Chap004 Intermediate

8/3/2019 Chap004 Intermediate

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Chapter 04 - The Income Statement and Statement of Cash Flows

4-1

Chapter 4 The Income Statement and Statement of CashFlows

QUESTIONS FOR REVIEW OF KEY TOPICS

Question 4-1The income statement is a change statement that reports transactions revenues, expenses

gains and losses that cause owners equity to change during a specified reporting period.

Question 4-2Income from continuing operations includes the revenue, expense, gain, and loss transactions

that will probably continue in future periods. It is important to segregate the income effects of theseitems because they are the most important transactions in terms of predicting future cash flows.

Question 4-3Operating income includes revenues and expenses and gains and losses that are directly related

to the principal revenue generating activities of the company. Nonoperating income includes itemsthat are not directly related to these activities.

Question 4-4The single-step format first lists all revenues and gains included in income from continuing

operations to arrive at total revenues and gains. All expenses and losses are then grouped and

subtotaled, subtracted from revenues and gains to arrive at income from continuing operations. Themultiple-step format reports a series (multiple) of intermediate totals such as gross profit, operatingincome, and income before taxes. Very often income statements adopt variations of these formatsfalling somewhere in between the two extremes.

Question 4-5The term earnings quality refers to the ability of reported earnings (income) to predict a

companys future earnings. After all, an income statement simply reports on events that already haveoccurred. The relevance of any historical-based financial statement hinges on its predictive value.

Question 4-6

Restructuring costs include costs associated with shutdown or relocation of facilities ordownsizing of operations. They are reported as an operating expense in the income statement.


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4-2

Question 4-7The process of intraperiod tax allocation matches tax expense or tax benefit with each major

component of income, specifically continuing operations and any item reported below continuingoperations. The process is necessary to achieve the desired result of separating the total income

effects of continuing operations from the two separately reported items - discontinued operations andextraordinary items, and also to show the after-taxeffect of each of those two components.

Answers to Questions (continued)

Question 4-8The net-of-tax income effects of a discontinued operation must be disclosed separately in the

income statement, below income from continuing operations. The income effects include income(loss) from operations and gain (loss) on disposal. The gain or loss on disposal must be disclosedeither on the face of the statement or in a disclosure note. If the component is held for sale but not

sold by the end of the reporting period, the income effects will include income (loss) from operationsand an impairment loss if the fair value less costs to sell is less than the book value of thecomponents assets. The income (loss) from operations of the component is reported separately indiscontinued operations on prior income statements presented for comparative purposes.

Question 4-9Extraordinary itemsare material gains and losses that are both unusual in nature and infrequent

in occurrence, taking into account the environment in which the entity operates.

Question 4-10Extraordinary gains and losses are presented, net of tax, in the income statement below

discontinued operations, if any.


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4-3

Answers to Questions (continued)

Question 4-11GAAP permit alternative treatments for similar transactions. Common examples are the choice

among FIFO, LIFO, and average cost for the measurement of inventory and the choice among

alternative revenue recognition methods. A change in accounting principle occurs when a companychanges from one generally accepted treatment to another.

In general, we report voluntary changes in accounting principles retrospectively. This meansrevising all previous periods financial statements as if the new method were used in those periods.In other words, for each year in the comparative statements reported, we revise the balance of eachaccount affected. Specifically, we make those statements appear as if the newly adopted accountingmethod had been applied all along. Also, if retained earnings is one of the accounts whose balancerequires adjustment (and it usually is), we revise the beginning balance of retained earnings for theearliest period reported in the comparative statements of shareholders equity (or statements ofretained earnings if theyre presented instead). Then we create a journal entry to adjust all account balances affected as of the date of the change. In the first set of financial statements after th

change, a disclosure note would describe the change and justify the new method as preferable. It alsowould describe the effects of the change on all items affected, including the fact that the retainedearnings balance was revised in the statement of shareholders equity along with the cumulativeeffect of the change in retained earnings.

An exception is a change in depreciation, amortization, or depletion method. These changesare accounted for as a change in estimate, rather than as a change in accounting principle. Changesin estimates are accounted for prospectively. The remaining book value is depreciated, amortized, ordepleted, using the new method, over the remaining useful life.

Question 4-12A change in accounting estimate is accounted for in the year of the change and in subsequent

periods; prior years financial statements are not restated. A disclosure note should justify that thechange is preferable and should describe the effect of a change on any financial statement line itemsand per share amounts affected for all periods reported.

Question 4-13Prior period adjustments are accounted for by restating prior years financial statements when

those statements are presented again for comparison purposes. The beginning of period retainedearnings is increased or decreased on the statement of shareholders equity (or the statement ofretained earnings) as of the beginning of the earliest period presented.


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4-4

Answers to Questions (concluded)

Question 4-14Earnings per share(EPS) is the amount of income achieved during a period for each share of

common stock outstanding. If there are different components of income reported below continuing

operations, their effects on earnings per share must be disclosed. If a period contains discontinuedoperations and extraordinary items, EPS data must be reported separately for income fromcontinuing operations and net income. Per share amounts for discontinued operations andextraordinary items would be disclosed on the face of the income statement.

Question 4-15Comprehensive income is the total change in equity for a reporting period other than from

transactions with owners. Reporting comprehensive income can be accomplished with a separatestatement or by including the information in either the income statement or the statement of changesin shareholders equity.

Question 4-16The purpose of the statement of cash flows is to provide information about the cash receipts

and cash disbursements of an enterprise during a period. Similar to the income statement, it is achange statement, summarizing the transactions that caused cash to change during a particular periodof time.

Question 4-17The three categories of cash flows reported on the statement of cash flows are:1. Operatingactivities Inflows and outflows of cash related to the transactions entering

into the determination of net income from operations.2. Investingactivities Involve the acquisition and sale of (1) long-term assets used in the

business and (2) nonoperating investment assets.3. Financingactivities Involve cash inflows and outflows from transactions with creditors

and owners.

Question 4-18 Noncash investing and financing activities are transactions that do not increase or decrease

cash but are important investing and financing activities. An example would be the acquisition of property, plant and equipment (an investing activity) by issuing either long-term debt or equitysecurities (a financing activity). These activities are reported either on the face of the statement ocash flows or in a disclosure note.

Question 4-19The direct method of reporting cash flows from operating activities presents the cash effect of

each operating activity directly on the statement of cash flows. The indirect method of reportingcash flows from operating activities is derived indirectly, by starting with reported net income andadding and subtracting items to convert that amount to a cash basis.


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Question 4-20There are two possible separately reported items that could appear in income statements

discontinued operations and extraordinary items. International Financial Reporting Standards(IFRS) prohibit reporting extraordinary items.

