Unit - Anna Lee

The Income Statement and
Comprehensive Income
An income
statement for a
hypothetical
manufacturing
company that you
can refer to as we
proceed through
the chapter.
Note: Dividend revenue: other income

4-2
Separately Reported Items
Reported separately, net of taxes:
Discontinued
operations
Extraordinary
items

4-3
Intraperiod Income Tax Allocation
Income Tax Expense must be associated with
each component of income that causes it.
Show Income Tax
Expense related to
Income from Continuing
Operations.
Report effects of
Discontinued Operations and
Extraordinary Items net of
related income tax effect.

4-4
Discontinued Operations
As part of the continuing process to converge U.S. GAAP and
international standards, the FASB and IASB have been working
together to develop a common definition and a common set of
disclosures for discontinued operations.
The proposed ASU (Accounting Standards Updates) defines a
discontinued operation as a “component” that either (a) has
been disposed of or (b) is classified as held for sale, and
represents one of the following:
1. a separate major line of business or major geographical area
of operations,
2. part of a single coordinated plan to dispose of a separate
major line of business or geographical area of operations, or
3. a business that meets the criteria to be classified as held for
sale on acquisition.

Reporting Discontinued Operations
Reporting for Components Sold
4-5
1. Income or loss from
operations of the component
from the beginning of the
reporting period to the
disposal date.
2. Gain or loss on the disposal of
the component’s assets.
Reporting for Components Held For Sale
1. Income or loss from
operations of the component
from the beginning of the
reporting period to the end
of the reporting period.
2. An “impairment loss”
if asset’s carrying value (book value) >
(fair value - cost to sell, i.e., net
realizable value).
1 & 2 can be combined or separately
reported.
If 1 & 2 are combined, the impairment
loss must be disclosed.

Impairment of Value
Accounting treatment differs.
Test for
impairment
of value when
considered
for sale.
4-6
Long-term assets
to be held and used
Long-term assets
held for sale
Tangible and
intangible
with finite
useful lives
Intangibles
with
indefinite
useful lives
Test for impairment of value
when it is suspected that book
value may not be recoverable.
Goodwill
Test for
impairment of
value at least
annually.
Other than
Goodwill: Test
for impairment
of value when it
is likely that
the fair value of
a reporting unit
is less than its
book value.

4-7
Finite-Life Assets to be Held and Used
Measurement – Step 1
An asset is impaired when . . .
The undiscounted
sum of its estimated
future cash flows
<
Its
book
value
Recoverability Test

4-8
Finite-Life Assets to be Held and Used
Impairment
loss =
Measurement – Step 2
Book
value
–
Fair
value
Reported in the income
statement as a separate
component of operating
expenses
Market value, price of similar assets,
or PV of future net cash inflows.
Undiscounted future
Fair value
cash flows
$0 $125
$250
Case 1: $50 book value.
No loss recognized
Case 3: $275 book value.
Loss = $275 BV– $125 FV
Case 2: $250 > $150 book value. No loss recognized

4-9
Assets Held for Sale
Assets held for sale:
assets that management
has committed to sell immediately in
their present condition and
for which sale is probable.
Impairment
loss
=
Book
value
–
Fair value less
cost to sell (NRV)

4-10
U.S. GAAP vs. IFRS
Impairment of Value: Property, Plant, and
Equipment and Finite-Life Intangible Assets
Assets are tested for impairment
when events or changes
indicates that book value may
not be recoverable.
An impairment loss is required
when an asset’s book value >
the undiscounted sum of the
estimated future cash flows.
Assets must be assessed for
circumstances of impairment at
the end of each reporting period.
An impairment loss is required
when an asset’s book value >
Recoverable amount: higher
of the asset’s value-in-use (present
value of estimated future cash
flow) and fair value less costs to
sell (NRV).

4-11
U.S. GAAP vs. IFRS
Impairment of Value: Property, Plant, and
Equipment and Finite-Life Intangible Assets
The impairment loss: book value
- fair value.
Reversals of impairment losses are
prohibited.
The impairment loss: book value -
recoverable amount (the higher of
the asset’s value-in-use and fair
value less costs to sell).
An impairment loss is reversed if
the circumstances that caused the
impairment are resolved.

4-12
Finite-Life Assets to be Held and Used
Because Acme Auto Parts has seen its sales steadily decrease due to the
decline in new car sales, Acme’s management believes that equipment
that originally cost $350 million, with a $200 million book value, may not
be recoverable. Management estimates that future undiscounted cash
flows associated with the equipment’s remaining useful life will be only
$140 million, and that the equipment’s fair value is $120 million.
Has Acme suffered an impairment loss and, if so, how should it be
recorded?
Step 1
$140 million < $200 million
Impairment loss is indicated.

