Solution manual intermediate accounting 15e by stice ch04

The major sections that may be included in a multiple-step income statement may be divided into two categories: a incomefrom continuing operations, separated intosix sections, and b irre

CHAPTER 4 QUESTIONS

1 The objective of financial reporting is to

provide useful information for users of the

financial statements The relevant

information for decision making is future

data, especially information dealing with

cash flows The primary financial

statements reflect economic transactions

and events that have taken place The

past is used to help project the future

Income, however, is only one of many

sources of cash flow The balance sheet

and statement of cash flows also furnish

relevant information upon which the

investor may project other future cash

flows In summary, the income statement

contains only some of the information that

is relevant for making economic decisions

2 Two approaches can be used to measure

income: the capital maintenance approach

and the transaction approach The capital

maintenance approach uses the balance

sheet elements to determine the change in

total equity after eliminating any

investments and withdrawals of resources

by owners The transaction approach

determines income by analyzing individual

transactions and events and their effect on

related assets, liabilities, and owners’

equity Although the method of

determining income differs, both

approaches arrive at the same total

income figure if the same attributes and

measurements are used However, the

transaction approach produces more

detail as to the composition of income

than does the capital maintenance

approach

3 Measurement methods that could be

applied to net assets in the capital

maintenance approach to income

determination are as follows:

(a) The historical cost of net assets

acquired in exchange transactions,

reduced by an allowance for their use

(b) The historical cost of net assets

acquired in exchange transactions,

reduced by an allowance for their use

and adjusted for a change in price

levels since original acquisition

(c) The current value of net assetsacquired in exchange transactions asdetermined by either their replacement

or market values

(d) Some variation of the above (athrough c) but including in assets allresources and claims to resources, notjust those acquired in exchangetransactions

4 The objectives of reporting income for

income tax purposes and for financialreporting to users are not the same Thoseformulating income tax laws are usuallyconcerned with fairness among taxpayersand with their ability to pay taxes Users,

on the other hand, are concerned with ameasure that distinguishes between areturn on investment and a return ofinvestment They want a measure thatmatches expenses against recognizedrevenue In most cases, the sameaccounting method can be used for bothpurposes This will reduce both the costand the confusion of using more than oneaccounting method for the sametransaction In some cases, however, thegenerally accepted accounting method isdifferent from that required by income taxregulations This results in a temporarydifference between the tax return and thebooks and gives rise to interperiod incometax allocation

5 A code law country is one in which rules,

laws, and accounting standards are set bylegal processes—from the top down Acommon law country is one in which rules,laws, and accounting standards evolve inresponse to societal and market forces—from the bottom up

6 Revenues and expenses are related to the

ongoing major or central activities of abusiness and are reported at gross

amounts Gains and losses are associated

with peripheral and incidental transactionsand events and are reported as thedifference between the selling price andthe book value (often the depreciatedcost) These classification and displaydistinctions will depend on the specific

circumstances and activities of an

enterprise

7 The following two factors must be

considered when deciding at what point

revenues and gains should be recognized:

(a) The resources from the transaction are

either already realized in cash or claims to

cash or are readily realizable in cash, and

(b) the revenues and gains have been

earned through substantial completion of

clearly identified tasks and activities Both

factors are usually met when merchandise

is delivered or services are rendered to

customers This is referred to as the point

of sale.

8 There are three specific exceptions to the

general rule that were discussed in the

chapter They are recognizing revenue (a)

at the point of completed production, (b) at

the time of cash collection, and (c) at

various points in time during the

operat-ing cycle (e.g., percentage-of-completion

method) The justification for the use of

these exceptions is that, in each case, the

realization and earning criteria established

by the FASB are met

9 Three expense recognition principles are

applied in matching costs with revenues:

(a) Direct matching—costs are associated

directly with specific revenues and

recognized as expenses of the period

in which the revenues are recognized

(b) Systematic and rational allocation—

when costs cannot be associated

directly with specific revenues, costs

are associated in a systematic and

rational manner with the periods or

products benefited

(c) Immediate recognition—those costs

that cannot be related to revenues

either by direct matching or by

systematic and rational allocation

must be recognized as expenses of

period

10 The multiple-step income statement can

contain too much information that might

be confusing to the reader and require

excess time to evaluate The detailed

listing of purchases and inventory might

best be displayed in a supplementary

schedule

The single-step income statement can be

too brief Information required for

investment decisions is sometimespresented in supporting schedules or notreported Because of these factors, thestatement could also be confusing, andvaluable time could be lost by thestatement reader in seeking additionalinformation

