Unit 2
U2M1
Q: What is the Role of the Income Statement?
A: Reports the result of operations over a specific period of time, tells a story about a company’s performance

Q: Role of Income Statement in Financial Analysis?
A: See if revenues and profits are increasing or decreasing and at what rate, earnings per share is also noted

Q: What is the objective of the Statement of Comprehensive Income?
A: To communicate the success of a company's operations, for a specific time period, to financial statement users 

Q: What does Statement of Comprehensive Income enable parties to do:
??Evaluate past performance and profitability
??Assist in predicting future performance
??Assess potential risk in achieving future net cash inflows

Q: What are the limitations of the Statement of Income/Comprehensive income?
??Items are excluded if they cannot be measured reliably- value of brand recognition, etc.
??Amounts reported are affected by accounting methods used
??Use of estimates in measuring income and financial reporting bias

Q: What is included in Comprehensive Income that is not in Income?
A: Comprehensive income includes all changes in equity during a period, except for those resulting from investments by owners and distributions to owners. Comprehensive income therefore includes net income, plus gains and losses that by-pass net income, but affect shareholders’ equity.

Q: Example of something that would be in the Comprehensive Income Statement?
A: Unrealized gains and losses associated with available-for-sale securities

2 

Q: How the Statement of Comprehensive Income should be displayed?
A: The AcSB decided that the components of other comprehensive income must be displayed in a separate financial statement (or an expanded income statement) with the same prominence as other key financial statements. Regardless of the format used, net income must be added to other comprehensive income to arrive at comprehensive income.

Q: What is a Discontinuance of Operations?
A: When an entity disposes of a segment of its business

Q: Why is it Important to Identify Discontinuance of Operations?
A: Since net income is a key number, care should be taken to ensure that items grouped with discontinued operations or other comprehensive income do indeed belong there

Q: How to qualify as discontinued operations?
A: The assets, results of operations, and activities of a segment of a business must be clearly distinguishable, physically and operationally, from the other assets, results of operations, and activities of the entity. 

Q: What are some examples of disposals of segments?
? Sale of a major division that represents the company's only activity in electronics industry, the assets and results of operations are clearly segregated 
? Sale by a meat packing company of a 25% interest in a professional football team, which has been accounted for under the equity method

Q: Examples of disposals that do not qualify as disposals of segments?
?Sale by a petrochemical company of a 25% interest in a petrochemical plant, which is accounted for as an investment in a corporate joint venture under the equity method, since the remaining activities of the company are in the same line of business.
?A manufacturer of children's wear discontinues all of its operations in Italy that were composed of designing and selling children's wear for the Italian market. In the context of determining a segment of a business by class of customer, the nationality of customers or slight variations in product lines to appeal to particular groups are not determining factors.

*Results of the disposal are reported in two components:
1. Income or loss from operation of the discontinued segment up to the measurement date, net of tax.
2. Gain or loss from disposal of the discontinued segment, net of tax.

4 
Q: How to handle Unusual Gains and Losses?
?If the amount is material, they are shown separate.
?Presented above income (loss) before discontinued operations
?Are NOT shown net of tax
Note that a company taking too many “one-time charges” (often accounting write-offs) in consecutive years, results in investors “discounting” the quality of information contained in the statements.

Q: What is Intraperiod Tax Allocation?
A: Is the procedure of allocating tax balances within a period
This intraperiod allocation is used for income from continuing operations, discontinued operations, extraordinary items and other comprehensive income. 
*See illustration 4-18 on page 181 in the text for an example of how this is applied.

Q: How are Changes in Estimates Handled?
A: Changes in estimates are accounted for in the period of change or the period of change and future periods if the change affects both, not handled retroactively
-Changes in depreciation methods, which under previous GAAP was treated as a change in accounting policy, is treated as a change in estimate under IFRS.

Q: Earnings per Share formula?

Net income – preferred dividends
Weighted average of common shares outstanding

NOTE: Dividends will be deducted if preferred shares are cumulative, regardless if the current year’s dividend has been paid. 
-Any dividends paid for amounts in arrears of cumulative preferred dividends (i.e. from previous years) will not be deducted as they were already considered in the previous year’s EPS calculation, Dividend declared on common shares have no effect on EPS
- EPS calculation is also broken down into components – eg. EPS from operations, EPS for Discontinued operations, EPS for EI = EPS from Net income.

