Ch11 Harrison 8e GE SM

Chapter 11
The Income Statement and the Statement

of Shareholders’ Equity
Short Exercises
(5-10 min.) S 11-1
There are several ways that companies improperly

recognize revenue which results in financial statement
fraud.
a. “Channel stuffing” where a company may ship

inventory to regular customers in amounts in excess of
the amounts ordered by the customer. This usually
occurs near the end of the reporting period so that the
excess merchandise cannot be returned to the seller
prior to the preparation of the financial statements.
b. Reporting revenue when a significant portion of the

services are still to be performed, goods are still to be
Chapter 11 The Income Statement and the Statement of 111
Shareholders’ Equity
delivered or that there are significant contingencies
associated with the transaction still to be resolved.
c. Providing incentives for customers to purchase

more inventory than is needed in return for future
discounts or other benefits.
d. Reporting sales to fictitious or nonexistent

customers, this may also include the falsification of
shipping and inventory records.
(10 min.) S 11-2
Req. 1
Gross profit = $704,078 thousand ($1,825,775 −

$1,121,697)
Income from continuing operations = $64,049 thousand
Net income = $61,549 thousand
Req. 2
112 Financial Accounting 8/e Solutions Manual

Income from continuing operations = $64,049 thousand
Continuing operations will continue from period to
period. Their continuity makes income from continuing
operations a good predictor of future net income.

(10-15 min.) S 11-3
Knowledge King, Inc.

Income Statement
Year Ended December 31, 2010
(Thousand
s)
Net sales $184,000
revenue……………………………………
Cost of goods 72,000
sold…………………………………..
Gross 112,000
profit…………………………………………...
Operating 60,000
expenses…………………………………
Operating 52,000
income……………………………………
Other gains (losses) (21,000)
…………………………………
Income from continuing operations
before income
tax…………………………………………. 31,000
Income tax expense (30%) 9,300
…………………………
Income from continuing 21,700
operations……………...
Loss on discontinued operations,
$17,000,
less income tax saving of
(11,900)
$5,100………………
Income before exceptional 9,800
items…………………
Exceptional items, $4,000, net of 2,800
tax…………….
Net $ 12,600
income……………………………………………
.

(10-15 min.) S 11-4
Earnings per share of ordinary shares

(10,000 shares of ordinary shares outstanding):
[($21,700 − $1,000) / 10,000] $2.07
…………………………
Loss on discontinued operations ($11,900 /
(1.19)
10,000)
Income before exceptional items
[($9,800 − $1,000) / 10,000] .88
………………………….
Exceptional items ($2,800 / 10,000) .28
…………………..
Net income [($12,600 − $1,000) / 10,000] $1.16
……………..
(5-10 min.) S 11-5
Knowledge King, Inc.

Income Statement (partial)
Net income (from S 11-3) $12,60

………………………... 0
Other comprehensive income:

Unrealized gain on $1,100

investments…………….
Foreign-currency translation 2,400
3,500
adjustment….
Comprehensive $16,10
income…………………………. 0
Earnings per share are not reported for comprehensive

income.
Earnings per share are reported only for net income
and its components.

(10-15 min.) S 11-6
Estimated Earnings per $2.1

value = share = 0 = $21.00
of one share Investment .10
of Kiwi shares capitalization
rate
On May 1, 2011, Kewi’s shares are quoted at $71.04. At

that price, an investor should sell because the investor
believes the shares are worth only $21.00.
Student responses will vary depending on the market

price accessed by the student.

(10 min.) S 11-7
Req. 1
Earning Net income − preferred dividends

s
per = Average number of common shares
share outstanding over the period net income
was earned
Req. 2
Earnings per share of ordinary shares:

Income (loss) from continuing $X.XX
operations……………....
Income (loss) from discontinued
.XX
operations……………
Income (loss) before exceptional items and
cumulative effect of change in accounting X.XX
principle.
Exceptional gain or .XX
loss………………………………….
Cumulative effect of change in accounting
.XX
principle….
Net income (net loss) $X.XX
………………………………………..

Req. 3
Earnings per share is useful because it relates a

company’s income to a single share. Share prices are
quoted at an amount per share, and investors usually
consider buying a certain number of shares. Earnings
per share is used to help determine the value of a
single share.

(15 min.) E 11-8
Req. 1
The discontinued operations were more like a revenue.

This is clear from the fact that their amount is added in
determining net income.
Req. 2
The discontinued operations should be included in net

income because they represent revenues, which are a
basic component of net income.
Req. 3
Use Income from continuing operations ($10,585

million) to predict future income because that amount
of income is most likely to repeat in future years.

(5-10 min.) S 11-9
Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
1. Income Tax Expense ($122,000 × . 36,60

30)…. 0
Income Tax Payable ($94,000 × . 28,20
30).... 0
Deferred Tax 8,400
Liability…………………..
Recorded income tax for the year.
2. INCOME STATEMENT
Income before income $122,000
tax…………………
Income tax
(36,600)
expense………………………...
Net $ 85,400
income…………………………………...
BALANCE SHEET
Current liabilities:
Income tax $ 28,200
payable……………………..
Long-term liabilities:
Deferred tax 8,400
liability…………………….

