Cpa Fin Su3 Outline

1
STUDY UNIT THREE

INCOME STATEMENT ITEMS
3.1
3.2
3.3
3.4
3.5
3.6
3.7
Discontinued Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Extraordinary Items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounting Changes and Error Corrections . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Earnings per Share (EPS) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Long-Term Construction Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Revenue Recognition after Delivery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fair Value Measurements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1
3
5
8
16
19
21
The first four subunits of this study unit concern the presentation of certain items on the income
statement. The next two subunits address various revenue recognition issues. The seventh subunit
addresses the tools available for the application of fair value to financial statement items.
3.1 DISCONTINUED OPERATIONS
1.
Overview
a.
The operating results of a discontinued operation are reported separately net of tax
in the income statement (or statement of activities of a not-for-profit entity) if three
conditions are met:
1)
b.
c.
2.
A component of the entity has been disposed of or is classified as held for

sale.
2) The operations and cash flows of this component are or will be eliminated from
the entitys operations.
3) The entity will have no significant continuing involvement in the operations of the
component after the disposal.
A component of an entity has operations and cash flows that are clearly
distinguishable for operating and financial reporting purposes. A component may be
a(n)
1) Reportable segment,
2) Operating segment,
3) Reporting unit,
4) Subsidiary, or
5) Asset group.
If a long-lived asset is not a component, it cannot be reported as a discontinued
operation. In this case, a gain or loss on its sale is included in income from continuing
operations before income taxes.
Adjustments
a.
Amounts reported in discontinued operations may require adjustment. If the

adjustment directly relates to a prior-period disposal of a component, it is
reported currently and separately in discontinued operations. Its nature and
amount are disclosed. Adjustments may include the following:
1)
2)
Contingencies arising under the terms of the disposal transaction may be

resolved, for example, by purchase price adjustments.
Contingencies directly related to the pre-disposal operations of the component
may be resolved. Examples are the sellers environmental and warranty
obligations.
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SU 3: Income Statement Items
3)
3.
Employee benefit plan obligations for pensions and other postemployment

benefits may be settled. Reporting in discontinued operations is required if the
settlement is directly related to the component disposed of.
Income Statement Presentation

a.
b.
The operating results of a component that has been disposed of or is classified as held
for sale are reported in discontinued operations. This section is presented after
continuing operations but before extraordinary items.
When a component is classified as held for sale, it is measured at the lower of its
carrying amount or fair value minus cost to sell.
1)
c.
Operating results reported in discontinued operations include any income earned

or loss incurred during the entire reporting period (before or after the
component was classified as held for sale).
2) Operating results also include any loss for a writedown to fair value minus cost to
sell. They also include a gain arising from an increase in fair value minus cost
to sell (limited to losses previously recognized).
3) From the moment the component is classified as held for sale, operating results
do not include depreciation or amortization.
4) If the component is disposed of during the period, any gain or loss on disposal
must be disclosed on the face of the income statement or in the notes.
The results of discontinued operations are reported minus/plus income tax/benefit.
EXAMPLE
On July 1, Year 1, Emkay Co. approved a plan to dispose of Segment X on October 1, Year 1. As a result, Segment X
(a component of the entity) was properly classified as held for sale. It was sold on October 1, Year 1, for $480,000. Emkays
income tax rate is 40%. The following data pertain to Segment X:
Operating losses were $110,000 for the period January 1 to June 30, Year 1.
Operating losses were $100,000 for the period July 1 to October 1, Year 1.
The operating losses presented above do not include a loss on disposal or a write-down to fair value minus cost
to sell.
The carrying amount on July 1, Year 1, was $600,000.
Fair value minus cost to sell on July 1, Year 1, was $450,000.
The following are Emkays Year 1 income statement items excluding Segment Xs operating results:
Revenues
Cost of goods sold
General and administrative
expenses
Interest expense
$950,000
380,000
90,000
50,000
Year 1 operating results of Segment X are reported in discontinued operations. The loss from discontinued operations for
the year ended December 31, Year 1, includes all of the following:
Operating losses incurred during the entire reporting period were $210,000 ($110,000 + $100,000).
The loss on write-down to fair value minus cost to sell on July 1 was $150,000 ($600,000 carrying amount
$450,000 fair value minus cost to sell).
The gain on disposal of the segment on October 1 was $30,000 ($480,000 $450,000).
The total Year 1 loss from discontinued operations before tax is $330,000 ($210,000 + $150,000 $30,000). The loss on
discontinued operations (net of tax) reported in the income statement is $198,000 [$330,000 (1 40%)].
-- Continued on next page --
EXAMPLE -- Continued
The following format may be used by Emkay to present its Year 1 income statement:
Emkay Co.
Income Statement
For the Year Ended 12/31/Yr 1
Revenues
Cost of goods sold
Gross profit
General and administrative expenses
Interest expense
Income from continuing operations before income taxes
Income taxes
Income from continuing operations
Discontinued operations
Loss from operations of component unit Segment X
(including gain on disposal of $30,000)
Income tax benefit
Loss of discontinued operations
Net income
1)
2)
$950,000
(380,000)
$570,000
90,000
50,000
(140,000)
$430,000
(172,000)
$258,000
$(330,000)
132,000
(198,000)
$ 60,000
Basic and diluted EPS amounts for a discontinued operation are presented on
the face of the income statement or in the notes.
The caption Income from continuing operations should be revised to Income
from continuing operations before extraordinary item if an extraordinary item is
reported.
IFRS Difference
Net cash flows from operating, investing, and financing activities of a discontinued operation
must be disclosed in the notes or the statements.
3.2 EXTRAORDINARY ITEMS

1.
Overview
a.
A material transaction or event that is unusual in nature and infrequent in

occurrence in the environment in which the entity operates is an extraordinary item.
1)
A transaction or event is unusual if it has a high degree of abnormality and is of

a type clearly unrelated to, or only incidentally related to, the ordinary and
typical activities of the entity.
EXAMPLE
A warehouse fire is clearly unrelated to an entitys ordinary and typical activities.
2)
A transaction or event is infrequent if it is not reasonably expected to recur in

the foreseeable future.
EXAMPLE
An earthquake in Florida (but not in California) is not reasonably expected to recur.
b.
Sometimes a pronouncement specifically classifies an item as extraordinary even if

these criteria are not met.
2.
Items Not Considered Extraordinary

a.
The following are examples:

1)
2)
b.
Write-downs of receivables, inventories, intangible assets, etc.