4-13
Finite-Life Assets to be Held and Used
Because Acme Auto Parts has seen its sales steadily decrease due to the
decline in new car sales, Acme’s management believes that equipment
that originally cost $350 million, with a $200 million book value, may not
be recoverable. Management estimates that future undiscounted cash
flows associated with the equipment’s remaining useful life will be only
$140 million, and that the equipment’s fair value is $120 million. Has
Acme suffered an impairment loss and, if so, how should it be recorded?
Step 2
Impairment loss = $200 million BV – $120 million FV = $80 million
Impairment loss ................................... 80,000,000
Accumulated depreciation ................... 150,000,000
Equipment ……………………. 230,000,000
To record impairment loss.

Indefinite-Life Intangibles
4-14
Goodwill
(Special treatment)
Other Indefinitelife
intangibles
Step 1 If BV of reporting unit
> FV, impairment indicated.
Step 2 Loss = BV of goodwill
- implied value of goodwill.
One-Step Process
If asset’s BV > FV,
recognize
impairment loss.
A reporting unit is an operating segment of a company or a component of an
operating segment for which discrete financial information is available (and
segment managers regularly review the operating results of that component).
Implied value = segment’s (reporting unit’s) FV – segment’s net assets (excluding
good will)

4-15
U.S. GAAP vs. IFRS
Impairment of Value: Indefinite-Life Intangible
Assets Other Than Goodwill
Indefinite-life intangible assets
other than goodwill are tested for
impairment at least annually.
Indefinite-life intangible assets
other than goodwill are tested for
impairment at least annually.
The impairment loss: = book value
- fair value.
The impairment loss = book value
- recoverable amount (the
higher of the asset’s value-in-use
(present value of estimated future
cash flows) and fair value less costs
to sell (NRV)).

4-16
U.S. GAAP vs. IFRS (cont’d)
Impairment of Value: Indefinite-Life Intangible
Assets Other Than Goodwill
Reversals of impairment losses are
prohibited.
If certain criteria are met,
indefinite-life intangible assets are
combined for the required annual
impairment test.
An impairment loss is reversed if
the circumstances that caused the
impairment are resolved.
Indefinite-life intangible assets may
not be combined with other
indefinite-life intangible assets for
the required annual impairment
test.

4-17
U.S. GAAP vs. IFRS
Impairment of Value: Goodwill
Goodwill is tested for impairment
when it is likely that the fair value
of a reporting unit is less than its
book value.
Reversals of impairment losses are
prohibited.
The level of testing (reporting
unit) is a segment or a component
of an operating segment for which
discrete financial information is
available.
Goodwill is tested for impairment
at least annually.
Reversals of impairment losses are
prohibited.
The level of testing (cashgenerating
unit) is the smallest
identifiable group of assets that
generates cash flows that are
largely independent of the cash
flows from other assets.

U.S. GAAP vs. IFRS
4-18
Impairment of Value: Goodwill
Measurement of an impairment
loss is a two-step process. In step
one the fair value of the reporting
unit is compared to its book value.
A loss is indicated if the fair value
is less than the book value. In
step two, the impairment loss is
calculated as the excess of book
value of goodwill over the implied
fair value of goodwill.
Measurement of an impairment
loss is a one-step process. The
recoverable amount of the cashgenerating
unit is compared to its
book value. If the recoverable
amount is < BV, 1 st , reduce
goodwill, 2 nd , reduce other assets.

4-19
Impairment of Goodwill
Simmons Company recorded $150 million of goodwill when it acquired
Blake Company. Blake continues to operate as a separate company and is
considered to be a reporting unit. At the end of the current year Simmons
noted the following related to Blake: (1) book value of net assets, including
$150 million of goodwill, is $500 million; (2) fair value of Blake is $400 million;
and (3) fair value of Blake’s identifiable net assets, excluding goodwill, is
$350 million. Is goodwill impaired and, if so, by what amount?
Step 1
$500 million net assets > $400 million FV
Impairment loss is indicated.

