Escolar Documentos
Profissional Documentos
Cultura Documentos
Chapter 4
Flows
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 companys future earnings. After all, an income statement simply reports on events that already have occurred. The relevance of any historical-based financial statement hinges on its predictive value.
Question 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.
4-1
Question 4-7
The process of intraperiod tax allocation matches tax expense or tax benefit with each major component of income, specifically continuing operations and any item reported below continuing operations. The process is necessary to achieve the desired result of separating the total income effects of continuing operations from the two separately reported items - discontinued operations and extraordinary items, and also to show the after-tax effect of each of those two components.
Question 4-9
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.
4-2
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.
4-3
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 separate statement or by including the information in either the income statement or the statement of changes in shareholders equity.
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.
4-4
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
IFRS provides the option of presenting components of other comprehensive income either in (a) a single statement of comprehensive income or (b) in a separate income statement followed by a statement of comprehensive income. U.S. GAAP also allows the reporting of other comprehensive income in the statement of shareholders equity
Question 4-22
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
4-5
BRIEF EXERCISES
Brief Exercise 4-1
PACIFIC SCIENTIFIC CORPORATION Income Statement For the Year Ended December 31, 2011
($ in millions)
Revenues and gains: Sales ................................................................ Gain on sale of investments ............................. Total revenues and gains .............................. Expenses and losses: Cost of goods sold ........................................... Selling .............................................................. General and administrative ............................... Interest ............................................................. Income tax expense* ....................................... Total expenses and losses ............................. Net income ......................................................... *$2,151 (1,240 + 126 + 105 + 35) = $645 x 40% = $258
$2,106 45 2,151
(b)
45 (35)
$10
4-6
PACIFIC SCIENTIFIC CORPORATION Income Statement For the Year Ended December 31, 2011
($ in millions)
Sales revenue ..................................................... Cost of goods sold .............................................. Gross profit ........................................................ Operating expenses: Selling .............................................................. General and administrative ............................... Total operating expenses .............................. Operating income ............................................... Other income (expense): Gain on sale of investments ............................. Interest expense ............................................... Total other income, net ................................ Income before income taxes .............................. Income tax expense* .......................................... Net income .........................................................
*$645 x 40%
4-7
(b)
(c)
(30,000) (25,800)
4-8
4-9
4-10
4-11
4-12
4-13
4-14
4-15
Only these four cash flow transactions relate to operating activities. The others are investing and financing activities.
4-16
4-17
EXERCISES
Exercise 4-1
Requirement 1
GREEN STAR CORPORATION Income Statement For the Year Ended December 31, 2011 Revenues and gains: Sales ................................................................ Interest ............................................................ Gain on sale of investments ............................. Total revenues and gains .............................. Expenses and losses: Cost of goods sold ........................................... Salaries ............................................................. Depreciation ..................................................... Interest ............................................................. Rent .................................................................. Income tax ....................................................... Total expenses and losses ............................. Net income ......................................................... Earnings per share ..............................................
4-18
GREEN STAR CORPORATION Income Statement For the Year Ended December 31, 2011 Sales revenue ..................................................... Cost of goods sold .............................................. Gross profit ........................................................ Operating expenses: Salaries ............................................................. Depreciation ..................................................... Rent ................................................................. Total operating expenses .............................. Operating income ............................................... Other income (expense): Interest revenue ............................................... Gain on sale of investments ............................. Interest expense ............................................... Total other income, net ................................ Income before income taxes .............................. Income tax expense ............................................ Net income ......................................................... Earnings per share .............................................. $1,300,000 720,000 580,000
4-19
Exercise 4-2
Requirement 1
GENERAL LIGHTING CORPORATION Income Statement For the Year Ended December 31, 2011 Revenues and gains: Sales ................................................................ Rental revenue ................................................. Total revenues and gains .............................. Expenses and losses: Cost of goods sold ........................................... Salaries ............................................................ Depreciation ..................................................... Interest ............................................................. Rent ................................................................. Loss on sale of investments ............................. Loss from inventory write-down ..................... Income tax expense * ....................................... Total expenses and losses ............................. Income before extraordinary item ...................... Extraordinary item: Loss from flood damage (net of $48,000 tax benefit) Net income ......................................................... Earnings per share: Income before extraordinary item ...................... Extraordinary loss .............................................. Net income .........................................................