(10 min.) S 11-10
iPlace, Inc.
Statement of Retained Earnings
Retained earnings balance, December 31,
2009,
as originally $71,000
reported……………………………………
Prior period adjustment — debit to correct
error
in
(19,000)
2009……………………………………………………...
2009, 52,000
as
adjusted………………………………………………...
Net income for
97,000
2010………………………………………...
149,000
Dividends for
(26,000)
2010…………………………………………..
Retained earnings balance, December 31, $123,00
2010……… 0

(10 min.) S 11-11
Req. 1
$1,140,000 ($40,000 + $1,100,000)
Req. 2
The share dividend:

 decreased retained earnings by $84,000
 increased total paid-in capital by $84,000
o $6,000 par value of ordinary shares
o $78,000 additional paid in capital
 had no effect on total shareholders’ equity

 had no effect on total assets
Req. 3
Cost of treasury shares Mason purchased = $8,000

Mason’s cost of treasury shares sold = $5,000
Mason sold the treasury shares for $12,000 ($5,000 +
$7,000)
(10-15 min.) S 11-12
Req. 1
Management of Ashburnham Computer, Inc. is

responsible for the company’s financial statements.
Req. 2
The accounting standard for financial statements is

accounting principles generally accepted in the United
States of America.
Req. 3
Management has established and maintains internal

accounting control over financial reporting to fulfill its
responsibility for reliable financial information.
Req. 4

Independent Registered Public Accounting Firm ,
auditors located in Portage, Michigan, gave an outside
opinion on Ashburnham’s financial statements.
Independent Registered Public Accounting Firm
released its opinion on December 28, 2010.
(continued) E 11-12
Req. 5
The audit covered Ashburnham’s balance sheets at

September 30, 2010, and September 30, 2009, income
statements (statements of operations), statements of
shareholders’ equity and statements of cash flows for
the three years ended September 30, 2010.
Req. 6
The standard for conducting an audit is the standards

of the Public Company Accounting Oversight Board
(United States).

Req. 7
The auditor believed that Ashburnham’s financial

statements conformed to U.S. generally accepted
accounting principles.

Exercises
Group A
(15-20 min.) E 11-13A
Dighton Cycles, Inc.

Income Statement
Year Ended September 30, 2010
Thousands
Net $14,000
sales……………………………………………………...
Total operating 12,800
expenses…………………………………
before
income tax 1,200
……………………………………………….
Income tax 295
expense………………………………………..
Income from continuing 905
operations…………………….
Income from discontinued operations,
$280, net of income tax, 224
$56…………………………..
Net $ 1,129
income…………………………………………………...

(20-25 min.) E 11-14A
Req. 1
Regan Books Company

Income Statement
Thousands
Sales $102,000
revenue………………………………………….
Other 2,400
revenues………………………………………..
Total 104,400
revenue…………………………………………..
expenses……………………………
Income from continuing operations before
income 7,200
tax……...................................................
Income tax 2,880
expense…………………………………..
Income from continuing operations. 4,320
……………...
Exceptional gain, $4,000, net of
income tax, 2,400
$1,600…………………………………
Net $ 6,720
income……………………………………………..
Earnings per share (EPS):

Income from continuing operations*
($4,320 / 1,800) $2.40
……......................................
Exceptional gain ($2,400 / 1,800) 1.33
………………..
Net income ($6,720 / 1,800) $3.73
……………………….

(continued) E 11-14A
Req. 2
Estimated
annual
Estimated value EPS in the $2.4
$48.0
= future = 0 =
0
per share of Investment .05
Regan Books capitalization
rate
(10-15 min.) E 11-15A
Estimated EPS for

value of continuing
= operations
one share of Investment
Prime Inc. capitalization rate
$4.80
$53.80 =
I

$4.80
i = = 8.9%
$53.80
(5-10 min.) E 11-

16A
EPS = $6.02 (rounded to nearest cent)
Computation:
[$6,100,000 − ($720,000 × .03)] / (1,100,000 shares
− 90,000 shares) = $6,078,400 / 1,010,000 shares
(15-20 min.) E 11-17A
(Amounts in millions, except per-share amounts)

Earnings per share of ordinary shares (600* shares
outstanding):
Income from continuing operations ($574 / $ 0.96
600)…..
Discontinued operations, net of tax (-$89 / - 0.15
600)…...
Income before Exceptionals, net of tax 0.81
($485 / 600)
Exceptional loss, net of tax ($-7 / 600) .01
………………
Net income ($478 / 600) $ 0.80
…………………………………
_____
*900 shares issued − 300 treasury shares = 600 shares
outstanding.

