Assignment 1: Accounting Policies for Reporting Income

Analyze how accounting policies are defined in the literature Accounting policies are specific policies and procedures used by a company to prepare its financial statements. This includes any methods, measurement systems and procedures for presenting disclosures. Accounting policies differ from accounting principles in that the principles are the rules and policies are the companys way of adhering to the rules. (Investopedia Accounting Policies). Accounting principles are lenient at times, so the policies of a company can be very important. Looking into a specific company's accounting policies can signal whether management is conservative or aggressive when reporting earnings (Investopedia Accounting Policies). Accounting principles are rules and guidelines of accounting. They determine such matters as the measurement of assets, the timing of revenue recognition, and the accrual of expenses. The ground rules for financial reporting are referred to as Generally Accepted Accounting Principles (GAAP). To be generally accepted an accounting principle must have substantial authoritative supports such as an announcement of the Financial Accounting Standards Board (FASB). Accounting principles are based on the important objective of financial reporting (Siegel & Shim, 2006). GAAP requires companies to disclose accounting policies 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. FASB topic 105-10-1 objective is to establish The Financial Accounting Standards Board (FASB) 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). Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants

(Codification, 2009). Topic 235-10-50-3 states that 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 (Codification, 2009). Topic 235-10-50-4 gives examples of disclosures by an entity commonly required with respect to accounting policies that include, among others, those relating to the following:

a. Basis of consolidation b. Depreciation methods c. Amortization of intangibles d. Inventory pricing e. Accounting for recognition of profit on long-term construction-type contracts f. Recognition of revenue from franchising and leasing operations (Codification, 2009).

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. Determine how the authoritative literature addresses comprehensive income and illustrate with an example. The Statement of Financial Accounting Standards No. 220 (SFAS 220-10-20) gives the definition of comprehensive income as: (Note: The following definition is Pending Content; see Transition Guidance in 220-10-65-1) the change in equity (net assets) of a business entity during a period from transactions and other events and circumstances from non-owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. Comprehensive income comprises both of the following: a. All components of net income
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b. All components of other comprehensive income (Codification, 2009) The 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. 220 (SFAS 220-10-2), If used with related disclosures 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 an entity's future cash flows (Codification, 2009). Examples of items that might affect comprehensive income (but not net income) include unrealized net loss from marking available-for-sale investments to market value, foreign currency translation adjustments, adjustments resulting from changes in the value of pension plan assets needed to fund pension plan liabilities, net losses on derivative activities constituting cash flow hedges and net investment hedge gains and losses. Compare and contrast three classifications within net income and illustrate with an example of each. Net income is a measure of financial performance resulting from the aggregation of revenues, expenses, gains, and losses that are not items of other comprehensive income. A variety of other terms such as net earnings or earnings may be used to describe net income. (Codification, 2009). Income from continuing operations Continuing operations describes the segments of a companys business that is considers to be normal, and expects to operate in the foreseeable future. The portion of the income statement that deals with operating items is interesting to investors because this section discloses information about revenues and expenses that are a direct result of the regular business

operations. For example, if a business builds widgets, then the continuing operation section would disclose the information about the revenues and expenses involved with the production of the widgets. Income from discontinuing operations Discontinued operations occur when a significant segment of a business has been identified for disposal. Once identified, any gain or loss from operations of the segment while it is being disposed of and any gain or loss on the sale of the assets of the segment, are reported separately from the remaining, continuing operations (Cliffnotes, 2012). 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 ABC, and that division earned $5 million in net income in 2012 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. Income from extraordinary items Extraordinary items are events that occur infrequently and are unusual. They can include acts of God as long as they rarely occur in the area where the business operates. Events that would not be extraordinary as they occur regularly, although not yearly, are a severe freeze effecting crops in Florida or an earthquake in southern California (Cliffnotes, 2012). It can be 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 company that sells widgets keeps their inventory in a warehouse in Colorado,

unfortunately the warehouse was located at the epicenter of the earthquake, and this is the first and only earthquake in Colorado. This would be and extraordinary event. Topic 225-20 gives guidance on extraordinary and unusual items. Compare and contrast three classifications within other comprehensive income and illustrate with an example of each. Other comprehensive income stems from those incomes not included in net income, but are a part of total comprehensive income. Foreign currency translation adjustments If an entity's functional currency is a foreign currency, translation adjustments result from the process of translating that entity's financial statements into the reporting currency. Translation adjustments shall not be included in determining net income but shall be reported in other comprehensive income (Topic 830-30-45-12) (Codification, 2009). 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. Unrealized holding gains and losses on available-for-sale securities Subsequent increases in the fair value of available-for-sale securities shall be included in other comprehensive income pursuant to paragraphs 320-10-35-1(b) and 320-10-45-8; subsequent decreases in fair value, if not an other-than-temporary impairment, also shall be included in other comprehensive income (Topic 320-10-9) (Codification, 2009). 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". 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. Gains and losses (effective portion) on derivative instruments that are designated as, and qualify as, cash flow hedges SFAS Topic 815-10-35-2 states that the accounting for subsequent changes in the fair value (that is, gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and, if so, on the reason for holding it. Specifically, subsequent gains and losses on derivative instruments shall be accounted for as follows: C: Cash flow hedge. The effective portion of the gain or loss on a derivative instrument designated and qualifying as a cash flow hedging instrument shall be reported as a component of other comprehensive income (outside earnings) and reclassified into earnings in the same period or periods during which the hedged forecasted transaction affects earnings, as provided in paragraphs 815-30-35-3 and 815-30-35-38 through 35-41. The remaining gain or loss on the derivative instrument, if any, shall be recognized currently in earnings, as provided in paragraph 815-30-35-3. If an entitys defined risk management strategy for a particular hedging relationship excludes a specific component of the gain or loss, or related cash flows, on the hedging derivative from the assessment of hedge effectiveness (see paragraphs 815-20-25-81 through 25-83), that excluded component of the gain or loss shall be recognized currently in earnings. The effective portion of the gain or loss on the hedging derivative instrument in a hedge of a forecasted foreign-currency-denominated transaction shall be reported as a component of other comprehensive income (outside earnings) and reclassified into earnings in the same period or periods during which the hedged forecasted transaction affects earnings, as

provided in paragraph 815-20-25-65. The remaining gain or loss on the hedging instrument shall be recognized currently in earnings (Topic 815-20-35-1) (Codification, 2009).

Cliffnotes. (2012). Retrieved February 17, 2012, from John Wiley & Sons, Inc: http://www.cliffsnotes.com/study_guide/Income-Statement.topicArticleId-21248,articleId21197.html Codification, F. (2009, September 15). FASB Accounting Standards Codification. Retrieved February 17, 2012, from Financial Accounting Foundation (US): https://asc.fasb.org/home Investopedia Accounting Policies. (n.d.). Retrieved 2 17, 2012, from Investopedia.com: http://www.investopedia.com/terms/a/accounting-policies.asp#axzz1meKPUm8M Siegel, J. G., & Shim, J. K. (2006). Accounting handbook. Hauppauge: Barron's Educational Series, Inc.