Question 4-21IFRS provides the option of presenting components of other comprehensive income either in

(a) a single statement of comprehensive income or (b) in a separate income statement followed by astatement of comprehensive income. U.S. GAAPalsoallows the reporting of other comprehensiveincome in the statement of shareholders equity

Question 4-22U.S. GAAP designates cash outflows for interest payments and cash inflows from interest and

dividends received as operating cash flows. Dividends paid to shareholders are classified asfinancing cash flows. IFRS allows more flexibility. Companies can report interest and dividends

paid as either operating or financing cash flows and interest and dividends received as eitheoperating or investing cash flows. Interest and dividend payments usually are reported as financingactivities. Interest and dividends received normally are classified as investing activities


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4-6

BRIEF EXERCISES

Brief Exercise 4-1

PACIFIC SCIENTIFIC CORPORATIONIncome Statement

For the Year Ended December 31, 2011($ in millions)

Revenues andgains:Sales ................................................................ $2,106Gain on sale of investments ............................. 45

Total revenues and gains .............................. 2,151

Expenses andlosses:Cost of goods sold ........................................... $1,240Selling .............................................................. 126General and administrative ............................... 105

Interest ............................................................. 35Income tax expense* ....................................... 258

Total expenses and losses ............................. 1,764 Net income ......................................................... $ 387

*$2,151 (1,240 + 126 + 105 + 35) = $645 x 40% = $258

Brief Exercise 4-2(a) Sales revenue $2,106

Less: Cost of goods sold (1,240)Gross profit 866Less: Selling expenses (126)

General and administrative expenses (105)Operating income $ 635

(b) Gain on sale of investments 45

Interest expense (35)Nonoperating income $10


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4-7

Brief Exercise 4-3

PACIFIC SCIENTIFIC CORPORATIONIncome Statement


Sales revenue ..................................................... $2,106Cost of goods sold .............................................. 1,240Gross profit ........................................................ 866

Operating expenses:Selling .............................................................. $126General and administrative ............................... 105

Total operating expenses .............................. 231

Operating income ............................................... 635

Other income (expense):Gain on sale of investments ............................. 45Interest expense ............................................... (35)

Total other income, net ................................ 10Income before income taxes .............................. 645

Income tax expense* .......................................... 258 Net income ......................................................... $ 387

*$645 x 40%


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4-8

Brief Exercise 4-4(a) Sales revenue $300,000

Less: Cost of goods sold (160,000)General and administrative expenses (40,000)

Restructuring costs (50,000)Selling expenses (25,000)

Operating income $ 25,000

(b) Operating income $25,000Add: Interest revenue 4,000Deduct: Loss on sale of investments (22,000)Income before income taxes and

Extraordinary item 7,000Income tax expense (40%) (2,800)

Income before extraordinary item $ 4,200

(c) Income before extraordinary item $ 4,200Extraordinary item:

Loss from flood damage, net of $20,000tax benefit (30,000)

Net loss (25,800)


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4-9

Brief Exercise 4-5

MEMORAX COMPANY

Partial Income StatementFor the Year Ended December 31, 2011

Income before income taxes and extraordinary item .......... $ 790,000Income tax expense* ......................................................... 316,000Income before extraordinary item ..................................... 474,000Extraordinary item:

Loss from earthquake, net of $208,000 tax benefit ......... (312,000) Net income ........................................................................ $ 162,000

*$790,000 x 40%


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4-10

Brief Exercise 4-6

WHITE AND SONS, INC.


Income before income taxes and extraordinary item .......... $ 850,000Income tax expense* ......................................................... 340,000Income before extraordinary item ..................................... 510,000Extraordinary item:

Loss from earthquake, net of $160,000 tax benefit ......... (240,000) Net income ........................................................................ $ 270,000

Earnings per share:Income before extraordinary item ...................................... $ 5.10Loss from earthquake ........................................................ (2.40)

Net income ........................................................................ $ 2.70

*$850,000 x 40%

Note: Restructuring costs, interest revenue, and loss on sale of investments areincluded in income before income taxes and extraordinary item.


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4-11

Brief Exercise 4-7

CALIFORNIA MICROTECH CORPORATION


Income from continuing operations before income taxes ... $ 5,800,000Income tax expense* ......................................................... 1,740,000Income from continuing operations ................................... $ 4,060,000Discontinued operations:

Loss from operationsof discontinued component(including gain on disposal of $2,000,000)** ......................... (1,600,000)

Income tax benefit ......................................................... 480,000

Loss on discontinued operations .................................... (1,120,000) Net income ........................................................................ $ 2,940,000

* $5,800,000 x 30%** Loss from operations of discontinued component:

Gain on sale of assets $ 2,000,000 ($10 million less $8 million)Operating loss (3,600,000)

Total before-tax loss $(1,600,000)


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4-12

Brief Exercise 4-8




Loss from operationsof discontinued component** ....... (3,600,000)Income tax benefit ......................................................... 1,080,000

Loss on discontinued operations .................................... (2,520,000)

Net income ........................................................................ $ 1,540,000

* $5,800,000 x 30%**Includes only the operating loss. There is no impairment loss.


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4-13

Brief Exercise 4-9




Loss from operationsof discontinued component(including impairment loss of $1,000,000)** ......................... (4,600,000)

Income tax benefit ......................................................... 1,380,000

Loss on discontinued operations .................................... (3,220,000) Net income ........................................................................ $ 840,000

*$5,800,000 x 30%** Loss from operations of discontinued component:

Impairment loss ($8 million book value less$7 million net fair value) $(1,000,000)

Operating loss (3,600,000)

Total before-tax loss $(4,600,000)


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4-14

Brief Exercise 4-10

The change in inventory method is a change in accounting principle. Thedepreciation method change is considered to be a change in accounting estimate that is

achieved by a change in accounting principle and is accounted for prospectively,exactly as we would account for any other change in estimate. The inventory methodchange, however, is accounted for by retrospectively recasting prior years financialstatements presented with the current year for comparative purposes, applying the newinventory method (FIFO in this case) in those years.

Brief Exercise 4-11

This is a change in accounting estimate.

When an estimate is revised as new information comes to light, accounting forthe change in estimate is quite straightforward. We do not restate prior yearsfinancial statements to reflect the new estimate. Instead, we merely incorporate thenew estimate in any related accounting determinations from there on. If the after-taxincome effect of the change in estimate is material, the effect on net income andearnings per share must be disclosed in a note, along with the justification for thechange. Depreciation for 2011 is $25,000:

$300,000 Cost$ 50,000 Previous annual depreciation ($300,000 6 years)x 2 years 100,000 Depreciation to date (2009-2010)

200,000 Book value

8 yrs. Estimated remaining life(10 years - 2 years)$ 25,000 New annual depreciation


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4-15

Brief Exercise 4-12

OREILLY BEVERAGE COMPANY

Statement of Comprehensive IncomeFor the Year Ended December 31, 2011

Net income ......................................................... $650,000Other comprehensive income (loss):

Unrealized gains on investment securities,net of tax ...................................................... $ 24,000

Deferred loss on derivatives, net of tax ........... (36,000)Total other comprehensive loss .......................... (12,000)Comprehensive income ...................................... $638,000


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4-16

Brief Exercise 4-13

Cash Flowsfrom Operating Activities:

Collections from customers $ 660,000

Interest on note receivable 12,000Interest on note payable (18,000)Payment of operating expenses (440,000)

Net cash flows from operating activities $214,000

Only these four cash flow transactions relate to operating activities. The others areinvesting and financing activities.