4-20
Impairment of Goodwill
Simmons Company recorded $150 million of goodwill when it acquired
Blake Company. Blake continues to operate as a separate company and is
considered to be a reporting unit. At the end of the current year Simmons
noted the following related to Blake: (1) book value of net assets, including
$150 million of goodwill, is $500 million; (2) fair value of Blake is $400
million; and (3) fair value of Blake’s identifiable net assets, excluding goodwill,
is $350 million. Is goodwill impaired and, if so, by what amount?
Step 2
Determination of implied goodwill
Fair value of Blake $ 400,000,000
Fair value of Blake's net assets excluding goodwill 350,000,000
Implied value of goodwill $ 50,000,000
Measure of impairment loss
Book value of goodwill $ 150,000,000
Implied value of goodwill 50,000,000
Impairment loss $ 100,000,000

4-21
Extraordinary Items
An extraordinary item is a material
event or transaction that is both:
1. Unusual in nature, and
2. Infrequent in occurrence
Extraordinary items are reported net
of related taxes

4-22
Items Not Extraordinary
1. Write-downs of receivables, inventories, intangible
assets.
2. Gains & losses from foreign currencies exchange or
translation.
3. Gains & losses on disposal of a component or entity.
4. Other gains or losses from sale of abandonment of
property, plant, & equipment.
5. Strikes
6. Adjustments of accruals on long-term contracts.

4-23
U. S. GAAP vs. IFRS
The scarcity of extraordinary gains and losses reported in
corporate income statements and the desire to converge
U.S. and international accounting standards could guide
the FASB to the elimination of the extraordinary item
classification.
Report extraordinary items
separately in the income
statement.
Prohibits reporting extraordinary
items in the income statement or
notes.

4-24
Unusual or Infrequent Items
Items that are material and are
either unusual or infrequent—but not
both—are included as separate
items in continuing operations, not
net of tax.

4-25
Accounting Changes
Type of Accounting
Changes
Change in Accounting
Principle
Change in Accounting
Estimate
Change in Reporting
Entity
Definition
Change from one GAAP method
to another GAAP method
Revision of an estimate
because of new information or
new experience
Preparation of financial
statements for an accounting
entity other than the entity that
existed in the previous period

4-26
Change in Accounting Principle
Occurs when changing from one GAAP method to
another GAAP method, for example, a change from LIFO
to FIFO
GAAP requires that most voluntary accounting changes be
accounted for retrospectively by revising prior years’
financial statements.
For mandated changes in accounting principles, the FASB
often allows companies to choose to account for the
change retrospectively or as a separately reported
item below extraordinary items.

4-27
Change in Accounting Principle - Example
Change in Accounting Principle: Gaubert Inc. decided in
March 2012 to change from FIFO to weighted-average inventory
pricing. Gaubert’s income before taxes, using the new weightedaverage
method in 2012, is $30,000.
Pretax Income Data
Calculation of a Change in
Accounting Principle
Income Statement
Presentation of a Change
in Accounting Principle
(Based on 30% tax rate)
Under the retrospective approach, the co. recasts the prior year’s income
Numbers under the new method.

4-28
Changes in Estimates
ESTIMATED
service life
ESTIMATED
residual value
Changes in estimates are accounted for prospectively.
The book value less any residual value at the date of change is
depreciated over the remaining useful life. A disclosure note
should describe the effect of a change.
Example: On January 1, equipment was purchased that cost
$30,000, has a useful life of 10 years, and no residual value. At the
beginning of the fourth year, it was decided that there were only 5
years remaining, instead of 7 years.
Calculate depreciation for the fourth
year using the straight-line method.

4-29
Changes in Estimates
Asset cost $ 30,000
Accumulated depreciation
($3,000 per year × 3 years) 9,000
Remaining book value 21,000
Divide by remaining life ÷ 5
Revised annual depreciation $ 4,200

4-30
Change in Depreciation Method
A change in depreciation, amortization, or depletion
method is considered a change in accounting estimate that
is a result of (achieved by) a change in accounting principle.
We account for these changes prospectively,
exactly as we would any other change in estimate.
On January 1, 2011, Matrix Inc. purchased office equipment for $400,000.
Matrix expected a residual value $40,000, and a service life of 5 years.
Matrix uses the double-declining-balance method to depreciate this type of
asset. During 2013, the company switched from double-declining balance to
straight-line depreciation. The residual value remained at $40,000. Let’s
determine the amount of depreciation to be recorded for 2013.

4-31
Change in Depreciation Method
Depreciation - 2011 $ 160,000 ($400,000 × 40%)
Depreciation - 2012 96,000 [($400,000 - $160,000) × 40%]
Total Depreciation $ 256,000
Cost of asset $ 400,000
Less: Accumulated depreciation 256,000
Undepreciated balance $ 144,000
Less: residual value (40,000)
New depreciable amount 104,000
Remaining service life ÷ 3
Annual depreciation $ 34,667
December 31, 2013:
Depreciation expense ................................... 34,667
Accumulated depreciation................ 34,667
To record depreciation expense.

