Advanced Accounting Chapter

Advanced Accounting Chapter

Quarterly Statements need not be audited. V. FAST Accounting Standards Codification Topic 270, Interim Reporting (FAST ASS 270) requires companies to treat interim periods as integral parts of an annual period rather than as discrete accounting periods in their own right. A. Generally, interim statements should be prepared following the name accounting principles and practices used in the annual statements. B. However, several items require special treatment for the interim statements to better reflect the expected annual amounts. 1.

Revenues are recognized for interim periods in the same way as they are on an annual basis. 2. Interim statements should not reflect the effect of a LIFO liquidation if the units of beginning inventory sold are expected to be replaced by year-end; inventory should not be written down to a lower market value if the market value is expected to recover above the inventory’s cost by year-end; and planned variances under a standard cost system should not be reflected in interim statements if they are expected to be absorbed by year-end. 3.

Costs incurred in one interim period but associated with activities or benefits of multiple interim periods (such as advertising and executive bonuses) should be allocated across interim periods on a reasonable basis through accruals and deferrals. 4. The materiality of an extraordinary item should be assessed by comparing its amount against the expected income for the full year. 5. Income tax related to ordinary income should be computed at n estimated annual effective tax rate; income tax related to an extraordinary item should be calculated at the margin.

VI. FAST ASS 270 provides guidance for reporting changes in accounting principles made in interim periods. A. Unless impracticable to do so, an accounting change is applied retrospectively, that is, prior period financial statements are restated as if the new accounting principle had always been used. B. When an accounting change is made in other than the first interim period, information for the interim periods prior to the change should be ported by retrospectively applying the new accounting principle to these pre-change interim periods. C.

If retrospective application of the new accounting principle to interim periods prior to the change of change is impracticable, the accounting change is not allowed to be made in an interim period but may be made only at the beginning of the next fiscal year. VII. Many companies provide summary financial statements and notes in their interim reports. A. U. S. GAP imposes minimum disclosure requirements for interim reports. 1 . Sales, income tax, extraordinary items, cumulative effect of counting change, and net income. 2. Earnings per share. . Seasonal revenues and expenses. 4. Significant changes in estimates or provisions for income taxes. 5. Disposal of a business segment and unusual items. 6. Contingent items. 7. Changes in accounting principles or estimates. 8. Significant changes in financial position. B. Disclosure of balance sheet and cash flow information is encouraged but not required. If not included in the interim report, significant changes in the following must be disclosed: 1 -Cash and cash equivalents. 2. Net working capital. 3. Long-term liabilities. 4.

Stockholders’ equity. VIII. Four items of information must also be disclosed by operating segment in interim financial statements: revenues from external customers, internments revenues, segment profit or loss, and, if there has been a material change since the annual report, total assets. IX. AS 34, “Interim Financial Reporting” provides guidance in FIRS with respect to interim financial statements. A. Unlike U. S. GAP, AS 34 requires each interim period to be treated as a discrete accounting period in terms of the amounts to be recognized.

As a result, expenses that are incurred in one ratter are expensed in that quarter even though the expenditure benefits the entire year. And there is no accrual in earlier quarters for expenses expected to be incurred later in the year. Answer to Discussion Question: How Does a Company Determine Whether a Foreign Country is Material? In his well-publicized “The Numbers Game” speech delivered in September 1998, former SEC chairman Arthur Levity cited “materiality’ as one of five gimmicks used by companies to manage earnings.

Although his remarks were not specifically directed toward the issue of geographic segment porting, the intent was to warn corporate America that materiality should not be used as an excuse for inappropriate accounting. To make the point even more salient, ASS 250-1 0-SYS (SAAB Topic 1 . M, Assessing Materiality, originally issued by the SEC as Staff Accounting Bulletin (SAAB) 99, “Materiality’), warns financial statement preparers that reliance on a simple numerical rule of thumb, such as 5% of net income, is not sufficient.

