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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 Tags Brief Exercise AACSB Tags


4–1 Reflective thinking 4–14 Reflective thinking, Commun.
4–2 Reflective thinking Exercises
4–3 Reflective thinking 4–1 Analytic
4–4 Reflective thinking 4–2 Analytic
4–5 Reflective thinking 4–3 Analytic
4–6 Reflective thinking 4–4 Analytic
4–7 Reflective thinking 4–5 Analytic
4–8 Reflective thinking 4–6 Analytic
4–9 Reflective thinking 4–7 Analytic
4–10 Reflective thinking 4–8 Analytic
4–11 Reflective thinking, Commun. 4–9 Reflective thinking
4–12 Reflective thinking 4–10 Analytic
4–13 Reflective thinking 4–11 Reflective thinking
4–14 Reflective thinking 4–12 Analytic
4–15 Reflective thinking 4–13 Diversity, Analytic
4–16 Reflective thinking 4–14 Analytic
4–17 Reflective thinking 4–15 Analytic
4–18 Reflective thinking 4–16 Analytic
4–19 Reflective thinking 4–17 Analytic
4–20 Reflective thinking 4–18 Analytic
4–21 Reflective thinking 4–19 Analytic
Brief Exercises 4–20 Communications
4–1 Analytic 4–21 Communications
4–2 Analytic 4–22 Reflective thinking
4–3 Analytic CPA/CMA
4–4 Analytic 1 Reflective thinking
4–5 Analytic 2 Analytic
4–6 Analytic 3 Analytic
4–7 Analytic 4 Analytic
4–8 Analytic 5 Reflective thinking
4–9 Analytic 6 Reflective thinking
4–10 Analytic 7 Reflective thinking
4–11 Analytic 8 Reflective thinking
4–12 Analytic 1 Reflective thinking
4–13 Analytic

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–1
CPA/CMA AACSB Tags
2 Reflective thinking
3 Reflective thinking
Problems
4–1 Analytic
4–2 Analytic, Reflective thinking
4–3 Analytic, Reflective thinking
4–5 Analytic
4–6 Analytic
4–7 Analytic
4–8 Analytic
4–9 Analytic
4–10 Analytic
4–11 Analytic

© The McGraw-Hill Companies, Inc., 2013


4–2 Intermediate Accounting, 7/e
QUESTIONS FOR REVIEW OF KEY TOPICS
Question 4–1
The income statement is a change statement that reports transactions—revenues, expenses,
gains, and losses—that cause owners’ equity to change during a specified reporting period.

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.

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–3
Answers to Questions (continued)

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.

© The McGraw-Hill Companies, Inc., 2013


4–4 Intermediate Accounting, 7/e
Answers to Questions (continued)

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.

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–5
Answers to Questions (continued)

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.

© The McGraw-Hill Companies, Inc., 2013


4–6 Intermediate Accounting, 7/e
Answers to Questions (concluded)

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.

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–7
BRIEF EXERCISES
Brief Exercise 4–1

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 ................................ 645
Income tax expense* ........................................... 258
Net income .......................................................... $ 387

* $645 x 40% = $258

Brief Exercise 4–2


(a) Sales revenue $2,106
Less: Cost of goods sold (1,240)
Gross profit 866
Less: Selling expenses (126)
General and administrative expenses (105)
Operating income $ 635

(b) Gain on sale of investments 45


Interest expense (35)
Nonoperating income $10
© The McGraw-Hill Companies, Inc., 2013
4–8 Intermediate Accounting, 7/e
Brief Exercise 4–3

PACIFIC SCIENTIFIC CORPORATION


Income Statement
For the Year Ended December 31, 2013
($ in millions)
Sales revenue ...................................................... $2,106
Cost of goods sold .............................................. 1,240
Gross profit ......................................................... 866

Operating expenses:
Selling ............................................................... $126
General and administrative ............................... 105
Total operating expenses .............................. 231
Operating income ................................................ 635

Other income (expense):


Gain on sale of investments ............................. 45
Interest expense ................................................ (35)
Total other income, net ................................. 10
Income before income taxes .............................. 645
Income tax expense* .......................................... 258
Net income .......................................................... $ 387

*$645 x 40%

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–9
Brief Exercise 4–4
(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 revenue 4,000
Deduct: Loss on sale of investments (22,000)
Income before income taxes and 7,000
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)

© The McGraw-Hill Companies, Inc., 2013


4–10 Intermediate Accounting, 7/e
Brief Exercise 4–5

MEMORAX COMPANY
Partial Income Statement
For the Year Ended December 31, 2013

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%

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–11
Brief Exercise 4–6

WHITE AND SONS, INC.


