Ch12in 1

587
Chapter 12
Income Taxes, Unusual Income Items, and Investments in Stock

OBJECTIVES

Obj 1 Journalize the entries for corporate income taxes, including deferred income taxes.
Obj 2 Describe and illustrate the reporting of unusual items on the income statement.
Obj 3 Prepare an income statement reporting earnings per share data.
Obj 4 Describe the concept and the reporting of comprehensive income.
Obj 5 Describe the accounting for investments in stocks.

QUESTION GRID

True/False
No. Objective Difficulty No. Objective Difficulty No. Objective Difficulty
1 12-01 Easy 24 12-02 Easy 47 12-05 Easy
2 12-01 Moderate 25 12-02 Easy 48 12-05 Easy
3 12-01 Easy 26 12-02 Easy 49 12-05 Easy
4 12-01 Easy 27 12-02 Easy 50 12-05 Easy
5 12-01 Easy 28 12-02 Easy 51 12-05 Easy
6 12-01 Easy 29 12-02 Easy 52 12-05 Easy
7 12-01 Easy 30 12-02 Easy 53 12-05 Easy
8 12-01 Easy 31 12-02 Easy 54 12-05 Easy
10 12-01 Easy 33 12-02 Easy 56 12-05 Easy
11 12-01 Easy 34 12-03 Easy 57 12-05 Easy
12 12-02 Easy 35 12-03 Easy 58 12-05 Easy
13 12-02 Easy 36 12-03 Easy 59 12-05 Easy
12 12-02 Easy 37 12-03 Easy 60 12-05 Easy
15 12-02 Easy 38 12-03 Easy 61 12-05 Easy
16 12-02 Easy 39 12-04 Easy 62 12-05 Easy
17 12-02 Easy 40 12-04 Easy 63 12-05 Easy
18 12-02 Easy 41 12-04 Easy 64 12-05 Easy
19 12-02 Easy 42 12-04 Easy 65 12-05 Easy
20 12-02 Easy 43 12-04 Easy 66 12-05 Moderate
21 12-02 Easy 44 12-04 Easy 67 12-05 Easy
22 12-02 Easy 45 12-04 Easy
23 12-02 Easy 46 12-04 Easy

588 Chapter 12/Income Taxes, Unusual Income Items, and Investments in Stock
Multiple Choice
2 12-01 Moderate 34 12-03 Moderate 66 12-05 Easy
3 12-01 Easy 35 12-03 Moderate 67 12-05 Easy
6 12-01 Easy 38 12-03 Easy 70 12-05 Easy
9 12-01 Moderate 41 12-03 Moderate 73 12-05 Easy
20 12-02 Easy 52 12-05 Easy 84 12-05 Easy
28 12-02 Moderate 60 12-05 Easy 92 12-05 Moderate
31 12-02 Moderate 63 12-05 Easy
32 12-03 Easy 64 12-05 Easy

Exercise/Other
1 12-01 Easy 6 12-02 Moderate 11 12-05 Moderate
2 12-01 Difficult 7 12-03 Moderate 12 12-05 Moderate
3 12-01 Moderate 8 12-03 Moderate 13 12-05 Moderate
5 12-02 Moderate 10 12-04 Moderate 15 12-03, 05 Moderate

Chapter 12/Income Taxes, Unusual Income Items, and Investments in Stock 589
Problem
1 12-01 Moderate 4 12-02 Moderate 7 12-05 Moderate
2 12-01 Difficult 5 12-02, 12-03 Difficult 8 12-05 Moderate

Chapter 12Income Taxes, Unusual Income Items, and Investments in Stocks

TRUE/FALSE

1. Temporary differences affect the timing of when revenues and expenses are recognized for tax
purposes and as a result, the total amount of taxes paid does not change
ANS: T DIF: Easy OBJ: 12-01
NAT: AACSB Analytic | AICPA FN-Measurement

2. A corporation has $300,000 income before income taxes, a 40% tax rate, and $120,000 taxable
income. The deferred income taxes is $72,000.
ANS: T DIF: Moderate OBJ: 12-01

3. Income tax expense reported on the income statement is the total taxes to be paid.
ANS: F DIF: Easy OBJ: 12-01

4. In future years, the Deferred Income Tax Payable will be transferred to Income Tax Payable as the
timing differences reverse and taxes become due.

5. The whole balance of Deferred Income Tax Payable at the end of the year is reported as a current
liability.

6. Permanent tax differences arise when certain revenues are exempt from tax and certain expenses are
not deductible in determining taxable income.

7. Income tax expense as a ratio to earnings before taxes is normally not a significant expense for most
companies.

8. Temporary differences affect only the timing of when revenues and expenses are recognized for tax
purposes.

income. The deferred income taxes is $48,000.
ANS: F DIF: Moderate OBJ: 12-01

10. A companys actual income tax liability is calculated in accordance with generally accepted
accounting principles.

11. The amount of income tax expense appearing on a companys income statement is calculated to
match current earnings.

12. Generally accepted accounting principles require that certain unusual items be reported on the
income statement. These items can be classified into two categories. One such category is those
items that affect the current period income statement.

13. Unusual items affecting the current periods income statement consist of fixed assets and
discontinued items.

14. Fixed asset impairment arises when the carrying value of the fixed asset exceeds its fair market
value.

15. Asset impairment accounting requires footnote disclosure that describes the nature of the asset
impaired and the cause of the impairment.

16. Asset impairment accounting recognizes the loss when it is first identified rather than at a later date.

17. Restructuring charges are costs associated with involuntarily terminating employees, terminating
contracts, consolidating facilities, or relocating employees.

18. The expense and liability to provide employee benefits should be recognized at its fair market value
on the plan communication date

19. The restructuring charge is reported as a separate expense deducted from income from continuing
operations.

20. The actual benefits paid to terminated employees should be debited to the liability as the employees
leave the firm.

21. When a corporation discontinues a segment of its operations at a loss, the loss should be reported as
a separate item after income from continuing operations on the income statement.

