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CHAPTER 12
UNDERSTANDING THE ISSUES
1. Viewing an interim period as an integral
part of a larger annual period has several
benefits. The allocation of expense under
this viewpoint provides information that al-
2. A number of factors are necessary in order
to determine the estimated effective annual
tax rate. First of all, the rate should reflect
conditions to be experienced for the entire
year. Therefore, in addition to year-to-date
pretax income/loss, such amounts must be
projected for the balance of the year. Statu-
tory tax rates are applied to these annual
amounts after considering the presence of
possible annual permanent differences
tax credit carrybacks and carryforwards.
3. Several factors may explain this situation. If
the third-quarter loss were greater than the
to the loss may not be recognized. How-
ever, if this were the case, one would
consider any known pretax income in the
carryback period and any “more likely than
tax income in the carryforward period.
4. There are a number of reasons why the
total operating profit of the reportable seg-
ments does not normally equal the consoli-
dated operating profit. First of all, not all
operating segments are reportable and yet
such amounts are included in consolidated
amounts. Second, there are a number of
intersegment transactions whose effect
luating segment performance and/or
because allocation is not possible on a rea-
sonable basis. Finally, the accounting
Ch. 12—Exercises 12–2
EXERCISES
EXERCISE 12-1
(1) Generally speaking, research and development (R&D) costs are expensed in the year in
which they are incurred. Therefore, absent contrary evidence, all of the $360,000 of costs
(2) A likely explanation for an effective tax rate less than the statutory rate is that there are dif-
ferences between how items of revenue and/or expense are recognized for tax purposes
(3) If the tax benefit associated with the net operating loss in the prior year was not fully recog-
nized in the year of loss, it is possible that an additional amount of benefit traceable to the
(4) In order to estimate the annual effective tax rate applicable to an interim period, it is neces-
sary to estimate the amount of annual taxable income. Therefore, the estimated amount of
(5) The effective tax rate for the first quarter of the current year suggests several things. First,
not all of the estimated current-year tax loss could be carried back against the prior two
years. If this had been the case, the effective tax rate would have been at least 25%.
Exercise 12-1, Concluded
(6) If the current year-to-date LIFO liquidation will not exist at year-end because it is estimated
that current-year purchases will exceed current-year sales, then the interim cost of sales
EXERCISE 12-2
Strategy A
Quarter 2
2015
YTD income (loss):
Existing operations ......................................................... $60,000
New strategy .................................................................. (85,000)
Subtotal .......................................................................... (25,000)
Projected for the balance of the year:
2015 2014
DR (CR) CR (DR)
Annual entry:
Taxes receivable (payable) ............................................
Deferred tax asset (15% x $40 K) .................................. 6,000
Deferred tax asset .......................................................... 4,000
Tax expense (benefit) .................................................... (4,000) (6,000)
Note: The deferred tax asset balance is $10,000 (15% × $50K + 25% × $10 K)
Ch. 12—Exercises 12–4
Strategy B
Quarter 2
2015
YTD income (loss):
Existing operations ......................................................... $60,000
New strategy .................................................................. (40,000)
Subtotal .......................................................................... 20,000
Projected for the balance of the year:
2015 2014
DR(CR) CR(DR)
Annual entry:
Taxes receivable (payable) ............................................
Deferred tax asset (15% x $40 K) .................................. 6,000
Deferred tax asset .......................................................... 3,500
Tax expense (benefit) .................................................... (3,500) (6,000)
Note: The deferred tax asset balance is $9,500 (15% × $50K + 25% × $8 K) represented by the
remaining $58 K ($84 K - $26 K) of 2014 loss
Effective tax rate & YTD tax benefit:
Strategy C
Quarter 2
2015
YTD income (loss):
Existing operations ......................................................... $60,000
New strategy ..................................................................
Subtotal .......................................................................... 60,000
Projected for the balance of the year:
12–5 Ch. 12—Exercises
2015 2014
DR(CR) CR(DR)
Annual entry:
Taxes receivable (payable) ............................................ (4,000)
(15% x $50 K + 25% x $6 - $5 tax credit)
Deferred tax asset (15% x $40 K) .................................. 6,000
Note: That there is no longer a deferred tax balance because all of the $84,000 prior year loss
has been used against current year income.
Effective tax rate & YTD tax benefit:
Annual expense (benefit) ............................................... 10,000
The estimated tax expense of $10,000 can also be calculated as follows:
The tax expense on $140,000 after the tax credit would be:
$50,000 at 15% .............................................................. $7,500
The $84,000 prior year operating loss had additional benefit of:
$40,000 at 30% .............................................................. 12,500
$44,000 at 25% .............................................................. 11,000
EXERCISE 12-3
Granger Supply, Inc.