11 The major sections that may be included

in a multiple-step income statement may

be divided into two categories: (a) incomefrom continuing operations, separated intosix sections, and (b) irregular orextraordinary items, separated into threesections The sections of income fromcontinuing operations are

1 Revenue from net sales

2 Cost of goods sold

3 Operating expenses

4 Other revenues and gains

5 Other expenses and losses

6 Income taxes on continuingoperations

The sections of irregular or extraordinaryitems are

7 Discontinued operations

8 Extraordinary items

9 Cumulative effects of changes inaccounting principles

12 A restructuring charge is a loss that arises

when a company proposes a restructuring

of its operations The charge is composed

of the loss in value associated with assetsthat no longer fit in the company’sstrategic plans The charge also includesthe additional costs associated with thetermination or relocation of employees.Restructuring charges are controversialbecause companies exercise considerablediscretion in determining the amount of arestructuring charge and thus can userestructuring charges as a tool formanipulating the amount of reported netincome

13 This flexibility in the timing of the

recognition of restructuring charges is

reduced by SFAS No 146 Intraperiod income tax allocation involves the

separation of income tax expensebetween income from continuingoperations and transitory, irregular, orextraordinary items Under this concept,each section of the transitory, irregular, orextraordinary items category is reportednet of its income tax effect

14 Pop-Up must separately disclose the

current year’s income related to the

operations of the segment that will be

discontinued together with the $10,000

loss resulting from the sale This total

would be reported on the income

statement, along with any associated

income tax impact, immediately following

income from continuing operations

15 The following items would not normally

qualify as extraordinary items:

(a) The write-down or write-off of

receivables

(b) Major devaluation of foreign currency

(c) Loss on sale of plant and equipment

(d) Gain from early extinguishment of

debt Before the issuance of SFAS No.

145 in April 2002, gains and losses

from early extinguishment of debt

were required to be classified as

extraordinary

(f) Loss due to extensive earthquake

damage to furniture company in Los

Angeles, California (Earthquakes are

not unusual in the Los Angeles area.)

(g) Farming loss due to heavy spring

rains in the Northwest (Spring rains

are not unusual in the Northwest.)

Item (e) is classified as extraordinary

because flood damage is both unusual

and infrequent in Las Vegas

16 a The effects of a change in accounting

principle that is applied to past periods

are disclosed in the financial

statements of the period of change

The effects of the change are

computed for past periods and

disclosed either as a cumulative effect

on current net income or as an

adjustment to the beginning retained

earnings The FASB has specified

criteria to determine which approach is

appropriate

b The effect of a change in accounting

estimate is disclosed entirely in the

current period or in the current and

future periods No adjustments are

made to prior periods’ statements as

may be done for a change in principle

The change in an estimate should be

sufficiently disclosed in the financial

statements so that readers are alerted

to those changes that will materially

affect future periods

17 Under International Financial Reporting

18 a change in accounting principle is

reported as a direct adjustment tobeginning retained earnings of thecurrent year

18 Generally accepted accounting principles

require entities to report share information for income fromcontinuing operations and for each section

earnings-per-of the transitory, irregular, or extraordinaryitems category of an income statement.The computation is made by dividing theincome or loss from each of thesesections by the weighted average number

of common shares outstanding during thereporting period If a potential dilution ofearnings exists due to the existence ofconvertible securities, stock options, orstock warrants, additional earnings-per-share information must also be presented

19 “Comprehensive income is the change in

equity of a business enterprise during aperiod from transactions and other eventsand circumstances from nonownersources It includes all changes in equityduring a period except those resultingfrom investments by owners anddistributions to owners.”1 Net income isthe reported income as required by GAAP.Currently, GAAP does not require allcomponents of comprehensive income to

be disclosed in the income statement Forexample, it does not include the effect oferror corrections, asset valuation changes,

or some effects of accounting changes

20 The starting point for the preparation of

forecasted financial statements is theforecast of sales

21 In forecasting depreciation expense, one

first must forecast how much property,plant, and equipment will be needed in thefuture This amount is then used, alongwith an assumption about how rapidly theplant and equipment will depreciate, toestimate future depreciation expense

1Statement of Financial Accounting Concepts No 6, “Elements of Financial Statements” (Stamford, CT:

Financial Accounting Standards Board, December 1985), par 70.