W: Nature versus Function?
-An entity must present an analysis of expenses based on either nature or function.
??Nature focuses on the type of each expense (personnel expenses and depreciation) ??Function focuses on the business activity that it relates to (e.g., selling costs, administrative costs) 

Q: Which requires more judgement?
-Function since costs such as payroll and amortization are allocated between functions. At a minimum, this method requires that cost of sales be presented separately from other costs. -This presentation gives more insight into the various phases of operations

Q: Statement of Income Sections?
??Sales or revenue section
??Cost of goods sold section
??Selling expenses
??Administrative or general expenses
?Other Income and Expense
??Financing Costs
??Income Tax
    ??Discontinued Operations. Gains and losses resulting from disposal of a component of a company
??Non-Controlling Interest. Shows an allocation of net income to the primary shareholders and to the non-controlling interest
??Earnings Per Share

Q: What is included in Comprehensive Income?
A: Other Comprehensive Income (OCI) plus Net Income= Comprehensive Income
-OCI includes such items as:
?    Unrealized gains or losses on certain investments classified as fair value
?    Investments classified as fair value
?    Unrealized gains or losses on revaluation of PPE
?    Certain foreign exchange gains or losses
?    Other gains or losses as defined by IFRS

Q: Two ways to present the income statement?
A: Single-step format or the Multiple-step format

Q: What is included in the Single-Step Income Statement?
A: Total costs and expenses are subtracted from total revenues in a "single step" to arrive at net income. Income taxes are shown as a separate item among the expenses (usually last) to indicate their relationship to income before taxes.

 
6
Q: What is the Multiple-Step Income Statement?
A: The multiple-step format separates results achieved by regular operations of the entity from those obtained by non-operating activities. 
-Expenses are also classified by function, such as cost of sales, selling, and administrative.

 
Q: Why is the Income Statement often referred to as the link between prior period and current period statements of financial position?
A: Because it explains a major reason for the change in shareholder’s equity (specifically the results of operations in the period)

Q: How is beginning SE (Net Assets) reconciled with ending SE?

    Shareholders Equity at the Beginning of the Period
+    Common Shares Issued
-    Dividends
+/-     Results of Operations for the period (net income or net loss)
+/-     Other comprehensive income (loss) for the period
=    Shareholders Equity at the End of the Period

Q: What is Accumulated Other Comprehensive Income?
A: It represents the cumulative effect of OCI recognized in previous and current years

Q: What happens if OCI is zero?
A: A full statement of comprehensive income including OCI is not required, an income statement will meet disclosure requirements

Q: What is High Quality of Earnings?
-Refers to the quality of information content and presentation used to determine and disclose earnings, based on unbiased numbers and understandable disclosures, predictive in value

Q: How are Prior Period Adjustments handled?
A: PPA is reported as a net of tax adjustment (debit or credit) to the opening balance of Retained Earnings. The PPA appears on the current period statement of retained earnings or statement of changes in equity

Exercise 4-1
Calculate the amount of net income for the period:
    Shareholders Equity at the Beginning of the Period
+    Common Shares Issued
-    Dividends
+/-     Results of Operations for the period (net income or net loss)
+/-     Other comprehensive income (loss) for the period
=    Shareholders Equity at the End of the Period

Owners’ Equity at the beginning of the period:
Assets- Liabilities: 100,000-36,000= 64,000
Additional Owner Contributions (Shares Issued)= 10,000
Owner Withdrawals over the period (Dividends)= (30,000)
Subtotal= 44,000
X= Results of Operations for the period (net income or net loss)
Owner’s Equity at the end of the period= 108,000-38000= 70,000

Solve for X= 70,000-44,000= 26,000

Q: Three reasons for change in Owner’s Equity
?    Additional Owner Investment
?    Owner Withdrawals
?    Results of Operations
Exercise 4-2
Elements of the Income Statement
-Revenues and Expenses result from an entity’s ongoing major or central operations and ordinary activities
-Gains and Losses are from peripheral or incidental transactions (sale of investments, disposal of PPE, asset impairment, theft, etc.)
-OCI= unrealized gains or losses, certain foreign exchange gains or losses, etc.

