In an income statement accountants report on the results of operations of an entity for a period of time. The income statement helps stakeholders such as investors and creditors predict future cash flows or the possibility of not achieving given goals setting by management.
Analysts find limitation on the income statement because it does not include items that contribute to financial growth, the figures are affected by methods used, and its measures are subject to estimates.
Irregular or non-recurrent items require close attention. Examples of these items are:
O Discontinued operations of a component of a business: When a component of a business is disposed of the result of operations, gain or loss. These amounts are reported in a separate income statement category called “Discontinued Operations,” which appears after continued operations but before extraordinary items.
O Unusual and material non-recurring items that are different from the typical business activities, called extraordinary items. Extraordinary items are infrequent that differ from the regular business activities of an organization. To be designated as extraordinary items, they must meet both of the following criteria: unusual nature and infrequency of occurrence. For example a mayor casualty caused by an earthquake, an expropriation such as confiscation of assets by a government, or a prohibition by a newly enacted law. Another characterist of extraordinary items is that they are not primarily dependent on decisions made by management (or owners)
O Unusual and material amounts that are not considered extraordinary. Typical examples are write off of receivables or inventories, gain or losses from exchange or translation of foreign currency, gains or losses on disposal of a segment of a business, etc.
O The cumulative adjustment that occurs when a change in accounting principle is reported. If a forensic accountant determined that the cumulative effect on prior years of a change in accounting principle (credit) was of $45,000. It means that the change in the accounting principle caused an increase in the reported amount of net income for the year. If the change had been a debit, this charge to the current income statement would have reduced net income by such amount.
Income measurement currently follows a modified all-inclusive approach where most irregular items included in income except for the following:
1.Prior years’ income errors
2.Retroactive changes in accounting policies
These exceptions are recorded as adjustments (reported net of tax) on the Statement of Retained Earnings.
The captions that would appear on a single-step income statement format for an entity reporting extraordinary gain, losses from discontinued operations, and a change in depreciation method are:
The Best Spot Inc.
For the Year Ended December 31. 20XX
Revenues (net sales and other revenues such as interest and dividends)
Minus: Expenses (Cost of Goods Sold, Selling Expenses, Administrative Expenses, Interest Expense, and Income Tax Expense)
Equals: Income from continuing operations before income taxes
Minus: Income taxes
Equals: Income from continuing operations
Minus: Loss from operations of discontinued component of business (net of tax)
Minus: Loss from disposal of discontinued component of business (net of tax)
Equals: Income before extraordinary item and cumulative effect of a change in accounting principle
Extraordinary gain (net of tax)
Minus: Cumulative effect on prior years of a change in depreciation method (net of tax)
Equals: Net Income
A single-Step Income Statement has the following characteristics:
O Income is calculated in one step, little detail provided.
O No gross profit figure is calculated.
O Revenues and gains are reported as a group.
O Expenses and losses are reported as a group.
O Simple; no indication of priorities.
O Often provided for those who do not wish a great amount of detail but want just the “bottom line”.
O Same presentation (as the multi-step format) of extraordinary items, discontinued operations and changes in accounting principles.
Forensic accountants strive to ensure reliability of the information presented, which is dependent on the quality of earnings.
High quality earnings are of two kinds:
1. Nature of Content
o Unbiased and determined objectively
o Represents economic reality
o Reflects earnings from ongoing operations
o Can be correlated with cash flows from operations
o Based on sound business strategy/model
o Does not disguise or mislead (transparent)
o Information presented is understandable
o Also, information is clear and concise
Forensic accountants are hired to verify the reliability of financial information because it is a decisive factor in assessing performance. When unrealistic goals are set many wrongdoing instances are uncovered through financial investigations where forensic accountants are actively involved.