(10-15 min.) E 11-18A
Journal
2010 Income Tax Expense ($375,000 × . 112,50

30)…… 0
30)….
Deferred Tax Liability ($75,000 x . 22,500
30)....
INCOME STATEMENT
Income before $375,000
tax………………………………...
Income tax 112,500
expense……………………………...
Net $262,500
income…………………………………………
BALANCE SHEET
Income tax $90,000
payable……………………………..
Deferred tax 22,500
liability…………………………….

(10 min.) E 11-19A
Req. 1
Journal

30)……
30)….
30)....
Req. 2
Current tax liability $15,00

0
Req. 3
Deferred tax liability ($36,000 + $15,000) $51,000

(10 min.) E 11-20A
Domicile, Inc.
(Million
s)
2009,
as originally $342
reported…………………………………….
Prior-period adjustment (debit) (16)
…………………………..
2009,
as 326
adjusted…………………………………………………
Net income for 96
2010…………………………………………
422
Dividends for (68)
2010…………………………………………..
Retained earnings balance, December 31, $354
2010……….
The prior-period adjustment does not affect net income

for 2010.

(15-25 min.) E 11-21A
Pacheco Mall, Inc.

Statement of Changes in Equity
Ordinary Additional
Share Paid-in Retained
$1.75 Par Capital Earnings Total
Balance, Dec. 31, $542,500 $700,000 $630,000 $1,872,500
2009
Share dividend 10,850 113,150 (124,000*) ——
Issuance of ordinary
shares 3,500 32,500 36,000
Net income 342,000 342,000
Cash dividends (187,000) (187,000)
Balance, Dec. 31, $556,850 $845,650 $661,000 $2,063,500
2010
_____
*310,000 shares × .02 × $20 per share = $124,000.

(20-25 min.) E 11-22A
Req. 1
(Thousands)
Other Total
$3 Par Additional
Compre-- Share-
Ordinary Paid In Retained
hensive holders’
share Capital Earnings
Income Equity
Balance, Dec. 31, $405 $1,695 $3,600 $ 12 $5,712
2009.
Net 950 950
earnings……………
Unrealized gain on
5 5
investments………..
Issuance of 60 240 300
shares……..
Cash (50) (50)
dividends………..
Balance, Dec. 31, $465 $1,935 $4,500 $17 $6,917
2010.
Req. 2
Total $8,000
Debt 53.6
= liabilities = =
ratio %
Total assets $8,000 + $6,917
Req. 3
The year was profitable, as indicated by net earnings

of $950,000.
Req. 4
Amount received $60 + $240 $15.00

Issue
= Number of shares = $60 / $3 per = per
price
issued share share

Exercises
Group B
(15-20 min.) E 11-23B
Searstown Cycles, Inc.

Income Statement
Year Ended September 30, 2010
Thousands
Net $13,300
sales……………………………………………………...
expenses…………………………………
before
income tax 900
……………………………………………….
Income tax 300
expense………………………………………..
Income from continuing 600
operations…………………….
Loss from discontinued operations,
$310, net of income tax saving, (248)
$62………………….
Net $ 352
income…………………………………………………...

(20-25 min.) E 11-24B
Req. 1
Beemer Books Company

Income Statement
Thousands
Sales $107,000
revenue………………………………………….
Other 2,100
revenues………………………………………..
Total 109,100
revenue…………………………………………..
Income from continuing operations before
income 12,100
tax……...................................................
Income tax 4,840
expense…………………………………..
operations……………....
Exceptional gain, $3,600, net of
income tax saving, 2,160
$1,440………………………..
Net $ 9,420

income……………………………………………..
Earnings per share (EPS):

Income from continuing operations*
($7,260 / 1,500) $ 4.84
……......................................
Exceptional gain ($2,160 / 1,500) 1.44
………………..
Net income ($9,420 / 1,500) $ 6.28
……………………….

(continued) E 11-24B
Req. 2
Estimated
annual
Estimated value of EPS in the $4.8
$80.6
= future = 4 =
7
per share of Investment .06
Beemer Books capitalization
rate
(10-15 min.) E 11-25B
Estimated EPS for

value of continuing
= operations
one share of Investment
Doppler, Inc. capitalization rate
shares
$4.20
$54.40 =
I
$4.20
i = = 7.7%
$54.40

(5-10 min.) E 11-26B
EPS = $7.48 (rounded to nearest cent)
Computation
[$6,000,000 − ($360,000 × .04)] / (1,000,000 shares
− 200,000 shares) = $5,985,600 / 800,000 shares
(15-20 min.) E 11-27B
(Amounts in millions, except per-share amounts)
Earnings per share of ordinary shares(400* shares

outstanding):

Income from continuing operations ($577 / $ 1.44
400)…..
Discontinued operations, net of tax ($88 / 0.22
400)…….
Income before Exceptionals, net of tax 1.66
($665 / 400)
Exceptional gain, net of tax ($10 / 400) .03
………………
Net income ($675 / 400) $ 1.69
…………………………………
_____
*600 shares issued − 200 treasury shares = 400 shares
outstanding.