    Normal    Unusual
Losses due to expropriation of assets in a foreign country        √
Revenue from the Ottawa Senators selling pop and hot dogs    √    
Loss due to hurricane at Jamaican subsidiary    √    
Loss due to hurricane at Calgary Subsidiary        √
The Toronto Maple Leafs Selling Hockey Jersey    √    
Loss due to power outage caused by severe ice storm        √
Gain from winning a lawsuit against a major competitor        √
Loss due to a strike at the subsidiary    √    
Gain of $2 million from winning a lottery jackpot from a ticket purchased with company funds        √
* Hurricanes are a normal occurrence in the Caribbean. Would only be abnormal if the losses were major
*Ottawa does have ice storms. The severity of the storm and loss would determine
* Strike is a normal occurrence, severity and length would determine

U2M2

Q: Why is a Statement of Financial Position useful?
A: If a statement of financial position is examined carefully, users can gain a considerable amount of information related to liquidity, solvency, and financial flexibility.

Q: What is Liquidity?
???Generally related to the amount of time that is expected to elapse until an asset is realized or otherwise converted into cash or until a liability has to be paid.

Q: What is Solvency?
A: Refers to the ability of an enterprise to pay its debts and related interest.

Q: What is Financial Flexibility?
A: The ability of an enterprise to take effective action to alter the amounts and timing of cash flows so it can respond to unexpected needs and opportunities.

Q: What are the limitations of the Statement of Financial Position?
??The use of historical cost, thus the failure to reflect current value information.
??The extensive use of estimates in determining the collectability of receivables, in assessing the saleability of inventory and in determining the useful lives of long-term assets.
??Failure to include items of financial value that cannot be recorded objectively, such as internally generated goodwill.

Assets

Q: What is an Asset?
Present economic benefits that the entity has rights or access where others do not

Q: What are the classifications for Assets?
A: Assets are classified as current or non-current, with the non-current divided among long-term investments; property, plant, and equipment; intangible assets; and other assets. 

Q: What is a Current Asset?
A: Current assets are resources that are expected to be realized in cash, sold, or consumed either in one year or in the operating cycle, whichever is longer. Exceptions involve prepaid expenses, investments in common shares, and the subsequent year's depreciation of fixed assets. 

Q: What order are current assets presented in the Balance Sheet?
A: In the order of their liquidity: 
??Cash—cash restricted for purposes other than current obligations is excluded
??Short-term investments—debt and equity securities are presented separately and valued a cost/amortized cost or fair value
??Receivables—amounts of expected uncollectibles, non-trade receivables, and accounts pledged or discounted should be disclosed.
??Inventories—the basis of valuation (e.g., cost or the lower of cost and net realizable value), cost formula (e.g., FIFO), and stage of completion of manufactured inventories 
??Prepaid expenses—expenses prepaid beyond the current operating cycle – as they will not require cash in the current year/operating cycle, they are included with current asset

Q: What are Non-Current Investments?
A: Just below current assets in a separate section called “Investments”, normally consist of:
??Debt securities (held-to-maturity and measured at amortized cost)
??Equity investments (subsidiaries, significant influence investment in associates, non-consolidated subsidiaries, or no influence or control);
??Other (such as a sinking funds or tangible assets held as investments) – generally measured at cost.

Q: How to handle Property, Plant and Equipment?
-Except for land, tangible assets are charged to income through depreciation (such as building or equipment) or depletion (for wasting resources). IFRS allows an option to carry these assets at fair value using a revaluation or fair value method. 

Q: What are Intangible Assets?
-Usually have a higher degree of uncertainty concerning their future benefits; however, their benefit lies in the rights they convey to the holder. 

Q: How to deal with Intangible Assets?
-Initially recorded at cost and classified into two groups for accounting purposes— those with finite lives, which are amortized over their useful lives, and those with infinite lives, which are not amortized. Both types are tested for impairment. 
3
Q: What are Other Assets?
After property, plant, and equipment, includes a wide variety of items that do not appear to fall clearly into one of the other classifications (deferred income tax assets, non-current receivables, intangible assets, assets in special funds, and advances to subsidiaries. 

