Accounting Policies, Income Statement and Related Items

GAAP requires company to disclose accounting policy in their financial reports. These policies provide relevant information to decision makers on choices taken by executives.

Financial statements are the final product of accounting process. Income statement provides data for investment and other decisions. The net income is essentially the common income statement form, consisting of classifications such as income from continuing operations, discontinued operations, extraordinary items, and cumulative effects of changes in accounting principles.In this study we investigate the relative ability of comprehensive income and net income to summarize firm performance. Per statement of financial accounting standards no. 220 (SFAS 220-10-2), if used with related disclosure and other information in the financial statements, the information provided by reporting comprehensive income should assist investors, creditors, and others in assessing an entity’s activities and the timing and magnitude of an entity’s future cash flows.

Accounting policies defined in the literatureAccounting policies are specific policies and procedures used by a company to prepare its financial statements. These include any methods, measurement systems and procedures for presenting disclosures. Accounting policies differ from accounting principles in that the principles are the rules and the policies are a company's way of adhering to the rules. (Investopedia. com) Disclosure of accounting policies should include accounting principles and methods of application that involve: (1) A selection from generally accepted alternatives; 2) Those peculiar to the industry or field of endeavor; and (3) Unusual or different applications of generally accepted accounting principles. Examples of disclosures are basis of consolidation, depreciation methods, and inventory pricing.

Disclosure of accounting policies assists financial readers in better interpreting a company's financial statements. Thus it results in fair presentation of the financial statements. (Answers. com) FASB topic 105-10-1 objective is to establish the Financial Accounting StandardsBoard Accounting Standards Codification as the source of authoritative principles and standards recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with generally accepted accounting principles (GAAP). (Codification, 2009) The AICPA Council designated Federal Accounting Standards Advisory Board (FASAB) as the body that establishes generally accepted accounting principles (GAAP) for federal reporting entities.

As such, the FASAB is responsible for identifying the “GAAP hierarchy” for federal reporting entities.The GAAP hierarchy consists of the sources of accounting principles used in the preparation of financial statements of federal reporting entities that are presented in conformity with GAAP and the framework for selecting those principles. The hierarchy lists the priority sequence of sources that an entity should look to for accounting and reporting guidance and is discussed in SFFAS 34, The Hierarchy of Generally Accepted Accounting Principles for Federal Entities, Including the Application of Standards Issued by the Financial Accounting Standards Board.The sources of accounting principles that are generally accepted are categorized in descending order of authority as follows: a. Officially established accounting principles consist of FASAB Statements of Federal Financial Accounting Standards (Standards) and Interpretations. FASAB Standards and Interpretations will be periodically incorporated in a publication by the FASAB.

b. FASAB Technical Bulletins and, if specifically made applicable to federal reporting entities by the AICPA and cleared by the FASAB, AICPA Industry Audit and Accounting Guides.Technical Releases of the Accounting and Auditing Policy Committee of the FASAB. d. Implementation guides published by the FASAB staff, as well as practices that are widely recognized and prevalent in the federal government.

(FASAB. gov) Comprehensive Income defined in literature Comprehensive income is the change in equity of a business enterprise during a period from transactions and other events from non-owner sources. It is the income of a company from any transaction that does not involve an owner's investment or distribution to an owner.It includes all non-owner changes in equity (in contrast to net income which does not include some changes in equity). Statement of Financial Accounting Standards No. 220 (SFAS 220-10-1) states that the purpose of reporting comprehensive income is to report a measure of all changes in equity of an entity that result from recognized transactions and other economic events of the period other than transactions with owners in their capacity as owners.

Per statement of financial accounting standards no. 20 (SFAS 220-10-2), if used with related disclosure and other information in the financial statements, the information provided by reporting comprehensive income should assist investors, creditors, and others in assessing an entity’s activities and the timing and magnitude of an entity’s future cash flows. (FASB. org) Net Income Classifications Net income is the residual income of a firm after adding total revenue and gains and subtracting all expenses and losses for the reporting period. Net income can be distributed among holders of common stock as a dividend or held by the firm as an addition to retained earnings.

The net income category is essentially the common income statement form, consisting of classifications such as income from continuing operations, discontinued operations, extraordinary items, and cumulative effects of changes in accounting principles. (Carter, 1997) Income from continuing operations Continuing operations are the businesses the company expects to be engaged in for the foreseeable future. The income statement is divided into two parts- the operating and non-operating sections.The portion of the income statement that deals with operating items is interesting to investors and analysts alike, because this section discloses information about revenues and expenses that are a direct result of the regular business operations. For example, if a business creates sports equipment, then the operating items section would talk about the revenues and expenses involved with the production of sports equipment. The non-operating items section discloses revenue and expense information about activities that are not tied directly to a company's regular operations.

