MGAC01 Intermediate Accounting I. (Income Statement Issues)

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1 MGAC01 Intermediate Accounting I S. Daga TOPIC: REPORTING FINANCIAL PERFORMANCE (Income Statement Issues) TEXT: P4-1, P4-12, P4-14, P4-15, IC4-1 LEARNING GOALS: 1. To understand the concepts underlying the measurement and presentation of income. 2. To know the intermediate components of income. 3. To learn and review the Financial Statement components - Comprehensive Income, Shareholders Equity and Retained Earnings. CLASS OUTLINE: LEARNING GOAL 1: To understand the concepts underlying the measurement and presentation of income. A. Importance of the Income Statement -helps to predict the amount, timing and uncertainty of future cash flows -evaluate the past performance of a company B. Limitations of the Income Statement - No general agreement on how to measure well-offness - Income numbers are affected by the accounting method used (concept of quality of earnings and the impact of earnings management) C. Income Statement Format: Disclosure of the Intermediate Components of Income Multiple-step format vs. Single-step format

2 LEARNING GOAL 2: To know the intermediate components of income. Presentation of items after income from continuing operations: a. Discontinued Operations Reported net of tax. -have two components: 1. Income or loss from the operation of the discontinued segment up to the measurement date, net of tax 2. Gain or loss from disposal of the discontinued segment, net of tax b. Unusual Gains and Losses In a multiple-step statement, these are reported in the other revenues and gains or other expenses and losses section. They are may not be presented net of tax. c. Other comprehensive income (if a combined statement of comprehensive income is being prepared)

3 LEARNING GOAL 3: To learn and review the Financial Statement components - Comprehensive Income, Shareholders Equity and Retained Earnings. 1.Statement of Comprehensive Income (CI) Net income (NI) is the starting point in the comprehensive income statement to which other comprehensive income (OCI) is added. NI + OCI = CI 2. Statement of Changes in Shareholders Equity A required statement under IFRS, but not under ASPE. 3.Statement of Retained Earnings A summary disclosure of the changes in the balance of the Retained Earnings account from the beginning to the end of the year. 4.Earnings per share It is a ratio shown on the income statement. It is a widely used measure of business performance. (net income preferred dividends)/weighted avg. common shares outstanding

4 TEXT: P4-1, P4-12, P4-14, P4-15, IC4-1 P4-1 In recent years, Grace Inc. has reported steadily increasing income. The company reported income of $20,000 in 2011, $25,000 in 2012, and $30,000 in Several market analysts have recommended that investors buy Grace Inc. shares because they expect the steady growth in income to continue. Grace is approaching the end of its 2014 fiscal year, and it looks to be a good year once again. However, it has not yet recorded warranty expense. Based on prior experience, this year's warranty expense should be around $5,000, but some of top management has approached the controller to suggest that a larger, more conservative warranty expense should be recorded this year. Income before warranty expense is $43,000. Specifically, by recording an $8,000 warranty accrual this year, Grace could report an income increase for this year and still be in a position to cover its warranty costs in future years. (a) What is earnings management? (b) What would be the effect of the proposed accounting in 2014? In 2015? (c) What is the appropriate accounting in this situation? (d) Discuss the effect of the proposed accounting on a potential investor's decision to invest in the company.

5 P4-12 Joe Schreiner, controller for On Time Clock Company Inc., recently prepared the company's income statement and statement of changes in equity for Schreiner believes that the statements are a fair presentation of the company's financial progress during the current period, but he also admits that he has not examined any recent professional pronouncements on accounting. ON TIME CLOCK COMPANY INC. Income Statement For the Year Ended December 31, 2014 Sales revenues $377,852 Less: Sales returns and allowances 16,320 Net sales revenue 361,532 Cost of goods sold: Inventory, January 1, 2014 $ 50,235 Purchases $192,143 Less: Purchase discounts 3, ,001 Cost of goods available for sale 239,236 Inventory, December 31, ,124 Cost of goods sold 198,112 Gross profit 163,420 Selling expenses 41,850 Administrative expenses 32,142 73,992 Income before income tax 89,428 Other revenues and gains Unrealized gain on fair value-oci investments 36,000 Dividend revenue 40, ,428 Income tax 56,900 Net income $108,528 ON TIME CLOCK COMPANY INC. Excerpt from Statement of Changes in Equity For the Year Ended December 31, 2014 Retained earnings, January 1, 2014 $216,000 Add: Net income for 2014 $108,528 Gain on sale of long-term investments 31,400 $139,928 Deduct: Loss on expropriation 13,000 Correction of mathematical error (net of tax) 17,186 (30,186) 109,742 Retained earnings, December 31, 2014 $325,742 (a) Assume that On Time Clock Company follows IFRS, and that the company accounts for its investments in accordance with IAS 39. Prepare a statement of comprehensive income showing expenses by function. Ignore calculation

6 of EPS. (b) Prepare the retained earnings and accumulated other comprehensive income portion of the statement of changes in equity. Assume an opening balance of $120,000 in accumulated other comprehensive income.

