4-41
PROBLEM 4-2
THOMPSON CORPORATION
Income Statement
For the Year Ended December 31, 2012
Revenues
Net sales ($1,100,000 – $14,500 – $17,500) …..
$1,068,000
Gain on sale of land …………………………………..
30,000
Rent revenue …………………………………………….
18,000
Total revenues ………………………………….
1,116,000
Income before income tax …………………………………..
140,000
Income tax ………………………………………………..
53,900
Net income …………………………………………………………
$ 86,100
Earnings per share ($86,100 ÷ 30,000) ………………….
$2.87
620,000
709,000
Expenses
Cost of goods sold* …………………………………..
Selling expenses ……………………………………….
Administrative expenses …………………………...
99,000
Total expenses ………………………………….
976,000
PROBLEM 4-2 (Continued)
THOMPSON CORPORATION
Retained Earnings Statement
For the Year Ended December 31, 2012
4-43
PROBLEM 4-3
MAHER INC.
Income Statement (Partial)
For the Year Ended December 31, 2012
Income from continuing operations
before income tax ……………………………………………….
$838,500(a)
Income tax …………………………………………………..
220,350(b)
Per share of common stock:
Income from continuing operations ………………
$5.15*
Discontinued operations, net of tax ………………
(0.67)*
Income before extraordinary items ……………….
4.48
Extraordinary item, net of tax ……………………….
As previously stated …………………………………………
Loss on sale of securities …………………………………
As restated………………………………………………………….
Income from continuing operations ……………………….
Discontinued operations
Less: Applicable income tax reduction …………
Income before extraordinary item …………………………..
Extraordinary item:
Major casualty loss …………………………..………….
Less: Applicable income tax reduction …………
PROBLEM 4-3 (Continued)
(b)Computation of income tax:
Income from continuing operations before taxes ……….
$838,500
Taxable income………………………………………………………..
Tax rate …………………………………………………………………..
4-45
PROBLEM 4-4
(a) TWAIN CORPORATION
Income Statement
For the Year Ended June 30, 2012
Sales Revenue
Sales revenue ……………………………………………………..
$1,578,500
Operating Expenses
Selling expenses
Sales commissions …………………………..
$97,600
Salaries and wages exp. …………………………..
56,260
Travel expense ………………………………………………..
Freight-out ………………………………………………………
21,400
Entertainment expense …………………………..
14,820
Telephone and Internet expense ……………………….
Maintenance and repairs expense …………………….
Depreciation expense …………………………..
Bad debt expense…………………………………………….
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
Miscellaneous office expenses ………………….
Income from operations …………………………..
Less: Sales discounts …………………………..
$31,150
Sales returns and allowances …………………….
Net sales ……………………………………………………….
Cost of goods sold ……………………………………………………
Gross profit ……………………………………………………….
PROBLEM 4-4 (Continued)
Other Revenues and Gains
Dividend revenue ……………………………………..
38,000
Other Expenses and Losses
Interest expense …………………………..…………..
18,000
Income before income tax …………………………….
Income tax ……………………………………………….
*Rounded
TWAIN CORPORATION
Retained Earnings Statement
For the Year Ended June 30, 2012
319,300
4-47
PROBLEM 4-4 (Continued)
(b) TWAIN CORPORATION
Income Statement
For the Year Ended June 30, 2012
Revenues
Net sales ……………………………………………………….
$1,485,050
Dividend revenue ………………………………………………..
38,000
Total revenues …………………………………………….
1,523,050
TWAIN CORPORATION
Retained Earnings Statement
For the Year Ended June 30, 2012
Retained earnings, July 1, 2011, as reported …………….
$337,000
Retained earnings, July 1, 2011 as adjusted …………….
Add: Net income ……………………………………………………
Dividends declared on preferred stock …………..
Dividends declared on common stock ……………
Expenses
Cost of goods sold ………………………………………………
Selling expenses …………………………………………………
Administrative expenses ……………………………………..
Interest expense ………………………………………………….
18,000
Total expenses ……………………………………………
Income before income tax ……………………………………………..
Income tax ……………………………………………………….
102,000
Earnings per common share………………………………………….
