Financial Accounting: In an Economic Context

KEY TERMS

Note: Definitions for these terms are provided in the glossary at the end of the text.

Business segment (p. 608)

Comprehensive income (p. 600)

Diluted earnings per share (p. 613)

Earnings persistence (p. 613)

Extraordinary items (p. 609)

Financing and investing transactions (p. 602)

Frequent (p. 607)

Intraperiod tax allocation (p. 612)

Matching process (p. 601)

Operating transactions (p. 602)

Pro forma (as if) basis (p. 611)

Usual (p. 607)

ETHICS in the Real World

The boards of directors of most major U.S. companies have established executive compensation plans that base executive pay on some measure of company performance. While these plans differ widely across companies, a large percentage use some form of reported earnings as the measure of performance. Recognizing that there are many different ways to measure earnings, these compensation contracts must be very specific about which earnings measure is used. Pillsbury, for example, bases its formula on operating earnings, the result of subtracting operating expenses from operating revenues, excluding such items as interest expense, interest income, gains and losses on asset sales, extraordinary gains and losses, and the effects of accounting changes. Other companies, such as DuPont and Ashland Oil, base their formulas on net income after such items—the “bottom line.”

Consider a company that has a compensation plan like that of DuPont, where compensation is a function of earnings after interest expense, and assume that ...