$1,200,300 300,000 100,000 90,000 50,000 22,500 200,000 186,880 2,149,680 280,320 (72,000) $ 208,320
* 40% x $467,200
4-20
Exercise 4-2 (concluded) Requirement 2 GENERAL LIGHTING CORPORATION Income Statement For the Year Ended December 31, 2011 Sales revenue ..................................................... Cost of goods sold .............................................. Gross profit ........................................................ Operating expenses: Salaries ............................................................ Depreciation .................................................... Rent ................................................................. Loss from inventory write-down ..................... Total operating expenses .............................. Operating income ............................................... Other income (expense): Rental revenue ................................................. Loss on sale of investments ............................. Interest expense ............................................... Total other income (expense), net ................ Income before taxes and extraordinary item ....... Income tax expense * .......................................... Income before extraordinary item ...................... Extraordinary item: Loss from flood damage (net of $48,000 tax benefit) Net income ......................................................... Earnings per share: Income before extraordinary item ...................... Extraordinary loss .............................................. Net income ......................................................... * 40% x $467,200 $300,000 100,000 50,000 200,000 650,000 499,700 80,000 (22,500) (90,000) (32,500) 467,200 186,880 280,320 (72,000) $ 208,320 $2,350,000 1,200,300 1,149,700
4-21
Exercise 4-3
LINDOR CORPORATION Statement of Income and Comprehensive Income For the Year Ended December 31, 2011 Sales revenue ................................................................. Cost of goods sold .......................................................... Gross profit .................................................................... Operating expenses: Selling and administrative ............................................ Operating income ........................................................... Other income (expense): Interest expense .............................................................. Income before income taxes and extraordinary item ....... Income tax expense * ...................................................... Income before extraordinary item ................................... Extraordinary item: Gain on litigation settlement (net of $120,000 tax expense) ................................................................ Net income Other comprehensive income: Unrealized holding gains on investment securities, net of tax .................................................................. Comprehensive income .................................................. Earnings per share: Income before extraordinary item ................................... Extraordinary gain ......................................................... Net income ..................................................................... * 30% x $440,000 $2,300,000 1,400,000 900,000
420,000 480,000
280,000 588,000
56,000 $644,000
4-22
Exercise 4-4
AXEL CORPORATION Income Statement For the Year Ended December 31, 2011 Sales revenue ................................................................. Cost of goods sold .......................................................... Gross profit .................................................................... Operating expenses: Selling ........................................................................ Administrative ........................................................... Restructuring costs ...................................................... Total operating expenses .......................................... Operating income ........................................................... Other income (expense): Interest and dividends .................................................. Interest expense ........................................................... Total other income, net ................................................ Income before income taxes and extraordinary item ...... Income tax expense* ...................................................... Income before extraordinary item ................................... Extraordinary item: Gain on litigation settlement (net of $34,400 tax expense) ................................................................ Net income ..................................................................... Earnings per share: Income before extraordinary item ................................... Extraordinary gain ......................................................... Net income ..................................................................... * 40% x $64,000 $ 592,000 325,000 267,000
51,600 $ 90,000
4-23
Exercise 4-5
CHANCE COMPANY Partial Income Statement For the Year Ended December 31, 2011 Income from continuing operations ................................... Discontinued operations: Loss from operations of discontinued component (including loss on disposal of $400,000)* .............................. Income tax benefit ......................................................... Loss on discontinued operations .................................... Net income ........................................................................ Earnings per share: Income from continuing operations ................................... Loss from discontinued operations .................................... Net income ........................................................................ * Loss on discontinued operations: Loss on sale of assets Operating loss Total before-tax loss Less: Income tax benefit (40%) Net-of-tax loss $(400,000) (130,000) (530,000) 212,000 $(318,000) $ 350,000
4-24
Exercise 4-6
ESQUIRE COMIC BOOK COMPANY Partial Income Statement For the Year Ended December 31, 2011 Income from continuing operations * ................................. Discontinued operations: Income from operations of discontinued component (including loss on disposal of $350,000) ................................ Income tax expense ......................................................... Income on discontinued operations ................................. Net income.......................................................................... $ 552,000
* Income from continuing operations: Income before considering additional items Decrease in income due to restructuring costs Before-tax income from continuing operations Income tax expense (40%) Income from continuing operations $1,000,000 (80,000) 920,000 (368,000) $ 552,000
4-25
Exercise 4-7
Requirement 1 KANDON ENTERPRISES, INC. Partial Income Statement For the Year Ended December 31, 2011 Income from continuing operations ................................... Discontinued operations: Loss from operations of discontinued component (including impairment loss of $50,000) * ............................. Income tax benefit ........................................................... Loss on discontinued operations ..................................... Net income ........................................................................ * Loss on discontinued operations: Operating loss Impairment loss ($250,000 - 200,000) Net before-tax loss Income tax benefit (40%) Net after-tax loss on discontinued operations Requirement 2 KANDON ENTERPRISES, INC. Partial Income Statement For the Year Ended December 31, 2011 Income from continuing operations ................................... Discontinued operations: Loss from operations of discontinued component * ......... Income tax benefit .......................................................... Loss on discontinued operations ..................................... Net income ........................................................................ $ 400,000 (140,000) 56,000 (84,000) $ 316,000 $(140,000) (50,000) (190,000) 76,000 $(114,000) $ 400,000
*Includes only the operating loss during the year. There is no impairment loss.