22. An extraordinary item results from events that are significantly different from the typical or normal
operating activities of the business.

23. Gains and losses on the disposal of fixed assets are examples of extraordinary items.

24. Changes in accounting principles could be the result of the FASB issuing a new accounting standard.

25. Reporting unusual items separately on the income statement allows investors to isolate the effects of
these items on income and cash flows.

26. Those unusual items reported as deductions from income from continuing operations should be listed
net of the related income tax.

27. Unusual items affecting the prior periods income statement are common in accounting.

28. A fixed asset impairment occurs when the fair value of a fixed asset falls below its book value and is
expected to recover at a later date.

29. When a corporation discontinues a segment of its operations at a loss, the loss should be reported as
a separate item before income from continuing operations on the income statement.

30. Changes in accounting principles are caused by the FASB issuing a new accounting standard.

31. An extraordinary loss of $300,000 that results in income tax savings of $90,000 should be reported
as an extraordinary loss (net of tax) of $210,000 on the income statement.

32. Unusual items affecting the prior periods income statement consist of errors and change in
accounting principles.

33. An example of an unusual item affecting the prior periods income statement is the correction of an
error in the financial statements of a previous year.

34. Earnings per common share is a convenient way to compare companies of different sizes.

35. Convertible preferred stock is a potentially dilutive stock.

36. In determining earnings per share the number of share outstanding should be averaged by weight if
shares outstanding have changed during the year.

37. Earnings per share amounts are only required to be presented for income from continuing operations
and net income on the face of the statement.

38. The amount of earnings per share based on the assumption that all convertible preferred stock and
bonds, options and warrants are converted to common stock is referred to as diluted earning per
share.

39. Comprehensive income is all changes in stockholders' equity during the period except those resulting
from dividends and stockholders' investment.

40. Comprehensive income is listed with unusual items on the income statement.

41. Other comprehensive income transactions should be reported net of taxes.

42. The cumulative effects of other comprehensive income items must be reported separately from
retained earnings and paid-in capital, on the balance sheet, as accumulated other comprehensive
income.

43. In the 2005 edition of Accounting Trends & Techniques, over 50% of the companies reported other
comprehensive income.

44. Comprehensive income does not affect net income or retained earnings.

45. The cumulative effects of other comprehensive income items is included in retained earnings, on the
balance sheet, as accumulated other comprehensive income.

46. Comprehensive income affects net income and ultimately retained earnings.

47. Although marketable securities may be retained for several years, they continue to be classified as
temporary, provided they are readily marketable and can be sold for cash at any time.

48. Available-for-sale securities are securities that management expects to sell in the future, but are not
actively traded for profit.

49. Temporary investments are recorded at their cost which would include broker's commissions.

50. Temporary investments are reported on the balance sheet at cost.

51. Any difference between the fair market values of the securities and their cost is a realized gain or
loss.

52. Unrealized gains and losses are reported as other comprehensive income items until the related
securities are sold, then the gains and losses become realized and are included in determining net
income.

53. Investments in stocks that are expected to be held for the long term are listed in the stockholder's
equity section of the balance sheet.

54. Ordinarily, a corporation owning a significant portion of the voting stock of another corporation
accounts for the investment using the equity method.

55. The investor carrying an investment by the equity method records cash dividends received as an
increase in the carrying amount of the investment.

56. Under the equity method, a stock purchase is recorded at its original cost, but is not subsequently
adjusted to fair market value.

57. The 2005 edition of Accounting Trends & Techniques indicated that over 75% of the companies used
the equity method to account for investments.
NAT: AACSB Analytic | AICPA BB-Industry

58. The equity method causes the investment account to mirror the proportional changes in book value
of the investee.

59. Accounting for the sale of stock is the same for both short-term and long-term investments.

60. When one corporation acquires the properties of another corporation and the latter then dissolves, the
joining of the two companies is called a merger.

61. The corporation owning all or a majority of the voting stock of another corporation is known as the
parent company.

62. The financial statements resulting from combining parent and subsidiary statements are called
consolidated statements.

63. The price-earnings ratio is calculated by dividing market price per share into the earnings per share.

64. The price-earnings ratio is a commonly quoted ratio by the financial press.

65. The price-earnings ratio is an assessment of a firm's growth potential and future earnings prospects.

66. It is not possible for one company to influence the operating policies of another company unless it
owns more than 50% interest in that company.
ANS: F DIF: Moderate OBJ: 12-05

67. The equity method is usually more appropriate for accounting for investments where the purchaser
does not have significant influence over the investee.

MULTIPLE CHOICE

1. Which of the following is an example of a permanent difference between taxable income and
reported income?
a. using the installment method of determining revenue for taxable income and recognizing revenue
when the sale is made for income statement reporting
b. using the straight-line depreciation method for income statement reporting and MACRS
depreciation for taxable income
c. including tax-exempt municipal bond interest in net income and not including any tax-exempt
municipal bond interest in taxable income
d. using the straight-line depreciation method for taxable income and MACRS depreciation for
income statement reporting
ANS: C DIF: Moderate OBJ: 12-01

2. Which of the following is an example of a temporary difference between taxable income and
reported income?
a. using the installment method of determining revenue for taxable income and for income
statement reporting
b. using the straight-line depreciation method for income statement reporting and MACRS
depreciation for taxable income
c. using the straight-line depreciation method for some assets and MACRS depreciation for other
assets
d. including tax-exempt municipal bond interest in net income and not including any tax-exempt
municipal bond interest in taxable income
ANS: B DIF: Moderate OBJ: 12-01

3. Deferred income tax may be reported on the balance sheet in the
a. current and/or intangible assets section as Prepaid Taxes
b. intangible assets section
c. current liabilities as taxes payable and long-term liabilities section as Deferred Income Tax
Payable
d. current assets section and investments section as Prepaid Taxes
ANS: C DIF: Easy OBJ: 12-01