Beginning inventory
Plus: Net purchases
Less: Ending inventory
Cost of goods sold
Corrections of Errors
Example: Inventory Errors
Revenues
Less: Cost of goods sold
Less: Other expenses
Net income
When analyzing inventory errors, it’s
helpful to visualize the way cost of goods
sold, net income, and retained earnings are
determined.
Beginning retained earnings
Plus: net income
Less: Dividends
Ending retained earnings
4-32

4-33
Inventory Errors
• Overstatement of ending inventory
◦ Understates cost of goods sold and
◦ Overstates pretax income.
• Understatement of ending inventory
◦ Overstates cost of goods sold and
◦ Understates pretax income.

4-34
Inventory Errors
• Overstatement of beginning inventory
◦ Overstates cost of goods sold and
◦ Understates pretax income.
• Understatement of beginning inventory
◦ Understates cost of goods sold and
◦ Overstates pretax income.

Correction of Inventory Errors -
Summary
4-35
Discovered the Following Year:
Example: If an inventory error was made in 2013, but not discovered
until 2014 (the following year), the 2013 financial statements were
incorrect as a result of the error. The error should be retrospectively
restated to reflect the correct inventory amount, cost of goods sold, net
income, and retained earnings when the comparative 2014 and 2013
financial statements are issued for 2014.
Dr. Retained Earnings
Cr. Inventory
Discovered Subsequent to the Following Year:
Example: If an error was made in 2013, but not discovered until 2015,
No correcting entry is needed in 2015. The error has self-corrected and
no prior period adjustment is needed.

4-36
Correction of Errors
Errors occur when transactions are either
recorded incorrectly or not recorded at all.
Errors
Discovered in
Same Year
Reverse original erroneous journal entry
and record the appropriate journal entry.
Material Errors
Discovered in
Subsequent Year
Record a prior period adjustment to the
beginning retained earnings balance in a
statement of shareholders’ equity.
Previous years’ financial statements that
are incorrect as a result of the error are
retrospectively restated to reflect the
correction.

4-37
Corrections of Errors (Cont’d)
In addition, a disclosure note is needed to describe the nature of
the error and the impact of its correction on net income, income
before extraordinary items, and earnings per share.

4-38
Corrections of Errors
– Sales Rev & Accounts Receivable Overstated
Example: in 2013, Hillsboro Co. determined that it incorrectly
overstated its accounts receivable and sales revenue by
$100,000 in 2010. In 2013, Hillboro makes the following entry
to correct for this error (ignore income taxes).
Retained earnings 100,000
Accounts receivable 100,000

4-39
Earnings Per Share
- Special Reporting Issues
BEPS =
Net income - Preferred dividends
Weighted average number of shares outstanding
An important business indicator.
Measures the dollars earned by each share of common
stock.
Must be disclosed on the income statement.

Earnings Per Share
- Example
4-40
Earnings Per Share: In 2012, Hollis Corporation reported net
income of $1,000,000. It declared and paid preferred stock
dividends of $250,000. During 2012, Hollis had a weighted
average of 190,000 common shares outstanding. Compute
Hollis’s 2012 earnings per share.
Net income - Preferred dividends
Weighted average number of shares outstanding
$1,000,000
190,000
- $250,000
= $3.95 per share

Special Reporting Issues
4-41
Assume that the co. had 100,000 shares outstanding for the entire year.
Divide by
weightedaverage
shares
outstanding
EPS

4-42
Earnings Per Share Disclosure
One of the most widely used ratios is earnings per
share (EPS), which shows the amount of income
earned by a company expressed on a per share basis.
Basic EPS
Diluted EPS
Net income less preferred dividends
Weighted-average number of
common shares outstanding for the
period
Reflects the potential dilution that could
occur for companies that have certain
securities outstanding that are convertible
into common shares or stock options that
could create additional common shares if
the options were exercised.

4-43
Computing Earnings Per Share
Earnings per share indicates the income earned by each share of
common stock.
Companies report earnings per share only for common stock.
When the income statement contains intermediate
components of income (such as discontinued operations or
extraordinary items), companies should disclose earnings per
share for each component.
Illustration 16-7

4-44
EPS - Simple Capital Structure
Simple Structure--Only common stock; no potentially
dilutive securities.
Complex Structure--Potentially dilutive securities are
present.
“Dilutive” means the ability to influence the EPS in a
downward direction.

4-45
EPS - Simple Capital Structure
Preferred Stock Dividends
Subtracts the current-year preferred stock dividend from net
income to arrive at income available to common stockholders.
Preferred dividends are subtracted on cumulative preferred
stock, whether declared or not.