4-26
Exercise 4-8
Pretax income from continuing operations Income tax expense Income from continuing operations Less: Net income Loss from discontinued operations $14,000,000 (5,600,000) 8,400,000 7,200,000 $1,200,000
$1,200,000 z 60%* = $2,000,000 = before tax loss from discontinued operations. *1-tax rate of 40% = 60% Pretax income of division Add: Loss from discontinued operations Impairment loss Fair value of divisions assets Add: Impairment loss Book value of divisions assets $4,000,000 2,000,000 $6,000,000 $11,000,000 6,000,000 $17,000,000
4-27
Exercise 4-9
Requirement 1 In general, we report voluntary changes in accounting principles retrospectively. However, a change in depreciation method is considered a change in accounting estimate resulting from a change in accounting principle. In other words, a change in the depreciation method reflects a change in the (a) estimated future benefits from the asset, (b) the pattern of receiving those benefits, or (c) the companys knowledge about those benefits, and therefore the two events should be reported the same way. Accordingly, Canliss reports the change prospectively; previous financial statements are not revised. Instead, the company simply employs the straight-line method from now on. The undepreciated cost remaining at the time of the change would be depreciated using the straight-line method over the remaining useful life. A disclosure note should justify that the change is preferable and should describe the effect of the change on any financial statement line items and per share amounts affected for all periods reported. Requirement 2 Assets cost Accumulated depreciation to date ($320,000 + 192,000) To be depreciated over remaining 3 years 2011 straight-line depreciation: $288,000 3 years = $96,000 Adjusting entry: Depreciation expense (calculated above) ..................... Accumulated depreciation ...................................... 96,000 96,000
4-28
Exercise 4-10
Requirement 1 This is a change in accounting estimate. Requirement 2 When an estimate is revised as new information comes to light, accounting for the change in estimate is quite straightforward. We do not restate prior years' financial statements to reflect the new estimate. Instead, we merely incorporate the new estimate in any related accounting determinations from there on. If the after-tax income effect of the change in estimate is material, the effect on net income and earnings per share must be disclosed in a note, along with the justification for the change. Requirement 3 $800,000 $160,000 x 2 years 320,000 480,000 6 yrs. $ 80,000 Cost Previous annual depreciation ($800,000 5 years) Depreciation to date (2009-2010) Book value Estimated remaining life (8 years - 2 years) New annual depreciation
4-29
Exercise 4-11
Requirement 1 This is a change in accounting estimate. Requirement 2 $2,400,000 $240,000 x 21/2 yrs. 600,000 1,800,000 5 yrs. $ 360,000
Cost Previous annual amortization ($2,400,000 10 years) Amortization to date (2009-2011) Book value Estimated remaining life (given) New annual amortization
Exercise 4-12
Earnings per share: Income from continuing operations Loss from discontinued operations Extraordinary gain Net income $5.00 (1.60) 2.20 $5.60
4-30
Exercise 4-13
Requirement 1
THE MASSOUD CONSULTING GROUP Statement of Income and Comprehensive Income (in part) For the Year Ended December 31, 2011 Net income ......................................................... Other comprehensive income (loss): Foreign currency translation gain, net of tax ... Unrealized losses on investment securities, net of tax ...................................................... Total other comprehensive income .................... Comprehensive income ...................................... $1,354,000 $168,000 (56,000) 112,000 $1,466,000
Requirement 2
THE MASSOUD CONSULTING GROUP Statement of Comprehensive Income For the Year Ended December 31, 2011 Net income ......................................................... Other comprehensive income (loss): Foreign currency translation gain, net of tax ... Unrealized losses on investment securities net of tax ...................................................... Total other comprehensive income .................... Comprehensive income ...................................... $1,354,000 $168,000 (56,000) 112,000 $1,466,000
4-31
Exercise 4-14
Requirement 1 U.S. GAAP also permits the presentation of other comprehensive income items in the statement of shareholders equity. Requirement 2 IAS No. 1 also allows companies to report other comprehensive income items in either a combined statement of income and comprehensive income or in a separate statement of comprehensive income. Presentation in the statement of shareholders equity is not permitted.
