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Chapter 4

The Income Statement, Comprehensive Income, an the Statement of Cash !"o#s

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Brief Exercise
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Brief Exercises
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Intermediate Accounting, 7'e

Q/ESTI01S !02 2E3IE4 0! 5E6 T0PICS


Question 4%&
The income statement is a change statement that reports transactions/revenues, expenses, gains, and losses/that cause owners0 equity to change during a specified reporting period.

Question 4%'
1ncome from continuing operations includes the revenue, expense, gain, and loss transactions that will probably continue in future periods. 1t is important to segregate the income effects of these items because they are the most important transactions in terms of predicting future cash flows.

Question 4%(
2perating income includes revenues and expenses and gains and losses that are directly related to the principal revenue generating activities of the company. 3onoperating income includes items that are not directly related to these activities.

Question 4%4
The single-step format first lists all revenues and gains included in income from continuing operations to arrive at total revenues and gains. All expenses and losses are then grouped and subtotaled, subtracted from revenues and gains to arrive at income from continuing operations. The multiple-step format reports a series 4multiple5 of intermediate totals such as gross profit, operating income, and income before taxes. 6ery often income statements adopt variations of these formats, falling somewhere in between the two extremes.

Question 4%)
The term earnings *ua"it+ refers to the ability of reported earnings 4income5 to predict a company0s future earnings. After all, an income statement simply reports on events that already have occurred. The relevance of any historical7based financial statement hinges on its predictive value.

Question 4%,
(estructuring costs include costs associated with shutdown or relocation of facilities or downsi8ing of operations. They are reported as an operating expense in the income statement.

Question 4%The process of intraperiod tax allocation matches tax expense or tax benefit with each ma9or component of income, specifically continuing operations and any item reported below continuing operations. The process is necessary to achieve the desired result of separating the total income effects of continuing operations from the two separately reported items/discontinued operations and extraordinary items/and also to show the a)ter-ta* effect of each of those two components.

Answers to Questions (continued) Question 4%.


The net7of7tax income effects of a discontinued operation must be disclosed separately in the income statement, below income from continuing operations. The income effects include income 4loss5 from operations and gain 4loss5 on disposal. The gain or loss on disposal must be disclosed
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either on the face of the statement or in a disclosure note. 1f the component is held for sale but not sold by the end of the reporting period, the income effects will include income 4loss5 from operations and an impairment loss if the fair value less costs to sell is less than the boo value of the component0s assets. The income 4loss5 from operations of the component is reported separately in discontinued operations on prior income statements presented for comparative purposes.

Question 4%7
:xtraordinary items are material gains and losses that are both unusual in nature and infrequent in occurrence, ta ing into account the environment in which the entity operates.

Question 4%&8
:xtraordinary gains and losses are presented, net of tax, in the income statement below discontinued operations, if any.

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Answers to Questions (continued) Question 4%&&


;AA< permit alternative treatments for similar transactions. Common examples are the choice among =1=2, >1=2, and average cost for the measurement of inventory and the choice among alternative revenue recognition methods. A change in accounting principle occurs when a company changes from one generally accepted treatment to another. 1n general, we report voluntary changes in accounting principles retrospectively. This means revising all previous periods0 financial statements as if the new method were used in those periods. 1n other words, for each year in the comparative statements reported, we revise the balance of each account affected. Specifically, we ma e those statements appear as if the newly adopted accounting method had been applied all along. Also, if retained earnings is one of the accounts whose balance requires ad9ustment 4and it usually is5, we revise the beginning balance of retained earnings for the earliest period reported in the comparative statements of shareholders0 equity 4or statements of retained earnings if they0re presented instead5. Then we create a 9ournal entry to ad9ust all account balances affected as of the date of the change. 1n the first set of financial statements after the change, a disclosure note would describe the change and 9ustify the new method as preferable. 1t also would describe the effects of the change on all items affected, including the fact that the retained earnings balance was revised in the statement of shareholders0 equity along with the cumulative effect of the change in retained earnings. An exception is a change in depreciation, amorti8ation, or depletion method. These changes are accounted for as a change in estimate, rather than as a change in accounting principle. Changes in estimates are accounted for prospectively. The remaining boo value is depreciated, amorti8ed, or depleted, using the new method, over the remaining useful life.

Question 4%&'
A change in accounting estimate is accounted for in the year of the change and in subsequent periods? prior years0 financial statements are not restated. A disclosure note should 9ustify that the change is preferable and should describe the effect of a change on any financial statement line items and per share amounts affected for all periods reported.

Question 4%&(
<rior period ad9ustments are accounted for by restating prior years0 financial statements when those statements are presented again for comparison purposes. The beginning of period retained earnings is increased or decreased on the statement of shareholders0 equity 4or the statement of retained earnings5 as of the beginning of the earliest period presented.

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Answers to Questions (continued) Question 4%&4


:arnings per share 4:<S5 is the amount of income achieved during a period for each share of common stoc outstanding. 1f there are different components of income reported below continuing operations, their effects on earnings per share must be disclosed. 1f a period contains discontinued operations and extraordinary items, :<S data must be reported separately for income from continuing operations and net income. <er share amounts for discontinued operations and extraordinary items would be disclosed on the face of the income statement.

Question 4%&)
Comprehensi,e income is the total change in equity for a reporting period other than from transactions with owners. %eporting comprehensive income can be accomplished with a continuous statement of comprehensive income that includes an income statement and other comprehensive income items or in two statements, an income statement and a separate statement of comprehensive income.

Question 4%&,
The purpose of the statement of cash flows is to provide information about the cash receipts and cash disbursements of an enterprise during a period. Similar to the income statement, it is a change statement, summari8ing the transactions that caused cash to change during a particular period of time.

Question 4%&The three categories of cash flows reported on the statement of cash flows are! $. -perating acti,ities/1nflows and outflows of cash related to the transactions entering into the determination of net income from operations. &. In,esting acti,ities/1nvolve the acquisition and sale of 4$5 long7term assets used in the business and 4&5 nonoperating investment assets. '. .inancing acti,ities/1nvolve cash inflows and outflows from transactions with creditors and owners.

Question 4%&.
3oncash investing and financing activities are transactions that do not increase or decrease cash but are important investing and financing activities. An example would be the acquisition of property, plant, and equipment 4an investing activity5 by issuing either long7term debt or equity securities 4a financing activity5. These activities are reported either on the face of the statement of cash flows or in a disclosure note.

Question 4%&7
The direct method of reporting cash flows from operating activities presents the cash effect of each operating activity directl/ on the statement of cash flows. The indirect method of reporting cash flows from operating activities is derived indirectl/, by starting with reported net income and adding and subtracting items to convert that amount to a cash basis.

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Answers to Questions (concluded) Question 4%'8


There are two possible separately reported items that could appear in income statements, discontinued operations and extraordinary items. 1nternational =inancial %eporting Standards 41=%S5 prohibit reporting extraordinary items.

Question 4%'&
@.S. ;AA< designates cash outflows for interest payments and cash inflows from interest and dividends received as operating cash flows. .ividends paid to shareholders are classified as financing cash flows. 1=%S allows more flexibility. Companies can report interest and dividends paid as either operating or financing cash flows and interest and dividends received as either operating or investing cash flows. 1nterest and dividend payments usually are reported as financing activities. 1nterest and dividends received normally are classified as investing activities.

B2IE! E9E2CISES Brief Exercise 4%&


PACI!IC SCIE1TI!IC C02P02ATI01 1ncome Statement =or the Aear :nded .ecember '$, &-$'
4B in millions5

(e,enues and gains1 Sales .................................................................. ;ain on sale of investments ............................... Total revenues and gains ............................... 2*penses and losses1 Cost of goods sold ............................................. Selling................................................................ ;eneral and administrative................................. 1nterest............................................................... Total expenses and losses .............................. 1ncome before income taxes ................................ 1ncome tax expenseC............................................ 3et income ........................................................... C B)"( x "-D E B&(+ B$,&"$&) $-( '(

B&,$-) "( &,$($

$,(-) )"( &(+ B '+*

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Brief Exercise 4%'

4a5

Sales revenue

B&,$-)

>ess! Cost of goods sold 4$,&"-5 ;ross profit +)) >ess! Selling expenses 4$&)5 ;eneral and administrative expenses 4$-(5 2perating income : ,() ;ain on sale of investments 1nterest expense 3onoperating income "( 4'(5 :&8

4b5

Brief Exercise 4%(


PACI!IC SCIE1TI!IC C02P02ATI01 1ncome Statement =or the Aear :nded .ecember '$, &-$'
4B in millions5

Sales revenue ....................................................... Cost of goods sold ............................................... ;ross profit .......................................................... -perating e*penses1 Selling................................................................ ;eneral and administrative................................. Total operating expenses ............................... 2perating income ................................................. -ther income 3e*pense41 ;ain on sale of investments ............................... 1nterest expense ................................................. Total other income, net .................................. 1ncome before income taxes ............................... 1ncome tax expenseC ............................................ 3et income ........................................................... CB)"( x "-D B$&) $-(

B&,$-) $,&"+))

&'$ )'( "( 4'(5 $)"( &(+ B '+*

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Intermediate Accounting, 7'e

Brief Exercise 4%4

4a5

Sales revenue 4$)-,---5 4"-,---5 4(-,---5 4&(,---5 : '),888 B&(,--",--4&&,---5 *,--4&,+--5 : 4,'88 B ",&-4'-,---5 ;'),.88<

B'--,---

>ess! Cost of goods sold ;eneral and administrative expenses %estructuring costs Selling expenses 2perating income 2perating income Add! 1nterest revenue .educt! >oss on sale of investments 1ncome before income taxes and 1ncome tax expense 4"-D5 1ncome before extraordinary item 1ncome before extraordinary item :xtraordinary item! >oss from flood damage, net of B&-,--tax benefit 3et loss

4b5

4c5

Brief Exercise 4%)


MEM02A9 C0MPA16 <artial 1ncome Statement =or the Aear :nded .ecember '$, &-$' 1ncome before income taxes and extraordinary item............ 1ncome tax expenseC ........................................................... 1ncome before extraordinary item ....................................... :xtraordinary item! >oss from earthqua e, net of B&-+,--- tax benefit........... 3et income ........................................................................... CB*,-,--- x "-D B *,-,--'$),--"*",--4'$&,---5 B $)&,---

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Brief Exercise 4%,


4=ITE A1> S01S, I1C? <artial 1ncome Statement =or the Aear :nded .ecember '$, &-$' 1ncome before income taxes and extraordinary item............ 1ncome tax expenseC ........................................................... 1ncome before extraordinary item ....................................... :xtraordinary item! >oss from earthqua e, net of B$)-,--- tax benefit........... 3et income ........................................................................... :arnings per share! 1ncome before extraordinary item........................................ >oss from earthqua e .......................................................... 3et income .......................................................................... CB+(-,--- x "-D 3ote! %estructuring costs, interest revenue, and loss on sale of investments are included in income before income taxes and extraordinary item. B +(-,--'"-,--($-,--4&"-,---5 B &*-,--B (.$4&."-5 B &.*-

Brief Exercise 4%CA@I!021IA MIC20TEC= C02P02ATI01 <artial 1ncome Statement =or the Aear :nded .ecember '$, &-$' 1ncome from continuing operations before income taxes..... 1ncome tax expenseC ............................................................ 1ncome from continuing operations ..................................... .iscontinued operations! >oss from operations of discontinued component 4including gain on disposal of B&,---,---5CC ........................... 1ncome tax benefit ............................................................ >oss on discontinued operations ....................................... 3et income ...........................................................................
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B (,+--,--$,*"-,--B ",-)-,--4$,)--,---5 "+-,--4$,$&-,---5 B &,,"-,--Intermediate Accounting, 7'e

C B(,+--,--- x '-D CC @oss from operations of iscontinue componentA ;ain on sale of assets >oss from operations Total before7tax loss B &,---,--- 4B$- million less B+ million5 4',)--,---5 B4$,)--,---5

Brief Exercise 4%.