4-46
EPS - Simple Capital Structure
Weighted-Average Number of Shares
Companies must weight the shares by the fraction of the period
they are outstanding.
When stock dividends or share splits occur, companies need to
restate the shares outstanding before the share dividend or split.

4-47
EPS - Simple Capital Structure
Illustration: Franks Inc. has the following changes in its common
stock during the period.
Compute the weighted-average number of shares outstanding
for Frank Inc.

4-48
Weighted-average Number of Shares Outstanding
Weighted-average Number of Shares Outstanding
Dates Outstanding (A) Shares Outstanding (B) Fraction of Year Weighted Shares (AxB)
1/1 - 12/31 90,000 90,000
4/1 - 12/31 30,000 9/12 22,500
7/1 - 12/31 (39,000) 6/12 (19,500)
11/1 - 12/31 60,000 2/12 10,000
Weighted-average
# of shares
outstanding 103,000

4-49
EPS - Complex Capital Structure
Complex Capital Structure exists when a business has
convertible securities,
options, warrants, or other rights
that upon conversion or exercise could dilute earnings per
share.
Company is required to report both basic and diluted
earnings per share.

EPS - Complex Capital Structure
Diluted EPS includes the effect of all potential dilutive common
shares that were outstanding during the period.
4-50
Companies will not report diluted EPS if the securities in their capital
structure are antidilutive. Ignore antidilutive securities in all calculations
and in computing diluted earnings per share.
The effect of the conversion or exercise of potential common shares
would increase rather than decrease the EPS, they are referred to as
“Antidilutive Securities”.

4-51
EPS - Complex Capital Structure
Diluted EPS – Convertible Securities
Measure the dilutive effects of potential conversion on EPS
using the if-converted method.
This method for a convertible bond assumes:
(1) the conversion at the beginning of the period (or at
the time of issuance of the security, if issued during
the period), and
(2) the elimination of related interest, net of tax.

4-52
EPS - Complex Capital Structure
Example - Convertible Bonds: In 2012 Buraka Enterprises issued, at par,
75, $1,000, 8% bonds, each convertible into 100 shares of common
stock. Buraka had revenues of $17,500 and expenses other than
interest and taxes of $8,400 for 2013. (Assume that the tax rate is 40%.)
Throughout 2013, 2,000 shares of common stock were
outstanding; none of the bonds was converted or redeemed.
Instructions
(a) Compute diluted earnings per share for 2013.
(b) Assume same facts as those for Part (a), except the 75 bonds were
issued on September 1, 2013 (rather than in 2012), and none have
been converted or redeemed.

4-53
EPS - Complex Capital Structure
(a) Compute diluted earnings per share for 2013.
Calculation of Net Income
Revenues $17,500
Expenses 8,400
Bond interest expense (75 x $1,000 x 8%) 6,000
Income before taxes 3,100
Income tax expense (40%) 1,240
Net income $ 1,860

4-54
EPS - Complex Capital Structure
(a) Compute diluted earnings per share for 2013.
When calculating Diluted EPS, begin with Basis EPS.
Basic EPS
Net income = $1,860
Weighted average shares = 2,000
= $.93

4-55
EPS - Complex Capital Structure
(a) Compute diluted earnings per share for 2013.
When calculating Diluted EPS, begin with Basic EPS.
Diluted EPS
$1,860
2,000
+ $6,000 (1 - .40)
+
7,500
$5,460
= = $.57
9,500
Basic EPS
= .93
Effect on EPS = .48
Adjustment for interest: interest is adjusted (added back as net income)
at “net of tax” if the 75 bonds are converted.
7,500 shares = 75x 100 shares, if converted

4-56
EPS - Complex Capital Structure
(b) Assume bonds were issued on Sept. 1, 2013 .
Calculation of Net Income
Revenues $ 17,500
Expenses 8,400
Bond interest expense (75 x $1,000 x 8% x 4/12) 2,000
Income before taxes 7,100
Income taxes (40%) 2,840
Net income $ 4,260

4-57
EPS - Complex Capital Structure
(b) Assume bonds were issued on Sept. 1, 2013 .
When calculating Diluted EPS, begin with Basic EPS.
Diluted EPS
$4,260
2,000
+
+
$2,000 (1 - .40)
7,500 x 4/12 yr.
$5,460
= = $1.21
4,500
Basic EPS
= 2.13
Effect on EPS = .48
2,000 interest = 6,000 x 4/12

4-58
EPS - Complex Capital Structure
Variation-Convertible Preferred Stock: Prior to 2012, Barkley
Company issued 40,000 shares of 6% convertible, cumulative preferred
stock, $100 par value. Each share is convertible into 5 shares of
common stock. Net income for 2012 was $1,200,000. There were
600,000 common shares outstanding during 2012. There were no
changes during 2012 in the number of common or preferred shares
outstanding.
Instructions
(a) Compute diluted earnings per share for 2012.