Interim Income Statements
For the Periods Ending Quarter 1 and 2 of the Current Year
Quarter 1
Quarter 2
Net sales .............................................................................. $12,000,000 $9,000,000
Cost of sales (See Schedule A) ........................................... 7,900,000 7,805,000
Gross profit .......................................................................... $ 4,100,000 $1,195,000
Schedule A—Cost of Sales
Quarter 1
Quarter 2
As stated:
Cost of sales—industrial supplies .................................. $4,300,000 $4,700,000
Cost of sales—cleaning equipment ................................ 3,000,000 3,200,000
Adjustment for replacement cost:
Schedule B—Income Tax Schedule
Quarter 1
Quarter 2
YTD income before tax ........................................................ $2,000,000 $1,395,000
Projected income ................................................................. 5,100,000 4,000,000
Estimated annual income ..................................................... $7,100,000 $5,395,000
Ordinary Pretax Income (Loss) Tax Expense (Benefit)
Interim Current Effective Tax Previously Current
EXERCISE 12-4
(1) Before After
Change
Change
YTD income (loss) ............................................ $100,000 $120,000
Projected income (loss) .................................... 110,000 135,000
Total annual ...................................................... $210,000 $255,000
Less exempt income ......................................... (5,000) (5,000)
Taxable income ................................................ $205,000 $250,000
(2) Total Total
Excluding Excluding
Ordinary Total Nonordinary Nonordinary
Income
Income Loss Gain
First six months continuing ........... $120,000 $120,000 $120,000 $120,000
Third quarter continuing ................ 80,000 80,000 80,000 80,000
Projected continuing ..................... 20,000 20,000 20,000 20,000
Incremental tax expense (benefit) traceable to:
All nonordinary items ($57,600 – $50,600) .......................... $ 7,000
All nonordinary losses ($71,600 – $57,600) ......................... $ (14,000)
All nonordinary gains [$7,000 – ($14,000)] .......................... $ 21,000
Taxable income:
Pretax accounting income ........ $220,000 $240,000 $280,000 $180,000
Less exempt income ................ (4,000) (4,000) (4,000) (4,000)
12–9 Ch. 12—Exercises
EXERCISE 12-5
Tax rates 30% 25% 15%
Case A 2015 2014 2013
YTD income (loss) ........................................................ $ (80,000)
Projected for the balance of the year ............................. 120,000
Effective rate .................................................................. 26.25%
YTD operating (loss) ..................................................... (80,000)
YTD tax (benefit) ........................................................... (21,000)
Case B 2015 2014 2013
YTD income (loss) ........................................................ $ (80,000)
Annual income (loss) .................................................... (80,000)
Effective rate .................................................................. 8.13%
YTD operating (loss) ..................................................... (80,000)
YTD tax (benefit) ........................................................... (6,500)
Ch. 12—Exercises 12–10
Deferred tax asset (30% x $20 K) ................................. 3,500
Tax expense (benefit) ................................................... (3,500) (2,500)
NOTE: The deferred tax asset at year-end 2015 is
$6,000.
Effective tax rate & YTD tax benefit:
Loss carryback to prior 2 years ...................................... 30,000
Taxable income .............................................................. $(60,000) $ (10,000) $30,000
Annual entry: DR (CR) DR (CR) DR (CR)
Taxes receivable (payable) ..................................... 4,500 (4,500)
Deferred tax asset (25% x $5 K) ............................. 1,250
EXERCISE 12-6
Quarter 1
Quarter 2
Originally
Stated
Continuing Discontinued Continuing Discontinued
YTD pretax income (loss) ............................. $ 800,000 $1,020,000 $(220,000) $1,545,000 $(700,000)
Projected pretax income (loss) ..................... 1,100,000 1,420,000 (320,000) 1,050,000 —
Estimated annual income .............................. $1,900,000 $2,440,000 $(540,000) $2,595,000 $(700,000)
Pretax Income (Loss) Tax Expense (Benefit)
Type of Current Effective Previously Current
Interim Quarter Income Period Year-to-Date Tax Rate Year-to-Date Reported Period
First Continuing Op. $ 800,000 $ 800,000 29.50% $ 236,000 $ — $ 236,000
First—Restated Continuing Op. 1,020,000 1,020,000 30.72% 313,344 — 313,344
First—Restated Discontinued (220,000) (220,000) Note A (77,344) — (77,344)
EXERCISE 12-7
Quarter 1, 2017 Quarter 2, 2017
Before After Before After
Change
Change Change Change
First-quarter income (loss) ................... $ 40,000 $ 70,000 $ 40,000 $ 70,000
Second-quarter income (loss) .............. — — (30,000) (10,000)