Brief Exercise 4-14

Cash Flowsfrom Investing Activities:

Proceeds from note receivable collection $100,000Sale of land 40,000Purchase of equipment (120,000)

Net cash flows from investing activities $20,000

Cash Flowsfrom Financing Activities:Issuance of common stock $200,000Payment of dividends (30,000)

Net cash flows from financing activities 170,000


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4-17

Brief Exercise 4-15


Net income $45,000

Adjustments for noncash effects:Depreciation expense 80,000

Changes in operatingassets andliabilities:Increase in prepaid rent (60,000)Increase in salaries payable 15,000Increase in income taxes payable 12,000

Net cash inflows from operating activities $92,000

Brief Exercise 4-16Under IFRS, interest received and interest paid usually are classified as investing

and financing cash flows, respectively, not operating cash flows as with U.S. GAAPThe revised cash flow categories usually would appear as follows:


Collections from customers $ 660,000Payment of operating expenses (440,000)


Cash Flowsfrom Investing Activities:Proceeds from note receivable collection $100,000Sale of land 40,000

Interest on note receivable 12,000

Purchase of equipment (120,000) Net cash flows from investing activities $32,000

Cash Flowsfrom Financing Activities:

Issuance of common stock $200,000Payment of dividends (30,000)

Interest on note payable (18,000) Net cash flows from financing activities 152,000


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4-18

EXERCISES

Exercise 4-1

Requirement 1

GREEN STAR CORPORATIONIncome Statement

For the Year Ended December 31, 2011

Revenues andgains:Sales ................................................................ $1,300,000Interest ............................................................ 30,000

Gain on sale of investments ............................. 50,000Total revenues and gains .............................. 1,380,000

Expenses andlosses:Cost of goods sold ........................................... $720,000

Salaries ............................................................. 160,000Depreciation ..................................................... 50,000Interest ............................................................. 40,000Rent .................................................................. 25,000

Income tax ....................................................... 130,000Total expenses and losses ............................. 1,125,000 Net income ......................................................... $ 255,000

Earnings per share .............................................. $2.55


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4-19

Exercise 4-1 (concluded)

Requirement 2

GREEN STAR CORPORATION

Income StatementFor the Year Ended December 31, 2011

Sales revenue ..................................................... $1,300,000Cost of goods sold .............................................. 720,000Gross profit ........................................................ 580,000

Operating expenses:

Salaries ............................................................. $160,000Depreciation ..................................................... 50,000Rent ................................................................. 25,000

Total operating expenses .............................. 235,000Operating income ............................................... 345,000

Other income (expense):Interest revenue ............................................... 30,000Gain on sale of investments ............................. 50,000

Interest expense ............................................... (40,000)Total other income, net ................................ 40,000Income before income taxes .............................. 385,000Income tax expense ............................................ 130,000

Net income ......................................................... $ 255,000

Earnings per share .............................................. $2.55


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4-20

Exercise 4-2

Requirement 1

GENERAL LIGHTING CORPORATIONIncome Statement


Revenues andgains:Sales ................................................................ $2,350,000Rental revenue ................................................. 80,000

Total revenues and gains .............................. 2,430,000

Expenses andlosses:Cost of goods sold ........................................... $1,200,300Salaries ............................................................ 300,000

Depreciation ..................................................... 100,000Interest ............................................................. 90,000Rent ................................................................. 50,000Loss on sale of investments ............................. 22,500Loss from inventory write-down ..................... 200,000Income tax expense * ....................................... 186,880

Total expenses and losses ............................. 2,149,680

Income before extraordinary item ......................Extraordinary item:Loss from flood damage (net of $48,000 tax benefit)

Net income .........................................................

280,320

(72,000)$ 208,320

Earnings per share:

Income before extraordinary item ......................Extraordinary loss ..............................................

Net income .........................................................

$ .93(.24)

$ .69

* 40% x $467,200


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4-21


Requirement 2

GENERAL LIGHTING CORPORATION

Income StatementFor the Year Ended December 31, 2011

Sales revenue ..................................................... $2,350,000Cost of goods sold .............................................. 1,200,300Gross profit ........................................................ 1,149,700

Operating expenses:Salaries ............................................................ $300,000Depreciation .................................................... 100,000

Rent ................................................................. 50,000Loss from inventory write-down ..................... 200,000

Total operating expenses .............................. 650,000Operating income ............................................... 499,700

Other income (expense):Rental revenue ................................................. 80,000Loss on sale of investments ............................. (22,500)Interest expense ............................................... (90,000)

Total other income (expense), net ................ (32,500)

Income before taxes and extraordinary item ....... 467,200Income tax expense * .......................................... 186,880Income before extraordinary item ......................Extraordinary item:Loss from flood damage (net of $48,000 tax benefit)

Net income .........................................................

280,320

(72,000)$ 208,320

Earnings per share:Income before extraordinary item ......................

Extraordinary loss .............................................. Net income .........................................................

$ .93

(.24)$ .69

* 40% x $467,200


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4-22

Exercise 4-3

LINDOR CORPORATIONStatement of Income and Comprehensive Income


Sales revenue ................................................................. $2,300,000Cost of goods sold .......................................................... 1,400,000Gross profit .................................................................... 900,000

Operating expenses:Selling and administrative ............................................ 420,000

Operating income ........................................................... 480,000

Other income (expense):Interest expense .............................................................. (40,000)Income before income taxes and extraordinary item ....... 440,000Income tax expense * ...................................................... 132,000Income before extraordinary item ...................................Extraordinary item:Gain on litigation settlement (net of $120,000

tax expense) ................................................................Net incomeOther comprehensive income:

Unrealized holding gains on investment securities,net of tax ..................................................................

Comprehensive income ..................................................

308,000

280,000588,000

56,000$644,000

Earnings per share:

Income before extraordinary item ...................................Extraordinary gain .........................................................Net income .....................................................................

$ 0.310.28

$ 0.59

* 30% x $440,000


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4-23

Exercise 4-4

AXEL CORPORATIONIncome Statement


Sales revenue ................................................................. $ 592,000Cost of goods sold .......................................................... 325,000Gross profit .................................................................... 267,000

Operating expenses:Selling ........................................................................ $67,000Administrative ........................................................... 87,000Restructuring costs ...................................................... 55,000

Total operating expenses .......................................... 209,000

Operating income ........................................................... 58,000

Other income (expense):Interest and dividends .................................................. 32,000Interest expense ...........................................................Total other income, net ................................................

(26,000)6,000

Income before income taxes and extraordinary item ...... 64,000Income tax expense* ...................................................... 25,600Income before extraordinary item ...................................Extraordinary item:Gain on litigation settlement (net of $34,400

tax expense) ................................................................Net income .....................................................................

38,400

51,600$ 90,000

Earnings per share:Income before extraordinary item ...................................Extraordinary gain .........................................................Net income .....................................................................

$ .38.52

$0.90

* 40% x $64,000


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4-24

Exercise 4-5

CHANCE COMPANY


Income from continuing operations ................................... $ 350,000Discontinued operations:

Loss from operationsof discontinued component(including loss on disposal of $400,000)* .............................. (530,000)

Income tax benefit ......................................................... 212,000Loss on discontinued operations .................................... (318,000)

Net income ........................................................................ $ 32,000

Earnings per share:Income from continuing operations ................................... $ 3.50Loss from discontinued operations .................................... (3.18)

Net income ........................................................................ $ .32

* Loss on discontinued operations:

Loss on sale of assets $(400,000)

Operating loss (130,000)Total before-tax loss (530,000)

Less: Income tax benefit (40%) 212,000 Net-of-tax loss $(318,000)


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4-25

Exercise 4-6

ESQUIRE COMIC BOOK COMPANY


Income from continuing operations * ................................. $ 552,000

Discontinued operations:Income from operations of discontinued component

(including loss on disposal of $350,000) ................................ 150,000Income tax expense ......................................................... 60,000Income on discontinued operations ................................. 90,000