4-59
EPS - Complex Capital Structure
(a) Compute diluted earnings per share for 2012.
When calculating Diluted EPS, begin with Basic EPS.
Basic EPS
Net income $1,200,000 – Pfd. Div. $240,000*
Weighted average shares = 600,000
= $1.60
* 40,000 shares x $100 par x 6% = $240,000 dividend

4-60
EPS - Complex Capital Structure
(a) Compute diluted earnings per share for 2012.
When calculating Diluted EPS, begin with Basic EPS.
Diluted EPS
$1,200,000 – $240,000
600,000
+
+
$240,000
200,000*
=
$1,200,000
800,000
=
Basic EPS = 1.60
Effect on
EPS = 1.20
$1.50
*(40,000 x 5)

4-61
EPS - Complex Capital Structure
(a) Compute diluted earnings per share for 2012 assuming each
share of preferred is convertible into 3 shares of common stock.
Diluted EPS
$1,200,000 – $240,000
600,000
+
+
$240,000
120,000*
=
$1,200,000
720,000
=
$1.67
Basic EPS = 1.60
Effect on
EPS = 2.00
*(40,000 x 3)

4-62
EPS - Complex Capital Structure
P16-8 (a) Compute diluted earnings per share for 2012 assuming
each share of preferred is convertible into 3 shares of common
stock.
Diluted EPS
Basic = Diluted EPS
$1,200,000 – $240,000
600,000
Basic EPS = 1.60
+
+
$240,000
120,000*
Antidilutive
Effect on
EPS = 2.00
=
$1,200,000
720,000
$1.67
*(40,000 x 3)
Because the $1.67 DEPS is > the $1.60 BEPS, the effective is antidilutive.
=

4-63
EPS - Complex Capital Structure
Diluted EPS – Options and Warrants
Measure the dilutive effects of potential conversion using the
treasury-stock method.
This method assumes:
(1) company exercises the options or warrants at the
beginning of the year (or date of issue if later), and
(2) that it uses those proceeds to purchase common
stock for the treasury.

4-64
EPS - Complex Capital Structure
Example - EPS with Options: Zambrano Company’s net income for 2012
is $40,000. The only potentially dilutive securities outstanding were
1,000 options issued during 2011, each exercisable for one share at $8.
None has been exercised, and 10,000 shares of common were
outstanding during 2012. The average market price of the stock during
2012 was $20.
Instructions
(a) Compute diluted earnings per share.
(b) Assume the 1,000 options were issued on October 1, 2012 (rather
than in 2011). The average market price during the last 3 months of
2012 was $20.

4-65
EPS - Complex Capital Structure
(a) Compute diluted earnings per share for 2012.
Treasury-Stock Method
Proceeds if shares issued (1,000 x $8) $8,000
Purchase price for treasury shares $20
Shares assumed purchased 400
Shares assumed issued 1,000
Incremental share increase 600
÷

4-66
EPS - Complex Capital Structure
(a) Compute diluted earnings per share for 2012; the options were
issued at beginning of the year.
When calculating Diluted EPS, begin with Basic EPS.
Diluted EPS
$40,000
10,000
+
+
600
=
$40,000
= $3.77
10,600
Basic EPS
= 4.00
Options

4-67
EPS - Complex Capital Structure
(b) Compute diluted earnings per share assuming the 1,000 options
were issued on October 1, 2012.
Treasury-Stock Method
Proceeds if shares issued (1,000 x $8) $ 8,000
Purchase price for treasury shares $ 20
Shares assumed purchased 400
Shares assumed issued 1,000
Incremental share increase 600
Weight for 3 months assumed outstanding 3/12
Weighted incremental share increase 150
÷
x

4-68
EPS - Complex Capital Structure
(b) Compute diluted earnings per share assuming the 1,000 options
were issued on October 1, 2012.
Diluted EPS
$40,000
10,000
+
150
=
$40,000
= $3.94
10,150
Basic EPS
= 4.00
Options

4-69
EPS - Complex Capital Structure
EPS Presentation and Disclosure
A company should show BEPS (if only has common stocks
outstanding) and DEPS (if has both common stocks and dilutive
“potential common stocks” (PCS)) for:
Income from continuing operations,
Income before extraordinary items, and
Net income.
Per share amounts for a discontinued operation or an extraordinary
item should be presented on the face of the income statement or in
the notes.