4. The income before income tax for the first year of operations is $750,000. Because of timing
differences in accounting and tax methods, the taxable income for the same year is $550,000.
Assuming an income tax rate of 50%, what is the amount of income tax to be reported on the income
statement?
a. $50,000
b. $325,000
c. $200,000
d. $375,000
ANS: D DIF: Easy OBJ: 12-01

Assuming an income tax rate of 50%, the amount of the deferred income tax would be
a. $ 200,000
b. $100,000
c. $50,000
d. $375,000
ANS: B DIF: Easy OBJ: 12-01

statement?
a. $25,000
b. $250,000
c. $300,000
d. $375,000

Assuming an income tax rate of 50%, the amount of the deferred income tax would be
a. $ 50,000
b. $100,000
c. $250,000
d. $300,000
ANS: A DIF: Easy OBJ: 12-01

8. When there is a difference in the timing of revenues and expenses for accounting versus income tax
purposes, it is usually necessary to
a. perform income tax procedures.
b. allocate between various financial statement periods.
c. adjust taxable income.
d. do nothing.

9. ABC Company has incurred a period income tax expense of $500,000. The tax accountants inform
the financial accountants that 60% of this value will be paid on March 15th, 2 1/2 months away,
while the balance will be paid in 14 1/2 months. The journal entry to recognize these obligations is:
a. Dec 31 Income Tax Expense 300,000
Income Tax Payable 200,000
Cash 500,000
b. Dec 31 Income Tax Expense 500,000
Income Tax Payable - Current 300,000
Income Tax Payable - Non Current 200,000
c. Dec 31 Income Tax Expense 500,000
Cash 500,000
d. Dec 31 Income Tax Payable 500,000
Income Tax Expense 500,000

10. Income tax allocation procedures are justified by what concept?
a. Revenue recognition
b. Matching
c. Conservatism
d. Cash basis accounting

11. Income tax expense represents the amount of income taxes
a. actually payable for this period.
b. applicable to the taxable income this period.
c. applicable to the accounting income this period.
d. computed according to tax law for this period.

12. When income tax expense is larger than the income tax payable for a period it is associated with
a. a larger accounting income than taxable income.
b. a larger taxable income than accounting income.
c. an error.
d. a debit to Deferred Income Tax Payable.

13. The journal entry to recognize the period income tax expense payable at a later date would be:
Cash 125,000
c. Dec 31 Income Tax Payable 125,000
Cash 125,000

Cash 500,000
Cash 500,000

Assuming an income tax rate of 50%, the amount of the deferred income tax would be:
a. $300,000
b. $75,000
c. $225,000
d. $50,000

16. Which of the following should be reported net of the related income tax effect on the income
statement?
a. Sale of an inventory item at a loss
b. Loss due to theft
c. Loss due to a discontinued operations of the business
d. Sale of a temporary investment at a loss

statement?
a. $300,000
b. $150,000
c. $75,000
d. $225,000
ANS: A
Income statement income tax is calculated by multiplying book income times tax rate. ($600,000 50% =
$300,000)
DIF: Moderate OBJ: 12-01

Cash 500,000
Cash 500,000

19. Which of the following items appears on the corporate income statement before income from
continuing operations?
a. cumulative effect of a change in accounting principles
b. extraordinary items
c. discontinued operations
d. restructuring charges

20. Which of the following is not an event that might cause an asset impairment?
a. decreases in the market price of fixed assets
b. significant changes in the business or regulations related to fixed assets
c. adverse conditions affecting the use of fixed assets
d. expected cash flow gains from using fixed assets

21. Which of the following would appear as an extraordinary item on the income statement?
a. loss resulting from the sale of fixed assets
b. gain resulting from the disposal of a segment of the business
c. loss from land condemned for public use
d. liquidating dividend

22. A loss on disposal of a segment would be reported in the income statement as a(n)
a. administrative expense
b. other expense
c. deduction from income from continuing operations
d. selling expense

23. An extraordinary item results from
a. a segment of the business being sold
b. corporate income tax being paid
c. a change from one accounting method to another acceptable accounting method
d. a transaction or event that is unusual and occurs infrequently.

24. Which of the following is considered an unusual item affecting the prior periods income statement?
a. Fixed asset impairments
b. Errors
c. Extraordinary item
d. Discontinued operations

25. Which of the following is considered an unusual item affecting the prior periods income statement?
a. Change in accounting principles
b. Fixed asset impairments
c. Extraordinary item
d. Discontinued operations

26. Which of the following should be classified as an extraordinary item on the income statement?
a. Gain on a sale of a long term investment.
b. Loss due to discontinued operations.
c. Restructuring charges.
d. Loss resulting from an infrequent natural disaster.

27. A loss due to a discontinued operation should be reported in the income statement
a. above income from continuing operations.
b. without related tax affect.
c. below income from continuing operations.
d. as an operating expense.

28. When a company changes from one acceptable accounting method to another, the change is reported
a. in the statement of retained earnings, as a correction to the beginning balance.
b. in the income statement, below income from continuing operations.
c. in the income statement, above income from continuing operations
d. through a retroactive restatement of prior period earnings.
ANS: D DIF: Moderate OBJ: 12-02

29. Which of the following items should be classified as an extraordinary item on a corporate income
statement?
a. Gain on the retirement of a bond payable
b. Gain from land condemned for public use
c. Loss due to an discontinued operation
d. Selling treasury stock for more than the company paid for it

30. Which of the following items appear on the corporate income statement before Income from
continuing operations?
a. Cumulative effect of a change in accounting principle
b. Income tax expense
c. Extraordinary gain
d. Loss on discontinued operations

31. Which of the following items should be classified as an extraordinary item on a corporate income
statement?
a. Gain on the retirement of a bond payable
b. Gain from land condemned for public use
c. Loss due to an discontinued operation
d. Selling treasury stock for more than the company paid for it

32. When the number of common shares outstanding has changed during the year, net income is divided
by
a. weighted-average shares outstanding of both common and preferred
b. weighted-average shares outstanding of common
c. number of common shares outstanding at the balance sheet date
d. number of common shares outstanding at the beginning of the accounting period

