Solution manual accounting 21e by warreni ch 14

Thus, a loss of $130 million should be disclosed on the income statement as a separate line item above the income from continuing operations, and the plant and equipment should be writte

CHAPTER 14 INCOME TAXES, UNUSUAL INCOME ITEMS, AND

INVESTMENTS IN STOCKS

CLASS DISCUSSION QUESTIONS

1 a Current liability

b Long-term liability or deferred credit

(following the Long-Term Liabilities

section)

2 This is an example of a fixed asset

impairment Thus, a loss of $130 million

should be disclosed on the income

statement as a separate line item above

the income from continuing operations, and

the plant and equipment should be written

down to their appraised value ($20 million).

3 The severance costs are a current period

expense associated with downsizing

operations Thus, a restructuring charge

should be recognized on the income

statement (above income from continuing

operations) and any liability recognized As

payments are made to employees, the

liability is decreased.

4 Extraordinary items:

Gain on condemnation of land, net of

applicable income tax of $60,000 $90,000

5 The urban renewal agency’s acquisition of

the property may be viewed as a form of

expropriation under paragraph 23 of

Accounting Principles Board Opinion No.

30, Reporting the Results of Operations—

Reporting the Effects of Disposal of a

Segment of a Business, and Extraordinary,

Unusual and Infrequently Occurring Events

and Transactions Paragraph 23 says a

gain or loss from sale or abandonment of

property, plant, or equipment used in the

business should be included as an

extraordinary item if it is the direct result of

an expropriation Accordingly, the gain

should be reported as an extraordinary

item in the income statement.

6 The “loss from discontinued operations” of

$2.3 billion should be identified on the

income statement as discontinued

operations and should follow the

presentation of the results of continuing

operations (sales less the customary costs

and expenses) The data on discontinued

operations (identity of the segment, date of

disposal, etc.) should be disclosed in a note.

7 Readers of the financial statements should

be able to assume that the successive financial statements of a business are based consistently on the same generally accepted accounting principles Therefore, significant changes in accounting methods must be disclosed so that the reader is alerted to the effect of those changes on the financial statements.

8 a Yes, the $0.45-per-share gain should

be reported as an extraordinary item.

b Operations appear to have declined.

The earnings per share for the current year that is comparable to the preceding year’s earnings per share of

$1.10 is $0.93 ($1.38 – $0.45).

9 a Examples of other comprehensive

income items include foreign currency items, pension liability adjustments, and unrealized gains and losses on certain investments in debt and equity securities.

b No Other comprehensive income does

not affect the determination of net income or retained earnings.

10 A business may purchase stocks as a

means of earning a return (income) on cess cash that it does not need for its normal operations In other cases, a business may purchase the stock of another company as a means of developing or maintaining business relationships with the other company A business may also purchase common stock as a means of gaining control of another company’s operations.

ex-11 On the balance sheet, temporary

investments in marketable securities are reported at their fair market values, net of any applicable income taxes related to any unrealized gains or losses.

12 Unrealized gains or losses (net of

applicable taxes) should be reported as either an addition to or deduction from net

131

132

13 a The equity method

b Investments

14 Investment in Gestalt Corporation

15 a Minority interest

b Preceding stockholders' equity, usually

in the Long-Term Liabilities section.

16 Investment in

Affiliates 2,400,000 Income of

Affiliates 2,400,000

133

Ex 14–1

Apr 15 Income Tax Expense 70,000

Cash 70,000 June 15 Income Tax Expense 70,000

Cash 70,000 Sept 15 Income Tax Expense 70,000

Cash 70,000 Dec 31 Income Tax Expense 150,000*

Income Tax Payable 40,000 Deferred Income Tax Payable 110,000**

Dec 31 Income Tax Expense 920,000

Deferred Income Tax Payable 120,000* Income Tax Payable 800,000**

*$300,000 × 40% = $120,000

**$2,000,000 × 40% = $800,000

2006

Dec 31 Income Tax Expense 880,000

Deferred Income Tax Payable 120,000

Income Tax Payable 1,000,000**

**$2,500,000 × 40% = $1,000,000

Ex 14–3

a.

