INTERMEDIATE ACCOUNTING

TENTH CANADIAN EDITION

Kieso • Weygandt • Warfield • Young • Wiecek • McConomy

CHAPTER 4
Reporting Financial
Performance

Prepared by:
Dragan Stojanovic, CA
Rotman School of Management,
University of Toronto
CHAPTER 4
Reporting Financial Performance
After studying this chapter, you should be able to:
• Understand how firms create value and manage performance.
• Understand how users use information about performance to make decisions.
• Understand the concept of and be able to assess quality of earnings/information.
• Understand the differing perspectives on how to measure income.
• Measure and report results of discontinued operations.
• Measure income and prepare the income statement and the statement of
comprehensive income using various formats.
• Prepare the statement of retained earnings and the statement of changes in
equity.
• Understand how disclosures and analysis help users of financial statements
assess performance.
• Identify differences in accounting between IFRS and ASPE and potential
changes.
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 Reporting Financial Performance

Performance Statement of Statement of Disclosure and IFRS/ASPE

• Business models Income / Retained Earnings / Analysis Comparison
and industries Comprehensive Changes in Equity • Disclosures • A comparison
• Communicating Income • Presentation of • Analysis of IFRS and
information about • Measurement statement of ASPE
performance • Discontinued retained earnings • Looking ahead
• Quality of earnings Operations • Presentation of
/ information • Presentation statement of
changes in equity

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 Business Models

• Business Model identifies three activities:

1. Financing
• Obtaining cash funding
2. Investing
• Use of funding to buy assets and invest in people
3. Operating
• Use of assets and people to generate profits
• Financial statements should capture these
fundamental business activities

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Overview of the Business Model

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 Communicating Information About
Performance
Income Statement helps users:
1. Evaluate past performance and profitability
2. Assist in predicting future performance
3. Assess potential risk or uncertainty in achieving
future net cash inflows

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 Limitations of Income Statement

Statement of income/comprehensive income has

the following limitations:

• Items are excluded if they cannot be measured

reliably
• Amounts reported are affected by accounting
methods used
• Use of estimates in measuring income
• Financial reporting bias
• GAAP shortcomings

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 Quality of Earnings

• Quality of earnings refers to how solid earnings

numbers are
• Two main aspects to consider:
1. Content
• Integrity of information
• Sustainability of earnings
2. Presentation
• Earnings presentation is clear and concise
• Easy to use and understandable

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 Quality of Earnings

• Characteristics of high quality earnings:

1. Nature of Content
– Unbiased and determined objectively
– Represents economic reality
– Reflects earnings from on-going core activities
– Can be correlated with cash flows from operations
– Based on sound business strategy/model
2. Presentation
– Does not disguise or mislead (transparent)
– Understandable
– Also, information is clear and concise
• Earnings management decreases quality of earnings

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 Comprehensive vs. Net Income

• Key question: how do we measure income?

• IFRS generally supports the all-inclusive approach to
measuring income
– This results in “comprehensive income”
– Comprehensive income includes any non-shareholder
transactions that causes a change in equity
• Example: unrealized gains/losses on revaluation of property, plant,
and equipment under the revaluation model
– Comprehensive Income = Net Income +/- Other Comprehensive
Income (OCI)
– OCI is closed to a balance sheet account called Accumulated
Other Comprehensive Income (AOCI)
• ASPE continues to focus on net income as the measure of
income
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 Discontinued Operations

• Discontinued operations includes components

that have been disposed of or are held for sale
• Components can include:
­ Under ASPE: an operating segment, reporting unit,
subsidiary, asset group, or operations without
assets
­ Under IFRS: separate major line of business or
geographical area of operations, or a business
qualifying as “held for sale” upon acquisition
­ IFRS is more restrictive

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 Discontinued Operations

• 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

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 Discontinued Operations
Measurement & Presentation
• Depreciation is not recognized for held for sale
assets
• Remeasured at lower of carrying value and fair
value net of cost to sell
• Once asset is written down, subsequent gains can
be recognized only up to the amount of original loss
• Presented separately on balance sheet
– Under ASPE, held for sale asset retains original
classification as current or non-current
– Under IFRS, held for sale assets generally classified
as current

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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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 Presentation of Performance

• Under IFRS, the statement of comprehensive

income can be presented either:
• as a single combined statement, or
• as two separate statements
• Companies can present income using either
– Single-step income statement, or
– Multiple-step income statement

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 Comprehensive Income Statement

• Example of a combined income and comprehensive

income statement:

• Sales 800,000
• Cost of goods sold 600,000
• Gross profit 200,000
• Operating expenses 90,000
• Net income 110,000
• Other comprehensive income
– Unrealized holding gain, net of tax 30,000
• Comprehensive income 140,000
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 Single-Step Income Statement

• Presents only two groupings before Income before

Discontinued Operations:
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:
– Oversimplification
– Less detail (e.g. operating and non-operating activities
reported together and cannot be distinguished)
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 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 must be
Earnings per disclosed separately from
Share Continuing Operations 19
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 Multiple-Step Income Statement

• Operating and non-operating activities are

separated
• 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

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 Multiple-Step Income Statement
• Operating section
Continuing Operations • Nonoperating section
• Income tax

Discontinued Operations • Income/Loss from operations

• Gain/Loss from disposition
• Both 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

Income Tax on 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 trade-off between
understandability and full disclosure
• Reduces “information overload”
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 Presenting Expenses: Nature versus
Function
• Under IFRS, analysis of expenses must be
presented based on either:
– Nature of expenses (e.g. purchase of materials,
transportation costs, employee benefits, depreciation,
etc.)
– Function of expenses (e.g. cost of sales,
administrative costs, etc.)
• Choice should result in information that is more
reliable and relevant
• No similar guidance under ASPE

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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. Other comprehensive income

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 Earnings per Share

• Earnings per share (EPS) is 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 EPS based on net income must be
shown on the face of the income statement
• EPS based on discontinued operations may be
disclosed in the notes to the financial statements

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 Earnings Per Share

• Calculated as:
Net Income less Preferred Dividends
Weighted Average of Common Shares Outstanding
• 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 share 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 restated
• Under IFRS, a Statement of Changes in Equity is
presented in lieu of a retained earnings statement.

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 Statement of Changes in Equity

This statement is required under IFRS and

presents the following:
1. Total comprehensive income
2. For each component of equity, the effects of
retrospective application/restatement
3. Reconciliation between the carrying amount of
each component of equity at the beginning
and end of the period.

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 Looking Ahead

• IASB and FASB are preparing a converged standard on

“Financial Statement Presentation”
– Working principles state that financial statements should:
• Provide a cohesive financial picture of an entity
• Provide information to help users assess the liquidity of an
entity
• Separate financing activities from other activities
• Provide information about measurement of assets and
liabilities, and
• Disaggregate information and present subtotals and totals
• IASB and FASB are also working on redefining the
meaning of “component” for discontinued operations

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 COPYRIGHT

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