Chap 004

Text

Chapter 4 The Income Statement, Comprehensive Income, and the Statement of Cash Flows AACSB assurance of learning standards in accounting and business education require documentation of outcomes assessment. Although schools, departments, and faculty may approach assessment and its documentation differently, one approach is to provide specific questions on exams that become the basis for assessment. To aid faculty in this endeavor, we have labeled each question, exercise, and problem in Intermediate Accounting, 7e, with the following AACSB learning skills:

Questions AACSB TagsBrief ExerciseAACSB Tags

41Reflective thinking414Reflective thinking, Commun.

42Reflective thinkingExercises

43Reflective thinking41Analytic








411Reflective thinking, Commun.49Reflective thinking


413Reflective thinking411Reflective thinking


415Reflective thinking413Diversity, Analytic







Brief Exercises420Communications

41Analytic421Communications

42Analytic422Reflective thinking

43AnalyticCPA/CMA


45Analytic2Analytic

46Analytic3Analytic

47Analytic4Analytic






413Analytic

CPA/CMAAACSB Tags

2Reflective thinking

3Reflective thinking

Problems

41Analytic

42Analytic, Reflective thinking

43Analytic, Reflective thinking

45Analytic

46Analytic

47Analytic

48Analytic

49Analytic

410Analytic

411Analytic

Questions for Review of Key Topics

Question 41

The income statement is a change statement that reports transactionsrevenues, expenses, gains, and lossesthat cause owners equity to change during a specified reporting period.

Question 42

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 43

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

Question 44

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 45

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

Question 46

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.

Question 47

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 itemsdiscontinued operations and extraordinary itemsand also to show the after-tax effect of each of those two components.

Answers to Questions (continued)Question 48

The net-of-tax income effects of a discontinued operation must be disclosed separately in the income statement, below income from continuing operations. The income effects include income (loss) from operations and gain (loss) on disposal. The gain or loss on disposal must be disclosed either on the face of the statement or in a disclosure note. If the component is held for sale but not sold by the end of the reporting period, the income effects will include income (loss) from operations and an impairment loss if the fair value less costs to sell is less than the book value of the components assets. The income (loss) from operations of the component is reported separately in discontinued operations on prior income statements presented for comparative purposes.

Question 49

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 410

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


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 theyre presented instead). Then we create a journal entry to adjust all account balances affected as of the date of the change. In the first set of financial statements after 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 along with the cumulative effect of the change in retained earnings.

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 412

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

Question 413

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) as of the beginning of the earliest period presented.


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 415

Comprehensive income is the total change in equity for a reporting period other than from transactions with owners. Reporting comprehensive income can be accomplished with a continuous statement of comprehensive income that includes an income statement and other comprehensive income items or in two statements, an income statement and a separate statement of comprehensive income.

Question 416

The purpose of the statement of cash flows is to provide information about the cash receipts and cash disbursements of an enterprise during a period. Similar to the income statement, it is a change statement, summarizing the transactions that caused cash to change during a particular period of time.

Question 417

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

1. Operating activitiesInflows and outflows of cash related to the transactions entering into the determination of net income from operations.

2. Investing activitiesInvolve the acquisition and sale of (1) long-term assets used in the business and (2) nonoperating investment assets.

3. Financing activitiesInvolve cash inflows and outflows from transactions with creditors and owners.

Question 418

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 on the face of the statement of cash flows or in a disclosure note.

Question 419

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.

Answers to Questions (concluded)Question 420

There are two possible separately reported items that could appear in income statements, discontinued operations and extraordinary items. International Financial Reporting Standards (IFRS) prohibit reporting extraordinary items.

Question 421

U.S. GAAP designates cash outflows for interest payments and cash inflows from interest and dividends received as operating cash flows. Dividends paid to shareholders are classified as financing cash flows. IFRS allows more flexibility. Companies can report interest and dividends paid as either operating or financing cash flows and interest and dividends received as either operating or investing cash flows. Interest and dividend payments usually are reported as financing activities. Interest and dividends received normally are classified as investing activities.brief exerciSes

Brief Exercise 41

PACIFIC SCIENTIFIC CORPORATION

Income Statement

For the Year Ended December 31, 2013

($ 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

Total expenses and losses

1,506

Income before income taxes

Income tax expense*

Net income

645

258

$ 387

* $645 x 40% = $258

Brief Exercise 42

(a) Sales revenue$2,106

Less: Cost of goods sold(1,240)

Gross profit866

Less: Selling expenses(126)

General and administrative expenses (105)

Operating income$ 635(b)Gain on sale of investments45

Interest expense(35)

Nonoperating income$10

Brief Exercise 43

PACIFIC SCIENTIFIC CORPORATION

Income Statement


($ in millions)

Sales revenue

$2,106

Cost of goods sold

1,240

Gross profit

866

Operating expenses:

Selling

$126


105

Total operating expenses

231

Operating income

635

Other income (expense):


45

Interest expense

(35)

Total other income, net

10


645

Income tax expense*

258

Net income

$ 387

*$645 x 40%

Brief Exercise 44

(a) Sales revenue$300,000

Less: Cost of goods sold(160,000)

General and administrative expenses(40,000)

Restructuring costs(50,000)

Selling expenses (25,000)

Operating income$ 25,000(b)Operating income$25,000

Add: Interest revenue4,000

Deduct: Loss on sale of investments(22,000)

Income before income taxes and7,000

Income tax expense (40%) (2,800)

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

Extraordinary item:

Loss from flood damage, net of $20,000

tax benefit(30,000)

Net loss(25,800)Brief Exercise 45

MEMORAX COMPANY

Partial Income Statement


Income before income taxes and extraordinary item

$ 790,000

Income tax expense*

316,000

Income before extraordinary item

474,000

Extraordinary item:

Loss from earthquake, net of $208,000 tax benefit

(312,000)

Net income

$ 162,000

*$790,000 x 40%

Brief Exercise 46

WHITE AND SONS, INC.




