50 Minutes, Strong
a.
Stockholders’ equit
y
:
Capital stock:
Common stock, $1 par, 100,000 shares authorized,
20,000 shares issued, 16,000 shares outstandin
g
20,000$
Stock dividend to be distributed
(
1
)
1,600
PROBLEM 12.8B
A
DAMS CORPORATIO
N
December 31, 201
5
Partial Balance Shee
t
A
DAMS CORPORATIO
N
48
528
1
$
(1
49
800
$
y
1
1
$
6
A
N
t
25 Minutes, Strong
CORP.
a.
(Dollars in
Th
ousan
d
s
)
Loss from continuing operations (38,940)$
Income from discontinued operations 24,000
Loss before extraordinary loss (14,940)$
Extraordinary loss on expropriation of foreign subsidiary (17,500)
b.
Net loss (32,440)$
PROBLEM 12.9B
CARDINAL MANUFACTURING CORPORATIO
N
For the Year Ended December 31, 20xx
Partial Income Statement
CARDINAL MANUFACTURIN
G
Education.
20 Minutes, Easy
a.
b.
SOLUTIONS TO CRITICAL THINKING CASE
S
WHAT’S THIS?
CASE 12.1
Both the operating loss from the noncoal minerals activities and the loss on disposal should be
classified in the income statement as discontinued operations and should be shown separately
A change in the estimated useful life of depreciable assets is a change in accounting estimate.
Education.
20 Minutes, Medium
a.
b.
c.
d.
CASE 12.2
Given that the baseball team was sold in 2015, JPI should earn a net income of approximately
The operating loss incurred by the baseball team in 2015 indicates that the team’s expenses (net of tax
If JPI had not sold the baseball team at the end of 2015, it still would have incurred the team’s
$1,300,000 operating loss for the year. However, the company would not have realized the $4,700,000
In 2015, JPI’s newspaper business earned $4,500,000, as shown by the subtotal, Income from
Continuing Operations. If the profitability of these operations increased by 7% in 2016, they would
IS THERE LIFE WITHOUT BASEBALL
?
30 Minutes, Strong
a.
b.
CASE 12.3
USING EARNINGS PER SHARE STATISTIC
S
The company reports earnings per share computed on both a basic and a diluted basis
because it has outstanding convertible preferred stock. The conversion of these securities
It is important to recognize that diluted earnings represent a hypothetical case. The
convertible securities have not actually been converted into common shares as of the close of
the current year.
The total dollar amount of the company’s extraordinary loss can be computed from the
earnings per share information as follows:
35 Minutes, Strong
a.
CASE 12.
4
INTERPRETING A STATEMENT O
F
STOCKHOLDERS’ EQUIT
Y
Beginning of year: 77,987,500 shares outstanding (82,550,000 issued 4,562,500 held in
treasury)
60 Minutes, Strong
a.
b.
c. 1.
CASE 12.5
An asset represents something with future economic benefit. But if the amount at which the
asset is presented in the balance sheet (i.e., its book value) cannot be recovered through
Although materiality in terms of size is important, size alone does not qualify a loss as an
extraordinary item. Nor does the fact that the item is not routine.
To qualify as extraordinary, an event should be unusual in nature, and not be expected to
Note to instructor: We do not consider this answer cut and dried. If these assets had been
expropriated, the losses would be classified as extraordinary. These assets have not been
expropriated—nor is there any indication that they will be. Nonetheless, there are some
parallels between this situation and an expropriation of assets by a foreign government. These
similarities may be set forth as an argument for classifying the losses as extraordinary.
CLASSIFICATION OF UNUSUAL ITEMS
—
AND THE POTENTIAL FINANCIAL IMPACT
Net income will be reduced by the same amount regardless of whether these losses are
Education.
f.
g.
Note to instructor: This case is adapted from an incident involving an international
pharmaceutical company. The details of the situation have been altered for the purpose of
creating an introductory level textbook assignment, and the so-called quotations from corporate
officers are entirely fictitious. Nonetheless, we believe that the outcome of the actual event
provides insight into the financial reporting process and also to the importance that investors
attach to the various computations of earnings per share.
Management originally classified the losses as extraordinary, and the auditors concurred. The
SEC, however, did not agree. It insisted that the corporation revise and reissue its financial
statements—with the controversial items classified as ordinary operating losses. When the
company announced the reclassification of these losses, its stock price fell substantially—despite
the fact that the reported amount of net income remained unchanged.
