Chapter 5, Problem 12QP Bookmark Chapter5 Problenm 1QP 2QP AS 1 recognizes the n

Question

Chapter 5, Problem 12QP Bookmark Chapter5 Problenm 1QP 2QP AS 1 recognizes the need for full disclosure of the components of reported net income. Explain why full disclosure of net income components is important if investors are to properly interpret the implications of current reported net income for future firm performance What is classification shifting? Why does classification shifting make it more difficult for investors to predict future firm performance from current reported net income? How could the problem of classification shifting be reduced? 3QP 4QP 5QP 6QP 7QP 8QP Step-by-step solution 90P 100P 11QP There is no solution to this problem yet. Get help from a Chegg subject expert. ASK AN EXPERT 12QP 130P 14QP 15QP 16QP 17QP 18QP 19QP 20QP

Explanation / Answer

1. Importance of full disclosure

Full disclosure of financial information is required as per IAS 1. The concept of full disclosure requires the entity to disclose each and every important information which may be required by a rational investor to make an informed disclosure. The disclosures allow an investor to measure and make judgements over the information available. The future income predictions are made by the investor on the basis of estimates, accounting policies adopted and method of recognition of revenue and expense.

2. Classification Shifting -

The income statement is classified under various line items and groups of revenue and expense. When the manager shifts the individual items under different groups to present a better core earning is known as Classification Shifting. The managers in order to showcase the income statement in favourable manner may alter the classification of items within the income statement.

3. Classification shifting issues to investor -

The classification shifting done by the managers in order to present a better operational earning makes it difficult for an investor to predict future earnings. The investor is unable to predict because the income statement is coated and there is lack of disclosure of information. The changes in the classification affects the clarity of information available with the investor.

4. Problem of Classification Shifting be reduced -

The application of stricter disclosure measures in every line item of the financial statements may help in reduction of classification shifting. The fixation of various line items in groups and specific criteria of the groups will be helpful.

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