4-48
PROBLEM 4-5
1. The usual but infrequently occurring charge of $8,500,000 should be
disclosed separately, assuming it is material. This charge is shown
above income before extraordinary items and would not be reported net
2. The extraordinary item of $6,000,000 should be reported net of tax in a
separate section for extraordinary items. An adjustment should be made
to income taxes to report this amount at $21,400,000. The $2,000,000 tax
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
such importance is ascribed to this statistic, the profession believes it
necessary to highlight the earnings per share figure. In this case the
company should report both income before extraordinary item and
net income on a per share basis.
4-49
PROBLEM 4-6
(a) ACADIAN CORP.
Retained Earnings Statement
For the Year Ended December 31, 2012
Retained earnings, January 1, as reported …………………………..
$257,600
Correction of error from prior period (net of tax) ………………………..
25,400
Adjustment for change in accounting principle
(net of tax) ……………………………………………………….……………………
(23,200)
Retained earnings, January 1, as adjusted …………………………..
Add: Net income ……………………………………………………….……………
Less: Cash dividends declared …………………………………………………
32,000
PROBLEM 4-7
WADE CORP.
Income Statement (Partial)
For the Year Ended December 31, 2012
Income from continuing operations
before income tax ………………………………
$1,200,000*
Income tax ……………………………………
456,000**
Income from continuing operations ………..
Discontinued operations
Less: Applicable income tax
reduction ……………………..
34,200
$ 55,800
Loss from disposal of subsidiary ……..
100,000
Less: Applicable income tax
reduction ……………………..
38,000
62,000
117,800
Income before extraordinary item …………..
Extraordinary item:
Gain on condemnation …………………..
Per share of common stock:
Income from continuing operations …………………………….
$4.96
Discontinued operations, net of tax …………………………….
(0.79)
Income before extraordinary item ……………………………….
Extraordinary item, net of tax ……………………………………..
Net income ($701,200 ÷ 150,000) …………………………………
4-51
PROBLEM 4-7 (Continued)
*Computation of income from continuing operations
before income tax:
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 special items, proper net of tax treatment, and presentation of per share data.
CA 4-2 (Time 10–15 minutes)
Purpose—to provide the student a real company context to identify factors that make income statement
information useful. The focus is on overly-aggregated information in a condensed income statement.
Additional detail would seem to be warranted either on the face of the statement or with reference to
the notes.
CA 4-3 (Time 20–25 minutes)
Purpose—to provide the student with an understanding of conditions where extraordinary item classification
is appropriate. In this case, it should be emphasized that in situations where extraordinary item
classification is not permitted, a classification as an unusual item may still be employed.
CA 4-4 (Time 20–25 minutes)
Purpose—to provide the student an illustration of how earnings can be managed. The case allows
students to see the effects of warranty expense timing on the trend of income and illustrates the potential
use of accruals to smooth earnings.
CA 4-5 (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 4-6 (Time 30–35 minutes)
Purpose—to provide the student with an unstructured case to comment on the reporting of discontinued
operations and extraordinary items. In addition, the student is asked to comment on materiality con–
siderations and earnings per share implications.
CA 4-7 (Time 30–40 minutes)
Purpose—to provide the student with the opportunity to comment on deficiencies in an income
statement. This case includes discussion of extraordinary items, discontinued items, and ordinary gains
and losses. The case is complete and therefore provides a broad overview to a number of items
discussed in the textbook.
CA 4-8 (Time 20–25 minutes)
Purpose—to provide the student with a variety of situations involving classification of special items. This
case is different from CA 4-7 in that an income statement is not presented. Instead, short factual
situations are described. A good comprehensive case for discussing the presentation of special items.
CA 4-9 (Time 10–15 minutes)
Purpose—to provide the student with an opportunity to show how comprehensive income should be
reported.
SOLUTIONS TO CONCEPTS FOR ANALYSIS
CA 4-1
The deficiencies of O’Malley Corporation’s income statement are as follows:
1. The heading is inappropriate. The heading should include the name of the company and the period
of time for which the income statement is presented.