4-70
EPS - Complex Capital Structure
Complex capital structures and dual presentation of EPS require the
following additional disclosures in note form.
1. Description of pertinent rights and privileges of the various securities
outstanding.
2. A reconciliation of the numerators and denominators of the basic and
diluted per share computations, including individual income and share
amount effects of all securities that affect EPS.
3. The effect given preferred dividends in determining income available to
common stockholders in computing basic EPS.
4. Securities that could potentially dilute basic EPS in the future that were
excluded in the computation because they would be antidilutive.
5. Effect of conversions subsequent to year-end, but before issuing
statements (subsequent event).

Revenue Recognition Before Delivery
Completed Contract and Percentage-of-Completion
Methods Compared
4-71
Example: At the beginning of 2013, the Harding Construction Company
received a contract to build an office building for $5 million. The project is
estimated to take three years to complete. According to the contract,
Harding will bill the buyer in installments over the construction period
according to a prearranged schedule. Information related to the contract is
as follows:

Accounting for the Cost of Construction
and Accounts Receivable
4-72
With both the completed contract and percentage-ofcompletion
methods, all costs of construction are recorded in
an asset account called construction in progress.

Gross Profit Recognition—General
Approach
4-73
In both methods the same
amounts of revenue, cost,
and gross profit are
recognized.
In both methods we add
gross profit to the
construction in progress
asset.

4-74
How to Determine Gross Profit and Revenue
– Completed Contract Method 3 steps
How To Calculate Gross Profit and Revenue :
1. % of completion = cost incurred/Total actual and estimated cost
2. Gross profit recognized = % of completion x Estimated total gross profit (that is "Contract price - Total actual and estimated cost")
3. Revenue recognized for long-term contract for the year = Gross profit recognized + Cost of construction
Demonstration for Relevant Amounts in 2013 Journal Entry
1. % of completion for 2013 = 1500000/3750000 = 40%
2. 500,000, Gross Profit for 2013 = 40% x (5000000 - 3750000)
3. 2,000,000 Revenue = 500,000 + 1,500,000

Gross Profit Recognition
- Completed Contract
4-75
The same journal entry is recorded to close out the billings
on construction contract and construction in progress
accounts under the completed contract and percentage-ofcompletion
methods.

Timing of Gross Profit Recognition
- Completed Contract Method
4-76
Under the completed contract method, all revenues
and expenses related to the project are recognized
when the contract is completed.

Timing of Gross Profit Recognition
- the Percentage-of-Completion Method
4-77
Under the percentage-of-completion method, profit
is recognized over the life of the project as the
project is completed.
We determine the amount of gross profit recognized in each
period using the following logic:

Percentage-of-Completion Method
Allocation of Gross Profit
4-78

Percentage-of-Completion Method
- Allocation of Gross Profit
4-79
Notice that the gross profit recognized in each period is
added to the construction in progress account.
Percentage-of-Completion
Construction in
Progress
Billings on
Construction Contract
2013 construction costs 1,500,000 1,200,000 2013 billings
2013 gross profit 500,000 2,000,000 2014 billings
End balance, 2013 2,000,000 1,800,000 2015 billings
2014 construction costs 1,000,000 5,000,000 Balance, before closing
2014 gross profit 125,000
End balance, 2014 3,125,000
2015 construction costs 1,600,000
2015 gross profit 275,000
Balance, before closing 5,000,000

Percentage-of-Completion Method
Income Statement - Allocation of Gross Profit
4-80
The income statement for each year will report
the appropriate revenue and cost of
construction amounts.

4-81
Income Recognition
The same total amount of profit or loss is recognized under
both the completed contract and the percentage-ofcompletion
methods, but the timing of recognition differs.
Percentage-of-Completion
Completed Contract
Gross profit recognized:
2013 $500,000 –0–
2014 125,000 –0–
2015 275,000 $900,000
Total gross profit $900,000 $900,000

4-82
Balance Sheet Recognition
The balance in the construction in progress account
differs between methods because of the earlier
gross profit recognition that occurs under the
percentage-of-completion method.

4-83
Balance Sheet Recognition
Billings on construction contract are subtracted
from construction in progress to determine balance
sheet presentation.
CIP > Billings
Asset
Billings > CIP
Liability

4-84
U. S. GAAP vs. IFRS
There are similarities and differences between
IFRS and U.S. GAAP when considering revenue
recognition for long-term construction
contracts.
Requires percentage-ofcompletion
when reliable
estimates can be made.
Requires percentage-ofcompletion
when reliable
estimates can be made.
Requires completed contract
method when reliable estimates
can’t be made.
Requires cost recovery method
when reliable estimates can’t be
made.