In summary, the adverse effects of these losses on the company’s stock price are likely to be
greater if the losses are classified as ordinary, rather than extraordinary. Therefore,
management has a self-interest in seeing these losses classified as an extraordinary item.
These write-offs are likely to increase the earnings reported in future periods, especially if
the company continues to do business in any of the related countries. With the assets having
The ethical dilemma is the classification of these losses. Because of the probable effects upon
In management’s shoes, how would you classify these losses? (We find this question easier to
ask than to answer.)
CASE 12.5
CLASSIFICATION (continued
)
The classification of these losses may well affect Elliot-Cole’s stock price. Investors consider
income from continuing operations a predictive subtotal. If the losses are classified as
effect upon stock price. But if the losses are classified as extraordinary, the per-share
earnings used in the computation of the company’s p/e ratio will not be affected.
Education.
30 Minutes, Medium
The fact that sales are sluggish but net income is steadily increasing at least raises an issue that
should be explored. All other things being equal, which they rarely are, one would not expect this
occur. One might expect sluggish sales to result in similarly sluggish net income in the absence of
some mitigating circumstances. Relationships of this type are things auditors should be conscious
of and, when encountered, auditors should seek explanations to insure that no errors have been
made and that nothing improper has taken place.
A possible explanation that is at least worth exploring is whether management has taken
conscious steps to overstate inventory. The motivation would be to increase reported net income
to enhance the position of management. The relationship of inventory to net income is as follows:
an overstatement of inventory is offset by an understatement of cost of goods sold which, in turn,
overstates net income. By overstating inventory, either intentionally or in error, net income is
improved and the company appears to be more profitable that it actually is.
CASE 12.6
MANAGING PROFITABILIT
Y
This case is tended to encourage students to think about how certain financial statement numbers
should ordinarily be expected to move in relation to other numbers (e.g., net income in
comparison with sales) and steps that might be taken by management to manage, or manipulate
profitability. While there may be logical reasons for the specific changes identified in three
bulleted items in the case statement that do not imply improper actions by management, the fact
that their evaluation is, at least in part, based on profit performances raised an important issue
that should be kept in mind by auditors.
We do not attempt in this solution to write the report that is required in the instructions in the
case, but rather to provide some ideas of how students might respond to each of the bulleted
items.
Relationship of sales revenue and net income
The case statement indicates that it is particularly important for Flexcom, Inc. to control its
inventory because of the highly competitive market in which they operate and the sensitivity of
inventory to changes in consumer demand and technology changes. This sounds as if competition
obsolescence problem and simply can’t sell its inventory which is building up. If inventory
obsolescence is an issue, the fact that the allowance for inventory obsolescence has significantly
declined raises an interesting question that is worthy of further exploration.
ETHICS, FRAUD & CORPORATE GOVERNANC
E
Education.
MANAGING PROFITABILITY (concluded
)
Reduction in allowance for inventory obsolescence
Understating the allowance overstates the net inventory amount, which results in an
understatement of cost of goods sold, which inflates net income.
The allowance to reduce inventory for obsolescence functions much as an allowance for
uncollectible accounts does to reduce accounts receivable to their net realizable value. If
inventory includes some obsolescence, but the specific obsolete items are not known in advance,
an allowance is established to reduce the total inventory to a lower recoverable amount with the
specific items that include the obsolescence to be determined at some later time. From the
since the net amount of the total inventory, less the allowance, is the inventory amount shown in
the balance sheet as an asset and used in the determination of cost of goods sold in the income
statement.
Education.
30 Minutes, Medium
STOCKHOLDERS’ EQUITY AND EPS
CASE 12.7
INTERNET
The following answers are based on information from March 22, 2013 (part a.) and
2012 annual financial statements for the remaining parts.
a. On March 22, 2013, Martin Marietta’s stock sold for a high of $103.92 and a low of
$102.50. These amounts will vary for other dates.
b. The number of shares of common stock outstanding on Dec. 31, 2012 was
c. There is no direct relationship between the amount the stock originally sold for and
the current market price of the stock. The original price at which the stock was sold is a
historical amount that represents the investment of owners in the company while the
current market price reflects a number of factors, including the long-term performance
of the company and many other factors directly and indirectly related to the company’s
performance.
d. The three-year trend in basic earnings per share (EPS), including discontinued
average number is used in computing EPS.
Education.