33. The Poe Corporation has a simple capital structure. Thaw company has 50,000 shares of common
stock outstanding. Net income for the year was $142,000. Poe declared and paid preferred stock
dividends of $16,000 during the year. Earnings per share for the year is
a. $3.16
b. $2.84
c. $2.52
d. $ .32

34. Based on the following information, what is earnings per share?

Common shares outstanding at the beginning
of the accounting period 210,000
Common shares outstanding at the end of the
accounting period 230,000
Weighted-average common shares outstanding
during the period 220,000
Preferred stock dividend declared and paid $ 70,000
Preferred stock dividend in arrears $ 20,000
Net income $500,000

a. $1.9545
b. $1.8696
c. $2.3810
d. $2.2727

35. The balance sheets at the end of each of the first two years of operations indicate the following:

2007 2006
Total current assets $250,000 $225,000
Total investments 50,000 25,000
Total fixed assets 450,000 300,000
Total current liabilities 100,000 37,500
Total long-term liabilities 200,000 112,500
Preferred 9% stock, $100 par 50,000 50,000
Common stock, $10 par 250,000 250,000
Paid-in capital in excess of par-
common stock 25,000 25,000
Retained earnings 125,000 125,000

If net income is $50,000 and interest expense is $20,000 for 2007, what are the earnings per share on
common stock for 2007?
a. $1.82
b. $2.00
c. $2.80
d. $1.20
ANS: A DIF: Moderate OBJ: 12-03

36. The following information is available for Spellman Corporation:

2006
Market price per share of common stock $30.00
Earnings per share on common stock 4.00

Which of the following statements is correct?
a. The price-earnings ratio is 7.5 and a share of common stock was selling for 7.5 times the amount
of earnings per share at the end of 2006.
b. The price-earnings ratio is 13.3% and a share of common stock was selling for 13.3% more than
the amount of earnings per share at the end of 2006.
c. The price-earnings ratio is 7.5 and a share of common stock was selling for 150 times the amount
of earnings per share at the end of 2006.
d. The market price per share and the earnings per share are not statistically related to each other.

37. For the year that just ended, a company reports net income of $3,200,000. There are 750,000 shares
authorized, 600,000 shares issued, and 500,000 shares of common stock outstanding. What is the
earnings per share?
a. $6.40
b. $3.20
c. $5.33
d. $3.33

38. A corporation with convertible preferred stock and stock options outstanding should disclose
a. earnings per share
b. primary earnings per share
c. fully diluted earnings per share
d. primary earnings per share and fully diluted earnings per share


2007 2006
Common stock, $10 par 250,000 250,000

If net income is $80,000 and interest expense is $20,000 for 2007, what are the earnings per share on
common stock for 2007?
a. $2.91
b. $3.02
c. $2.75
d. $3.20

earnings per share?
a. $6.40
b. $4.27
c. $4.57
d. $5.33

earnings per share?
a. $4.40
b. $3.14
c. $4.57
d. $3.67

42. Which of the following would be involved in the computation of earnings per share for a company
with a simple capital structure?
a. Weighted average number of share outstanding
b. Shares outstanding at end of year whether or not the number has changed during the year
c. Number of shares of preferred stock outstanding
d. Dividends declared on common stock

43. The Lange Company has a simple capital structure. The company has 20,000 shares of common
stock outstanding. Net income for the year was $65,000. Lange declared and paid a preferred stock
dividends of $4,000 during the year. Earnings per share for the year is:
a. $3.25
b. $.125
c. $3.05
d. $3.45
ANS: C


44. For the year that just ended, a company reports net income of $360,000. There are 500,000 shares
authorized 100,000 issued, and 80,000 shares of common stock outstanding. What is the earnings per
share?
a. $3.60
b. $4.00
c. $4.50
d. $4.00
ANS: C


45. Which of the following would be considered an Other Comprehensive Income item?
a. net income.
b. extraordinary loss related to flood.
c. gain on disposal of discontinued operations.
d. unrealized loss on available-for-sale securities.

46. Which of the following is not a part of comprehensive income?
a. foreign currency items
b. restructuring charges
c. unrealized gains and losses
d. pension liability adjustments

47. Companies may report comprehensive income on each of the statements below except
a. income statement
b. separate statement of comprehensive income
c. statement of stockholders equity
d. statement of retained earnings

48. Which of the following investments below should be accounted for by using the cost method?
a. temporary investments in stock
b. long-term investments in stock where the investor does not have a significant influence over the
investee
c. long-term investments in stock where the investor does have significant influence over the
investee
d. temporary investments in stock and long-term investments in stock where the investor does not
have a significant influence over the investee

49. Which of the following statements below is not a reason a company may purchase another
company's stock?
a. earning a return on excess cash
b. buoying up the other company's stock price
c. gaining control of another company's operations
d. developing or maintaining business relationships

50. The cost method of accounting for investments
a. requires the investment to be reported at its market value
b. requires the investment to be reported at its original cost in the balance sheet
c. requires the investment be increased by the reported net income of the investee
d. requires the investment be decreased by the reported net income of the investee

51. An investor purchased 500 shares of common stock, $25 par, for $21,750. Subsequently, 100 shares
were sold for $49.50 per share. What is the amount of gain or loss on the sale?
a. $12,750 gain
b. $600 gain
c. $600 loss
d. $9,250 loss

52. During the current year, the North Company purchased 200 shares of in the South Company for
$12,000 as a temporary investment. At the end of the year, the market value of the stock was
$10,000. The North company's financial statements for the current year should show
a. a loss of $2,000 on the income statement and temporary investments of $12,000 on the balance
sheet
b. no loss on the income statement and temporary investments of $12,000 on the balance sheet
c. a gain of $2,000 on the income statement and temporary investments of $10,000 on the balance
sheet
d. a loss of $2,000 on the income statement and temporary investments of $10,000 on the balance
sheet