PRACTICE EXERCISES

PRACTICE 4 1 FINANCIAL CAPITAL MAINTENANCE

Net assets, beginning of period 170,000

Deduct investment by owners 100,000

PRACTICE 4 2 PHYSICAL CAPITAL MAINTENANCE

Net assets, beginning of period 170,000

Income, financial capital maintenance $ 75,000

Deduct increase necessary to maintain physical capital 65,000

Income, physical capital maintenance $ 10,000

PRACTICE 4 3 COMPUTATION OF INCOME USING MATCHING

PRACTICE 4 4 REVENUE RECOGNITION

PRACTICE 4 5 EXPENSE RECOGNITION

Cost Method This Year

PRACTICE 4 6 SINGLE-STEP INCOME STATEMENT

Less expenses:

Selling and administrative expense 750

Income before income taxes $ 2,150

Income before income taxes $2,150

PRACTICE 4 8 COMPUTATION OF GROSS PROFIT

Revenues $9,488.8Cost of sales 5,784.9Gross profit $3,703.9Gross profit/Sales = $3,703.9/$9,488.8 = 39.0%

PRACTICE 4 9 COMPUTATION OF OPERATING INCOME

Revenues $9,488.8Operating expenses:

Cost of sales 5,784.9 Selling and administrative 2,689.7 Restructuring charge, net (Note 13) (0.1)Total operating expenses $8,474.5Operating income $1,014.3Operating income/Sales = $1,014.3/$9,488.8 = 10.7%

PRACTICE 4 10 COMPUTATION OF INCOME FROM CONTINUING OPERATIONS

Income from continuing operations $ 1,890

PRACTICE 4 11 COMPUTATION OF INCOME FROM DISCONTINUED OPERATIONS

2005 2004

Income tax expense (30%) 180 150

Income from continuing operations $ 420 $ 350

Discontinued operations:

Income (loss) from operations

(including loss on disposal

Income tax expense (benefit)30% (720) 180

Income (loss) on discontinued operations (1,680) 420

PRACTICE 4 12 COMPUTATION OF INCOME FROM DISCONTINUED OPERATIONS

2005 2004

Income tax expense (benefit) 30% (120) 180

Income from continuing operations $ (280) $ 420

Discontinued operations:

Income from operations

(including gain on disposal

Income on discontinued operations 1,470 350

Operating expenses and gains/losses:

Selling and administrative expense (1,750)

Other revenues and expenses:

Loss from an unusual but frequent event$(1,000)

Gain from a normal but infrequent event 1,250

Income from continuing operations $ 3,240

Extraordinary loss (net of tax benefit of $160) (240)

Oil and gas exploration expense 700 600 400

Income tax expense (30%) 1,290 720 480

Income from continuing operations $3,010 $1,680 $1,120

Cumulative effect of change

in accounting principle (net of income

tax benefit of $510) (1,190) 0 0

Cumulative effect = [($400 + $600) – ($1,500 + $1,200)] = ($1,700)

PRACTICE 4 15 ACCOUNTING FOR CHANGES IN ESTIMATES

Original depreciation = $100,000/20 years = $5,000 per year

Accumulated depreciation as of January 1, 2005 = $5,000 per year  5 years = $25,000Revised depreciation = Remaining depreciable book value/Remaining life

= ($100,000  $25,000)/(30 years  5 years elapsed already)

= $75,000/25 years

= $3,000 per year

PRACTICE 4 16 RETURN ON SALES

Return on sales = Net income/Sales = $200/$13,000 = 1.5%

PRACTICE 4 17 EARNINGS PER SHARE

Percentage increase in 2004: ($3.00  $2.50)/$2.50 = 20%

Percentage increase in 2005: ($4.00  $3.00)/$3.00 = 33%

PRACTICE 4 18 PRICE-EARNINGS (P/E) RATIO

Price-earnings ratio = Market price per share/Earnings per share = $20.00/$1.67 = 12.0

PRACTICE 4 19 COMPREHENSIVE INCOME

Income from continuing operations $ 11,000

Cumulative effect of a change in accounting principle (400)

Unrealized loss on available-for-sale securities (2,100)

Foreign currency translation adjustment (equity increase) 1,250

PRACTICE 4 20 FORECASTED BALANCE SHEET

Actual Forecasted

Plant and equipment (net) 5,000 7,000 40% increase

PRACTICE 4 21 FORECASTED INCOME STATEMENT

Actual Forecasted

Cost of goods sold 6,000 7,800 30% natural increase

Depreciation expense 1,000 1,200 same proportion with PPE

Interest expense 400 500 same apparent 10% interest rateIncome before income taxes$ 2,600 $ 3,500

Income tax expense 910 1,225 same tax rate ($910/$2,600) = 35%

4–22.