Partial Income Statement
For the Year Ended December 31, 2013

Income before income taxes and extraordinary item .......... $ 850,000


Income tax expense* .......................................................... 340,000
Income before extraordinary item ...................................... 510,000
Extraordinary item:
Loss from earthquake, net of $160,000 tax benefit ......... (240,000)
Net income .......................................................................... $ 270,000

Earnings per share:


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

*$850,000 x 40%

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

© The McGraw-Hill Companies, Inc., 2013


4–12 Intermediate Accounting, 7/e
Brief Exercise 4–7

CALIFORNIA MICROTECH CORPORATION


Partial Income Statement
For the Year Ended December 31, 2013

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)

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–13
Brief Exercise 4–8

CALIFORNIA MICROTECH CORPORATION


Partial Income Statement
For the Year Ended December 31, 2013

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** ...... (3,600,000)
Income tax benefit ............................................................ 1,080,000
Loss on discontinued operations ...................................... (2,520,000)
Net income .......................................................................... $ 1,540,000

* $5,800,000 x 30%
** Includes only the loss from operations. There is no impairment loss.

© The McGraw-Hill Companies, Inc., 2013


4–14 Intermediate Accounting, 7/e
Brief Exercise 4–9

CALIFORNIA MICROTECH CORPORATION


Partial Income Statement
For the Year Ended December 31, 2013

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 impairment loss of $1,000,000)** ........................... (4,600,000)
Income tax benefit ............................................................ 1,380,000
Loss on discontinued operations ...................................... (3,220,000)
Net income ........................................................................... $ 840,000

* $5,800,000 x 30%
** Loss from operations of discontinued component:

Impairment loss ($8 million book value less


$7 million net fair value) $(1,000,000)
Loss from operations (3,600,000)
Total before-tax loss $(4,600,000)

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–15
Brief Exercise 4–10

O’REILLY BEVERAGE COMPANY


Statement of Comprehensive Income
For the Year Ended December 31, 2013

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

© The McGraw-Hill Companies, Inc., 2013


4–16 Intermediate Accounting, 7/e
Brief Exercise 4–11
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 $214,000

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

Brief Exercise 4–12


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

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–17
Brief Exercise 4–13
Cash flows from operating activities:
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 payable 15,000
Increase in income taxes payable 12,000
Net cash inflows from operating activities $92,000

Brief Exercise 4–14


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:

Cash flows from operating activities:


Collections from customers $ 660,000
Payment of operating expenses (440,000)
Net cash flows from operating activities $220,000

Cash flows from investing activities:


Proceeds from note receivable collection $100,000
Sale of land 40,000
Interest on note receivable 12,000
Purchase of equipment (120,000)
Net cash flows from investing activities $32,000

Cash flows from financing activities:


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

© The McGraw-Hill Companies, Inc., 2013


4–18 Intermediate Accounting, 7/e
EXERCISES
Exercise 4–1
Requirement 1

GREEN STAR CORPORATION


Income Statement
For the Year Ended December 31, 2013

Revenues and gains:


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

Expenses and losses:


Cost of goods sold ............................................ $720,000
Selling ............................................................... 160,000
General and administrative ............................... 75,000
Interest ............................................................... 40,000
Total expenses and losses ............................. 995,000
Income before income taxes ............................... 385,000
Income tax expense ............................................. 130,000
Net income .......................................................... $ 255,000

Earnings per share .............................................. $2.55

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–19
Exercise 4–1 (concluded)
Requirement 2

GREEN STAR CORPORATION


Income Statement
For the Year Ended December 31, 2013

Sales revenue ....................................................... $1,300,000


Cost of goods sold ............................................... 720,000
Gross profit .......................................................... 580,000

Operating expenses:
Selling ................................................................ $160,000
General and administrative ................................ 75,000
Total operating expenses ............................... 235,000
Operating income ................................................ 345,000

Other income (expense):


Interest revenue ................................................. 30,000
Gain on sale of investments .............................. 50,000
Interest expense ................................................ (40,000)
Total other income, net ................................. 40,000
Income before income taxes ............................... 385,000
Income tax expense ............................................. 130,000
Net income .......................................................... $ 255,000

Earnings per share ............................................... $2.55

© The McGraw-Hill Companies, Inc., 2013


4–20 Intermediate Accounting, 7/e
Exercise 4–2
Requirement 1

GENERAL LIGHTING CORPORATION


Income Statement
For the Year Ended December 31, 2013

Revenues and gains:


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

Expenses and losses:


Cost of goods sold ............................................ $1,200,300
Selling .............................................................. 300,000
General and administrative ............................... 150,000
Interest ............................................................... 90,000
Loss on sale of investments ............................. 22,500
Loss from inventory write-down ..................... 200,000
Total expenses and losses ............................. 1,962,800
Income before income taxes and extraordinary
Item …………………………………………. 467,200
Income tax expense * …………………………. 186,880
Income before extraordinary item ...................... 280,320
Extraordinary item:
Loss from flood damage (net of $48,000 tax benefit) (72,000)
Net income .......................................................... $ 208,320

Earnings per share:


Income before extraordinary item ...................... $ .93
Extraordinary loss ............................................... (.24)
Net income .......................................................... $ .69

* 40% x $467,200

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–21
Exercise 4–2 (concluded)
Requirement 2