Depreciation expense per year:

years 10

0

$20,000,00 00

$100,000,0 

= $8,000,000 per year

December 31, 2006 net book value (carrying value) prior to impairment adjustment:

Fiber optic network cost $100,000,000

Less accumulated depreciation 16,000,000

Fiber optic net book value $ 84,000,000

b.

2006

Dec 31 Loss from Fixed Asset Impairment 39,000,000*

Fixed Assets—Fiber Optic Network 39,000,000

*$84,000,000 – $45,000,000

c.

Balance sheet:

Fixed assets—Fiber optic network $61,000,000*

Less accumulated depreciation 16,000,000

Fixed assets—Fiber optic network net book value $ 45,000,000

*$100,000,000 – $39,000,000

2006

Dec 31 Loss from Fixed Asset Impairment 99,000,000

Fixed Assets—Land 8,000,000 Fixed Assets—Equipment 11,000,000

b On December 31, 2006, management determined that one of the resort properties was permanently impaired due to the discovery of an adjacent toxic chemical waste site Bookings to this property have dropped significantly, and it was determined that the property had to abandoned As a result, a $99 million asset impairment loss was recognized in 2006, reflecting the fair value of assets associated with this site, as detailed in the following table:

Buildings and improvements $80,000,000

Land 8,000,000

Equipment 11,000,000

Total impairment $ 99,000,000

Ex 14–5

a.

2006

Nov 1 Restructuring Charge 3,600,000

Employee Termination Obligation 3,600,000 Average salary $ 60,000 Planned number of positions eliminated × 150 Total annual salary eliminated $ 9,000,000 Average tenure × 8 yrs Severance rate × 5% Total severance $ 3,600,000

b

2006

Dec 15 Employee Termination Obligation 960,000

Cash 960,000 Average salary $ 60,000 Number of positions eliminated × 40 Average tenure × 8 yrs Severance rate × 5% Total severance $960,000 c.

Balance sheet disclosure:

2006 for the accrued termination benefits Of this amount, $960,000 was distributed to terminated employees in 2006 The remaining $2,640,000 was recognized as a current liability and will be paid to employees terminated during the first three months of 2007.

Contract termination costs 120,000 Total restructuring charge $ 3,039,200

*Employee severance costs:

Note: The obligation is not “employee termination obligation” because there are

several types of restructuring charges included in the total Thus, the account Restructuring Obligation is used to represent the total obligation.

Ex 14–6 (Concluded)

e Note disclosure:

On July 1, 2006, the board of directors of the company approved and announced a restructuring plan that resulted in a $3,039,200 charge in 2006 consisting of the following items:

Contract termination costs 120,000 Total restructuring charge $ 3,039,200 The restructuring was caused by unfavorable publicity regarding the caffeine content of our juice products The adverse publicity reduced the demand for our products, requiring us to consolidate operations by closing one of our juice plants and eliminating 280 direct labor positions On December 31, 2006, there remains a current restructuring obligation of $1,814,400, primarily related to employee severance agreements.

Note: While no information was provided in the exercise, it is likely that the

factory building is also impaired requiring a write-down and appropriate disclosures.

Dec 31 Restructuring Charge 650,000*

Employee Termination Obligation 650,000

*65 employees × $10,000

b December 31, 2006 balance sheet disclosures:

Fixed assets:

Tractor-trailers $19,000,000 Less accumulated depreciation (9,000,000) Tractor-trailer net book value $10,000,000 Current liabilities:

Employee termination obligation $650,000 Note:

On December 31, 2006, the board of directors approved and communicated a restructuring plan in response to low-cost competition in the company’s service market The plan calls for the sale of 50 tractor-trailers and elimination

of 50 drivers and 15 staff personnel Due to the general overcapacity in the transportation market, tractor-trailer market values are estimated to be 40% of the existing book value, causing us to recognize an unrecoverable loss on fixed asset impairment of $15,000,000 in 2006 for the entire fleet In addition, a severance plan was approved for the eliminated positions The charge for employee severance was $650,000 for 2006, all of which is currently payable

at the end of the fiscal year It is estimated that all severance obligations will

be satisfied by the end of the first quarter in 2007.

c.