Debit changes in accounts during 2005 other

than Retained Earnings:

Cash $ 95,500 Accounts Receivable 92,000 Buildings and Equipment (net) 190,000 Accounts Payable 75,000 $ 452,500 Credit changes in accounts during 2005 other

than Retained Earnings:

Inventory $ 30,000 Patents 5,000 Bonds Payable 150,000 Capital Stock 100,000 Additional Paid-In Capital 50,000 335,000 Change in Retained Earnings for 2005 $ 117,500 Add: Dividends declared 25,000 Net income $ 142,500 4–23.

(a) The receipt of an order from a customer does not constitute realization, nor does it qualify as an earnings activity Therefore no revenue is recognized.

(b) There has been no sale of the asset to support the recognition of revenue Production remains to be performed, followed by sale of the finished product Accretion may give rise to revenue in certain instances in which it can be objectively determined and the product has

a ready market at a definite price.

(c) The rendering of services is the earning activity, and it is assumed that a valid claim exists against the client The recognition criteria are met (d) The appreciation in value of the land is generally not recognized because it is not yet realized.

(e) The receipt of cash meets the realization criteria; however, the revenue

is generally not reported as earned because the product has not yet been delivered Some argue that an estimate of the costs incurred to honor the certificate can be made so that revenue could be recognized

at the time of certificate sale.

(f) Collection of cash on the subscriptions is realization However, the earning activity has yet to take place.

(g) The retirement of debt at less than the recorded liability results in the recognition of a gain The retirement of the debt meets the recognition criterion for gains.

income-(d) Because a claim against the customer (an asset) is created when the merchandise is shipped and actions to prepare and ship the inventory are felt to represent the earning activity, revenue is recognized at the time of sale In theory, the possibility of return should be evaluated and recorded as a reduction of revenue if some return is probable and the value of the return can be estimated Similarly, the probability of a customer’s taking a cash discount should be considered and a reduction made to revenue for estimated cash discounts In practice, both sales returns and cash discounts are usually not recorded until they actually occur.

(e) This is a difficult one As discussed in Chapter 8, under the provisions

of SAB No 101 the SEC generally does not allow the recognition of

revenue until title transfers In such a case, the receipt of the 15% down payment would be recorded as a debit to cash and a credit to a liability such as Deposit Liability.

(f) The initial agreement does not represent a claim against the client until the contract is at least partially complete Because part of the work was accomplished in 2005, a portion of the revenue could be recognized in

2005 on a percentage basis However, because the bulk of the work will

be done in 2006, revenue could be deferred until the audit is completed and billed.

4–25.

(a) Immediate recognition The future benefits of the new drug are highly

uncertain.

(b) Direct matching The warranty costs are anticipated expenses that are

directly related to revenues.

(c) Systematic and rational allocation The lease agreement benefits

several accounting periods in a systematic and rational way.

(d) Direct matching Labor associated with assembling a product is

matched with revenues and reported in the period the goods are sold.

(e) Systematic and rational allocation The delivery trucks are expected to

benefit several accounting periods in a systematic and rational way.

(f) Immediate recognition The advertising indirectly helps to generate

revenues and is not related to specific revenues.

Original cost of patent $450,000 Amortization for 5 years ($30,000 per year 2000–2004) 150,000 Remaining unamortized balance $ 300,000 New estimated life from January 1, 2005 4 years Amortization expense for each year (2005–2008) $75,000 Separate disclosure of the $45,000 increase due to the change in estimate would be required in 2005 if it is considered a material amount.

4–27.

(a) Subtracted or included in determining net purchases in the Cost of Goods Sold section

(b) Other revenues and gains

(c) Other revenues and gains

(d) Other expenses and losses

(e) Either extraordinary items or other expenses and losses depending on whether unusual and infrequent

(f) Operating expenses—selling expenses

(g) Discontinued operations

(h) Deduction from income from continuing operations before income taxes

(i) Other revenues and gains

(j) Subtraction from sales

(k) Other expenses and losses

(l) Cost of goods sold (an item entering into cost of goods manufactured) (m) Cumulative effect of change in accounting principle

(n) Operating expenses—general and administrative

(o) Cost of goods sold

Caribou Inc.

