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The international accounting body FASB updates the accounting principles on a regular basis. One of the objectives of these updates is to make accounting policies easier to apply, so everyone could understand them. However, the main objective of the updates is to make the financial accounting reports produced under the codification more informative and comparable. This paper discusses the accounting standard update no. 2012-08. The objective of the discussion is to show why the update was necessary and how it affects the reporting of discontinued operations and earnings of a company.
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The accounting standards are regulations that govern the way accounts are reported by providing a standardized guide. The Generally Accepted Accounting Principles are widely accepted accounting standards that are used throughout the world. The accounting standard update is a document that communicates how a specific accounting standard codification is being amended and provides information that helps users of Generally Accepted Accounting Principles (GAAP) understand how and why GAAP is changing and when the changes will be effective.
The Accounting Standard Update 2014 -08 was published by the Financial Accounting Standard Board, which recognized the need to stipulate the guidelines for disposing of small groups’ assets that were recurring and qualifying them as discontinued operations. It is involved with the financial statement presentation (topic 205) and property, plant and equipment (topic 306), reporting discontinued operations, as well as disclosure of components of an entity (FASB, 2014).
According to this update, discontinued operations may include the element of an entity or a collection of elements of an entity. It also encompasses business and nonprofit activity (FASB, 2014). The amendment identifies the disclosure methods for discontinued operations that include major changes affecting the net income and the total operating cash flows for the reported period.
The key points from the update referenced herein are summarized to include various issues. To begin with, the discontinued operations will include a component of an entity or a group of component of an entity or a business or nonprofit activity. Secondly, asset disposals will need to be reported in discontinued operations if they represent a strategic move with major implications on an entity’s tasks and financial results. The disposal also requires reporting when an entity can be classified as held for sale, disposed by sale, disposed by means other than sale such as abandonment of a property. The disclosure requires discontinued operations that vary depending on nature of the discontinued operation (FASB, 2014).
In addition, various definitions have changed such as the component of an entity that is currently defined as a reportable segment or the operating segment in discontinued operation. A business is an integrated set of activities and assets that is capable of being conducted and managed for a return in form of dividends and cost savings among others. Nonprofit activity is an integrated set of activities and assets capable of being conducted and managed for providing benefits other than goods and services at a profit or else profit equivalent (FASB, 2014).
The update requires entities to expand their disclosure about discontinued operations and the pre-tax income attributed to the disposal of individually significant components of an entity that do not qualify for discontinued operations presentation in the financial statement. There are several reasons for the FASB update, which include the need to provide interest groups of financial statements with more data about the financial implications of discontinued operations. This is aimed at ensuring more accurate accounts and simplified calculation (FASB, 2014).
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The Reasons Why FASB Issues the Update
In 2014, the board recognized the need to make financial statements for the discontinued operations more useful for users as opposed to the ones that had too many small groups of assets that were recurrent in nature being disposed. The amendment would also address the issue of increased cost for preparers due to the complexity and difficulty in application of guidance used in reporting discontinued operations (FASB, 2014).
In addition, there is a necessity to change the criteria of reporting discontinued operations and enhance convergence of the FASB and the International Accounting Standard Board (IASB) reporting requirements for discontinued operation. The accounting system requires regular updates due to the varying nature of accounts and operations in the business market. Firm analysts are guided by a standard way of recording accounts because they are uniform and easy to interpret. The company’s operations that are affected have to be clearly explained to the company managers to avoid conflicts when the records of accounts are published and the updates provide information that facilitate the dissemination of this information.
The Likely Effect of the Update
The requirement that an entity should be able to disclose face of the financial statement as part of the previous financial year’s account is one of the effects of the update (ASU 2014-08, Pg 29). The amendment also requires an entity to disclose the pre-tax profit or loss of an individually significant element that does not make the grade for discontinued operations reporting. The amendments will affect the general strategies applied in accounting and recording of accounts. The International Accounting Standard Committee (IASC) states that accounting standards will be met by the update since it ensures high quality of all reported accounts (FASB, 2014).
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The updated standard was made effective in the first quarter of 2015 for public organizations. For most non-public organizations, it is effective for annual financial statements with their fiscal years beginning on or after the 15th of December. For any period of time that an entity’s financial statements have not yet been made available for issuance, an early adoption would be permitted (FASB, 2014).
Expected Benefits of the Update
Among the expected benefits of this update for financial statement preparers is that it simplifies the recording systems thus making it easy for the preparers to know what to do in accounting for transactions or economic events. It also minimizes the risks of errors, restatements, and second-guessing during statement preparations. The accounting updates reduce the systems and data distinctions needed during financial statement preparations and allows for the development of more effective internal controls that result in cheaper accounting.
Due to the vivid definition of discontinuing operations in this update, reporting is made more explanatory and understandable. The accounting standards update limits reporting to disposal of components of an entity that represent a strategic shift with major impact on entity, thus improving the definition of discontinued operations. The update will include an equity method investment that meets the definition of discontinued operation making preparation of financial statements easier. The update does not have the operations and cash flow of the components as a result of disposal transaction thus resulting in less complex reporting. The system includes any significant continuing involvement in the operations of the components after the disposal transaction eliminating unnecessary complexity (Trott, 2015).
Earning quality is the current performance of a company’s operating performance in relation to the future operating performance. The analysts use this information to estimate the value of the firm at the current time and in the future. High quality earnings are achieved when the earning number of a firm exceeds its internal value. The earning quality relies on the accruals based on estimations and judgements that are done by analysts who have information on the accounting standards. The analysis requires all discontinued operations to be reported to indicate the actual profits or losses of an organisation (Dechow & Schrand, 2004). The update of the accounting standards has a positive impact on the earning quality since it will ensure that all assets disposed are reported as discontinued operations and the actual capital is reported.
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The amendments in the updates require all disposals that cause a major shift in the income to be reported boosting the accuracy of the accounting system used. The earnings quality of a firm is affected in that all cash flow is recorded and indicated in the accounts. The clarity of an account is boosted when the earning quality indicates the future value of the firm, whether it is profitable or running at a loss. The Financial Accounting Standards Board bridged the gap between the small asset disposals and the actual operating assets within a firm. The assets that undergo depreciation are indicated because they qualify as held for sale. When such assets are sold or abandoned in the course of a financial year, they have to be reported in the accounts.
A firm calculates the bottom line net income from the total accrued income by deducting all operating cost, depreciation, taxes, and interest paid to financial lending institution. The net income is calculated from total revenue by deducting total expenses that include the cost of goods and depreciation rates. An analyst uses it for ratio analysis and development of a financial statement. The update from FSAB affects the income of the firm by ensuring that all depreciation costs are accounted for from disposed assets termed as discontinued operations (FASB, 2014).
In conclusion, the updates have increased the quality of accounting systems by making amendments to the internationally used standards. They make the accounting standards less complicated for preparers and financial analysts. The current accounting standards are very flexible which complicates the financial reporting but are simplified by the updated version as it improves on definition and presentation of discontinued operations that ease the understanding of the nature of disposal activities in a business and the impact they have on financial statements.
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