Exercise 4-15
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. b a a c b c b a d c c Purchase of equipment for cash. Payment of employee salaries. Collection of cash from customers. Cash proceeds from a note payable. Purchase of common stock of another corporation for cash. Issuance of common stock for cash. Sale of machinery for cash. Payment of interest on note payable. Issuance of bonds payable in exchange for land and building. Payment of cash dividends to shareholders. Payment of principal on note payable.
4-32
Exercise 4-16
Bluebonnet Bakers Statement of Cash Flows For the Year Ended December 31, 2011 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 Cash flows from investing activities: Collection of note receivable Sale of investments Purchase of equipment Net cash flows from investing activities 50,000 30,000 (85,000) (5,000)
$131,000
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 Net increase in cash Cash and cash equivalents, January 1 Cash and cash equivalents, December 31
4-33
Exercise 4-17
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 (E4-16) or could be presented as follows: Bluebonnet Bakers Statement of Cash Flows For the Year Ended December 31, 2011 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 Cash flows from investing activities: Collection of note receivable Interest on note receivable Sale of investments Purchase of equipment Net cash flows from investing activities 50,000 6,000 30,000 (85,000) 1,000
$110,000
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 Net increase in cash Cash and cash equivalents, January 1 Cash and cash equivalents, December 31
4-34
Exercise 4-18
Cash flows from operating activities: Net income Adjustments for noncash effects: Depreciation expense Changes in operating assets and liabilities: Increase in accounts receivable Decrease in inventory Decrease in prepaid insurance Decrease in salaries payable Increase in interest payable Net cash flows from operating activities $17,300 7,800 (4,000) 5,500 1,200 (2,700) 800 $25,900
Exercise 4-19
Requirement 1 1. 2. 3. 4. 5. 6. 7. 8. 9. Financing $300,000 Investing $(10,000) $ (5,000) (6,000) (70,000) 55,000
__________ __________ __________
Operating
$300,000
$(10,000)
$(26,000)
$264,000
4-35
4-36
Exercise 4-20
Cash flows from operating activities: Net income Adjustments for noncash effects: Depreciation and amortization expense Changes in operating assets and liabilities: Decrease in accounts receivable Increase in inventories Increase in prepaid expenses Increase in salaries payable Decrease in income taxes payable Net cash flows from operating activities $624,000 87,000 22,000 (9,200) (8,500) 10,000 (14,000) $711,300
4-37
Exercise 4-21
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, 2011 Cash flows from operating activities: Collections from customers Purchase of inventory Payment of operating expenses Net cash flows from operating activities Cash flows from investing activities: Interest on note receivable Dividends received from investments Collection of note receivable Purchase of equipment Net cash flows from investing activities Cash flows from financing activities: Payment of interest on note payable Proceeds from issuance of common stock Dividends paid Net cash flows from financing activities Net increase in cash Cash and cash equivalents, January 1 Cash and cash equivalents, December 31
4,000 2,400 100,000 (154,000) (47,600) (8,000) 200,000 (40,000) 152,000 204,400 28,600 $233,000
4-38
Exercise 4-22
Tiger Enterprises Statement of Cash Flows For the Year Ended December 31, 2011 ($ 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 Cash flows from financing activities: Proceeds from issuance of common stock 100 Proceeds from note payable 200 (940) Payment of dividends (1) Net cash flows from financing activities(640) Net increase in cash Cash, January 1 Cash, December 31
(1) Retained earnings, beginning + Net income - Dividends Retained earnings, ending $540 900 x $500
(300)
x = $940
4-39
Exercise 4-23
The T-account analysis of the transactions related to operating cash flows is shown below. To derive the cash flows, the beginning and ending balances in the related assets and liabilities are inserted, together with the revenue and expense amounts from the income statements. In each balance sheet account, the remaining (plug) figure is the other half of the cash increases or decreases.
