Chapter 4 Income Statement QUESTIONS 4- 1.

Extraordinary items are events or transactions that are distinguished by their unusual nature and infrequency of occurrence. They might include casualty losses or losses from expropriation or prohibition. They must be shown separately, net of tax, in order that trend analysis can be made of income before extraordinary items. d, f Examples include sales of securities, write-down of inventories, disposal of a product line not qualifying as a segment, gain or loss from a lawsuit, etc. They are shown separately because of their materiality and the desire to achieve full disclosure. They are not given net-of-tax treatment because they are included in income before the income tax is deducted. Also, net-of-tax treatment would infer that these items are extraordinary. Under the equity method, equity in earnings of nonconsolidated subsidiaries is a problem in profitability analysis because the income recognized is not a cash inflow. The cash inflow is only the amount of the investor share of dividends declared and paid. Further, equity earnings do not come directly from the operations of the business in question, but rather from a subsidiary. It would appear that this is the disposal of a product line that is specifically separate from the dairy products line. The disposal of the vitamin line should be identified as discontinued operations and be presented net-of-tax after income from continuing operations on the income statement. Unusual or infrequent items relate to operations. Examples are write-downs of receivables and write-downs of inventory. A new FASB issued in May, 2005 requires retrospective application to prior periodical financial statements of a voluntary change in accounting principle unless it is impracticable.

4- 2. 4- 3.

4- 4.

4- 5.

4- 6. 4- 7.

4- 8.

The declaration of a cash dividend reduces retained earnings and increases current liabilities. The payment of a cash dividend reduces current liabilities and cash. First, a stock split is usually for a larger number of shares. Secondly, a stock dividend reduces retained earnings and increases paid-in capital. A stock split merely increases the shares and reduces the par value, leaving the capital stock account intact. Both require restatement of any per share items.

4- 9.

4-10.

If a firm consolidates subsidiaries that are not wholly owned, the total revenues and expenses of the subsidiaries are included with those of the parent. To determine the income that would accrue to the parent, however, it is necessary to deduct the portion of income that would belong to the net income noncontrolling interest. The statement of retained earnings summarizes the changes to retained earnings. Retained earnings represents the undistributed earnings of the corporation. The income statement net income is added to retained earnings. A loss is deducted from retained earnings. A dividend is deducted from retained earnings. 1. 2. 3. Appropriations as a result of a legal requirement Appropriations as a result of a contractual agreement Appropriations as a result of management discretion

4-11.

4-12.

Appropriations as a result of management discretion are not likely a detriment to the payment of a dividend. 4-13. The balance sheet shows the account balances as of a particular point in time. The income statement shows the revenues and expenses resulting from transactions for the period of time. a. b. 4-15. Net income noncontrolling interest is an income statement item that represents the minority owners' share of consolidated earnings. Equity in earnings is the proportionate share of the earnings of the investor that relate to the investor's investment.

4-14.

The two traditional formats for presenting the income statement are the multiple-step and single-step. The multiple-step is preferable for analysis because it provides intermediate profit figures that are useful in analysis. 2011 2010 2009 $ .80

4-16. 4-17.

Earnings per share

$1.40 $1.00

Accountants have not accepted the role of disclosing the firms capacity to make distributions to stockholders. Therefore, the firms capacity to make distributions to stockholders cannot be determined using published financial statements. Management does not usually like to tie comprehensive income closely with the income statement because the items within accumulated other comprehensive income have the potential to be volatile. This represents a finer line item discloser than under U.S. GAAP. Many of the items are similar but with an IAS describing what goes in each function. For example, U.S. GAAP has other gains and losses but the content may be different than under IFRS.

4-18.

4-19.

4-20.

This represents a finer line item disclosure than under U.S. GAAP. Many of the items are similar but with an IAS describing what goes by each nature. U.S. GAAP would have some similar items such as (1) revenue, (2) other gains and losses, and (3) share of profits of associates. Per Exhibit 4-12: $ 27,049 23,04 9 (4,000 $ 27,04 27,049 $ (4,000 23,049

4-21.

Profit for the year Profit attributable to: Owners of the company Noncontrolling interests U.S. GAAP: Profit for the year Less: Net income noncontrolling interest Net income

PROBLEMS PROBLEM 4-1

CALVIN COMPANY INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 2012

Sales $50,300 Cost of goods sold 29,200 Gross profit $21,100 Operating expenses: Selling expenses: Advertising $2,600 Commissions 3,5415 Insurance - salesperson's auto 3,350 Total selling expenses $9,465 General and administrative expenses: Depreciation office building $4,000 Salaries and wagesoffice 13,660 Suppliesoffice 1,990 Total general and administrative expenses 19,650 Total operating expenses 29,115 Loss from operations $(8,015) Other revenues and expenses: Interest expense $(1,400) Interest revenue 2,340 Rent revenue Income before taxes Income tax expense Net income Excess 8,640 of other revenues over other expenses 7,700 $625 190 $435

PROBLEM 4-2

A.