ASS 250-1 0-SYS reminds financial statement preparers that in its Concepts Statement 2, the FAST stated the essence of the concept of materiality as allows: “The omission or misstatement Of an item in a financial report is material if, in the light of surrounding circumstances, the magnitude of the item is such that it is probable that the judgment of a reasonable person relying upon the report would have been changed or influenced by the inclusion or correction of the item. Further, ASS 250-10-SYS reminds companies that both quantitative and qualitative factors should be considered in determining materiality. With respect to segment reporting, ASS 250-1 0-SYS states: “The materiality of a misstatement may turn on where it appears in the uncial statements. For example, a misstatement may involve a segment of the registrant’s operations.

In that instance, in assessing materiality of a misstatement to the financial statements taken as a whole, registrants and their auditors should consider not only the size of the misstatement but also the significance of the segment information to the financial statements taken as a whole. “A misstatement of the revenue and operating profit of a relatively small segment that is represented by management to be important to the future profitability of the entity” is more likely to be material to investors than a misstatement in a segment that management has not identified as especially important.

In assessing the materiality of misstatements in segment information – as with materiality generally – situations may arise in practice where the auditor will conclude that a matter relating to segment information is qualitatively material even though, in his or her judgment, it is quantitatively immaterial to the financial statements taken as a whole. Thus, in addition to quantitative factors, such as the relative percentage of total revenues generated in an individual foreign country, companies should insider qualitative factors as well.

Qualitative factors that might be relevant in assessing the materiality of a specific foreign country include: the growth prospects in that country and the level of risk associated with doing business in that country. There are competing arguments for the FAST establishing a significance test for determining material foreign countries. On one hand, such a quantitative materiality test flies in the face of the warning provided in ASS 250-10-599.

For example, a 10% of total revenue or long-lived asset test might give companies an excuse to avoid reporting individual countries that would be eternal for qualitative reasons. Assume that from one year to the next a company increases its revenues in China from 2% of total revenues to 6% of total revenues. Although 6% of total revenues would not meet a 10% test, the relatively large increase in total revenues generated in China could be material in that it could affect an investor’s assessment Of the company’s future prospects.

This company might be reluctant to disclose Information about its revenues in China because of potential competitive harm. On the other hand, the FAST could establish a materiality threshold low enough, for example, 5% of total revenues, that would be likely to ensure that “material” countries are disclosed regardless of whether they are material for quantitative or qualitative reasons. A bright-line materiality threshold would ensure a minimum level of disclosure and would enhance the comparability of financial disclosures provided across companies.

Answers to Questions 1. Consolidation presents the account balances of a business combination without regard for the individual component companies that comprise the organization. Thus, no distinction can be drawn as to the financial position or operations of the separate enterprises that form the corporate structure. Without a method by which to identify the various individual operations, financial analysis cannot be well refined. 2. The word disaggregated refers to a whole that has been broken apart.

Thus, disaggregated financial information is the data of a reporting unit that has been broken down into components so that the separate parts can be identified and studied. 3. According to the FAST, the objective of segment reporting is to provide information to help users of financial statements: a. Better understand the enterprise’s performance, b. Better assess its prospects for future net cash flows, and c. Make more informed judgments about the enterprise as a whole. 4.

Defining segments on the basis of a company’s organizational structure removes much of the flexibility and subjectivity associated with defining industry segments under prior standards. In addition, the incremental cost of providing segment information externally should be minimal because that information is already generated for internal use. Analysts should benefit from this approach because it reflects the risks and opportunities considered important by management and allows the analyst to see the company the way it is viewed by management.

This should enhance the analyses ability to predict management actions that can significantly affect future cash flows. 5. An operating segment is defined as a component of an enterprise: a. That engages in business activities from which it earns revenues and incurs expenses, b. Whose operating results are regularly reviewed by the chief operating decision maker to assess performance and make resource allocation decisions, and c. For which discrete financial information is available. 6. Two criteria must be considered in this situation to determine an enterprise’s operating segment.

If more than one set of organizational units exists, but there is only one set for which segment managers are held responsible, that set constitutes the operating segments. If segment managers exist for ;o or more overlapping sets of organizational units, the organizational units based on products and services are defined as the operating segments. 7. The Revenue Test. An operating segment is separately reportable if its total revenues amount to 1 0 percent or more of the combined total revenues f all operating segments. The Profit or Loss Test.

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