Intermediate Accounting

13th Canadian Edition, Volume 1

Kieso ● Weygandt ● Warfield ● Wiecek ● McConomy

Chapter 4

Reporting Financial Performance

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Copyright ©2022 John Wiley & Sons, Canada, Ltd.

Statement of Financial Performance
• The statement of income/earnings has many names
o Under ASPE, income statement is most common
o Under IFRS, income can be reported
• In two separate statements: the statement of profit or
loss and the statement of comprehensive income, or
• In a combined statement, sometimes known as the
statement of financial performance—new from the IFRS
Conceptual Framework
• It is a report that measures the success of a company’s
operations over a specific time period

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Communicating Information About
Performance
• Investors and creditors can use the information in the
income statement to
o Evaluate past performance and profitability
o Provide a basis for predicting future performance
(however, past success does not necessarily mean future
success)
o Help assess the risk of not achieving future net cash
inflows by looking at relationships between the various
components of income
A useful statement of income has both feedback and predictive value, which
helps investors, creditors, and other users make decisions about stewardship
and resource allocation.

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Quality of Earnings/Information
• The statement of income/comprehensive income
has the following shortcomings:
o Items that cannot be measured reliably are not
reported in the income statement
o Income numbers are affected by the accounting
methods used
o Income measurement involves the use of estimates;
accrual accounting requires estimates
o Financial reporting contains bias
o GAAP is not always optimal

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Quality of Earnings
• Quality of earnings refers to
o How solid earnings numbers are
o Quality of information for the decision at hand
• Two main aspects to consider:
o Content
• Integrity of information
• Sustainability of earnings
o Presentation
• Earnings presentation is clear and concise
• Easy to use and understandable

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Characteristics of High-Quality Earnings
• Content
o Unbiased and objectively determined
o Reflects economic reality
o Reflects primary earnings from on-going core
activities
o Closely correlate with cash flows from operations
o Based on a sound business strategy and business
model
• Presentation
o Transparent—does not disguise or mislead
o Understandable

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Earnings Management
• Earnings management decreases quality of earnings
• Means targeting earnings levels and then working backward
to ensure the targets are met through
o Selection of specific accounting policies
o Use of aggressive assumptions/estimates
o Unnecessary transactions
o Presentation of results in the best light
• Used to increase current income by reducing future income or
vice versa
• Used by companies to meet investors expectations
• Users should assess the quality of earnings before making
decisions
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Measurement of Income
• Various ways to measure income
o Net income—revenues and gains less expenses and losses from
continuing and discontinued operations
• Supported by ASPE
o Comprehensive income—net income plus/minus other
comprehensive income/loss
• All-inclusive approach: includes all changes in equity except
shareholder transactions
• Supported by IFRS
o Operating income—ongoing revenues less expenses
• Current operating performance approach
• Supports the idea that regular and recurring items provide the
best predictive sustainability
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Other Comprehensive Income (OCI)
• OCI is made up of unrealized gains and losses on certain
securities, foreign exchange gains or losses, and other gains
and losses as defined by IFRS.
• Other comprehensive income = comprehensive income less
net income
• All items of income and expense should be included in net
income except under exceptional circumstances
• In principle, all items should be recycled to net income in
future periods if this treatment results in relevant information
that is representationally faithful (but there are some
exceptions, as we will discuss in later chapters)
• OCI is closed to an equity account on the SFP called
Accumulated Other Comprehensive Income (AOCI)
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Discontinued Operations
• Discontinued operations include separate components of
an enterprise
o that have been disposed of (by sale, abandonment,
spinoff)
o are classified as held for sale where they
• Represent (or are part of a plan to dispose of) a major line
of business or geographical area or
• Are a subsidiary acquired for resale
• Discontinued operations are presented separately, net of
tax, on the statement of income/comprehensive income
and on the statement of cash flows

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Components of an Enterprise
• The component of an enterprise must operate as a separate
unit with operations, cash flows and financial elements that
are clearly distinguishable from the rest of the enterprise
• Separate financial information is critical so the gain or loss
from discontinued operations can be properly measured
• The component must be a major line of business or a
geographical area—however what is “major” is a matter of
judgement
Is it material to users? The determination of “major” is generally
based on size but may also be made in terms of whether the
presentation as discontinued operations would affect decision-making.