Cash Flows (Operating) (a.) 7,080 (b.) 130 (c.) 3,460 (d.) 1,900 (e.) 550 Sales Revenue Accounts Receivable 1/1 830 (a.) 7,080 7,000 <-----------> 7,000 12/31 750 Insurance Expense 100
1/1
Prepaid Insurance 20 (b.) 130 100 <-----------> 12/31 50 Accounts Payable (c.) 3,460 1/1
Inventory 360 1/1 600 3,400 <-----------> 3,400 12/31 300 12/31 640
3,360 <----------->
Admin. & Other Payables Admin. & Other Expense (d.) 1,900 1/1 400 1,800 <-----------> 1,800 12/31 300 Income Taxes Payable (e.) 550 1/1 150 600 <-----------> 12/31 200 Income Tax Expense 600
Based on the information in the T-accounts above, the operating activities section of the SCF for Tiger Enterprises would be as shown next.
4-40
Exercise 4-23 (concluded) Tiger Enterprises Statement of Cash Flows For the Year Ended December 31, 2011 ($ 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
4-41
Exercise 4-24
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 is FASB ASC 26010501: Earnings per ShareOverallDisclosure. 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.
4-42
Exercise 4-25
The FASB Accounting Standards Codification represents the single source of authoritative U.S. generally accepted accounting principles. The specific citation for each of the following items is: 1. The criteria for determining if a gain or loss should be reported as an extraordinary item: FASB ASC 22520452: Income StatementExtraordinary and Unusual ItemsOther Presentation MattersCriteria for Presentation as Extraordinary. Extraordinary items are events and transactions that are distinguished by their unusual nature and by the infrequency of their occurrence. Thus, both of the following criteria shall be met to classify an event or transaction as an extraordinary item: a. Unusual nature. The underlying event or transaction should possess a high degree of abnormality and be of a type clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the entity, taking into account the environment in which the entity operates. b. Infrequency of occurrence. The underlying event or transaction should be of a type that would not reasonably be expected to recur in the foreseeable future, taking into account the environment in which the entity operates. 2. The calculation of the weighted average number of shares for basic earnings per share purposes: FASB ASC 26010552: Earnings per ShareOverallImplementation Guidance and IllustrationComputing a Weighted Average. The weighted-average number of shares is an arithmetical mean average of shares outstanding and assumed to be outstanding for EPS computations. The most precise average would be the sum of the shares determined on a daily basis divided by the number of days in the period. Less-precise averaging methods may be used, however, as long as they produce reasonable results. Methods that introduce artificial weighting, such as the Rule of 78 method, are not acceptable for computing a weighted-average number of shares for EPS computations.
4-43
3.
The alternative formats permissible for reporting comprehensive income: FASB ASC 22010458: Comprehensive IncomeOverallOther Presentation ItemsAlternative Formats for Reporting Comprehensive Income. An entity shall display comprehensive income and its components in a financial statement that is displayed with the same prominence as other financial statements that constitute a full set of financial statements. This Subtopic does not require a specific format for that financial statement but requires that an entity display net income as a component of comprehensive income in that financial statement. Examples 1 through 2 (paragraphs 220-10-55-4 through 5527) provide illustrations of the components of other comprehensive income and total comprehensive income being reported below the total for net income in a statement that reports results of operations, in a separate statement of comprehensive income that begins with net income, and in a statement of changes in equity.
4.
The classifications of cash flows required in the statement of cash flows: FASB ASC 23010451: Statement of Cash FlowsOverallOther Presentation MattersForm and Content. A statement of cash flows shall report the cash effects during a period of an entity's operations, its investing transactions, and its financing transactions.
4-44
Exercise 4-26
List A f g 1. Intraperiod tax allocation 2. Comprehensive income List B a. Unusual, infrequent, and material gains and losses. b. Starts with net income and works backwards to convert to cash. c. Reports the cash effects of each operating activity directly on the statement. d. Correction of a material error of a prior period. e. Related to the external financing of the company. f. Associates tax with income statement item. g. Total nonowner change in equity. h. Related to the transactions entering into the determination of net income. i. Related to the acquisition and disposition of long-term assets. j. Required disclosure for publicly traded corporation. k. A component of an entity. l. Directly related to principal revenuegenerating activities.
d 7. Prior period adjustment e 8. Financing activities h 9. Operating activities (SCF) i 10. Investing activities c 11. Direct method b 12. Indirect method
4-45
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. d. The change in the estimate for warranty costs is based on new information obtained from experience and qualifies as a change in accounting estimate. A change in accounting estimate affects current and future periods and is not accounted for by restating prior periods. The accounting change is a part of continuing operations. 6. a. Dividends paid to shareholders is considered a financing cash flow, not an operating cash flow. 7. c. Issuing common stock for cash is considered a financing cash flow, not an investing cash flow.