GENERAL LIGHTING CORPORATION


Income Statement
For the Year Ended December 31, 2013
Sales revenue ....................................................... $2,350,000
Cost of goods sold ............................................... 1,200,300
Gross profit .......................................................... 1,149,700
Operating expenses:
Selling ............................................................... $300,000
General and administrative ............................... 150,000
Loss from inventory write-down ...................... 200,000
Total operating expenses ............................... 650,000
Operating income ................................................ 499,700
Other income (expense):
Rental revenue .................................................. 80,000
Loss on sale of investments .............................. (22,500)
Interest expense ................................................ (90,000)
Total other income (expense), net ................. (32,500)
Income before income taxes and extraordinary
item .................................................................... 467,200
Income tax expense * ........................................... 186,880
Income before extraordinary item ....................... 280,320
Extraordinary item:
Loss from flood damage (net of $48,000 tax benefit) (72,000)
Net income .......................................................... $ 208,320

Earnings per share:


Income before extraordinary item ....................... $ .93
Extraordinary loss ............................................... (.24)
Net income .......................................................... $ .69

* 40% x $467,200

© The McGraw-Hill Companies, Inc., 2013


4–22 Intermediate Accounting, 7/e
Exercise 4–3

LINDOR CORPORATION
Statement of Comprehensive Income
For the Year Ended December 31, 2013

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

Other income (expense):


Interest expense ............................................................... (40,000)
Income before income taxes and extraordinary item ....... 440,000
Income tax expense * ....................................................... 132,000
Income before extraordinary item ................................... 308,000
Extraordinary item:
Gain on litigation settlement (net of $120,000
tax expense) .................................................................. 280,000
Net income 588,000
Other comprehensive income:
Unrealized holding gains on investment securities,
net of tax .................................................................... 56,000
Comprehensive income ................................................... $644,000

Earnings per share:


Income before extraordinary item ................................... $ 0.31
Extraordinary gain ........................................................... 0.28
Net income ....................................................................... $ 0.59

* 30% x $440,000

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–23
Exercise 4–4

AXEL CORPORATION
Income Statement
For the Year Ended December 31, 2013

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
Total operating expenses ........................................... 209,000
Operating income ............................................................ 58,000

Other income (expense):


Interest and dividends ................................................... 32,000
Interest expense ............................................................ (26,000)
Total other income, net ................................................. 6,000
Income before income taxes and extraordinary item ....... 64,000
Income tax expense* ....................................................... 25,600
Income before extraordinary item ................................... 38,400
Extraordinary item:
Gain on litigation settlement (net of $34,400
tax expense) .................................................................. 51,600
Net income ....................................................................... $ 90,000

Earnings per share:


Income before extraordinary item ................................... $ .38
Extraordinary gain ........................................................... .52
Net income ....................................................................... $0.90

* 40% x $64,000

© The McGraw-Hill Companies, Inc., 2013


4–24 Intermediate Accounting, 7/e
Exercise 4–5

CHANCE COMPANY
Partial Income Statement
For the Year Ended December 31, 2013

Income from continuing operations .................................... $ 350,000


Discontinued operations:
Loss from operations of discontinued component
(including loss on disposal of $400,000)* ............................... (530,000)
Income tax benefit ............................................................ 212,000
Loss on discontinued operations ...................................... (318,000)
Net income ........................................................................... $ 32,000

Earnings per share:


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

* Loss on discontinued operations:

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)

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–25
Exercise 4–6

ESQUIRE COMIC BOOK COMPANY


Partial Income Statement
For the Year Ended December 31, 2013

Income from continuing operations * .................................. $ 552,000

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

* 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

© The McGraw-Hill Companies, Inc., 2013


4–26 Intermediate Accounting, 7/e
Exercise 4–7
Requirement 1

KANDON ENTERPRISES, INC.


Partial Income Statement
For the Year Ended December 31, 2013
Income from continuing operations .................................... $ 400,000
Discontinued operations:
Loss from operations of discontinued component
(including impairment loss of $50,000) * .............................. (190,000)
Income tax benefit ............................................................. 76,000
Loss on discontinued operations ...................................... (114,000)
Net income .......................................................................... $ 286,000

* Loss on discontinued operations:


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.


Partial Income Statement
For the Year Ended December 31, 2013
Income from continuing operations .................................... $ 400,000
Discontinued operations:
Loss from operations of discontinued component * ......... (140,000)
Income tax benefit ............................................................ 56,000
Loss on discontinued operations ...................................... (84,000)
Net income .......................................................................... $ 316,000

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

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–27
Exercise 4–8
Pretax income from continuing operations $14,000,000
Income tax expense (5,600,000)
Income from continuing operations 8,400,000
Less: Net income 7,200,000
Loss 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 operations 2,000,000
Impairment loss $6,000,000

Fair value of division’s assets $11,000,000


Add: Impairment loss 6,000,000
Book value of division’s assets $17,000,000

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

© The McGraw-Hill Companies, Inc., 2013


4–28 Intermediate Accounting, 7/e
Exercise 4–10

THE MASSOUD CONSULTING GROUP


Statement of Comprehensive Income
For the Year Ended December 31, 2013

Net income .......................................................... $1,354,000


Other comprehensive income (loss):
Foreign currency translation gain, net of tax ... $168,000
Unrealized losses on investment securities,
net of tax ....................................................... (56,000)
Total other comprehensive income ..................... 112,000
Comprehensive income ...................................... $1,466,000

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.