(10-15 min.) E 11-28B
Journal

35)…… 0
35)…. 0
Deferred Tax Liability ($100,000 x 35,000
.35)..
INCOME STATEMENT
Income before $750,000
tax………………………………...
Income tax 227,500
expense……………………………...
Net $522,500
income…………………………………………
BALANCE SHEET
Income tax $227,500
payable……………………………..
Deferred tax 35,000
liability…………………………….

(10 min.) E 11-29B
Req. 1
Journal

32)…… 0
32)…. 0
32)....
Req. 2
Current tax liability $115,20

0
Req. 3
Deferred tax liability ($34,000 + $16,000) $50,000

(10 min.) E 11-30B
Tidy, Inc.
(Million
s)
2009,
as originally $343
reported…………………………………….
Prior-period adjustment (credit) 8
…………………………..
2009,
as 351
adjusted…………………………………………………
Net income for 98
2010…………………………………………
449
Dividends for (65)
2010…………………………………………..
Retained earnings balance, December 31, $384
2010……….

The prior-period adjustment does not affect net income
for 2010

(15-25 min.) E 11-31B
Cox Mall, Inc.

Statement of Changes in Equity
Ordinary Additional
Share Paid-in Retained
$2 Par Capital Earnings Total
Balance, Dec. 31, $560,000 $700,000 $645,000 $1,905,000
2010
Share dividend 5,600 72,800 (78,400*) ——
Issuance of ordinary
shares 4,200 25,200 29,400
Net income 343,000 343,000
Cash dividends (180,000) (180,000)
Balance, Dec. 31, $569,800 $798,000 $729,600 $2,097,400
2011
_____
*280,000 shares × .01 × $28 per share = $78,400.

(20-25 min.) E 11-32B
Req. 1
(Thousands)
Other Total
$2 Par Additional
Compre- Share-
Ordinary Paid In Retained
hensive holders’
shares Capital Earnings
Income Equity
Balance, Dec. 31, $390 $1,710 $5,000 $ 9 $7,109
2009.
Net 1,170 1,170
earnings……………
Unrealized gain on
2 2
investments………..
Issuance of 90 270 360
shares……..
Cash (50) (50)
dividends………..
Balance, Dec. 31, $480 $1,980 $6,120 $11 $8,591
2010.
Req. 2
Total $6,700
Debt 43.8
= liabilities = =
ratio %
Total assets $6,700 + $8,591
Req. 3
The year was profitable, as indicated by net earnings.

Req. 4
Amount received $90 + $270 $8.00

Issue
= Number of shares = $90 / $2 par = per
price
issued per share share

Quiz
Q11-33 b
Q11-34 c
Q11-35 b ($33,000 / 0.08 = $412,500)
Q11-36 b [($240,000 − $100,000 + $150,000) × (1 − .

30) =
$203,000]
Q11-37 d [($240,000 − $100,000 + $150,000) × (1

− .30)]
− (9,000 × $100 × .07) = $0.70
200,000 shares
Q11-38 d
Q11-39 c [$160,000 − .30 ($160,000) = $112,000]
Q11-40 b ($120,000 × .30 = $36,000)
Q11-41 a [($160,000 − $120,000) × .30 = $12,000]
Q11-42 b
Q11-43 b ($84,000 / 3,000 shares = $28 per share)
Q11-44 c

Problems
Group A
(20-30 min.) P 11-45A

Req. 1
Daughtry Cosmetics, Inc.

Income Statement
Revenues and gains:
Sales $610,00
revenue………………………………………… 0
Dividend 20,000
revenue…………………………………….
Gain on lawsuit
14,000
settlement…………………………
Total revenues and 644,000
gains……………………….
Expenses and losses:

Cost of goods $324,00
sold………………………………….. 0
Selling 105,000
expenses……………………………………..
General 85,000
expenses……………………………………
Interest expense…………………………………. 30,000
…..
Loss on sale of 15,000
PPE………………………………...
Income tax 33,98

expense………………………………… 0
Total expenses and
592,980
losses……………………..
operations…………………
$21,000, less income tax, 12,320
$8,680…………………
Income before exceptional items……………………

63,340
Exceptional loss, $29,400, less
income tax saving of
(17,120)
$12,280………………………
Net $
income……………………………………………….. 46,220

(continued) P 11-45A
Req. 1
Earnings per share:

[($51,020 − $2,400) / 22,000] $2.21
………………………………...
Income from discontinued operations ($12,320 / .56
22,000)
[($63,340 − $2,400) / 22,000] 2.77
………………………………...
Exceptional loss ($17,120 / 22,000) (.78)
………………………...
Net income [($46,220 − $2,400) / 22,000] $1.99
…………………….
_____
Computations:
Preferred dividends: $60,000 × .04 = $2,400
Common shares outstanding: 25,000 shares issued minus
3,000 treasury shares = 22,000 shares outstanding
Req. 2
Evaluation: 2010 was a disappointing year. Most

important, income from continuing operations was only
8.4% of sales ($51,020 / $610,000), which failed to
meet earnings target of 12% of sales.
(10-15 min.) P 11-46A
Daughtry Cosmetics, Inc.

