Solution manual intermediate accounting 7th by nelson spiceland ch04

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 an

in shareholders’ equity

Question 4-3

Income 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 these items because they are the most important transactions in terms of predicting future cash flows

Question 4-4

Operating income includes revenues and expenses that are directly related to the principal revenue generating activities of the company Nonoperating income includes items that are not directly related to these activities

Question 4-5

The 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 The

multiple-step format reports a series (multiple) of intermediate totals such as gross profit, operating income, and income before taxes Very often income statements adopt variations of these formats, falling somewhere in between the two extremes

Question 4-6

The term earnings quality refers to the ability of reported earnings (income) to predict a company’s future earnings After all, an income statement simply reports on events that already have occurred The relevance of any historical-based financial statement hinges on its predictive value

Question 4-7

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

Chapter 4QUESTIONS FOR REVIEW OF KEY TOPICS

Answers to Questions (continued)

Question 4-8

The 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 continuing operations 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 and extraordinary items, and also to show the after-tax effect of each of those two components

Question 4-10 Extraordinary items are 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 4-11

Extraordinary gains and losses are presented, net of tax, in the income statement below discontinued operations, if any

Answers to Questions (continued)

Question 4-12

GAAP 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 company changes from one generally accepted treatment to another

In general, we report voluntary changes in accounting principles retrospectively This means revising 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 each account affected Specifically, we make those statements appear as if the newly adopted accounting method had been applied all along Also, if retained earnings is one of the accounts whose balance requires adjustment (and it usually is), we revise the beginning balance of retained earnings for the earliest period reported in the comparative statements of shareholders’ equity (or statements of retained earnings if they’re 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 the change, a disclosure note would describe the change and justify the new method as preferable It also would describe the effects of the change on all items affected, including the fact that the retained earnings balance was revised in the statement of shareholders’ equity

An exception is a change in depreciation, amortization, or depletion method These changes are accounted for as a change in estimate, rather than as a change in accounting principle Changes

in estimates are accounted for prospectively The remaining book value is depreciated, amortized, or depleted, using the new method, over the remaining useful life

Question 4-13 Earnings 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 discontinued operations and extraordinary items, EPS data must be reported separately for income from continuing operations and net income Per share amounts for discontinued operations and extraordinary items would be disclosed on the face of the income statement

Question 4-14

A 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 the change is preferable and describe the effect of a change on any financial statement line items and per share amounts affected for all periods reported

Answers to Questions (concluded)

Question 4-15

Prior period adjustments are accounted for by restating prior years’ financial statements when those statements are presented again for comparison purposes The beginning of period retained earnings is increased or decreased on the statement of shareholders’ equity (or the statement of retained earnings) in the year the error is discovered

The three categories of cash flows reported on the statement of cash flows are:

1 Operating activities — Inflows and outflows of cash related to the transactions entering into the determination of net income from operations

2 Investing activities — Involve the acquisition and sale of (1) long-term assets used in the business and (2) nonoperating investment assets

3 Financing activities — 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 equity securities (a financing activity) These activities are reported either in a separate schedule or in a note

Question 4-19

The 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 reporting cash flows from operating activities is derived indirectly, by starting with reported net income and adding and subtracting items to convert that amount to a cash basis

Brief Exercise 4-1

Net income $650,000 Other 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

BRIEF EXERCISES

Brief Exercise 4-2

PACIFIC SCIENTIFIC CORPORATION

Income Statement

For the Year Ended December 31, 2006

($ in millions) Revenues and gains: Sales $2,106 Gain on sale of investments 45

Total revenues and gains 2,151 Expenses and losses: Cost of goods sold $1,240 Selling 126

General and administrative 105

Interest 35

Income 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 4-3 (a) Sales revenue $2,106 Less: Cost of goods sold (1,240) Gross profit 866 Less: Selling expenses (126) General and administrative expenses (105)

Brief Exercise 4-4

PACIFIC SCIENTIFIC CORPORATION

Income Statement For the Year Ended December 31, 2006 ($ in millions)

Sales revenue $2,106 Cost of goods sold 1,240

Gross profit 866

Operating expenses: Selling $126

General and administrative 105

Total operating expenses 231

Operating income 635

Other income (expense):

Gain on sale of investments 45

Interest expense (35)

Total other income, net 10

Income before income taxes 645

Income tax expense* 258

Net income $ 387

*$645 x 40%

Brief Exercise 4-5

General and administrative expenses (40,000)

Deduct: Loss on sale of investments (22,000) Income before income taxes and

Extraordinary item:

Loss from flood damage, net of $20,000

Brief Exercise 4-6

WHITE AND SONS, INC

Partial Income Statement For the Year Ended December 31, 2006

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

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

Earnings per share:

Income before extraordinary item $ 5.10 Loss from earthquake (2.40) Net income $ 2.70