$ 850,000

Income tax expense*

340,000


510,000

Extraordinary item:

Loss from earthquake, net of $160,000 tax benefit

(240,000)

Net income

$ 270,000

Earnings per share:


$ 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 47

CALIFORNIA MICROTECH CORPORATION



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 operations of discontinued component

(including gain on disposal of $2,000,000)**

(1,600,000)

Income tax benefit

480,000

Loss on discontinued operations

(1,120,000)

Net income

$ 2,940,000

* $5,800,000 x 30%

** Loss from operations of discontinued component:

Gain on sale of assets$ 2,000,000 ($10 million less $8 million)

Loss from operations (3,600,000)

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

Brief Exercise 48





$ 5,800,000

Income tax expense*

1,740,000


$ 4,060,000


Loss from operations of discontinued component**

(3,600,000)

Income tax benefit

1,080,000


(2,520,000)

Net income

$ 1,540,000

* $5,800,000 x 30%

** Includes only the loss from operations. There is no impairment loss.

Brief Exercise 49





$ 5,800,000

Income tax expense*

1,740,000


$ 4,060,000



(including impairment loss of $1,000,000)**

(4,600,000)

Income tax benefit

1,380,000


(3,220,000)

Net income

$ 840,000

* $5,800,000 x 30%

** Loss from operations of discontinued component:

Impairment loss ($8 million book value less

$7 million net fair value)$(1,000,000)

Loss from operations (3,600,000)

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

Brief Exercise 410

OREILLY BEVERAGE COMPANY

Statement of Comprehensive Income


Net income

$650,000

Other comprehensive income (loss):

Deferred loss on derivatives, net of tax

$(36,000)

Unrealized gains on investment securities,

net of tax

24,000

Total other comprehensive loss

(12,000)

Comprehensive income

$638,000

Brief Exercise 411

Cash flows from operating activities:

Collections from customers $ 660,000

Interest on note receivable 12,000

Interest on note payable (18,000)

Payment of operating expenses (440,000) Net cash flows from operating activities$214,000Only these four cash flow transactions relate to operating activities. The others are investing and financing activities.

Brief Exercise 412

Cash flows from investing activities:

Proceeds from note receivable collection$100,000

Sale of land 40,000

Purchase of equipment (120,000)

Net cash flows from investing activities

$20,000

Cash flows from financing activities:

Issuance of common stock $200,000

Payment of dividends (30,000) Net cash flows from financing activities 170,000

Brief Exercise 413


Net income $45,000

Adjustments for noncash effects:

Depreciation expense 80,000

Changes in operating assets and liabilities: Increase in prepaid rent(60,000)

Increase in salaries payable15,000

Increase in income taxes payable 12,000

Net cash inflows from operating activities

$92,000Brief Exercise 414

Under IFRS, interest received and interest paid usually are classified as investing and financing cash flows, respectively, not operating cash flows as with U.S. GAAP. The revised cash flow categories usually would appear as follows:


Collections from customers $ 660,000

Payment of operating expenses (440,000) Net cash flows from operating activities$220,000


Proceeds from note receivable collection$100,000

Sale of land 40,000

Interest on note receivable12,000

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

$32,000


Issuance of common stock $200,000

Payment of dividends (30,000)Interest on note payable(18,000) Net cash flows from financing activities 152,000

exercises

Exercise 41

Requirement 1

GREEN STAR CORPORATION

Income Statement


Revenues and gains:

Sales

$1,300,000

Interest

30,000


50,000


1,380,000


Cost of goods sold

$720,000

Selling

160,000


75,000

Interest

40,000


995,000


385,000

Income tax expense

130,000

Net income

Earnings per share

$ 255,000$2.55

Exercise 41 (concluded)Requirement 2

GREEN STAR CORPORATION

Income Statement


Sales revenue

$1,300,000

Cost of goods sold

720,000

Gross profit

580,000

Operating expenses:

Selling

$160,000


75,000


235,000

Operating income

345,000


Interest revenue

30,000


50,000

Interest expense

(40,000)


40,000


385,000

Income tax expense

130,000

Net income

$ 255,000

Earnings per share

$2.55

Exercise 42

Requirement 1

GENERAL LIGHTING CORPORATION

Income Statement


Revenues and gains:

Sales

$2,350,000

Rental revenue

80,000


2,430,000


Cost of goods sold

$1,200,300

Selling

300,000


150,000

Interest

90,000

Loss on sale of investments

22,500

Loss from inventory write-down

200,000


1,962,800

Income before income taxes and extraordinary

Item .

Income tax expense * .


Extraordinary item:

Loss from flood damage (net of $48,000 tax benefit) Net income

467,200

186,880

280,320

(72,000)$ 208,320

Earnings per share:Income before extraordinary item

Extraordinary loss

Net income

$ .93

(.24) $ .69

* 40% x $467,200

Exercise 42 (concluded)Requirement 2

GENERAL LIGHTING CORPORATION

Income Statement


Sales revenue

$2,350,000

Cost of goods sold

1,200,300

Gross profit

1,149,700

Operating expenses:

Selling

$300,000


150,000

Loss from inventory write-down

200,000


650,000

Operating income

499,700


Rental revenue

80,000

Loss on sale of investments

(22,500)

Interest expense

(90,000)

Total other income (expense), net

(32,500)


item

467,200

Income tax expense *

186,880


Extraordinary item:

Loss from flood damage (net of $48,000 tax benefit) Net income

280,320

(72,000)

$ 208,320


Extraordinary loss

Net income

$ .93

(.24) $ .69

* 40% x $467,200

Exercise 43

lindor CORPORATION



Sales revenue

$2,300,000

Cost of goods sold

1,400,000

Gross profit

900,000

Operating expenses:

Selling and administrative

420,000

Operating income

480,000


Interest expense

(40,000)


440,000

Income tax expense *

132,000


Extraordinary item:

Gain on litigation settlement (net of $120,000

tax expense)

Net income

Other comprehensive income:

Unrealized holding gains on investment securities,

net of tax


308,000

280,000588,000

56,000

$644,000

Earnings per share:


Extraordinary gain

Net income

$ 0.31

0.28

$ 0.59

* 30% x $440,000

Exercise 44

AXEL CORPORATION

Income Statement


Sales revenue

$ 592,000

Cost of goods sold

325,000

Gross profit

267,000

Operating expenses:

Selling

$67,000

Administrative

87,000

Restructuring costs

55,000


209,000

Operating income

58,000

Other income (expense):Interest and dividends

32,000

Interest expense


(26,000)