Net income.......................................................................... $642,000

* Income from continuing operations:

Income before considering additional items $1,000,000Decrease in income due to restructuring costs (80,000)

Before-tax income from continuing operations 920,000

Income tax expense (40%) (368,000)Income from continuing operations $ 552,000


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4-26

Exercise 4-7

Requirement 1

KANDON ENTERPRISES, INC.Partial Income Statement


Income from continuing operations ................................... $ 400,000

Discontinued operations:Loss from operations of discontinued component

(including impairment loss of $50,000) * ............................. (190,000)Income tax benefit ........................................................... 76,000Loss on discontinued operations ..................................... (114,000)

Net income ........................................................................ $ 286,000

*Loss on discontinued operations:Operating loss $(140,000)Impairment loss ($250,000 - 200,000) (50,000)

Net before-tax loss (190,0Income tax benefit (40%) 76,000

Net after-tax loss on discontinued operations $(114,000)

Requirement 2

KANDON ENTERPRISES, INC.Partial Income Statement


Income from continuing operations ................................... $ 400,000

Discontinued operations:Loss from operations of discontinued component *......... (140,000)

Income tax benefit .......................................................... 56,000Loss on discontinued operations ..................................... (84,000) Net income ........................................................................ $ 316,000

*Includes only the operating loss during the year. There is no impairment loss.


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4-27

Exercise 4-8

Pretax income from continuing operations $14,000,000Income tax expense (5,600,000)

Income from continuing operations 8,400,000Less: Net income 7,200,000Loss from discontinued operations $1,200,000

$1,200,000 z 60%* = $2,000,000 = before tax loss from discontinuedoperations.

*1-tax rate of 40% = 60%

Pretax income of division $4,000,000Add: Loss from discontinued operations 2,000,000Impairment loss $6,000,000

Fair value of divisions assets $11,000,000Add: Impairment loss 6,000,000Book value of divisions assets $17,000,000


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4-28

Exercise 4-9

Requirement 1

In general, we report voluntary changes in accounting principles retrospectivelyHowever, a change in depreciation method is considered a change in accounting

estimate resulting from a change in accounting principle. In other words, a change inthe depreciation method reflects a change in the (a) estimated future benefits from theasset, (b) the pattern of receiving those benefits, or (c) the companys knowledgeabout those benefits, and therefore the two events should be reported the same way.Accordingly, Canliss reports the change prospectively; previous financial statementsare not revised. Instead, the company simply employs the straight-line method fromnow on. The undepreciated cost remaining at the time of the change would bedepreciated using the straight-line method over the remaining useful life. A disclosurenote should justify that the change is preferable and should describe the effect of the

change on any financial statement line items and per share amounts affected for allperiods reported.

Requirement 2

Assets cost $800,000

Accumulated depreciation to date ($320,000 + 192,000) (512,000)

To be depreciated over remaining 3 years $288,000

2011 straight-line depreciation: $288,000 3 years = $96,000

Adjusting entry:

Depreciation expense (calculated above) ..................... 96,000Accumulated depreciation ...................................... 96,000


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4-30

Exercise 4-11

Requirement 1

This is a change in accounting estimate.

Requirement 2

$2,400,000 Cost$240,000 Previous annual amortization ($2,400,000 10 years)x 2

1/2 yrs. 600,000 Amortization to date (2009-2011)

1,800,000 Book value 5 yrs. Estimated remaining life(given)

$ 360,000 New annual amortization

Exercise 4-12Earnings per share:

Income from continuing operations $5.00Loss from discontinued operations (1.60)Extraordinary gain 2.20

Net income $5.60


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4-31

Exercise 4-13

Requirement 1

THE MASSOUD CONSULTING GROUPStatement of Income and Comprehensive Income (in part)


Net income ......................................................... $1,354,000Other comprehensive income (loss):

Foreign currency translation gain, net of tax ... $168,000Unrealized losses on investment securities,

net of tax ...................................................... (56,000)

Total other comprehensive income .................... 112,000Comprehensive income ...................................... $1,466,000

Requirement 2

THE MASSOUD CONSULTING GROUPStatement of Comprehensive Income


Net income ......................................................... $1,354,000Other comprehensive income (loss):

Foreign currency translation gain, net of tax ... $168,000Unrealized losses on investment securities

net of tax ...................................................... (56,000)Total other comprehensive income .................... 112,000Comprehensive income ...................................... $1,466,000


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4-32

Exercise 4-14

Requirement 1

U.S. GAAP also permits the presentation of other comprehensive income itemsin the statement of shareholders equity.

Requirement 2

IAS No. 1 also allows companies to report other comprehensive income items in eithera combined statement of income and comprehensive income or in a separate statementof comprehensive income. Presentation in the statement of shareholders equity is not

permitted.

Exercise 4-151. b Purchase of equipment for cash.

2. a Payment of employee salaries.3. a Collection of cash from customers.4. c Cash proceeds from a note payable.5. b Purchase of common stock of another corporation for cash.

6. c Issuance of common stock for cash.7. b Sale of machinery for cash.8. a Payment of interest on note payable.9. d Issuance of bonds payable in exchange for land and building.

10. c Payment of cash dividends to shareholders.

11. c Payment of principal on note payable.


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4-33

Exercise 4-16Bluebonnet Bakers

Statement of Cash FlowsFor the Year Ended December 31, 2011

Cash flows from operatingactivities:Collections from customers $ 380,000

Interest on note receivable 6,000Purchase of inventory (160,000)Interest on note payable (5,000)Payment of salaries (90,000) Net cash flows from operating activities $131,000

Cash flows from investingactivities:

Collection of note receivable 50,000Sale of investments 30,000Purchase of equipment (85,000) Net cash flows from investing activities (5,000)

Cash flows from financingactivities:Proceeds from note payable 100,000Payment of note payable (25,000)Payment of dividends (20,000) Net cash flows from financing activities 55,000

Net increase in cash 181,000

Cash and cash equivalents, January 1 17,000

Cash and cash equivalents, December 31 $ 198,000


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4-34

Exercise 4-17Cash collected for interest, considered an operating cash flow by U.S. GAAP

could be classified as either an operating cash flow or an investing cash flowaccording to International Accounting Standards.

Cash paid for interest, considered an operating cash flow by U.S. GAAP, couldbe classified as either an operating cash flow ora financing cash flow according toInternational Accounting Standards.

Cash paid for dividends, considered a financing cash flow by U.S. GAAP, couldbe classified as either an operating cash flow ora financing cash flow according toInternational Accounting Standards.

Accordingly, the statement of cash flows prepared according to IFRS could bethe same as under U.S. GAAP (E4-16) or could be presented as follows:

Bluebonnet Bakers



Purchase of inventory (160,000)Payment of salaries (90,000)Payment of dividends (20,000) Net cash flows from operating activities $110,000

Cash flows from investingactivities:Collection of note receivable 50,000Interest on note receivable 6,000Sale of investments 30,000

Purchase of equipment (85,000) Net cash flows from investing activities 1,000

Cash flows from financingactivities:Proceeds from note payable 100,000Payment of note payable (25,000)Interest on note payable (5,000) Net cash flows from financing activities 70,000



Cash and cash equivalents, December 31 $ 198,000


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4-35

Exercise 4-18Cash flows from operatingactivities:

Net income $17,300Adjustmentsfor noncash effects:

Depreciation expense 7,800Changes in operatingassets andliabilities:

Increase in accounts receivable (4,000)Decrease in inventory 5,500Decrease in prepaid insurance 1,200Decrease in salaries payable (2,700)Increase in interest payable 800Net cash flows from operating activities $25,900

Exercise 4-19

Requirement 1

Financing Investing Operating1. $300,0002. $(10,000)3. 4.