53. The account Unrealized Loss on Temporary Investments in Stock should be included in the
a. Income statement
b. Balance sheet as an addition to Temporary Investments in Stock
c. Balance sheet as a deduction in Stockholders' Equity
d. Statement of Retained Earnings

54. The equity method of accounting for investments
a. requires a year-end adjustment to revalue the stock to lower of cost or market
b. requires the investment to be reported at its original cost
c. requires the investment be increased by the reported net income of the investee
d. requires the investment be decreased by the reported net income of the investee

55. Able Company owns 15,000 of the 50,000 shares of common stock outstanding of Troy Company
and exercises a significant influence over its operating and financial policies. The investment should
be accounted for by the
a. equity method
b. market method
c. cost or market method
d. cost method

56. Under the equity method, the receipt of cash dividends on an investment in common stock of
Wellington Corporation is accounted for as a debit to Cash and a credit to
a. Investment in Wellington
b. Retained Earnings
c. Dividend Revenue
d. Dividend Receivables

57. Long-term investments are held for all of the listed reasons below except
a. their income
b. long-term gain potential
c. influence over another business entity
d. meet current cash needs

58. The method of accounting for investments in equity securities in which the investor records its share
of periodic net income of the investee is the
a. cost method
b. market method
c. income method
d. equity method

59. When shares of stock held as an investment are sold, the difference between the proceeds and the
carrying amount of the investment is recorded as a(n)
a. prior period adjustment
b. extraordinary gain or loss
c. paid-in capital addition
d. gain or loss

60. Temporary investments are
a. recorded at cost but reported at fair market value
b. recorded at cost and reported at cost
c. recorded at cost but reported at lower of cost or fair market value
d. recorded at fair market value and reported at fair market value

61. Which one of the following items below would not affect the investor's income for the period?
a. interest received on a temporary investment in bonds
b. dividends received on a long-term investment in stock where the investor owns 10% of the
investee's stock
c. dividends received on a long-term investment in stock where the investor owns 30% of the
investee's stock
d. interest received on a long-term investment in bonds

62. Webber Company owns 28% of the common stock of Patten Company and accounts for the
investment using the equity method. Assuming that Webber Company purchased the stock several
years ago, the balance in the investment account would be equal to the cost of the
a. investment
b. investment plus Webber's share of Patten's net income earned since the investment was purchased
c. investment plus the total amount of dividends Webber has received from Patten since the
investment was purchased
d. investment plus Webber's share of Patten's net income earned since the investment was purchased
minus the total amount of dividends Webber has received from Patten since the investment was
purchased

63. Bean Corporation purchased 17% of the outstanding shares of common stock of Williams
Corporation as a long-term investment. Subsequently, Williams Corporation reported net income and
declared and paid cash dividends. What journal entry would Bean Corporation use to record the
purchase of Williams Corporation common stock?
a. debit Investment in Williams Corporation; credit Cash
b. debit Cash; credit Dividend Revenue
c. debit Investment in Williams Corporation; credit Income of Williams Corporation
d. debit Cash; credit Investment in Williams Corporation

declared and paid cash dividends. What journal entry would Bean Corporation use to record
dividends from Williams Corporation?

declared and paid cash dividends. What journal entry would Bean Corporation use to record its share
of the earnings of Williams Corporation?
a. debit Investment in Williams Corporation Stock; credit Cash

declared and paid cash dividends. What journal entry would Bean Corporation use to record the
dividends it receives from Williams Corporation?

67. Low Company owns 40% of the voting stock of High Corporation and uses the equity method in
recording this investment. High Corporation reported a $10,000 net loss. Low Corporation's entry
would include a
a. Debit to the investment account for $10,000
b. Debit to the investment account for $4,000
c. Credit to the investment account for $4,000
d. Debit to a loss account for $4,000

68. Patterson Company owns 83% of the outstanding stock of Taylor Company. Patterson Company is
referred to as the
a. parent
b. minority interest
c. affiliate
d. subsidiary

69. Greg Company owns 87% of the outstanding stock of Kay company. Kay Company is referred to as
the
a. parent
c. affiliate
d. subsidiary

70. Financial statements in which financial data for two or more companies are combined as a single
entity are called
a. conventional statements
b. consolidated statements
c. audited statements
d. constitutional statements

71. In general, consolidated financial statements should be prepared
a. when a corporation owns more than 20% of the common stock of another company
b. when a corporation owns more than 50% of the common stock of another company
c. only when a corporation owns 100% of the common stock of another company
d. whenever the market value of the stock investment is significantly lower than its cost

72. The price-earnings ratio is an assessment of a firm's
a. ability to increase its stock authorization amount
b. ability to use the correct sales price for its goods
c. relationship of the selling price of goods to the earnings on the sales
d. growth potential and future earnings prospects

73. The price-earnings ratio
a. indicates what the market is willing to pay per dollar of company earnings for a share of stock
b. indicates the amount of the dividend an investor will get in relation to the amount paid for stock
c. assumes that all companies within the same industry are equal
d. cannot be computed for very small corporations

74. For 2008, net income is $250,000, shares outstanding are 80,000, and the market price is $24. What
is the price-earnings ratio on common stock (round to one decimal point?)
a. 3.1
b. 7.7
c. 34.9
d. 2.5

75. Based on the following information, what is Company B's price-earnings ratio?

Company A Company B
Market price per share $70.00 $85.00
Earnings per share 14.00 11.00
Dividends per share 0.05 0.10
Investor's cost per share 40.00 50.00

a. 935
b. 7.73
c. 5.00
d. 0.13


2008 2007
Common stock, $10 par 500,000 500,000

For 2008, net income is $125,000, interest expense is $40,000, and the market price is $25. What is
the price-earnings ratio on common stock (round to one decimal point)?
a. 10.0
b. 10.8
c. 14.7
d. 7.6

77. Companies merge in order to create synergy. All of the statements below represent strategies to
create synergy except
a. reduce costs
b. replace management
c. horizontal expansion
d. reduce selling price