*$850,000 x 40%

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

Brief Exercise 4-7

CALIFORNIA MICROTECH CORPORATION

Partial Income Statement For the Year Ended December 31, 2006 Income from continuing operations before income taxes $ 5,800,000 Income tax expense* 1,740,000 Income from continuing operations $ 4,060,000 Discontinued operations:

(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)

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

Brief Exercise 4-8

CALIFORNIA MICROTECH CORPORATION

Partial Income Statement For the Year Ended December 31, 2006 Income from continuing operations before income taxes $ 5,800,000 Income tax expense* 1,740,000 Income from continuing operations $ 4,060,000 Discontinued operations:

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

Brief Exercise 4-9

CALIFORNIA MICROTECH CORPORATION

Partial Income Statement For the Year Ended December 31, 2006 Income from continuing operations before income taxes $ 5,800,000 Income tax expense* 1,740,000 Income from continuing operations $ 4,060,000 Discontinued operations:

(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

Brief Exercise 4-10

The change in inventory method is a change in accounting principle The depreciation 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 method change, however, is accounted for by retrospectively recasting prior years’ financial statements presented with the current year for comparative purposes, applying the new inventory 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 for the change in estimate is quite straightforward We do not restate prior years' financial statements to reflect the new estimate Instead, we merely incorporate the new estimate in any related accounting determinations from there on If the after-tax income effect of the change in estimate is material, the effect on net income and earnings per share must be disclosed in a note, along with the justification for the change Depreciation for 2006 is $25,000:

$300,000 Cost $ 50,000 Old annual depreciation ($300,000 ÷ 6 years)

x 2 years 100,000 Depreciation to date (2004-2005)

200,000 Book value _ ÷ 8 yrs Estimated remaining life(10 years - 2 years) $ 25,000 New annual depreciation

Brief Exercise 4-12

Cash Flows from Operating Activities:

Only these four cash flow transactions relate to operating activities The others are investing and financing activities

Brief Exercise 4-13

Cash Flows from Investing Activities:

Net cash flows from investing activities $(80,000)

Cash Flows from Financing Activities:

Proceeds from note payable collection $100,000

Net cash flows from financing activities 270,000

Net cash inflows from operating activities $92,000

Exercise 4-1

Requirement 1

Statement of Income and Comprehensive Income (in part)

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

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

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

Requirement 2

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

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

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

EXERCISES

Exercise 4-2

Requirement 1

Revenues and gains:

Sales $1,300,000 Interest 30,000 Gain on sale of equipment 50,000 Total revenues and gains 1,380,000

Expenses and losses:

Cost of goods sold $720,000 Salaries 160,000 Depreciation 50,000 Interest 40,000 Rent 25,000 Income tax 130,000 Total expenses and losses 1,125,000 Net income $ 255,000 Earnings per share $2.55

Exercise 4-2 (concluded)

Requirement 2

GREEN STAR CORPORATION

Income Statement For the Year Ended December 31, 2006

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

Operating expenses:

Salaries $160,000 Depreciation 50,000 Rent 25,000 Total operating expenses 235,000 Operating income 345,000

Interest revenue 30,000 Gain on sale of equipment 50,000 Interest expense (40,000) Total other income, net 40,000 Income before income taxes 385,000 Income tax expense 130,000 Net income $ 255,000 Earnings per share $2.55

Exercise 4-3

Requirement 1

GENERAL LIGHTING CORPORATION

Income Statement For the Year Ended December 31, 2006

Revenues and gains:

Sales $2,350,000 Rental revenue 80,000 Total revenues and gains 2,430,000

Expenses and losses:

Cost of goods sold $1,200,300 Salaries 300,000 Depreciation 100,000 Interest 90,000 Rent 50,000 Loss on sale of equipment 22,500 Loss from inventory write-down 200,000 Income tax expense * 186,880 Total expenses and losses 2,149,680 Income before extraordinary item

Earnings per share:

Income before extraordinary item

Extraordinary loss

Net income

$ 93 (.24) $ 69

* 40% x $467,200

Exercise 4-3 (concluded)

Requirement 2

GENERAL LIGHTING CORPORATION

Income Statement For the Year Ended December 31, 2006 Sales revenue $2,350,000 Cost of goods sold 1,200,300 Gross profit 1,149,700

Operating expenses:

Salaries $300,000 Depreciation 100,000 Rent 50,000 Loss from inventory write-down 200,000 Total operating expenses 650,000 Operating income 499,700

Other income (expense):

Rental revenue 80,000 Loss on sale of equipment (22,500) Interest expense (90,000) Total other income (expense), net (32,500) Income before taxes and extraordinary item 467,200 Income tax expense * 186,880 Income before extraordinary item

Earnings per share:

Income before extraordinary item

Extraordinary loss

Net income

$ 93 (.24) $ 69

* 40% x $467,200

Exercise 4-4

Statement of Income and Comprehensive Income For the Year Ended December 31, 2006 Sales revenue $2,300,000 Cost of goods sold 1,400,000 Gross profit 900,000

Extraordinary item:

Gain on early debt extinguishment (net of $120,000 tax expense)

Net income Other comprehensive income:

Unrealized holding gains on investment securities, net of tax

Comprehensive income

308,000

280,000 588,000

56,000

$644,000

Earnings per share:

Income before extraordinary item

Extraordinary gain

Net income

$ 0.31 0.28 $ 0.59

* 30% x $440,000

Operating expenses:

Selling $67,000 Administrative 87,000 Restructuring costs 55,000 Total operating expenses 209,000 Operating income 58,000

Other income (expense):

Interest and dividends 32,000 Interest expense

Total other income, net

(26,000)

6,000 Income before income taxes and extraordinary item 64,000 Income tax expense* 25,600 Income before extraordinary item

Earnings per share:

Income before extraordinary item

Extraordinary gain

Net income

$ 38 52 $0.90

* 40% x $64,000

(including loss on disposal of $400,000)* (530,000) Income tax benefit 212,000

Loss on discontinued operations (318,000) Net income $ 32,000

Earnings per share:

Income from continuing operations $ 3.50 Loss from discontinued operations (3.18) Net income $ .32

* Loss on discontinued operations:

Total before-tax loss (530,000) Less: Income tax benefit (40%) 212,000

Exercise 4-7

ESQUIRE COMIC BOOK COMPANY

Partial Income Statement For the Year Ended December 31, 2006 Income from continuing operations * $ 552,000

Discontinued operations:

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

Income on discontinued operations 90,000 Net income 642,000

* Income from continuing operations:

Income before considering additional items $1,000,000 Decrease in income due to restructuring costs (80,000) Before-tax income from continuing operations 920,000

Exercise 4-8

Requirement 1

KANDON ENTERPRISES, INC

Partial Income Statement For the Year Ended December 31, 2006 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 76,000 Loss on discontinued operations (114,000) Net income $ 286,000

* Loss on discontinued operations:

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

Requirement 2

KANDON ENTERPRISES, INC

Partial Income Statement For the Year Ended December 31, 2006 Income from continuing operations $ 400,000 Discontinued operations:

Loss from operations of discontinued component * (140,000) Income tax benefit 56,000 Loss on discontinued operations (84,000) Net income $ 316,000

Exercise 4-9

Pretax income from continuing operations $14,000,000

$1,200,000 ÷ 60%* = $2,000,000 = before tax loss from discontinued operations

*1-tax rate of 40% = 60%

Add: Net loss from discontinued operations 2,000,000

Requirement 3

$800,000 Cost $160,000 Old annual depreciation ($800,000 ÷ 5 years)

x 2 years 320,000 Depreciation to date (2004-2005)

480,000 Book value _ ÷ 6 yrs Estimated remaining life(8 years - 2 years) $ 80,000 New annual depreciation

Exercise 4-11

Requirement 1

In general, we report voluntary changes in accounting principles retrospectively However, a change in depreciation method is considered a change in accounting estimate resulting from a change in accounting principle In other words, a change in the depreciation method reflects a change in the (a) estimated future benefits from the asset, (b) the pattern of receiving those benefits, or (c) the company’s knowledge about those benefits, and therefore the two events should be reported the same way Accordingly, Canliss reports the change prospectively; previous financial statements are not revised Instead, the company simply employs the straight-line method from now on The undepreciated cost remaining at the time of the change would be depreciated using the straight-line method over the remaining useful life A disclosure note should justify that the change is preferable and describe the effect of the change

on any financial statement line items and per share amounts affected for all periods reported

Requirement 2

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

2006 straight-line depreciation: $288,000 ÷ 3 years = $96,000

Earnings per share:

1 d

2 d

Exercise 4-14

1 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

Exercise 4-15

Bluebonnet Bakers

Statement of Cash Flows For the Year Ended December 31, 2006

Cash flows from operating activities:

Interest on note receivable 6,000

Net cash flows from operating activities $131,000

Cash flows from investing activities:

Collection of note receivable 50,000

Net cash flows from investing activities (5,000)

Cash flows from financing activities:

Net cash flows from financing activities 55,000

Cash flows from operating activities:

Collections from customers $ 55,000

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)

Cash flows from investing activities:

Net cash flows from investing activities (10,000)

Cash flows from financing activities:

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

Cash and cash equivalents, March 1 40,000 Cash and cash equivalents, March 31 $ 304,000

Noncash investing and financing activities:

Acquired $40,000 of equipment by paying cash and issuing a note as follows:

Exercise 4-17

1 c

2 d

3 b