P13–2
a. Bonus = 25% (Income from Operations Before Interest Expense – Interest Expense)
= 25% [$1,200,000 – ($1,000,000 8% Interest Rate)]
c. The decision whether to finance the plant expansion through an equity issue or through a debt issue is
worth $20,000 to the managers because the managers will receive an additional $20,000 in bonuses if
d. If interest expense was not considered to be an operating expense, the managers‘ bonus would be the
same whether the company issued debt or equity. In either case the bonus would be 25% of
P13–3
a. 1. Financing
2. Operating
b.
Raleigh Corporation
Income Statement
For the Year Ended December 31, 2015
Fees earned …………………………………………………………………….. $ 580,000
Expenses:
P13–3 Concluded
c. Comprehensive Income = Change in Equity from Non-owner Sources
= Revenues – Expenses + Gains – Losses + Cumulative
Accounting Adjustments
P13–4
a.
Income Statement Classification .
Sales Yes Usual and frequent
Sales returns Yes Usual and frequent
Cost of goods sold Yes Usual and frequent
P13–4 Concluded
Note: The loss on sale of food services division and the loss incurred by food services division would
be classified as a disposal of a business segment only if the food services division meets the
requirements of being a business segment as defined under GAAP. If the food services division
b.
Crozier Industries
Income Statement
For the Year Ended December 31, 2015
Revenue:
Sales revenue ………………………………………………………………. $ 977,000
Less: Sales returns …………………………..…………………………... (9,000)
Gain on sale of short-term investments ………………………….. 142,000
Total revenue……………………………………………………….………….. $ 1,110,000
Expenses:
Cost of goods sold………………………………………………………… $ 496,000
(net of tax benefit of $3,500) ……………………………………….. $ (6,500)
Loss on disposal of discontinued segment
(net of tax benefit of $700) ………………………………………….. (1,300)
Discontinued operations ………………………………………….. (7,800)
Income before extraordinary items ……………………………………. $ 189,150
Extraordinary gain on appropriated land (net of
taxes of $32,200) …………………………………………………………. 59,800
a.
1. Hurricanes are unusual in that they are not part of a company’s normal operations; however, they
2. A loss on the disposal of a business segment is not considered an extraordinary item. This item
3. This loss appears to be both unusual and infrequent; consequently, it should be classified as an
4. Writing off an open account receivable as uncollectible should not be disclosed on the income
5. Floods are unusual in that they are not part of a company’s normal operations. Although Arizona
does get flooding, particularly flash floods, the flooding would probably be considered to be
P13–6
a. Income from continuing operations (before taxes) $ 850,000
Income taxes 297,500
Income from continuing operations $ 552,500
b. Income tax expense = Income taxes on net income generated during 2015
= Income taxes on income from continuing operations + Income
P13–6 Concluded
c.
MTM Company
Statement of Retained Earnings
For the Year Ended December 31, 2015
d. The balance in the Income Tax Liability account would equal the beginning balance plus the entire
amount owed to the government for income taxes as of December 31, 2015 less tax payments made
during 2015. MTM has two sources of income taxes during 2015. The first source is the income tax on
P13–7
a. This allows the user of the financial statements to try and make estimates of the future potential
results of the company. Discontinued operations will not impact future revenues and expenses so this
b. An estimate of the number of shares outstanding is calculated by taking net earnings ($3,544.2) and
dividing it by the basic net earnings per share ($2.87) or 1,235 million shares.
c. The distinction between basic net earnings per share and diluted net earnings per share is that basic is
P13–8
a. The readers of the financial statements are interested in what operations and profitability are
likely to continue into the following year. Line items such as discontinued operations and
P13–8 Concluded
c. Earnings per share represents the net income that can be attached to each share that is currently
outstanding. If, however, additional shares become outstanding (due to, for example, the
P13–9
a.
1. Extraordinary losses are disclosed on the income statement net of the tax benefit after
discontinued operations but before the effect of changes in accounting methods.