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Assets Held for Sale
• If a component is not yet disposed of, it can be presented
as discontinued operations if it is considered held for sale
• There must be a formal plan in place for disposal of the
assets to be considered as held for sale
• Assets are “held for sale” if they meet all criteria
o Authorized plan to sell exists
o Asset available for immediate sale
o Active search for a buyer
o Sale is probable within a year
o Asset is reasonably priced and actively marketed
o Changes to the plan are unlikely

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Measurement and Presentation
• When an asset is held for sale (IFRS)
o Remeasured at “lower of carrying amount and fair value less
cost to sell”
o Gains can be recognized only up to the amount of any
previously recognized loss
o Depreciation is not recognized on held for sale assets
• Presented separately on balance sheet
o Under ASPE, held for sale assets retain original classification as
current or non-current
o Under IFRS, held for sale assets are generally classified as
current
• Held for sale assets might not meet the definition of
discontinued operations
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Presentation of Discontinued
Operations
PiP 4.4

The assets of the discontinued Or the amount could be shown as a single-line

operations would be shown item on the statement of
separately on the statement of income/comprehensive income, with the
financial position. details shown in the notes

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Statement of Income/Comprehensive
Income--Presentation
• Different ways to present performance information
o Minimum requirements set by GAAP
o Formatting—single step; multiple-step
o Classifications: customer, product line, nature, or
function, or by operating and non-operating,
continuing and discontinued, and regular and
irregular categories
• Objective of financial reporting is to communicate
information that users need to make decisions

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Ordinary versus Peripheral Activities
• Distinction between revenues and gains (and expenses and
losses)—depends on definition of ordinary or typical business
activities
o Revenues/expenses (e.g., selling an ice-cream cone)
o Gains/losses (selling an ice-cream-making machine)
o Unusual gains/losses
• Not typical; occur infrequently (write-downs of inventories;
foreign exchange gains/losses)
• Still part of continuing operations

Any items that are material and/or relevant to understanding the

financial performance should be presented separately under the full
disclosure principle.

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Basic Presentation Requirements
Items Required in the Statement of Income/Comprehensive Income under GAAP
ASPE per Section 1520 IFRS per IAS 1
• Revenue • Revenue
• Income from investments • Finance costs
• Income tax expense (before • Share of profit/loss for investments accounted for using the
discontinued operations) equity method
• Income or loss before discontinued • Expenses by nature or function
operations • Tax expense
• Results of discontinued operations • Results of discontinued operations
• Net income or loss • Profit or loss
• Net income attributable to • Other comprehensive income classified by nature showing which
noncontrolling interest and owners will be recycled and which will not
• Share of other comprehensive income of investments accounted
for using the equity method
• Total other comprehensive income
• Profit or loss and comprehensive income attributable to non-
From Illustration 4.6 controlling interest and owners
• Comprehensive income

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Combined Statement of
Income/Comprehensive Income
• Under IFRS, two presentation styles
o Single combined statement with revenues, expenses,
gains, losses, net income, other comprehensive income,
and comprehensive income
• OCI items must be grouped and presented based on their
recycle status
o Two separate statements—communicates information
about all changes in net assets
1. Traditional income statement
2. Second statement beginning with net income, and showing
other comprehensive income and comprehensive income

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Single-Step Income Statement
• Only two main groups of items: revenues (including
gains) less expenses (including losses)
• Single-step—single subtraction needed to arrive at net
income before discontinued operations
• Income tax reported separately before net income
before discontinued operations
• Advantages
o Presentation is simple
o No one type of revenue or expense item is implied to
have priority over any other
• Disadvantage—oversimplification and less detail
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Multiple-Step Income Statements
• Separates operating from non-operating transactions
• Matches costs and expenses with related revenues
• Highlights intermediate components to facilitate analysis
o Gross profit margin; operating earnings
o Income/loss from discontinued operations (non-recurring
so little predictive value; but provides feedback value)
• Net income from only continuing operations is viewed as
higher quality
Separate disclosure helps users recognize that incidental or irregular activities
are unlikely to continue at the same level (enhances predictive value).