Income Statement For the Year Ended December 31, 2005 Sales $1,600,000 (a) Cost of goods sold:

Beginning inventory $ 136,000

Net purchases 919,200 (b)

Cost of goods available for sale $1,055,200

Less: Ending inventory 95,200

Cost of goods sold 960,000 Gross profit on sales $ 640,000 Operating expenses:

Selling expenses $ 208,000 (c)

General expenses (including bad debts) 272,000 (d) 480,000

Income before income taxes and extraordinary items $ 160,000 Income taxes 48,000 Income before extraordinary items $ 112,000 Extraordinary gain (net of income taxes of $9,000) 21,000 Net income $ 133,000 Earnings per share (e): Income before extraordinary items $0.86 Extraordinary gain 0.16 Net income $ 1.02 COMPUTATIONS: (a) Sales Income before income taxes as a percentage of sales: Sales 100%

Cost of goods sold (see below) 60

Gross profit on sales 40%

Selling expenses 13%

General expenses, including bad debts 17 30

Income before income taxes 10% Sales: $160,000 (income before income taxes) ÷ 0.10 = $1,600,000 Cost of goods sold:

General expenses, excluding bad debts = 15% of sales and 25% of cost of sales: therefore, 0.15  sales = 0.25  Cost of goods sold Cost of goods sold = 0.15 ÷ 0.25 = 0.60 of sales

(d) (0.15  $1,600,000) + (0.02  $1,600,000) = $272,000

(e) Earnings per share (130,000 shares of common stock outstanding): Income before extraordinary gain: $112,000 ÷ 130,000 shares = $0.86 Extraordinary gain: $21,000 ÷ 130,000 shares = $0.16

Net income: $133,000 ÷ 130,000 shares = $1.02 4–29.

Brigham Corporation Income Statement (Partial) For the Year Ended December 31, 2005 Income from continuing operations before income taxes $ 210,000 Income tax expense on continuing operations ($210,000  0.35) 73,500 Income from continuing operations $ 136,500 Discontinued operations:

Loss from operations of discontinued business

component (including gain on disposal of $20,000) $ (30,000)

Net income tax benefit 10,500 (19,500) Extraordinary gain (net of income taxes of $49,000) 91,000 Net income $ 208,000 4–30.

(a) Discontinued operations:

Loss from operations of discontinued business component (including gain on disposal of

$15,000) $(115,000) Income tax benefit 34,500 $ (80,500) (b) If Garrison Manufacturing were reporting using the accounting standards of the United Kingdom, it would also disclose information about sales and operating profits for the continuing and discontinued operations This additional information allows financial statement users

to compare the relative size and operating profitability of the continuing and discontinued operations This practice is also similar to the

reporting requirements of IFRS 35.

4–31.

2005 2004 2003

Discontinued operations:

Income (loss) from operations

(including gain on disposal

(net of applicable taxes) 544 2 Net income $ 1,576 5 Earnings per common share:

Income from continuing operations $ 2.06 Cumulative effect of accounting change 1.09 Net income $ 3.15

(b) If Sears were a non-U.S company reporting under the provisions of IFRS 8, the

$544.2 million “gain” from the cumulative effect of the change in accounting principle would not be shown in the income statement at all Instead, the $544.2 million amount would be shown as a direct adjustment (an increase) to the beginning balance in retained earnings for the year.

4–33.

(a) Sales revenue.

(b) Loss on disposal of discontinued operations; a separate component of income shown net of taxes before extraordinary items but after income from continuing operations.

(c) Extraordinary item, net of taxes.