2009,
as originally $
reported…………………………………... 195,000
Prior-period adjustment (debit)
(1,000)
…………………………..
2009,
as 194,000
adjusted………………………………………………..
Net income for 46,220
2010………………………………………..
240,220
Dividends for (26,400)

2010……………………………………….... *
Retained earnings balance, December 31, $
2010……... 213,820
* Dividends for 2010 - $24,000 + ($60,000 x 4%) =

$26,400

(10-15 min. — after working P 11-45A) P 11-47A
Estimated annual Income from

continuing
Estimated
income in the operations ($51,020)
value $1,020,4
= future = =
of Daughtry 00
Investment .05
shares
capitalization
rate
Current market value

= $946,000 (22,000 shares* × $43 per
of
share)
Daughtry shares
The investors would offer approximately $1,020,000 for

Daughtry shares. The owners of Daughtry Cosmetics
should accept $1,020,000 because their outstanding
shares are now worth around $946,000.
_____
*Issued shares……………………. 25,000
Less Treasury shares……….…. (3,000)
Outstanding shares…………….. 22,000

(25-35 min.) P 11-48A
Req. 1
Earnings per share:

[($220,000 − $25,300) / 128,000] $1.52
………………………
Loss on discontinued operations ($67,000 / (.52)
128,000).
[($153,000 − $25,300) / 128,000] 1.00
……………………….
Exceptional gain ($50,000 / 128,000) .39
………………….
Net income [($203,000 − $25,300) / 128,000] $1.39
…………..
_____
Computations:
Preferred dividends: 11,000 × $2.30 = $25,300
Req. 2
Investment Capitalization
Rates
10% 12% 14%
Estimated value

$ 1.52 $ 1.52 $ 1.52
of OEL =
.10 .12 .14
shares
= $15.21 $12.68 $10.86
The final estimate ($10.86 at 14%) presumes the

investment is the most risky. That is why the investor
is willing to pay the least for OEL shares.

(30-40 min.) P 11-49A
Perfect Pie Foods, Inc.

Income Statement
Year Ended June 30, 2010
Revenues:
Net sales revenue ($896,000 less
returns
of $23,000 and discounts of $861,00
$12,000)… 0
Expenses:
sold………………………….. 0
Selling 101,000
expenses…………………………….
General 93,000
Income tax 35,00
expense………………………… 0
Total
616,000
expenses…………………………….
Income from continuing operations. 245,000
………..
Gain on discontinued operations,
$27,000, less income tax of $10,800
16,200
item………….....
Exceptional loss, $42,000,
less income tax savings of
(25,200)
$16,800………
Net
236,000
income……………………………………….
Unrealized loss on (13,000)
investments…………..
Less income tax savings of 40%
5,200 (7,800)
………….
Comprehensive $228,20
income………………………. 0

(continued) P 11-49A
Earnings per share:

Income from continuing operations ($245,000 / $12.25
20,000)
Gain from discontinued operations ($16,200 / .81
20,000)..
Income before exceptional item ($261,200 / 13.06
20,000)…..
Exceptional loss ($25,200 / 20,000) (1.26)
……………………….
Net income ($236,000 / 20,000) $11.80
…………………………….
_____
Computation of common shares outstanding:
24,000 shares issued − 4,000 treasury shares =

20,000 shares outstanding

(25-35 min.) P 11-50A
Req. 1
Pretax accounting income of 2010. $230,000

…………….
+ Additional taxable income for
accounting
income of 2011 that is taxed in 18,000
2010………..
− Additional depreciation expense for
tax depreciation (30,000)
purposes……………………….
Taxable income of 2010. $218,000
………………………….
Req. 2
Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDI
T
30)….. 0
Income Tax Payable ($218,000 × 65,40
.30).. 0
Deferred Tax Liability ($12,000 3,600
× .30)..
Req. 3
Crowley Publications, Inc.

Income Statement
Total $930,000
revenue…………………………...
Expenses:
sold………………...
Operating 290,000
expenses……………….
Income tax 69,000
expense……………….
Total 769,000
expenses……………………..
Net $ 161,000
income……………………………...

(15-20 min.) P 11-51A
Req. 1
$280 $280
Income before income million million $400
= =
tax: 1 – Tax 1 – .30 million
rate
Req. 2
$50 million par value

Par value of ordinary $2 per
25 million shares =
shares: share
issued
Req. 3
$250 million
received $10.00 per
Price per share of issuance: =
25 million share
shares issued
Req. 4
Cost of treasury shares sold: $ 13 million

Selling price of treasury shares sold: $ 25 million
Increase in total shareholders’ equity: $ 25 million

Req. 5
$100 million
Share dividend
$450 million + $50 = 20%
percentage:
million

Problems
Group B
(20-30 min.) P 11-52B
Req. 1
Ahern Cosmetics, Inc.

