PROBLEM 4.4 (Continued)
(a)Computation of income before income tax:
As previously stated ………………………..
€790,000
Uninsured flood loss ………………………..
(90,000)
Gain on sale of securities …………………
Error in computation of depreciation
As computed (€54,000 ÷ 6) ……………………
Corrected (€54,000 – €9,000) ÷ 6 ……………
Note: No adjustment is needed for the inventory method change, since the
PROBLEM 4.5
Revenue
Sales revenue …………………………………………………….
$1,578,500
Less: Sales discounts ………………………………………..
$31,150
Sales returns ……………………………………………
93,450
Net sales …………………………………………………………….
Cost of goods sold …………………………………………………..
896,770
Gross profit ……………………………………………………………..
Selling expenses
Sales commissions ………………………….
$97,600
Salaries and wages expense (sales) ….
56,260
Travel expense ………………………………..
28,930
Entertainment expense …………………….
14,820
Telephone and internet exp. …………….
Maintenance and repairs expense …….
Depreciation expense ………………………
Bad debt expense …………………………...
PROBLEM 4.5 (Continued)
Administrative Expenses
Maintenance and repairs expense ………
9,130
Property tax expense …………………………
7,320
Depreciation expense ………………………..
7,250
Supplies expense …………………………..….
3,450
Telephone and internet expense ………..
2,820
Office expense ………………………………….
Other income and expense
Interest expense………………………………..
Income before income tax ……………………….
323,525
Income tax ………………………………………..
102,000
Net income …………………………..………………..
$221,525
PROBLEM 4.5 (Continued)
TWAIN CORPORATION
Retained Earnings Statement
For the Year Ended June 30, 2019
Retained earnings, July 1, 2018, as reported …………..
$337,000
Retained earnings, July 1, 2018, as adjusted ………….
Add: Net income ………………………………………………….
540,825
Less:
Dividends declared on preference shares ……….
$ 9,000
Dividends declared on ordinary shares …………
37,000
PROBLEM 4.6
1. The impairment of intangibles charge of ¥8,500,000 should be disclosed
separately, assuming it is material. This charge is shown above income
2. The loss on sale of equipment of ¥17,000,000 should be reported in the
3. The adjustment required for correction of an error is inappropriately
labeled and also should not be reported in the retained earnings
4. Earnings per share should be reported on the face of the income
statement and not in the notes to the financial statements. Because
PROBLEM 4.7
Retained Earnings Statement
For the Year Ended December 31, 2019
Retained earnings, January 1, as reported …………………………..
$257,600
Correction of error from prior period ………………………………………….
25,400
Adjustment for change in accounting principle ………………………….
Retained earnings, January 1, as adjusted …………………………..
Add: Net income …………………………………………………………………….
Less: Cash dividends declared …………………………………………………
32,000
(b) 1. Gain on sale of investments—body of income statement. This gain
should be shown under other income and expense on the income
statement.
PROBLEM 4.8
Income before income tax ……………………..
€1,325,000*
Income tax ……………………………………
265,000**
Income from continuing operations ……….
1,060,000
Discontinued operations
Less: Applicable income tax
reduction ……………………..
18,000
Loss from disposal of subsidiary ……..
100,000
Less: Applicable income tax
reduction ……………………..
20,000
80,000
(152,000)
Net income ……………………………………………
€ 908,000
Earnings per share*:
Income from continuing operations …………………………….
€7.06
Discontinued operations, net of tax ……………………………..
PROBLEM 4.8 (Continued)
*Computation of income before income tax:
As previously stated
€1,210,000
Loss on sale of equipment [€40,000 – (€80,000 – €30,000)]
(10,000)
Gain on condemnation of property
Restated
**Computation of income tax expense:
TIME AND PURPOSE OF CONCEPTS FOR ANALYSIS
CA 4.1 (Time 20–25 minutes)
Purpose—to provide the student with the opportunity to comment on deficiencies in an income
statement format. The student is required to comment on such items as inappropriate heading,
incorrect classification of unusual items, proper net of tax treatment, and presentation of per share data.
