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Intermediate Accounting 7e Chapter 4 Solutions PDF
Intermediate Accounting 7e Chapter 4 Solutions PDF
Question 4–2
Income from continuing operations includes the revenue, expense, gain, and loss transactions
that will probably continue in future periods. It is important to segregate the income effects of these
items because they are the most important transactions in terms of predicting future cash flows.
Question 4–3
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 4–4
The single-step format first lists all revenues and gains included in income from continuing
operations to arrive at total revenues and gains. All expenses and losses are then grouped and
subtotaled, subtracted from revenues and gains to arrive at income from continuing operations. The
multiple-step format reports a series (multiple) of intermediate totals such as gross profit, operating
income, and income before taxes. Very often income statements adopt variations of these formats,
falling somewhere in between the two extremes.
Question 4–5
The term earnings quality refers to the ability of reported earnings (income) to predict a
company’s future earnings. After all, an income statement simply reports on events that already have
occurred. The relevance of any historical-based financial statement hinges on its predictive value.
Question 4–6
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 4–7
The process of intraperiod tax allocation matches tax expense or tax benefit with each major
component of income, specifically continuing operations and any item reported below continuing
operations. The process is necessary to achieve the desired result of separating the total income
effects of continuing operations from the two separately reported items—discontinued operations
and extraordinary items—and also to show the after-tax effect of each of those two components.
Question 4–8
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
component’s assets. The income (loss) from operations of the component is reported separately in
discontinued operations on prior income statements presented for comparative purposes.
Question 4–9
Extraordinary items are material gains and losses that are both unusual in nature and infrequent
in occurrence, taking into account the environment in which the entity operates.
Question 4–10
Extraordinary gains and losses are presented, net of tax, in the income statement below
discontinued operations, if any.
Question 4–11
GAAP permit alternative treatments for similar transactions. Common examples are the
choice among FIFO, LIFO, and average cost for the measurement of inventory and the choice
among alternative revenue recognition methods. A change in accounting principle occurs when a
company changes from one generally accepted treatment to another.
In general, we report voluntary changes in accounting principles retrospectively. This means
revising all previous periods’ financial statements as if the new method were used in those periods.
In other words, for each year in the comparative statements reported, we revise the balance of each
account affected. Specifically, we make those statements appear as if the newly adopted accounting
method had been applied all along. Also, if retained earnings is one of the accounts whose balance
requires adjustment (and it usually is), we revise the beginning balance of retained earnings for the
earliest period reported in the comparative statements of shareholders’ equity (or statements of
retained earnings if they’re presented instead). Then we create a journal entry to adjust all account
balances affected as of the date of the change. In the first set of financial statements after the
change, a disclosure note would describe the change and justify the new method as preferable. It also
would describe the effects of the change on all items affected, including the fact that the retained
earnings balance was revised in the statement of shareholders’ equity 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 4–12
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 4–13
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.
Question 4–14
Earnings per share (EPS) is the amount of income achieved during a period for each share of
common stock outstanding. If there are different components of income reported below continuing
operations, their effects on earnings per share must be disclosed. If a period contains discontinued
operations and extraordinary items, EPS data must be reported separately for income from
continuing operations and net income. Per share amounts for discontinued operations and
extraordinary items would be disclosed on the face of the income statement.
Question 4–15
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 4–16
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 4–17
The three categories of cash flows reported on the statement of cash flows are:
1. Operating activities—Inflows and outflows of cash related to the transactions entering into
the determination of net income from operations.
2. Investing activities—Involve the acquisition and sale of (1) long-term assets used in the
business and (2) nonoperating investment assets.
3. Financing activities—Involve cash inflows and outflows from transactions with creditors
and owners.
Question 4–18
Noncash investing and financing activities are transactions that do not increase or decrease
cash but are important investing and financing activities. An example would be the acquisition of
property, plant, and equipment (an investing activity) by issuing either long-term debt or equity
securities (a financing activity). These activities are reported either on the face of the statement of
cash flows or in a disclosure note.
Question 4–19
The direct method of reporting cash flows from operating activities presents the cash effect of
each operating activity directly on the statement of cash flows. The indirect method of reporting
cash flows from operating activities is derived indirectly, by starting with reported net income and
adding and subtracting items to convert that amount to a cash basis.