6,000


64,000

Income tax expense*

25,600


Extraordinary item:

Gain on litigation settlement (net of $34,400

tax expense)

Net income

38,400

51,600$ 90,000


Extraordinary gain

Net income

$ .38

.52

$0.90

* 40% x $64,000Exercise 45

CHANCE COMPANY




$ 350,000



(including loss on disposal of $400,000)*

(530,000)

Income tax benefit

212,000


(318,000)

Net income

$ 32,000

Earnings per share:


$ 3.50

Loss from discontinued operations

(3.18)

Net income

$ .32

* Loss on discontinued operations:

Loss on sale of assets$(400,000)

Loss from operations (130,000)

Total before-tax loss(530,000)

Less: Income tax benefit (40%)212,000

Net-of-tax loss$(318,000)

Exercise 46

ESQUIRE COMIC BOOK COMPANY



Income from continuing operations *

$ 552,000


Income from operations of discontinued component

(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

Income tax expense (40%) (368,000)

Income from continuing operations$ 552,000

Exercise 47

Requirement 1

KANDON ENTERPRISES, INC.




$ 400,000



(including impairment loss of $50,000) *

(190,000)

Income tax benefit

76,000


(114,000)

Net income

$ 286,000

* Loss on discontinued operations:

Loss from operations$(140,000)

Impairment loss ($250,000 200,000) (50,000)

Net before-tax loss(190,000)

Income tax benefit (40%) 76,000

Net after-tax loss on discontinued operations$(114,000)Requirement 2

KANDON ENTERPRISES, INC.




$ 400,000


Loss from operations of discontinued component *

(140,000)

Income tax benefit

56,000


(84,000)

Net income

$ 316,000

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

Exercise 48

Pretax income from continuing operations$14,000,000

Income tax expense(5,600,000)

Income from continuing operations8,400,000

Less: Net income7,200,000Loss from discontinued operations$1,200,000

$1,200,000 ( 60%* = $2,000,000 = Before-tax loss from discontinued

operations.

*1 tax rate of 40% = 60%

Pretax income of division$4,000,000

Add: Loss from discontinued operations2,000,000Impairment loss$6,000,000

Fair value of divisions assets$11,000,000

Add: Impairment loss 6,000,000Book value of divisions assets$17,000,000Exercise 49

Earnings per share:

Income from continuing operations$5.00

Loss from discontinued operations(1.60)

Extraordinary gain 2.20

Net income$5.60

Exercise 410

THE MASSOUD CONSULTING GROUP



Net income

$1,354,000


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


$1,466,000

Exercise 411

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 412

Bluebonnet Bakers

Statement of Cash Flows



Collections from customers$ 380,000

Interest on note receivable 6,000

Purchase of inventory (160,000)


Payment of salaries (90,000)

Net cash flows from operating activities$131,000


Collection of note receivable 50,000

Sale of investments 30,000



(5,000)


Proceeds from note payable 100,000

Payment of note payable (25,000)

Payment of dividends (20,000)

Net cash flows from financing activities

55,000

Net increase in cash

181,000

Cash and cash equivalents, January 1 17,000Cash and cash equivalents, December 31$ 198,000

Exercise 413

Cash collected for interest, considered an operating cash flow by U.S. GAAP, could be classified as either an operating cash flow or an investing cash flow according to International Accounting Standards.

Cash paid for interest, considered an operating cash flow by U.S. GAAP, could be classified as either an operating cash flow or a financing cash flow according to International Accounting Standards.

Cash paid for dividends, considered a financing cash flow by U.S. GAAP, could be classified as either an operating cash flow or a financing cash flow according to International Accounting Standards.

Accordingly, the statement of cash flows prepared according to IFRS could be the same as under U.S. GAAP (E412) or could be presented as follows:

BLUEBONNET BAKERS






Payment of salaries (90,000)




Collection of note receivable 50,000





1,000


Proceeds from note payable 100,000

Payment of note payable (25,000)



70,000


181,000

Cash and cash equivalents, January 1 17,000Cash and cash equivalents, December 31$ 198,000

Exercise 414


Net income$17,300


Depreciation expense7,800

Changes in operating assets and liabilities:

Increase in accounts receivable (4,000)

Decrease in inventory5,500

Decrease in prepaid insurance 1,200

Decrease in salaries payable(2,700)

Increase in interest payable 800

Net cash flows from operating activities$25,900Exercise 415

Requirement 1

FinancingInvestingOperating

1. $300,000

2.($(10,000)

3.

(4.

(5.

$ (5,000)

6.

(6,000)

7.

(70,000)

8.

55,000

9.

(

______________________________

$300,000$(10,000)$(26,000)= $264,000Exercise 415 (concluded)Requirement 2

WAINWRIGHT CORPORATION


For the Month Ended March 31, 2013



Payment of rent(5,000)

Payment of one-year insurance premium(6,000)

Payment to suppliers of merchandise for sale (70,000)

Net cash flows from operating activities

$ (26,000)


Purchase of equipment(10,000)


(10,000)


Issuance of common stock 300,000


300,000Net increase in cash

264,000

Cash and cash equivalents, March 1

40,000Cash and cash equivalents, March 31

$ 304,000Noncash investing and financing activities:

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

$40,000

Cash paid

10,000 Note issued

$30,000

Exercise 416


Net income$624,000


Depreciation and amortization expense87,000


Decrease in accounts receivable 22,000

Increase in inventories(9,200)

Increase in prepaid expenses (8,500)

Increase in salaries payable10,000

Decrease in income taxes payable (14,000)

Net cash flows from operating activities$711,300Exercise 417

Consistent with U.S. GAAP, international standards also require a statement of cash flows. Consistent with U.S. GAAP, cash flows are classified as operating, investing, or financing. However, the U.S. standard designates cash outflows for interest payments and cash inflows from interest and dividends received as operating cash flows. Dividends paid to shareholders are classified as financing cash flows.

IAS No. 7, on the other hand, allows more flexibility. Companies can report interest and dividends paid as either operating or financing cash flows and interest and dividends received as either operating or investing cash flows. Interest and dividend payments usually are reported as financing activities. Interest and dividends received normally are classified as investing activities.