Gains and losses from exchange or translation of foreign currencies, including
those resulting from major devaluations and revaluations
3) Gains and losses on disposal of a component of an entity
4) Other gains and losses from sale or abandonment of property, plant, and
equipment used in the business
5) Effects of a strike, including those against competitors and major suppliers
6) Adjustments of accruals on long-term contracts
However, an extraordinary event or transaction may occur that includes a gain or loss
listed just above. In one of these rare cases, gains or losses, such as those in 2.a.1)
and 2.a.4) above, may be classified as extraordinary.
1)
3.
The gains or losses that qualify are those directly resulting from a(n)
a) Major casualty (e.g., flood),

b) Expropriation, or
c) Prohibition under a new law or regulation.
2) Disposal of a component of an entity, item 2.a.3), is accounted for and presented
in the income statement as discontinued operations even if the criteria of
extraordinary item is met.
c. Any portion of the losses described in 2.b. above that would have resulted from
measurement of assets on a going-concern basis (e.g., writing down assets to fair
value) is not included in the extraordinary items.
Adjustments of Estimates
a.
4.
Adjustments of estimates included in extraordinary items previously reported are

separately presented and disclosed in the current statements. They are classified in
the same way as the original items.
Income Statement Presentation
a.
Extraordinary items should be reported individually in a separate section in the income

statement, net of tax, after results of discontinued operations. However, disclosure in
the notes of individual items included in this section also is acceptable.
1)
b.
Basic and diluted EPS amounts for extraordinary items are presented on the
face of the income statement or in the notes (discussed in Subunit 3.4).
If a material transaction or event is unusual or infrequent but not both, it is not an
extraordinary item. Thus, it is reported as a separate component of income from
continuing operations but not net of tax. No EPS disclosure is made on the income
statement.
IFRS Difference
No items are classified as extraordinary, either on the face of the statement of comprehensive
income or in the notes.
c.
The following memory aid is helpful for learning the order of items on the income
statement:
I = Income from Continuing Operations
D = Discontinued Operations
E = Extraordinary Items
I
Do
Excel
3.3 ACCOUNTING CHANGES AND ERROR CORRECTIONS

The AICPA traditionally tests candidates knowledge of how to account for the effects of a change in
accounting principle, a change in accounting estimate, and the correction of errors. Be prepared to see
questions that ask how to handle each of these situations, either by describing the accounting, calculating
the requested amounts, or choosing the correct journal entries.
1.
Accounting Changes -- Overview

a.
If financial information is to have the qualities of comparability and consistency, entities

must not make voluntary changes in accounting principles unless they can be
justified as preferable.
1)
b.
2.
Thus, the general presumption is that a principle once adopted must be

applied consistently in preparing financial statements.
The three types of accounting changes are a change in accounting principle, a
change in accounting estimate, and a change in reporting entity.
Change in Accounting Principle (Retrospective Application)

a.
A change in accounting principle occurs when an entity (1) adopts a generally

accepted principle different from the one previously used, (2) changes the method of
applying a generally accepted principle, or (3) changes to a generally accepted
principle when the principle previously used is no longer generally accepted.
1)
b.
A change in principle does not include the initial adoption of a principle because
of an event or transaction occurring for the first time or that previously had an
immaterial effect.
2) It also does not include adoption of a principle to account for an event or
transaction that clearly differs in substance from a previously occurring event or
transaction.
Retrospective application is required for all direct effects and the related income tax
effects of a change in principle.
1)
2)
An example of a direct effect is an adjustment of an inventory balance to

implement a change in the method of measurement.
Retrospective application must not include indirect effects. These are changes
in current or future cash flows from a change in principle applied
retrospectively.
a)
c.
An example of an indirect effect is a required profit-sharing payment based

on a reported amount that was directly affected (e.g., revenue).
b) Indirect effects are recognized and reported in the period of change.
Retrospective application requires the carrying amounts of (1) assets, (2) liabilities,
and (3) retained earnings (or other components of equity or net assets) at the
beginning of the first period reported to be adjusted for the cumulative effect (CE) of
the new principle on the prior periods.
1)
d.
All periods presented must be individually adjusted for the period-specific

effects (PSE) of the new principle.
It may be impracticable to determine the cumulative effect of a new principle on any
prior period.
1)
In that case, the new principle must be applied as if the change had been made
prospectively at the earliest date practicable.
e.
It may be practicable to determine the cumulative effect of applying the new principle
to all prior periods but not the period-specific effects on all prior periods presented.
1)
In these circumstances, cumulative-effect adjustments must be made to the

beginning balances for the first period to which the new principle can be
applied.
Figure 3-1
3.
Change in Accounting Estimate (Prospective Application)

a.
A change in accounting estimate results from new information. It is a reassessment of

the future status and benefits and obligations of assets and liabilities. Its effects must
be accounted for only in the period of change and any future periods affected
(prospectively).
1)
For a change in accounting estimate, the entity must not (a) restate or
retrospectively adjust prior-period statements or (b) report pro forma amounts
for prior periods.
EXAMPLE
On January 1, Year 1, Entity D purchased a machine for $98,000. Depreciation is based on the straight-line method using
an estimated useful life of 10 years with a salvage value of $8,000. During Year 3, Entity D determined that the machine
has a useful life of 8 years from the date of acquisition and that its salvage value is $2,000. Entity D reports only annual
financial statements.
Annual depreciation on the machine in Years 1 and 2 is $9,000 [($98,000 historical cost $8,000 salvage value)
10 years]. On December 31, Year 2, the carrying amount of the machine is $80,000 [$98,000 historical cost
($9,000 annual depreciation 2 years elapsed)].
The annual depreciation of the machine from the beginning of Year 3 is based on revised estimates of the machines useful
life (8 years) and salvage value ($2,000). The carrying amount of the machine ($80,000) at the beginning of the accounting
period in which the change in estimates occurred is used in the new calculation.
The new depreciable base of the machine is $78,000 ($80,000 $2,000).

The remaining useful life of the machine from the beginning of the accounting period in which the change in
estimates occurred (January 1, Year 3) is 6 years (8 2).
Annual depreciation on the machine in Years 3 through 8 is $13,000 ($78,000 6).
The carrying amount of the machine on December 31, Year 3, is $67,000 ($80,000 January 1, Year 3, carrying
amount $13,000 depreciation expense in Year 3).
b.
A change in estimate inseparable from a change in principle is accounted for as a

change in estimate, i.e., prospective application.
1)
An example is a change in a method of depreciation, amortization, or depletion

of long-lived, nonfinancial assets.
4.
Change in Reporting Entity

a.
A change in reporting entity results in statements that are effectively those of a

different entity.
1)
2)
3)
5.
Most such changes occur when (a) consolidated or combined statements

