Solution manual advanced accounting 10e by fischer taylor CH12

If the pretax income in these periods were not sufficient to absorb the remaining pre-tax loss, then some of the third-quarter pre-tax loss would not recognize a benefit.. In order to fu

CHAPTER 12 UNDERSTANDING THE ISSUES

1 Viewing an interim period as an integral

part of a larger annual period has several

benefits The allocation of expense under

this viewpoint provides information that

al-lows for more meaningful and insightful

predictions of annual results Furthermore,

the effect of certain interim conditions that

are not expected to exist at year-end may

be given special accounting treatment

Ex-amples of this include special accounting

for temporary inventory liquidations and

temporary unfavorable variances If special

accounting treatment were not available,

projections of annual amounts would be

distorted

2 A number of factors are necessary in order

to determine the estimated effective annual

tax rate First of all, the rate should reflect

conditions to be experienced for the entire

year Therefore, in addition to year-to-date

pretax income/loss, such amounts must be

projected for the balance of the year

Statu-tory tax rates are applied to these annual

amounts after considering the presence of

possible annual permanent differences

be-tween book and tax income The resulting

taxes must also be reduced by possible tax

credits The applicability of the above

fac-tors becomes more complex in situations

where there is an estimated annual pretax

loss This situation requires the

considera-tion of possible tax loss and/or tax credit

carrybacks and carryforwards

3 Several factors may explain this situation If

the third-quarter loss were greater than the

pretax income in the first two quarters plus

the forecasted pretax income for the fourth

quarter, then some of the benefit traceable

to the loss may not be recognized

Howev-er, if this were the case, one would

consid-er any known pretax income in the carry-

back period and any “more likely than not” pretax income in the carryforward periods

If the pretax income in these periods were not sufficient to absorb the remaining pre-tax loss, then some of the third-quarter pre-tax loss would not recognize a benefit In order to fully recognize the benefit asso-ciated with an interim period pretax loss, there must be some combination of the fol-lowing: sufficient pretax income in other quarters of the current year, sufficient pre-tax income in the carryback period, and/or sufficient “more likely than not” pretax in-come in the carryforward period

4 There are a number of reasons why the

total operating profit of the reportable ments does not normally equal the consoli-dated operating profit First of all, not all operating segments are reportable and yet such amounts are included in consolidated amounts Second, there are a number of intersegment transactions whose effect would be included in operating profits of reportable segments but eliminated from consolidated amounts Third, not all ele-ments of consolidated income are allocated

seg-to reportable segments This is traceable

to the fact that not all elements are used

by the chief operating decision maker in evaluating segment performance and/or because allocation is not possible on a rea-sonable basis Finally, the accounting employed from a management approach perspective may be different from the re-quirement to use GAAP in the measure-ment of consolidated amounts

EXERCISES EXERCISE 12-1

Income Statement For 3-Month Period Ended June 30, 20X2 Sales $860,000 Cost of goods sold:

Standard cost of goods manufactured $600,000

Add finished goods inventory, April 1, 20X2,

at standard cost 71,000

Deduct finished goods inventory, June 30, 20X2,

at standard cost (98,000)

Cost of goods sold at standard cost $573,000

Add net unfavorable cost variances 1,700*

Adjusted cost of goods sold 574,700 Gross profit $285,300

Selling and administrative expenses:

Selling expenses $ 68,000

General and administrative expenses 117,000 185,000 Net income $100,300 *Purchase price variances or volume or capacity cost variances that are planned and ex-

pected to be absorbed by the end of the annual period should ordinarily be deferred at

interim reporting dates Therefore, the net unfavorable cost variance recognized is

$1,700 ($2,600 – $900)

Income Statement For 3-Month Period Ended June 30, 20X2 Sales $860,000 Cost of goods sold 648,000** Gross profit $212,000 Selling and administrative expenses:

Selling expenses $ 68,000

General and administrative expenses 117,000 185,000 Net income $ 27,000

**$596,000 + [13,000 units × ($11 – $7)] = $648,000 Inventory at the interim reporting date

should not give effect to the LIFO liquidation, and the cost of goods sold should include

the expected cost of replacement of the liquidated LIFO base Since it is expected that

2,000 units of beginning inventory will be part of the 20X2 cost of goods sold, only 13,000

units need to be adjusted

Ch 12—Exercises

Exercise 12-1 Concluded

Income Statement For 3-Month Period Ended June 30, 20X2 Sales $860,000

Cost of goods sold 493,300‡

‡Recoveries of inventory losses from market declines in earlier interim periods of the same

fiscal year should be recognized as gains; such gains should not exceed previously