For example, if the sport equipment company sold a factory and some old plant equipment, then this information would be in the non-operating items section. (Answers. com, Answers Corporation) Income from discontinuing operations Income from discontinued operations is written separately in a company's Income Statement so that investors understand that, although the company earned that income in that last year or quarter, they shouldn't expect those earnings to be around in the future as that division no longer exists.Income from discontinued operations also includes the proceeds of the sale of any businesses. For Example, if a company has a division that makes widget XYZ, and that division earned $5 million in net income in 2008 before the company sold the division for $100 million to a competitor, the company would report $105 million in income from discontinued operations on its income statement. (Wikiinvest.

com) Income from extraordinary items FASB section 117-101 specifies that an enterprise shall show extraordinary items separately as an item of net income for the period on the face of its income statement.Extraordinary items are events or transactions that are unusual and unrelated to the enterprise’s ordinary activities and would occur infrequently. These events or transactions can be unexpected natural disaster, expropriation or prohibitions under new regulations. Extraordinary items are listed after the net line, after-tax. (Wikipedia. com) Results of a company are often presented with and without these extraordinary items.

The logic of excluding these items is that investors have a better notion of future performance if one-time events are excluded.It is a large gain or loss in a company's earnings due to a non-recurring event that is out of the company's control. For example, a water distribution company may have unusually high earnings from sales because a natural disaster required relief organizations to purchase large quantities of clean water. On the other hand, it may have low earnings from sales because all the relief organizations had previously stocked up on water and did not need to buy any more. Other Comprehensive Income Classifications.

Financial Accounting Standards Board (FASB) issued the Statement of Financial Accounting Standards No. 130 (SFAS 130), Reporting Comprehensive Income. For fiscal years beginning after December 15, 1997, SFAS 130 requires the disclosure of both net income and other comprehensive income which includes four items recorded as owners’ equity under previous FASB pronouncements- a. Adjustments to unrealized gains and losses on available-for-sale marketable securities (SFAS 115) -FASB standards require all investments in securities to be reported in the balance sheet at fair value.However the unrealized gains and losses on securities that are not part of an actively traded portfolio (so called "available for sale" securities) are reported as "other comprehensive income".

(Brainmass. com) An unrealized loss occurs when a stock decreases after an investor buys it, but he or she has yet to sell it. If a large loss remains unrealized, the investor is probably hoping the stock's fortunes will turn around and the stocks worth will increase past the price at which it was purchased.If the stock rose back above the original price, then the investor would have an unrealized gain for the time he or she still holds onto the stock. For example, Sara Marshall buy shares in TSJ Sports Conglomerate at $10 per share, and then shortly afterwards the stock's price plummets to $3 per share, but she does not sell her shares.

At this point, she has an unrealized loss on this stock of $7 per share, because the value of her position is $7 dollars less than when she first entered into the position.If the company's fortune shifts and the share price soars to $18, and Sara has still not sold the stock, she'd now have an unrealized gain of $8 per share ($8 above where she first bought in). (Investopedia) b. Foreign currency translation adjustments (SFAS 52) - Currency translation adjustment occurs when the company has net assets, including equity investments, and liabilities “denominated” in a foreign currency. Functional currency is defined in Statement no.

52 as the currency of the primary economic environment in which the entity operates, which is normally the currency in which an entity primarily generates and expends cash.It is commonly the local currency of the country in which the foreign entity operates. It may, however, be the parent’s currency if the foreign operation is an integral component of the parent’s operations, or it may be another currency. (Sorensen, 2008). For example, if a company exchanges two currencies for practical, rather than investment, purposes, any profit from the transaction may be considered other comprehensive income.

(Financial-dictionary. com) c. Minimum required pension liability adjustments (SFAS 87), - Condition that is recognized when the Accumulated BenefitObligation is greater than the fair value of plan assets. However, no recognition is given in the opposite case. When an accrued pension liability exists, only an additional liability for the difference between the minimum liability and the accrued pension liability can be recorded. When an additional liability is recorded, it is offset by recognizing an intangible asset not exceeding the amount of unamortized prior service cost.

If it does exceed that amount, the excess is shown as a reduction of stockholders' equity in an account called net loss not recognized as pension expense.Assume an accumulated benefit obligation of $500,000, and a fair value of pension plan assets of $400,000, leaving a minimum pension liability of $100,000. If we assume that the accrued pension liability is $40,000, then the additional pension liability is $60,000. The unamortized prior service cost is assumed to be $50,000.

(Answer) d. Changes in the market values of certain futures contracts qualifying as hedges (SFAS 80) - If a derivative qualifies as a "highly effective" hedge, SFAS 133 permits companies to match the timing of the gains and losses of hedged items and their hedging derivatives.For a fair value hedge, SFAS 133 permits the hedger to record the change in the fair value of the hedged item concurrently with the gain or loss on the hedging derivative. For a cash flow hedge, the effective portion of any changes in the hedging derivative's fair value is recorded in other comprehensive income until the change in the value of the hedged item is recognized in earnings.In addition, and probably the most difficult calculations required by SFAS 130, other comprehensive income items must be adjusted for amounts currently reported in the net income category and also reported as part of other comprehensive income in a previous period. For example, a $1,000 gain on securities reported as part of net income in 1997 (a realized gain) and previously reported as an adjustment to equity in 1996 (an unrealized holding gain), would require an adjustment to unrealized gains and losses on securities reported as part of other comprehensive income in 1997.

Without such adjustments, called reclassification adjustments, it is possible that gains and losses would affect equity twice, once in the period in which they affect other comprehensive income (unrealized) and once in the period in which they affect net income (realized). (Carter, 1997) Companies are permitted to display the components of other comprehensive income: (1) Below the total for net income in an income statement.