5. The income effect due to change in accounting method would be disclosed net of the tax effect on
the income statement as the last item before net income.
b. Extraordinary items:
Extraordinary loss (net of tax benefit of $87,500) …………………………. (162,500)
P13–9 Concluded
c. Income from continuing operations…………………………..…. $ 3.00
Disposal of business segment ……………………………………… 0.16a
P13–10
Microbiology Labs
Income Statement
For the Year Ended December 31, 2015
Sales revenue…………………………..………………………………….. $ 10,000,000
Cost of goods sold ……………………………………………………….. 2,500,000
Gross profit ……………………………………………………….………… $ 7,500,000
Operating expenses ……………………………………………………… 750,000
Income from operations ……………………………………………….. $ 6,750,000
Extraordinary items:
Loss on retirement of bonds (net of tax benefit
of $28,000) ……………………………………………………….…… $ (52,000)
Earnings per share:
Income from continuing operations ………………………………………………………….. $ 2.17
The objectives of financial accounting are to allow prediction of future cash flows. Earnings
numbers are useful because they reflect changes in a company’s resources. Some measures such as
income from operations reflect amounts expected to persist in the future from the normal business
operations. Other measures, such as income from continuing operations, reflect an infrequent or
P13–11
a. The sale of the credit card division (disposal of a business segment) would be shown on the income
statement after net income from continuing operations; the segment would be separated into two
revenues and expenses”, on the income statement after the calculation of net operating income.
b. Sears’ performance over the two-year period is better measured when the one-time, non-recurring
items are removed from the analysis. The profitability of $309 million is not as strong as it appears,
P13–12
a. Recognized income and expense under IFRS is similar to comprehensive income under U.S. GAAP.
b. The SORIE would be presented as:
Net profit 1,800
Fair value gains(losses) on available-for-sale securities
P13–13
a. Adjusting journal entries
(1) Inventory (ending) (+A) ……………………………………………………….. 480,000
Cost of Goods Sold (E, –SE) …………………………………………………… 737,000
(3) Depreciation Expense (E, –SE) ………………………………………………. 85,000
(4) Insurance Expense (E, –SE) …………………………………………………… 20,000
Income Tax Liability (–L) …………………………………………………………………. 12,250*
Extraordinary Loss (–Lo, +SE) ……………………………………………………. 12,250
Recognized income tax benefit from extraordinary loss.
P13–13 Continued
Closing entries
(c1) Income Summary ………………………………………………………………… 22,750
Sales …………………………..……………………………………………………… 1,256,000
Gain on Sale of Land …………………………………………………………… 76,000
Cost of Goods Sold ……………………………………………………….. 737,000
Administrative Expenses ………………………………………………… 100,000
Selling Expenses ……………………………………………………………. 255,000
(c2) Retained Earnings ………………………………………………………………. 22,750
(c3) Retained Earnings ……………………………………………………………….. 135,000
P13–13 Concluded
b.
Laidig Industries
Income Statement
For the Year Ended December 31, 2015
Revenues:
Sales …………………………..………………………………………………. $ 1,256,000
Gain on sale of fixed assets …………………………..………………. 76,000
Total revenues …………………………..……………………………. $ 1,332,000
Expenses:
Interest expense ………………………………………………………….. 50,000
Total expenses ………………………………………………………… 1,272,000
Income from continuing operations (before taxes) ………………. $ 60,000
Income taxes …………………………………………………………………… 21,000
Income from continuing operations ……………………………………. $ 39,000
Extraordinary loss (net of tax benefit of $12,250) ………………… (22,750)
c.
Laidig Industries
Statement of Retained Earnings
For the Year Ended December 31, 2015
d. The objectives of financial accounting are to allow prediction of future cash flows. Earnings numbers
reflect changes in a company’s resources. Some measures such as income from continuing operations
ISSUES FOR DISCUSSION
ID13–1
a. The net income and comprehensive income for CVS are very similar due to the relatively low dollar
amount of changes to equity that did not also affect profitability. Caterpillar, on the other hand, saw a
b. Caterpillar operates globally, so it must deal with foreign currency exposure; as shown, if exchange
rates move the company will see a change to its equity. CVS is mainly focused on its domestic retail
c. An analyst would focus on the companies’ profit levels, but would also focus on what other factors could
harm the company’s equity cushion. A certain level of expertise and understanding in foreign exchange
ID13–2
a. Tightened credit markets will mean less volume in debt issuances. Since each issue is rated by an
agency, the revenue of the ratings agencies will decline as the number of debt issuances declines.
b. The income statement will be directly affected with a drop in revenue and a consequent drop in profits.
Stockholders’ equity will be affected due to the reduced net income shown on the income statement.
