Chapter 11
Evaluating Performance: Earnings
Quality, the Income Statement & the
Statement of Comprehensive Income
Ethics Check
(5-10 min.) EC 11-1
a. Integrity
b. Due care
c. Objectivity and independence
d. Integrity
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
b. Reporting revenue when a significant portion of the services are still
to be performed or goods are still to be delivered.
(10 min.) S 11-2
Req. 1
Gross profit = $760,212 thousand ($1,806,092 − $1,045,880)
Req. 2
Income from continuing operations = $117,187 thousand.
(10-15 min.) S 11-3
Musicality, Inc.
Income Statement
Year Ended December 31, 2016
(Thousands)
Net sales revenue ………………………………………………………….
$195,000
Cost of goods sold ………………………………………………………..
74,000
Gross profit ……………………………………………………………………
121,000
Operating income…………………………………………………………..
Other gains (losses) ………………………………………………………
Income from continuing operations before income tax …..
Income tax expense (40%) ……………………………………………..
Income from continuing operations ……………………………….
Loss on discontinued operations, $10,000,
less income tax savings of $4,000 ………………………………
Net income …………………………………………………………………….
(10-15 min.) S 11-4
Estimated value
=
Earnings per share
=
$2.10
=
$21.00
of one share
Investment
.10
of Orange stock
capitalization rate
(10 min.) S 11-5
Journal
DATE
ACCOUNT TITLES AND EXPLANATION
DEBIT
CREDIT
Sept.
12
Accounts Receivable (200,000 x $.36) …….
72,000
Sales Revenue ………………………………….
72,000
18
Cash (100,000 x $.31) …………………………….
31,000
Foreign-Currency Transaction Loss ………
Accounts Receivable ($72,000 x ½) ……
36,000
Nov.
Cash (100,000 x $.39) …………………………….
39,000
Accounts Receivable ………………………..
Foreign-Currency Transaction Gain …..
(10-15 min.) S 11-6
Journal
DATE
ACCOUNT TITLES AND EXPLANATION
DEBIT
CREDIT
Apr.
24
Cash (700,000 pesos × $0.096) ………………..
67,200
Accounts Receivable
(700,000 pesos × $0.092) ……………….
64,400
Collection on account.
Oct.
25
Accounts Payable
(29,000 Swiss francs × $0.78) ………………….
22,620
Foreign-Currency Transaction Loss ………..
Cash (29,000 Swiss francs × 0.83) ……..
Payment on account.
Both the Mexican peso and the Swiss franc strengthened against the
U.S. dollar.
(15 min.) S 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
Req. 3
(5-10 min.) S 11-8
Journal
DATE
ACCOUNT TITLES AND EXPLANATION
DEBIT
CREDIT
1.
Income Tax Expense ($171,000 × .40) …………
68,400
Income Tax Payable ($148,000 × .40) ……..
59,200
Deferred Tax Liability …………………………...
Recorded income tax for the year.
2.
INCOME STATEMENT
Income before income tax …………………………
$171,000
Income tax expense ………………………………….
Net income ……………………………………………….
BALANCE SHEET
Current liabilities:
Income tax payable ……………………………….
Long-term liabilities:
(10 min.) S 11-9
Req. 1
Req. 2
Earnings per share of common stock:
Income (loss) from continuing operations …………………………..
$X.XX
Net income (net loss) …………………………………………………………
$X.XX
Req. 3
Earnings per share is useful because it relates a company’s income to
one share of the company’s stock. Since stock prices are quoted at an
(10-15 min.) S 11-10
Earnings per share of common stock
(10,000 shares of common stock outstanding):
Income from continuing operations
(5-10 min.) S 11-11
Musicality, Inc.
Statement of Comprehensive Income
Year Ended December 31, 2016
(in
thousands)
Net income …………………………..…………………………..
$13,200
Other comprehensive income:
Foreign-currency translation gain, net of tax ….
Comprehensive income …………………………………….
Unrealized gains on investments in AFSS,
The other comprehensive income would also be added to the
Accumulated Other Comprehensive Income in the stockholders’ equity
section of the balance sheet.
Musicality, Inc.
Balance Sheet (Partial)
December 31, 2016
(in
thousands)
Stockholders’ Equity:
Accumulated Other Comprehensive Income
(assuming no beginning balance)
(10 min.) S 11-12
iWorld, Inc.