5. Loss on obsolescence of inventories might be classified as an unusual item and separately
disclosed if it is unusual or infrequent but not both.
CA 4-2
(a) The main deficiency in the Boeing income statement is that important information is being
aggregated, particularly in the “Costs and expenses” line item. More detail likely could be found in
CA 4-3
1. Classify as an extraordinary item because the two conditions of an extraordinary item, unusual in
nature and infrequent in occurrence, are met.
4-54
CA 4-3 (Continued)
4. Classify as gain or loss, but not extraordinary. Because the company maintains a portfolio of such
securities, the gain or loss would not be considered unusual in nature.
CA 4-4
(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
2009
2010
2011
2012
2013
Income before warranty expense
$43,000
$43,000
Warranty expense
7,000
3,000
Income
$20,000
$25,000
$30,000
$36,000
$40,000
(c) Appropriate Accounting
Income before warranty expense
$43,000
$43,000
Warranty expense
5,000
5,000
CA 4-5
(a) The ethical issues involved are integrity and honesty in financial reporting, full disclosure,
CA 4-6
(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
Simpson Corp. and, therefore, the accounting requirements related to discontinued operations should
be followed. Although the financial vice-president might be correct theoretically, professional pro-
CA 4-7
The income statement of Walters Corporation contains the following weaknesses in classification and
disclosure:
1. Sales taxes. Sales taxes have been erroneously included in both gross sales and cost of goods
sold on the income statement of Walters Corporation. Failure to deduct these taxes directly from
CA 4-7 (Continued)
2. 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
3. Recoveries of accounts written off in prior years. These collections should be credited to the
4. Freight-in and freight-out. Although freight-out is an expense of selling and is therefore reported
5. Loss on discontinued styles. This type of loss, though often substantial, should not be treated
as an extraordinary item because it is apparently typical of the customary business activity of the
corporation. It should be reported in “Costs and expenses” as an operating expense.
6. Loss on sale of marketable securities. This item should be reported as a separate component
7. Loss on sale of warehouse. This type of item is specifically excluded by FASB ASC 225-20-45
8. Federal Income taxes. The provision for federal income taxes and intraperiod tax allocation are
not presented in the income statement. This omission implies that the federal income tax is a
4-57
CA 4-8
Classification
Rationale
1.
No disclosure.
Error has “washed out”; that is, subsequent
income statement compensated for the error.
However, prior year income statements should
be restated.
6.
Adjustment to the beginning balance of
retained earnings.
A change in inventory methods is a change in
accounting principle and prior periods are
adjusted.
7.
Reported in body of the income statement,
possibly as an unusual item.
Loss on preparation of such proposals is not
considered extraordinary in nature.
9.
Prior period adjustment, adjust beginning
retained earnings.
Corrections of errors are shown as prior period
adjustments.
Extraordinary item section.
Material, unusual in nature, and infrequent in
occurrence.
activities are clearly distinguishable physically,
operationally, and for financial reporting
purposes.
2.
Extraordinary item section.
Material, unusual in nature, and infrequent in
occurrence.
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.
5.
Reported in body of the income statement,
possibly as an unusual item.
Sale does not meet criteria for either the disposal
of a component of the business or an
extraordinary item.
4-58
CA 4-9
(a) Separate Statement
Current Year
Prior Year
. . . income components . . .
Net income ………………………………………………………………….
$400,000
$410,000
Unrealized gains …………………………………………………………..
Net income …………………………………………………………………..
Unrealized gains ……………………………………………………………
FINANCIAL REPORTING PROBLEM
(a) P&G uses the multiple-step income statement because it separates
operating from nonoperating activities. A multiple-step income statement
is used to recognize additional relationships related to revenues and
Health Care, 17%
Snacks and Pet Care, 4%
Grooming, 9%
(c) P&G’s gross profit (Net Sales – Cost of Products Sold) was $40,131 million
in 2009, $42,212 million in 2008, and $39,173 million in 2007. P&G’s
gross profit decreased by 5% in 2009 compared to 2008. The decrease in
the gross profit in 2009 is due primarily to higher commodity and
energy costs, and unfavorable foreign exchange and incremental
restructuring charges (see MD&A).