Q: What is Deferred/future income taxes?
A: represent the taxes that may be avoided or saved due to deductions that a company may take in the future. This tax deduction represents a benefit, which is recognized on the statement of financial position.

Q: What is a Liability?
A: Present economic burden or obligation that is enforceable

Q: What are the classifications for Liabilities?
A: Current or non-current. 

Q: What are Current Liabilities?
A: Current liabilities are the obligations that are reasonably expected to be liquidated either through the use of current assets or the creation of other current liabilities.

Q: Typical Items in Current Liabilities?
??Payables resulting from the acquisition of goods and services: accounts payable, wages payable, taxes payables
??Collections received in advance for the delivery of goods or the performance of services: prepaid rent, prepaid subscriptions.
??Other liabilities whose liquidation will take place within the operating cycle: bonds maturing in the current period, short-term obligations arising from purchase of equipment.

Q: What order are current liabilities reported at?
A: Frequently reported in the order they will be paid. Obligations due to be paid during the next year may be excluded from the current liability section if the item is expected to be refinanced through long-term debt or the item will be paid out of non-current assets.

Q: Difference in how ASPE and IFRS treat current debt?
ASPE: if a company has refinanced a current debt after the statement of financial position date but not before the financial statements are issued, the current debt may be classified with non-current liabilities as at the statement of financial position date.
IFRS: the statement of financial position should show the conditions existing at the statement of financial position date

Q: How is interest on a long term debt or long-term receivable classified?
A: Interest is usually due annually or more frequently so the interest is current

Q: What are Long-Term Debt/Liabilities?
A: Obligations whose settlement date extends beyond the normal operating cycle or one year, whichever is longer. Examples: bonds payable, notes payable, lease obligations, and pension obligations. 

Q: What are the three types?
1. Obligations arising from specific financing situations where additional assets are acquired: issuance of bonds, long-term lease obligations, and long-term notes payable.
2. Obligations arising from ordinary operations of the enterprise, such as pension obligations and deferred income taxes.
3. Obligations that are dependent upon the occurrence or non-occurrence of one or more future events to confirm the amount payable, or the payee, or the date payable.

Q: When is a long-term debt classified as current?
A: The currently maturing portion of long-term debt is classified as a current liability. Supplementary information that is usually disclosed in separate schedules includes the existence of debt covenants and restrictions and the terms of the debt, such as maturity dates, interest rates, and amounts of any securities pledged to support the debt.
4
Q: What is a contra account?
A: A valuation account whose normal balance (debit or credit) is the opposite of the normal balance of the account to which the control account relates (example- allowance for doubtful accounts has credit balance, opposite of AR which is debit balance)

Q: What is a Valuation Account?
A: An account whose balance is needed to properly value the account to which it relates

Q: What is an Adjunct Account?
A: a valuation account whose normal balance is the same as the normal balance of the account to which it relates.

Q: What is Shareholders Equity?
The residual interests in the entity’s assets that remain after deducting its liabilities. In a business enterprise, the equity is the ownership interest.

Q: What are the four sections of shareholders’ equity? 
1. Share capital—the amounts authorized, issued, and outstanding should be disclosed
2. Contributed surplus—includes premiums on shares issued and capital donations
3. Retained earnings—the undistributed earnings of the corporation. Separate disclosure is made of unrestricted (available for dividends) and appropriated (restricted) retained earnings
4. Accumulated other comprehensive income— includes unrealized gains and losses on certain investments, certain gains or losses from hedging activities, gains or losses on revalued property, plant, and equipment, and other. This does not need to be called “Accumulated other comprehensive income”.