5. $ (5,000)6. (6,000)7. (70,000)8. 55,0009.

__________ __________ __________

$300,000 $(10,000) $(26,000) = $264,000


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4-36


Requirement 2

Wainwright CorporationStatement of Cash FlowsFor the Month Ended March 31, 2011

Cash flows from operatingactivities:Collections from customers $ 55,000Payment of rent (5,000)Payment of one-year insurance premium (6,000)Payment to suppliers of merchandise for sale (70,000) Net cash flows from operating activities $ (26,000)


Purchase of equipment (10,000) Net cash flows from investing activities (10,000)

Cash flows fromfinancingactivities:

Issuance of common stock 300,000 Net cash flows from financing activities 300,000

Net increase in cash 264,000Cash and cash equivalents, March 1 40,000Cash and cash equivalents, March 31 $ 304,000

Noncash investingandfinancingactivities:

Acquired $40,000 of equipment by paying cash and issuing a note as follows:Cost of equipment $40,000Cash paid 10,000 Note issued


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4-37

Exercise 4-20Cash flows from operatingactivities:


Depreciation and amortization expense 87,000Changes in operatingassets andliabilities:

Decrease in accounts receivable 22,000Increase in inventories (9,200)Increase in prepaid expenses (8,500)Increase in salaries payable 10,000Decrease in income taxes payable (14,000)



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4-38

Exercise 4-21Consistent with U.S. GAAP, international standards also require a statement of

cash flows. Consistent with U.S. GAAP, cash flows are classified as operatinginvesting, or financing. However, the U.S. standard designates cash outflows forinterest payments and cash inflows from interest and dividends received as operating

cash flows. Dividends paid to shareholders are classified as financing cash flows.IAS No. 7, on the other hand, allows more flexibility. Companies can report

interest and dividends paid as either operating or financing cash flows and interest anddividends received as either operating or investing cash flows. Interest and dividend

payments usually are reported as financing activities. Interest and dividends receivednormally are classified as investing activities.

Accordingly, the statement of cash flows prepared according to IFRS mostlylikely would be presented as follows (differences from U.S. GAAP in italics):

Bronco Metals

Statement of Cash Flows


Cash flows from operating activities:Collections from customers $ 353,000Purchase of inventory (186,000)Payment of operating expenses (67,000)


Cash flows from investing activities:Interest on note receivable 4,000

Dividends receivedfrom investments 2,400Collection of note receivable 100,000Purchase of equipment (154,000)

Net cash flows from investing activities (47,600)

Cash flows from financing activities:Payment ofinterest on note payable (8,000)Proceeds from issuance of common stock 200,000Dividends paid (40,000)

Net cash flows from financing activities 152,000 Net increase in cash 204,400


Cash and cash equivalents, December 31 $233,000


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4-39

Exercise 4-22Tiger Enterprises


($ in thousands)

Cash flows from operatingactivities:

Net income $ 900Adjustmentsfor noncash effects:

Depreciation expense 240Changes in operatingassets andliabilities:

Decrease in accounts receivable 80Increase in inventory (40)Increase in prepaid insurance (30)

Decrease in accounts payable (60)Decrease in administrative and other payables (100)Increase in income taxes payable 50 Net cash flows from operating activities $1,040

Cash flows from investingactivities:Purchase of plant and equipment (300)

Cash flows from financingactivities:Proceeds from issuance of common stock 100

Proceeds from note payable 200Payment of dividends (1) (940)

Net cash flows from financing activities(640)

Net increase in cash 100

Cash, January 1 200Cash, December 31 $ 300

(1)

Retained earnings, beginning $540

+ Net income 900- Dividends x x = $940Retained earnings, ending $500


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4-40

Exercise 4-23The T-account analysis of the transactions related to operating cash flows is

shown below. To derive the cash flows, the beginning and ending balances in therelated assets and liabilities are inserted, together with the revenue and expense

amounts from the income statements. In each balance sheet account, the remaining(plug) figure is the other half of the cash increases or decreases.

Cash Flows (Operating)

(a.) 7,080 (b.) 130

(c.) 3,460

(d.) 1,900

(e.) 550

Sales Revenue Accounts Receivable

1/1 830 (a.) 7,080

7,000 7,000

12/31 750

Prepaid Insurance Insurance Expense

1/1 20

(b.) 130 100 100

12/31 50

Accounts Payable Inventory Cost of Goods Sold

(c.) 3,460 1/1 360 1/1 600 3,360 3,360

3,400 3,400

12/31 300 12/31 640

Admin. & Other Payables Admin. & Other Expense

(d.) 1,900 1/1 400

1,800 1,800

12/31 300

Income Taxes Payable Income Tax Expense

(e.) 550 1/1 150

600 600

12/31 200

Based on the information in the T-accounts above, the operating activities sectionof the SCF for Tiger Enterprises would be as shown next.


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4-41


Tiger Enterprises


($ in thousands)


Prepayment of insurance (130)Payment to inventory suppliers (3,460)Payment for administrative & other exp. (1,900)Payment of income taxes (550)

Net cash flows from operating activities $ 1,040


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4-42

Exercise 4-24

Requirement 1

FASB ASC 260: Earnings per Share.

Requirement 2

The specific citation that describes the additional information for earnings per

share that must be included in the notes to the financial is FASB ASC 26010501:Earnings per ShareOverallDisclosure.

Requirement 3

For each period for which an income statement is presented, an entity disclosesall of the following:

a. A reconciliation of the numerators and the denominators of the basic and dilutedper-share computations for income from continuing operations. The reconciliation

includes the individual income and share amount effects of all securities that affectearnings per share (EPS). Example 2 (see paragraph 260-10-55-51) illustratesthat disclosure. (See paragraph 260-10-45-3.) An entity is encouraged to refer to

pertinent information about securities included in the EPS computations that isprovided elsewhere in the financial statements as prescribed by Subtopic 505-10.

b. The effect that has been given to preferred dividends in arriving at incomeavailable to common stockholders in computing basic EPS.

c. Securities (including those issuable pursuant to contingent stock agreements) that

could potentially dilute basic EPS in the future that were not included in thecomputation of diluted EPS because to do so would have been antidilutive for the

period(s) presented. Full disclosure of the terms and conditions of these securitiesis required even if a security is not included in diluted EPS in the current period.

For the latest period for which an income statement is presented, an entity mustprovide a description of any transaction that occurs after the end of the most recent

period but before issuance of the financial statements that would have changedmaterially the number of common shares or potential common shares outstanding atthe end of the period if the transaction had occurred before the end of the period.

Examples of those transactions include the issuance or acquisition of common shares;the issuance of warrants, options, or convertible securities; the resolution of acontingency pursuant to a contingent stock agreement; and the conversion orexercise of potential common shares outstanding at the end of the period into commonshares.