YTD income (loss) ............................... $ 40,000 $ 70,000 $ 10,000 $ 60,000
Projected income (loss) ....................... (210,000) (155,000) (150,000) (130,000)
Total annual ......................................... $(170,000) $ (85,000) $(140,000) $ (70,000)
Estimated tax benefit:
12–13 Ch. 12—Exercises
EXERCISE 12-8
Total Total
Excluding Excluding
Ordinary Total Nonordinary Nonordinary
Income Income Loss (A) Gain (B & C)
Continuing income (loss) .................. $60,000 $ 60,000 $60,000 $ 60,000
Nonordinary item A ........................... — (30,000) — (30,000)
Nonordinary item B ........................... — 25,000 25,000 —
Incremental tax expense (benefit) traceable to:
All nonordinary items ($10,000 – $10,000) ................................ $ 0
All nonordinary losses ($10,000 – $18,850) ............................... (8,850)
All nonordinary gains [$0 – ($8,850)] ......................................... $ 8,850
On first $50,000 @ 15% .............. $ 7,500 $ 7,500 $5,250 $7,500
On next $25,000 @ 25% ............. 2,500 2,500 — 1,250
Total estimated tax ...................... $10,000 $10,000 $5,250 $8,750
Incremental tax expense (benefit) traceable to: Percent of Total
Item B ($10,000 – $5,250) ................................. $4,750 79.2%
EXERCISE 12-9
(1) It seems most likely that the area of oils and lubricants could be combined with the distribu-
tion of specialized tools. Both areas share a number of similarities including serving the
(2) Determination of whether segments are reportable:
Is Segment’s
Absolute
Value of
Revenue Profit/Loss Assets Is
10% or More of 10% or More of 10% or More of Segment
Segment $30,750,000? $4,514,200? $32,660,000? Reportable?
(3) Items that may comprise the reconciliation of segment totals to companywide totals may
include the following:
• Not all segments are reportable.
• Corporate-level components of other income such as interest income, extraordinary
12–15 Ch. 12—Exercises
EXERCISE 12-10
Determination of whether segments are reportable:
Revenues
Reported
Segment External Intersegment Total Profit (Loss) Assets
Film Studios ............................................ $ 82,000,000 $ 0 $ 82,000,000 $(11,000,000) $38,000,000
Software Development ............................ 12,000,000 3,400,000 15,400,000 (2,600,000) 5,400,000
Is Segment’s
Absolute Value
Revenue of Profit or Assets
10% or Loss 10% or 10% or
More of More of More of Is Segment
Segment $167,100,000? $29,700,000? $61,400,000? Reportable?
Film Studios ............................................ Yes Yes Yes Yes
Software Development ............................ No No No No
Ch. 12—Problems 12–16
PROBLEMS
PROBLEM 12-1
Pretax Income (Loss) Tax Expense (Benefit)
Current Year-to- Effective Year-to- Previously Current
Quarter Period Date Tax Rate Date Reported Period
1 $(150,000) $(150,000) 16.00% $(24,000) $ — $(24,000)
Schedule of Estimated Effective Tax Rates
Quarter 1 Quarter 2 Quarter 3
YTD income (loss):
First quarter ........................................... $(150,000) $(150,000) $(150,000)
Second quarter ...................................... 120,000 120,000
Third quarter .......................................... — 97,000
Total ....................................................... $(150,000) $ (30,000) $ 67,000
Projected income (loss) ................................ (75,000) (50,000) 33,000
Total annual income (loss) ............................ $(225,000) $ (80,000) $ 100,000
Plus nondeductible expenses ....................... 22,000 15,000 20,000
Less nontaxable income ............................... — (5,000) (7,000)
Taxable income (loss) ................................... $(203,000) $ (70,000) $ 113,000
Tax expense if taxable income:
Amount of benefit .............................. $ 36,000 $ 21,000
Plus tax credit carryback:
Carryback to 2009 ............................. — —
Carryback to 2010 (Note B) .............. — 6,000
Tax benefit ............................................. $ 36,000 $ 27,000
PROBLEM 12-2
Quarter 1 Quarter 1 Quarter 1 Quarter 2 Quarter 3
Original
Continuing DISCO Continuing Continuing
YTD income ........................................................ $(45,000) $(30,000) $(15,000) $28,000 $ 68,000
Projected income ................................................ (25,000) 15,000 (40,000) 62,000 42,000
Pretax Income (Loss) Tax Expense (Benefit)
Interim Period Type of Current Year- Effective Year- Previously Current
(quarter) Income Period to-Date Tax Rate to-Date Reported Period
First Continuing Op. $(45,000) $(45,000) See a $ (6,400) $ — $ (6,400)
First—Restated Continuing Op. (30,000) (30,000) See b (6,400) — (6,400)
First—Restated Discontinued (15,000) (15,000) See b — — —
Second Continuing Op. 58,000 28,000 26.44% 7,403 (6,400) 13,803
Second Discontinued (57,000)c (72,000) Note A (23,040) — (23,040)
Problem 12-2, Concluded
Note A: Ordinary
Income
All Sources
Annual income (loss) ....................... $90,000 $18,000