CA@I!021IA MIC20TEC= C02P02ATI01 <artial 1ncome Statement =or the Aear :nded .ecember '$, &-$' 1ncome from continuing operations before income taxes..... 1ncome tax expenseC ............................................................ 1ncome from continuing operations ..................................... .iscontinued operations! >oss from operations of discontinued componentCC ......... 1ncome tax benefit ............................................................ >oss on discontinued operations ....................................... 3et income ........................................................................... B (,+--,--$,*"-,--B ",-)-,--4',)--,---5 $,-+-,--4&,(&-,---5 B $,("-,---

C B(,+--,--- x '-D CC 1ncludes only the loss from operations. There is no impairment loss.

Brief Exercise 4%7


CA@I!021IA MIC20TEC= C02P02ATI01 <artial 1ncome Statement =or the Aear :nded .ecember '$, &-$' 1ncome from continuing operations before income taxes..... 1ncome tax expenseC ............................................................ 1ncome from continuing operations ..................................... .iscontinued operations! >oss from operations of discontinued component
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B (,+--,--$,*"-,--B ",-)-,---

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4including impairment loss of B$,---,---5CC ............................

1ncome tax benefit ............................................................ >oss on discontinued operations ....................................... 3et income ........................................................................... C B(,+--,--- x '-D CC @oss from operations of iscontinue componentA 1mpairment loss 4B+ million boo value less B* million net fair value5 >oss from operations Total before7tax loss

4",)--,---5 $,'+-,--4',&&-,---5 B +"-,---

B4$,---,---5 4',)--,---5 B4",)--,---5

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Brief Exercise 4%&8


0B2EI@@6 BE3E2ACE C0MPA16 Statement of Comprehensive 1ncome =or the Aear :nded .ecember '$, &-$' 3et income ........................................................... 2ther comprehensive income 4loss5! .eferred loss on derivatives, net of tax ............ @nreali8ed gains on investment securities, net of tax ........................................................ Total other comprehensive loss ........................... Comprehensive income ........................................ B)(-,--B4'),---5 &",--4$&,---5 B)'+,---

Brief Exercise 4%&&


Cash )lows )rom operating acti,ities1 Collections from customers 1nterest on note receivable 1nterest on note payable <ayment of operating expenses 3et cash flows from operating activities B ))-,--$&,--4$+,---5 4""-,---5 B&$",---

2nly these four cash flow transactions relate to operating activities. The others are investing and financing activities.

Brief Exercise 4%&'

Cash )lows )rom in,esting acti,ities1 <roceeds from note receivable collection Sale of land <urchase of equipment 3et cash flows from investing activities

B$--,--"-,--4$&-,---5 B&-,-- The McGraw-Hill Companies, Inc., 2 !" %&!"

#olutions Manual, $ol.!, Chapter %

Cash )lows )rom )inancing acti,ities1 1ssuance of common stoc <ayment of dividends 3et cash flows from financing activities

B&--,--4'-,---5 $*-,---

Brief Exercise 4%&(

Cash )lows )rom operating acti,ities1 3et income Ad7ustments )or noncash e))ects1 .epreciation expense Changes in operating assets and lia8ilities1 1ncrease in prepaid rent 1ncrease in salaries payable 1ncrease in income taxes payable 3et cash inflows from operating activities

B"(,--+-,--4)-,---5 $(,--$&,--B,&,---

@nder 1=%S, interest received and interest paid usually Brief Exercise 4%&4are classified as investing and financing cash flows, respectively, not operating cash flows as with @.S. ;AA<. The revised cash flow categories usually would appear as follows! Cash )lows )rom operating acti,ities1 Collections from customers <ayment of operating expenses 3et cash flows from operating activities Cash )lows )rom in,esting acti,ities1 <roceeds from note receivable collection Sale of land Interest on note recei,a8le <urchase of equipment 3et cash flows from investing activities Cash )lows )rom )inancing acti,ities1 1ssuance of common stoc <ayment of dividends Interest on note pa/a8le 3et cash flows from financing activities B ))-,--4""-,---5 B&&-,--B$--,--"-,--!2, 4$&-,---5 B'&,--B&--,--4'-,---5 3!5, 4 $(&,---

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Intermediate Accounting, 7'e

E9E2CISES Exercise 4%&

2e*uirement & C2EE1 STA2 C02P02ATI01 1ncome Statement =or the Aear :nded .ecember '$, &-$'

(e,enues and gains1 Sales .................................................................. 1nterest .............................................................. ;ain on sale of investments ............................... Total revenues and gains ............................... 2*penses and losses1 Cost of goods sold ............................................. Selling................................................................ ;eneral and administrative................................. 1nterest............................................................... Total expenses and losses .............................. 1ncome before income taxes ................................ 1ncome tax expense ............................................. 3et income ........................................................... :arnings per share ............................................... B*&-,--$)-,--*(,--"-,---

B$,'--,--'-,--(-,--$,'+-,---

,,(,--'+(,--$'-,--B &((,--B&.((

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Exercise 41 (concluded) 2e*uirement ' C2EE1 STA2 C02P02ATI01 1ncome Statement =or the Aear :nded .ecember '$, &-$' Sales revenue ....................................................... Cost of goods sold ............................................... ;ross profit .......................................................... -perating e*penses1 Selling................................................................ ;eneral and administrative................................. Total operating expenses ............................... 2perating income ................................................. -ther income 3e*pense41 1nterest revenue ................................................. ;ain on sale of investments ............................... 1nterest expense ................................................. Total other income, net .................................. 1ncome before income taxes ............................... 1ncome tax expense ............................................. 3et income ........................................................... :arnings per share ............................................... B$)-,--*(,--&'(,--'"(,--'-,--(-,--4"-,---5 "-,--'+(,--$'-,--B &((,--B&.(( B$,'--,--*&-,--(+-,---

Exercise 4%'

2e*uirement &

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CE1E2A@ @IC=TI1C C02P02ATI01 1ncome Statement =or the Aear :nded .ecember '$, &-$' (e,enues and gains1 Sales .................................................................. %ental revenue .................................................. Total revenues and gains ............................... 2*penses and losses1 Cost of goods sold ............................................. Selling ............................................................... ;eneral and administrative................................. 1nterest............................................................... >oss on sale of investments ............................... >oss from inventory write7down ....................... Total expenses and losses .............................. 1ncome before income taxes and extraordinary 1tem FFFFFFFFFFFFFFFF. 1ncome tax expense C FFFFFFFFFF. 1ncome before extraordinary item ........................ :xtraordinary item! >oss from flood damage 4net of B"+,--- tax benefit5 3et income ........................................................... 2arnings per share1 1ncome before extraordinary item ........................ :xtraordinary loss ................................................ 3et income ........................................................... C "-D x B")*,&-Exercise 42 (concluded) 2e*uirement ' CE1E2A@ @IC=TI1C C02P02ATI01 1ncome Statement =or the Aear :nded .ecember '$, &-$' Sales revenue .......................................................
#olutions Manual, $ol.!, Chapter %

B&,'(-,--+-,--&,"'-,--B$,&--,'-'--,--$(-,--,-,--&&,(-&--,--$,,)&,+-")*,&-$+),++&+-,'&4*&,---5 B &-+,'&B .,' 4.&"5 B .),

B&,'(-,-- The McGraw-Hill Companies, Inc., 2 !" %&!7

Cost of goods sold ............................................... ;ross profit .......................................................... -perating e*penses1 Selling ............................................................... ;eneral and administrative ................................ >oss from inventory write7down ....................... Total operating expenses ............................... 2perating income ................................................. -ther income 3e*pense41 %ental revenue .................................................. >oss on sale of investments ............................... 1nterest expense ................................................. Total other income 4expense5, net ................. 1ncome before income taxes and extraordinary item.................................................................... 1ncome tax expense C............................................ 1ncome before extraordinary item ........................ :xtraordinary item! >oss from flood damage 4net of B"+,--- tax benefit5 3et income ........................................................... 2arnings per share1 1ncome before extraordinary item ........................ :xtraordinary loss ................................................ 3et income ........................................................... C "-D x B")*,&-B'--,--$(-,--&--,---

$,&--,'-$,$",,*--

)(-,--",,,*-+-,--4&&,(--5 4,-,---5 4'&,(--5 ")*,&-$+),++&+-,'&4*&,---5 B &-+,'&B .,' 4.&"5 B .),

Exercise 4%(
@I1>02 C02P02ATI01 Statement of Comprehensive 1ncome =or the Aear :nded .ecember '$, &-$' Sales revenue .................................................................... Cost of goods sold ............................................................ ;ross profit ....................................................................... -perating e*penses1 Selling and administrative...............................................
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B&,'--,--$,"--,--,--,--"&-,--Intermediate Accounting, 7'e

2perating income ............................................................. -ther income 3e*pense41 1nterest expense ................................................................ 1ncome before income taxes and extraordinary item......... 1ncome tax expense C........................................................ 1ncome before extraordinary item ..................................... :xtraordinary item! ;ain on litigation settlement 4net of B$&-,--tax expense5 ................................................................... 3et income 2ther comprehensive income! @nreali8ed holding gains on investment securities, net of tax .................................................................... Comprehensive income ..................................................... 2arnings per share1 1ncome before extraordinary item ..................................... :xtraordinary gain ............................................................ 3et income ....................................................................... C '-D x B""-,---