replace those of individual entities, (b) consolidated statements include different
subsidiaries, or (c) combined statements include different entities.
A change in reporting entity does not result from a business combination or
consolidation of a variable interest entity.
This change is retrospectively applied to interim and annual statements.
Error Correction
a.
An error in prior statements results from (1) a mathematical mistake, (2) a mistake in
the application of GAAP, or (3) an oversight or misuse of facts existing when the
statements were prepared. A change to a generally accepted accounting principle
from one that is not is an error correction, not an accounting change.
1)
Any error related to a prior period discovered after the statements are, or are
available to be, used must be reported as an error correction by restating the
prior-period statements. Restatement requires the same adjustments as
retrospective application of a new principle.
a)
b)
The carrying amounts of (1) assets, (2) liabilities, and (3) retained earnings
at the beginning of the first period reported are adjusted for the
cumulative effect of the error on the prior periods.
Corrections of prior-period errors must not be included in net income.
EXAMPLE
On January 1, Year 1, Entity E acquired a machine at a cost of $240,000. The freight-in and site preparation costs for the
machine of $30,000 were mistakenly expensed as incurred by the bookkeeper. The machine was depreciated on the
straight-line basis over a 6-year period with no residual value. During Year 3, Entity Es controller discovered the error made
by the bookkeeper in Year 1.
All the costs necessarily incurred to bring the machine to the condition and location necessary for its intended use ($30,000)
must be capitalized as part of the historical cost of the machine and depreciated in future periods. Ignoring the tax effect,
the following error correction should be made by Entity E in Year 3.
The carrying amount of the machine on January 1, Year 3, with the error is $160,000 [$240,000 historical cost
($40,000 annual depreciation 2 years elapsed)].
The carrying amount of the machine on January 1, Year 3, without the error should have been $180,000
[$270,000 historical cost ($45,000 annual depreciation 2 years elapsed)].
The cumulative effect of the error for the two prior periods on the carrying amount of retained earnings is
$20,000. This amount is the difference between (1) cumulative expenses actually recognized for Years 1 and
2 of $110,000 ($30,000 freight-in and site preparation costs + $80,000 depreciation expense in the first
2 years) and (2) cumulative expenses that should have been recognized without the error of $90,000. The
carrying amount of retained earnings should be credited (i.e., decreased) for the cumulative effect (an
overstatement of expenses).
The error correction journal entry in Year 3 is
Machine -- cost ($270,000 $240,000)
Retained earnings January 1, Year 3
Accumulated depreciation ($90,000 $80,000)
$30,000
$20,000
10,000
The annual depreciation expense recognized in Years 3 to 6 is $45,000 ($270,000 historical cost 6 years of
useful life).
2)
Error corrections must be reported in single-period statements as adjustments of

the opening balance of retained earnings.
a)
If comparative statements are presented, corresponding adjustments must

be made to net income (and its components) and retained earnings (and
other affected balances) for all periods reported.
6.
Error Analysis
a.
A correcting journal entry combines the reversal of the error with the correct entry.
Thus, it requires a determination of the (1) journal entry originally recorded, (2) event
or transaction that occurred, and (3) correct journal entry.
EXAMPLE
If the purchase of a fixed asset on account had been debited to purchases:

Incorrect Entry
Purchases
Payables
Correct Entry
Fixed asset
Payables
Correcting Entry
Fixed asset
Purchases
Correct Entry
Fixed asset
Payables
Correcting Entry
Fixed Asset
Cash
Purchases
Payables
If cash had been incorrectly credited:

Incorrect Entry
Purchases
Cash
b.
c.
d.
e.
Error analysis addresses (1) whether an error affects prior-period statements, (2) the
timing of error detection, (3) whether comparative statements are presented, and
(4) whether the error is counterbalancing.
An error affecting prior-period statements may or may not affect prior-period net
income. For example, misclassifying an item as a gain rather than a revenue does
not affect income and is readily correctable. No prior-period adjustment to retained
earnings is required.
An error that affects prior-period net income is counterbalancing if it self-corrects
over two periods. However, despite the self-correction, the financial statements
remain misstated. They should be restated if presented comparatively in later
periods. The flowchart on inventory errors in Study Unit 7, Subunit 7 illustrates this
concept.
An example of a noncounterbalancing error is a misstatement of depreciation. Such
an error does not self-correct over two periods. Thus, a prior-period adjustment will
be necessary.
IFRS Difference
A prior-period error must be corrected by restatement unless it is impracticable to do so. The
indirect effects of a change in accounting policy are not addressed by IFRS.
3.4 EARNINGS PER SHARE (EPS)

1.
Overview
a.
Earnings per share (EPS) is the amount of current-period earnings that can be
associated with a single share of a corporations common stock.
1)
The guidance regarding calculation and presentation of EPS must be followed by

public entities and by other entities that choose to report EPS.
a)
The common stock or other equity securities of public entities are traded in
a public market or stock exchange.
b.
EPS is calculated only for common stock because common shareholders are the
residual owners of a corporation.
1)
Because preferred shareholders have a superior claim to the entitys earnings,

amounts associated with preferred stock must be removed during the
calculation of EPS.
Over the years, the topic of earnings per share has been continually tested on CPA exams, often through
calculations. Expect to see one or two questions testing earnings per share on your exam.
2.
Basic Earnings per Share (BEPS)

a.
All corporations must report two BEPS amounts on the face of the income statement.
Their numerators are income from continuing operations and net income,
respectively.

EXAMPLE
At year end, an entitys capital structure consisted of 10,000,000 shares of $1 par-value common stock. The entity issued
no new shares during the year. Its income from continuing operations and net income for the year were $1,278,000 and
$1,141,000, respectively.
BEPS calculations:
Income from continuing operations:
Net income:
b.
3.
$1,278,000 10,000,000 = $0.128

$1,141,000 10,000,000 = $0.114
If an entity has no discontinued operations, the income from continuing operations

equals net income. Thus, one amount of BEPS for net income available to common
shareholders is presented on the face of the income statement.
Calculation of the BEPS Numerator

a.
Income available to common shareholders is the BEPS numerator.

1)
Thus, neither BEPS amount (income from continuing operations or net income)
is calculated directly from the amount reported for that line item on the income
statement.
a)
Income in the BEPS numerator is reduced by dividends

i)
2)
Declared in the current period on preferred stock (whether or

not paid) and
ii) Accumulated for the current period on cumulative preferred
stock (whether or not earned).
b) Dividends paid in the current period for undistributed accumulated
preferred dividends for prior years do not affect the calculation. They are
included in BEPS of prior years.
The following calculation is performed for net income and income from
continuing operations (or other number):
Income statement amount
Minus: Dividends on preferred stock for the current period
(cumulative or declared noncumulative)
Equals: Income available to common shareholders
10
EXAMPLE
An entity has two classes of preferred stock. It declared a 4% dividend on its $100,000 of noncumulative preferred stock.
The entity did not declare a dividend on its $200,000 of 6% cumulative preferred stock. Undistributed dividends for the past
4 years have accumulated on this stock. The following is an excerpt from the entitys condensed income statement for the
year:
Income from continuing operations before income taxes
Income taxes
Income from continuing operations
$1,666,667
(666,667)
$1,000,000
Discontinued operations:
Income from operations of component unit -Pipeline Division (including gain on disposal of $2,897)
Income tax expense
Income before extraordinary item
Loss from volcano damage, net of applicable income taxes of $52,221
Net income
$15,283
(5,283)
10,000
$1,010,000
(140,000)
$ 870,000
The numerators for income from continuing operations and for net income are calculated as follows:
Income statement amounts