2007

Mar 14 Employee Termination Obligation 650,000

Cash 650,000

Note: The noncash utilization of the employee severance was not described

in the notes, but it could include pension, health, or other employee benefit increases In addition, employee benefit obligations would be included with other accrued liabilities on the balance sheet.

To be classified as an extraordinary item for income statement reporting purposes, the item (event) must be (1) unusual from the typical operating activities of the business and (2) occurring infrequently Although it would seem that the income from the Stabilization Act would meet these criteria, the airline industry (including Delta) did not report the income as an extraordinary item Indeed, the complete costs and income from the September 11, 2001 terrorist incident were not accounted for as extraordinary items as explained below

The text from the Emerging Issues Task Force, “Accounting for the Impact of the Terrorist Attacks of September 11, 2001,” explains the reason for the decision:

The EITF reached a consensus that losses or costs resulting from the September

11 events should be included in the determination of income from continuing operations; thus, they should not be classified as extraordinary items In the opinion of the Task Force, it would not be possible to isolate the effects of the September 11 events in a single line item, because of the difficulty in distinguishing losses that are directly attributable to such events from those that are not Losses or costs associated with the events of September 11 may, however, be reported as a separate component of income from continuing operations if they are deemed to be either unusual or infrequently occurring in nature

In the final analysis, the Task Force reached the foregoing decision based on its conclusion that users of financial statements would not be well served by separate reporting as an extraordinary item of only a portion of the impact of the September 11 events that strictly qualify for extraordinary classification under APB No 30, Reporting the Results of Operations Pursuant to Opinion 30, only losses or costs that can be clearly measured and irrefutably attributed to a specific event may be shown as an extraordinary item

The Task Force acknowledges that, while the September 11 events no doubt contributed to the pace and severity of the economic slowdown, identifying the impact of those events would be subjective and difficult—if at all possible Moreover, the Task Force points out that the most significant financial statement impact for many affected companies might be lost or reduced revenues; in accordance with Opinion 30, the measurement of an extraordinary item does not reflect an estimate of forgone sales or income

WAVE RUNNER, INC.

Income Statement For the Year Ended June 30, 2006 Sales $976,400 Cost of merchandise sold 431,900 Gross profit $544,500 Operating expenses:

Selling expenses $125,100

Administrative expenses 92,400 217,500 Other expenses:

Fixed asset impairment 100,000 Restructuring charge 80,000

Income tax expense 58,800 Income from continuing operations $ 88,200 Loss on discontinued operations, net of applicable

income tax of $36,000 54,000 Income before extraordinary item and cumulative

effect of a change in accounting principle $ 34,200 Extraordinary item:

Gain on condemnation of land, net of applicable

income tax of $17,200 25,800 Less cumulative effect on prior years of changing to a

different depreciation method, net of applicable

income tax reduction of $24,000 (36,000) Net income $ 24,000

Earnings per common share:

Income from continuing operations $ 8.82 Loss on discontinued operations 5.40 Income before extraordinary item and cumulative

effect of a change in accounting principle $ 3.42 Extraordinary item 2.58 Less cumulative effect on prior years of changing

to a different depreciation method (3.60) Net income $ 2.40

Ex 14–13

1 The order of presentation of the unusual items is incorrect The order should

be as follows:

Income from continuing operations

Loss on discontinued operations

Income before extraordinary items and cumulative effect of a change in accounting method

3 The fixed asset impairment should be disclosed above income from continuing operations.

4 The earnings per share data are presented in the incorrect order—see (1) above.

5 The earnings per share computations are incorrect The amount of preferred stock dividends ($20,000) should be subtracted from “income from continuing operations,” “income before extraordinary item and cumulative effect of change in accounting principle,” and “net income” in computing the earnings per share of common stock.