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–29
Exercise 4–12
Bluebonnet Bakers
Statement of Cash Flows
For the Year Ended December 31, 2013
Cash flows from operating activities:
Collections from customers $ 380,000
Interest on note receivable 6,000
Purchase of inventory (160,000)
Interest on note payable (5,000)
Payment of salaries (90,000)
Net cash flows from operating activities $131,000
Cash flows from investing activities:
Collection of note receivable 50,000
Sale of investments 30,000
Purchase of equipment (85,000)
Net cash flows from investing activities (5,000)
Cash flows from financing activities:
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 17,000

Cash and cash equivalents, December 31 $ 198,000

© The McGraw-Hill Companies, Inc., 2013


4–30 Intermediate Accounting, 7/e
Exercise 4–13
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 (E4–12) or could be presented as follows:
BLUEBONNET BAKERS
Statement of Cash Flows
For the Year Ended December 31, 2013
Cash flows from operating activities:
Collections from customers $ 380,000
Purchase of inventory (160,000)
Payment of salaries (90,000)
Payment of dividends (20,000)
Net cash flows from operating activities $110,000
Cash flows from investing activities:
Collection of note receivable 50,000
Interest on note receivable 6,000
Sale of investments 30,000
Purchase of equipment (85,000)
Net cash flows from investing activities 1,000
Cash flows from financing activities:
Proceeds from note payable 100,000
Payment of note payable (25,000)
Interest on note payable (5,000)
Net cash flows from financing activities 70,000
Net increase in cash 181,000
Cash and cash equivalents, January 1 17,000
Cash and cash equivalents, December 31 $ 198,000
© The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol.1, Chapter 4 4–31
Exercise 4–14
Cash flows from operating activities:
Net income $17,300
Adjustments for noncash effects:
Depreciation expense 7,800
Changes in operating assets and liabilities:
Increase in accounts receivable (4,000)
Decrease in inventory 5,500
Decrease in prepaid insurance 1,200
Decrease in salaries payable (2,700)
Increase in interest payable 800
Net cash flows from operating activities $25,900

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

© The McGraw-Hill Companies, Inc., 2013


4–32 Intermediate Accounting, 7/e
Exercise 4–15 (concluded)
Requirement 2

WAINWRIGHT CORPORATION
Statement of Cash Flows
For the Month Ended March 31, 2013

Cash flows from operating activities:


Collections from customers $ 55,000
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)

Cash flows from investing activities:


Purchase of equipment (10,000)
Net cash flows from investing activities (10,000)

Cash flows from financing activities:


Issuance of common stock 300,000
Net cash flows from financing activities 300,000
Net increase in cash 264,000
Cash and cash equivalents, March 1 40,000
Cash and cash equivalents, March 31 $ 304,000

Noncash investing and financing activities:

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


Cost of equipment $40,000
Cash paid 10,000
Note issued $30,000

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–33
Exercise 4–16
Cash flows from operating activities:
Net income $624,000
Adjustments for noncash effects:
Depreciation and amortization expense 87,000
Changes in operating assets and liabilities:
Decrease in accounts receivable 22,000
Increase in inventories (9,200)
Increase in prepaid expenses (8,500)
Increase in salaries payable 10,000
Decrease in income taxes payable (14,000)
Net cash flows from operating activities $711,300

© The McGraw-Hill Companies, Inc., 2013


4–34 Intermediate Accounting, 7/e
Exercise 4–17
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
Statement of Cash Flows
For the Year Ended December 31, 2013

Cash flows from operating activities:


Collections from customers $ 353,000
Purchase of inventory (186,000)
Payment of operating expenses (67,000)
Net cash flows from operating activities $100,000

Cash flows from investing activities:


Interest on note receivable 4,000
Dividends received from investments 2,400
Collection of note receivable 100,000
Purchase of equipment (154,000)
Net cash flows from investing activities (47,600)

Cash flows from financing activities:


Payment of interest on note payable (8,000)
Proceeds from issuance of common stock 200,000
Dividends paid (40,000)
Net cash flows from financing activities 152,000
Net increase in cash 204,400

Cash and cash equivalents, January 1 28,600

Cash and cash equivalents, December 31 $233,000

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–35
Exercise 4–18
TIGER ENTERPRISES
Statement of Cash Flows
For the Year Ended December 31, 2013
($ in thousands)
Cash flows from operating activities:
Net income $ 900
Adjustments for noncash effects:
Depreciation expense 240
Changes in operating assets and liabilities:
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
Net cash flows from operating activities $1,040
Cash flows from investing activities:
Purchase of plant and equipment (300)
Cash flows from financing activities:
Proceeds from issuance of common stock 100
Proceeds from note payable 200
Payment of dividends (1) (940)
Net cash flows from financing activities(640)