Declared or accumulated preferred dividends:
Dividends declared on noncumulative preferred stock in the current period
Dividends accumulated on cumulative preferred stock in the current period
Income available to common shareholders
b.
4.
Income from
Continuing
Operations
$1,000,000
Net Income
$870,000
(4,000)
(12,000)
$ 984,000
(4,000)
(12,000)
$854,000
Given an extraordinary item but no discontinued operation, BEPS is reported for

income before extraordinary items, not income from continuing operations.
Calculation of the BEPS Denominator

a.
The weighted-average number of common shares outstanding is determined by

relating the portion of the period that the shares were outstanding to the total time in
the period.
1)
Weighting is necessary because some shares may have been issued or

reacquired during the period.
EXAMPLE
In the previous example, assume the following common stock transactions during the year just ended:
Date
Jan 1
Mar 1
Aug 1
Nov 1
Stock Transactions
Beginning balance
Issued 60,000 shares
Repurchased 20,000 shares
Total
Common Shares
Outstanding
240,000
300,000
280,000
360,000
Times:
Portion
of Year
2 12
5 12
3 12
2 12
Equals:
Weighted
Average
40,000
125,000
70,000
60,000
295,000
The BEPS amounts for income from continuing operations and net income are $3.336 ($984,000 295,000) and $2.895
($854,000 295,000), respectively.
11
b.
Stock dividends and stock splits require an adjustment to the weighted-average of

common shares outstanding.
1)
2)
EPS amounts for all periods presented are adjusted retroactively to reflect the
change in capital structure as if it had occurred at the beginning of the first
period presented.
Adjustments are made for such changes even if they occur after the end of the
current reporting period but before issuance (or the availability for issuance) of
the financial statements.
EXAMPLE
In the previous example, assume declaration of a 50% common stock dividend on June 1 and a 2-for-1 common stock split
on October 1:
Date
Jan 1
Mar 1
Jun 1
Aug 1
Oct 1
Nov 1
Stock Transactions
Beginning balance
Distributed 50% stock dividend
Repurchased 20,000 shares
Distributed 2-for-1 stock split
Total
Common Shares
Outstanding
240,000
300,000
450,000
430,000
860,000
940,000
Times:
Restate for
Stock Div.
1.5
1.5
Times:
Restate for
Stock Split
2
2
Times:
Portion
of Year
2 12
5 12
Equals:
Weighted
Average
120,000
375,000
3 12
215,000
2 12
156,667
866,667
The BEPS amounts for income from continuing operations and net income are $1.135 ($984,000 866,667) and $0.985
($854,000 866,667), respectively.
c.
Contingently issuable shares are shares issuable for little or no cash consideration
upon satisfaction of certain conditions.
1)
5.
Contingently issuable common shares are treated as outstanding and included in

the calculation of the BEPS denominator from the date when the conditions for
contingent issuance have been met.
Diluted Earnings per Share (DEPS)

a.
A corporation with only common stock outstanding (a simple capital structure) must
report only BEPS.
1)
An entity that does not have a simple capital structure must report DEPS as well
as BEPS. Thus, the DEPS calculation includes the effects of dilutive potential
common shares (PCS).
a)
b.
PCS are securities or other contracts that may entitle the holder to obtain
common stock.
b) PCS are included in the DEPS calculation only if they are dilutive.
Dilution is a reduction in BEPS (or an increase in loss per share) resulting from the
assumption that
1)
2)
3)
Convertible securities (preferred stock or debt) were converted;

Options, warrants, and their equivalents were exercised; or
Contingently issuable common shares were issued.
a)
b)
The conditions for contingent issuance may be satisfied by year end. The
shares are then deemed to have been issued at the beginning of the
period or date of the contingent stock agreement, if later.
However, the conditions may not have been met at year end. In this case,
the shares included in the DEPS denominator equal those that would
have been issued if the end of the year were the end of the contingency
interval.
12
EXAMPLE
The contingency may involve earnings. The contingently issuable shares equal those issuable (if any) based on the current
periods earnings if the result is dilutive.
6.
Calculation of DEPS
a.
DEPS measures performance after considering the effect on the numerator and
denominator of dilutive PCS. DEPS is calculated as follows:
1)
2)
The BEPS denominator is increased to include the weighted-average number

of additional shares of common stock that would have been outstanding if
dilutive PCS had been issued.
The BEPS numerator is adjusted to add back any dividends on convertible
preferred stock and the after-tax interest expense (an amount that includes
amortization of discount or premium) related to any convertible debt.

EXAMPLE
Green Companys current year BEPS is $40 ($400,000 income available to common shareholders 10,000 weightedaverage number of common shares outstanding). No dividend was declared this year, and the companys effective tax rate
is 30%. The following PCS were outstanding during the year:
$500,000 face amount, 10-year, 6%, convertible bonds. The bonds were originally issued at par, and
each $5,000 bond is convertible into 10 of Greens common shares.
10,000 shares of $20 par, 10%, cumulative, convertible preferred stock. The conversion ratio is 5 shares
of preferred stock to 2 shares of common stock.
Assuming that the bonds and the preferred stock are dilutive securities, the DEPS for the period is calculated as follows:
Adjustment of BEPS Numerator
Convertible bonds: The BEPS numerator is adjusted to add back the after-tax amount of interest expense recognized in
the current period associated with the convertible bonds. Because the bonds were issued at par, interest expense is
calculated using the bonds stated rate. Thus, the amount added back is calculated as follows:
$500,000 face amount 6% (1.0 .30) = $21,000
Cumulative convertible preferred stock: The BEPS numerator is adjusted to add back any convertible preferred
dividends that were declared or accumulated. No dividends were declared. However, the income available to common
shareholders of $400,000 reflected the dividends accumulated for the current period on cumulative convertible preferred
stock. Thus, the amount added back is calculated as follows:
10,000 preferred shares $20 par 10% = $20,000
Adjustment of BEPS Denominator
Convertible bonds: The BEPS denominator is increased to include the weighted-average number of additional shares of
common stock that would have been outstanding if the dilutive convertible bonds (PCS) had been converted. Thus, the
increase is calculated as follows:
($500,000 face amount $5,000 par) 10 = 1,000 common shares
Cumulative convertible preferred stock: The BEPS denominator is increased to include the weighted-average number of
additional shares of common stock that would have been outstanding if the dilutive convertible preferred stock (PCS) had
been converted. Thus, the increase is calculated as follows:
10,000 preferred shares (5 2) conversion ratio = 4,000 common shares
The DEPS for the year is

