Chapter 11 Evaluating Performance: Earnings Quality, the Income Statement, & the Statement of Comprehensive Income
11-1
Chapter 11
Evaluating Performance: Earnings
Quality, the Income Statement & the
Statement of Comprehensive Income
Short Exercises
(5-10 min.) S 11-1
There are several ways that companies improperly recognize revenue
which results in financial statement fraud whereby revenues are
overstated.
a. “Channel stuffing” where a company may ship inventory to regular
customers in amounts in excess of the amounts ordered by the
customer. This usually occurs near the end of the reporting period so
that the excess merchandise cannot be returned to the seller prior to the
preparation of the financial statements.
Chapter 11 Evaluating Performance: Earnings Quality, the Income Statement, & the Statement of Comprehensive Income
11-3
(10 min.) S 11-2
Req. 1
Gross profit = $903,935 thousand ($1,917,425 − $1,013,490)
Req. 2
Income from continuing operations = $194,910 thousand.
(10-15 min.) S 11-3
Fisher Fine Coffees, Inc.
Income Statement
Year Ended December 31, 2014
(Thousands)
Net sales revenue ………………………………………………………….
$197,000
Cost of goods sold ………………………………………………………..
73,000
Gross profit ……………………………………………………………………
124,000
Operating expenses ……………….. ………………………………
65,000
Operating income…………………………………………………………..
59,000
Other gains (losses) ………………………………………………………
(19,000)
Income from continuing operations before income tax …..
40,000
Income tax expense (35%) ……………………………………………..
14,000
Income from continuing operations ……………………………….
26,000
Loss on discontinued operations, $13,000,
less income tax savings of $4,550 ………………………………
(8,450)
Income before extraordinary item …………………………………..
17,550
Extraordinary gain, $3,000,
less income tax of $1,050 …………………………………………..
1,950
Net income …………………………………………………………………….
$ 19,500
(10-15 min.) S 11-4
(10-15 min.) S 11-6
Req. 1
Journal
DATE
ACCOUNT TITLES AND EXPLANATION
DEBIT
CREDIT
Apr.
24
Cash (850,000 pesos × $0.099) ………………..
84,150
Accounts Receivable
(850,000 pesos × $0.094) ……………….
79,900
Foreign-Currency Transaction Gain ….
4,250
Collection on account.
Req. 2
Oct.
25
Accounts Payable
(21,000 Swiss francs × $1.12) ………………….
23,520
Foreign-Currency Transaction Loss ………..
420
Cash (21,000 Swiss francs × $1.14) ……
23,940
Payment on account.
Req. 3
Chapter 11 Evaluating Performance: Earnings Quality, the Income Statement, & the Statement of Comprehensive Income
11-7
(15 min.) E 11-7
Req. 1
The discontinued operations were more like a revenue. This is clear from
the fact that their amount is added in determining net income.
Req. 2
(5-10 min.) S 11-8
Journal
DATE
ACCOUNT TITLES AND EXPLANATION
DEBIT
CREDIT
1.
Income Tax Expense ($171,000 × .30) …………
51,300
Income Tax Payable ($152,000 × .30) ……..
45,600
Deferred Tax Liability …………………………...
5,700
Recorded income tax for the year.
2.
INCOME STATEMENT
Income before income tax …………………………
$171,000
Income tax expense ………………………………….
(51,300)
Net income ……………………………………………….
$119,700
BALANCE SHEET
Current liabilities:
Income tax payable ……………………………….
$45,600
Long-term liabilities:
Deferred tax liability ……………………………..
5,700
(10-15 min.) S 11-9
Earnings per share of common stock
(10,000 shares of common stock outstanding):
Income from continuing operations
[($26,000 − $5,000) / 10,000] ……………………………………..
$2.10
Loss on discontinued operations, net of tax
($8,450 / 10,000) ………………………………………………………
(0.85)
Income before extraordinary item
[($17,550 − $5,000) / 10,000] ……………………………………..
1.25
Extraordinary gain, net of tax ($1,950 / 10,000) ……………..
.20
Net income [($19,500 − $5,000) / 10,000] ……………………….
$1.45
Chapter 11 Evaluating Performance: Earnings Quality, the Income Statement, & the Statement of Comprehensive Income
11-9
(5-10 min.) S 11-10
Req. 1
Fisher Fine Coffees, Inc.
Statement of Comprehensive Income
Year Ended December 31, 2014
(in
thousands)
Net income …………………………..…………………………..
$19,500
Other comprehensive income:
Unrealized gains on investments in AFSS, net of
tax ……………………………………………………….………
$2,300
Foreign-currency translation gain, net of tax ….
2,900
5,200
Comprehensive income …………………………………….
$24,700
Req. 2
(10 min.) S 11-11
Req. 1
Earnings
=
Net income − preferred dividends
per share
Weighted-average number of common shares
outstanding
Req. 2
Earnings per share of common stock:
Income (loss) from continuing operations …………………………..
$X.XX
Income (loss) from discontinued operations ……………………….
.XX
Income (loss) before extraordinary item ……………………………..
X.XX
Extraordinary gain or loss………………………………………………….
.XX
Net income (net loss) …………………………………………………………
$X.XX
Req. 3
Earnings per share is useful because it relates a company’s income to
Chapter 11 Evaluating Performance: Earnings Quality, the Income Statement, & the Statement of Comprehensive Income
11–11
(10 min.) S 11-12
iLife Inc.
Statement of Retained Earnings
Year Ended December 31, 2014
Retained earnings balance, December 31, 2013,
as originally reported ……………………………………………………
$ 56,000
Prior period adjustment — debit to correct error
in 2013 …………………………………………………………………………
(12,500)
Retained earnings balance, December 31, 2013,
as adjusted ………………………………………………………………….