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Multiple-Step Income Statement
Presentation—Operating Section
1. Continuing Operations
a. Operating section. A report of the revenues and expenses
of the company's principal operations.
i. Sales or Revenue. A subsection presenting sales, discounts,
allowances, returns, and other related information. Its
purpose is to arrive at the net amount of sales revenue.
ii. Cost of Goods Sold. A subsection that shows the cost of
goods that were sold to produce the sales.
iii. Selling Expenses. A subsection that lists expenses resulting
from the company's efforts to make sales.
iv. Administrative or General Expenses. A subsection
reporting expenses for general administration.
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Multiple-Step Income Statement
Presentation—Non-Operating Section
b. Non-Operating section. A report of revenues and expenses
resulting from the company's secondary or auxiliary activities.
In addition, special gains and losses that are infrequent and/or
unusual are normally reported in this section. Generally these
items break down into two main subsections:
i. Other Revenues and Gains. A list of the revenues earned or gains
incurred from non-operating transactions, and generally net of
related expenses.
ii. Other Expenses and Losses. A list of the expenses or losses
incurred from non-operating transactions, and generally net of
any related income.
c. Income Tax. A short section reporting income taxes on income
from continuing operations.

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Multiple-Step Income Statement
Presentation--Other Sections
2. Discontinued Operations. Material gains or losses
resulting from the disposition of a part of the business
(net of taxes).
3. Other Comprehensive Income (IFRS). Other gains/losses
that are not required by primary sources of GAAP to be
included in net income. This section includes all other
changes in equity that do not relate to shareholder
transactions (net of taxes).
Financial statements that are provided to external users have less detail than
internal management reports. Having less detail contributes to
understandability because it reduces “information overload.”

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Condensed Financial Statements
• Includes only the totals of expense groups—using
supplementary schedules to support the totals
• Income statement may be reduced to one page
• How much detail?
o Simple summarized statement is quick to read
o Some users require detailed relevant information
• Significant amount of flexibility allowed if basic GAAP
requirements are met
The use of supplementary schedules
is an example of a trade-off between
understandability and full disclosure.

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Expenses: Nature versus Function
• Under IFRS, analysis of expenses must be presented based on
either:
o Nature of expenses (e.g., purchase of materials, transportation
costs, employee benefits, depreciation, etc.); no allocation of
costs required
o Function of expenses (e.g., cost of sales, administrative costs,
etc.); requires more judgement as some expenses must be
allocated between activities
• Under IFRS, if expenses are presented by function some
expenses must also be disclosed by nature
• No similar guidance under ASPE
• Which is better? Most companies use a combination of both

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Statements of Comprehensive
Income—Expenses by Nature
Consolidated Statement of Loss; Classified Primarily by Nature

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Intraperiod Tax Allocation
• Refers to the allocation of tax balances within a period
• Certain irregular items on the income statement are
reported net of tax
• Specifically, income tax expense (or benefit) is calculated
and presented separately for income from
o Continuing operations
o Discontinued operations
o Other comprehensive income
• Relates income tax expense to the items being taxed
• IFRS: can present OCI either net of tax individually, or
before tax with one amount related to all OCI items
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Earnings Per Share (EPS)
• Earnings per share (EPS) is considered a key indicator of
a company’s performance
• Measures the number of dollars earned per common
share; it does not report the dollars paid (or to be paid)
to shareholders as dividends
Income available to common shareholders*
EPS =
Weighted average number of common shares outstanding
*Income available to common shareholders = Net income − Preferred Dividends
• Some companies’ earnings per share are subject to
dilution (reduction) because existing contingencies allow
future issues of common shares

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Presentation of Earnings Per Share
• Disclosures on the face of the income statement or
notes to the statements related to EPS :
o Public companies are required to disclose basic EPS
o Must report EPS for income before discontinued
operations as well as per-share amounts for
discontinued operations
o Corporations present both basic and fully diluted EPS
• EPS is less relevant for private companies (shares are
closely held), so companies following ASPE are not
required to include EPS.