4-46
4-47
PROBLEMS
Problem 4-1
REED COMPANY Comparative Income Statements For the Years Ended December 31 Sales revenue ...................................................... [1] Cost of goods sold ............................................... [2] Gross profit ......................................................... Operating expenses: Administrative .................................................. [3] Selling .............................................................. [4] Loss from fire damage ....................................... Loss from write-down of obsolete inventory ...... Total operating expenses ............................... Operating income ................................................ Other income (expense): Interest revenue ................................................. Interest expense ................................................. Total other expenses (net) .............................. Income from continuing operations before income taxes and extraordinary item .............. Income tax expense ............................................. Income from continuing operations before extraordinary item ............................................ Discontinued operations: Income (loss) from operations of discontinued component (including loss on disposal of $50,000 in 2011) ............................................. Income tax benefit (expense) ............................... Income (loss) on discontinued operations ......... [5] Income before extraordinary item ........................ Extraordinary item: Loss from earthquake (net of $40,000 tax benefit) . Net income ..........................................................
Earnings per share: Income from continuing operations before extraordinary item................................................... Discontinued operations ........................................... Extraordinary loss .................................................... Net income ................................................................
2011 $4,000,000 2,570,000 1,430,000 750,000 340,000 50,000 35,000 1,175,000 255,000 150,000 (200,000) (50,000) 205,000 82,000 123,000
[6] [7]
2010 $3,000,000 1,680,000 1,320,000 635,000 282,000 --917,000 403,000 140,000 (200,000) (60,000) 343,000 137,200 205,800
[8] [9]
4-48
Problem 4-1 (concluded) [1] $4,400,000 - 400,000 [2] [3] [4] $2,860,000 - 290,000 $800,000 - 50,000 $360,000 - 20,000
[5] Loss in 2011: Operating income Loss on sale of assets Loss before tax benefit Tax benefit (40% x $10,000) Loss on discontinued operations, net of tax benefit [6] [7] [8] [9]
$3,500,000 - 500,000 (sales from discontinued operation) $2,000,000 - 320,000 (cost of goods sold from discontinued operation) $675,000 - 40,000 (administrative expenses from discontinued operations) $312,000 - 30,000 (selling expenses from discontinued operations)
4-49
Problem 4-2
Requirement 1 JACKSON HOLDING COMPANY Comparative Income Statements (in part) For the Years Ended December 31 2011 Income from continuing operations before income taxes [1] ........................................ $3,000,000 Income tax expense ........................................ 1,200,000 Income from continuing operations ................ 1,800,000 Discontinued operations: Income from operations of discontinued component (including gain on disposal of $600,000 in 2011) [2] ...................................... 200,000 Income tax expense (benefit) ....................... 80,000 Income (loss) on discontinued operations .... 120,000 Net Income .................................................... $1,920,000
Income from continuing operations before income taxes: 2011 2010 Unadjusted $2,600,000 $1,000,000 300,000 Add: Loss from discontinued operation 400,000 Adjusted $3,000,000 $1,300,000 Income from discontinued operations: 2011 Operating loss $(400,000) Gain on disposal 600,000 Total $ 200,000 [2]
[1]
4-50
Problem 4-2 (concluded) Requirement 2 The 2011 income from discontinued operations would include only the operating loss 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 2011 income from discontinued operations would include the operating loss 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).
4-51
Problem 4-3
Requirement 1 MICRON CORPORATION Partial Income Statement For the Year Ended December 31, 2011 Income from continuing operations before income taxes and extraordinary item ....... Income tax expense ................................... Income from continuing operations ........... Discontinued operations: Loss from operations of discontinued component (including loss on disposal of $300,000) ............................................... Income tax benefit .................................. Loss on discontinued operations ............. Income before extraordinary item ............. Extraordinary item: Loss from earthquake (net of $240,000 tax benefit) ..................... Net Income ...............................................
[1] $1,300,000 390,000 910,000
(560,000) $ 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: Operating income Deduct: Loss on sale of assets Loss before tax Tax benefit (30% x $140,000) Loss on discontinued operations $ 160,000 (300,000) (140,000) 42,000 $ (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.