"+-,--4"-,---5 ""-,--$'&,--'-+,--&+-,--(++,--(),--B)"",--B -.'$ -.&+ B -.(,

Exercise 4%4
A9E@ C02P02ATI01 1ncome Statement =or the Aear :nded .ecember '$, &-$' Sales revenue .................................................................... Cost of goods sold ............................................................ ;ross profit ....................................................................... -perating e*penses1 Selling ........................................................................... Administrative .............................................................. %estructuring costs ........................................................ Total operating expenses ............................................ 2perating income ............................................................. -ther income 3e*pense41 1nterest and dividends .................................................... 1nterest expense ............................................................. Total other income, net ................................................. 1ncome before income taxes and extraordinary item.........
#olutions Manual, $ol.!, Chapter %

B (,&,--'&(,--&)*,--B)*,--+*,--((,--&-,,--(+,--'&,--4&),---5 ),--)",-- The McGraw-Hill Companies, Inc., 2 !" %&!6

1ncome tax expenseC ........................................................ 1ncome before extraordinary item ..................................... :xtraordinary item! ;ain on litigation settlement 4net of B'","-tax expense5 ................................................................... 3et income ....................................................................... 2arnings per share1 1ncome before extraordinary item ..................................... :xtraordinary gain ............................................................ 3et income ....................................................................... C "-D x B)",---

&(,)-'+,"-($,)-B ,-,--B .'+ .(& B-.,-

Exercise 4%)
C=A1CE C0MPA16 <artial 1ncome Statement =or the Aear :nded .ecember '$, &-$' 1ncome from continuing operations ..................................... .iscontinued operations! >oss from operations of discontinued component 4including loss on disposal of B"--,---5C ................................ 1ncome tax benefit ............................................................ >oss on discontinued operations ....................................... 3et income ........................................................................... :arnings per share! 1ncome from continuing operations ..................................... >oss from discontinued operations ...................................... 3et income .......................................................................... D @oss on iscontinue operationsA >oss on sale of assets >oss from operations Total before7tax loss >ess! 1ncome tax benefit 4"-D5 3et7of7tax loss
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B '(-,--4('-,---5 &$&,--4'$+,---5 B '&,--B '.(4'.$+5 B .'&

B4"--,---5 4$'-,---5 4('-,---5 &$&,--B4'$+,---5


Intermediate Accounting, 7'e

Exercise 4%,
ESQ/I2E C0MIC B005 C0MPA16 <artial 1ncome Statement =or the Aear :nded .ecember '$, &-$' 1ncome from continuing operations C ................................... .iscontinued operations! 1ncome from operations of discontinued component 4including loss on disposal of B'(-,---5 .................................. 1ncome tax expense ........................................................... 1ncome on discontinued operations ................................... 3et income............................................................................ B ((&,---

$(-,--)-,--,-,--B)"&,---

D Income from continuing operationsA 1ncome before considering additional items .ecrease in income due to restructuring costs Before7tax income from continuing operations 1ncome tax expense 4"-D5 1ncome from continuing operations B$,---,--4+-,---5 ,&-,--4')+,---5 B ((&,---

Exercise 4%-

2e*uirement & 5A1>01 E1TE2P2ISES, I1C? <artial 1ncome Statement =or the Aear :nded .ecember '$, &-$'

1ncome from continuing operations ..................................... .iscontinued operations! >oss from operations of discontinued component 4including impairment loss of B(-,---5 C ............................... 1ncome tax benefit............................................................. >oss on discontinued operations ....................................... 3et income ..........................................................................
#olutions Manual, $ol.!, Chapter %

B "--,---

4$,-,---5 *),--4$$",---5 B &+),---

The McGraw-Hill Companies, Inc., 2 !" %&2!

C @oss on iscontinue operationsA >oss from operations 1mpairment loss 4B&(-,--- # &--,---5 3et before7tax loss 1ncome tax benefit 4"-D5 3et after7tax loss on discontinued operations 2e*uirement ' 5A1>01 E1TE2P2ISES, I1C? <artial 1ncome Statement =or the Aear :nded .ecember '$, &-$' 1ncome from continuing operations ..................................... .iscontinued operations! >oss from operations of discontinued component D.......... 1ncome tax benefit ............................................................ >oss on discontinued operations ....................................... 3et income .......................................................................... B "--,--4$"-,---5 (),--4+",---5 B '$),--B4$"-,---5 4(-,---5 4$,-,---5 *),--B4$$",---5

DInc"u es on"+ the operating "oss uring the +ear? There is no impairment "oss?

Exercise 4%.

<retax income from continuing operations 1ncome tax expense 1ncome from continuing operations >ess! 3et income >oss from discontinued operations

B$",---,--4(,)--,---5 +,"--,--*,&--,--B$,&--,---

B$,&--,--- )-DC E B&,---,--- E Before7tax loss from discontinued operations. C$ # tax rate of "-D E )-D <retax income of division Add! >oss from discontinued operations 1mpairment loss
The McGraw-Hill Companies, Inc., 2 !" %&22

B",---,--&,---,--B),---,--Intermediate Accounting, 7'e

=air value of division0s assets Add! 1mpairment loss Boo value of division0s assets

B$$,---,--),---,--:&-,888,888

Exercise 4%7

:arnings per share! B(.-4$.)-5 &.&B(.)-

1ncome from continuing operations >oss from discontinued operations :xtraordinary gain 3et income

Exercise 4%&8
T=E MASS0/> C01S/@TI1C C20/P Statement of Comprehensive 1ncome =or the Aear :nded .ecember '$, &-$' 3et income ........................................................... 2ther comprehensive income 4loss5! =oreign currency translation gain, net of tax ..... @nreali8ed losses on investment securities, net of tax ........................................................ Total other comprehensive income ...................... Comprehensive income ........................................ B$,'(",--B$)+,--4(),---5 $$&,--B$,")),---

Exercise 4%&& cash.


&. '. ". (. ). aG aG cG bG cG

$.GGG b

<urchase of equipment for

<ayment of employee salaries. Collection of cash from customers. Cash proceeds from a note payable. <urchase of common stoc of another corporation for cash. 1ssuance of common stoc for cash.
The McGraw-Hill Companies, Inc., 2 !" %&2"

#olutions Manual, $ol.!, Chapter %

*. +. ,. $-. $$.

bG aG dG cG cG

Sale of machinery for cash. <ayment of interest on note payable. 1ssuance of bonds payable in exchange for land and building. <ayment of cash dividends to shareholders. <ayment of principal on note payable. B"ue$onnet BaEers Statement of Cash =lows =or the Aear :nded .ecember '$, &-$'

Exercise 4%&'

Cash )lows )rom operating acti,ities1 Collections from customers B '+-,--1nterest on note receivable ),--<urchase of inventory 4$)-,---5 1nterest on note payable 4(,---5 <ayment of salaries 4,-,---5 3et cash flows from operating activities Cash )lows )rom in,esting acti,ities1 Collection of note receivable Sale of investments <urchase of equipment 3et cash flows from investing activities Cash )lows )rom )inancing acti,ities1 <roceeds from note payable <ayment of note payable <ayment of dividends 3et cash flows from financing activities 3et increase in cash Cash and cash equivalents, Hanuary $ Cash and cash equivalents, .ecember '$ (-,--'-,--4+(,---5

B$'$,---

4(,---5 $--,--4&(,---5 4&-,---5 ((,--$+$,--$*,--B $,+,---

The McGraw-Hill Companies, Inc., 2 !" %&2%

Intermediate Accounting, 7'e

Cash collected for interest, considered an operating cash flow by @.S. ;AA<, could be classified as either an operating cash flow or an investing cash flow according to 1nternational Accounting Standards. Cash paid for interest, considered an operating cash flow by @.S. ;AA<, could be classified as either an operating cash flow or a financing cash flow according to 1nternational Accounting Standards. Cash paid for dividends, considered a financing cash flow by @.S. ;AA<, could be classified as either an operating cash flow or a financing cash flow according to 1nternational Accounting Standards. Accordingly, the statement of cash flows prepared according to 1=%S could be the same as under @.S. ;AA< 4:"#$&5 or could be presented as follows!

Exercise 4%&(

B@/EB011ET BA5E2S Statement of Cash =lows =or the Aear :nded .ecember '$, &-$' Cash )lows )rom operating acti,ities1 Collections from customers B '+-,--<urchase of inventory 4$)-,---5 <ayment of salaries 4,-,---5 <ayment of dividends 4&-,---5 3et cash flows from operating activities Cash )lows )rom in,esting acti,ities1 Collection of note receivable 1nterest on note receivable Sale of investments <urchase of equipment 3et cash flows from investing activities Cash )lows )rom )inancing acti,ities1 <roceeds from note payable <ayment of note payable 1nterest on note payable 3et cash flows from financing activities 3et increase in cash Cash and cash equivalents, Hanuary $ Cash and cash equivalents, .ecember '$ (-,--),--'-,--4+(,---5 $,--$--,--4&(,---5 4(,---5 *-,--$+$,--$*,--B $,+,---

B$$-,---

#olutions Manual, $ol.!, Chapter %

The McGraw-Hill Companies, Inc., 2 !" %&2+

Exercise 4%&4

Cash )lows )rom operating acti,ities1 B$*,'-*,+-4",---5 (,(-$,&-4&,*--5 +-:'),788

3et income Ad7ustments )or noncash e))ects1 .epreciation expense Changes in operating assets and lia8ilities1 1ncrease in accounts receivable .ecrease in inventory .ecrease in prepaid insurance .ecrease in salaries payable 1ncrease in interest payable 3et cash flows from operating activities 2e*uirement &

Exercise 4%&)
$. &. '. ". (. ). *. +. ,. =inancing B'--,-- 1nvesting B4$-,---5 B 4(,---5 4),---5 4*-,---5 ((,-- B'--,--GGGGGGGGGG

2perating

B4$-,---5

GGGGGGGGGG

B4&),---5

GGGGGGGGGG

:',4,888

The McGraw-Hill Companies, Inc., 2 !" %&20

Intermediate Accounting, 7'e

Exercise 415 (concluded) 2e*uirement '


