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I'm Larry Walther.
This is principlesofaccounting.com, chapter 15.
In this module, we will look at special reporting situations,
special disclosures that are appropriate.
The accounting profession uses an all inclusive approach to measuring income.
In other words, virtually all transactions and events, other than shareholder
related transactions are channeled through the income statement.
We don't decide that a loss can be charged or credited direct to the retain earnings,
for example, it needs to be reflected in the income statement.
At certain situations though, the accounting rules have evolved such that
special disclosures are appropriate for
events that are other than just kind of central ongoing or mainstream operations.
So we're going to look at error corrections, discontinued operations,
other comprehensive income as well as changes in accounting methods.
Let's start with corrections of errors.
These are mathematical mistakes, incorrect reportings,
oversights, omissions, mistakes, errors.
Once an error is discovered in our reported financial statements,
it must be corrected.
Catch ups are not permitted.
In other words, if we failed to record depreciation in 20X4, we can't go,
oops, let's just double count in 20X5 and we're back on track.
Both years would be wrong in that case.
In the truest sense of the word,
we should go back and correct the financial statements of the prior period.
Corrections of errors are handled by prior period adjustments.
That is the prior period financial statements are subjected to restatement
to make them correct.
Now, there is a global exception for
adjustments that maybe impractical to determine.
Let's think about this in a journal entry context.
A correcting journal entry would effect retained earnings, because revenue and
expense accounts from earlier periods were wrong and it'd all ready been closed.
So to record deprecation for
20X4 during 20X5, we'll need to credit the balance sheet account that's effected.
In this case, accumulated depreciation, but the offsetting debit will be to
retained earnings since last year's income was always closed out.
We're not gonna go back and reopen the books, then record the expense.
We'll simply charge the affect to retained earnings.
The credit to accumulated depreciation provides a catch up
adjustment to where the account would have been
had the depreciation been correctly recorded in the prior year.
Now if we show comparative financial statements,
however, we need to go back and change those.
In other words, if we have income statements for X5 and X4, we need to go
back and change the amount and show the correct amount of expense for each year.
So, what we do in the ledger may not be the same as what we're showing in
the financial statements.
If an error related to periods prior to those for which comparative data
are presented, then we would adjust the earliest retained earnings presented.
So, here's an example.
I'm assuming we're only showing a single period's financial statements, 20X5.
So here, I'm going to show retained earnings at January 1,
20X5 as was previously reported.
Last year's ending including the error, then I'm gonna take
less the effect of the correction of the error to come up with my adjusted or
corrected beginning retainer earnings number.
This would be the presentation that would apply to the earliest retain earnings
statement presented and it reflects all effects of errors prior to the date of
that earliest financial statement.
But again, if I showed comparative income statements,
I'd want both of those to be the correct depreciation amounts.
Let's move on to the subject of discontinued operations.
A company may decide to exit a unit of operation by sale or disposal.
The disposal of a complete business component has unique reporting rules.
A business component has operations that are clearly distinguishable operationally
and for reporting purposes.
What I'm showing here in this income statement is we have a discontinued
operation.
Bailout Corporation completely disposed of business component during the year.
And after income continuing operations, I'm showing the loss from the operation of
this sports equipment business as well as a loss on disposal
to come up with the loss from discontinued operations net of taxes at $470,000.
Once I've entered into the phase of accounting for a operation as
discontinued, none of the sales or cost of sales or other expenses than the income
continuing operations amounts include anything related to that segment.
Everything is in pulled down into discontinued operations.
Company disposes of a facility or some other set of assets that is not a business
component, then discontinued operations reporting is not involved or invoked.
Here, I'm talking about selling off something less than a complete
business component.
For example, Sail Out sold its facility in Georgia,
but continued to distribute the same products at other locations.
That would not constitute a discontinued operation.
The income statement might include a gain or loss on the sale of the Georgia
location, but that would be included as part of the income continuing operations.
It's not a separate discontinued operation.
Importantly, with discontinued operations,
I noted that we were showing the effects net of taxes.
I say, income taxes are split between continuing operations and
the taxes that relate to discontinued operations.
This is referred to as intra or within the same period tax allocation.
It's also applicable to other items that are reported below continuing operations,
as well as the prior period adjustment and other certain equity effects are sometimes
shown net of their related tax consequence.
Moving on to another category, we'll look at other comprehensive income.
This may arise from changes such in the fair value of available for
sale securities.
We saw this in an early chapter nine.
We might have certain pension plan adjustments or we might have effects from
the translation of financial statements of foreign affiliates.
Moving on, changes in accounting methods.
Changing from one acceptable accounting method to another, such as a change from
the FIFO inventory method to the average cost inventory method
is what we're talking about here in the context of changes in accounting methods.
Now changes should only occur for good reason and
we don't wanna flip-flop back and forth,
just trying to have a higher net income is not deemed a good reason for change.
There should be some other substantial explanation for
why the company is making the change.
And when we make those change, we make them by retrospective adjustment.
Financial statements of prior accounting periods are reworked as if
the new principle had been in use all along.
This is similar to the treatment for corrections of errors,
except almost in semantics.
We call error corrections prior period adjustments and
changes in accounting methods.
We're going to refer to them as retrospective adjustments.
When we make a change in accounting methods, we need to have full disclosure.
Notes need to indicate why the newly adopted method is preferable.
The presentation that we make for the change should illustrate the amounts that
were previously presented versus the newly derived amounts with a clear description
of the effects of all changes and further disclosure should show the cumulative
effect of what the change would have done in all financial statement periods prior
to the earliest period presented.
Changes in accounting methods are not to be confused with changes in accounting
estimates.
Changes in estimates are handled prospectively.
We looked at an example of this back in the earlier chapter on property,
plant and equipment.
We did not make a retrospective adjustment.
We accounted for the change's effects over the current and future periods.
If a change in principle cannot be separated from a change in estimate,
we deem it to be a change in estimate and we report as such.
Let me close by talking about EBIT and EBITDA.
These are not accounting measurements.
EBIT is earnings before interest and taxes and EBITDA is earnings before interest,
taxes, depreciation and amortization.
These are tools that analysts sometimes use.
They're sometimes used in evaluating the viability of a business acquisition
transaction.
They're not accounting measurements,
they're calculations of database to telling account methods.
While they might be useful in certain contexts,
one needs to be very careful in their interpretation.
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