Statement of Retained Earnings
Year Ended December 31, 2016
Retained earnings balance, December 31, 2015,
as originally reported …………………………………………………..
$ 55,000
Net income for 2016 …………………………………………………………
Subtotal
Dividends declared for 2016 ……………………………………………..
Retained earnings balance, December 31, 2016 …………………
(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
may be by product line, by type of business, or by geographic region.
Req. 2
Segment reporting provides the user with more detailed information
about a company and its different types of business activities, and the
different economic environments in which it operates. Seeing this
(10-15 min.) S 11-14
Req. 1
Management of Meinike Computer Inc. is responsible for the company’s
financial statements.
Req. 2
The accounting standards for preparation of the financial statements are
generally accepted accounting principles in the United States of America
(GAAP).
Req. 3
Management has established and maintains internal accounting control
Req. 4
SLMA, LLP, auditors located in Aurora, Colorado, gave an outside
opinion on Meinike’s financial statements. SLMA, LLP released its
opinion on December 28, 2016.
Req. 5
The audit covered Meinike’s consolidated balance sheets at September
30, 2016, and September 30, 2015, and consolidated income statements
(continued) S 11-14
Req. 6
The standards for conducting an audit are the standards of the Public
Company Accounting Oversight Board (United States).
Req. 7
The auditor believed that Meinike’s financial statements present fairly, in
Exercises
(15-20 min.) E 11-15A
Req.1
Searstown Cycles, Inc.
Income Statement
Year Ended September 30, 2016
Thousands
Net sales …………………………………………………………………
$13,500
Total operating expenses …………………………………………
12,200
Income from continuing operations before
income tax ……………………………………………………….
Income tax expense …………………………………………………
Income from continuing operations ………………………….
Income from discontinued operations,
$290, less income tax, $58 …………………………………
232
Req.2
Searstown Cycles, Inc.
Statement of Comprehensive Income
Year Ended September 30, 2016
Thousands
Net income ………………………………………………………………
$1,227
Other comprehensive income (loss):
Unrealized gain on investments in AFSS, net of tax…
$ 36
Foreign-currency translation gain, net of tax ………….
350
Total other comprehensive income …………………………..
Comprehensive income
(20-25 min.) E 11-16A
Req. 1
Hooper Book Company
Income Statement
Year Ended December 31, 2016
Thousands
Sales revenue ………………………………………………………….
$122,000
Total revenue …………………………………………………………..
123,600
Total operating expenses …………………………………………
104,800
Income tax expense …………………………………………………
5,640
Net income ……………………………………………………….……..
Earnings per share (EPS):
Net income ($13,160 / 1,000) ………………………………
$13.16
Req. 2
The company’s quality of earnings would be considered to be very good,
based on its steady growth each year and no discontinued operations
during recent years.
Req. 3
(10-15 min.) E 11-17A
Estimated
EPS from
value of
=
continuing operations
one share of
Investment
=
(10-15 min.) E 11-18A
Req. 1
Journal
DATE
ACCOUNT TITLES AND EXPLANATION
DEBIT
CREDIT
May
9
Inventory …………………………………………………….
6,440
Accounts Payable (700,000 yen × $.0092) ….
6,440
Cash (700,000 yen × $.0085) ……………………..
5,950
Foreign-Currency Transaction Gain ………….
490
22
Accounts Receivable (40,000 euros × $1.22) ….
48,800
Sales Revenue …………………………………………
48,800
28
Cash (40,000 euros × $1.18) ………………………….
47,200
Foreign-Currency Transaction Loss ……………..
1,600
Accounts Receivable …………………………..…..
48,800
Req. 2
On May 10, Holloway wanted the dollar to strengthen in order to pay
Toyita with yen that cost fewer dollars. That was what happened, and
Holloway had a foreign-currency transaction gain.
(10 min.) E 11-19A
Req. 1
Income Tax Expense ($320,000 × .25) ………………..
80,000
Income Tax Payable ($280,000 × .25)…………….
Deferred Tax Liability ………………………………….
Req. 2
Tax to pay currently ……………………………………………………….
$70,000
Deferred tax liability ($31,000 + $10,000) ………………………….
$41,000
(10 min.) E 11-20A
Net income –
preferred dividends
$6,200,000 − ($900,000 × .06)