4AI142IC=T C02P02ATI01 Statement of Cash =lows =or the Ionth :nded Iarch '$, &-$' Cash )lows )rom operating acti,ities1 Collections from customers <ayment of rent <ayment of one7year insurance premium <ayment to suppliers of merchandise for sale 3et cash flows from operating activities Cash )lows )rom in,esting acti,ities1 <urchase of equipment 3et cash flows from investing activities Cash )lows )rom )inancing acti,ities1 1ssuance of common stoc 3et cash flows from financing activities 3et increase in cash Cash and cash equivalents, Iarch $ Cash and cash equivalents, Iarch '$ 9oncash in,esting and )inancing acti,ities1 Acquired B"-,--- of equipment by paying cash and issuing a note as follows! Cost of equipment B"-,--Cash paid $-,--3ote issued B'-,--B ((,--4(,---5 4),---5 4*-,---5 B 4&),---5 4$-,---5 4$-,---5 '--,--'--,--&)",--"-,--B '-",---

Exercise 4%&,

Cash )lows )rom operating acti,ities1 B)&",--+*,--&&,--4,,&--5 4+,(--5 $-,--4$",---5


The McGraw-Hill Companies, Inc., 2 !" %&27

3et income Ad7ustments )or noncash e))ects1 .epreciation and amorti8ation expense Changes in operating assets and lia8ilities1 .ecrease in accounts receivable 1ncrease in inventories 1ncrease in prepaid expenses 1ncrease in salaries payable .ecrease in income taxes payable
#olutions Manual, $ol.!, Chapter %

3et cash flows from operating activities :-&&,(88 Consistent with @.S. ;AA<, international standards also require a statement of cash flows. Consistent with @.S. ;AA<, Exercise 4%&-cash flows are classified as operating, investing, or financing. Jowever, the @.S. standard designates cash outflows for interest payments and cash inflows from interest and dividends received as operating cash flows. .ividends paid to shareholders are classified as financing cash flows. IA# 9o. 7, on the other hand, allows more flexibility. Companies can report interest and dividends paid as either operating or financing cash flows and interest and dividends received as either operating or investing cash flows. 1nterest and dividend payments usually are reported as financing activities. 1nterest and dividends received normally are classified as investing activities. Accordingly, the statement of cash flows prepared according to 1=%S mostly li ely would be presented as follows 4differences from @.S. ;AA< in italics5!
B201C0 META@S Statement of Cash !"o#s !or the 6ear En e >ecem$er (&, '8&( Cash flows from operating activities! Collections from customers <urchase of inventory <ayment of operating expenses 3et cash flows from operating activities Cash flows from investing activities! Interest on note recei,a8le :i,idends recei,ed )rom in,estments Collection of note receivable <urchase of equipment 3et cash flows from investing activities Cash flows from financing activities! ;a/ment o) interest on note pa/a8le <roceeds from issuance of common stoc .ividends paid 3et cash flows from financing activities 3et increase in cash Cash and cash equivalents, Hanuary $ Cash and cash equivalents, .ecember '$ B '(',--4$+),---5 4)*,---5 B$--,--%, 2,% $--,--4$(",---5 4"*,)--5 35, 4 &--,--4"-,---5 $(&,--&-","-&+,)-B&'',---

Exercise 4%&.
The McGraw-Hill Companies, Inc., 2 !" %&25

TICE2 E1TE2P2ISES Statement of Cash =lows


Intermediate Accounting, 7'e

=or the Aear :nded .ecember '$, &-$' 4B in thousands5 Cash )lows )rom operating acti,ities1 3et income B ,-Ad7ustments )or noncash e))ects1 .epreciation expense &"Changes in operating assets and lia8ilities1 .ecrease in accounts receivable +1ncrease in inventory 4"-5 1ncrease in prepaid insurance 4'-5 .ecrease in accounts payable 4)-5 .ecrease in administrative and other payables 4$--5 1ncrease in income taxes payable (3et cash flows from operating activities B$,-"Cash )lows )rom in,esting acti,ities1 <urchase of plant and equipment Cash )lows )rom )inancing acti,ities1 <roceeds from issuance of common stoc $-<roceeds from note payable &-<ayment of dividends ;&< 4,"-5 3et cash flows from financing activities4)"-5 3et increase in cash Cash, Hanuary $ Cash, .ecember '$
%etained earnings, beginning B(";&< K 3et income ,-# .ividends x x F :748 %etained earnings, ending B(--

4'--5

$-&-B '--

The T7account analysis of the transactions related to operating Exercise 4%&7 cash flows is shown below. To derive the cash flows, the beginning and ending balances in the related assets and liabilities are inserted, together with the revenue and expense amounts from the income statements. 1n each balance sheet account, the remaining 4plug5 figure is the other half of the cash increases or decreases.

#olutions Manual, $ol.!, Chapter %

The McGraw-Hill Companies, Inc., 2 !" %&26

Cash =lows 42perating5 ;a?< -,8.8 ;$?< &(8 ;c?< (,4,8 ; ?< &,788 ;e?< ))8 Sales %evenue Accounts %eceivable $L$ +';a?< -,8.8 *,--- M77777777777N *,--$&L'$ *(1nsurance :xpense $--

<repaid 1nsurance &;$?< &(8 $-- M77777777777N $&L'$ ($L$

Accounts <ayable 1nventory ;c?< (,4,8 $L$ ')$L$ )-',"-- M77777777777N ',"-$&L'$ '-$&L'$ )"-

',')- M77777777777N

Cost of ;oods Sold ',')-

Admin. O 2ther <ayables Admin. O 2ther :xpense ; ?< &,788 $L$ "-$,+-- M77777777777N $,+-$&L'$ '-1ncome Taxes <ayable ;e?< ))8 $L$ $()-- M77777777777N $&L'$ &-1ncome Tax :xpense )--

Based on the information in the T7accounts above, the operating activities section of the SC= for Tiger :nterprises would be as shown next.

The McGraw-Hill Companies, Inc., 2 !" %&"

Intermediate Accounting, 7'e

Exercise 419 (concluded) TICE2 E1TE2P2ISES Statement of Cash =lows =or the Aear :nded .ecember '$, &-$' 4B in thousands5 Cash )lows )rom operating acti,ities1 Collections from customers <repayment of insurance <ayment to inventory suppliers <ayment for administrative O other exp. <ayment of income taxes 3et cash flows from operating activities B *,-+4$'-5 4',")-5 4$,,--5 4((-5 B $,-"-

Exercise 4%'8 2e*uirement &


=ASB ASC &)-! P:arnings per Share.Q 2e*uirement ' The specific citation that describes the additional information for earnings per share that must be included in the notes to the financial statements is =ASB ASC &)-# $-#(-#$! P:arnings per Share#2verall#.isclosure.Q 2e*uirement ( =or each period for which an income statement is presented, an entity discloses all of the following! a. A reconciliation of the numerators and the denominators of the basic and diluted per7share computations for income from continuing operations. The reconciliation includes the individual income and share amount effects of all securities that affect earnings per share 4:<S5. :xample & 4see paragraph &)-#$-#((#($5 illustrates that disclosure. 4See paragraph &)-#$-#"(#'.5 An entity is encouraged to refer to pertinent information about securities included in the :<S computations that is provided elsewhere in the financial statements as prescribed by Subtopic (-(7$-. b. The effect that has been given to preferred dividends in arriving at income avai"a$"e to common stocEho" ers in computing basic :<S. c. Securities 4including those issuable pursuant to contingent stoc agreements5 that could potentially dilute basic :<S in the future that were not included in the computation of diluted :<S because to do so would have been antidilutive for the
#olutions Manual, $ol.!, Chapter % The McGraw-Hill Companies, Inc., 2 !" %&"!

period4s5 presented. =ull disclosure of the terms and conditions of these securities is required even if a securit+ is not included in diluted :<S in the current period. =or the latest period for which an income statement is presented, an entity must provide a description of any transaction that occurs after the end of the most recent period but before issuance of the financial statements that would have changed materially the number of common shares or potential common shares outstanding at the end of the period if the transaction had occurred before the end of the period. :xamples of those transactions include the issuance or acquisition of common shares? the issuance of warrants, options, or convertible securities? the resolution of a contingency pursuant to a contingent stocE agreement? and the conversion or exercise of potential common shares outstanding at the end of the period into common shares.

Exercise 4%'&

The =ASB Accounting Standards Codification represents the single source of authoritative @.S. generally accepted accounting principles. The specific citation for each of the following items is! $. The criteria for etermining if a gain or "oss shou" extraor inar+ itemA $e reporte as an

=ASB ASC &&(#&-#"(#&! P1ncome Statement#:xtraordinary and @nusual 1tems#2ther <resentation Iatters#Criteria for <resentation as :xtraordinary.Q :xtraordinary items are events and transactions that are distinguished by their unusual nature and by the infrequency of their occurrence. Thus, both of the following criteria shall be met to classify an event or transaction as an extraordinary item! a. @nusual nature. The underlying event or transaction should possess a high degree of abnormality and be of a type clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the entity, ta ing into account the environment in which the entity operates. b. 1nfrequency of occurrence. The underlying event or transaction should be of a type that would not reasonably be expected to recur in the foreseeable future, ta ing into account the environment in which the entity operates. &. The ca"cu"ation of the #eighte average num$er of shares for $asic earnings per share purposesA =ASB ASC &)-#$-#((#&! P:arnings per Share#2verall#1mplementation ;uidance and 1llustration#Computing a Reighted Average.Q
The McGraw-Hill Companies, Inc., 2 !" %&"2 Intermediate Accounting, 7'e

The weighted7average number of shares is an arithmetical mean average of shares outstanding and assumed to be outstanding for :<S computations. The most precise average would be the sum of the shares determined on a daily basis divided by the number of days in the period. >ess7precise averaging methods may be used, however, as long as they produce reasonable results. Iethods that introduce artificial weighting, such as the %ule of *+ method, are not acceptable for computing a weighted7average number of shares for :<S computations.

#olutions Manual, $ol.!, Chapter %

The McGraw-Hill Companies, Inc., 2 !" %&""

Exercise 421 (continued) '. The a"ternative formats permissi$"e for reporting comprehensive incomeA =ASB ASC &&-#$-#"(#$! PComprehensive <resentation 1tems#%eporting Comprehensive 1ncome.Q 1ncome#2verall#2ther

$A. An entity reporting comprehensive income in a single continuous financial statement shall present its components in two sections, net income and other comprehensive income. 1f applicable, an entity shall present the following in that financial statement! a. A total amount for net income together with the components that ma e up net income. b. A total amount for other comprehensive income together with the components that ma e up other comprehensive income. As indicated in paragraph &&-#$-# $(#', an entity that has no items of other comprehensive income in any period presented is not required to report comprehensive income. c. Total comprehensive income. $B. An entity reporting comprehensive income in two separate but consecutive statements shall present the following! a. Components of and the total for net income in the statement of net income b. Components of and the total for other comprehensive income as well as a total for comprehensive income in the statement of other comprehensive income, which shall be presented immediately after the statement of net income. A reporting entity may begin the second statement with net income. $C. An entity shall present, either in a single continuous statement of comprehensive income or in a statement of net income and statement of other comprehensive income, all items that meet the definition of comprehensive income for the period in which those items are recogni8ed. Components included in other comprehensive income shall be classified based on their nature.