Tampa Corporation Income Statement Year Ended December 31, 2012 Revenues: Delivery revenue $280,000 $82,000 43,000 28,000 18,000

Expenses: Salary and wage expense Rent expense Water, gas, and electricity Income tax expense Net income

171,00 $109,0 00

B. The company appears profitable. Basing the decision solely on profitability, it appears the company can generate operating income to enable it to repay the loan. But the company also had accounts payable and notes payable of $30,000 and $34,000, respectively, for which cash may not be available to pay when these amounts become due. C. $42,000 + $109,000 - $85,000 = $66,000

PROBLEM 4-3 Consolidated Can Income Statement For the Year Ended December 31, 2010 Sales Cost of products sold Gross profit Selling and administrative expenses Operating income Other income Income before tax and extraordinary items Interest expense Income before tax and extraordinary items Income tax Income before extraordinary items Extraordinary gain, net of tax Net income plus retained earnings 1/1 Retained earnings 1/1 Net income plus retained earnings on 1/1 Less: dividends Retained earnings $ 480,000 (410,000) 70,00 0 ( 42,000) 28,00 0 1,600 29,60 0 (8,700) 20,90 0 (9,300) 11,60 0 1,000 12,60 0 270,000 282,60 0 (3,000) $ 279,600

PROBLEM 4-4 a. Taperline Corporation Income Statement For the Year Ended December 31, 2010 Revenues: Sales Rental income Gain on the sale of fixed assets Total revenues Expenses: Cost of sales Selling expenses General and administrative expenses Depreciation expense Interest expense Income before extraordinary items and taxes on income Income tax Earnings before extraordinary item Casualty loss Less: Tax saving Net income Earnings per share on common stock: (30,000 shares outstanding) Income before extraordinary items Net income $ 300,000 97,000 110,000 10,000 1,900 $ 670,000 3,600 3,000 $ 676,600

(518,900) $ 157,700 (63,080) $ 94,620 (18,000) $ $ $ 76,620 3.15 2.55

$ 30,000 (12,000)

b. Taperline Corporation Income Statement Sales Cost of sales Gross profit For the Year Ended December 31, 2010 $ 670,000 (300,000) 370,000

Operating expenses Selling expenses General and administrative expenses Depreciation expense Operating income Other revenue: Rental income Gain on the sale of fixed assets Total other revenue Other expenses: Interest expense Income before extraordinary items and taxes on income tax Income Income before extraordinary item Casualty loss Less: Tax saving Net income Earnings per share on common stock: (30,000 shares outstanding) Net income Income before extraordinary items PROBLEM 4-5 Tax Rate = Taxes Income Before $20,000 = = $40,000

$ 97,000 110,000 10,000

217,000 $ 153,000

3,600 3,000 $ 6,600

$ 30,000 (12,000)

(1,900) $ 157,700 (63,080) $ 94,620 (18,000) $ 76,620 $ $ 2.55

50% $ 50,000 25,000 $ 25,000 $ 50,000 (30,000) $ 45,000

Taxes Provision for unusual write-offs Less: tax effects (50% x $50,000) Net item Extraordinary charge, net of tax of $10,000 Net earnings (loss) Net earnings with nonrecurring items removed [(30,000) + $25,000 + $50,000]

PROBLEM 4-6

Sales Cost of sales Gross profit Operating expenses: Administrative expenses Selling expenses Operating income Interest expense Earnings before tax

$ 4,000,0001 (2,000,000) $ 2,000,000 (1,000,000) $

$ 400,0002 600,000

3 $ 890,000 (110,000) Income tax (48%) (427,200) Net income 462,80 $ 0 $9.2 Earnings per share 6 1 Administrative expenses are 20% of $2,000,000. This is 10% of sales. Therefore, sales are $4,000,000. 2 3

150% times $400,000 $1,000,000 x 11% = $110,000

PROBLEM 4-7 Total revenues from regular operations Total expenses from regular operations Income from operations Extraordinary gain, net of tax Net income Earnings per share: Before extraordinary items Extraordinary gain Net income $ 832,000 776,000 56,000 30,000 $ 86,000 $56,000/10,000 = $5.60 $30,000/10,000 = $3.00 $86,000/10,000 = $8.60

PROBLEM 4-8

Victor, Inc. Partial Income Statement For the Year Ended December 31, 2010 Income from continuing operations, unadjusted Adjustments: Settlement of lawsuit Gain on sale of securities Income from continuing operations, adjusted, before tax Income tax (30%) Income from continuing operations Discontinued operations: Loss on operations of consumer products division Loss from disposal of assets Tax effect (30%) Loss from discontinued operations Income before extraordinary item Extraordinary item: Loss from hailstorm Tax effect (30%) Income before cumulative change in accounting principle Cumulative change in accounting principle from average cost to FIFO Tax effect (30%) Increase in income from change in accounting principle Net income Earnings per share: (100,000 shares outstanding) Income from continuing Discontinued operations operations Extraordinary loss Cumulative effect of a change in accounting principle Net income $ 60,000 90,000 $ 150,000 (45,000) (105,000) $ 189,000 $ 20,000 (6,000) $ 30,000 (9,000) 21,000 $ 196,000 $ (1.0 5) (0.1 4) $ 400,000 (10,00 30,000 $ 420,000 (126,000) $ 294,000

(14,000) $ 175,000

0.21 $ 1.96

PROBLEM 4-9

a. b. c. d. e. f. g.