Q: Key Statement of Financial Position Ratios?
a. Current Ratio: Provides a measure of liquidity
b. Debt to Equity Ratio: provides a measure of insolvency

Q: What is a reserve?
A: It’s an appropriation of retained earnings, which refers to the portion of retained earnings that for one reason or another is restricted and cannot be used as a basis for declaration of dividends

Exercise 5-1
Options:
CA- Current Assets
STI- Short Term Investments
INV- Non-current Investments
PPE- Property Plant and Equipment
GW- Goodwill
ITG- Intangible Assets    OA- Other Assets
CL- Current Liabilities
LTL- Long-term Liabilities
CS- Capital Shares
CON- Contributed Surplus
RE- Retained Earnings

CL    1. Accounts Payable
CA    2. Accounts Receivable
CA    3. Accrued Interest Receivable on Long-Term Investments
CL    4. Accrued Interest Payable
CL    5. Accrued Taxes Payable
    6. Accumulated Depreciation
    7. Accumulated Depreciation-Building
    8. Administrative Expenses
    9. Advances by Customers
    10. Advances to Affiliates
    11. Advances to Vendors
    12. Advertising Expenses
    13. Allowance for Bad Debts
    14. Allowance for Depreciation
    15. Allowance for Doubtful Accounts
    16. Allowance for Excess of Cost over Net Realizable Value of Inventory
    17. Allowance for Purchase Discounts
    18. Allowance for Sales Discounts
    19. Allowance for Uncollectible Accounts
    20. Allowance to Reduce Inventory to Net Realizable Value
    21. Appropriation for Bond Sinking Fund
    22. Appropriation for Contingencies
    23. Appropriation for Future Plant Expansion
    24. Bank Overdraft
    25. Bond Interest Payable
    26. Bond Interest Receivable
    27. Bond Sinking Fund
    28. Buildings
CA    29. Cash
    30. Cash Surrender Value of Life Insurance
    31. Certificate of Deposit
    32. Common Shares
    33. Construction in Progress (entity’s new plant under construction)
    34. Creditors accounts with debit balances
    35. Current Maturities of Bonds Payable (to be paid from Bond Sinking Fund)
    36. Current Maturities of Bonds Payable (to be paid from General Cash Account)
    37. Current Portion of Long-Term Debt
    38. Current Portion of Mortgage Payable
    39. Customers’ accounts with credit balances
    40. Customers’ Deposits
    41. Deferred Office Supplies
    42. Deferred Property Tax Expense
    43. Deferred Rent Revenue
    44. Deferred Service Revenue
    45. Deferred Subscription Revenue
    46. Deposits on Equipment Purchases
    47. Depreciation of Equipment
    48. Discount on Bonds Payable
    49. Discount on Notes Payable
    50. Discount on Notes Receivable
    51. Dishonoured Notes Receivable
    52. Dividends Payable
    53. Dividend Payable in Common Shares
    54. Earned Rent Revenue
    55. Estimated Liability for Income Tax
    56. Estimated Premium Claims Outstanding
    57. Factory Supplies
    58. Finished Goods Inventory
    59. Furniture and Fixtures
    60. Gain on Sale of Equipment
    61. Goodwill
    62. Income Tax Payable
    63. Income Tax Withheld (from employees)
    64. Income Taxes Receivable
    65. Interest Income
    66. Interest Payable
    67. Interest Receivable
    68. Investment in Canada Savings Bonds
    69. Investment in Microsoft Shares
    70. Investment in Research in Motion Shares
    71. Investment in Unconsolidated Subsidiary
PPE    72. Land
INV    73. Land Held for Future Plant Site
PPE    74. Land Used for Parking Lot
    75. Leasehold Costs
    76. Leasehold Improvements
    77. Loss on Sale of Investments
    78. Machinery and Equipment
    79. Machinery and Equipment Sitting Idle
STI    80. Marketable Securities
    81. Merchandise Inventory
    82. Mineral Resources
    83. Mortgage Payable
    84. Notes Payable
    85. Notes Payable to Banks
    86. Notes Receivable
    87. Notes Receivable form Officers
    88. Office Supplies
    89. Office Supplies Expense
    90. Office Supplies Pre-paid
    91. Office Supplies Used
    92. Patents
    93. Pension Obligation
    94. Petty Cash Fund
    95. Plant and Equipment
    96. Preferred Share Redemption Fund
    97. Premium on Bonds Payable
    98. Premium on Common Shares
CA    99. Prepaid Advertising
CA    100. Prepaid Insurance
CA    101. Prepaid Insurance Expense
CA    102. Prepaid Office Supplies
CA    103. Prepaid Property Tax
CA    104. Prepaid Royalty Payments
    105. Provision for Bad Debts
    106. Provision for Income Tax
    107. Rent Revenue
    108. Salaries and Wages Payable
    109. Sales Discounts and Allowances
    110. Selling Expense Control
    111. Share Dividends Distributable
    112. Share Dividends Payable
    113. Store Supplies
    114. Store Supplies Used
    115. Tool and Dies (5-year life)
    116. Tools and Dies (6-Month Life)
    117. Unamortized Bond Issue Costs
    118. Unamortized Discount on Bonds Payable
    119. Unearned Rent Revenue
    120. Unearned Royalties
    121. Unearned Subscription Revenue
    122. Unexpired Insurance
    123. Vouchers Payable
    124. Warranty Liability
    125. Work in Process