The McGraw-Hill Companies, Inc., 2 !" %&"%

Intermediate Accounting, 7'e

Exercise 421 (concluded) ". The c"assifications of cash f"o#s re*uire in the statement of cash f"o#sA =ASB ASC &'-#$-#"(#$! PStatement of Cash =lows#2verall#2ther <resentation Iatters#=orm and Content.Q A statement of cash flows shall report the cash effects during a period of an entitySs operations, its investing transactions, and its financing transactions.

Exercise 4%''
The McGraw-Hill Companies, Inc., 2 !" %&"+

#olutions Manual, $ol.!, Chapter %

@ist A f g $. 1ntraperiod tax allocation &. Comprehensive income

@ist B a. @nusual, infrequent, and material gains and losses. b. Starts with net income and wor s bac wards to convert to cash. c. %eports the cash effects of each operating activity directly on the statement. d. Correction of a material error of a prior period. e. %elated to the external financing of the company. f. Associates tax with income statement item. g. Total nonowner change in equity. h. %elated to the transactions entering into the determination of net income. i. %elated to the acquisition and disposition of long7term assets. 9. %equired disclosure for publicly traded corporation. . A component of an entity. l. .irectly related to principal revenue7 generating activities.

a '. :xtraordinary items l ". 2perating income (. A discontinued operation 9 ). :arnings per share

d *. <rior period ad9ustment e +. =inancing activities h ,. 2perating activities 4SC=5 i $-. 1nvesting activities c $$. .irect method b $&. 1ndirect method

The McGraw-Hill Companies, Inc., 2 !" %&"0

Intermediate Accounting, 7'e

CPA / CMA 2E3IE4 Q/ESTI01S


CPA Exam Questions
$. c? &.
d. @.S. ;AA< requires that discontinued operations be disclosed separately below

income from

continuing operations. 2ther than sales, C2;S, and administrative expenses, only the gain or loss from disposal of equipment is considered part of income from continuing operations. 1ncome from continuing operations was 4B(,---,--- # ',---,--# $,---,--- K &--,---5 E B$,&--,---.

'. a? 1n a single7step income statement, revenues include sales as well as other revenues and gains. Sales revenue 1nterest revenue ;ain on sale of equipment Total B$+*,--$-,&-",*-B&-$,,--

The discontinued operations and the extraordinary gain are reported below income from continuing operations. ". a. The B"--,--- impairment loss and the B$,---,--- loss from operations should be combined for a total loss of B$,"--,---. (. ). *.
a. Dividends paid to shareholders is considered a financing cash flow, not an operating cash flow.

c.

Issuing common stock for cash is considered a financing cash flow, not an investing cash flow.

b.

IFRS prohibits reporting extraordinary items, and restructuring costs are not separately reported under both IFRS and .S. !""#. $oth IFRS and .S. !""# report discontinued operations as a separate item, net of tax.

+.

c.

Interest paid can be classified as either an operating or financing cash flow.

#olutions Manual, $ol.!, Chapter %

The McGraw-Hill Companies, Inc., 2 !" %&"7

CMA Exam Questions


$. ? .iscontinued operations and extraordinary gains and losses are shown separately in the income statement, below income from continuing operations. The cumulative effect of most voluntary changes in accounting principle is accounted for by retrospectively revising prior years0 financial statements. c? The operating section of a retailer0s income statement includes all revenues and costs necessary for the operation of the retail establishment, for example, sales, cost of goods sold, administrative expenses, and selling expenses. a? :xtraordinary items should be presented net of tax after income from operations.

&.

'.

Pro$"em 4%& P20B@EMS


2EE> C0MPA16 Comparative 1ncome Statements =or the Aears :nded .ecember '$ Sales revenue .........................................................G&H Cost of goods sold ................................................ G'H ;ross profit ........................................................... -perating e*penses1 Administrative .....................................................G(H Selling ................................................................. G4H >oss from fire damage ......................................... >oss from write7down of obsolete inventory ....... Total operating expenses ................................. 2perating income .................................................. -ther income 3e*pense41 1nterest revenue .................................................... 1nterest expense ................................................... Total other expenses 4net5 ............................... 1ncome from continuing operations before income taxes and extraordinary item................ 1ncome tax expense ............................................... 1ncome from continuing operations before extraordinary item..............................................
The McGraw-Hill Companies, Inc., 2 !" %&"5

'8&( B",---,--&,(*-,--$,"'-,--*(-,--'"-,--(-,--'(,--$,$*(,--&((,--$(-,--4&--,---5 4(-,---5 &-(,--+&,--$&',---

G,H G-H

'8&' B',---,--$,)+-,--$,'&-,--)'(,--&+&,--77 77 ,$*,--"-',--$"-,--4&--,---5 4)-,---5 '"',--$'*,&-&-(,+-Intermediate Accounting, 7'e

G.H G7H

.iscontinued operations! 1ncome 4loss5 from operations of discontinued component 4including loss on disposal of B(-,--- in &-$'5 ................................................ 1ncome tax benefit 4expense5................................. 1ncome 4loss5 on discontinued operations ..........G)H 1ncome before extraordinary item ......................... :xtraordinary item! >oss from earthqua e 4net of B"-,--- tax benefit5 . 3et income ............................................................
2arnings per share1 1ncome from continuing operations before extraordinary item..................................................... .iscontinued operations ............................................. :xtraordinary loss ...................................................... 3et income ...................................................................

4$-,---5 ",--4),---5 $$*,--4)-,---5 B (*,---

$$-,--4"",---5 )),--&*$,+-77 B &*$,+--

."$ 4.-&5 4.&-5 B .$,

.), .&& 77 B .,$

#olutions Manual, $ol.!, Chapter %

The McGraw-Hill Companies, Inc., 2 !" %&"6

Problem 41 (concluded) G&H B","--,--- # "--,--G'H G(H G4H B&,+)-,--- # &,-,--B+--,--- # (-,--B')-,--- # &-,--B "-,--4(-,---5 4$-,---5 ",--B 4),---5

G)H >oss in &-$$! 1ncome from operations >oss on sale of assets >oss before tax benefit Tax benefit 4"-D x B$-,---5 >oss on discontinued operations, net of tax benefit G,H G-H G.H G7H

B',(--,--- # (--,--- 4sales from discontinued operation5 B&,---,--- # '&-,--- 4cost of goods sold from discontinued operation5 B)*(,--- # "-,--- 4administrative expenses from discontinued operations5 B'$&,--- # '-,--- 4selling expenses from discontinued operations5 2e*uirement &

Pro$"em 4%'

IAC5S01 =0@>I1C C0MPA16 Comparative 1ncome Statements 4in part5 =or the Aears :nded .ecember '$ '8&( 1ncome from continuing operations before income taxes G&H .......................................... B',---,--1ncome tax expense .......................................... $,&--,--1ncome from continuing operations .................. $,+--,--.iscontinued operations! 1ncome 4loss5 from operations of discontinued component 4including gain on disposal of B)--,--- in &-$$5 G'H ........................................ &--,-- The McGraw-Hill Companies, Inc., 2 !" %&%

'8&' B$,'--,--(&-,--*+-,---

4'--,---5
Intermediate Accounting, 7'e

1ncome tax benefit 4expense5.......................... 1ncome 4loss5 on discontinued operations ...... 3et 1ncome ....................................................... G&H

4+-,---5 $&-,--B$,,&-,---

$&-,--4$+-,---5 B )--,---

Income from continuing operations $efore income taxesA '8&( '8&' @nad9usted B&,)--,--- B$,---,--Add! >oss from discontinued operations "--,--'--,--Ad9usted B',---,--- B$,'--,--G'H Income from iscontinue operationsA '8&( >oss from operations B4"--,---5 ;ain on disposal )--,--Total B &--,--'8&' B4'--,---5 7 B4'--,---5

#olutions Manual, $ol.!, Chapter %

The McGraw-Hill Companies, Inc., 2 !" %&%!

Problem 42 (concluded) 2e*uirement ' The &-$' income from discontinued operations would include only the loss from operations of B"--,---. Since no impairment loss is indicated 4B(,---,--- # ","--,--E B)--,--- anticipated gain5, none is included. The anticipated gain on disposal is not recogni8ed until it is reali8ed, presumably in the following year. 2e*uirement ( The &-$' income from discontinued operations would include the loss from operations of B"--,--- as well as an impairment loss of B(--,--- 4B","--,--- boo value of assets less B',,--,--- fair value5.

Pro$"em 4%(2e*uirement &


MIC201 C02P02ATI01 <artial 1ncome Statement =or the Aear :nded .ecember '$, &-$' 1ncome from continuing operations before income taxes and extraordinary item......... 1ncome tax expense ..................................... 1ncome from continuing operations before extraordinary item........................................ .iscontinued operations! >oss from operations of discontinued component 4including loss on disposal of ................................................................... 1ncome tax benefit ................................................................... >oss on discontinued operations ............... 1ncome before extraordinary item ............... :xtraordinary item! >oss from earthqua e 4net of B&"-,--- tax benefit5 ...................... 3et 1ncome ..................................................
The McGraw-Hill Companies, Inc., 2 !" %&%2

G&H B$,'--,--',-,--,$-,---

B'--,---5

B4$"-,---5 "&,--G'H 4,+,---5 +$&,--4()-,---5 B &(&,--Intermediate Accounting, 7'e

G&H Income from continuing operations $efore taxesA @nad9usted B$,&--,--Add! ;ain from sale of factory $--,--Ad9usted B$,'--,--G'H @oss on iscontinue operationsA 1ncome from operations .educt! >oss on sale of assets >oss before tax Tax benefit 4'-D x B$"-,---5 >oss on discontinued operations B $)-,--4'--,---5 4$"-,---5 "&,--B 4,+,---5

2e*uirement ' These events will not, or are unli ely to occur again in the near future. By segregating them, users are better able to predict )uture cash )lows. $. %estructuring is an example of an event that is either unusual or Pro$"em 4%4 infrequent, but not both. %estructuring costs should be included in income from continuing operations but reported as a separate income statement component. The item is reported gross, not net of tax as with extraordinary gains and losses. &. The extraordinary gain should be presented, net of tax, in the income statement below income from continuing operations. Also, earnings per share for income from continuing operations and for the extraordinary item should be disclosed. '. The correction of the error should be treated as a prior period ad9ustment to beginning retained earnings, not as an ad9ustment to current yearSs cost of goods sold. 1n addition, the &-$& financial statements should be restated to reflect the correction, and a disclosure note is required that communicates the impact of the error on &-$& income.