78. An investor purchased 500 shares of common stock, $25 par, for $21,750. Subsequently, 100 shares
were sold for $47.50 per share. What is the amount of gain or loss on the sale?
a. $4,350 gain
b. $400 gain
c. $400 loss
d. $16,800 loss

79. Patterson Company owns 83% of the outstanding stock of Taylor Company. Taylor Company is
referred to as the
a. parent
c. affiliate
d. subsidiary

80. Greg Company owns 87% of the outstanding stock of Kay company. Greg Company is referred to as
the
a. parent
c. affiliate
d. subsidiary

81. For 2008, net income is $240,000, shares outstanding are 80,000, and the market price is $24. What
is the price-earnings ratio on common stock (round to one decimal point?)
a. 8.0
b. 7.7
c. 10.0
d. 3.0

82. Based on the following information, what is Company X's price-earnings ratio?

Company X Company Y

a. 4.00
b. 6.25
c. 5.00
d. 1.50

83. Based on the following information, what is Company Y's price-earnings ratio?

Company X Company Y

a. 4.00
b. 6.25
c. 5.00
d. 1.50

84. Based on the following information, what is Company A's price-earnings ratio?

Company A Company B

a. 9.35
b. 7.73
c. 5.00
d. 0.13

The balance sheets at the end of each of the first two years of operations indicate the following:

2008 2007
Common stock, $10 par 500,000 500,000

85. For 2008, net income is $140,000, interest expense is $40,000, and the market price is $25. What is
a. 9.5
b. 10.8
c. 14.7
d. 7.6

86. For 2008, net income is $150,000, interest expense is $40,000, and the market price is $24. What is
a. 10.0
b. 10.8
c. 8.5
d. 6.3

87. Joslyn Corporation makes an investment in 100 shares of Sampson Company's common stock. The
stock is purchased for $40 a share plus brokerage fees of $300. The entry for the purchase is:
a. Debt Investments 4,000
Cash 4,000
b. Stock Investments 4,300
Cash 4,300
c. Stock Investments 4,000
Brokerage Fee Expense 300
Cash 4,300
d. Stock Investments 4,000
Cash 4,000
ANS: B
Recorded price of investment is the purchase price plus fees.

88. For accounting purposes, the method used to account for investments in common stock is determined
by
a. the amount paid for the stock by the investor.
b. whether the acquisition of the stock by the investor was "friendly" or "hostile."
c. the extent of an investor's influence over the operating and financial affairs of the investee.
d. whether the stock has paid dividends in past years.

89. When the cost method is used to account for an investment the carrying value of the investment is
affected by
a. the dividend distributions of the investee.
b. the periodic net income of the investee.
c. the earnings and dividend distributions of the investee.
d. neither the earnings nor the dividends of the investee.

90. The company whose stock is owned by the parent company is called the
a. controlled company.
b. investee company.
c. subsidiary company.
d. sibling company.

91. A company that owns more than 50% of the common stock of another company is known as the
a. parent company.
b. management company.
c. subsidiary company.
d. in-charge company.

92. If one company owns more than 50% of the common stock of another company a
a. a partnership exists.
b. parentsubsidiary relationship exists.
c. the company whose stock is owned must be liquidated
d. the cost method should be used to account for the investment.

93. Based on the following information, what is Company As price-earning ratio?

Company A Company B

Earnings per share 11.00
Dividends per share .10 .12
Investors cost per share 35.00 40.00

a. $6.00
b. $600
c. $1.71
d. $5.45
ANS: D


94. Based on the following information, what is Company Bs price-earning ratio?

Company A Company B

Dividends per share .10 .12
Investors cost per share 35.00 40.00

a. $5.00
b. $583
c. $1.75
d. $280
ANS: A


EXERCISE/OTHER

income. Provide the journal entry for the current years taxes.
ANS:
Deferred Income Tax Payable 60,000

Income tax expense based on $300,000 reported income at 40% $120,000
Income tax payable based on $150,000 taxable income at 40% 60,000
Income tax deferred to future years $ 60,000

NAT: AACSB Analytic | AICPA FN-Measurement TOP: Example Exercise 12-1

ANS:



ANS:



ANS:



5. On December 10 of the current year, Sanchez Corporation determined that equipment has been
impaired so that the book value of the equipment was reduced by $35,000. In addition, the senior
management of the company communicated an employee severance plan whereby 40 employees
could receive a termination benefit of $5,000 per employee. Provide the journal entry for the asset
impairment and the restructuring charge.
ANS:
Dec. 10 Loss on Fixed Asset Impairment 35,000
Equipment 35,000

Restructuring Charge 200,000*
Employee Termination Obligation 200,000

*40 employees $5,000

6. On December 10 of the current year, Sanchez Corporation determined that equipment has been
impaired so that the book value of the equipment was reduced by $55,000. In addition, the senior
management of the company communicated an employee severance plan whereby 50 employees
could receive a termination benefit of $6,000 per employee. Provide the journal entry for the asset
impairment and the restructuring charge.
ANS:
Dec. 10 Loss on Fixed Asset Impairment 55,000
Equipment 55,000

Restructuring Charge 300,000*
Employee Termination Obligation 300,000

*50 employees $6,000

7. Sunland Company had net income of $250,000 during the year. There were 200,000 common shares
outstanding during the year. There were 1,000 shares of $100 par value, 8% preferred stock
outstanding during the year. Determine the basic earnings per share.
ANS:

*$100 8% 1000 shares

8. Sunland Company had net income of $240,000 during the year. There were 100,000 common shares
outstanding during the year. There were 1,000 shares of $100 par value, 8% preferred stock
outstanding during the year. Determine the basic earnings per share.
ANS:

*$100 8% 1000 shares

9. Jacobs Company had a net income of $75,000, and other comprehensive income of $12,500 for
2008. On January 1, 2008, the Retained Earnings balance was $525,000 and the Accumulated Other
Comprehensive Income balance was $55,000. Determine the (a) comprehensive income for 2008, (b)
Retained Earnings balance on December 31, 2008, and (c) the Accumulated Other Comprehensive
Income on December 31, 2008.
ANS:
(a) $87,500 = $75,000 + $12,500
(b) $600,000 = $525,000 + $75,000
(c) $67,500 = $55,000 + $12,500