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

BRONCO METALS






Payment of operating expenses (67,000)


$100,000



Dividends received from investments2,400

Collection of note receivable100,000



(47,600)


Payment of interest on note payable (8,000)

Proceeds from issuance of common stock200,000

Dividends paid (40,000)


152,000


204,400

Cash and cash equivalents, January 1 28,600 Cash and cash equivalents, December 31$233,000

Exercise 418

TIGER ENTERPRISES



($ in thousands)


Net income$ 900


Depreciation expense240


Decrease in accounts receivable 80

Increase in inventory(40)

Increase in prepaid insurance (30)

Decrease in accounts payable(60)

Decrease in administrative and other payables(100)

Increase in income taxes payable 50



Purchase of plant and equipment

(300)


Proceeds from issuance of common stock 100

Proceeds from note payable 200

Payment of dividends (1) (940)

Net cash flows from financing activities(640)


100

Cash, January 1 200Cash, December 31$ 300

(1)

Retained earnings, beginning$540

+ Net income

900

Dividends

x

x = $940Retained earnings, ending

$500

Exercise 419

The T-account analysis of the transactions related to operating cash flows is shown below. To derive the cash flows, the beginning and ending balances in the related assets and liabilities are inserted, together with the revenue and expense amounts from the income statements. In each balance sheet account, the remaining (plug) figure is the other half of the cash increases or decreases.

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

Exercise 419 (concluded)TIGER ENTERPRISES



($ in thousands)



Prepayment of insurance (130)

Payment to inventory suppliers (3,460)

Payment for administrative & other exp. (1,900)

Payment of income taxes (550)


$ 1,040

Exercise 420

Requirement 1

FASB ASC 260: Earnings per Share.

Requirement 2

The specific citation that describes the additional information for earnings per share that must be included in the notes to the financial statements is FASB ASC 26010501: Earnings per ShareOverallDisclosure.

Requirement 3

Disclosure of accounting policies shall identify and describe the accounting principles followed by the entity and the methods of applying those principles that materially affect the determination of financial position, cash flows, or results of operations. In general, the disclosure shall encompass important judgments as to appropriateness of principles relating to recognition of revenue and allocation of asset costs to current and future periods; in particular, it shall encompass those accounting principles and methods that involve any of the following:

a. A selection from existing acceptable alternatives

b. Principles and methods peculiar to the industry in which the entity operates, even if such principles and methods are predominantly followed in that industry

c. Unusual or innovative applications of GAAP.









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

a. The fair value measurements at the reporting date

b. The level within the fair value hierarchy in which the fair value measurements in their entirety fall, segregating fair value measurements using any of the following:

1. Quoted prices in active markets for identical assets or liabilities (Level 1)

2. Significant other observable inputs (Level 2)

3. Significant unobservable inputs (Level 3).

c. For fair value measurements using significant unobservable inputs (Level 3), a reconciliation of the beginning and ending balances, separately presenting changes during the period attributable to any of the following:

1. Total gains or losses for the period (realized and unrealized), segregating those gains or losses included in earnings (or changes in net assets), and a description of where those gains or losses included in earnings (or changes in net assets) are reported in the statement of income (or activities)

2. Purchases, sales, issuances, and settlements (net)

3. Transfers in and/or out of Level 3 (for example, transfers due to changes in the observability of significant inputs).

d. The amount of the total gains or losses for the period in (c)(1) included in earnings (or changes in net assets) that are attributable to the change in unrealized gains or losses relating to those assets and liabilities still held at the reporting date and a description of where those unrealized gains or losses are reported in the statement of income (or activities)

e. In annual periods only, the valuation technique(s) used to measure fair value and a discussion of changes in valuation techniques, if any, during the period.

f. The fair value measurements at the reporting date

a.A reconciliation of the numerators and the denominators of the basic and diluted per-share computations for income from continuing operations. The reconciliation includes the individual income and share amount effects of all securities that affect earnings per share (EPS). Example 2 (see paragraph 260105551) illustrates that disclosure. (See paragraph 26010453.) An entity is encouraged to refer to pertinent information about securities included in the EPS computations that is provided elsewhere in the financial statements as prescribed by Subtopic 505-10.

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

c.Securities (including those issuable pursuant to contingent stock agreements) that could potentially dilute basic EPS in the future that were not included in the computation of diluted EPS because to do so would have been antidilutive for the period(s) presented. Full disclosure of the terms and conditions of these securities is required even if a security is not included in diluted EPS in the current period.

For the latest period for which an income statement is presented, an entity must provide a description of any transaction that occurs after the end of the most recent period but before issuance of the financial statements that would have changed materially the number of common shares or potential common shares outstanding at the end of the period if the transaction had occurred before the end of the period. Examples of those transactions include the issuance or acquisition of common shares; the issuance of warrants, options, or convertible securities; the resolution of a contingency pursuant to a contingent stock agreement; and the conversion or exercise of potential common shares outstanding at the end of the period into common shares.

Exercise 421

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

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

FASB ASC 22520452: Income StatementExtraordinary and Unusual ItemsOther Presentation MattersCriteria for Presentation as Extraordinary.

Extraordinary items are events and transactions that are distinguished by their unusual nature and by the infrequency of their occurrence. Thus, both of the following criteria shall be met to classify an event or transaction as an extraordinary item:

a.Unusual nature. The underlying event or transaction should possess a high degree of abnormality and be of a type clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the entity, taking into account the environment in which the entity operates.

b.Infrequency of occurrence. The underlying event or transaction should be of a type that would not reasonably be expected to recur in the foreseeable future, taking into account the environment in which the entity operates.

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

FASB ASC 26010552: Earnings per ShareOverallImplementation Guidance and IllustrationComputing a Weighted Average.

The weighted-average number of shares is an arithmetical mean average of shares outstanding and assumed to be outstanding for EPS computations. The most precise average would be the sum of the shares determined on a daily basis divided by the number of days in the period. Less-precise averaging methods may be used, however, as long as they produce reasonable results. Methods that introduce artificial weighting, such as the Rule of 78 method, are not acceptable for computing a weighted-average number of shares for EPS computations.Exercise 421 (continued)3. The alternative formats permissible for reporting comprehensive income:

FASB ASC 22010451: Comprehensive IncomeOverallOther Presentation ItemsReporting Comprehensive Income.