Income Statement
Revenues and gains:
Sales $560,00
revenue………………………………………… 0
Dividend
15,000
revenue…………………………………….
Gain on lawsuit settlement
9,000
Total revenues and 584,00
gains…………………… 0
Expenses and losses:
Cost of goods sold…………………………………. $314,000
Selling 90,000
expenses…………………………………….
General 80,000
expenses……………………………………
Interest 25,000
expense……………………………………..
Loss on sale of 13,000
PPE………………………………...
Income tax 24,450
expense…………………………………
Total expenses and
losses………………… 546,45
0
operations…………………
$18,000, less income tax,
10,810
$7,190…………………
item…………………….
Exceptional loss, $32,000,
less income tax savings of (19,090)
$12,910…………….
Net income……………………………………………... $
29,270

(continued) P 11-52B
Req. 1 (continued)
Earnings per share:

[($37,550 – 750 / 23,000………………………. $1.60
Income from discontinued operations ($10,810 / .47
23,000)
Income before exceptional item
[($48,360 − $750) / 23,000] 2.07
…………………………….
Exceptional loss ($19,090 / 23,000) (.83)
……………………...
Net income [($29,270 − $750) / 23,000] $1.24
………………...
_____
Computations:
Preferred dividends: $7,500 x 10% = $750
Common shares outstanding: 27,000 shares issued
minus
4,000 treasury shares =
23,000
shares outstanding
Req. 2

Evaluation: The year ended December 31, 2010 was
disappointing. Ahern’s managers fell short of their goal
of earning income from continuing operations equal to
14% of sales.
Income from continuing operations was only 6.7% of

sales ($37,550 / $560,000 = .067).

(10-15 min.) P 11-53B
Ahern Cosmetics, Inc

2009
as originally $ 193,000
reported…………………………………...
Prior-period adjustment (debit) 3,000
………………………….
2009
as 190,000
adjusted………………………………………………..
Net income for
29,270
2010………………………………………..
219,270
Dividends for
(23,750)*
2010…………………………………………
Retained earnings balance, December 31, $ 195,520
2010………
* Dividends for 2010 - $23,000 + ($7,500 x 10%) =

$23,750

(10-15 min. — after working P 11-52B) P 11-54B
Estimated annual Income from

continuing
Estimated
income in the operations ($37,550)
value
= future = = $375,500
of Ahern
Investment .10
shares
capitalization
rate
Current market
value
of Ahern = $437,000 (23,000 shares *× $19 per
share)
shares
The investors would offer approximately $375,000 (no

more than $375,500). The owners of Ahern Cosmetics,
Inc. should not accept $375,000 because their
outstanding shares is worth $437,000.
_____
*Issued shares…………………... 27,000
Less Treasury shares……….… (4,000)
Outstanding shares……………. 23,000

(20-25 min.) P 11-55B
Req. 1
Earnings per share:

[($225,000 − $26,400) / 134,000] $1.48
…………………
Loss on discontinued operations ($66,000 / ( .
134,000) 49)
[($159,000 − $26,400) / 134,000] .99
……………………….
Exceptional gain ($48,000 / 134,000) .36
………………….
Net income [($207,000 − $26,400) / 134,000] $
………… 1.35
_____
Computations:
Preferred dividends: 12,000 × $2.20 = $26,400
Req. 2
Investment Capitalization
Rates
9% 11% 13%
Estimated
value
of NVL = $ 1.48 $ 1.48 $1.48
shares .09 .11 .13
= $16.47 $11.40
$13.47
The final estimate ($11.40 at 13%) presumes the

investment is the most risky. That is why the investor
is willing to pay the least for NVL shares.

(30-40 min.) P 11-56B
Edible Pie Foods

Income Statement
Year Ended June 30,2010
Revenues:
Net sales revenue ($894,000 less returns
of $26,000 and discounts of $854,00
$14,000) 0
Expenses:
sold………………………… 0
Selling 106,000
expenses…………………………...
General 95,000
expenses………………………….
Income tax 33,00
expense……………………….. 0
Total
616,000
expenses…………………………..
operations……….
Loss on discontinued operations,
$26,000, less income tax saving,
(18,200)
$7,800.
item……………
Exceptional gain, $40,000,
less income tax of 28,000
$12,000……………….
Net $
income……………………………………... 247,800
Unrealized loss on $
investments………… 12,000
Less income tax of 30%
(3,600) (8,400)
…………………...
Comprehensive $
income……………………... 239,400

(continued) P 11-56B
Earnings per share:

Income from continuing operations ($238,000 / $23.8
10,000). 0
Loss from discontinued operations ($18,200 /
(1.82)
10,000)…
Income before exceptional item ($219,800 / 21.98
10,000)….
Exceptional gain ($28,000 / 10,000)
2.80
…………………….
Net income ($247,800 / 10,000)........................... $24.7
………… 8
_____
Computation of common shares outstanding:
13,000 shares issued − 3,000 treasury shares =

10,000 shares outstanding

(25-35 min.) P 11-57B
Req. 1
Pretax accounting income of $180,000

2010……………..
+ Additional taxable income for cash
earned in 2011 but taxed in 13,000
2010…………….
− Additional depreciation expense for
tax depreciation (40,000)
purposes…………………….
Taxable income of $153,000
2010…………………………..
Req. 2
Journal
35)….. 0
Income Tax Payable ($153,000 × 53,55
.35).. 0
Deferred Tax Liability ($27,000 × 9,450
.35)..
Req. 3
Consolidate Publications, Inc.