Question 4–20
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 4–21
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.
Operating expenses:
Selling ............................................................... $126
General and administrative ............................... 105
Total operating expenses .............................. 231
Operating income ................................................ 635
*$645 x 40%
MEMORAX COMPANY
Partial Income Statement
For the Year Ended December 31, 2013
*$790,000 x 40%
*$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.
* $5,800,000 x 30%
** Loss from operations of discontinued component:
* $5,800,000 x 30%
** Includes only the loss from operations. There is no impairment loss.
* $5,800,000 x 30%
** Loss from operations of discontinued component:
Only these four cash flow transactions relate to operating activities. The others are
investing and financing activities.
Operating expenses:
Selling ................................................................ $160,000
General and administrative ................................ 75,000
Total operating expenses ............................... 235,000
Operating income ................................................ 345,000
* 40% x $467,200
* 40% x $467,200
LINDOR CORPORATION
Statement of Comprehensive Income
For the Year Ended December 31, 2013
Operating expenses:
Selling and administrative ............................................. 420,000
Operating income ............................................................ 480,000
* 30% x $440,000
AXEL CORPORATION
Income Statement
For the Year Ended December 31, 2013
Operating expenses:
Selling .......................................................................... $67,000
Administrative ............................................................. 87,000
Restructuring costs ....................................................... 55,000
Total operating expenses ........................................... 209,000
Operating income ............................................................ 58,000
* 40% x $64,000
CHANCE COMPANY
Partial Income Statement
For the Year Ended December 31, 2013
Discontinued operations:
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
*Includes only the operating loss during the year. There is no impairment loss.
Exercise 4–9
Earnings per share:
Income from continuing operations $5.00
Loss from discontinued operations (1.60)
Extraordinary gain 2.20
Net income $5.60
Exercise 4–11
1. b Purchase of equipment for cash.
2. a Payment of employee salaries.
3. a Collection of cash from customers.
4. c Cash proceeds from a note payable.
5. b Purchase of common stock of another corporation for cash.
6. c Issuance of common stock for cash.
7. b Sale of machinery for cash.
8. a Payment of interest on note payable.
9. d Issuance of bonds payable in exchange for land and building.
10. c Payment of cash dividends to shareholders.
11. c Payment of principal on note payable.
Exercise 4–15
Requirement 1
Financing Investing Operating
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) = $264,000
WAINWRIGHT CORPORATION
Statement of Cash Flows
For the Month Ended March 31, 2013
BRONCO METALS
Statement of Cash Flows
For the Year Ended December 31, 2013
Based on the information in the T-accounts above, the operating activities section
of the SCF for Tiger Enterprises would be as shown next.
TIGER ENTERPRISES
Statement of Cash Flows
For the Year Ended December 31, 2013
($ in thousands)
b. The effect that has been given to preferred dividends in arriving at income
available to common stockholders in computing basic EPS.
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.
© The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol.1, Chapter 4 4–39
Exercise 4–21
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:
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.
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.
MICRON CORPORATION
Partial Income Statement
For the Year Ended December 31, 2013
Income from continuing operations before
income taxes and extraordinary item ....... [1] $1,300,000
Income tax expense .................................... 390,000
Income from continuing operations before
extraordinary item ....................................... 910,000
Discontinued operations:
Loss from operations of discontinued
component (including loss on disposal of
$300,000) ................................................. $(140,000)
Income tax benefit ................................... 42,000
Loss on discontinued operations .............. [2]
(98,000)
Income before extraordinary item .............. 812,000
Extraordinary item:
Loss from earthquake
(net of $240,000 tax benefit) ..................... (560,000)
Net Income ................................................. $ 252,000
Note:
The depreciation expense error is a prior period adjustment (to retained earnings) and is not
reported in the income statement.
Requirement 2
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.