Net increase in cash 100

Cash, January 1 200


Cash, December 31 $ 300
(1)
Retained earnings, beginning $540
+ Net income 900
– Dividends x x = $940
Retained earnings, ending $500

© The McGraw-Hill Companies, Inc., 2013


4–36 Intermediate Accounting, 7/e
Exercise 4–19
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.
Cash Flows (Operating)
(a.) 7,080 (b.) 130
(c.) 3,460
(d.) 1,900
(e.) 550

Sales Revenue Accounts Receivable


1/1 830 (a.) 7,080
7,000 <-----------> 7,000
12/31 750

Prepaid Insurance Insurance Expense


1/1 20
(b.) 130 100 <-----------> 100
12/31 50

Accounts Payable Inventory Cost of Goods Sold


(c.) 3,460 1/1 360 1/1 600 3,360 <-----------> 3,360
3,400 <-----------> 3,400
12/31 300 12/31 640

Admin. & Other Payables Admin. & Other Expense


(d.) 1,900 1/1 400
1,800 <-----------> 1,800
12/31 300

Income Taxes Payable Income Tax Expense


(e.) 550 1/1 150
600 <-----------> 600
12/31 200

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

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–37
Exercise 4–19 (concluded)

TIGER ENTERPRISES
Statement of Cash Flows
For the Year Ended December 31, 2013
($ in thousands)

Cash flows from operating activities:


Collections from customers $ 7,080
Prepayment of insurance (130)
Payment to inventory suppliers (3,460)
Payment for administrative & other exp. (1,900)
Payment of income taxes (550)
Net cash flows from operating activities $ 1,040

© The McGraw-Hill Companies, Inc., 2013


4–38 Intermediate Accounting, 7/e
Exercise 4–20
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 260–
10–50–1: “Earnings per Share–Overall–Disclosure.”
Requirement 3
For each period for which an income statement is presented, an entity discloses
all of the following:
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 260–10–55–51) illustrates
that disclosure. (See paragraph 260–10–45–3.) 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.
© 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:

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


extraordinary item:
FASB ASC 225–20–45–2: “Income Statement–Extraordinary and Unusual
Items–Other Presentation Matters–Criteria 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 260–10–55–2: “Earnings per Share–Overall–Implementation
Guidance and Illustration–Computing 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.

© The McGraw-Hill Companies, Inc., 2013


4–40 Intermediate Accounting, 7/e
Exercise 4–21 (continued)

3. The alternative formats permissible for reporting comprehensive income:


FASB ASC 220–10–45–1: “Comprehensive Income–Overall–Other
Presentation Items–Reporting 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 220–10–15–3, 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.

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–41
Exercise 4–21 (concluded)

4. The classifications of cash flows required in the statement of cash flows:


FASB ASC 230–10–45–1: “Statement of Cash Flows–Overall–Other
Presentation Matters–Form 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.

© The McGraw-Hill Companies, Inc., 2013


4–42 Intermediate Accounting, 7/e
Exercise 4–22
List A List B
f 1. Intraperiod tax allocation a. Unusual, infrequent, and material gains
and losses.
g 2. Comprehensive income b. Starts with net income and works
backwards to convert to cash.
a 3. Extraordinary items c. Reports the cash effects of each operating
activity directly on the statement.
l 4. Operating income d. Correction of a material error of a prior
period.
k 5. A discontinued operation e. Related to the external financing of the
company.
j 6. Earnings per share f. Associates tax with income statement
item.
d 7. Prior period adjustment g. Total nonowner change in equity.
e 8. Financing activities h. 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 activities j. Required disclosure for publicly traded
corporation.
c 11. Direct method k. A component of an entity.
b 12. Indirect method l. Directly related to principal revenue-
generating activities.

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–43
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 revenue 10,200
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.

© The McGraw-Hill Companies, Inc., 2013


4–44 Intermediate Accounting, 7/e
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 retailer’s 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.

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–45
PROBLEMS
Problem 4–1
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 --
Total operating expenses ................................ 1,175,000 917,000
Operating income ................................................. 255,000 403,000
Other income (expense):
Interest revenue ................................................... 150,000 140,000
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
Income from continuing operations before
extraordinary item ............................................. 123,000 205,800
Discontinued operations:
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
Income before extraordinary item ........................ 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

© The McGraw-Hill Companies, Inc., 2013


4–46 Intermediate Accounting, 7/e
Problem 4–1 (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)

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–47
Problem 4–2
Requirement 1

JACKSON HOLDING COMPANY


Comparative Income Statements (in part)
For the Years Ended December 31
2013 2012
Income from continuing operations before
income taxes [1] .......................................... $3,000,000 $1,300,000
Income tax expense ......................................... 1,200,000 520,000
Income from continuing operations ................ 1,800,000 780,000
Discontinued operations:
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:


2013 2012
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:


2013 2012
Loss from operations $(400,000) $(300,000)
Gain on disposal 600,000 -
Total $ 200,000 $(300,000)

© The McGraw-Hill Companies, Inc., 2013


4–48 Intermediate Accounting, 7/e
Problem 4–2 (concluded)
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).