Pro$"em 4%)
A@E9IA1 S6STEMS, I1C? 1ncome Statement =or the Aear :nded .ecember '$, &-$'
4B in millions except per share date5

3et sales revenue ................................................. Cost of goods sold ............................................... ;ross profit ..........................................................
#olutions Manual, $ol.!, Chapter %

G&H

B"&( &)( $)-

The McGraw-Hill Companies, Inc., 2 !" %&%"

-perating e*penses1 Selling and administrative ................................. %estructuring costs ............................................ Total operating expenses ............................... 2perating income ................................................. -ther income1 1nterest revenue ................................................. ;ain on sale of investments ............................... Total other income ......................................... 1ncome before income taxes and extraordinary item................................................................... 1ncome tax expense ............................................. 1ncome before extraordinary item ........................ :xtraordinary gain 4net of B"+ tax expense5 ................ 3et income ........................................................... :arnings per share! 1ncome before extraordinary item ........................ :xtraordinary gain ............................................... 3et income ...........................................................
G&H B&*- # ( 4prior period ad9ustment5 G'H B$(" # &) 4restructuring costs5 G(H "-D x B$( G4H B$&- less taxes of B"+ 4"-D x B$&-5

G'H B$&+

&) $(" ) ' ) ,


G(H G4H

$( ) , *& B +$

B -."( '.)B ".-(

3ote! The difference in net income of B' million 4B+$ million compared to B*+ million on the original income statement5 is the effect of the inventory error of B( million, less the "-D tax effect.

Pro$"em 4%2e*uirement &


SC=EMB2I MA1/!ACT/2I1C C02P02ATI01 Statement of Comprehensive 1ncome =or the Aear :nded .ecember '$, &-$' 4B in ---s5 Sales revenue ................................................................... Cost of goods sold .......................................................... ;ross profit ..................................................................... 2perating expenses! Selling ...........................................................................
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B$(,'-),&-,,$-B$,'-Intermediate Accounting, 7'e

;eneral and administrative ........................................... %estructuring costs ....................................................... Total operating expenses ........................................ 2perating income ............................................................

+-$,&-','-(,+--

2ther income 4expense5! >oss on sales of investments ............................................................ B4&&-5 1nterest expense ............................................................................... 4$+-5 1nterest revenue ............................................................................... +( 2ther income 4expense5 ................................................................ 1ncome from continuing operations before income taxes and extraordinary item FFFFFFFFFFFF. 1ncome tax expense ......................................................... 1ncome from continuing operations before extraordinary item .............................................................................. .iscontinued operations! 1ncome from operations of discontinued component 4including gain on disposal of B$,"--5 ....................... +"1ncome tax expense ...................................................... 4'')5 1ncome from discontinued operations .......................... 1ncome before extraordinary item ................................... :xtraordinary item! >oss from earthqua e 4net of B+-- tax benefit5 ........... 3et income....................................................................... 2ther comprehensive income! @nreali8ed gains from investments, net of tax $,& >oss from foreign currency translation, net of tax 4$""5 Comprehensive income

4'$(5 (,"+( &,$," ',&,$

(-" ',*,( 4$,&--5 &,(,( "+ B&,)"'

Problem 47 (concluded)
:arnings per share!C 1ncome from continuing operations before extraordinary item .iscontinued operations :xtraordinary loss 3et income CReighted7average shares E $,---,--- K 4"--,---L&5 E $,&--,---

B&.*" ."& 4$.--5 B&.$)

1oteA The depreciation expense error is a prior period ad9ustment 4to retained earnings5 and is not reported in the income statement.
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#olutions Manual, $ol.!, Chapter %

2e*uirement '
SC=EMB2I MA1/!ACT/2I1C C02P02ATI01

Statement of Comprehensive 1ncome =or the Aear :nded .ecember '$, &-$'
4B in ---s5 3et income ....................................................................... 2ther comprehensive income 4loss5! @nreali8ed gains from investments, net of tax................. >oss from foreign currency translation, net of tax Total other comprehensive income ................................... Comprehensive income ..................................................... B&,(,( B$,& 4$""5 "+ B&,)"'

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Intermediate Accounting, 7'e

Pro$"em 4%.
>/5E C0MPA16 Statement of Comprehensive 1ncome =or the Aear :nded .ecember '$, &-$'
Sales revenue ................................................................... Cost of goods sold .......................................................... ;ross profit ..................................................................... 2perating expenses! ;eneral and administrative ........................................... Selling .......................................................................... %estructuring costs ....................................................... >oss from write7down of obsolete inventory Total operating expenses .......................................... 2perating income ............................................................ 2ther income 4expense5! 1nterest expense ............................................................ 1ncome before income taxes and extraordinary item........ 1ncome tax expense ......................................................... 1ncome before extraordinary item ................................... :xtraordinary item! >oss from expropriation of overseas plant 4net of B$,&--,--- tax benefit5 ............................................ 3et 1ncome....................................................................... 2ther comprehensive income 4loss5! =oreign currency translation ad9ustment loss, net of tax @nreali8ed gains on investment securities, net of tax Total other comprehensive loss Comprehensive income B$,---,--(--,--'--,--"--,--&,&--,--',+--,--4*--,---5 ',$--,--$,&"-,--$,+)-,--4$,+--,---5 )-,--4$&-,---5 $-+,--4$&,---5 B "+,--B$(,---,--,,---,--),---,---

3otes! $. The restructuring costs and the loss from write7down of inventory are not extraordinary items. &. The depreciation expense error is a prior period ad9ustment and is not reported in the income statement.

Pro$"em 4%7

2e*uirement & >I3E2SI!IE> P02T!0@I0 C02P02ATI01 Statement of Cash =lows =or the Aear :nded .ecember '$, &-$'
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#olutions Manual, $ol.!, Chapter %

Cash )lows )rom operating acti,ities1 Collections from customers ;&< <ayment of operating expenses ;'< <ayment of income taxes ;(< 3et cash flows from operating activities Cash )lows )rom in,esting acti,ities1 Sale of investments 3et cash flows from investing activities Cash )lows )rom )inancing acti,ities1 <roceeds from issue of common stoc <ayment of dividends 3et cash flows from financing activities 1ncrease in cash Cash and cash equivalents, Hanuary $ Cash and cash equivalents, .ecember '$

B++-,--4))-,---5 4+(,---5 B$'(,--(-,--(-,--$--,--4+-,---5 &-,--&-(,--*-,--B&*(,---

;&< B,--,--- in service revenue less B&-,--- increase in accounts receivable. ;'< B*--,--- in operating expenses less B'-,--- in depreciation less B$-,--- increase

in accounts payable. ;(< B+-,--- in income tax expense plus B(,--- decrease in income taxes payable.

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Intermediate Accounting, 7'e

Problem 49 (concluded) 2e*uirement ' >I3E2SI!IE> P02T!0@I0 C02P02ATI01 Statement of Cash =lows =or the Aear :nded .ecember '$, &-$' Cash )lows )rom operating acti,ities1 3et income B$&-,--Ad7ustments )or noncash e))ects1 .epreciation expense '-,--Changes in operating assets and lia8ilities1 1ncrease in accounts receivable 4&-,---5 1ncrease in accounts payable $-,--.ecrease in income taxes payable 4(,---5 3et cash flows from operating activities B$'(,---

Pro$"em 4%&8

2e*uirement &

2 !2 Cash1 &-$& Cash K 3et increase in cash E &-$' Cash &-$& Cash K B+) E B$"( &-$& Cash E B)7 2 !" A'(1 &-$& AL% K Cr. Sales # Cash collections E &-$' AL% B+" K +# *$ E B 7( 2 !2 In,entor/1 &-$& AL< K <urchases # Cash paid E &-$' AL< B'- K <urchases # '- E B"Therefore, <urchases E B"&-$& 1nventory K <urchases # &-$' 1nventory E Cost of goods sold &-$& 1nventory K B"# )E B'& &-$& 1nventory E B)' 2 !2 Accumulated depreciation1 &-$' accumulated depreciation less &-$' depreciation E &-$& accumulated depreciation B)( # $- E B))
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Intermediate Accounting, 7'e

Problem 410 (continued) 2 !2 Total assets1 B(, K +" K (& K (- K $(- # (( E :(48 2 !" Total assets1 B$"( K ,' K )- K $(- # )( E :(.( 2 !2 Income ta*es pa/a8le1 &-$& 1nc. taxes payable K 1nc. tax expense # 1ncome taxes paid E &-$' 1nc. taxes payable &-$& 1nc. taxes payable E&-$' 1nc. taxes payable K Taxes paid # 1nc. tax expense &-$& 1nc. taxes payable E B&& K , # * E :'4 2 !" (etained earnings1 &-$& %L: K 3et income # .ividends E &-$' %L: B"* K &+ # ' E B -' 2 !2 Total lia8ilities and shareholders< e=uit/1 B'- K , K &" K &'- K "* E :(48 2 !" Total lia8ilities and shareholders< e=uit/1 B"- K , K && K &"- K *& E :(.(

#olutions Manual, $ol.!, Chapter %

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Problem 410 (concluded) 2e*uirement ' C2A1>3IE4 C02P02ATI01 Statement of Cash =lows =or the Aear :nded .ecember '$, &-$'
4B in millions5

Cash )lows )rom operating acti,ities1 3et income Ad7ustments )or noncash e))ects1 .epreciation expense ;ain on sale of investments Changes in operating assets and lia8ilities1 1ncrease in accounts receivable$ 1ncrease in inventory& 1ncrease in accounts payable' .ecrease in income taxes payable" 3et cash flows from operating activities
$ & ' "

B &+ $4$(5 4,5 4+5 $4&5 B$"

B,' # +" B)- # (& B"- # 'B&& # &" SA1TA1A I1>/ST2IES Statement of Cash =lows =or the Aear :nded .ecember '$, &-$' 4B in thousands5 B ',+($,)-4'--5 4$,---5 $('-Intermediate Accounting, 7'e