Revenue Recognition after Delivery
Installment Sales Method & Cost Recovery Method
Recognizing revenue when goods and services are delivered assumes we are able to
make reasonable estimates of amounts due from customers that potentially might be
uncollectible. For product sales, this also includes amounts not collectible due to
customers returning the products they purchased. Otherwise, we would violate one of the
requirements of the revenue realization principle—that there must be reasonable
certainty as to the collectibility of cash from the customer.
4-85
In a few situations in which uncertainties are so severe that they could cause a delay
in recognizing revenue from a sale of a product or service. For each of these situations,
notice that the accounting is essentially the same—deferring recognition of the gross
profit arising from a sale of a product or service until uncertainties have been
resolved.
Installment sales can be accounted for using the installment sales method or the cost
recovery method.
The installment sales method recognizes the gross profit by applying the gross profit
percentage on the sale to the amount of cash actually collected.
The cost recovery method defers all gross profit recognition until cash equal to the cost
of the item sold has been collected.

4-86
Installment Sales Method
On November 1, 2013, the Belmont Corporation, a real
estate developer, sold a tract of land for $800,000. The
sales agreement requires the customer to make four
equal annual payments of $200,000 plus interest on
each November 1, beginning November 1, 2013. The
land cost $560,000 to develop. The company’s fiscal
year ends on December 31.
Gross Profit
$240,000 ÷ $800,000
= 30%
Amount Allocated to:
Gross
Date
Cash
Collected
Cost
(70%)
Profit
(30%)
Nov. 1, 2013 $ 200,000 $ 140,000 $ 60,000
Nov. 1, 2014 200,000 140,000 60,000
Nov. 1, 2015 200,000 140,000 60,000
Nov. 1, 2016 200,000 140,000 60,000
Totals $ 800,000 $ 560,000 $ 240,000

Installment Sales Method
4-87
11/1/2013
Record installment sales:
Cash 200,000
Installment receivable 600,000
Cost of Goods Sold 560,000
Inventory 560,000
Installment Sales 800,000
During 2013, Belmont Corporation collected
$200,000 on its installment sales.
This entry records the realized gross profit by
adjusting the deferred gross profit account.

4-88
Cost Recovery Method
On November 1, 2013, the Belmont Corporation, a real
estate developer, sold a tract of land for $800,000. The
sales agreement requires the customer to make four
equal annual payments of $200,000 plus interest on
each November 1, beginning November 1, 2013. The
land cost $560,000 to develop. The company’s fiscal
year ends on December 31.
Date
Cash
Collected
Cost
Recovery
Gross Profit
Recognized
Nov. 1, 2013 $ 200,000 $ 200,000 $ -
Nov. 1, 2014 200,000 200,000 -
Nov. 1, 2015 200,000 160,000 40,000
Nov. 1, 2016 200,000 - 200,000
Totals $ 800,000 $ 560,000 $ 240,000

Cost Recovery Method
4-89

4-90
Revenue Recognition Prior to Delivery
Long-term
Contracts
Completed
Contract Method
Percentage-of-
Completion
Method

Revenue Recognition – General Principles
generally occurs (1) when earned and when realized or
realizable.
FASB Concepts Statement No. 5:
Revenue is not recognized until earned. Revenues are considered to have been
earned when the entity has substantially accomplished what it must do to be
entitled to the benefits represented by the revenues.
Revenues are realized when goods or services are exchanged for cash or
claims to cash. Revenues are realizable when related assets received in
exchanges are readily convertible to known amounts of cash or claims to cash.
Short and Sweet Tricks:
(1). Earned = work is done.
(2). (a) Realized = cash was exchanged.
(b) Realizable = claim to cash.
C, D, E, F: Collectability (1); Delivery (1); Evidence of an arrangement (2);
Fee is fixed or determinable (2) (SOP 97-2 Software Revenue Recognition)
4-91

Measuring Assets and Liabilities
- Fair Value Valuation Techniques
4-92
Fair value: is the price that would be received to sell and
asset or paid to transfer a liability in an orderly market
participants at the measurement date.
Market approached: based valuation on market
information.
Income approach: by estimating future amounts (earnings
or cash flows) and converting those amounts to a single
present value.
Cost approach: estimating the amount that would be
required to buy or construct an asset of similar quality
and condition.

4-93
Fair Value Hierarchy
U.S. GAAP gives companies the option to report some or all of
their financial assets and liabilities at fair value.