External Financial Reporting Decisions
What you must be able to do
Know the four core statements (income, balance sheet, cash flows, statement of changes in equity) plus comprehensive income, and be able to move an item from one statement to another. Master the five-step revenue model (identify contract, identify performance obligations, determine transaction price, allocate, recognize as obligations are satisfied). Know inventory rules, lease accounting for lessees, PP&E, intangibles, contingencies, deferred taxes, EPS, and discontinued operations.
Traps that appear in questions
- US GAAP vs IFRS differences: LIFO is barred under IFRS; inventory is written down to lower of cost or NRV under IFRS but lower of cost or market under GAAP; IFRS allows revaluation of PP&E and capitalization of development costs when criteria are met; IFRS uses a single lessee lease model.
- EPS dilution: potentially dilutive securities are included only when they reduce EPS. Under the treasury stock method, options with a strike price above the average market price are antidilutive and excluded.
- Stock splits and dividends restate all prior-period per-share amounts; they never change total equity.
- Cash flow classification: interest paid is operating under GAAP (may be financing or operating under IFRS); dividends paid are financing under GAAP.
- Foreign currency: a remeasurement gain or loss (functional currency differs from local) hits income; a translation adjustment (functional currency is the foreign currency) goes to OCI.
Rule of thumb and worked example
Under the indirect method: start with net income, add back noncash charges such as depreciation, remove gains and losses from investing or financing activities, then adjust for changes in working capital. If the balance of an asset rises, subtract; if a liability rises, add.
Basic EPS = (net income minus preferred dividends) / weighted-average common shares. Net income $500,000, preferred dividends $20,000, weighted-average shares 120,000: ($500,000 - $20,000) / 120,000 = $4.00.