4–33 (Concluded)

(d) Prior-period adjustment (error correction); retained earnings adjustment

(e) Operating expense (or reduction in revenue)—it is a change in estimate

(f) Asset

(g) Results of discontinued operations: a separate component of income shown net

of taxes before extraordinary items but after income from continuing operations

(h) Asset (possibly could be expensed)

(i) Prior-period adjustment (error correction); retained earnings adjustment

(j) Other Revenues and Gains section of income statement

(k) Other Expenses and Losses section of income statement unless the event is considered unusual and infrequent, in which case it would be reported as an extraordinary item

(l) Cumulative effect of change in accounting principle; a separate component of income shown net of taxes as last item before net income

(m) Operating expense; it is a change in estimate

(n) Other Revenues and Gains section of income statement

(o) Operating Expense or Other Expenses and Losses section, depending on nature of business unless the event is considered unusual and infrequent, in which case, it would be reported as an extraordinary item

(p) Operating expense or adjustment to cost of goods sold

(q) Included with current-year tax expense

(r) Other Expenses and Losses section because the sale is only a portion of business segment

(s) Operating expense because the move does not qualify as discontinued operations

(t) Operating expense

Income StatementRevenue:

Sales

Less: Sales discounts

Sales returns and allowances Cost of goods sold:

Inventory—beginning

Net purchases:

Purchases Less: Purchase discounts

Purchase returns and allowances Freight-in

Cost of goods available for sale

Officers’ salaries expense Office salaries expense Office supplies expense Depreciation expense—office building Depreciation expense—office furniture and fixtures Bad debt expense

Insurance expense Property taxes expense Miscellaneous general expense Operating income

Other revenues and gains:

Income from continuing operations before income taxes

Income tax expense

Income from continuing operations

Loss from discontinued operations (net of income taxes of _ ) Extraordinary gain (net of income taxes of _ )

Net income

Earnings per common share:

Income from continuing operations

Loss from discontinued operations

For the Year Ended December 31, 2005 Sales revenue $1,380,000 Expenses:

Costs of goods sold $765,000

The Pensacola Awning Company Statement of Retained Earnings For the Year Ended December 31, 2005 Retained earnings, January 1 $444,500 Add: Net income 45,894

$ 490,394

Deduct: Dividends 45,000 Retained earnings, December 31 $

Gain on sale of land 18,350 Interest revenue 4,500 25,650

$39,330 Less: Increased depreciation—change in estimate $ 5,000

Loss on sale of equipment 3,860 Extraordinary casualty loss 27,730 36,590 Corrected net income $ 2,740

4–36 (Concluded)

2.

Losser Corporation Retained Earnings Statement For the Year Ended December 31, 2005 Retained earnings, January 1, 2005 $

85,949 Add: Net income 2,740

$88,689 Deduct: Dividends declared 10,000 Retained earnings, December 31, 2005 $ 78,689

3 All items except dividends declared during the year would be reported on the

income statement and included in net income Extraordinary items would be reported separately after income from continuing operations.

4–37.

1 The unrealized losses on available-for-sale securities will decrease

comprehensive income because the value of the securities decreased during the year The foreign currency translation adjustment will decrease comprehensive income because the value of the currencies of Svedin’s foreign subsidiaries weakened relative to the U.S dollar The minimum pension liability adjustment will decrease comprehensive income.

Statement of Comprehensive Income For the Year Ended December 31, 2005 Net income $17,650

Unrealized losses on available for sale securities (1,285)

Foreign currency translation adjustment (287)

Minimum pension liability adjustment (315)

Comprehensive income $ 15,763

Cost of goods sold 700 770 35% of sales,

as last year Gross profit $1,300 $1,430

Depreciation expense 120 160 20% of PPE,

same as last year Other operating expenses 1,010 1,111 50.5% of sales,

same as last year Operating profit $ 170 $ 159

Interest expense 90 75 15% of bank loan,

same as last year Income before taxes $ 80 $ 84

Income taxes 30 32 37.5% of pretax,

same as last year Net income $ 50 $ 52

4-39.

Ryan Company Forecasted Balance Sheet December 31, 2006

2006

2005 Forecasted Cash $ 10 $ 15 50% natural increase Other current assets 250 375 50% natural increase Property, plant, and equipment,

net 800 800 more efficient, item (b) Total assets $ 1,060 $ 1,190

Accounts payable $ 100 $ 150 50% natural increase Bank loans payable 700 900 new loan of $200,

item (c) Total stockholders’ equity 260 140 to balance

Total liabilities and

stockholders’ equities $ 1,060 $ 1,190

4-39 (Concluded)

Ryan Company Forecasted Income Statement For the Year Ended December 31, 2006

2006

2005 Forecasted Sales $1,000 $1,500 given, item (a)

Cost of goods sold 750 1,125 75% of sales,

same as last year Gross profit $ 250 $ 375

Depreciation expense 40 40 5% of PPE,

same as last year Other operating expenses 80 120 8% of sales,

same as last year Operating profit $ 130 $ 215

Interest expense 70 90 10% of bank loan,

same as last year Income before taxes $ 60 $ 125

Income taxes 20 42 33.3% of pretax,

same as last year Net income $ 40 $ 83

Note: Total stockholders’ equity is forecasted to decrease by $120 ($260  $140) This will happen even though net income will cause stockholders’ equity to increase by

$83 These forecasts imply that Ryan Company is either planning to pay out a large cash dividend or to buy back a large amount of shares of its own stock.