2012 Cash:
2012 Cash + Net increase in cash = 2013 Cash
2012 Cash + $86 = $145
2012 Cash = $59
2013 A/R:
2012 A/R + Cr. Sales – Cash collections = 2013 A/R
$84 + 80 – 71 = $93
2012 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 = $52
$65 – 10 = $55
GRANDVIEW CORPORATION
Statement of Cash Flows
For the Year Ended December 31, 2013
($ in millions)
Cash flows from operating activities:
Net income $ 28
Adjustments for noncash effects:
Depreciation expense 10
Gain on sale of investments (15)
Changes in operating assets and liabilities:
Increase in accounts receivable1 (9)
Increase in inventory2 (8)
Increase in accounts payable3 10
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
Writing (30%)
______ 6 Terminology and tone appropriate to the audience of a chief
financial officer.
______ 12 English
____ Sentences grammatically clear and well organized,
concise.
____ Word selection.
____ Spelling.
____ Grammar and punctuation.
____
______ 30 points
RE: Income Statement treatment of October 17, 1989, earthquake damage costs.
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.
Requirement 2
The specific citation that addresses the initial measurement of these obligations is
FASB ASC 420–10–30–1: “Exit or Disposal Cost Obligations–Overall–Initial
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 420–10–50–1: “Exit or Disposal Cost Obligations–Overall–
Disclosure.”
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:
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:
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.
Requirement 2
Situations 3, 5, and 8 would be reported in the statement of income and
comprehensive income net-of-tax. Also, the net-of-tax effect of the correction of the
amortization error, situation 7, would increase or decrease retained earnings.
1Watts, R.L., and J.L. Zimmerman, “Towards a Positive Theory of the Determination of Accounting Standards,” The
Accounting Review, January 1978, and “Positive Accounting Theory: A Ten Year Perspective,” The Accounting
Review, January 1990.
2For example, see Healy, P.M., “The Effect of Bonus Schemes on Accounting Decisions,” Journal of Accounting and
Economics, April 1985, and Dhaliwal, D., G. Salamon, and E. Smith, “The Effect of Owner Versus Management
Control on the Choice of Accounting Methods,” Journal of Accounting and Economics, July 1982.
3Bowen, R.M., E.W. Noreen, and J.M. Lacy, “Determinants of the Corporate Decision to Capitalize Interest,” Journal of
Accounting and Economics,” August 1981.
4This “political cost” motive is suggested by Watts, R.L.. and J.L. Zimmerman, “ “Positive Accounting Theory: A Ten-
Year Perspective,” The Accounting Review, January 1990, and Zmijewski, M., and R. Hagerman, “An Income Strategy
Approach to the Positive Theory of Accounting Standard Setting/Choice,” Journal of Accounting and Economics,
August 1981.
© The McGraw-Hill Companies, Inc., 2013
4–76 Intermediate Accounting, 7/e
Research Case 4–14
(Note: This case requires the student to reference a journal article.]
Requirement 2
The authors use the S&P 500 companies as their sample.
Requirement 3
77% in 2001 and only 54% in 2003.
Requirement 4
In 2001, 85% of firms have greater pro forma than GAAP earnings. This ratio
declined to 67% in 2003.
Requirement 5
In 2001, 136 firms reported “Restructuring Charges,” and the same number of
firms reported a “Divestiture/Sale of Business Units. In 2003, the most frequently
reported adjustment was “Amortization/Impairment of Goodwill and Other
Intangibles.”
Requirement 6
The authors’ main conclusions are that the introduction of pro forma regulation is
associated with a substantial change in firms’ pro forma reporting. Notably, far fewer
firms are reporting pro forma earnings, while those that continue to report appear to
do so in a manner consistent with the intention of the regulation, to provide useful
information, not to mislead.
Income Statement:
1. The miscellaneous expense should be classified as an extraordinary item and
shown net of tax below income from continuing operations. A note should
describe the event.
2. Earnings per share disclosure is required.
3. The restructuring charges should be shown as a separate operating expense
item in the income statement and described in a note.
Requirement 2
Provision for income taxes ÷ Income before taxes
$715 ÷ $3,350 = 21% = Approximate income tax rate
Requirement 3
$2,635 ÷ $61,494 = 4.3%
Requirement 2
AF classifies interest paid and interest received as operating cash flows, and
dividends received as an investing cash flow. Under IFRS, companies can report
interest paid as either an operating or financing cash flow and interest and dividends
received as either operating or investing cash flows.