue.
3-71© 2023 McGraw Hill LimitedEnd of Chapter Summary Part 3The five-step model for determining when and the amount to recognize revenue is:1.Identify the contract,2.Identify the seller’s performance obligations (promised goods and services),3.Determine the transaction price,4.Allocate the transaction price to the performance obligations, and5.Recognize revenue when each performance obligation is satisfied.