4-52
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 2010 financial statements should be restated to reflect the correction, and a disclosure note is required that communicates the impact of the error on 2010 income.
4-53
Problem 4-5
ALEXIAN SYSTEMS, INC. Income Statement For the Year Ended December 31, 2011
($ in millions except per share date)
Net sales revenue ............................................... Cost of goods sold .............................................. Gross profit ........................................................ Operating expenses: Selling and administrative ............................... Restructuring costs .......................................... Total operating expenses .............................. Operating income ............................................... Other income: Interest revenue ............................................... Gain on sale of investments ............................. Total other income ....................................... Income before income taxes and extraordinary item ................................................................ Income tax expense ............................................ Income before extraordinary item ...................... Extraordinary gain (net of $48 in taxes) ..................... Net income ......................................................... Earnings per share: Income before extraordinary item ...................... Extraordinary gain ............................................. Net income .........................................................
[1] $270 - 5 (prior period adjustment) [2] $154 - 26 (restructuring costs) [3] 40% x $15 [4] $120 less taxes of $48 (40% x $120) [2] $128
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 $5 million, less the 40% tax effect.
4-54
Problem 4-6
REMBRANDT PAINT COMPANY Income Statement For the Year Ended December 31, 2011
($ in thousands, except per share amounts)
Sales revenue ................................................................. Cost of goods sold .......................................................... Gross profit .................................................................... Operating expenses: Selling and administrative ........................................... Restructuring costs ...................................................... Operating income ........................................................... Interest income (expense), net ........................................ Income from continuing operations before income taxes and extraordinary item ................................................ Income tax expense ........................................................ Income from continuing operations before extraordinary item ............................................................................ Discontinued operations: Income from operations of discontinued component
(including gain on disposal of $2,000) ................................
Income tax expense ..................................................... Income on discontinued operations ............................. Income before extraordinary item ................................... Extraordinary gain (net of $900 tax expense) ..................... Net income...................................................................... Earnings per share: Income from continuing operations before extraordinary item ............................................................................. Income on discontinued operations ................................ Extraordinary gain ......................................................... Net income .....................................................................
4-55
Problem 4-7
SCHEMBRI MANUFACTURING CORPORATION Combined Statement of Income and Comprehensive Income For the Year Ended December 31, 2011 ($ in 000s) Sales revenue ............................................................... Cost of goods sold ........................................................ Gross profit .................................................................. Operating expenses: Selling ....................................................................... General and administrative ........................................ Restructuring costs .................................................... Total operating expenses ....................................... Operating income ......................................................... Other income (expense): Loss on sales of investments ........................................... Interest expense .............................................................. Interest revenue .............................................................. Other income (expense) ............................................... Income from continuing operations before income taxes and extraordinary item .................................................... Income tax expense ...................................................... Income from continuing operations before extraordinary item ........................................................................... Discontinued operations: Income from operations of discontinued component (including gain on disposal of $1,400) ..................... Income tax expense ................................................... Income from discontinued operations ........................ Income before extraordinary item ................................. Extraordinary item: Loss from earthquake (net of $800 tax benefit) .......... Net income .................................................................... Other comprehensive income: Unrealized gains from investments (net of $128 tax) Loss from foreign currency translation (net of $96 tax) Comprehensive income $15,300 6,200 9,100 $1,300 800 1,200 3,300 5,800 $(220) (180) 85 (315) 5,485 2,194 3,291
48 $2,643
4-56
Earnings per share:* Income from continuing operations before extraordinary item Discontinued operations Extraordinary loss Net income *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.
4-57
Problem 4-8
DUKE COMPANY Statement of Income and Comprehensive Income For the Year Ended December 31, 2011
Sales revenue ............................................................... Cost of goods sold ........................................................ Gross profit .................................................................. Operating expenses: General and administrative ........................................ Selling ...................................................................... Restructuring costs .................................................... Loss from write-down of obsolete inventory Total operating expenses ......................................... Operating income ......................................................... Other income (expense): Interest expense ......................................................... Income before income taxes and extraordinary item ..... Income tax expense ...................................................... Income before extraordinary item ................................. Extraordinary item: Loss from expropriation of overseas plant (net of $1,200,000 tax benefit) .......................................... Net Income .................................................................... Other comprehensive income (loss): Foreign currency translation adjustment loss, net of tax Unrealized gains on investment securities, net of tax Total other comprehensive loss Comprehensive income $1,000,000 500,000 300,000 400,000 2,200,000 3,800,000 (700,000) 3,100,000 1,240,000 1,860,000 $15,000,000 9,000,000 6,000,000
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.