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4-43

Exercise 4-25

The FASB Accounting Standards Codification represents the single source ofauthoritative U.S. generally accepted accounting principles. The specific citation foreach of the following items is:

1. The criteria for determining if a gain or loss should be reported as anextraordinary item:

FASB ASC 22520452: Income StatementExtraordinary and UnusualItemsOther Presentation MattersCriteria for Presentation as Extraordinary.Extraordinary items are events and transactions that are distinguished by theirunusual nature and by the infrequency of their occurrence. Thus, both of thefollowing criteria shall be met to classify an event or transaction as anextraordinary item:

a. Unusual nature. The underlying event or transaction should possess a highdegree of abnormality and be of a type clearly unrelated to, or only incidentallyrelated to, the ordinary and typical activities of the entity, taking into account

the environment in which the entity operates.

b. Infrequency of occurrence. The underlying event or transaction should be ofa type that would not reasonably be expected to recur in the foreseeable future,

taking into account the environment in which the entity operates.

2. The calculation of the weighted average number of shares for basicearnings per share purposes:

FASB ASC 26010552: Earnings per ShareOverallImplementationGuidance and IllustrationComputing a Weighted Average.The weighted-average number of shares is an arithmetical mean average ofshares outstanding and assumed to be outstanding for EPS computations. Themost precise average would be the sum of the shares determined on a daily

basis divided by the number of days in the period. Less-precise averagingmethods may be used, however, as long as they produce reasonable results.Methods that introduce artificial weighting, such as the Rule of 78 method, arenot acceptable for computing a weighted-average number of shares for EPScomputations.


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3. The alternative formats permissible for reporting comprehensive income:FASB ASC 22010458: Comprehensive IncomeOverallOther

Presentation ItemsAlternative Formats for Reporting Comprehensive Income.An entity shall display comprehensive income and its components in a financialstatement that is displayed with the same prominence as other financialstatements that constitute a full set of financial statements. This Subtopic doesnot require a specific format for that financial statement but requires that an

entity display net income as a component of comprehensive income in thatfinancial statement. Examples 1 through 2 (paragraphs 220-10-55-4 through 55-27) provide illustrations of the components of other comprehensive income andtotal comprehensive income being reported below the total for net income in astatement that reports results of operations, in a separate statement ofcomprehensive income that begins with net income, and in a statement ofchanges in equity.

4. The classifications of cash flows required in the statement of cash flows:FASB ASC 23010451: Statement of Cash FlowsOverallOtherPresentation MattersForm and Content.A statement of cash flows shall report the cash effects during a period of anentity's operations, its investing transactions, and its financing transactions.


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4-45

Exercise 4-26

List A List B

f 1. Intraperiod tax allocation a. Unusual, infrequent, and material gainsand losses.

g 2. Comprehensive income b. Starts with net income and worksbackwards to convert to cash.

a 3. Extraordinary items c. Reports the cash effects of each operatingactivity directly on the statement.

l 4. Operating income d. Correction of a material error of a priorperiod.

k 5. A discontinued operation e. Related to the external financing of thecompany.

j 6. Earnings per share f. Associates tax with income statementitem.

d 7. Prior period adjustment g. Total nonowner change in equity.e 8. Financing activities h. Related to the transactions entering into

the determination of net income.h 9. Operating activities (SCF) i. Related to the acquisition and disposition

of long-term assets.i 10. Investing activities j. Required disclosure for publicly traded

corporation.c 11. Direct method k. A component of an entity.

b 12. Indirect method l. Directly related to principal revenue-generating activities.


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4-46

CPA / CMA REVIEW QUESTIONS

CPA Exam Questions

1. c. U.S. GAAP requires that discontinued operations be disclosed separatelybelow income from continuing operations.

2. d. Other than sales, COGS, and administrative expenses, only the gain or lossfrom disposal of equipment is considered part of income from continuingoperations. Income from continuing operations was ($5,000,000 - 3,000,000- 1,000,000 + 200,000) = $1,200,000.

3. a. In a single-step income statement, revenues include sales as well as otherrevenues and gains.

Sales revenue $187,000Interest revenue 10,200Gain on sale of equipment 4,700

Total $201,900

The discontinued operations and the extraordinary gain are reported belowincome from continuing operations.

4. a. The $400,000 impairment loss and the $1,000,000 loss from operationsshould be combined for a total loss of $1,400,000.

5. d. The change in the estimate for warranty costs is based on new informationobtained from experience and qualifies as a change in accounting estimate.A change in accounting estimate affects current and future periods and is notaccounted for by restating prior periods. The accounting change is a part ofcontinuing operations.

6. a. Dividends paid to shareholders is considered a financing cash flow, not anoperating cash flow.

7. c. Issuing common stock for cash is considered a financing cash flow, not aninvesting cash flow.


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4-47

CMA Exam Questions

1. d. Discontinued operations and extraordinary gains and losses are shownseparately in the income statement, below income from continuingoperations. The cumulative effect of most voluntary changes in accounting

principle is accounted for by retrospectively revising prior years financialstatements.

2. c. The operating section of a retailers income statement includes all revenuesand costs necessary for the operation of the retail establishment, e.g., sales,cost of goods sold, administrative expenses, and selling expenses.

3 a. Extraordinary items should be presented net of tax after income fromoperations.


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4-48

PROBLEMSProblem 4-1

REED COMPANY

Comparative Income StatementsFor the Years Ended December 31

2011 2010

Sales revenue ......................................................[1] $4,000,000 [6] $3,000,000Cost of goods sold ............................................... [2] 2,570,000 [7] 1,680,000Gross profit ......................................................... 1,430,000 1,320,000

Operating expenses:Administrative ..................................................[3] 750,000 [8] 635,000Selling ..............................................................[4] 340,000 [9] 282,000Loss from fire damage ....................................... 50,000 - -

Loss from write-down of obsolete inventory ...... 35,000 - -Total operating expenses ............................... 1,175,000 917,000

Operating income ................................................ 255,000 403,000

Other income (expense):Interest revenue ................................................. 150,000 140,000Interest expense ................................................. (200,000) (200,000)

Total other expenses (net) .............................. (50,000) (60,000)Income from continuing operations before

income taxes and extraordinary item .............. 205,000 343,000Income tax expense ............................................. 82,000 137,200Income from continuing operations before

extraordinary item ............................................ 123,000 205,800Discontinued operations:

Income (loss) from operations of discontinuedcomponent (including loss on disposal of$50,000 in 2011) ............................................. (10,000) 110,000

Income tax benefit(expense) ............................... 4,000 (44,000)Income (loss) on discontinued operations ......... [5] (6,000) 66,000

Income before extraordinary item ........................ 117,000 271,800Extraordinary item:Loss from earthquake (net of $40,000 tax benefit) . (60,000) - - Net income .......................................................... $ 57,000 $ 271,800

Earnings per share:Income from continuing operations before

extraordinary item ......................... .......................... $ .41 $ .69Discontinued operations .......................... ................. (.02) .22Extraordinary loss .......................... .......................... (.20) - -

Net income ......................... ........................... ............ $ .19 $ .91


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4-49

Problem 4-1 (concluded)

[1] $4,400,000 - 400,000

[2] $2,860,000 - 290,000

[3] $800,000 - 50,000

[4] $360,000 - 20,000

[5] Loss in 2011:Operating income $ 40,000Loss on sale of assets (50,000)Loss before tax benefit (10,000)

Tax benefit (40% x $10,000) 4,000Loss on discontinued operations, net of tax benefit $ (6,000)

[6] $3,500,000 - 500,000 (sales from discontinued operation)

[7] $2,000,000 - 320,000 (cost of goods sold from discontinued operation)