Income Statement
For the Year 2010

Total $920,00
revenue………………………………….. 0
Expenses:
sold………………………… 0
Operating 270,000
expenses……………………….
Income tax 63,00
expense……………………….. 0
Total 803,00
expenses……………………………... 0
Net $117,000
income……………………………………..

(15-20 min.) P 11-58B
Req. 1
$420 $420
Income before income $700
million = million =
tax: million
1 − Tax rate 1 − .40
Req. 2
Par value of ordinary $10 million par value $1 per

=
shares: 10 million shares issued share
Req. 3
$230 million
received $23.00 per
Price per share of issuance: =
10 million shares share
issued
Req. 4
Cost of treasury shares sold: $11 million

Selling price of treasury shares sold: $27 million
Increase in total shareholders’ equity: $27 million
Req. 5
$45 million = 10%

Share dividend $440 million + $10
percentage: million

Decision Cases
(15-20 min.) Decision Case 1
EPS to use for predicting future profits:

Unaudited $1.19
EPS…………………………………………...
Include:
Gain on sale of building……………………….. .05
Restructuring expenses……………………….. (.29)
Loss on lawsuit settlement…………………… (.12)
Lost income due to employee labor (.24)
strike…
EPS to use for $0.59
prediction……………………………
Reasoning: Include all the preceding items for your

prediction because are normal business
occurrences and are thus part of income
from continuing operations. None is an
exceptional item, and none is part of
discontinued operations.
Exclude the following items:

 unrealized loss on available-for-sale
investments because this is not even
part of net income (it is included in
comprehensive income).
 income from discontinued operations
because that income will not be part of
this company in the next period and
beyond.
(15-20 min.) Decision Case 2
Magid’s earnings are of higher quality than those of

Bay Area. Magid follows more conservative (and more
realistic) accounting policies than Bay Area. Here are
some examples:
SALES REVENUE
Magid records sales revenue when it receives a sale

contract and a cash down payment from a customer. In
contrast, Bay Area records revenue when it receives a
sale contract regardless of whether Bay Area receives
a customer down payment or not. Therefore, Magid’s

receivables appear to be more collectible than Bay
Area’s receivables, and as a result, Magid’s revenues
look stronger.
INSURANCE REVENUE
Magid records insurance revenue over the life of the

policy, while Bay Area records insurance revenue up
front when the customer signs the insurance contract.
Magid’s policy is more realistic because both
companies earn the insurance revenue over the life of
the contract as they provide insurance coverage for
policyholders. They do not earn the revenue at the
beginning of the contract period, which is when Bay
Area records the revenue.
Bay Area’s full recognition of insurance revenue when

an insurance contract is signed and recognition of
expenses over the life of the insurance contracts is a
violation of the Matching Principle.

Overall, Bay Area’s policies for recording revenue
suggest that the company may be overstating its
revenue. Magid’s accounting policies make Magid
appear to be the safer investment.

Ethical Issue
Req. 1
The ethical issue: Does it matter how a company

reports its operating results as long as the totals are
accurate? May all items of income and loss be
combined or should items from recurring and non-
recurring sources be reported separately?
Req. 2 and Req. 3
The stakeholders in this case include the company, its

officers and directors, shareholders, prospective
shareholders, and company analysts.
Economic analysis: Prospective investors want to

predict the level of net income and cash flows that a
company will generate from year to year. Continuing
operations are more predictable than exceptional
items and other non-recurring items. This is why
exceptional gains and losses are highlighted
separately on the income statement — to alert
investors and creditors of their special, nonrecurring
nature. In this case, the company and its existing
shareholders could be helped economically by
management’s action. By hiding the
(continued) Ethical Issue
exceptional gain and the effect of the accounting

change, the second income statement makes the
company look better than it really is. By burying the
exceptional gain in income from continuing operations,
the second income statement makes it appear that
Royal Bank of Singapore can earn more income each
year than it really can. Projecting this rosy picture of
operations may enable the company to borrow on
better terms, and its share price may temporarily
perform better than it should. Lenders who loan money
to Royal Bank of Singapore and shareholders who buy
the company’s shares based on the second income

statement can be hurt. They may lend to the company
on too-favorable terms, or they may pay too high a
price for its shares. When the truth comes out — in
terms of actual results — Royal Bank may be unable to
pay its loans. Or the company’s share price may fall,
leaving the new shareholders with shares worth less
than they paid for it.
Legal analysis: Generally accepted accounting

principles as well as the Accounting Standards
Committee of Singapore have legal and regulatory
requirements for segregating recurring items from non-
recurring items. To depart from these
(continued) Ethical Issue
rules violates International Financial Reporting

Standards (IFRS) and can subject the company and its
officers to civil and possibly criminal penalties.