3)
4)
13
The calculation of DEPS does not assume the conversion, exercise, or

contingent issuance of antidilutive securities, i.e., securities that increase EPS
or decrease loss per share.
Dilutive securities issued during a period and dilutive convertible securities for
which (a) conversion options lapse, (b) preferred stock is redeemed, or (c) debt
is extinguished are included in the DEPS denominator for the period they were
outstanding.
a)
b.
7.
Moreover, dilutive convertible securities that were actually converted are

included for the period before conversion. Common shares actually
issued are included for the period after conversion.
5) Previously reported DEPS is not retroactively adjusted for subsequent
conversions or changes in the market price of the common stock.
Three methods are used to determine the dilutive effect of PCS: (1) the if-converted
method for convertible securities, (2) the treasury stock method for call options and
warrants, and (3) the reverse treasury stock method for put options.
The If-Converted Method

a.
The if-converted method calculates DEPS assuming the conversion of all dilutive
convertible securities at the beginning of the period or at the time of issue, if
later.
1)
b.
The conversion of antidilutive securities (those whose conversion would

increase EPS or decrease loss per share) is not assumed. Thus, convertible
PCS are antidilutive if the current dividend or after-tax interest per common
share issuable exceeds BEPS.
In determining whether PCS are dilutive, each issue or series of issues of PCS are
considered separately (rather than in the aggregate) and in sequence from the most
dilutive to the least dilutive. The goal of this process is to maximize the dilution of
BEPS (lowest possible DEPS).
1)
The control number to establish whether PCS are dilutive or antidilutive is the
BEPS for the period.
a)
2)
3)
4)
If a discontinued operation or extraordinary item is reported, the control

number is BEPS from continuing operations.
The issue with the lowest earnings per incremental share is included in DEPS
before issues with higher earnings per incremental share. If the issue with the
lowest earnings per incremental share is found to be dilutive with respect to
BEPS, it is included in a trial calculation of DEPS.
If the issue with the next lowest earnings per incremental share is dilutive with
respect to the first trial calculation of DEPS, it is included in a new DEPS
calculation that adjusts the numerator and denominator from the prior
calculation.
This process continues until all issues of PCS have been tested.
14
EXAMPLE
Using the data from the previous example on page 12, assume that Greens current-year BEPS is $23.20
($232,000 income available to common shareholders 10,000 weighted-average number of common shares outstanding).
The DEPS for the period is calculated as follows:
The earnings per incremental share of the convertible bonds is $21 ($21,000 1,000). The earnings per incremental share
of the cumulative convertible preferred stock is $5 ($20,000 4,000).
Because the preferred stocks earnings per incremental share ($5) is lower than bonds earnings per incremental share
($21), it is more dilutive. Thus, it is compared first with the BEPS for the period (the control number). Because $5 is lower
than $23.20, the cumulative convertible preferred stock is dilutive. Accordingly, it is included in the trial calculation of DEPS.
The result is

The next step is to compare the earnings per incremental share of the convertible bonds ($21) with the new control number
($18). Because it is higher than the control number, the convertible bonds are antidilutive and must not be included in the
calculation of DEPS. Thus, the DEPS for the period is $18.
NOTE: The inclusion of convertible bonds and preferred stock in the calculation of DEPS results in DEPS of $18.20
[($232,000 + $20,000 + $21,000) (10,000 + 4,000 + 1,000)]. This amount ($18.20) is not the lowest possible DEPS ($18).
NOTE: The inclusion of only convertible bonds in the calculation of DEPS results in DEPS of $23 [($232,000 + $21,000)
(10,000 + 1,000)]. This amount also is not the lowest DEPS possible ($18).
c.
8.
If a discontinued operation or extraordinary item is reported, the same number of

shares used to adjust the denominator for income from continuing operations (or
income before extraordinary items) is used to adjust the DEPS denominator for all
other reported earnings amounts. This rule applies even if the effect on the other
amounts is antidilutive.
Treasury Stock Method

a.
The second method used to determine the dilutive effect of PCS is the treasury stock
method. It is used to determine the dilutive effect of outstanding call options,
warrants, and their equivalents.
1)
b.
Call options and warrants are dilutive only if the average market price for the
period of the common shares is greater than the exercise price of the options
or warrants (they are in the money).
2) Equivalents include nonvested stock granted to employees, stock purchase
contracts, and partially paid stock subscriptions.
The treasury stock method assumes that
1)
c.
The options and warrants are exercised at the beginning of the period (or time of
issuance, if later),
2) Common shares are issued, and
3) The proceeds of exercise are used to purchase common stock at the average
market price for the period.
If the options or warrants are dilutive, their exercise affects only the denominator in the
computation of DEPS. Any additional number of common shares outstanding
(incremental shares) is added as an adjustment of the BEPS denominator.
1)
Because the numerator in the computation of DEPS is not affected, the earnings
per incremental share is $0. Thus, options and warrants are generally the most
dilutive PCS. They should be included first (before other series of PCS) in the
trial calculation of DEPS.
15
d.
The number of incremental shares from dilutive call options or warrants that must be
included in the denominator of the DEPS computation is determined as follows:
1)
2)
3)
Calculate the proceeds from exercising the options or warrants (number

outstanding exercise price).
Calculate the number of shares assumed purchased (proceeds from exercise
average market price for the period of common shares).
Calculate the number of incremental shares (number of common shares
assumed issued number of common shares assumed purchased).
a)
The number of common shares assumed issued is the amount of common

shares that would have been issued assume all the options or warrants
were exercised.
EXAMPLE
Troupe Companys current-year BEPS is $11 ($440,000 net income 40,000 weighted-average number of common shares
outstanding). Unexercised call options to purchase 20,000 shares of Troupes common stock at $20 per share were
outstanding at the beginning and end of the year. For the year, the average market price per share of Troupes common
stock was $25. The DEPS for the current year is calculated as follows:
1)
2)
3)
4)
5)
The call options are dilutive because the exercise price ($20) is less than the average market price ($25).
The proceeds from exercising the options are $400,000 (20,000 number of call options outstanding $20
exercise price of the options).
The number of shares assumed purchased is 16,000 ($400,000 proceeds from exercising the options $25
average market price).
The number of incremental shares is 4,000 (20,000 number of common shares assumed issued 16,000
number of common shares assumed purchased).
The number of incremental shares is added to the BEPS denominator in the computation of DEPS.
Thus, DEPS for the current year is

9.