1A. An entity reporting comprehensive income in a single continuous financial statement shall present its components in two sections, net income and other comprehensive income. If applicable, an entity shall present the following in that financial statement:

a.A total amount for net income together with the components that make up net income.

b.A total amount for other comprehensive income together with the components that make up other comprehensive income. As indicated in paragraph 22010153, an entity that has no items of other comprehensive income in any period presented is not required to report comprehensive income.

c.Total comprehensive income.

1B. An entity reporting comprehensive income in two separate but consecutive statements shall present the following:

a.Components of and the total for net income in the statement of net income

b.Components of and the total for other comprehensive income as well as a total for comprehensive income in the statement of other comprehensive income, which shall be presented immediately after the statement of net income. A reporting entity may begin the second statement with net income.

1C. An entity shall present, either in a single continuous statement of comprehensive income or in a statement of net income and statement of other comprehensive income, all items that meet the definition of comprehensive income for the period in which those items are recognized. Components included in other comprehensive income shall be classified based on their nature.

Exercise 421 (concluded)4. The classifications of cash flows required in the statement of cash flows:

FASB ASC 23010451: Statement of Cash FlowsOverallOther Presentation MattersForm and Content.

A statement of cash flows shall report the cash effects during a period of an entity's operations, its investing transactions, and its financing transactions.Exercise 422

List A List B

f 1.Intraperiod tax allocationa.Unusual, infrequent, and material gains

and losses.

g 2.Comprehensive incomeb.Starts with net income and works

backwards to convert to cash.

a 3.Extraordinary itemsc.Reports the cash effects of each operating

activity directly on the statement.

l 4.Operating incomed.Correction of a material error of a prior

period.

k 5.A discontinued operatione.Related to the external financing of the

company.

j 6.Earnings per sharef.Associates tax with income statement

item.

d 7.Prior period adjustment g.Total nonowner change in equity.

e 8.Financing activitiesh.Related to the transactions entering into

the determination of net income.

h 9.Operating activities (SCF)i.Related to the acquisition and disposition

of long-term assets.

i 10.Investing activitiesj.Required disclosure for publicly traded

corporation.

c 11.Direct methodk.A component of an entity.

b 12.Indirect methodl.Directly related to principal revenue-

generating activities.

cpa / cma rEVIEW qUESTIONS

CPA Exam Questions

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

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

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

Sales revenue$187,000

Interest revenue10,200

Gain on sale of equipment 4,700

Total$201,900

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

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

5.a. Dividends paid to shareholders is considered a financing cash flow, not an operating cash flow.

6.c. Issuing common stock for cash is considered a financing cash flow, not an investing cash flow.

7.b. IFRS prohibits reporting extraordinary items, and restructuring costs are not separately reported under both IFRS and U.S. GAAP. Both IFRS and U.S. GAAP report discontinued operations as a separate item, net of tax.

8.c. Interest paid can be classified as either an operating or financing cash flow.CMA Exam Questions

1. d. Discontinued operations and extraordinary gains and losses are shown separately in the income statement, below income from continuing operations. The cumulative effect of most voluntary changes in accounting principle is accounted for by retrospectively revising prior years financial statements.

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

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

problems

Problem 41

REED COMPANY

Comparative Income Statements

For the Years Ended December 31

2013 2012

Sales revenue [1]$4,000,000[6] $3,000,000

Cost of goods sold [2] 2,570,000[7] 1,680,000

Gross profit

1,430,000 1,320,000

Operating expenses:

Administrative [3] 750,000[8] 635,000

Selling [4] 340,000[9] 282,000

Loss from fire damage

50,000- -

Loss from write-down of obsolete inventory

35,000 - -


1,175,000 917,000

Operating income

255,000 403,000


Interest revenue

150,000140,000

Interest expense

(200,000) (200,000)

Total other expenses (net)

(50,000) (60,000)

Income from continuing operations before

income taxes and extraordinary item

205,000 343,000

Income tax expense

82,000 137,200


extraordinary item

123,000 205,800


Income (loss) from operations of discontinued

component (including loss on disposal of

$50,000 in 2013)

(10,000)110,000

Income tax benefit (expense)

4,000 (44,000)

Income (loss) on discontinued operations [5] (6,000) 66,000


117,000 271,800

Extraordinary item:

Loss from earthquake (net of $40,000 tax benefit)

(60,000) - -

Net income

$ 57,000 $ 271,800

Earnings per share:Income from continuing operations before

extraordinary item

$ .41$ .69

Discontinued operations

(.02) .22

Extraordinary loss

(.20) - -

Net income

$ .19 $ .91

Problem 41 (concluded)

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

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

[3] $800,000 50,000

[4] $360,000 20,000

[5] Loss in 2011:

Income from operations$ 40,000

Loss on sale of assets (50,000)

Loss before tax benefit(10,000)

Tax benefit (40% x $10,000) 4,000

Loss on discontinued operations, net of tax benefit$ (6,000)

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

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

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

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

Problem 42

Requirement 1

JACKSON HOLDING COMPANY

Comparative Income Statements (in part)

For the Years Ended December 31

20132012


income taxes [1]

$3,000,000$1,300,000

Income tax expense

1,200,000 520,000


1,800,000 780,000


Income (loss) from operations of discontinued

component (including gain on disposal of

$600,000 in 2011) [2]

200,000(300,000)

Income tax benefit (expense)

(80,000) 120,000

Income (loss) on discontinued operations

120,000 (180,000)

Net Income

$1,920,000$ 600,000

[1]Income from continuing operations before income taxes:

20132012

Unadjusted$2,600,000$1,000,000

Add: Loss from discontinued operations 400,000 300,000

Adjusted $3,000,000$1,300,000[2] Income from discontinued operations:

20132012

Loss from operations$(400,000)$(300,000)

Gain on disposal 600,000 -

Total$ 200,000$(300,000)


Requirement 2

The 2013 income from discontinued operations would include only the loss from operations of $400,000. Since no impairment loss is indicated ($5,000,000 4,400,000 = $600,000 anticipated gain), none is included. The anticipated gain on disposal is not recognized until it is realized, presumably in the following year.

Requirement 3

The 2013 income from discontinued operations would include the loss from operations of $400,000 as well as an impairment loss of $500,000 ($4,400,000 book value of assets less $3,900,000 fair value).