Write-up to offset first-quarter write-down (2,200)

Cost of goods sold $493,300

EXERCISE 12-2

(1) Although research and development (R&D) costs are generally expensed in the year in

which such costs are incurred, the question at hand is how they should be treated for

inte-rim reporting purposes Because an inteinte-rim period is considered to be an integral part of a

larger annual period, interim data are viewed as a possible predictor of annual values

Therefore, the R&D recognized in a given interim period might become the basis for

esti-mating an annual amount If all the R&D were expensed in a single quarter, one might

sug-gest that annual R&D is four times that amount In order to avoid this incorrect conclusion,

the R&D should be amortized over the current and remaining quarters within the annual

pe-riod In this specific case, the $130,000 of costs should be allocated to each of the four

quarters in the amount of $32,500 per quarter

Exercise 12-2, Concluded (2) In interim reporting, the year-to-date (YTD) tax expense represents the best estimate of the

annual estimated effective tax rate The YTD tax expense is allocated to the current and

prior quarters If the estimated effective tax rate has been revised from a previous estimate,

this change in estimate is recognized in the new YTD values and also in the current

quar-ter’s tax expense Therefore, a given quarquar-ter’s tax expense reflects the tax on the quarquar-ter’s

income and the effect of a rate change on previous quarters To illustrate, assume the

fol-lowing:

Quarter

Current Income

YTD Income

Tax Rate

YTD Tax Expense

Current Tax Expense

1 $50,000 $ 50,0 30% $15,000 $15,000

2 70,000 120,000 35 42,000 27,000The tax expense in quarter 2 reflects the tax on $70,000 at 35%, or $24,500, and the 5%

increase in taxes traceable to quarter 1, or $50,000 at 5%, or $2,500 The total current tax

expense of $27,000 for quarter 2 is approximately 39% (versus the effective rate of 35%) of

the second-quarter income

EXERCISE 12-3

Granger Supply, Inc

Interim Income Statements For the Periods Ending Quarter 1 and 2, 20X7

Net sales $12,000,000 $9,000,000 Cost of sales (See Schedule A) 7,900,000 7,805,0Gross profit $ 4,100,000 $1,195,000 Selling, general, and administrative 2,100,000 1,800,0Income before taxes $ 2,000,000 $ (605,00Income tax expense (See Schedule B) 700,800 (217,15Net income $ 1,299,200 $ (387,84

Schedule A—Cost of Sales

As stated:

Cost of sales—industrial supplies $4,300,000 $4,700,000 Cost of sales—cleaning equipment 3,000,000 3,200,0Adjustment for replacement cost:

400 units × ($2,700 – $1,500) 480,000

Adjustment for loss due to market decline 120,000 (95,000New cost of sales $7,900,000 $7,805,000

Estimated adjusted taxable income $7,160,000 $5,430,000

Statutory tax rate 35.00% 35.00%

Tax on estimated adjusted taxable income $2,506,000 $1,900,500

Tax credits 18,000 30,000

Net tax $2,488,000 $1,870,500

Effective tax rate 35.04% 34.67%

Ordinary Pretax Income (Loss) Tax Expense (Benefit)

Interim Current Effective Tax Previously Current

Period Period Year-to-Date Rate Year-to-Date Reported Period

YTD income (loss) $100,000 $120,000

Projected income (loss) 110,000 135,000

Effective tax rate 20.83% 23.33%

First 6 months’ tax expense (benefit):

Pretax income (loss) $100,000 $120,000

Effective tax rate per above × 20.83% × 23.33%

Tax expense (benefit) $ 20,833 $ 27,996

The change in accounting principle resulted in an increase in tax expense for the first 6

months of $7,163 ($27,996 vs $20,833)

Exercise 12-4, Concluded

First 6 months continuing $120,000 $120,000 $120,000 $120,000 Third quarter continuing 80,000 80,000 80,000 80,000 Projected continuing 20,000 20,000 20,000 20,000 Nonordinary loss (40,000) (40,000) Nonordinary gain 60,000 60,000

Pretax income (loss) $220,000 $240,000

Tax expense (benefit) $ 50,600 $ 57,600 $ 71,600 $

35,400

Incremental tax expense (benefit) traceable to:

All nonordinary items ($57,600 – $50,600) $ 7,000

All nonordinary losses ($71,600 – $57,600) $ (14,000)