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Presentation of the Statement of
Retained Earnings (ASPE)
• Under ASPE, the statement of retained earnings shows
accumulated income (or deficit) as well as how much has
been paid out as dividends
• Other variables that affect retained earnings
o Retrospective applied changes in accounting policies
o Retrospective corrections of errors
o Changes in accounting estimates are accounted for
prospectively (in the income statement, not the
statement of retained earnings)
• Statement can be prepared separately or combined with
the statement of income
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Statement of Retained Earnings

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Presentation of the Statement of
Changes in Equity (IFRS)
• IFRS requires a statement showing changes in each
equity component and for total shareholders’ equity
• Items that must be presented in the statement
o Total comprehensive income (attributable to owners and
noncontrolling interests)
o For each component of equity
• Effects of retrospective application
• Reconciliation of beginning and ending carrying amounts
(profit or loss, OCI, owner transactions)
• Must also disclose an analysis of OCI by item—in the
statement or the notes
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Presentation of Consolidated
Statement of Changes in Shareholders’
Equity (IFRS)

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Presentation of Shareholders’ Equity in
the Consolidated Statements of
Financial Position

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Disclosure
• Notes are a great source of background and explanatory
information
• Notes supplement the main statements and should be cross-
referenced to the main financial statements
• The notes should include
o Accounting policies
o Sources of estimation uncertainty
o Information about the capital and how it is managed
o Information including dividends, the legal form, its country of
incorporation, description of the business, and the name of the
parent company
o Other items under the full disclosure principle

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Analytics
• When analyzing the health of a company and its quality
of earnings, look for and analyze
o Accounting policies—aggressive, soft numbers
o Notes to financial statements—unrecognized liabilities,
asset overstatement
o Measurement uncertainty—risk
o Financial statements—complexity of presentation and
language; percentage of net income from ongoing
operations; cash versus net income; financing and
revenue-generating assets
o Other—environmental factors, competition, strategic
positioning, future of the industry
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Non-GAAP Measures
• Measures with modified GAAP information
• Non- GAAP earnings, for example
o GAAP net income plus or minus non-operating items
o Calculation should be clearly disclosed and explained
o Should be reconciled to net income
o Should add value to the decision-making process
• Disadvantage is there are no standards to ensure the
calculation is
o Consistently prepared
o Comparable between companies
• Ontario Securities Commission has set out certain principles
for use of non- GAAP measures
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Other Key Measures
• Price-earnings ratio—common ratio based on earnings
Market price per share
EPS
• Multiply every dollar earned by the P/E ratio = approximate
share value
• Sometimes called an earnings multiple
• Used to track and compare earnings multiples between
companies and industries
• High-level introduction to show the importance of EPS when
valuing companies

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IFRS/ASPE Comparison
IFRS ASPE
Income statement Mandated list of items Requirements are different
presentation
Guidance on expense Present an analysis based on nature No guidance—must meet
classification or function required disclosures
Discontinued operations Held-for-sale assets and liabilities Held-for-sale assets and
reclassified as current liabilities reclassified as current
or non-current
Other comprehensive Classified as comprehensive or net Not recognized
income income, must prepare a statement
of comprehensive income
Earnings per share Basic and diluted in the statements Not mentioned—not relevant
to private entities
Changes in equity Statement of changes in equity is Statement of retained earnings
required
Accounting changes New policy—must be reliable and Does not have to meet “must
more relevant be reliable and more relevant”

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