4–40.

Payette Co.

Income Statement For the Year Ended June 30, 2005 Revenue:

Sales ($2,380,000 less returns and

allowances, $30,000) $2,350,000 Interest revenue 52,000

$2,402,000 Expenses:

Cost of goods sold (net purchases,

$1,473,000 less increase in inventory, $10,000) $1,463,000 Selling and general expenses 238,000

Income taxes 262,800 1,963,800 Net income $ 438,200 Earnings per common share

($438,200 ÷ 325,000 shares) $ 1.35

Payette Co.

Retained Earnings Statement For the Year Ended June 30, 2005 Retained earnings, July 1, 2004 $1,356,800 Add: Net income 438,200

$1,795,000 Deduct: Dividends 260,000 Retained earnings, June 30, 2005 $ 1,535,000

1 Income statement–time of shipment:

Richmond Company Income Statement For the Years Ended December 31

2006 2005 Sales $150,000 $125,000 Cost of goods sold 90,000 75,000 Gross profit $ 60,000 $ 50,000 Bad debt expense (7,500) (6,250) Selling expenses (15,000) (25,000) General and administrative expenses (22,000) (22,000) Net income (loss) $ 15,500 $ (3,250) Income statement—time of sale:

Richmond Company Income Statement For the Years Ended December 31

2006 2005 Sales $132,000 $ 84,000 Cost of goods sold 66,000 42,000 Gross profit $ 66,000 $ 42,000 Bad debt expense (660) (420) Selling expenses (15,000) (25,000) General and administrative expenses (22,000) (22,000) Net income (loss) $ 28,340 (5,420) $

2 Under the first dealer agreement, revenue is recognized when goods are shipped to the dealers The dealer makes payment after receipt of the goods Possible bad debt losses are greater under this agreement because the dealer may not have the cash to pay for the toys until they are sold The second type of dealer agreement is actually a consignment of inventory Because there is a right of return, the revenue should not be recognized until the dealer makes a sale The risk

is borne by Richmond To cover this risk, the sales price is higher for the toys.

In the problem, Richmond would have a larger loss in 2005 under the consignment agreement than under the sale agreement; however, in

2006 the consignment agreement would produce a greater profit In addition, at the end of 2006 Richmond will still have 19,000 units out on consignment, assuming that none of the units have been returned, with

a potential profit of $3 per unit less bad debt costs Of course, if these 19,000 units are returned and cannot be resold, this profit will not be realized The uncertainty of the second type of dealer agreement justifies the delay of revenue recognition until the dealer makes a sale.

1 (a) Revenue must be both earned and realized in order to be reported on

the income statement Until Hadley ships the inventory, the $18,000 of orders paid for in advance should not be reported on the income statement.

(b) Because customers are not returning the products, the earnings process can be considered substantially complete when the sale is made The revenues and associated cost of goods sold should be included on the income statement.

(c) The rent will benefit several accounting periods and should be allocated

in a systematic fashion.

(d) It is difficult to determine the period of time that is benefited by general advertising Because the advertising costs cannot be related to specific revenues, the costs are typically recognized as expenses immediately (e) Current cost information is currently not disclosed on the face of the income statement Some companies elect to provide supplemental information of this nature in the notes to the financial statements.

(f) If warranty costs can be reasonably estimated, the expenses are matched directly to the period in which the revenue is generated Using the actual costs incurred to approximate warranty expense violates the matching principle.

2 Sales $183,000

Cost of goods sold 101,500 Gross profit $ 81,500 Rent expense (12,000) Advertising expense (24,000) Warranty expense (9,150) Other expenses (15,000) Net income $ 21,350 Sales: $185,000 – $18,000 + $16,000 = $183,000

Cost of goods sold: $94,000 + $7,500 = $101,500

Rent expense: $18,000 – $6,000 = $12,000

Advertising expense: $6,000 + $18,000 = $24,000

Warranty expense: $183,000  0.05 = $9,150

Delaney Manufacturing Inc.