All nonordinary gains [$7,000 – ($14,000)] $ 21,000

Ch 12—Exercises

EXERCISE 12-5

Corporation A Corporation B Corporation C Corporation D

YTD realized income (loss) $ 95,000 $ 5,000 $ (80,000) $ 20,000

Projected income (loss) 30,000 (70,000) (50,000) (35,000)

Total income (loss) $125,000 $(65,000) $(130,000) $(15,000)

Income adjustments (7,000)* 2,000

Total taxable income (loss) $125,000 $(72,000) $(128,000) $(15,000)

Statutory tax rate × 40% × 40% × 40% × 40%

Tax expense (benefit) $ 50,000 $(28,800) $ (51,200) $( 6,000)

Tax credit (2,000) (3,500) (1,000)

Net tax expense (benefit) $ 48,000 $(32,300) $ (51,200) $ (7,000)

Limit to tax benefits $(14,400)b $ (38,860)c $ (5,000)d

Effective annual tax rate 38.4%a 22.2%b 29.9%c 33.3%d

*$15,000 text exempt municipal income—$8,000 deductions not allowed

The prior two years’ income totals $140,000, of which $128,000 may be offset by the NOL

carryback, resulting in a tax benefit of $38,860 [($105,000 × 30%) + ($23,000 × 32%)]

d$5,000 ÷ $15,000 = 33.3%

Tax benefit limited to projected carryforward ($12,500 × 40%)

EXERCISE 12-6

YTD pretax income (loss) $ 800,000 $1,020,000 $(220,000) $1,545,000 $(700,000)

Projected pretax income (loss) 1,100,000 1,420,000 (320,000) 1,050,000 —

Estimated annual income $1,900,000 $2,440,000 $(540,000) $2,595,000 $(700,000)

Effective tax rate 29.50% 30.72% 31.53%

Note A: The difference between the first and first restated continuing operations is the tax benefit attributed to the discontinued

operations

Note B: Continuing

Annual income (loss) $2,595,000 $1,895,000

Annual net tax expense (benefit) 818,250 573,250 [(30% × $1,500,000) + (35% × $395,000) – $15,000]

The difference between $818,250 and $573,250 represents the tax benefit associated with the discontinued operation

Ch 12—Exercises

EXERCISE 12-7

Quarter 1, 20X7 Quarter 2, 20X7 Before After Before After

First-quarter income (loss) $ 40,000 $ 70,000 $ 40,000 $ 70,000

Second-quarter income (loss) — — (30,000) (10,000

YTD income (loss) $ 40,000 $ 70,000 $ 10,000 $ 60,000

Projected income (loss) (210,000) (155,000) (150,000) (130,00

Total tax benefit $32,250 $17,150 $28,250 $12,500

Estimated rate of benefit 18.97% 20.18% 20.18% 17.86%

Quarter tax expense (benefit):

YTD pretax income (loss) $ 40,000 $ 70,000 $ 10,000 $ 60,000

Effective tax rate per above × 18.97% × 20.18% × 20.18% × 17.86%

YTD tax expense (benefit) $ 7,588 $ 14,126 $ 2,018 $ 10,716

Prior quarter expense (benefit) — — 7,588 14,126

Current quarter expense (benefit) $ 7,588 $ 14,126 $ (5,570) $ (3,410)

EXERCISE 12-8

Income Income Loss (A) Gain (B & C) Continuing income (loss) $60,000 $ 60,000 $60,000$ 60,000

Nonordinary item A — (30,000) — (30,000) Nonordinary item B — 25,000 25,000 — Nonordinary item C — 5,000 5,000 — Pretax income (loss) $60,000 $ 60,000 $90,000$ 30,000

Tax expense (benefit) $10,000 $ 10,000 $18,850$ 4,500

Estimated tax:

On first $50,000 @ 15% $ 7,500 $ 7,500 $ 7,500 $4,500

On next $25,000 @ 25% 2,500 2,500 6,250 —

On next $25,000 @ 34% — — 5,100 — Total estimated tax $10,000 $10,000 $18,850 $4,500 Incremental tax expense (benefit) traceable to:

All nonordinary items ($10,000 – $10,000) $ 0

All nonordinary losses ($10,000 – $18,850) (8,850)

All nonordinary gains [$0 – ($8,850)] $ 8,850

Continuing income (loss) $60,000 $ 60,000 $ 60,000 $

60,000

Nonordinary item A — (30,000) (30,000) (30,000) Nonordinary item B — 25,000 — 25,000 Nonordinary item C — 5,000 5,000