Problem 43

Requirement 1

MICRON CORPORATION




income taxes and extraordinary item

[1] $1,300,000

Income tax expense

390,000

Income from continuing operations before extraordinary item

910,000


Loss from operations of discontinued

component (including loss on disposal of

$300,000)

$(140,000)

Income tax benefit 42,000


[2] (98,000)


812,000

Extraordinary item:

Loss from earthquake

(net of $240,000 tax benefit)

(560,000)

Net Income

$ 252,000

[1]Income from continuing operations before taxes:

Unadjusted$1,200,000

Add: Gain from sale of factory 100,000

Adjusted$1,300,000

[2]Loss on discontinued operations:

Income from operations$ 160,000

Deduct: Loss on sale of assets (300,000)

Loss before tax(140,000)

Tax benefit (30% x $140,000) 42,000

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

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

Problem 44

1.Restructuring is an example of an event that is either unusual or infrequent, but not both. Restructuring costs should be included in income from continuing operations but reported as a separate income statement component. The item is reported gross, not net of tax as with extraordinary gains and losses.

2.The extraordinary gain should be presented, net of tax, in the income statement below income from continuing operations. Also, earnings per share for income from continuing operations and for the extraordinary item should be disclosed.

3.The correction of the error should be treated as a prior period adjustment to beginning retained earnings, not as an adjustment to current year's cost of goods sold. In addition, the 2012 financial statements should be restated to reflect the correction, and a disclosure note is required that communicates the impact of the error on 2012 income.

Problem 45

ALEXIAN SYSTEMS, INC.

Income Statement


($ in millions except per share date)

Net sales revenue

$425

Cost of goods sold

[1] 265

Gross profit

160

Operating expenses:


[2] $128

Restructuring costs

26


154

Operating income

6

Other income:

Interest revenue

3


6

Total other income

9


item

15

Income tax expense

[3] 6


Extraordinary gain (net of $48 tax expense)

Net income

9

[4] 72$ 81

Earnings per share:


Extraordinary gain

Net income

$ 0.45

3.60

$ 4.05

[1] $270 5 (prior period adjustment)

[2] $154 26 (restructuring costs)

[3] 40% x $15

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

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

Problem 46

rembrandt paint company

Income Statement


($ in thousands, except per share amounts)

Sales revenue

$18,000

Cost of goods sold

10,500

Gross profit

7,500

Operating expenses:


$2,500

Restructuring costs

800 3,300

Operating income

4,200

Interest income (expense), net

(150)


and extraordinary item

4,050

Income tax expense

1,215

Income from continuing operations before extraordinary

item

2,835



(including gain on disposal of $2,000)

400

Income tax expense

120


280


3,115

Extraordinary gain (net of $900 tax expense)

2,100

Net income

5,215

Earnings per share:


item

$ 5.67


.56

Extraordinary gain

4.20

Net income

$10.43

Problem 47

Requirement 1

SCHEMBRI MANUFACTURING CORPORATION



($ in 000s)

Sales revenue

$15,300

Cost of goods sold

6,200

Gross profit

9,100

Operating expenses:

Selling

$1,300

General and administrative 800

Restructuring costs 1,200


3,300

Operating income

5,800


Loss on sales of investments

$(220)

Interest expense

(180)

Interest revenue

85

Other income (expense)

(315)


and extraordinary item .5,485

Income tax expense

2,194

Income from continuing operations before extraordinary item

3,291



(including gain on disposal of $1,400)

840

Income tax expense

(336)

Income from discontinued operations

504


3,795

Extraordinary item:

Loss from earthquake (net of $800 tax benefit)

(1,200)

Net income

2,595

Other comprehensive income:

Unrealized gains from investments, net of tax192

Loss from foreign currency translation, net of tax(144) 48

Comprehensive income$2,643


Earnings per share:*


item$2.74

Discontinued operations.42

Extraordinary loss(1.00)

Net income$2.16

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

Note:The depreciation expense error is a prior period adjustment (to retained earnings) and is not reported in the income statement.

Requirement 2

SCHEMBRI MANUFACTURING CORPORATION



($ in 000s)

Net income

$2,595


Unrealized gains from investments, net of tax

$192

Loss from foreign currency translation, net of tax (144)

Total other comprehensive income

48


$2,643

Problem 48

DUKE COMPANY



Sales revenue

$15,000,000

Cost of goods sold

9,000,000

Gross profit

6,000,000

Operating expenses:


$1,000,000

Selling

500,000

Restructuring costs

300,000

Loss from write-down of obsolete inventory 400,000


2,200,000

Operating income

3,800,000


Interest expense

(700,000)


3,100,000

Income tax expense

1,240,000


1,860,000

Extraordinary item:

Loss from expropriation of overseas plant (net

of $1,200,000 tax benefit)

(1,800,000)

Net Income

60,000


Foreign currency translation adjustment loss, net of tax(120,000)

Unrealized gains on investment securities, net of tax108,000

Total other comprehensive loss (12,000)

Comprehensive income$ 48,000

Notes:

1.The restructuring costs and the loss from write-down of inventory are not extraordinary items.

2. The depreciation expense error is a prior period adjustment and is not reported in the income statement.

Problem 49

Requirement 1

DIVERSIFIED PORTFOLIO CORPORATION




Collections from customers (1)$880,000

Payment of operating expenses (2)(660,000)

Payment of income taxes (3)(85,000)




Net cash flows from investing activities 50,000


Proceeds from issue of common stock100,000

Payment of dividends(80,000)

Net cash flows from financing activities 20,000

Increase in cash

205,000

Cash and cash equivalents, January 1 70,000Cash and cash equivalents, December 31$275,000(1) $900,000 in service revenue less $20,000 increase in accounts receivable.

(2) $700,000 in operating expenses less $30,000 in depreciation less $10,000 increase

in accounts payable.