U2M2

Q: What is the statement of Cash Flows?
A: It summarizes how a company gets it cash (sources) and what it spends it cash on (uses)

Q: What is the primary purpose of the statement of cash flows?
A: To allow users to assess the ability of the enterprise to generate cash and cash equivalents and the needs of the enterprise for cash resources. 

Q: What is one of the more important numbers on the statement of cash flows?
A: Net cash used or provided by operating activities, important because a company that cannot generate net positive cash flow from its primary business activities will most likely not survive for long

Q: What are the three different activities related to cash flows?
1. Operating activities represent the principal revenue-producing activities of the enterprise and all other activities that are not investing or financing activities.
2. Investing activities represent the acquisition and disposal of long-term assets and other investments not included in "cash equivalents."
3. Financing activities represent activities that result in changes in the size and composition of the equity capital and borrowing of the enterprise.
Examples of investing and financing activities include:
Investing Activities    Financing Activities
Sale of non-current assets    Issuance of equity securities
Sale of investments    Issuance of debt
Collection of loans    Payment of dividends
Purchase of non-current assets    Retirement of debt or shares
Loan to other entities    
The basic format of the statement of cash flows is shown below.
 
Q: Are any non-cash transactions reported in the statement of cash flows?
A: No, Non-cash transactions, which would be reflected in the balance sheet, Examples include items such as the conversion of long-term debt to common shares or the acquisition of property through issuance of shares or through exchange for other property.

Q: Where do you obtain the information required to prepare a statement of cash flows?
A: statement of financial position, the income statement, and selected transactions, primarily from the cash account. 

Q: What are the steps to preparing one?
1. Determine the cash provided by or used in operating, investing, and financing activities.
2. Determine the change (increase or decrease) in cash during the period.
3. Reconcile the change in cash with the beginning and ending cash balances.

Q: What questions does the statement of cash flows answer? 
??How successful is the company at generating cash from operating activities?
??What are the trends in net cash flow from operating activities over time?
??What are the major reasons for the changes in cash from operating activities?
??Are cash flows sustainable (i.e., can they be replicated over time)?

Q: What are the common types of ratios in ratio analysis?
A: Liquidity, activity, profitability and solvency

Q: What does a liquidity ratio measure?
A: Measure a company’s ability to cover its maturing debt

Q: What does an activity ratio measure?
A: How quickly assets can be turned into cash and how effectively the company is using its assets

Q: What does profitability ratio measure?
A: Financial performance and shareholder returns.

Q: What do solvency ratios measure? 
 A: A company’s ability to meet its long term debt and the long term protection for creditors and investors

Q: Why are industry averages important for ratio analysis?
A: The significance on an inventory turnover ratio calculated for one type of industry may be quite different for another industry. 

Q: Other than industry averages, what do you compare ratios to?
A: Other ratios and performance in previous years 

Q: Classification of Interest and Dividends different on Statement of Cash Flows between ASPE and IFRS.
ASPE: Interest received and paid, and dividends received, are operating activities, whereas dividends paid is a financing activity
IFRS: Interest and dividends received may each be classified as either operating or investing activities, and interest and dividends paid may each be classified as either operating or financing activities, provided that they are separately disclosed and consistent

U2L4

Q: What is crucial before you can understand how to recognize revenue for an org?
A: That you understand the org itself, what type of activity, how payment made?