A A A B B A A

h .i . j . k .l . m .n . o . h .i . j . k .l . m .n .

B C B B B A B B

p q . .r . s .t . u . v .

A A A A B B A

PROBLEM 4-10 a. b. c. d. e. f. g. C B A B A B C B B A B A B B o p . . q .r . A B A B

PROBLEM 4-11 a . b . c . d . e . Net income Plus: Extraordinary loss from flood $60,000 $60,000 $40,000 $100,000 $50,000 = $50,000 $ 20,000 120,000 $ 140,000

PROBLEM 4-12 a. Net income from operations $146,000 b. $20,000 Loss c. $94,000 30,000 50,000 +25,000 $39,000

PROBLEM 4-13

a.

1 .

Receipt of cash: Sales, 210,000 ounces x $300 Cost of goods sold (1), 210,000 Gross profit ounces x Selling expenses Administrative expenses Profit before taxes Taxes Net income (1) $50,000,000 200,000 =

= =

$ 63,000,000 $ (52,500,00 10,500,000 (2,000,00 0) (1,250,000) $ 7,250,000 (3,625,000) $ 3,625,000

$250 ounce

2 .

Point of sale: Sales, 230,000 ounces x Cost $300 of goods sold, 230,000 ounces x $250 Gross profit Selling expenses Administrative expenses Taxes Net income Profit before taxes

= =

$ 69,000,000 57,500,000 $ 11,500,000 (2,000,00 0) (1,250,000) (4,125,000) $ 4,125,000 $ 8,250,000

PROBLEM 4-13

3 .

End of production: Sales, 200,000 ounces x Cost $300 of goods sold, 200,000 ounces x $250 Gross profit Selling expenses Administrative expenses Taxes Net income Profit before taxes

= =

$ 60,000,000 (50,000,000) $ 10,000,000 (2,000,00 0) (1,250,000) (3,375,000) $ 3,375,000 $ 6,750,000

4 .

Based on delivery: Sales, 190,000 ounces x Cost $300 of goods sold, 190,000 ounces x $250 Gross profit Selling expenses Administrative expenses Taxes Net income Profit before taxes

= =

$ 57,000,000 (47,500,000) $ 9,500,000 (2,000,00 0) (1,250,000) (3,125,000) $ 3,125,000 $ 6,250,000

b.

1 .

Receipt of cash This method should only be used when the prospects of collection are especially doubtful at the time of sale.

2 .

Point of sale In practice, the point of realization usually is the point of sale. At this point, the earnings process is virtually complete and the exchange value can be determined.

3 .

End of production The realization of revenue at the completion of the production process is acceptable when the price of the item is known and there is a ready market. This method should receive strong consideration in this case. The question that needs to be resolved is how fixed is the price of uranium. Since the price has gone from $150 per ounce in 1981 to $300 per ounce in 2006, the price does not appear to be fixed.

4 .

Based on delivery

This is not usually an acceptable realization point. Delivery is an objective guideline, but delivery does not usually represent a significant event.

PROBLEM 4-14

a.

No. This loss does not relate to the cost of goods sold. It is likely an extraordinary loss meeting the criteria of being of unusual in nature and infrequent in occurrence. No. Land is carried at historical cost. Yes. The cost of machinery and equipment should be charged to a fixed asset account. No. Depreciation should be recognized over the period of use. Yes. Some loss to employees would be expected and it is immaterial in relation to the cost of goods sold. No. This car should not be recorded on the companys books, unless it is to be used for company business.

b. c. d. e. f.

PROBLEM 4-15 a. Comprehensive income will tend to be more volatile than net income because the items within other comprehensive income tend to be more volatile than net income. The standard directs that earnings per share be computed based on net income. $30,000 5,000 3,000 $38,000 d. No. These items could net out as an addition to net income or a deduction from net income.

b. c.

a. b.

2 2

Advertising expense would be classified as an operating expense. Equity in earnings of nonconsolidated subsidiaries would be recurring as long as there is an investment in the subsidiary. If our firm gained control, then there would be consolidation. Beginning inventory $ 180,000 (5,000) $ 65,000 Computed 175,000 240,000 Computed (30,000) $ 210,000

c.

Purchases Purchase returns Total available Less ending inventory Cost of goods sold d. e. f.

3, 4, 5 Discontinued operations and extraordinary items are considered to be nonrecurring items. 3 1 30% x $150,000 = $45,000 Extraordinary items are material events and transactions distinguished by their unusual nature and by the infrequency of their occurrence. A loss from a tornado would qualify as an extraordinary item. A cash dividend declared by the board of directors reduces retained earnings by the amount of the dividend declared. The overall effect is to leave stockholders equity in total unchanged and each owners share of stockholders equity unchanged; however, the total number of shares increase.

g. h.

2 5