[8] $675,000 - 40,000 (administrative expenses from discontinued operations)

[9] $312,000 - 30,000 (selling expenses from discontinued operations)


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4-50

Problem 4-2

Requirement 1

JACKSON HOLDING COMPANYComparative Income Statements (in part)

For the Years Ended December 312011 2010

Income from continuing operations beforeincome taxes [1] ........................................ $3,000,000 $1,300,000

Income tax expense ........................................ 1,200,000 520,000

Income from continuing operations ................ 1,800,000 780,000Discontinued operations:

Income from operations of discontinuedcomponent (including gain on disposal of$600,000 in 2011)[2] ...................................... 200,000 (300,000)

Income tax expense (benefit) ....................... 80,000 120,000Income (loss) on discontinued operations .... 120,000 (180,000)

Net Income .................................................... $1,920,000 $ 600,000

[1] Income from continuing operations before income taxes:

2011 2010

Unadjusted $2,600,000 $1,000,000Add: Loss from discontinued operation 400,000 300,000Adjusted $3,000,000 $1,300,000

[2] Income from discontinued operations:

2011 2010Operating loss $(400,000) $(300,000)Gain on disposal 600,000 -Total $ 200,000 $(300,000)


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Requirement 2

The 2011 income from discontinued operations would include only the operatingloss of $400,000. Since no impairment loss is indicated ($5,000,000 4,400,000 =

$600,000 anticipated gain), none is included. The anticipated gain on disposal is notrecognized until it is realized, presumably in the following year.

Requirement 3

The 2011 income from discontinued operations would include the operating lossof $400,000 as well as an impairment loss of $500,000 ($4,400,000 book value ofassets less $3,900,000 fair value).


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4-52

Problem 4-3

Requirement 1

MICRON CORPORATIONPartial Income Statement


Income from continuing operations beforeincome taxes and extraordinary item ....... [1]$1,300,000

Income tax expense ................................... 390,000

Income from continuing operations ........... 910,000

Discontinued operations:Loss from operations of discontinued

component (including loss on disposal of$300,000) ............................................... $(140,000)

Income tax benefit .................................. 42,000

Loss on discontinued operations ............. [2] (98,000)

Income before extraordinary item ............. 812,000

Extraordinary item:Loss from earthquake

(net of $240,000 tax benefit) ..................... (560,000)

Net Income ............................................... $ 252,000

[1] Income from continuing operations before taxes:Unadjusted $1,200,000Add: Gain from sale of factory 100,000Adjusted $1,300,000

[2] Loss on discontinued operations:Operating income $ 160,000Deduct: Loss on sale of assets (300,000)Loss before tax (140,000)Tax benefit (30% x $140,000) 42,000

Loss on discontinued operations $ (98,000)Requirement 2

These events will not, or are unlikely to occur again in the near future. Bysegregating them, users are better able topredictfuture cash flows.


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4-53

Problem 4-41. Restructuring is an example of an event that is either unusual or infrequent, but not

both. Restructuring costs should be included in income from continuing operations but reported as a separate income statement component. The item is reported

gross, not net of tax as with extraordinary gains and losses.2. The extraordinary gain should be presented, net of tax, in the income statement

below income from continuing operations. Also, earnings per share for incomefrom continuing operations and for the extraordinary item should be disclosed.

3. The correction of the error should be treated as a prior period adjustment tobeginning retained earnings, not as an adjustment to current year's cost of goodssold. In addition, the 2010 financial statements should be restated to reflect thecorrection, and a disclosure note is required that communicates the impact of theerror on 2010 income.


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4-54

Problem 4-5

ALEXIAN SYSTEMS, INC.Income Statement


($ in millions except per share date)

Net sales revenue ............................................... $425Cost of goods sold .............................................. [1] 265Gross profit ........................................................ 160

Operating expenses:Selling and administrative ............................... [2] $128Restructuring costs .......................................... 26

Total operating expenses .............................. 154Operating income ............................................... 6

Other income:Interest revenue ............................................... 3Gain on sale of investments ............................. 6

Total other income ....................................... 9Income before income taxes and extraordinary

item ................................................................ 15Income tax expense ............................................ [3] 6Income before extraordinary item ......................Extraordinary gain (net of $48 in taxes).....................

Net income .........................................................

9[4] 72

$ 81

Earnings per share:Income before extraordinary item ......................Extraordinary gain .............................................

Net income .........................................................

$ 0.453.60

$ 4.05

[1]$270 - 5 (prior period adjustment)[2] $154 - 26 (restructuring costs)

[3]40% x $15[4] $120 less taxes of $48 (40% x $120)

Note: The difference in net income of $3 million ($81 million compared to $78 million on theoriginal income statement) is the effect of the inventory error of $5 million, less the 40% tax effect.


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4-55

Problem 4-6

REMBRANDT PAINT COMPANYIncome Statement

For the Year Ended December 31, 2011($ in thousands, except per share

amounts)

Sales revenue ................................................................. $18,000Cost of goods sold .......................................................... 10,500

Gross profit .................................................................... 7,500Operating expenses:

Selling and administrative ........................................... $2,500Restructuring costs ...................................................... 800 3,300

Operating income ........................................................... 4,200Interest income (expense), net ........................................ (150)

Income from continuing operations before income taxesand extraordinary item ................................................ 4,050

Income tax expense ........................................................ 1,215Income from continuing operations before extraordinary

item ............................................................................ 2,835Discontinued operations:

Income from operations of discontinued component(including gain on disposal of $2,000) ................................ 400

Income tax expense ..................................................... 120Income on discontinued operations ............................. 280

Income before extraordinary item ................................... 3,115

Extraordinary gain (net of $900 tax expense) ..................... 2,100 Net income...................................................................... 5,2

Earnings per share:Income from continuing operations before extraordinary

item ............................................................................. $ 5.67Income on discontinued operations ................................ .56Extraordinary gain ......................................................... 4.20 Net income ..................................................................... $10.43


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4-56

Problem 4-7

SCHEMBRI MANUFACTURING CORPORATIONCombined Statement of Income and Comprehensive Income

For the Year Ended December 31, 2011($ in 000s)

Sales revenue ............................................................... $15,300Cost of goods sold ........................................................ 6,200Gross profit .................................................................. 9,100Operating expenses:

Selling ....................................................................... $1,300

General and administrative ........................................ 800Restructuring costs .................................................... 1,200

Total operating expenses ....................................... 3,300Operating income ......................................................... 5,800

Other income (expense):Loss on sales of investments ......................................... $(220)Interest expense ............................................................ (180)Interest revenue ............................................................ 85

Other income (expense) ............................................. (315)Income from continuing operations before income taxes

and extraordinary item .................................................. 5,485Income tax expense ...................................................... 2,194Income from continuing operations before extraordinary

item ........................................................................... 3,291

Discontinued operations:Income from operationsof discontinued component(including gain on disposal of $1,400) ..................... 840

Income tax expense ................................................... (336)Income from discontinued operations ........................ 504

Income before extraordinary item ................................. 3,795Extraordinary item:

Loss from earthquake (net of $800 tax benefit) .......... (1,200) Net income .................................................................... 2,595Other comprehensive income:

Unrealized gains from investments (net of $128 tax) 192

Loss from foreign currency translation (net of $96 tax) (144) 48Comprehensive income $2,643



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4-57

Earnings per share:*Income from continuing operations before extraordinary

item $2.74Discontinued operations .42

Extraordinary loss (1.00) Net income $2.1

*Weighted-average shares = 1,000,000 + (400,000/2) = 1,200,000

Note:The depreciation expense error is a prior period adjustment (to retained earnings) and is notreported in the income statement.