Pro$"em 4%&&

Cash )lows )rom operating acti,ities1 3et income Ad7ustments )or noncash e))ects1 .epreciation expense Changes in operating assets and lia8ilities1 1ncrease in accounts receivable 1ncrease in inventory .ecrease in prepaid rent 1ncrease in accounts payable
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1ncrease in interest payable 1ncrease in unearned service revenue .ecrease in income taxes payable 3et cash flows from operating activities Cash )lows )rom in,esting acti,ities1 <urchase of equipment Sale of equipment 3et cash flows from investing activities

$-&-4&(-5 B",)(4",---5 (-4',(--5

Cash )lows )rom )inancing acti,ities1 <roceeds from loan payable (,--<ayment of dividends 4$,---5 3et cash flows from financing activities ",--3et increase in cash Cash, Hanuary $ Cash, .ecember '$ (,$(&,&-B*,'(-

CASES Iu gment Case 4%&

2e*uirement & The term earnings =ualit/ refers to the ability of reported earnings 4income5 to predict a company0s future earnings. After all, an income statement simply reports on events that already have occurred. The relevance of any historical7based financial statement hinges on its predictive value. 2e*uirement ' To enhance predictive value, analysts try to separate a company0s transitor/ earnings effects from its permanent earnings. Transitory earnings effects result from transactions or events that are not li ely to occur again in the foreseeable future, or that are li ely to have a different impact on earnings in the future. 2e*uirement ( An often7debated contention is that, within ;AA<, managers have the power, to a limited degree, to manipulate reported company income. And the manipulation is not always in the direction of higher income. Iany believe that manipulating income reduces earnings quality because it can mas permanent earnings. 2e*uirement 4 Aou would consider the si8e of the gain in relation to net income, the si8e of the company0s investment portfolio, and the frequency of gains and losses from the sale of
#olutions Manual, $ol.!, Chapter % The McGraw-Hill Companies, Inc., 2 !" %&+"

investment securities in past years. The main ob9ective is to determine the li elihood of this type of gain occurring again in the future.

Iu gment Case 4%'

2e*uirement &

(estructuring costs include costs associated with shutdown or relocation of facilities or downsi8ing of operations. =acility closings and related employee layoffs translate into costs incurred for severance pay and relocation costs as well as asset write7downs or write7offs. 2e*uirement ' <rior to &--', restructuring costs were recogni8ed 4expensed5 in the period the decision to restructure was made, not in the period or periods in which the actual activities too place. 3ow, restructuring costs are expensed in the period4s5 incurred. 2e*uirement ( %estructuring costs would be included as an operating expense in a multi7step income statement. 2e*uirement 4 An analyst must interpret restructuring charges in light of a company0s past history in this area. 1nformation in disclosure notes describing the restructuring and management plans related to the business involved also can be helpful. 3o. Companies generally prefer to report earnings that Iu gment Case 4%(follow a smooth, regular, upward path. They try to avoid declines, but they also want to avoid increases that vary wildly from year to year. 1t is better to have two years of $(D earnings increases than a '-D gain one year and none the next. As a result, some companies Pban Q earnings by understating them in particularly good years and use the ban ed profits to increase earnings in bad years.

2ea" 4or" Case 4%4

2e*uirement &

Companies often voluntarily provide a pro )orma earnings number when they announce annual or quarterly earnings calculated according to ;AA<. These pro forma earnings numbers are management0s view of permanent earnings. These pro forma earnings numbers are controversial as they represent management0s biased view of permanent earnings and should be interpreted in that light. 2e*uirement ' The term earnings =ualit/ refers to the ability of reported earnings 4income5 to predict a company0s future earnings. Ianagement believes that pro forma earnings are of much higher quality than reported earnings because they are more indicative of future profitability.
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The critical question that student groups should Communication Case 4%)address is whether or not the gain on the sale of the timber tracts should be reported as an extraordinary item on the &-$' income statement. There is no right or wrong answer. The process of developing the proposed solutions will li ely be more beneficial than the solutions themselves. Students should benefit from participating in the process, interacting first with other group members, then with the class as a whole. Solutions should address the following issues! $. 1s the gain materialT A consensus should be reached that the gain is material. &. 1s the event both unusual and infrequentT .ebate should center on the critical issue of whether the event is li ely to occur again in the foreseeable future. '. 1f the event is deemed to require presentation as an extraordinary item, the gain should be reported net of tax below income from continuing operations. A disclosure note also is required and earnings per share disclosure should reflect the income statement presentation. As a real world example of a similar situation, in $,*" Hohns Ianville Corporation, manufacturer of asbestos products, reported a B&$ million extraordinary gain from the sale of timber tracts. 3o disclosure note was provided to explain the event, so we can only speculate as to the circumstances leading to the companySs presentation of the gain as extraordinary. 1t is important that each student actively participate in the process. .omination by one or two individuals should be discouraged. Students should be encouraged to contribute to the group discussion by 4a5 offering information on relevant issues, and 4b5 clarifying or modifying ideas already expressed, or 4c5 suggesting alternative direction. Suggeste Cra ing Concepts an Cra ing Communication Case 4%, SchemeA Content 4*-D5 GGGGGGG $- 1s the loss materialT GGGGGGG &( >ists the alternative treatments. GGGGGG <resent before7tax amount as a separate line item. GGGGGG <resent the after7tax amount as an extraordinary item. GGGGGG 1n either case, disclosure is required. GGGGGGG &( Cites the appropriate authoritative pronouncement, =ASB ASC &&(#&-#"( 4previously A<B2 3o. '-5, and discuss the concepts of unusual and infrequent in the context of the company0s environment.
#olutions Manual, $ol.!, Chapter % The McGraw-Hill Companies, Inc., 2 !" %&++

GGGGGGG $- A clear, well7supported recommendation is made. GGGGGG GGGGGGG *- points 4riting 4'-D5 GGGGGGG ) Terminology and tone appropriate to the audience of a chief financial officer. GGGGGGG $& 2rgani8ation permits ease of understanding. GGGGGG 1ntroduction that states purpose. GGGGGG <aragraphs that separate main points. GGGGGGG $& :nglish GGGGGG Sentences grammatically clear and well organi8ed, concise. GGGGGG Rord selection. GGGGGG Spelling. GGGGGG ;rammar and punctuation. GGGGGG GGGGGGG '- points

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Intermediate Accounting, 7'e

C se 4! (continued) The following is provided as an example. August $,,T2! Chief =inancial 2fficer, Carter Jawley Jale Stores 4CJJS5 =%2I! Hohn .oe, Controller 4CJJS5 %:! 1ncome Statement treatment of 2ctober $*, $,+,, earthqua e damage costs.

A decision on the income statement treatment of the earthqua e damage costs involves a number of considerations. =irst, the damage costs are clearly material. 1nclusion of the costs in earnings results in an increase in the net loss for the fiscal year ended August ", $,,-, from B,."* million to B&(.,* million. This leaves us only two options for the income statement presentation of the loss! $. <resent the before7tax amount of the loss 4B&*.( million5 as a separate line item in the income statement. &. <resent the after7tax effect of the loss 4B$).( million5 as an e*traordinar/ item, below income from continuing operations. 1n both cases, a disclosure note would be required to explain the loss. The appropriate authoritative pronouncement pertaining to this case is =ASB ASC &&(#&-#"(! P1ncome Statement#:xtraordinary and @nusual 1tems#2ther <resentation IattersQ 4previously Accounting <rinciples Board 2pinion 3o. '-5. 1t states that 9udgment is required in determining whether or not an event warrants separate reporting in the income statement as an extraordinary item. Jowever, the following broad guideline is provided in paragraph &!
P:xtraordinary items are events and transactions that are distinguished by their unusual nature and by the infrequency of their occurrence.Q

The characteristics of unusual nature and in)re=uenc/ o) occurrence must be considered in light of the environment in which the company operates. These characteristics are only aids in answering the important question! Rhat is the li elihood that this event will occur again in the foreseeable futureT 1f it is not li ely to occur again, then this should be communicated to financial statement users by segregating the income effect of the event as an extraordinary item. This will help them in using the income statement to predict future cash flows.

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C se 4! (concluded) 2EC0MME1>ATI01 1 recommend that the earthqua e damage costs be treated as an extraordinary loss, net of tax, in the income statement for the fiscal year ended August ", $,,-. 1n addition, earnings per share for income both before and after the loss must be presented. Rhile many earthqua es do occur in California, extremely large earthqua es causing significant amounts of damage are both unusual and infrequent. 1 do not believe that this type of loss will occur again in the foreseeable future.

Ethics Case 4%-

.iscussion should include these elements.

!actsA The company incurred B$- million in expenses related to a product recall. The company had experienced product recalls in the past and they do occur in the industry. To show a profit from continuing operations, Him .iet8, the controller, wants to report the B$- million as an extraordinary loss, rather than as an expense included in operating income. Je tells the C:2 that the company has never had a product recall of this magnitude and that the company fixed the design flaw and upgraded quality control. :xtraordinary items are gains and losses that are material, and result from events that are both unusual and in)re=uent. These criteria must be considered in light of the environment in which the entity operates. There obviously is a considerable degree of sub9ectivity involved in the determination. The concepts of unusual and infrequent require 9udgment. 1n ma ing these 9udgments, an accountant should eep in mind the overall ob9ective of the income statement. The ey question is how the event relates to a firm0s future profitability. 1f it is 9udged that the event, because of its unusual nature and infrequency of occurrence, is not li>el/ to occur again, separate reporting as an extraordinary item is warranted. Ethica" >i"emmaA 1t appears from the facts of the case that it would be difficult for the company to come to the conclusion that a material product recall is not li ely to occur again in the foreseeable future. This type of event has occurred before and is common in the industry. Rhile a sub9ective 9udgment, extraordinary treatment of the B$- million does not appear warranted. 1s the obligation of Him and the C:2 to maximi8e income from continuing operations, the companySs position on the stoc mar et, and management bonuses stronger than their obligation to fairly present accounting information to the users of financial statementsT 4ho is affecte J
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Intermediate Accounting, 7'e

Him .iet8 C:2 and other managers 2ther employees Shareholders <otential shareholders from the stoc mar et Creditors Company auditors

2esearch Case 4%.