ID13–3
a. For an event to be classified as extraordinary, the event must have been both unusual in nature and
infrequent in occurrence.
b. If the eruptions continue periodically, then such eruptions would probably not be viewed as being
ID13–4
a. Standard & Poor’s may have viewed the charge as different from previous years and felt including it
would distort comparisons from year to year. Value Line may have felt that the exclusion of the charge
would be a distortion of the income for the year.
b. The income statement is comprised of several categories. Revenues and expenses that are both usual
and frequent are classified as operations. Revenues and expenses that are either usual or frequent, but
c. All items listed on a company’s income statement are important in that these items affect a company’s
actual financial position and/or the amounts reported on the balance sheet for assets and liabilities.
Thus, financial analysts do not care how or where the information is recorded as long as the
information is available.
ID13–5
a. Analysts are many times looking for companies that will be the dominant company in different business
categories. The internet has provided an alternative method for selling goods and services to the
public. Since this is a new industry many analysts were not sure how much market share this channel
companies.
b. The specific effect that this FASB rule had on the income statements on companies like Amazon.com
was to increase the cost of good sold and decrease the gross profit percentage. These companies
lobbied against this change because these companies were promoting the idea that their gross profit
percentages were much higher than traditional retailers. After this change it became very apparent
investors as to the future cash flows of these companies. This change highlighted information in a way
that reduced investors’ future estimates of the profitability or cash flow of these companies.
ID13–6
a. Although it could be argued that lawsuits are a normal part of conducting business in the United States
and that lawsuits may not be that infrequent, the settlement was probably disclosed as an
extraordinary loss. The determining factor in each case would be if the event was infrequent and
b. The patent infringement case is an example of a contingency. SFAS No. 5, “Accounting for
Contingencies” states that a contingency is “an existing condition, situation, or set of circumstances
involving uncertainty as to possible gain or loss to an enterprise that will ultimately be resolved when
one or more future events occur or fail to occur.” In this particular case, Polaroid had a gain
that Kodak would eventually lose the lawsuit and (2) whether the amount of the loss could be
reasonably estimated in 1989. If the probability that Kodak would eventually lose the lawsuit was
remote, then Kodak could ignore the lawsuit for financial reporting purposes. If the probability of the
loss was reasonably possibly or if the amount of the loss could not be reasonably estimated, Kodak
c. There are at least two reasons why Kodak’s stock increased in value. First, the settlement provided
unexpected “good” news about Kodak. The stock market may have expected Kodak to lose the lawsuit
and have to pay out close to the amount being asked for by Polaroid. The fact that Kodak had to pay
ID13–7
a. Impairment charge – is shown as an other expense item on the income statement. Research and
development costs – are shown as an expense below cost of goods sold and before income from
continuing operations. Foreign currency translation – recognized gains and losses are shown gross on
the income statement as an other gain or loss. Any unrecognized gains or losses are included in
b. The items that would be expected to be persistent or be repeated in future years are research and
development costs, foreign currency translation, cost of products sold and equity income from
ID13–8
a. Federal Express should report this as an extraordinary gain on its income statement. This assumes
that aircraft being destroyed by fire is both unusual and infrequent. This is a one-time impact on
the wealth of Federal Express and would not be expected to persist in the future.
b. Motorola would report the gains related to these asset sales below the gross profit line in a
section called “Other Gains and Losses”. The sale of assets is not Motorola’s primary business and
c. Owens-Corning would report the $68 million restructuring charge below the income from
operations line, the $11 million of equity in net income of affiliates in the revenue section, and the
d. Owens-Corning would report the $875 million charge below the income from operations line on
the income statement. The class action lawsuits related to asbestos are (as a group) unusual and
ID13–9
a. Rising raw material costs would be reflected in Cost of Goods Sold on the income statement, as well as
in Inventory (Raw Materials) on the balance sheet. Currency fluctuations would be reflected in
b. Rising material costs and costs to introduce new models might be expenses that will permanently affect
BMW’s business model.
c. Comprehensive income measures all changes in a company’s equity due to nowowner transactions.
ID13–10
a. Carrefour defines operating income to come before (to not include) income from affiliated
companies, while VW and Sony include the equity income from affiliates in its operating income.
VW includes interest (finance) costs in its calculation of operating income, while Carrefour and
Sony both deduct interest expense after operating income is calculated.
b. It is possible that the financing function for Volkswagen is more aligned with that company’s daily
ID13–11
a. The significant item shown below operation income is interest and other income, but these amounts
total less than 1.5% of total revenues for the company. Only in 2012 did Google show operations that