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4-58

Problem 4-8

DUKE COMPANYStatement of Income and Comprehensive Income

For the Year Ended December 31, 2011Sales revenue ............................................................... $15,000,000Cost of goods sold ........................................................ 9,000,000Gross profit .................................................................. 6,000,000

Operating expenses:General and administrative ........................................ $1,000,000Selling ...................................................................... 500,000Restructuring costs .................................................... 300,000Loss from write-down of obsolete inventory 400,000

Total operating expenses ......................................... 2,200,000

Operating income ......................................................... 3,800,000

Other income (expense):Interest expense ......................................................... (700,000)

Income before income taxes and extraordinary item ..... 3,100,000Income tax expense ...................................................... 1,240,000Income before extraordinary item ................................. 1,860,000Extraordinary item:Loss from expropriation of overseas plant (net

of $1,200,000 tax benefit) .......................................... (1,800,000) Net Income .................................................................... 60,000

Other comprehensive income (loss):Foreign currency translation adjustment loss, net of tax (120,000)Unrealized gains on investment securities, net of tax 108,000

Total other comprehensive loss (12,000)Comprehensive income $ 48,000

Notes:1. The restructuring costs and the loss from write-down of inventory are not extraordinary items.2. The depreciation expense error is a prior period adjustment and is not reported in the income

statement.


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4-59

Problem 4-9

Requirement 1

Diversified Portfolio Corporation

Statement of Cash Flows



Collections from customers (1) $880,000Payment of operating expenses (2) (660,000)Payment of income taxes (3) (85,000)



Sale of investments 50,000 Net cash flows from investing activities 50,000

Cash flows from financingactivities:

Proceeds from issue of common stock 100,000

Payment of dividends (80,000) Net cash flows from financing activities 20,000

Increase in cash 205,000Cash and cash equivalents, January 1 70,000Cash and cash equivalents, December 31 $275,000

(1)$900,000 in service revenue less $20,000 increase in accounts receivable.(2) $700,000 in operating expenses less $30,000 in depreciation less $10,000 increase

in accounts payable.(3)$80,000 in income tax expense plus $5,000 decrease in income taxes payable.


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4-60


Requirement 2

Diversified Portfolio Corporation





Increase in accounts receivable (20,000)Increase in accounts payable 10,000

Decrease in income taxes payable (5,000) Net cash flows from operating activities $135,000


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4-61

Problem 4-10

Requirement 1

2010 Cash:

2010 Cash + Net increase in cash = 2011 Cash2010 Cash + 86 = 1452010 Cash = 59

2011 A/R:

2010 A/R + Cr. Sales Cash collections = 2011 A/R84 + 80 71 = 93

2010 Inventory:

2010 A/P + Purchases Cash Paid = 2011 A/P30 + Purchases 30 = 40Therefore, Purchases = 402010 Inventory + Purchases 2011 Inventory = Cost of goods sold2010 Inventory + 40 60 = 322010 Inventory = 52

2010 Accumulateddepreciation:

2011 accumulated depreciation less 2011 depreciation = 2010 accumulated depreci

65 10 = 55


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4-62

Problem 4-10 (continued)

2010 Totalassets:

$59 + 84 + 52 + 50 + 150 55 = $340

2011 Totalassets:$145 + 93 + 60 + 150 65 = $383

2010 Income taxes payable:

2010 Inc. taxes payable + Inc. tax expense Income taxes paid =2011 Inc. taxes payable2010 Inc. taxes payable =2011 Inc. taxes payable + Taxes paid Inc. tax expense2010 Inc. taxes payable = 22 + 9 7 = $24

2011 Retainedearnings:

2010 R/E + Net income Dividends = 2011 R/E47 + 28 3 = 72

2010 Total liabilities andshareholders equity:

$30 + 9 + 24 + 230 + 47 = $340

2011 Total liabilities andshareholders equity:

$40 + 9 + 22 + 240 + 72 = $383


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4-63


Requirement 2

Grandview CorporationStatement of Cash Flows



Net income $ 28Adjustmentsfor noncash effects:

Depreciation expense 10

Gain on sale of investments (15)Changes in operatingassets andliabilities:

Increase in accounts receivable1 (9)Increase in inventory

2(8)

Increase in accounts payable3

10Decrease in income taxes payable

4(2)

Net cash flows from operating activities $14

1$93 84

2$60 52

3

$40 304$22 24


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4-64

Problem 4-11Santana Industries


($ in thousands)


Net income $ 3,850Adjustmentsfor noncash effects:


Increase in accounts receivable (300)Increase in inventory (1,000)Decrease in prepaid rent 150

Increase in accounts payable 300Increase in interest payable 100Increase in unearned service revenue 200Decrease in income taxes payable (250) Net cash flows from operating activities $4,650

Cash flows from investingactivities:Purchase of equipment (4,000)

Sale of equipment 500 Net cash flows from investing activities (3,500)

Cash flows from financingactivities:Proceeds from loan payable 5,000Payment of dividends (1,000)

Net cash flows from financing activities 4,000


Cash, January 1 2,200Cash, December 31 $7,350


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CASES

Judgment Case 4-1

Requirement 1

The term earnings quality refers to the ability of reported earnings (income) topredict a companys future earnings. After all, an income statement simply reports on

events that already have occurred. The relevance of any historical-based financialstatement hinges on its predictive value.

Requirement 2

To enhance predictive value, analysts try to separate a companys transitoryearnings effects from its permanent earnings. Transitory earnings effects result fromtransactions or events that are not likely to occur again in the foreseeable future, orthat are likely to have a different impact on earnings in the future.

Requirement 3

An often-debated contention is that, within GAAP, managers have the power, toa limited degree, to manipulate reported company income. And the manipulation isnot always in the direction of higher income. Many believe that manipulating incomereduces earnings quality because it can mask permanent earnings.

Requirement 4

You would consider the size of the gain in relation to net income, the size of thecompanys investment portfolio, and the frequency of gains and losses from the saleof investment securities in past years. The main objective is to determine thelikelihood of this type of gain occurring again in the future.


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Judgment Case 4-2

Requirement 1

Restructuring costs include costs associated with shutdown or relocation of

facilities or downsizing of operations. Facility closings and related employee layoffstranslate into costs incurred for severance pay and relocation costs as well as asset

write-downs or write-offs.

Requirement 2

Prior to 2003, restructuring costs were recognized (expensed) in the period thedecision to restructure was made, not in the period or periods in which the actualactivities took place. Now, restructuring costs are expensed in the period(s) incurred.

Requirement 3

Restructuring costs would be included as an operating expense in a multi-step

income statement.

Requirement 4

An analyst must interpret restructuring charges in light of a companys pasthistory in this area. Information in disclosure notes describing the restructuring andmanagement plans related to the business involved also can be helpful.

Judgment Case 4-3No. Companies generally prefer to report earnings that follow a smooth, regular

upward path. They try to avoid declines, but they also want to avoid increases that

vary wildly from year to year. It is better to have two years of 15% earningsincreases than a 30% gain one year and none the next. As a result, some companiesbank earnings by understating them in particularly good years and use the banke

Documents

Chap004 Intermediate