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


Requirement 2

DIVERSIFIED PORTFOLIO CORPORATION




Net income$120,000




Increase in accounts receivable(20,000)

Increase in accounts payable10,000

Decrease in income taxes payable (5,000)


Problem 410

Requirement 1

2012 Cash:

2012 Cash + Net increase in cash = 2013 Cash

2012 Cash + $86 = $145

2012 Cash = $592013 A/R:

2012 A/R + Cr. Sales Cash collections = 2013 A/R $84 + 80 71 = $932012 Inventory:

2012 A/P + Purchases Cash paid = 2013 A/P

$30 + Purchases 30 = $40

Therefore, Purchases = $40

2012 Inventory + Purchases 2013 Inventory = Cost of goods sold

2012 Inventory + $40 60 = $32

2012 Inventory = $522012 Accumulated depreciation:

2013 accumulated depreciation less 2013 depreciation = 2012 accumulated depreciation

$65 10 = $55

Problem 410 (continued)

2012 Total assets:

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

2013 Total assets:

$145 + 93 + 60 + 150 65 = $3832012 Income taxes payable:

2012 Inc. taxes payable + Inc. tax expense Income taxes paid =

2013 Inc. taxes payable

2012 Inc. taxes payable =2013 Inc. taxes payable + Taxes paid Inc. tax expense

2012 Inc. taxes payable = $22 + 9 7 = $242013 Retained earnings:

2012 R/E + Net income Dividends = 2013 R/E

$47 + 28 3 = $722012 Total liabilities and shareholders equity:

$30 + 9 + 24 + 230 + 47 = $3402013 Total liabilities and shareholders equity:

$40 + 9 + 22 + 240 + 72 = $383Problem 410 (concluded)

Requirement 2

GRANDVIEW CORPORATION



($ in millions)


Net income$ 28


Depreciation expense10

Gain on sale of investments(15)


Increase in accounts receivable1(9)

Increase in inventory2(8)

Increase in accounts payable310

Decrease in income taxes payable4 (2)

Net cash flows from operating activities$14

1 $93 84

2 $60 52

3 $40 30

4 $22 24

Problem 411

SANTANA INDUSTRIES



($ in thousands)


Net income$ 3,850




Increase in accounts receivable (300)

Increase in inventory(1,000)

Decrease in prepaid rent 150

Increase in accounts payable300

Increase in interest payable100

Increase in unearned service revenue200

Decrease in income taxes payable (250)



Purchase of equipment(4,000)

Sale of equipment 500


(3,500)


Proceeds from loan payable 5,000


Net cash flows from financing activities 4,000


5,150

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

cases

Judgment Case 41

Requirement 1

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

Requirement 2

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

Requirement 3

An often-debated contention is that, within GAAP, managers have the power, to a limited degree, to manipulate reported company income. And the manipulation is not always in the direction of higher income. Many believe that manipulating income reduces earnings quality because it can mask permanent earnings.

Requirement 4

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

Judgment Case 42

Requirement 1

Restructuring costs include costs associated with shutdown or relocation of facilities or downsizing of operations. Facility closings and related employee layoffs translate into costs incurred for severance pay and relocation costs as well as asset write-downs or write-offs.

Requirement 2

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

Requirement 3

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

Requirement 4

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

Judgment Case 43

No. Companies generally prefer to report earnings that follow a smooth, regular, upward path. They try to avoid declines, but they also want to avoid increases that vary wildly from year to year. It is better to have two years of 15% earnings increases than a 30% gain one year and none the next. As a result, some companies bank earnings by understating them in particularly good years and use the banked profits to increase earnings in bad years.

Real World Case 44

Requirement 1

Companies often voluntarily provide a pro forma earnings number when they announce annual or quarterly earnings calculated according to GAAP. These pro forma earnings numbers are managements view of permanent earnings. These pro forma earnings numbers are controversial as they represent managements biased view of permanent earnings and should be interpreted in that light.

Requirement 2

The term earnings quality refers to the ability of reported earnings (income) to predict a companys future earnings. Management believes that pro forma earnings are of much higher quality than reported earnings because they are more indicative of future profitability.

Communication Case 45

The critical question that student groups should address is whether or not the gain on the sale of the timber tracts should be reported as an extraordinary item on the 2013 income statement. There is no right or wrong answer. The process of developing the proposed solutions will likely be more beneficial than the solutions themselves. Students should benefit from participating in the process, interacting first with other group members, then with the class as a whole.

Solutions should address the following issues:

1.Is the gain material? A consensus should be reached that the gain is material.

2.Is the event both unusual and infrequent? Debate should center on the critical issue of whether the event is likely to occur again in the foreseeable future.

3.If the event is deemed to require presentation as an extraordinary item, the gain should be reported net of tax below income from continuing operations. A disclosure note also is required and earnings per share disclosure should reflect the income statement presentation.

As a real world example of a similar situation, in 1974 Johns Manville Corporation, manufacturer of asbestos products, reported a $21 million extraordinary gain from the sale of timber tracts. No disclosure note was provided to explain the event, so we can only speculate as to the circumstances leading to the company's presentation of the gain as extraordinary.

It is important that each student actively participate in the process. Domination by one or two individuals should be discouraged. Students should be encouraged to contribute to the group discussion by (a) offering information on relevant issues, and (b) clarifying or modifying ideas already expressed, or (c) suggesting alternative direction.

Communication Case 46

Suggested Grading Concepts and Grading Scheme:

Content (70%)

10Is the loss material?

25Lists the alternative treatments.

Present before-tax amount as a separate line item.

Present the after-tax amount as an extraordinary item.

In either case, disclosure is required.

25Cites the appropriate authoritative pronouncement,

FASB ASC 2252045 (previously APBO No. 30), and

discuss the concepts of unusual and infrequent in

the context of the companys environment.

10A clear, well-supported recommendation is made.

70 points

Writing (30%)

6Terminology and tone appropriate to the audience of a chief

financial officer.

12Organization permits ease of understanding.

Introduction that states purpose.

Paragraphs that separate main points.

12English

Sentences grammatically clear and well organized,

concise.

Word selection.

Spelling.

Grammar and punctuation.

30 points

Case 46 (continued)

The following is provided as an example.

August 1990

TO:Chief Financial Officer, Carter Hawley Hale Stores (CHHS)

FROM:John Doe, Controller (CHHS)

RE:Income Statement treatment of October 17, 1989, earthquake damage costs.

A decision on the income statement treatment of the earthquake damage costs involves a number of considerations. First, the damage costs are clearly material. Inclusion of the costs in earnings results in an increase in the net loss for the fiscal year ended August 4, 1990, from $9.47 million to $25.97 million. This leaves us only two options for the income statement presentation of the loss:

1.Present the before-tax amount of the loss ($27.5 million) as a separate line item in the income statement.