6 A corrected presentation appears on the next page.

AUDIO AFFECTION, INC.

Income Statement For the Year Ended December 31, 2006 Net sales $ 9,450,000 Cost of merchandise sold 7,100,000 Gross profit $ 2,350,000 Operating expenses:

Selling expenses $820,000

Administrative expenses 320,000 1,140,000 Special charges:

Restructuring charge $ 85,000

Fixed asset impairment 30,000 115,000 Income from continuing operations before income tax $ 1,095,000 Income tax expense 394,500* Income from continuing operations $ 700,500 Loss on discontinued operations (net of applicable

income tax of $76,000) (184,000) Income before extraordinary items and cumulative effect

of change in accounting method $ 516,500 Extraordinary item:

Gain on condemnation of land, net of applicable

income tax of $80,000 120,000 Cumulative effect on prior years’ income (decrease) of

changing to a different depreciation method (net of

applicable income tax reduction of $86,000) (204,000) Net income $ 432,500 Earnings per common share:

Income from continuing operations

[($700,500 – $20,000) ÷ 50,000 shares] $ 13.61 Loss on discontinued operations (3.68) Income before extraordinary item and cumulative

effect of change in accounting principle $ 9.93 Extraordinary item 2.40 Cumulative effect on prior years’ income (decrease)

of changing to a different depreciation method (4.08) Net income $ 8.25

*$420,000 – $25,500 tax benefit from restructuring charge

Ex 14–14

Basic earnings per share when there is preferred stock is determined as,

Earnings per Common Share =

g Outstandin Shares

Common of

Number

Dividends Stock

Preferred -

Income Net

Earnings per Common Share =

shares common

125,000

share) per

$6 shares pref.

(50,000 -

Earnings per Common Share = $3.52 per share

Ex 14–15

a Other comprehensive income (in millions):

Foreign currency translation $ 263

Net investment hedges,

net of $238 tax benefit (397)

Other, net of tax benefit (106)

Total other comprehensive income (loss) $(240)

b Percentage decline in net income due to other comprehensive losses:

COSBY CORPORATION Statement of Comprehensive Income For the Year Ended December 31, 2006

Net income $145,000 Other comprehensive income:

Unrealized gain on investment portfolio, net of tax 40,000 Total comprehensive income $185,000

b.

COSBY CORPORATION Stockholders’ Equity December 31, 2006

Common stock $ 35,000 Paid-in capital in excess of par value 350,000 Retained earnings 580,000* Accumulated other comprehensive loss (20,000)** Total $945,000

*$435,000 + $145,000

**($60,000) + $40,000

Ex 14–18

a 2006

Unrealized loss [10,000 shares × ($20 – $17)] $30,000

Less tax benefit on unrealized loss (40% rate) 12,000

Unrealized loss, net of income tax benefit $18,000

2007

Unrealized gain [10,000 shares × ($27 – $17)] $10,000

Less taxes on unrealized gain (40% rate) 40,000

Unrealized gain, net of income tax $60,000

Note: The tax benefit and expense give rise to temporary differences, since

gains and losses are only included for tax purposes at the time of sale.

LYON RESEARCH CORPORATION

Balance Sheet December 31, 2006

Assets Current assets:

Temporary investments in marketable securities,

LYON RESEARCH CORPORATION Statement of Comprehensive Income For the Year Ended December 31, 2006 Net income $ 80,000 Other comprehensive loss:

Unrealized loss on temporary investments in marketable

securities (net of applicable income tax benefit of $4,400) (6,600) Comprehensive income $ 73,400