10. Jacobs Company had a net income of $77,000, and other comprehensive income of $12,500 for
2008. On January 1, 2008, the Retained Earnings balance was $425,000 and the Accumulated Other
Comprehensive Income balance was $52,000. Determine the (a) comprehensive income for 2008, (b)
Retained Earnings balance on December 31, 2008, and (c) the Accumulated Other Comprehensive
Income on December 31, 2008.
ANS:
(a) $89,500 = $77,000 + $12,500
(b) $502,000 = $425,000 + $77,000
(c) $64,500 = $52,000 + $12,500


11. New Company began operations on January 1, 2008, and purchased temporary investments in
marketable securities during the year at a cost of $65,000. The end of period market value for these
investments was $110,000. Net income was $150,000 for 2008. Determine (a) the reported amount
of marketable securities on the December 31, 2008, balance sheet, and (b) the comprehensive income
for 2008. Assume a tax rate of 40%.
ANS:
(a) $ 92,000*
(b) $ 177,000**

* $65,000 + [($110,000 - $65,000) (1 - 40%)]
** $150,000 + [($110,000 - $65,000) (1- 40%]

12. New Company began operations on January 1, 2008, and purchased temporary investments in
marketable securities during the year at a cost of $85,000. The end of period market value for these
investments was $160,000. Net income was $160,000 for 2008. Determine (a) the reported amount
of marketable securities on the December 31, 2008 balance sheet, and (b) the comprehensive income
for 2008. Assume a tax rate of 40%.
ANS:
(a) $ 130,000*
(b) $ 205,000**

* $85,000 + [($160,000 - $85,000) (1- 40%)]
** $160,000 + [($160,000 - $85,000) (1- 40%]

13. Songs Company purchased 40% of the outstanding stock of Tang Company on January 1, 2008.
Tang reported net income of $75,000 and declared dividends of $20,000 during 2008. How much
would Songs adjust their investment in Tang Company under the equity method?
ANS:
Songs share of Tang reported net income (40% $75,000) $30,000
Less: Songs share of the Tang dividend (40% $20,000) 8,000
Increase in the Investment in Tang Company Stock $22,000


14. Tongs Company purchased 40% of the outstanding stock of Sang Company on January 1, 2008.
Sang reported net income of $80,000 and declared dividends of $20,000 during 2008. How much
would Tongs adjust their investment in Sang Company under the equity method?
ANS:
Tongs share of Sang reported net income (40% $80,000) $32,000
Less: Songs share of the Tang dividend (40% $20,000) 8,000
Increase in the Investment in Tang Company Stock $24,000


15. A corporation has the following stockholders' equity accounts at the end of the current fiscal year,
after all closing entries have been posted: Common Stock, $10 par, $1,800,000; Paid-In Capital in
Excess of Par - Common Stock, $375,000; Paid-In Capital from Treasury Stock, $18,000; Retained
Earnings, $1,285,000. The earnings for the current year, during which there were no unusual items,
were $324,000.

(a) Compute the earnings per share of common stock.
(b) Assuming that the market price of the common stock at the end of the current fiscal
year was $61.20, compute the price-earnings ratio.

ANS:
(a) $1.80 per share ($324,000 180,000 shares)
(b) 34 ($61.20 $1.80)

DIF: Moderate OBJ: 12-03 | 12-05

PROBLEM

1. During its first four years of operations a company elected to use different methods for determining
the amount of particular expenses for tax purposes and for reporting purposes, with the following
results:

First Year Second Year Third Year Fourth Year
Income before
income tax $20,000 $50,000 $62,100 $ 84,000
Taxable income 6,000 41,000 57,500 101,000

Assuming an income tax rate of 40%, determine (a) the amount of income tax reported on the
income statement for each year, (b) the amount of income tax that would be paid each year, and (c)
the deferred income tax payable that would be reported on the balance sheet at the end of each of the
four years.
ANS:
First Year Second Year Third Year Fourth Year
Income tax on
income statement $8,000 $20,000 $24,840 $33,600
Income tax paid 2,400 16,400 23,000 40,400
Deferred income
tax payable 5,600 9,200 11,040 4,240


2. On December 31, 2005, the tax accountants of Mega Sales inform the accountants that 70% of the
current years tax expense should be considered payable on March 15, 2006. The balance will be
payable on March 15, 2007. Mega Sales journalizes any taxes payable within the next calendar year
to Income Tax Payable and taxes due after the next calendar year to the Deferred Income Tax
Payable account. The accountants determine that taxable income for the year 2005 $175,000.00 and
that the total income tax obligation is 35%.
(a) Journalize the recognition of the tax obligations at the end of the current year.
(b) Journalize the payment of the 2005 tax obligation on March 15, 2006.
(c) Journalize the payment of the 2005 tax obligation on March 15, 2007.
ANS:
(a) Dec 31, 2005 Income Tax Expense 61,250.00
Income Tax Payable 42,875.00
Deferred Income Tax Payable 18,375.00

(b) Mar 15, 2006 Income Tax Payable 42,875.00
Cash 42,875.00

(c) Mar 15, 2007 Deferred Income Tax Payable 18,375.00
Cash 18,375.00
DIF: Difficult OBJ: 12-01

3. On December 31, 2005, the tax accountants of Mega Sales inform the accountants that 75% of the
current years tax expense should be considered payable on March 15, 2006, 15% of the tax liability
will be payable on March 15, 2007, and the balance will be payable on March 15, 2008.

On December 31, 2006, the tax accountants inform the accountants that 80% of the current years tax
expense should be considered payable on March 15, 2007, and the balance will be payable March 15,
2008.

Mega Sales journalizes any taxes payable within the next calendar year to Income Tax Payable and
taxes due after the next calendar year to the Deferred Income Tax Payable account.