Reverse Treasury Stock Method

a.
The third method used to determine the dilutive effect of PCS is the reverse treasury
stock method. It is used when the entity has entered into contracts to repurchase its
own stock, for example, when it has written put options held by other parties.
1)
When the contracts are in the money (the exercise price exceeds the average
market price), the potential dilutive effect on EPS is calculated by
a)
b.
Assuming the issuance at the beginning of the period of sufficient shares to

raise the proceeds needed to satisfy the contracts,
b) Assuming those proceeds are used to repurchase shares, and
c) Including the excess of shares assumed to be issued over those assumed
to be repurchased in the calculation of the DEPS denominator.
Options held by the entity on its own stock, whether they are puts or calls, are not
included in the DEPS denominator because their effect is antidilutive.
10. Income Statement Presentation

a.
An entity with only common stock outstanding (a simple capital structure) must
report BEPS but not DEPS for income from continuing operations and net income on
the face of the income statement.
1)
2)
All other entities must present BEPS and DEPS for income from continuing
operations and net income with equal prominence on the face of the income
statement.
An entity that reports a discontinued operation, an extraordinary item, or both
must report BEPS and DEPS for those line items on the face of the income
statement or in the notes.
16
b.
EPS disclosures are made for all periods for which an income statement or earnings
summary is presented. For each period for which an income statement is presented,
the following are disclosed:
1)
c.
d.
A reconciliation by individual security of the numerators and denominators of

BEPS and DEPS for income from continuing operations, including income and
share effects
2) The effect of preferred dividends on the BEPS numerator
3) PCS not included in DEPS because it would have had an antidilutive effect in the
periods reported
If DEPS data are reported for at least one period, they are reported for all periods
shown, even if they are equal to BEPS amounts.
For the latest period for which an income statement is presented, an entity must
disclose subsequent events that would have had a material effect on common
shares or PCS outstanding if the transaction had occurred prior to the balance sheet
date.
1)
e.
Subsequent events occur after the balance sheet date and prior to the issuance
(or availability for issuance) of the financial statements.
An entity must explain within its financial statements the rights of outstanding
securities. It also must disclose the number of shares issued upon conversion,
exercise, or satisfaction of conditions during the last fiscal year and any subsequent
interim period presented.
1)
The equity section should disclose in the aggregate the preferences given in
involuntary liquidation to senior stock that are considerably greater than par or
stated value.
a)
2)
The entity also must disclose the aggregate or per-share amounts at which
preferred stock is callable and the aggregate and per-share amounts of
preferred dividends in arrears.
Other necessary disclosures are the redemption requirements for the next
5 years for capital stock redeemable at fixed or determinable prices and dates.
3.5 LONG-TERM CONSTRUCTION CONTRACTS

1.
The Completed-Contract Method

a.
The completed-contract method is used to account for a long-term project when the
percentage-of-completion method is inappropriate.
1)
2)
It defers all contract costs in the inventory account construction in progress

until the project is completed. It records progress billings in the contra-inventory
account progress billings.
Revenue and gross profit are recognized only upon completion.
17
2.
The Percentage-of-Completion Method

a.
Percentage-of-completion is the preferable method. It records (1) all contract costs in

construction in progress and (2) all amounts billed in progress billings. However, the
percentage-of-completion method differs from the completed-contract method
because it recognizes revenue on long-term contracts when the
1)
b.
Extent of progress toward completion, contract revenue, and contract costs are
reasonably estimable;
2) Enforceable rights regarding goods or services to be provided, the consideration
to be exchanged, and the terms of settlement are clearly specified; and
3) Obligations of the parties are expected to be fulfilled.
The amount of gross profit recognized in a period is calculated as follows:
1)
Calculate the estimated total gross profit on the project.

EXAMPLE
A contractor is constructing an office complex for a real estate developer. The agreed-upon contract price was $75 million.
As of the close of Year 4 of the project, the contractor had incurred $44 million of costs. By its best estimates as of that
date, costs remaining to finish the project were $19 million.
Contract price
Minus: costs incurred to date
Minus: estimated costs to complete
Estimated total gross profit
2)
$75,000,000
(44,000,000)
(19,000,000)
$12,000,000
Calculate the percentage of the project completed as of the reporting date,

determined by the ratio of costs incurred thus far to estimated total costs.
EXAMPLE
Total estimated costs for the project as of the end of Year 4 are calculated as follows:
Costs incurred to date
Estimated costs to complete
Total estimated costs
$44,000,000
19,000,000
$63,000,000
The project is therefore 69.8% complete ($44,000,000 $63,000,000).
3)
Subtract the gross profit recognized so far.

EXAMPLE
The contractor will recognize $2,151,000 in gross profit for Year 4, calculated as follows:
Estimated total gross profit
Times: percentage complete
Gross profit earned to date
Minus: gross profit recognized in prior periods (given)
Gross profit for current period
c.
d.
$12,000,000
69.8%
$ 8,376,000
(6,225,000)
$ 2,151,000
When estimated revenue and costs are revised, a change in accounting estimate is
recognized. Recognition of the change is in
1) The period of change if only that period is affected or
2) The period of change and future periods if both are affected.
As soon as an estimated loss on any project becomes apparent, it is recognized in
full, under both the completed-contract and percentage-of-completion methods.
18
3.
Comparative Journal Entries

EXAMPLE
A contractor agrees to build a bridge that will take 3 years to complete. The contract price is $2 million and expected total
costs are $1.2 million.
Costs incurred during each year
Costs expected in future
Year 1
$300,000
900,000
Year 2
$600,000
600,000
Year 3
$550,000
0
By the end of Year 1, 25% ($300,000 $1,200,000) of expected costs has been incurred. Using percentage-of-completion,
the contractor will recognize 25% of the revenue or gross profit that will be earned on the project. The total gross profit is
expected to be $800,000 ($2,000,000 $1,200,000), so $200,000 ($800,000 25%) of gross profit should be recognized in
Year 1.
Year 1:
Construction in progress
Cash or accounts payable
Construction gross profit
Percentage-of-Completion
$300,000
$300,000
$200,000
Completed-Contract
$300,000
$300,000
--
$200,000
--
At the end of Year 2, total costs incurred are $900,000 ($300,000 + $600,000). Given that $600,000 is expected to be
incurred in the future, the total expected cost is $1,500,000 ($900,000 + $600,000), and the estimate of gross profit is
$500,000 ($2,000,000 contract price $1,500,000 costs). If the project is 60% complete ($900,000 $1,500,000),
$300,000 of cumulative gross profit should be recognized for Years 1 and 2 ($500,000 60%) under percentage-ofcompletion. Because $200,000 was recognized in Year 1, $100,000 should be recognized in Year 2.
Year 2:
$600,000
Completed-Contract
$600,000
$600,000
$600,000
--
$100,000
$100,000
--
At the end of the third year, total costs are $1,450,000. Thus, the total gross profit is known to be $550,000. Because a total
of $300,000 was recognized in Years 1 and 2, $250,000 should be recognized in Year 3, using percentage-of-completion. *
Year 3:
Cash
$550,000
Completed-Contract
$550,000
$550,000
$2,000,000
$550,000
$2,000,000
$1,750,000
250,000
$1,450,000
550,000
* This is the first recognition of gross profit under the completed-contract method.
4.
Progress Billings
a.
Ordinarily, progress billings are made and payments are received during the term of
the contract. The entries are
1)
The customer is billed:

Accounts receivable
Progress billings
$XXX
The customer pays:

Cash
Accounts receivable
$XXX
$XXX
$XXX
Neither billing nor the receipt of cash affects gross profit. Moreover, billing,
receipt of payment, and incurrence of cost have the same effects under both
accounting methods.
19
b.
The difference between construction in progress (costs and recognized gross profit)
and progress billings to date is reported as a current asset if construction in
progress exceeds total billings and as a current liability if billings exceed
construction in progress.
Closing entry:
Progress billings
c.
$XXX
$XXX
A variation on the preceding entries is to credit periodic gross revenue instead of gross
profit. This practice requires a debit to a cost of revenue earned account similar to
cost of goods sold. The debit equals the costs incurred in the current period. For
example, in Year 1, the second entry would be
Construction in progress (gross profit)
Construction expenses (a nominal account)
Gross revenue
$200,000
300,000
$500,000
IFRS Difference
The completed-contract method is not used. When the outcome of a long-term construction
contract cannot be reliably estimated, revenue recognition is limited to recoverable costs
incurred. Contract costs must be recognized as an expense in the period in which they are
incurred.
3.6 REVENUE RECOGNITION AFTER DELIVERY

1.
The Installment Method

a.
b.
The installment method is only acceptable when receivables are collectible over an
extended period and no reasonable basis exists for estimating the degree of
collectibility.
The installment method recognizes a partial profit on a sale as each installment is
collected.
1)
c.
This approach differs from the ordinary procedure, that is, recognition of revenue
when a transaction is complete. Thus, when collection problems (bad debts)
can be reasonably estimated, the full profit is usually recognized in the period of
sale.
The amount recognized each period under the installment method is the realized
gross profit. This amount equals the cash collected on installment sales for the
period times the gross profit percentage on installment sales for the period (a
separate gross profit percentage is calculated for each period).
!!

1)
!

In addition, interest income must be accounted for separately from the gross
profit on the sale
20
EXAMPLE
A TV costing $600 is the only item sold on the installment basis in Year 1. The TV was sold for a price of $1,000 on
November 1, Year 1. Thus, the gross profit percentage is 40% [($1,000 $600) $1,000]. A down payment of $100 was
received, and the remainder is due in nine monthly payments of $100 each. Because all payments are due within 1 year,
no interest is charged. The entry for the sale is
Cash
Installment receivable, Year 1
Cost of installment sales
Inventory
Installment sales
d.
$100
900
600
$ 600
1,000
At the end of the period, a portion of deferred gross profit is realized.

EXAMPLE
In December, when the first installment is received, the entry is

Cash
Installment receivable, Year 1
$100
$100
At December 31, installment sales and cost of installment sales are closed, and deferred gross profit is recognized.
Moreover, deferred gross profit must be adjusted to report the portion that has been earned. Given that $200 of the total
price has been received, $80 of the gross profit ($200 40%) has been earned. The entry is
Installment sales
Cost of installment sales
Deferred gross profit
Deferred gross profit (Year 1)
Realized gross profit
$1,000
$600
400
$80
$80
Net income should include only the $80 realized gross profit for the period. The balance sheet should report a receivable of
$800 minus the deferred gross profit of $320. Thus, the net receivable is $480.
Balance sheet:
Installment receivable
(net of deferred gross profit of $320)
e.
$480
The gross profit percentage for the period of the sale continues to be applied to the
realization of deferred gross profit from sales of that period.
EXAMPLE
In Year 2, the remaining $800 is received, and the $320 balance of deferred gross profit is recognized. If only $400 were
received in Year 2 (if payments were extended), the December, Year 2, statements would report a $400 installment
receivable and $160 of deferred gross profit.
f.
If goods sold are repossessed due to nonpayment, their fair value, remaining deferred
gross profit, and any loss are debited. The remaining receivable is credited.
EXAMPLE
Assume that the TV is repossessed because no payments other than the down payment were made. The realized gross
profit at December 31 is therefore $40 ($100 40%). Assume also that the used TV is recorded at its fair value at the time
of repossession of $400.
Inventory of used merchandise
Loss on repossession
Installment receivable
$400
360
140
$900
The loss on repossession is the difference between the $400 fair value and the $540 carrying amount [$900 remaining
receivable ($400 deferred gross profit $40 realized gross profit)] of the receivable.
21
g.
2.
The term installment sale applies not to the use of the installment method but to a
sale in which the consideration is receivable in installments. The sale price is the
present value of the consideration and is recognized as revenue at the time of sale.
Interest is recognized as earned under the effective interest method.
Cost-Recovery Method
a.
The cost-recovery method may be used only in the same circumstances as the
installment method. However, no profit is recognized until collections exceed the cost
of the item sold. Subsequent receipts are treated entirely as revenues.
EXAMPLE
In Year 1, Creditor made a $100,000 sale. The cost of the item sold was $70,000, and Year 1 collections equaled $50,000.
In Year 2, collections equaled $25,000, and $10,000 of the receivable was determined to be uncollectible. The net
receivable (receivable deferred profit) was $0 at the end of Year 2. The following entries are based on the cost-recovery
method:
Year 1:
Year 2:
3.
Receivable
Inventory
$100,000
$70,000
30,000
Cash
Receivable
$50,000
Cash
Receivable
Realized gross profit
$25,000
5,000

Receivable
$10,000
$50,000
$25,000
5,000
$10,000
Deposit Method
a.
This method is used when cash is received, but the criteria for a sale have not been
met. Thus, the seller continues to account for the property in the same way as an
owner. No revenue or profit is recognized because it has not been earned, e.g., by
transferring the property. The entry is
Cash
Deposit liability
$XXX
$XXX
3.7 FAIR VALUE MEASUREMENTS

