The Accrual ConceptThe Accrual Concept

What is it?What is it?

DefinitionsDefinitions

Economic incomeEconomic income Distributable earningsDistributable earnings Permanent earningsPermanent earnings Accounting incomeAccounting income

Review??Review??

Income statementIncome statement– Various formatsVarious formats– Suggested format (p 35)Suggested format (p 35)– Why shouldn’t we use presented format?Why shouldn’t we use presented format?– What about nonrecurring items?What about nonrecurring items?

Empirical researchEmpirical research

Surprising to me!!!Surprising to me!!!

Predictive ability?Predictive ability?Unusual & infrequent itemsUnusual & infrequent items

Why do you think that’s true?Why do you think that’s true?

Revenue RecognitionRevenue Recognition

Timing?Timing?

Measurement?Measurement?

Different ways to recognize revenueDifferent ways to recognize revenue

Prior to title passagePrior to title passage

After title passageAfter title passage

Remember construction accounting?Remember construction accounting?

Completed contract vs % of completion?Completed contract vs % of completion?

Costs incurred? Costs incurred? What type of account?What type of account?

Amt’s billed to customers?Amt’s billed to customers?What type of accountWhat type of account

Impact of choice of method on financials??Impact of choice of method on financials??

Additional revenue recognition Additional revenue recognition methodsmethods

Installment methodInstallment method

Cost recovery methodCost recovery method

Accounting IssuesAccounting Issues

Revenue Recognition Revenue Recognition Sales incentivesSales incentives

BarterBarter

Membership feesMembership fees

EstimatesEstimates

Gross vs net recognitionGross vs net recognition

Early recognitionEarly recognition

Shipping & handlingShipping & handling

Accounting IssuesAccounting Issues

Expense RecognitionExpense RecognitionDeferralsDeferrals

Bad debtBad debt

WarrantiesWarranties

Accounting IssuesAccounting Issues

ClassificationClassificationFrom cgs to operating expenseFrom cgs to operating expense

Complex Revenue Recognition Complex Revenue Recognition

SoftwareSoftware

BroadcastBroadcast

Mortgage issuersMortgage issuers

Exercise clubsExercise clubs

IncentivesIncentives

Nonrecurring ItemsNonrecurring Items

Unusual or infrequentUnusual or infrequent

DiscontinuedDiscontinued

ExtraordinaryExtraordinary

ChangeChange

Unusual or InfrequentUnusual or Infrequent

““Special items”Special items”

ReorganizationsReorganizations

RestructuringsRestructurings

Incentive to increase losses?Incentive to increase losses?

Discontinued ItemsDiscontinued Items

Segregate operating income, any gains/losses Segregate operating income, any gains/losses (net of taxes) as of the measurement date.(net of taxes) as of the measurement date.

Extraordinary ItemsExtraordinary Items

Unusual AND infrequentUnusual AND infrequent

Plus g/l from early retirement of l.t. debt (most Plus g/l from early retirement of l.t. debt (most from this)from this)

Accounting ChangesAccounting Changes

Voluntary vs. mandatoryVoluntary vs. mandatory

How to Analyze Nonrecurring How to Analyze Nonrecurring

Ignore company’s classificationIgnore company’s classification

Sometimes nonrecurring recur a lotSometimes nonrecurring recur a lot

Income statement:Income statement:Misreporting impacts prior and future incomeMisreporting impacts prior and future income

Cash flow statement:Cash flow statement:No impactNo impact

Current period onlyCurrent period only

Future impactFuture impact

Implications for continuing operationsImplications for continuing operations

Earnings ManipulationEarnings Manipulation

TimingTimingIncome smoothingIncome smoothing

IntertemporalIntertemporal

ClassificatoryClassificatory

Big-bathBig-bath

Accounting changesAccounting changes

ClassificationClassification

Good news/bad newsGood news/bad news

Empirical ResearchEmpirical Research

Big bath --- not provenBig bath --- not proven

Smoothing – provenSmoothing – proven

Quality of earningsQuality of earnings

Consistency versus ConservatismConsistency versus Conservatism

Balance SheetBalance Sheet

A = L + SEA = L + SE