4-58
Problem 4-9
Requirement 1 Diversified Portfolio Corporation Statement of Cash Flows For the Year Ended December 31, 2011 Cash flows from operating activities: Collections from customers (1) Payment of operating expenses (2) Payment of income taxes (3) Net cash flows from operating activities Cash flows from investing activities: Sale of investments Net cash flows from investing activities Cash flows from financing activities: Proceeds from issue of common stock Payment of dividends Net cash flows from financing activities Increase in cash Cash and cash equivalents, January 1 Cash and cash equivalents, December 31
50,000 50,000
(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.
4-59
Problem 4-9 (concluded) Requirement 2 Diversified Portfolio Corporation Statement of Cash Flows For the Year Ended December 31, 2011 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
4-60
Problem 4-10
Requirement 1 2010 Cash: 2010 Cash + Net increase in cash = 2011 Cash 2010 Cash + 86 = 145 2010 Cash = 59 2011 A/R: 2010 A/R + Cr. Sales Cash collections = 2011 A/R 84 + 80 71 = 93 2010 Inventory: 2010 A/P + Purchases Cash Paid = 2011 A/P 30 + Purchases 30 = 40 Therefore, Purchases = 40 2010 Inventory + Purchases 2011 Inventory = Cost of goods sold 2010 Inventory + 40 60 = 32 2010 Inventory = 52 2010 Accumulated depreciation: 2011 accumulated depreciation less 2011 depreciation = 2010 accumulated depreciation 65 10 = 55
4-61
Problem 4-10 (continued) 2010 Total assets: $59 + 84 + 52 + 50 + 150 55 = $340 2011 Total assets: $145 + 93 + 60 + 150 65 = $383 2010 Income taxes payable: 2010 Inc. taxes payable + Inc. tax expense Income taxes paid = 2011 Inc. taxes payable 2010 Inc. taxes payable =2011 Inc. taxes payable + Taxes paid Inc. tax expense 2010 Inc. taxes payable = 22 + 9 7 = $24 2011 Retained earnings: 2010 R/E + Net income Dividends = 2011 R/E 72 47 + 28 3 = 2010 Total liabilities and shareholders equity: $30 + 9 + 24 + 230 + 47 = $340 2011 Total liabilities and shareholders equity: $40 + 9 + 22 + 240 + 72 = $383
4-62
Problem 4-10 (concluded) Requirement 2 Grandview Corporation Statement of Cash Flows For the Year Ended December 31, 2011
($ in millions)
Cash flows from operating activities: Net income Adjustments for noncash effects: Depreciation expense Gain on sale of investments Changes in operating assets and liabilities: Increase in accounts receivable1 Increase in inventory2 Increase in accounts payable3 Decrease in income taxes payable4 Net cash flows from operating activities
1 2 3 4
4-63
Problem 4-11
Santana Industries Statement of Cash Flows For the Year Ended December 31, 2011 ($ in thousands) Cash flows from operating activities: Net income Adjustments for noncash effects: Depreciation expense Changes in operating assets and liabilities: Increase in accounts receivable Increase in inventory Decrease in prepaid rent Increase in accounts payable Increase in interest payable Increase in unearned service revenue Decrease in income taxes payable Net cash flows from operating activities Cash flows from investing activities: Purchase of equipment Sale of equipment Net cash flows from investing activities $ 3,850 1,600 (300) (1,000) 150 300 100 200 (250) $4,650 (4,000) 500 (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 Cash, January 1 Cash, December 31 5,150 2,200 $7,350
4-64
CASES
4-65
4-66
*New accounting standards discussed in Chapters 10 and 11 require that goodwill no longer be amortized. This standard became effective after August of 2001.
4-67
4-68
_____
_____
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
4-69
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.
4-70
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.
4-71
4-72
4-73
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 is 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.
4-74
Situation 1. 2. 3. 4. 5. 6. 7. 8.
Treatment (a-g) b c f g a b e d.
4-75
4-76
4-77
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.
4-78
Requirement 2 The authors use the S&P 500 companies as their sample. Requirement 3 77 percent 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.
4-79
4-80
Requirement 2 Provision for income taxes Income before taxes $846 $3,324 = 25% = approximate income tax rate Requirement 3 $2,478 $61,101 = 4%
4-81
4-82