The accountants determine that taxable income for the year 2005 $175,000.00 and that the total
income tax obligation is 35%.

For the year 2006 the net income is $190,000.00 and that the total income tax obligation is 35%.

(a) Journalize the recognition of the tax obligations at December 31, 2005.
(b) Journalize the payment of the 2005 tax obligation on March 15, 2006.
(c) Journalize the recognition of the tax obligations at December 31, 2006.
(d) Journalize the payment required March 15, 2007 for the 2005 and 2006 tax obligations.
ANS:
(a) Dec 31, 2005 Income Tax Expense 61,250.00

(b) Mar 15, 2006 Income Tax Payable 45,937.50
Cash 45,937.50

(c) Dec 31, 2006 Income Tax Expense 66,500.00

(d) Mar 15, 2007 Income Tax Payable 53,200.00
Cash 62,387.50
DIF: Difficult OBJ: 12-01

4. Prepare an Income Statement using the following data for Spiritlight Ventures for the current fiscal
year ended December 31:

Net Sales $21,500,000
Cost of Merchandise Sold 10,900,000
Operating Expenses 6,300,000
Losses from Asset Impairment 2,000,000
Restructuring Charge 800,000
Loss on Discontinued Operations 200,000
Net Loss on Extraordinary Item 100,000

ANS:

Spiritlight Ventures
Income Statement
For the Year Ended December 31

Net Sales $21,500,000
Cost of Merchandise Sold 10,900,000
Gross Profit 10,600,000
Operating Expenses 6,300,000
Losses from Asset Impairment 2,000,000
Restructuring Charge 800,000 9,100,000
Income from Continuing Operations 1,500,000
Before Income Tax
Income from Continuing Operations 1,000,000
Loss on Discontinued Operations 200,000
Income before Extraordinary Expense 800,000
Net Loss on Extraordinary Item 100,000
Net Income 700,000

5. From the following data for Noll Company for the current fiscal year ended December 31, prepare a
multiple-step income statement. Show parenthetically earnings per share for the following: income
from continuing operations, loss on discontinued operations (less applicable income tax), income
before extraordinary item, extraordinary item (less applicable income tax), and net income.
Common stock, $50 par $200,000
Cost of merchandise sold 252,000
Administrative expenses 48,250
Income tax (applicable to continuing operations) 142,000
Interest expense 3,750
Loss on discontinued operations,
net of applicable tax of $2,700 5,400
Sales 775,000
Selling expenses 83,000
Uninsured flood loss, net of applicable
income tax of $4,500 14,000
ANS:
Noll Company
Income Statement
For Year Ended December 31, 2006

Sales $775,000
Cost of merchandise sold 252,000
Gross profit $523,000
Operating expenses:
Selling expenses $ 83,000
Administrative expenses 48,250
Total operating expenses 131,250
Income from operations $391,750
Other expense:
Interest expense 3,750
Income from continuing operations
before income tax $388,000
Income tax expense 142,000
Income from continuing operations $246,000
Loss on discontinued operations, net of
applicable income tax of $2,700 5,400
Income before extraordinary item $240,600
Extraordinary item:
Uninsured flood loss, net of applicable
income tax of $4,500 14,000
Net income $226,600

Earnings per common share:
Income from continuing operations $61.50
Loss on discontinued operations 1.35
Income before extraordinary item $60.15
Extraordinary item:
Uninsured flood loss 3.50
Net Income $56.65
DIF: Difficult OBJ: 12-02 | 12-03

6. Present entries to record the following selected transactions of Belton Co.

(a) Purchased 500 shares of the 100,000 shares outstanding $10 par common shares of Denver
Corporation for $5,100.
(b) Purchased 2,000 shares of the 10,000 shares no par common shares of Reilly Co. for
$45,600. The investment was accounted for by the equity method.
(c) Received a cash dividend of $1 per share on the Denver Corporation stock acquired in (a).
(d) Received a cash dividend of $2 per share on the Reilly Co. stock acquired in (b).
(e) Sold 100 shares of the Denver Corporation shares acquired in (a) for $2,100.
(f) Recorded the appropriate share of Reilly's Co. net income of $50,000. The stock was
acquired in (b).

ANS:
(a)
Investment in Denver Corporation Stock 5,100
Cash 5,100

(b)
Investment in Reilly Co. Stock 45,600
Cash 45,600

(c)
Cash 500
Dividend Revenue 500

(d)
Cash 4,000

(e)
Cash 2,100
Investment in Denver Corporation
Stock 1,020
Gain on Sale of Investments 1,080

(f)
Income of Reilly Co. 10,000


7. Prepare the journal entries for the following transactions for Miller Co.

(a) Miller Co. purchased 25,000 shares of the total of 100,000 shares of Bud Corp. stock for
$10 per share plus a $400 commission.
(b) Bud Corp.'s total earnings for the period are $80,000.
(c) Bud Corp. paid a total of $45,000 in cash dividends.

ANS:
(a)
Investment in Bud Corp. Stock 250,400
Cash 250,400

(b)
Income of Bud Corp. 20,000

(c)
Cash 11,250


8. Prepare the journal entries for the following transactions for Byman Co.

(a) Byman Co. purchased 1,200 shares of the total of 100,000 shares of Roy Corp. stock for
$20 5/8 per share plus a $70 commission.
(b) Roy's total earnings for the period are $84,000.
(c) Roy paid a total of $40,000 in cash dividends.

ANS:
(a)
Investment in Roy Corp. Stock 24,820
Cash 24,820

(b)
No entry

(c)
Cash 480.00
Dividend Revenue 480.00


9. Based on the following information for Company A and Company B:

Company A Company B
Dividends per share 3.00 .10

(a) Calculate the price-earnings ratio for each company.
(b) Assume that Company A and B are in the same industry. Which one is expected to have the
greater growth and the more improved earnings? Why?

ANS:
(a) Company A $75/$12 = 6.25 Company B $95/$5 = 19
(b) Company B because it has the higher P/E ratio.


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