43,500
Net income for 2014 …………………………..……………………………..
73,000
Subtotal
116,500
Dividends declared for 2014 ……………………………………………..
(31,000)
Retained earnings balance, December 31, 2014 ………………….
$ 85,500
(10-15 min.) S 11-13
Req. 1
A segment is any subset or division of a business that earns revenues
and incurs expenses. Typically, large corporations have segments that
Req. 2
Segment reporting provides the user with more detailed information
about a company and its different types of business activities, and the
(10-15 min.) S 11-14
Req. 1
Management of Meinike Computer Inc. is responsible for the company’s
financial statements.
Req. 2
Req. 5
The audit covered Meinike’s consolidated balance sheets at September
30, 2014, and September 30, 2013, and consolidated income statements
(continued) S 11-14
statements of shareholders’ equity and cash flows for each of the three
Chapter 11 Evaluating Performance: Earnings Quality, the Income Statement, & the Statement of Comprehensive Income
11–15
Exercises
(15-20 min.) E 11-15A
Req.1
Armstrong Cycles, Inc.
Income Statement
Year Ended September 30, 2014
Thousands
Net sales ………………………………………………………………….
$14,300
Total operating expenses ………………………………………….
12,200
Income from continuing operations before
income tax ………………………………………………………..
2,100
Income tax expense ………………………………………………….
635
Income from continuing operations …………………………..
1,465
Income from discontinued operations,
$320, less income tax, $94 …………………………………
226
Income before extraordinary item ……………………………..
1,691
Extraordinary loss, $12, less income tax saving, $4 ……
(8)
Net income ………………………………………………………………
$ 1,683
Req.2
Armstrong Cycles, Inc.
Statement of Comprehensive Income
Year Ended September 30, 2014
Thousands
Net income ………………………………………………………………
$1,683
Other comprehensive income (loss):
Unrealized gain on investments in AFSS, net of tax…
$ 39
Foreign-currency translation gain, net of tax …………..
310
Total other comprehensive income …………………………...
349
Comprehensive income
$2,032
(20-25 min.) E 11-16A
Req. 1
Taavon Book Company
Income Statement
Year Ended December 31, 2014
Thousands
Sales revenue …………………………………………………………..
$124,000
Other revenues ………………………………………………………..
1,700
Total revenue …………………………………………………………..
125,700
Total operating expenses ………………………………………….
101,600
Income tax expense ………………………………………………….
7,040
Net income ………………………………………………………………
$ 17,060
Earnings per share (EPS):
Net income ($17,060 / 1,000) ……………………………….
$17.06
Req. 2
The company’s quality of earnings would be considered to be very good,
based on it’s steady growth each year and no discontinued operations
during recent years.
Req. 3
Chapter 11 Evaluating Performance: Earnings Quality, the Income Statement, & the Statement of Comprehensive Income
11–17
(10-15 min.) E 11-17A
Estimated
EPS from
value of
=
continuing operations
one share of
Investment
Omega Inc. stock
capitalization rate
$75.60
=
$6.50
i
i
=
$6.50
=
8.6%
$75.60
(10-15 min.) E 11-18A
Req. 1
Journal
DATE
ACCOUNT TITLES AND EXPLANATION
DEBIT
CREDIT
June
9
Inventory ……………………………………………………..
4,368
Accounts Payable (560,000 yen × $.0078) …..
4,368
July
18
Accounts Payable ………………………………………..
4,368
Cash (560,000 yen × $.0072) ………………………
4,032
Foreign-Currency Transaction Gain …………..
336
22
Accounts Receivable (45,000 euros × $1.17) …..
52,650
Sales Revenue …………………………………………
52,650
28
Cash (45,000 euros × $1.14)…………………………..
51,300
Foreign-Currency Transaction Loss ………………
1,350
Accounts Receivable ………………………………..
52,650
Req. 2
On June 10, Cooper wanted the dollar to strengthen in order to pay
Moshu with yen that cost fewer dollars. That was what happened, and
(10 min.) E 11-19A
Req. 1
Income Tax Expense ($608,000 × .35) ………………..
212,800
Income Tax Payable ($495,000 × .35) …………….
173,250
Deferred Tax Liability …………………………………..
39,550
Req. 2
Tax to pay currently …………………………..…………………………...
Deferred tax liability ($25,600 + $39,550) …………………………..
(10 min.) E 11-21A
(Amounts in millions, except per-share amounts)
Earnings per share of common stock (640* shares
outstanding):
Income from continuing operations ($745 / 640) ……………..
$ 1.16
Income from discontinued operations, net of tax
($92 / 640)…………………………………………………………………..
0.14
Income before extraordinary gain ($837 / 640) ……………………
1.30
Extraordinary gain, net of tax ($6 / 640) ………………………….
.01
Net income ($843 / 640) …………………………………………………
$ 1.31
(10 min.) E 11-22A
Sparkle, Inc.
Statement of Retained Earnings
Year Ended December 31, 2014
(Millions)
Retained earnings balance, December 31, 2013,
as originally reported ……………………………………………………
$463
Prior-period adjustment …………………………………………………….
12
Retained earnings balance, December 31, 2013,
as adjusted …………………………………………………………………..
475
Net income for 2014 ………………………………………………………….
81
Subtotal
556
Dividends declared for 2014 ………………………………………………
(42)
Retained earnings balance, December 31, 2014 ………………….
$514
The prior-period adjustment does not affect net income for 2014.