Q: Exceptions to typical revenue recognition (point of delivery, transfer of risk)
A: Regardless of situation, we also need to consider the following exceptions: 
1. Barter transactions
2. Concessionary terms in sales agreements
3. Legal issues

Q: How to handle Revenue Recognition of Barter transactions?
A: The transaction should be treated as a sale and should be recorded at fair value unless the value of the assets is more clearly determinable, if the transaction lacks commercial substance (i.e., there is no significant change in the timing, amount and/or riskiness of its future cash flows), book values are used to record the exchanged asset.

Q: What are Concessionary Terms?
A: Concessionary terms are terms that are more lenient than usual and are meant to induce sales. Determined if the concession significantly affects when revenue would be recognized

Q: How to handle Concessionary Terms and Revenue Recognition?
A: May create additional obligations or reflect the fact that the risks and rewards or control has not yet passed to the customer. Can create additional recognition and measurement uncertainty, may even indicate that no sale has taken place at all

Q:When does legal title pass in a sales contract obligation?
??FOB shipping point: title passes at the point of shipment.
??FOB destination: title passes when the asset reaches the customer.
Other laws may create an obligation that should be recognized on the statement of financial position (ex: environmental laws)
Q: What is the Earnings Approach to Revenue Recognition? 
A: Recognizes revenues when performance is achieved. 
??The risk and rewards of ownership are transferred to the customer and/or the earnings process is substantially complete. For a company that sells goods, the critical event is at the point of delivery.
??The vendor has no continuing involvement in, nor effective control over, the goods sold.
??Costs and revenues can be measured reliably.
??Collectability is probable.

Q: Earnings approach for service versus sale of goods?
A: Sale of goods, delivery of the goods is the generally the critical event. For services, the performance of the service is the determination of revenue recognition (continuous?)

Q: What are the two main methods for Accounting for Long-Term Contracts?
??Percentage-of-Completion Method- recognizes revenues and gross profit each period based on progress or contract completion
??Completed-Contract Method- recognizes revenue and gross profit only after the whole contract is completed. 

Q: When is the percentage completion method preferred?
A: When performance consists of many ongoing acts, as long as a company can measure the transaction. 

Q: When is the Completed Contract Method Preferred? 
A: When performance consists of a single act or if progress can't be measured, then the completed contract method may be used. 

Q: What is under IFRS for long-term contracts?
A: No mention of completed-contract-method, IFRS allows recognition of recoverable revenues equal to costs incurred if outcome is not reliably measurable. (Zero-profit method)

Q: Calculating the Percentage-of-Completion Method?
This percentage may be based on input measures (costs incurred, labour hours worked), or output measures (tons produced, stories of a building completed, miles of highway completed). Popular- is percentage cost (sometimes referred to as the cost-to-cost basis). 

 

Q: How is this accounted for?
A: No recognition is given to the contract when it is first entered into, a receivable is set up over the earnings period based on progress billings. The account “Billings on Construction in Process” is offset against the “Construction in Process” account. The Construction in Process account accumulates all the costs and profit recognized over the earnings period, so that at the end of the contract, the balance in both accounts completely offsets each other and a final entry is recorded to close both accounts.

 

 
 
4
Completed-Contract Method
Under the completed-contract method, revenue, expenses and gross profit are recognized when the contract is completed. The principal advantage of the completed contract method is that reported revenue is based on final results rather than on estimates regarding unperformed work. Its major disadvantage is the distortion of earnings that may occur over the periods during which the work is done. The accounting entries made under the completed-contract method are the same as those made under the percentage-of completion method, with the notable exception of periodic income recognition. This method is used under ASPE if the outcome of the contract is not determinable. The completed contract method is not allowed under IFRS. We can compare the results for the same contract under both methods:

 
 

 
6
Zero-Profit (Cost-Recovery) Method
In the accounting for long-term contracts, an additional complexity may arise where the outcome of the contract is not determinable. This might occur, for example, at the beginning of the contract where it might be difficult to estimate costs to completion and therefore the percentage complete. In this case, as noted earlier, recoverable revenues equal to costs incurred would be recognized under IFRS. As stated aboce, under ASPE, if the outcome were not determinable, the accounting would default to the completed contract method.