1.
Overview
a.
b.
GAAP establish a framework for fair value measurements (FVMs) required by other
pronouncements. But they do not determine when FVMs are required. Accordingly,
they
1) Define fair value,
2) Discuss valuation techniques,
3) Establish a fair value hierarchy of inputs to valuation techniques, and
4) Require expanded disclosures about FVMs.
Practicability exceptions to FVMs stated in other pronouncements are not affected by
this guidance. For example, it does not eliminate the exemption from the requirement
to measure financial instruments at fair value if it is not feasible to do so.
22
2.
Definitions
a.
b.
Fair value is the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement
date.
The FVM is for a particular asset or liability that may stand alone (e.g., a financial
instrument) or constitute a group (e.g., a business). The definition also applies to
instruments measured at fair value that are classified as equity.
1)
2)
3)
The price is an exit price paid or received in a hypothetical transaction

considered from the perspective of a market participant.
The FVM considers attributes specific to the asset or liability, e.g., restrictions on
sale or use, condition, and location.
The unit of account is what is measured.
a)
c.
For example, a component of an entity may be classified as held for sale

and remeasured at fair value minus cost to sell. Thus, the component is
the unit of account.
Market participants are not related parties. They are independent of the reporting
entity.
1)
d.
e.
They are knowledgeable (i.e., they have a reasonable understanding based on

all available information).
2) They are willing and able (but not compelled) to engage in transactions involving
the asset or liability.
3) The FVM is market-based, not entity-specific.
An orderly transaction is not forced, and time is assumed to be sufficient to allow for
customary marketing activities.
The transaction is assumed to occur in the reporting entitys principal market for the
asset or liability.
1)
2)
In the absence of such a market, it is assumed to occur in the most

advantageous market. This market is the one in which the specific reporting
entity can (a) maximize the amount received for selling the asset or
(b) minimize the amount paid for transferring the liability, after considering
transportation and transaction costs.
Given a principal (or most advantageous) market, the FVM is the price in that
market without adjustment for transaction costs.
a)
f.
However, if location is an attribute of the asset or liability, the price includes

transportation costs.
Assets. The FVM is based on the highest and best use (HBU) by market
participants.
1)
g.
The HBU is in-use if the value-maximizing use is in combination with other

assets in a group. An example is machinery in a factory.
2) The HBU is in-exchange if the value-maximizing use is as a stand-alone asset.
An example is a financial asset.
Liabilities. The FVM assumes transfer, not settlement.
1)
2)
The liability to the counterparty is unaffected.

Nonperformance risk is unaffected and is included in the FVM.
3.
Valuation Techniques
a.
These should be consistently applied, appropriate in the circumstances, and based on

sufficient data. Given a range, the FVM is the point most representative of fair value.
All or any of the following should be used:
1)
2)
b.
The market approach is based on information, such as multiples of prices, from

market transactions involving identical or comparable items.
The income approach uses valuation methods based on current market
expectations about future amounts, e.g., earnings or cash flows.
a) It converts future amounts to one present discounted amount.

b) Examples are present value methods and option-pricing models.
3) The cost approach is based on current replacement cost. It is the cost to buy or
build a comparable asset.
Inputs to valuation techniques are the pricing assumptions of market participants.
1)
2)
4.
23
Observable inputs are based on market data obtained from independent

sources.
Unobservable inputs are based on the entitys own assumptions about the
assumptions of market participants that reflect the best available information.
Their use should be minimized.
The Fair Value Hierarchy

a.
Level 1 inputs are the most reliable. They are unadjusted quoted prices in active
markets for identical assets or liabilities that the entity can access at the
measurement date.
1)
b.
If the entity has a position in a single financial instrument that is traded in an

active market, the position is measured within Level 1. The FVM equals the
quantity held times the instruments quoted price.
Level 2 inputs are observable. But they exclude quoted prices included within
Level 1.
1)
c.
Examples are quoted prices for similar items in active markets, quoted prices in
markets that are not active, and observable inputs that are not quoted prices.
Level 3 inputs are the least reliable. They are unobservable inputs that are used in
the absence of observable inputs. They should be based on the best available
information in the circumstances.
1)
5.
The entity need not exhaust every effort to gain information about the
assumptions of market participants.
Disclosures
a.
One set of quantitative disclosures in tabular format is made for each major
category of assets and liabilities measured at fair value on a recurring basis
(e.g., trading securities).
1)
b.
For example, a reconciliation of the beginning and ending balances is required

for any assets or liabilities measured at fair value on a recurring basis that use
significant unobservable inputs (that is, Level 3) during the period.
For each major category of assets and liabilities measured at fair value on a
nonrecurring basis (e.g., impaired assets) during the period, quantitative
disclosures also must be made in tabular format.

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1

STUDY UNIT THREE

A component of the entity has been disposed of or is classified as held for

Amounts reported in discontinued operations may require adjustment. If the

Contingencies arising under the terms of the disposal transaction may be

SU 3: Income Statement Items

Employee benefit plan obligations for pensions and other postemployment

Income Statement Presentation

Operating results reported in discontinued operations include any income earned

SU 3: Income Statement Items

3.2 EXTRAORDINARY ITEMS

A material transaction or event that is unusual in nature and infrequent in

A transaction or event is unusual if it has a high degree of abnormality and is of

A warehouse fire is clearly unrelated to an entitys ordinary and typical activities.

A transaction or event is infrequent if it is not reasonably expected to recur in

An earthquake in Florida (but not in California) is not reasonably expected to recur.

Sometimes a pronouncement specifically classifies an item as extraordinary even if

SU 3: Income Statement Items

Items Not Considered Extraordinary

The following are examples:

Write-downs of receivables, inventories, intangible assets, etc.

a) Major casualty (e.g., flood),

Adjustments of estimates included in extraordinary items previously reported are

Extraordinary items should be reported individually in a separate section in the income

SU 3: Income Statement Items

3.3 ACCOUNTING CHANGES AND ERROR CORRECTIONS

Accounting Changes -- Overview

If financial information is to have the qualities of comparability and consistency, entities

Thus, the general presumption is that a principle once adopted must be

Change in Accounting Principle (Retrospective Application)

A change in accounting principle occurs when an entity (1) adopts a generally

An example of a direct effect is an adjustment of an inventory balance to

An example of an indirect effect is a required profit-sharing payment based

All periods presented must be individually adjusted for the period-specific

SU 3: Income Statement Items

In these circumstances, cumulative-effect adjustments must be made to the

Change in Accounting Estimate (Prospective Application)

A change in accounting estimate results from new information. It is a reassessment of

The new depreciable base of the machine is $78,000 ($80,000 $2,000).

A change in estimate inseparable from a change in principle is accounted for as a

An example is a change in a method of depreciation, amortization, or depletion

SU 3: Income Statement Items

Change in Reporting Entity

A change in reporting entity results in statements that are effectively those of a

Most such changes occur when (a) consolidated or combined statements

Error corrections must be reported in single-period statements as adjustments of

If comparative statements are presented, corresponding adjustments must

SU 3: Income Statement Items

If the purchase of a fixed asset on account had been debited to purchases:

If cash had been incorrectly credited:

3.4 EARNINGS PER SHARE (EPS)

The guidance regarding calculation and presentation of EPS must be followed by

SU 3: Income Statement Items

Because preferred shareholders have a superior claim to the entitys earnings,

Basic Earnings per Share (BEPS)

$1,278,000 10,000,000 = $0.128

If an entity has no discontinued operations, the income from continuing operations

Calculation of the BEPS Numerator

Income available to common shareholders is the BEPS numerator.

Income in the BEPS numerator is reduced by dividends

Declared in the current period on preferred stock (whether or

SU 3: Income Statement Items

Income statement amounts

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