CA 4.2 (Time 20–25 minutes)
CA 4.3 (Time 15–20 minutes)
Purpose—to provide the student an illustration of how earnings can be managed by how losses are
reported, including ethical issues.
CA 4.4 (Time 30–35 minutes)
CA 4.5 (Time 30–40 minutes)
CA 4.6 (Time 20–25 minutes)
CA 4.7 (Time 10–15 minutes)
SOLUTIONS TO CONCEPTS FOR ANALYSIS
CA 4.1
The deficiencies of O’Malley plc’s income statement are as follows:
2. Dividends and gain on recovery of insurance proceeds should be classified as other income and
expense items.
4. Loss on obsolescence of inventories should be classified as an other income and expense item.
6. Intraperiod income tax allocation is required to relate income tax expense to income from continuing
operations, and loss on discontinued operations.
8. Per share data is a required presentation for income from continuing operations, discontinued
CA 4.2
(a) Earnings management is often defined as the planned timing of revenues, expenses, gains and
losses to smooth out bumps in earnings. In most cases, earnings management is used to increase
(b) Proposed Accounting
2016
2017
2018
2019
2020
Income before warranty expense
€43,000
€43,000
Warranty expense
7,000
3,000
(c) Appropriate Accounting
2016
2017
2018
2019
2020
Income before warranty expense
€43,000
€43,000
Warranty expense
5,000
5,000
CA 4.3
(a) The ethical issues involved are integrity and honesty in financial reporting, full disclosure,
accountant’s professionalism, and job security for Charlie.
CA 4.4
(a) It appears that the sale of the Casino Knights Division would qualify as a discontinued operation.
The operation of gambling facilities appears to meet the criteria for discontinued operations for
CA 4.4 (Continued)
(b) The “walkout” or strike should be reported as an “Other income and expense” item. Events of this
nature are a general risk that any business enterprise takes and should not warrant special
treatment.
CA 4.5
The income statement of Walters plc contains the following weaknesses in classification and
disclosure:
1. Sub-totals for gross profit, operating income, and income from continuing operations are not
provided.
2. Sales taxes. Sales taxes have been erroneously included in both gross sales and cost of goods
sold on the income statement of Walters plc. Failure to deduct these taxes directly from customer
3. Purchase discounts. Purchase discounts should not be treated as revenue by being lumped with
other revenues such as dividends and interest. A purchase discount is more logically a reduction
4. Recoveries of accounts written off in prior years. These collections should be credited to the
allowance for doubtful accounts unless the direct write-off method was used in accounting for bad
debt expense. Generally, the direct write-off method is not allowed.
5. Delivery expense and freight-in. Although delivery expense is an expense of selling and is
therefore reported properly in the statement, freight-in is an inventoriable cost and should have
6. Loss on discontinued styles. This type of loss, though often substantial, should not be treated
7. Loss on sale of marketable securities. This item should be reported as a separate component
of income from continuing operations and not as an unusual item.
CA 4.5 (Continued)
8. Loss on sale of warehouse. This item should be reported as a separate component of income
from continuing operations and not as an unusual item.
CA 4.6
Classification
Rationale
1.
No disclosure in current year.
Other income and expense section.
Material, unusual in nature, and non-recurring.
3.
Depreciation expense in body of income
statement, based on new useful life.
Material item, but change in estimated useful life
is considered part of normal business activity.
Error has “washed out”; that is, subsequent
income statement compensated for the error.
However, prior year income statements should
be restated.
5.
Discontinued operations section.
Sale meet the criteria for the disposal of a
component of a business.
6.
Adjustment to the beginning balance of
retained earnings.
Other income and expense section.
Material, unusual in nature, and non-recurring.
Other income and expense section.
Material, unusual in nature, and non-recurring.
Other income and expense section.
Material, unusual in nature, and non-recurring.
Discontinued operations section.
activities are clearly distinguishable physically,
operationally, and for financial reporting
purposes.
A change in inventory methods is a change in
accounting principle and prior periods are
adjusted.