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–49
Problem 4–3
Requirement 1

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

[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.
© The McGraw-Hill Companies, Inc., 2013
4–50 Intermediate Accounting, 7/e
Problem 4–4
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.

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–51
Problem 4–5

ALEXIAN SYSTEMS, INC.


Income Statement
For the Year Ended December 31, 2013
($ in millions except per share date)
Net sales revenue ................................................. $425
Cost of goods sold ............................................... [1] 265
Gross profit .......................................................... 160
Operating expenses:
Selling and administrative ................................ [2] $128
Restructuring costs ........................................... 26
Total operating expenses ............................... 154
Operating income ................................................ 6
Other income:
Interest revenue ................................................. 3
Gain on sale of investments .............................. 6
Total other income ........................................ 9
Income before income taxes and extraordinary
item ................................................................... 15
Income tax expense ............................................. [3] 6
Income before extraordinary item ....................... 9
Extraordinary gain (net of $48 tax expense) .............. [4] 72
Net income .......................................................... $ 81

Earnings per share:


Income before extraordinary item ....................... $ 0.45
Extraordinary gain ............................................... 3.60
Net income .......................................................... $ 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.

© The McGraw-Hill Companies, Inc., 2013


4–52 Intermediate Accounting, 7/e
Problem 4–6

REMBRANDT PAINT COMPANY


Income Statement
For the Year Ended December 31, 2013
($ in thousands, except per share
amounts)
Sales revenue ................................................................... $18,000
Cost of goods sold ........................................................... 10,500
Gross profit ...................................................................... 7,500
Operating expenses:
Selling and administrative ............................................ $2,500
Restructuring costs ....................................................... 800 3,300
Operating income ............................................................ 4,200
Interest income (expense), net ......................................... (150)
Income from continuing operations before income taxes
and extraordinary item................................................... 4,050
Income tax expense ......................................................... 1,215
Income from continuing operations before extraordinary
item .............................................................................. 2,835
Discontinued operations:
Income from operations of discontinued component
(including gain on disposal of $2,000) .................................. 400
Income tax expense ...................................................... 120
Income on discontinued operations ............................. 280
Income before extraordinary item ................................... 3,115
Extraordinary gain (net of $900 tax expense) ..................... 2,100
Net income........................................................................ 5,215

Earnings per share:


Income from continuing operations before extraordinary
item ............................................................................... $ 5.67
Income on discontinued operations ................................. .56
Extraordinary gain ........................................................... 4.20
Net income ....................................................................... $10.43

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–53
Problem 4–7
Requirement 1

SCHEMBRI MANUFACTURING CORPORATION


Statement of Comprehensive Income
For the Year Ended December 31, 2013
($ 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
Total operating expenses ........................................ 3,300
Operating income ............................................................ 5,800
Other income (expense):
Loss on sales of investments .......................................... $(220)
Interest expense .............................................................. (180)
Interest revenue .............................................................. 85
Other income (expense) .............................................. (315)
Income from continuing operations before income taxes
and extraordinary item ………………………………. 5,485
Income tax expense ......................................................... 2,194
Income from continuing operations before extraordinary
item .............................................................................. 3,291
Discontinued operations:
Income from operations of discontinued component
(including gain on disposal of $1,400) ...................... 840
Income tax expense ...................................................... (336)
Income from discontinued operations .......................... 504
Income before extraordinary item ................................... 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 tax 192
Loss from foreign currency translation, net of tax (144) 48
Comprehensive income $2,643

© The McGraw-Hill Companies, Inc., 2013


4–54 Intermediate Accounting, 7/e
Problem 4–7 (concluded)

Earnings per share:*


Income from continuing operations before extraordinary
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


Statement of Comprehensive Income
For the Year Ended December 31, 2013
($ in 000s)

Net income ....................................................................... $2,595


Other comprehensive income (loss):
Unrealized gains from investments, net of tax ............... $192
Loss from foreign currency translation, net of tax (144)
Total other comprehensive income ................................. 48
Comprehensive income ................................................... $2,643

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–55
Problem 4–8
DUKE COMPANY
Statement of Comprehensive Income
For the Year Ended December 31, 2013
Sales revenue .................................................................. $15,000,000
Cost of goods sold ........................................................... 9,000,000
Gross profit ..................................................................... 6,000,000
Operating expenses:
General and administrative .......................................... $1,000,000
Selling ......................................................................... 500,000
Restructuring costs ....................................................... 300,000
Loss from write-down of obsolete inventory 400,000
Total operating expenses .......................................... 2,200,000
Operating income ............................................................ 3,800,000
Other income (expense):
Interest expense ............................................................ (700,000)
Income before income taxes and extraordinary item ....... 3,100,000
Income tax expense ......................................................... 1,240,000
Income before extraordinary item ................................... 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
Other comprehensive income (loss):
Foreign currency translation adjustment loss, net of tax (120,000)
Unrealized gains on investment securities, net of tax 108,000
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.