2.Present the after-tax effect of the loss ($16.5 million) as an extraordinary item, below income from continuing operations.

In both cases, a disclosure note would be required to explain the loss.

The appropriate authoritative pronouncement pertaining to this case is FASB ASC 2252045: Income StatementExtraordinary and Unusual ItemsOther Presentation Matters (previously Accounting Principles Board Opinion No. 30). It states that judgment is required in determining whether or not an event warrants separate reporting in the income statement as an extraordinary item. However, the following broad guideline is provided in paragraph 2:

Extraordinary items are events and transactions

that are distinguished by their unusual nature and

by the infrequency of their occurrence.

The characteristics of unusual nature and infrequency of occurrence must be considered in light of the environment in which the company operates.

These characteristics are only aids in answering the important question: What is the likelihood that this event will occur again in the foreseeable future? If it is not likely to occur again, then this should be communicated to financial statement users by segregating the income effect of the event as an extraordinary item. This will help them in using the income statement to predict future cash flows.

Case 46 (concluded)RECOMMENDATION

I recommend that the earthquake damage costs be treated as an extraordinary loss, net of tax, in the income statement for the fiscal year ended August 4, 1990. In addition, earnings per share for income both before and after the loss must be presented. While many earthquakes do occur in California, extremely large earthquakes causing significant amounts of damage are both unusual and infrequent. I do not believe that this type of loss will occur again in the foreseeable future.

Ethics Case 47

Discussion should include these elements.

Facts:

The company incurred $10 million in expenses related to a product recall. The company had experienced product recalls in the past and they do occur in the industry. To show a profit from continuing operations, Jim Dietz, the controller, wants to report the $10 million as an extraordinary loss, rather than as an expense included in operating income. He tells the CEO that the company has never had a product recall of this magnitude and that the company fixed the design flaw and upgraded quality control.

Extraordinary items are gains and losses that are material, and result from events that are both unusual and infrequent. These criteria must be considered in light of the environment in which the entity operates. There obviously is a considerable degree of subjectivity involved in the determination. The concepts of unusual and infrequent require judgment. In making these judgments, an accountant should keep in mind the overall objective of the income statement. The key question is how the event relates to a firms future profitability. If it is judged that the event, because of its unusual nature and infrequency of occurrence, is not likely to occur again, separate reporting as an extraordinary item is warranted.

Ethical Dilemma:

It appears from the facts of the case that it would be difficult for the company to come to the conclusion that a material product recall is not likely to occur again in the foreseeable future. This type of event has occurred before and is common in the industry. While a subjective judgment, extraordinary treatment of the $10 million does not appear warranted. Is the obligation of Jim and the CEO to maximize income from continuing operations, the company's position on the stock market, and management bonuses stronger than their obligation to fairly present accounting information to the users of financial statements?

Who is affected?

Jim Dietz

CEO and other managers

Other employees

Shareholders

Potential shareholders from the stock market

Creditors

Company auditors

Research Case 48Requirement 1

The accounting standards topic number that addresses exit or disposal cost obligations is FASB ASC 420: Exit or Disposal Cost Obligations.

Requirement 2

The specific citation that addresses the initial measurement of these obligations is FASB ASC 42010301: Exit or Disposal Cost ObligationsOverallInitial Measurement.

Requirement 3

A liability for a cost associated with an exit or disposal activity is measured initially at its fair value in the period in which the liability is incurred.

Requirement 4

The specific citation that describes the disclosure requirements for exit or disposal obligations is FASB ASC 42010501: Exit or Disposal Cost ObligationsOverallDisclosure.

Case 48 (concluded)

Requirement 5

All of the following information is disclosed in notes to financial statements that include the period in which an exit or disposal activity is initiated and any subsequent period until the activity is completed:

a. A description of the exit or disposal activity, including the facts and circumstances leading to the expected activity and the expected completion date.

b. For each major type of cost associated with the activity (for example, one-time employee termination benefits, contract termination costs, and other associated costs), both of the following are disclosed:

1. The total amount expected to be incurred in connection with the activity, the amount incurred in the period, and the cumulative amount incurred to date.

2. A reconciliation of the beginning and ending liability balances showing separately the changes during the period attributable to costs incurred and charged to expense, costs paid or otherwise settled, and any adjustments to the liability with an explanation of the reason(s) why.

c. The line item(s) in the income statement or the statement of activities in which the costs in (b) are aggregated.

d. For each reportable segment, as defined in Subtopic 280-10, the total amount of costs expected to be incurred in connection with the activity, the amount incurred in the period, and the cumulative amount incurred to date, net of any adjustments to the liability with an explanation of the reason(s) why.

e. If a liability for a cost associated with the activity is not recognized because fair value cannot be reasonably estimated, that fact and the reasons why.

Judgment Case 49

Financial Statement

Presentation

SituationTreatment (ag)(CO, BC, or RE)

1.b.CO

2.c.RE

3.f.CO

4.g.CO

5.a.BC

6.b.CO

7.e.BC

8.d.RE

Judgment Case 410

1.The loss is not unusual or infrequent. It is included in income from continuing operations along with other nonoperating items.

2.The sale of the financing component is treated as a discontinued operation. The gain or loss from the sale of the assets along with income or loss generated by the component is presented below income from continuing operations.

3.A change in depreciation method is treated as a change in accounting estimate achieved by a change in accounting principle. Changes in estimates are accounted for prospectively. The remaining book value is depreciated, using the new method, over the remaining useful life.

4.This event is not unusual but may be infrequent. It usually is presented as a separate line item included in income from continuing operations.

5.The correction of an error is treated as a prior period adjustment. The effect of the correction is not included in income, but as an adjustment to retained earnings. Prior years financial statements are restated to correct the error.

6.This event requires no unusual treatment. The lipstick line does not qualify as a component of an entity requiring treatment as a discontinued operation. The loss on sale of the assets of the product line is included in continuing operations.

IFRS Case 411

1. GSK reported interest received and dividends from associates and joint ventures as investing cash flows. U.S. GAAP requires these items to be included with operating cash flows.

2. Interest paid is reported as a financing cash flow.

Chap 004

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Transcript of Chap 004