7 P4-14 Amos Corporation was incorporated and began business on January 1, It has been successful and now requires a bank loan for additional working capital to finance an expansion. The bank has requested an audited income statement for the year 2014 using IFRS. The accountant for Amos Corporation provides you with the following income statement, which Amos plans to submit to the bank: AMOS CORPORATION Income Statement Sales revenue $850,000 Dividend revenue 32,300 Gain on recovery of insurance proceeds from earthquake loss 27,300 (unusual) Unrealized holding gain on fair value-oci investments 5, ,600 Less: Selling expenses $100,100 Cost of goods sold 510,000 Advertising expense 13,700 Loss on inventory due to decline in NRV 34,000 Loss on discontinued operations 48,600 Administrative expenses 73, ,800 Income before income tax 134,800 Income tax 33,700 Net income $101,100 Amos had 100,000 common shares outstanding during the year. Amos accounts for its investments in accordance with IAS 39. (a) Indicate the deficiencies in the income statement as it currently is. Assume that the corporation prepares a single-step income statement. (b) Prepare a revised single-step statement of comprehensive income.

8 P4-15 The equity accounts of Feeling Alright Vitamin Limited as at January 1, 2014, were as follows: Retained earnings, January 1, 2014 $257,600 Common shares 600,000 Preferred shares 250,000 Contributed surplus 300,000 Accumulated other comprehensive income 525,000 During 2014, the following transactions took place: Adjustment to correct error in prior years (gain net of tax) $ 48,000 Unrealized gains on fair value-oci investments (net of tax) 82,000 Dividends: Common shares 120,000 Preferred shares 62,000 Issue of equity: Common shares 300,000 Preferred shares 5,000 Net income 325,000 Prepare a statement of changes in equity for the year ended December 31, The company follows IFRS and accounts for its investments in accordance with IAS 39.

9 IC4-1 United Manufacturing Company (UMC) recently filed for bankruptcy protection. The company manufactures downhill skis and its shares trade on the TSX. With the increased popularity of such alternative winter sports as snowboarding and tubing, sales of skis are sagging. The company has decided to start a new line of products that focuses on the growing industry surrounding snow tubing and snowboarding. At present, however, the company needs interim financing to pay suppliers and its payroll. It also needs a significant amount of cash so that it can reposition itself in the marketplace. Management is planning to go to the bank with draft financial statements to discuss additional financing. The company's year end is December 31, 2013, and it is now January 15, Current interest rates for loans are 5%, but because it is in bankruptcy protection, UMC feels that it will likely have to pay at least 15% on any loan. There is concern that the bank will turn the company down. At a recent management meeting, the company decided to convert its ski manufacturing facilities into snowboard manufacturing facilities. It will no longer produce skis. Management is unsure if the company will be able to recover the cost of the ski inventory. Although the conversion will result in significant expenditures, the company feels that this is justified if UMC wants to remain a viable business. The shift in strategic positioning will not result in any layoffs as most employees will work in the retrofitted plant. The remaining employees will be trained in the new business. The conversion to snowboard manufacturing facilities would not require selling the ski manufacturing machines as these machines can be used to produce snowboards. The company estimates the results and cash flows from its operation of selling skis to be a $20-million loss. On December 15, 2013, the company entered into an agreement with LKT to sell its entire inventory in ski bindings to LKT. Under the terms of the deal, LKT paid $10 million cash for the inventory (its regular selling price at the time). The cost to UMC of this inventory was $6 million and so a profit of $4 million was booked pre-tax. In a separate deal, UMC agreed to buy back the inventory in January for $10,125,000. Before filing for bankruptcy protection, the company was able to buy a large shipment of snow tubes wholesale for a bargain price of $7 million from a supplier that was in financial trouble. The value of the inventory is approximately $10 million. The inventory was sitting in the UMC manufacturing facility taking up a lot of space. Because the manufacturing facility was being renovated, UMC reached an agreement with its leading competitor, MMN. According to the contract, MMN agreed to purchase the snow tubes from UMC for $8 million and UMC shipped the inventory on December 31 to arrive on January 5. The inventory was shipped f.o.b. shipping point. UMC normally reimburses its customers if the inventory is damaged in transit. UMC has a tentative verbal agreement that it will repurchase the snow tubes that MMN does not sell by the time the renovations are complete (in approximately six months). The buyback price will include an additional amount that will cover storage and insurance costs. Adopt the role of Mia Romano the company controller and discuss the financial reporting issues related to the preparation of the financial statements for the year ended December 31, 2013.

MGAC01 Intermediate Accounting I

MGAC01 Intermediate Accounting I S. Daga CLASS TOPIC: INVESTMENTS TEXT: E9-11, E9-16, E9-21, P9-11, CA9-3 LEARNING GOALS: 1. Be able to RECOGNIZE, MEASURE & PRESENT Non-Strategic investments. 2. Be able