Statement of earnings (SOE) format and content elements

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Chapter 4

• Statement of earnings (SOE) format and content
  elements
• Items that are either unusual or infrequent, but
  not both
• Special treatment items
• Discontinued operations
• Extraordinary events
• Accounting changes

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Statement Format

• The multi-step statement is the preferred
  statement from my perspective (see Exhibit 6-2)
• The single-step statement is acceptable, but less
  preferred.

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Elements of SOE

• Sales and operating revenues
• Cost of goods sold
• Operating expenses
• Non-operating items
• Provision for income taxes
• Special reporting items
• Net income

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SOE Operating Section

• Revenues RRRR
• Cost of goods sold COGS
• Gross margin MARG
• Selling expenses SEXP
• Administrative expenses ADEX EXPN
• Income from operations IO.IO

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SOE Non-Operating Section

• Income from operations IOIO
• Other income and gains
• Gain on sale of building GAIN
• Other expenses and losses
• Interest expense INTR
• Loss on sale of equipment LOSS ( LOSS)
• Income before tax IBTX
• Provision for income taxes FITX
• Income from continuing activities NICA

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SOE Special Item Section

• Discontinued operations (net
• of related taxes) DISC
• Extraordinary gains (losses)
• (net of related taxes) EXTRA
• Cumulative effect of a change
• in accounting principle
• (net of related taxes) CHANGE
• Net income NETIN

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SOE Special Item Section

• Now, let us consider in more detail the three
  items that receive separate, special treatment in
  the statement of earnings.

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Discontinued Operations

• Objective is to communicate to investors the
  impact on assets, liabilities, and income that is
  associated with the disposal of a line of
  business or major class of customers.

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Discontinued Operations--II

• Income from operations and gains or losses on the
  disposal of a line-of-business must be shown
  separately from the results of continuing
  operations.
• The operating component consists of the total
  revenues, expenses, gains, and losses up to the
  measurement date (plan adoption)

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Discontinued Operations--III

• The disposal component consists of the sum of the
  revenues, expenses, gains, and losses after the
  measurement date (plan adoption)
• Reported net of income taxes

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Extraordinary items

• Must be unusual in nature in the operating
  environment involved
• Must be infrequent in the recent history of the
  reporting entity
• One notable exception to the above requirements
  includes the gain or loss on the early retirement
  of debt.
• Reported net of income taxes

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Accounting Changes

• Change in an accounting method (principle)
• Change of an accounting estimate
• Change in an accounting entity
• Except for a change of an estimate, the above are
  reported net of income taxes

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Change in an accounting method (principle)

• Change from one GAAP method to another
• The new method is adopted as of the beginning of
  the fiscal year.
• Current operating results are reported under the
  method newly adopted.
• Effects on prior periods reported using either
  the current or the retroactive approaches.

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Why change accounting methods?

• If FASB issues a new standard, some or all
  companies may have to change their accounting for
  affected transactions.
• Suppose an item was accounted for using a
  non-GAAP method, but was immaterial. If that
  item becomes material, then it would have to be
  reported in accordance with GAAP

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Why change methods?

• Companies in a competitive industry may
  voluntarily change methods to be more in line
  with their competitors. Uniform reporting within
  an industry is believed to enhance comparability.
• If an items goes from being immaterial to being
  material, changing to a GAAP method is not a
  change in methods.

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What do we do (usually)?

• The new method is effective as of first day of
  the year of the change.
• The effects of the new method on the income of
  the year of the change must be disclosed in the
  footnotes or supplementary information.

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What do we do (usually)?

• Cumulative difference in income as between using
  the new method and the previous one is reported
  as an element of income during the period of the
  change.
• Certain income and per-share figures for all
  prior periods included in a report must be
  disclosed as if the new principle were in effect
  during those periods.

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What we do not do

• The statements from prior years are unchanged.

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Accounting Errors

• Errors arise from a variety of causes.
• Mathematical errors
• Using an accounting principle not in conformity
  with GAAP
• Applying a GAAP incorrectly

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Accounting Errors--II

• Disregarding or misusing facts that existed at
  the date the financial statements were prepared,
  including the deliberate manipulation of
  estimates.

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Correction of an Acct. Error

• Errors discovered in the same period they are
  made are simply corrected when discovered. No
  special reporting is required since the
  correction is made before external users see the
  information.
• Unintentional errors from a prior period are
  reported in the period discovered

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Correction of an Acct. Error

• Reported net of federal income tax
• Reported in a statement of retained earnings as
  an adjustment to beginning balance of Retained
  Earnings. The correction of an error does not
  affect the determination of periodic income.
• Some errors, such as inventory errors, may be
  self-correcting over time.

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Accounting Estimates

• Estimates must be made in the normal course of
  recognizing revenue and measuring expenses. Such
  estimates are unavoidable if we are to provide
  meaningful information to statement users when
  the information is needed to make timely
  decisions. Business involves risk and
  uncertainty!

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Examples from AMIS 521

• Provision for doubtful accounts (AMIS 211)
• Estimates of useful lives of depreciable assets
  (ch. 5)
• Estimates of salvage values of depreciable assets
  (ch. 5)
• Estimates of total contract expenses for the
  percentage-completion method of recognizing
  revenue (ch 4)

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More Examples

• Estimates of warranty service costs when
  recognizing revenue from the sale of manufactured
  products (ch. 4)
• Estimates of the costs of warranty services when
  recognizing income from warranty contracts (ch.4)
• Provisions for contingent obligations for
  environmental damage (ch.3)

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What do we do?

• Accounting estimates of material costs should be
  reevaluated regularly.
• When revisions are necessary, all future reports
  should reflect the revised estimates. These
  estimates will be used until revised again.
• Revisions that materially affect results should
  be explained in a footnote.

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What we do not do.

• The effects on prior years of estimate revisions
  are not disclosed. The idea is that if we
  constantly revise earlier reports, confidence in
  accounting statements will be reduced.
• The financial statements do not include any
  special items, beyond footnote disclosure, to
  report even the material effects of changes in
  estimates.

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Why do estimates change?

• Economic conditions change
• Changes in technology or methods may change the
  useful lives of depreciable assets, for example.
• New information becomes available
• We learn and better understand what we could have
  known before but did not

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THE END