Ethical analysis: The action being considered by Royal
Bank of Singapore is not truthful. It violates the rights
of prospective shareholders and creditors to all the
information they need about the company to make
informed decisions.
Req. 4
The bank should report their results of operations in a
way that separates the recurring from the non-
recurring items. This course of action is not only the
legal and ethical thing to do, but in the long run it is
also in the best economic interest of the company, its
management, and its existing shareholders.

Focus on Financials: Nokia Corporation
(20-30 min.)
Req. 1
Gross Profit Margin (GPM) = 34.3%

Operating Profit Margin (OPM) = 9.8%
Net Profit Margin (NPM) = 7.9%
Compared with previous years, GPM improved from
2007 (33.8%) and 2006 (32.5%), indicating improving
quality of earnings
There was no exceptional items nor discontinued
operations disclosed, indicating earnings will be
recurring.
Req. 2
Engaging in special one time transactions to increase
gains, e.g., selling of PPE. These gains are not
sustainable and lower earnings quality.
Recording revenue prematurely. It makes current
period look better at the expense of future periods.
Also it does not give investors an accurate picture of
the firm’s performance in the reporting period.
Shifting current period expenses to later periods. It
makes current period look better at expense of future
periods.

Req. 3
We may use the average income over the last 3 years

to determine our estimated annual income for the
future. This figure is (3,889+6,746+4,366)/3 which
equals 5,000 million
At 5% capitalisation rate
5000/0.05 = 100,000 million
Given that there are 3,697,872,000 ordinary shares

outstanding, one share would be worth $27.04
5000/0.06= 83,333 million

One share = $22.54
5000/0.07 = 71,429 million

One share = $19.32
The higher the capitalization rate, the higher the risk.

Therefore if we deemed Nokia as risky we would be
using the 7% rate.
Req. 4

Stock price of Nokia Corporation at December 31, 2008
was $15.50. Thus the price at 7% capitalization rate is
more realistic.

Group Project
1-2 hours
Student responses on this problem will vary.


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Chapter 11

The Income Statement and the Statement

(5-10 min.) S 11-1

There are several ways that companies improperly

a. “Channel stuffing” where a company may ship

b. Reporting revenue when a significant portion of the

c. Providing incentives for customers to purchase

d. Reporting sales to fictitious or nonexistent

(10 min.) S 11-2

Gross profit = $704,078 thousand ($1,825,775 −

112 Financial Accounting 8/e Solutions Manual

Chapter 11 The Income Statement and the Statement of 113

Knowledge King, Inc.

Chapter 11 The Income Statement and the Statement of 115

Earnings per share of ordinary shares

(5-10 min.) S 11-5

Knowledge King, Inc.

Net income (from S 11-3) $12,60

Other comprehensive income:

116 Financial Accounting 8/e Solutions Manual

Earnings per share are not reported for comprehensive

Chapter 11 The Income Statement and the Statement of 117

Estimated Earnings per $2.1

On May 1, 2011, Kewi’s shares are quoted at $71.04. At

Student responses will vary depending on the market

118 Financial Accounting 8/e Solutions Manual

Earning Net income − preferred dividends

Earnings per share of ordinary shares:

Chapter 11 The Income Statement and the Statement of 119

Earnings per share is useful because it relates a

120 Financial Accounting 8/e Solutions Manual

The discontinued operations were more like a revenue.

The discontinued operations should be included in net

Use Income from continuing operations ($10,585

Chapter 11 The Income Statement and the Statement of 121

1. Income Tax Expense ($122,000 × . 36,60

Chapter 11 The Income Statement and the Statement of 123

Chapter 11 The Income Statement and the Statement of 125

$1,140,000 ($40,000 + $1,100,000)

The share dividend:

o $78,000 additional paid in capital

 had no effect on total shareholders’ equity

Cost of treasury shares Mason purchased = $8,000

Management of Ashburnham Computer, Inc. is

The accounting standard for financial statements is

Management has established and maintains internal

Chapter 11 The Income Statement and the Statement of 127

The audit covered Ashburnham’s balance sheets at

The standard for conducting an audit is the standards

128 Financial Accounting 8/e Solutions Manual

The auditor believed that Ashburnham’s financial

Chapter 11 The Income Statement and the Statement of 129

Dighton Cycles, Inc.

130 Financial Accounting 8/e Solutions Manual

Regan Books Company

Earnings per share (EPS):

132 Financial Accounting 8/e Solutions Manual

(10-15 min.) E 11-15A