Item B ($10,000 – $5,250) $4,750 79.2%

Item C ($10,000 – $8,750) 1,250 20.8

Total $6,000 100.0%

EXERCISE 12-9

The key to defining the segments of Norfo International is to analyze how information might be structured for purposes of decision making by the chief operating decision maker Possible al-ternatives would be to organize the information around products or services, geographic areas,

or product/service groups within geographic areas For example, a product/service approach might suggest major segments of foodstuffs (including food processing, citrus groves, and packaging), resort and travel, and paper products The paper products and food packaging areas could be combined to form a separate segment Organizing the information around geo-graphic areas might suggest the following: southeastern United States, eastern seaboard, Great Lakes region, the Bahamas, and Europe (Spain and Italy)

Obviously, various combinations are possible and students should be encouraged to think about which combinations seem most relevant for addressing the issues of how to evaluate perfor-mance and allocate resources among the various activities of an enterprise Attention should also be focused on organizing information in such a way that the aggregation guidelines of the FASB are not violated For example, does it really make sense to analyze information structured around the eastern seaboard region when that segment would include hotels, travel agencies, and the manufacture of paper products? Would it make more sense to separate the eastern seaboard into two segments: hotels/travel agencies and paper products? For example, if unem-ployment in the eastern seaboard is high, the travel and leisure area would probably be affected differently than the paper manufacturing division

Total $161,000,000 $6,100,000 $167,100,000 $ 16,100,000

Total of all reported profits $ 29,700,000

Total of all reported losses (13,600,000)

Significance of reportable segments:

Consolidated revenue $177,000,000

Percentage requirement × 75%

Dollar requirement $132,750,000

External revenue of all reportable segments $149,000,000

Conclusion: The reportable segments represent a significant portion of the enterprise

Total of all reported profits $4,530,800

Total of all reported losses (687,000)

Value of Profit

Significance of reportable segments:

Consolidated revenue $9,074,000

Percentage requirement × 75%

Dollar requirement $6,805,500

External revenue of all reportable segments $6,872,200

Conclusion: The reportable segments represent a significant portion of the enterprise

Ch 12—Exercises

Exercise12-11, Concluded Reconciliation to Consolidated Revenue and Profit:

Revenues

Total revenues for reportable segments $7,712,000 Revenues for nonreportable segments 850,000 Elimination of intersegment revenue (839,800) Corporate-level revenues (Note A) 1,351,800

Total consolidated revenues $9,074,000

Profit or loss

Total profit or loss for reportable segments $4,292,800 Profit or loss of nonreportable segments (449,000) Corporate-level:

Revenues (Note A) 1,351,800 Expenses (Note B) (756,100)

Total consolidated income $4,439,500

Note A: The corporate-level revenue is calculated by taking the consolidated revenue of

$9,074,000 less the external revenues from all segments of $7,722,200

Note B: The expenses for all segments total $4,718,200 ($8,562,000 – $3,843,800) This

total includes the cost of goods/services acquired on an intersegment basis of

$839,800 Assuming there was no intercompany profit in ending inventory, the real

total expense after eliminating intercompany costs is $3,878,400 ($4,718,200 –

$839,800) Therefore, the corporate-level expenses are $756,100 ($4,634,500 –

$3,878,400)

Total of all reported losses (314,000)

Value of Profit Revenue 10% or Loss 10% Assets 10%

or More of or More of or More of Is Segment Segment $8,174,000? $2,129,000? $9,265,000? Reportable?

(2) Significance of reportable segments:

Consolidated revenue $8,715,700

Percentage requirement × 75%

Dollar requirement $6,536,775

External revenue of all reportable segments $7,186,000

Conclusion: The reportable segments represent a significant portion of the enterprise

(3) Information traceable to nonreportable segments should be combined into one segment

that has been referred to in the text as the “all other” segment Information regarding this

“all other” segment would be disclosed in the reconciliations of total reportable segment

amounts to the respective consolidated enterprise amounts

(4) Because revenues with a single external customer amount to 10% or more of enterprise

revenues, special disclosure is required Such a disclosure might appear as follows:

Staven Supplies’ consolidated revenues include $1,230,000 of revenues traceable to

sales made to the federal government The sales were generated by segment 3

PROBLEMS PROBLEM 12-1

(1) When publicly traded companies report summarized interim financial information to their stockholders at interim dates, the following data should be reported, as a minimum:

(a) Sales or gross revenues, provision for income taxes, extraordinary items, cumulative effects of changes in accounting principles, and net income

(b) Primary and fully diluted earnings-per-share data for each period presented

(c) Seasonal revenues, costs or expenses, and contingent items

(d) Disposal of a segment of a business and extraordinary, unusual, or infrequently ring items (including related income tax effects)

occur-(e) Changes in accounting principles or estimates, including significant changes in mates or provisions for income taxes

esti-(f) Significant changes in financial position

When summarized interim financial data are regularly reported on a quarterly basis, the foregoing information for the current quarter and the current YTD or the last 12 months to date should be furnished, as well as comparable data for the preceding year When a sepa-rate fourth-quarter report or disclosure of the fourth-quarter results is not included in the annual report, material year-end adjustments, extraordinary items, and disposal of seg-ments of a business should be disclosed in the annual report in a note to the financial statements

Management should provide commentary relating to the effects of significant events upon the interim financial results, similar to its commentary in annual reports Published balance sheet and funds flow data at interim dates are desirable, but disclosure of significant changes in financial position or funds flow should be presented as a minimum

(2) There are two general weaknesses in the form and content of presentation of the quarter information: (1) some information in the statement needs further explanation, and (2) additional financial statements or summarized data should be presented and explained

first-as appropriate in the circumstances [See discussion presented in entry (1).]

The major weakness in the first-quarter report is that it is misleading because the company

is expecting a profit for the year, not a loss as normally would be assumed from the lished report alone Both sales and production were equal to the units budgeted for the first quarter, and if actual activity continues as planned for the rest of the year, Mikelson will show a profit of $371,250 {$450,000 – [$175,000 × (1 – 0.55)]} for 20X5 Thus, Mikelson should indicate in the interim report that sales, production, and net income (loss) are in line with expectations, as related to budgeted data and first quarters of prior years

pub-No other weakness in form and content is evident, except as discussed below in entry (3)

Ch 12—Problems

Problem 12-1, Concluded (3) (a) The treatment of underapplied fixed factory overhead as an asset in this situation is

the preferred method of accounting The expected year-end result is that actual

pro-duction will exactly equal budgeted propro-duction upon which the standard was based;

thus, no volume variance should exist at year-end

(b) The manner in which the selling, general, and administrative expenses were handled

in the report is the preferred method These costs cannot be inventoried, they cannot

be associated directly with the product, and they have been incurred at expected

le-vels Thus, they should be expensed as period costs when incurred or be allocated

among interim periods based on the estimate of time expired, benefit received, or

ac-tivity associated with the periods

(c) The warehouse fire loss is an extraordinary item that should be appropriately disclosed

in the interim financial report, net of income tax effect In this situation, the $175,000

loss should be reduced by the effective income tax benefit of $96,250 Thus, the loss

should reduce net income by $78,750 ($175,000 – $96,250), and the nature of the loss

should be appropriately explained in the commentary accompanying the quarterly

da-ta

(d) A negative income tax expense (an income tax benefit) should have been included in

the interim report The $35,000 loss from regular operations should have been

re-duced by $19,250 ($35,000 × 55%), the expected tax reduction to be realized from

profitable operations during the remaining three quarters of 20X5 The tax benefits

re-sulting from losses that arise in the early portion of the year should be recognized only

when realization is more likely than not An established seasonal pattern of losses in

early interim periods, offset by income in later interim periods, should constitute

suffi-cient evidence that realization is more likely than not—unless other evidence

contra-dicts this conclusion

Estimated annual income $(70,000) $(15,000) $(55,000) $90,000 $110,000

Tax (benefit) of NOL carryback to prior 2 years $(6,400)a $(4,440)b

Tax credits — (1,960)b (5,000) (8,000)

Net tax expense (benefit) $(6,400) $(6,400) $23,800 $27,200

Effective tax rate 9.14% 42.67% 26.44% 24.73%

(quarter) Income Period to-Date Tax Rate to-Date Reported Period

(6,400)

aBecause there is no future income that is “more likely than not” and there were carrybacks available, the tax benefit can only be

found by adding the tax expense in the past 2 years [($12,000 × 30%) + ($10,000 × 28%)]

bBecause there is no future income that is “more likely than not” and there were carrybacks available, the tax benefit can only be

found by carrying the $15,000 loss and tax credit back to the past 2 years [($12,000 × 30%) + ($3,000 × 28%) + $1,960 of tax