© The McGraw-Hill Companies, Inc., 2013


4–56 Intermediate Accounting, 7/e
Problem 4–9
Requirement 1
DIVERSIFIED PORTFOLIO CORPORATION
Statement of Cash Flows
For the Year Ended December 31, 2013

Cash flows from operating activities:


Collections from customers (1) $880,000
Payment of operating expenses (2) (660,000)
Payment of income taxes (3) (85,000)
Net cash flows from operating activities $135,000

Cash flows from investing activities:


Sale of investments 50,000
Net cash flows from investing activities 50,000

Cash flows from financing activities:


Proceeds from issue of common stock 100,000
Payment of dividends (80,000)
Net cash flows from financing activities 20,000
Increase in cash 205,000
Cash and cash equivalents, January 1 70,000
Cash 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.

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–57
Problem 4–9 (concluded)
Requirement 2
DIVERSIFIED PORTFOLIO CORPORATION
Statement of Cash Flows
For the Year Ended December 31, 2013

Cash flows from operating activities:


Net income $120,000
Adjustments for noncash effects:
Depreciation expense 30,000
Changes in operating assets and liabilities:
Increase in accounts receivable (20,000)
Increase in accounts payable 10,000
Decrease in income taxes payable (5,000)
Net cash flows from operating activities $135,000

© The McGraw-Hill Companies, Inc., 2013


4–58 Intermediate Accounting, 7/e
Problem 4–10
Requirement 1

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

2012 Accumulated depreciation:


2013 accumulated depreciation less 2013 depreciation = 2012 accumulated depreciation

$65 – 10 = $55

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–59
Problem 4–10 (continued)

2012 Total assets:


$59 + 84 + 52 + 50 + 150 – 55 = $340

2013 Total assets:


$145 + 93 + 60 + 150 – 65 = $383

2012 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 = $24

2013 Retained earnings:


2012 R/E + Net income – Dividends = 2013 R/E
$47 + 28 – 3 = $72

2012 Total liabilities and shareholders’ equity:


$30 + 9 + 24 + 230 + 47 = $340

2013 Total liabilities and shareholders’ equity:


$40 + 9 + 22 + 240 + 72 = $383

© The McGraw-Hill Companies, Inc., 2013


4–60 Intermediate Accounting, 7/e
Problem 4–10 (concluded)
Requirement 2

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

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–61
Problem 4–11
SANTANA INDUSTRIES
Statement of Cash Flows
For the Year Ended December 31, 2013
($ in thousands)
Cash flows from operating activities:
Net income $ 3,850
Adjustments for noncash effects:
Depreciation expense 1,600
Changes in operating assets and liabilities:
Increase in accounts receivable (300)
Increase in inventory (1,000)
Decrease in prepaid rent 150
Increase in accounts payable 300
Increase in interest payable 100
Increase in unearned service revenue 200
Decrease in income taxes payable (250)
Net cash flows from operating activities $4,650

Cash flows from investing activities:


Purchase of equipment (4,000)
Sale of equipment 500
Net cash flows from investing activities (3,500)
Cash flows from financing activities:
Proceeds from loan payable 5,000
Payment of dividends (1,000)
Net cash flows from financing activities 4,000

Net increase in cash 5,150

Cash, January 1 2,200


Cash, December 31 $7,350

© The McGraw-Hill Companies, Inc., 2013


4–62 Intermediate Accounting, 7/e
CASES
Judgment Case 4–1
Requirement 1
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.
Requirement 2
To enhance predictive value, analysts try to separate a company’s 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
company’s 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.

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–63
Judgment Case 4–2
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 company’s 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 4–3


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.

© The McGraw-Hill Companies, Inc., 2013


4–64 Intermediate Accounting, 7/e
Real World Case 4–4
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 management’s view of permanent earnings. These pro
forma earnings numbers are controversial as they represent management’s 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 company’s future earnings. Management believes that pro forma earnings
are of much higher quality than reported earnings because they are more indicative of
future profitability.

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–65
Communication Case 4–5
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.

© The McGraw-Hill Companies, Inc., 2013


4–66 Intermediate Accounting, 7/e
Communication Case 4–6
Suggested Grading Concepts and Grading Scheme:
Content (70%)
______ 10 Is the loss material?

______ 25 Lists 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.

______ 25 Cites the appropriate authoritative pronouncement,


FASB ASC 225–20–45 (previously APBO No. 30), and
discuss the concepts of unusual and infrequent in
the context of the company’s environment.

______ 10 A clear, well-supported recommendation is made.


____
______ 70 points

Writing (30%)
______ 6 Terminology and tone appropriate to the audience of a chief
financial officer.

______ 12 Organization permits ease of understanding.


____ Introduction that states purpose.
____ Paragraphs that separate main points.

______ 12 English
____ Sentences grammatically clear and well organized,
concise.
____ Word selection.
____ Spelling.
____ Grammar and punctuation.
____
______ 30 points

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–67
Case 4–6 (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 225–20–45: “Income Statement–Extraordinary and Unusual Items–Other
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.