Income Statement (Partial) For the Fiscal Year Ended July 31, 2005 Income from continuing operations before income taxes $1,014,000 (a) Incomes taxes 304,200 (b) Income from continuing operations $ 709,800 Extraordinary gain (net of income taxes of $30,300) 70,700 (c) Loss from disposal of a business component (net of income tax

savings of $42,000) (98,000)(d) Net income $ 682,500 COMPUTATIONS:

(a) $975,000 – $101,000 + $140,000 = $1,014,000

(b) $1,014,000  0.30 = $304,200

(c) $101,000  0.30 = $30,300; $101,000 – $30,300 = $70,700

(d) $140,000  0.30 = $42,000; $140,000 – $42,000 = $98,000

Delaney Manufacturing Inc.

Retained Earnings Statement For the Fiscal Year Ended July 31, 2005 Retained earnings, August 1, 2004 $2,750,000 Less: Prior-period adjustment (net of income tax savings of $22,500) 52,500(a) Adjusted retained earnings, August 1, 2004 $2,697,500 Add: Net income 682,500 Retained earnings, July 31, 2005 $ 3,380,000 (a) $75,000  0.30 = $22,500; $75,000 – $22,500 = $52,500

Radiant Cosmetics Inc.

Income Statement (Partial) For the Year Ended December 31, 2005 Income from continuing operations before income taxes $ 210,000 Income taxes ($82,000 + $20,000 – $8,000 – $10,000) 84,000 Income from continuing operations $ 126,000 Discontinued operations:

Loss from operations of discontinued cosmetics

division (including loss on disposal of $50,000) $(32,000)

Income tax benefit (12,000) (20,000) Extraordinary gain (net of income taxes of $10,000) 15,000 Net income $ 121,000 Earnings per common share:

Income from continuing operations ($126,000 ÷ 35,000 shares) $ 3.60 Loss from discontinued operations ($20,000 ÷ 35,000 shares) (0.57) Extraordinary gain ($15,000 ÷ 35,000 shares) 0.43 Net income $ 3.46

Radiant Cosmetics Inc.

Retained Earnings Statement For the Year Ended December 31, 2005 Retained earnings, January 1, 2005 $620,000 Add: Correction of sales understatement in 2004

(net of income taxes of $21,000) 39,000

$659,000 Deduct correction for omission of depreciation of prior periods

(net of income tax refund claim of $8,000) 12,000 Adjusted retained earnings, January 1, 2005 $647,000 Add: Net income 121,000

$768,000 Deduct: Dividends 40,000 Retained earnings, December 31, 2005 $ 728,000

Discontinued operations:

Loss from operations of discontinued business component (including loss on disposal of $5,000) $ (94,900)

Income tax benefit (33,215)

$ (61,685) The expected operating loss and the expected disposal gain in 2006 are not reported

in the 2005 income statement Before the release of SFAS No 144 changed the

accounting for discontinued operations, these two expected items would have been used to compute an “expected loss on disposal.”

4–46.

(a) Gross profit percentage 48.0% 52.0% 54.0% (b) Net profit percentage 7.0% 9.3% 12.9% (c) Price-earnings ratio 13.7 18.1 20.9

2 While RoboCon’s sales are increasing every year, its gross margin is declining, resulting in a decreasing profit margin The market is apparently aware of this information and is pricing the stock accordingly Even though sales are increasing, the firm’s earnings multiple has declined each of the past 2 years.

Connell Company Multiple-Step Income Statement For the Year Ended December 31, 2005Revenue:

Sales $8,125,000

Less: Sales discounts $ 55,000

Sales returns and allowances 95,000 150,000 $

Cost of goods available for sale $5,505,500

Less: Inventory, December 31 (net of write-down) 750,000 4,755,500 Gross profit $

Depreciation expense—delivery trucks 29,000

Depreciation expense—store equipment 25,000

Miscellaneous selling expenses 50,000 $1,050,000

General and administrative expenses:

Officers’ and office salaries $ 550,000

Employee pension expense 190,000

Property taxes expense 100,000

Bad debt expense 32,000

Depreciation expense—office building 25,000

Depreciation expense—office equipment 10,000

Miscellaneous general expenses 45,000 952,000 2,002,000 Operating income $