2e*uirement &

The accounting standards topic number that addresses exit or disposal cost obligations is =ASB ASC "&-! P:xit or .isposal Cost 2bligations.Q 2e*uirement ' The specific citation that addresses the initial measurement of these obligations is =ASB ASC "&-#$-#'-#$! P:xit or .isposal Cost 2bligations#2verall#1nitial Ieasurement.Q 2e*uirement ( A liability for a cost associated with an exit or disposal activity is measured initially at its fair value in the period in which the liability is incurred. 2e*uirement 4 The specific citation that describes the disclosure requirements for exit or disposal obligations is =ASB ASC "&-#$-#(-#$! P:xit or .isposal Cost 2bligations#2verall# .isclosure.Q

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The McGraw-Hill Companies, Inc., 2 !" %&+6

C se 4" (concluded) 2e*uirement ) All of the following information is disclosed in notes to financial statements that include the period in which an exit or disposal activity is initiated and any subsequent period until the activity is completed! a. A description of the exit or disposal activity, including the facts and circumstances leading to the expected activity and the expected completion date. b. =or each ma9or type of cost associated with the activity 4for example, oneKtime emp"o+ee termination $enefits, contract termination costs, and other associated costs5, both of the following are disclosed! $. The total amount expected to be incurred in connection with the activity, the amount incurred in the period, and the cumulative amount incurred to date. &. A reconciliation of the beginning and ending liability balances showing separately the changes during the period attributable to costs incurred and charged to expense, costs paid or otherwise settled, and any ad9ustments to the liability with an explanation of the reason4s5 why. c. The line item4s5 in the income statement or the statement of activities in which the costs in 4b5 are aggregated. d. =or each reportable segment, as defined in Subtopic &+-7$-, the total amount of costs expected to be incurred in connection with the activity, the amount incurred in the period, and the cumulative amount incurred to date, net of any ad9ustments to the liability with an explanation of the reason4s5 why. e. 1f a liability for a cost associated with the activity is not recogni8ed because fair value cannot be reasonably estimated, that fact and the reasons why. !inancia" Statement Presentation
Intermediate Accounting, 7'e

Iu gment Case 4%7


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Situation $. &. '. ". (. ). *. +.

Treatment ;a%g< b. c. f. g. a. b. e. d.

;C0, BC, or 2E< C2 %: C2 C2 BC C2 BC %:

$. The loss is not unusual or infrequent. 1t is included in Iu gment Case 4%&8 income from continuing operations along with other nonoperating items. &. The sale of the financing component is treated as a discontinued operation. The gain or loss from the sale of the assets along with income or loss generated by the component is presented below income from continuing operations. '. A change in depreciation method is treated as a change in accounting estimate achieved by a change in accounting principle. Changes in estimates are accounted for prospectively. The remaining boo value is depreciated, using the new method, over the remaining useful life. ". This event is not unusual but may be infrequent. 1t usually is presented as a separate line item included in income from continuing operations. (. The correction of an error is treated as a prior period ad9ustment. The effect of the correction is not included in income, but as an ad9ustment to retained earnings. <rior years0 financial statements are restated to correct the error. ). This event requires no unusual treatment. The lipstic line does not qualify as a component of an entity requiring treatment as a discontinued operation. The loss on sale of the assets of the product line is included in continuing operations.

I!2S Case 4%&&

$. ;SU reported Pinterest receivedQ and Pdividends from associates and 9oint venturesQ as investing cash flows. @.S. ;AA< requires these items to be included with operating

cash flows. &. P1nterest paidQ is reported as a financing cash flow. @.S. ;AA< requires interest paid to be included with operating cash flows

Iu gment Case 4%&'


#olutions Manual, $ol.!, Chapter %

2e*uirement &
The McGraw-Hill Companies, Inc., 2 !" %&0!

$. &. '. ". (. ). *. +.

a. As a component of operating income. b. As a nonoperating income item. d. As an other comprehensive income item. b. As a nonoperating income item. c. As a separately reported item. a. As a component of operating income. e. As an ad9ustment to retained earnings. c. As a separately reported item.

2e*uirement ' Situations ', (, and + would be reported in the statement of income and comprehensive income net7of7tax. Also, the net7of7tax effect of the correction of the amorti8ation error, situation *, would increase or decrease retained earnings.

1t would be nice to thin that management ma es all Iu gment Case 4%&(accounting choices in the best interest of fair and consistent financial reporting. @nfortunately, other motives influence the choices among accounting methods and whether to change methods. 1t has been suggested that the effect of choices on management compensation, on existing debt agreements, and on union negotiations each can affect management0s selection of accounting methods. =or instance, research has suggested that managers of companies with bonus plans are more li ely to choose accounting methods that maximi8e their bonuses 4often those that increase net income5. 2ther research has indicated that the existence and nature of debt agreements and other aspects of a firm0s capital structure can influence accounting choices. Rhether a company is forbidden from paying dividends if retained earnings fall below a certain level, for example, can affect the choice of accounting methods. Choices made are not always those that tend to increase income. As you will learn in Chapter +, many companies use the >1=2 inventory method because it reduces income and therefore reduces the amount of income taxes that must be paid currently. Also, some very large and visible companies might be reluctant to report high income
$ & '

$ Ratts, %.>., and H.>. Vimmerman, PTowards a <ositive Theory of the .etermination of Accounting Standards,Q The

Accounting (e,iew, Hanuary $,*+, and P<ositive Accounting Theory! A Ten Aear <erspective,Q The Accounting (e,iew, Hanuary $,,-. & =or example, see Jealy, <.I., PThe :ffect of Bonus Schemes on Accounting .ecisions,Q ?ournal o) Accounting and 2conomics, April $,+(, and .haliwal, .., ;. Salamon, and :. Smith, PThe :ffect of 2wner 6ersus Ianagement Control on the Choice of Accounting Iethods,Q ?ournal o) Accounting and 2conomics , Huly $,+&. ' Bowen, %.I., :.R. 3oreen, and H.I. >acy, P.eterminants of the Corporate .ecision to Capitali8e 1nterest,Q ?ournal o) Accounting and 2conomics ,Q August $,+$.
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that might render them vulnerable to union demands, government regulations, or higher taxes.
"

2esearch Case

;1oteA This case re*uires the stu ent to reference a Lourna" 4%&4artic"e?H

2e*uirement ' The authors use the SO< (-- companies as their sample. 2e*uirement ( **D in &--$ and only ("D in &--'. 2e*uirement 4 1n &--$, +(D of firms have greater pro forma than ;AA< earnings. This ratio declined to )*D in &--'. 2e*uirement ) 1n &--$, $') firms reported P%estructuring Charges,Q and the same number of firms reported a P.ivestitureLSale of Business @nits. 1n &--', the most frequently reported ad9ustment was PAmorti8ationL1mpairment of ;oodwill and 2ther 1ntangibles.Q 2e*uirement , The authors0 main conclusions are that the introduction of pro forma regulation is associated with a substantial change in firms0 pro forma reporting. 3otably, far fewer firms are reporting pro forma earnings, while those that continue to report appear to do so in a manner consistent with the intention of the regulation, to provide useful information, not to mislead. >E!ICIE1CIESA

Integrating Case 4%&)

Ba"ance SheetA $. The asset section of the balance sheet should be classified. Cash, short7term investments, accounts receivable, and inventories should be included as current assets. &. Accounts receivable should be shown net of the allowance for uncollectible accounts. '. 1nventories/the method used to cost inventory should be disclosed in a note. ". Iar etable securities/B&$,--- of investments 4B*+,--- # (*,---5 should be classified in a noncurrent investments category. (. <roperty and equipment/should be classified in a separate category. 2riginal cost should be disclosed along with the accumulated depreciation to arrive at
" This Ppolitical costQ motive is suggested by Ratts, %.>.. and H.>. Vimmerman, P P<ositive Accounting Theory! A Ten7

Aear <erspective,Q The Accounting (e,iew, Hanuary $,,-, and Vmi9ews i, I., and %. Jagerman, PAn 1ncome Strategy Approach to the <ositive Theory of Accounting Standard SettingLChoice,Q ?ournal o) Accounting and 2conomics, August $,+$.
#olutions Manual, $ol.!, Chapter % The McGraw-Hill Companies, Inc., 2 !" %&0"

). *.

+. ,.

the net amount. Also, the method used to compute depreciation should be disclosed in a note. The liability and shareholdersS equity section of the balance sheet should be classified into 4$5 current liabilities, 4&5 long7term liabilities, and 4'5 shareholdersS equity. Current liabilities should include accounts payable and accruals, notes payable 4the B+-,--- note due in &-$" and the B)-,--- installment on note W & due in &-$"5. The latter should be classified as current maturities of long7term debt. Also, note disclosure is required for the notes providing information such as payment terms, interest rates, and collateral pledged as security for the debt. >ong7term liabilities should include the B)-,--- second installment on note W&. Common stoc /the par value, if any, and the number of shares authori8ed, issued, and outstanding should be disclosed.

Income StatementA $. The miscellaneous expense should be classified as an extraordinary item and shown net of tax below income from continuing operations. A note should describe the event. &. :arnings per share disclosure is required. '. The restructuring charges should be shown as a separate operating expense item in the income statement and described in a note.

!inancia" Ana"+sis Case 4%&,

2e*uirement & .(?7M increase 4'?'M ecrease

&-$- to &-$$! 4B&,)'( # $,"''5 X B$,"'' E &--, to &-$-! 4B$,"'' # &,"*+5 X B&,"*+ E

2e*uirement ' <rovision for income taxes X 1ncome before taxes B*$( X B','(- E '&M E Approximate income tax rate 2e*uirement ( B&,)'( X B)$,"," E 4?(M Answers to the questions will, of course, vary 2ea" 4or" Case 4%&-because students will research financial statements of different companies. 3o specific standards dictate how income from continuing operations must be displayed, so companies have considerable latitude in how they present the components of income from continuing operations. This flexibility has resulted in a considerable
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variety of income statement presentations. Jowever, we can identify two general approaches, the single-step and the multiple-step formats that might be considered the two extremes, with the income statements of most companies falling somewhere in between. The presentation of separately reported items, however, is mandated and students should be able to easily identify them.

Air !rance%5@M Case

2e*uirement &

A= classifies its expenses by both natural descriptions 4e.g., salaries and related costs, taxes other than income taxes5 and functions 4e.g., external expenses5. 1n the @nited States, expenses are classified by function. 2e*uirement ' A= classifies interest paid and interest received as operating cash flows, and dividends received as an investing cash flow. @nder 1=%S, companies can report interest paid as either an operating or financing cash flow and interest and dividends received as either operating or investing cash flows.

#olutions Manual, $ol.!, Chapter %

The McGraw-Hill Companies, Inc., 2 !" %&0+