© The McGraw-Hill Companies, Inc., 2013


4–68 Intermediate Accounting, 7/e
Case 4–6 (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.

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–69
Ethics Case 4–7
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 firm’s 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
© The McGraw-Hill Companies, Inc., 2013
4–70 Intermediate Accounting, 7/e
Research Case 4–8
Requirement 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 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.”

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–71
Case 4–8 (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.

© The McGraw-Hill Companies, Inc., 2013


4–72 Intermediate Accounting, 7/e
Judgment Case 4–9
Financial Statement
Presentation
Situation Treatment (a–g) (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 4–10


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.

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–73
IFRS Case 4–11
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. U.S. GAAP requires interest
paid to be included with operating cash flows

© The McGraw-Hill Companies, Inc., 2013


4–74 Intermediate Accounting, 7/e
Judgment Case 4–12
Requirement 1
1. a. As a component of operating income.
2. b. As a nonoperating income item.
3. d. As an other comprehensive income item.
4. b. As a nonoperating income item.
5. c. As a separately reported item.
6. a. As a component of operating income.
7. e. As an adjustment to retained earnings.
8. c. As a separately reported item.

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.

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–75
Judgment Case 4–13
It would be nice to think that management makes all accounting choices in the
best interest of fair and consistent financial reporting. Unfortunately, other motives
influence the choices among accounting methods and whether to change methods. It
has been suggested that the effect of choices on management compensation, on
existing debt agreements, and on union negotiations each can affect management’s
selection of accounting methods.1 For instance, research has suggested that managers
of companies with bonus plans are more likely to choose accounting methods that
maximize their bonuses (often those that increase net income).2 Other research has
indicated that the existence and nature of debt agreements and other aspects of a
firm’s capital structure can influence accounting choices.3 Whether a company is
forbidden from paying dividends if retained earnings fall below a certain level, for
example, can affect the choice of accounting methods.
Choices made are not always those that tend to increase income. As you will
learn in Chapter 8, many companies use the LIFO inventory method because it
reduces income and therefore reduces the amount of income taxes that must be paid
currently. Also, some very large and visible companies might be reluctant to report
high income that might render them vulnerable to union demands, government
regulations, or higher taxes.4

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.

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–77
Integrating Case 4–15
DEFICIENCIES:
Balance Sheet:
1. The asset section of the balance sheet should be classified. Cash, short-term
investments, accounts receivable, and inventories should be included as
current assets.
2. Accounts receivable should be shown net of the allowance for uncollectible
accounts.
3. Inventories—the method used to cost inventory should be disclosed in a note.
4. Marketable securities—$21,000 of investments ($78,000 – 57,000) should be
classified in a noncurrent investments category.
5. Property and equipment—should be classified in a separate category.
Original cost should be disclosed along with the accumulated depreciation to
arrive at the net amount. Also, the method used to compute depreciation
should be disclosed in a note.
6. The liability and shareholders' equity section of the balance sheet should be
classified into (1) current liabilities, (2) long-term liabilities, and (3)
shareholders' equity.
7. Current liabilities should include accounts payable and accruals, notes payable
(the $80,000 note due in 2014 and the $60,000 installment on note # 2 due in
2014). The latter should be classified as current maturities of long-term debt.
Also, note disclosure is required for the notes providing information such as
payment terms, interest rates, and collateral pledged as security for the debt.
8. Long-term liabilities should include the $60,000 second installment on note
#2.
9. Common stock—the par value, if any, and the number of shares authorized,
issued, and outstanding should be disclosed.

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.

© The McGraw-Hill Companies, Inc., 2013


4–78 Intermediate Accounting, 7/e
Financial Analysis Case 4–16
Requirement 1
2010 to 2011: ($2,635 – 1,433) ÷ $1,433 = 83.9% increase

2009 to 2010: ($1,433 – 2,478) ÷ $2,478 = 42.2% decrease

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%

Real World Case 4–17


Answers to the questions will, of course, vary because students will research
financial statements of different companies.
No specific standards dictate how income from continuing operations must be
displayed, so companies have considerable latitude in how they present the
components of income from continuing operations. This flexibility has resulted in a
considerable variety of income statement presentations. However, we can identify
two general approaches, the single-step and the multiple-step formats that might be
considered the two extremes, with the income statements of most companies falling
somewhere in between.
The presentation of separately reported items, however, is mandated and students
should be able to easily identify them.

© The McGraw-Hill Companies, Inc., 2013


Solutions Manual, Vol.1, Chapter 4 4–79
Air France–KLM Case
Requirement 1
AF classifies its expenses by both natural descriptions (e.g., salaries and related
costs, taxes other than income taxes) and functions (e.g., external expenses). In the
United States, expenses are classified by function.

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.

© The McGraw-Hill Companies, Inc., 2013


4–80 Intermediate Accounting, 7/e

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