Slide 4-1

Separately Reported Items

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Separately Reported Items

Three types of events are reported separately, net of taxes:
Income from continuing operations 1. Discontinued operations (net of tax effect) 2. Extraordinary items (net of tax effect) 3. Cumulative effect of a change in accounting principle (net of tax effect) Net Income $ xxx xx xx xx $ xxx

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Intraperiod Income Tax Allocation

Income Tax Expense must be associated with each component of income that causes it.

Show Income Tax Expense related to Income from Continuing Operations.

Report effects of Discontinued Operations, Extraordinary Items, and Cumulative Effect of Accounting Changes NET OF INCOME TAXES.

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Discontinued Operations
Sale or disposal of a component of an entity. A component includes:
Reportable segments Operating segments Reporting units Subsidiaries Asset groups

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Discontinued Operations
Report results of operations separately if two conditions are met: The operations and cash flows of the component have been (or will be) eliminated from the ongoing operations. The entity will not have any significant continuing involvement in the operations of the component after the disposal transaction.

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Discontinued Operations
Results of operations include two items:
1. The income or loss stream for the period from the identifiable discontinued operation. 2. The actual gain or loss from disposal of the component or an impairment loss if the component is held for resale.

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Discontinued Operations
Results of operations include two items:

1. The income or loss stream for the period from the identifiable discontinued operation. 2. The actual gain or loss from Carrying Value of Assets > (Fair Value of Assets - Cost to Sell) disposal of the component or an impairment loss if the component is held for resale.

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Discontinued Operations Example

During the year, Apex Co. sold an unprofitable component of the company. The component had a net loss from operations during the period of $150,000 and its assets sold at a loss of $100,000. Apex reported income from continuing operations of $120,000. All items are taxed at 30%.

How will this appear on the income statement?

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Discontinued Operations Example

Computation of Loss from Discontinued Operations (Net of Tax Effect):

Loss from discontinued operations Less: Tax benefit ($150,000 30%) Net loss Loss on disposal of assets Less: Tax benefit ($100,000 30%) Net loss

$ $ $ $

(150,000) 45,000 (105,000) (100,000) 30,000 (70,000)

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Discontinued Operations Example

Income Statement Presentation:

Income from continuing operations Discontinued operations: Loss on operations (net of tax benefit of $45,000) Loss on disposal of assets (net of tax benefit of $30,000) Net loss

$ 120,000

(105,000) (70,000) $ (55,000)

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Another Example: Kandon Enterprises E4-8 (p. 206)

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Extraordinary Items
Material in amount Gains or losses that are
unusual in nature and infrequent in occurrence. required by GAAP.

Reported net of related taxes

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Extraordinary Items Example

During the year, Apex Co. experienced a loss of $75,000 due to an earthquake at one of its manufacturing plants in Nashville. This was considered an extraordinary item. The company reported income before extraordinary item of $120,000. All gains and losses are subject to a 30% tax rate.

How would this item appear on the income statement?

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Extraordinary Items Example

Extraordinary Loss Less: Tax Benefits ($75,000 30%) Net Loss $ (75,000) 22,500 $ (52,500)

Income Statement Presentation:

Income before extraordinary item Extraordinary Loss: Earthquake loss (net of tax benefit of $22,500) Net income

$ 120,000

(52,500) $ 67,500

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Unusual or Infrequent Items

Items that are material and are either unusual or infrequentbut not both are included as a separate item in continuing operations.

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Application Case 4-8 (page 214)

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Accounting Changes
Type of Accounting Change
Change in Accounting Principle Change in Accounting Estimate

Definition
Replaces one GAAP with another Revision of an estimate because of new information or new experience Change from reporting as one type of entity to another type of entity

Change in Reporting Entity

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Change in Accounting Principle

Occurs when
Changing from one GAAP method to another GAAP method, or Changing the method of application of an existing principle.

Make a catch-up adjustment known as the cumulative effect of a change in accounting principle. The cumulative effect is reported net of taxes and after extraordinary items.

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Change in Accounting Principle Example

During the year, Apex Co. decided to change from the double-declining balance to the straight-line method for depreciation. The effect of this change is an increase in net income of $65,000. Apex reported income of $120,000 during the year. All items of income are subject to a 30% tax rate.

How would this item appear on the income statement?

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Change in Accounting Principle Example

Computation:
Increase in income $ Less: Tax expense ($65,000 30%) Net increase in income $ 65,000 (19,500) 45,500

Income from operations Cumulative effect of change in accounting principle: (net of $19,500 tax expense) Net income

$ 120,000

45,500 $ 165,500

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Change in Estimates
Revision of a previous accounting estimate. The new estimate should be used in the current and future periods. The prior accounting results should not be be restated.

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Change in Estimates Example

On January 1, 2000, we purchased equipment costing $30,000, with a useful life of 10 years and no salvage value. During 2003, we determine that the remaining useful is 5 years (8-year total life). We use straight-line depreciation.

Compute the revised depreciation expense for 2003.

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Change in Estimates Example

Asset cost Accumulated depreciation 12/31/02 - ($3,000 3 years) Remaining to be depreciated Remaining useful life Revised annual depreciation $ 30,000 (9,000) 21,000 5 years 4,200

Record depreciation expense of $4,200 for 2003 and subsequent years.

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Change in Reporting Entity

Financial statements are prepared for separate entities.

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Change in Reporting Entity

If two entities combine, a single set of consolidated financial statements is generally required.

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Change in Reporting Entity

If two entities combine:
1. Prepare a single set of consolidated financial statements. 2. Retroactively restate financial statements of prior periods.

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Prior Period Adjustments

Corrections of errors from a previous period. Appear on the Statement of Retained Earnings as an adjustment to beginning retained earnings. Must show the adjustment net of income taxes.

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Prior Period Adjustments Example

While reviewing the depreciation entries for 2001-2004, the controller found that in 2003 depreciation expense was incorrectly debited for $150,000 when in fact it should have been debited $125,000. All items are taxed at 30%.
Prepare the necessary journal entry in 2004 to correct this prior period error.

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Prior Period Adjustments Example

GENERAL JOURNAL
Date Description PR Debit Page: 180 Credit

12/31/03 Depreciation Expense Accumulated Depreciation

150,000 150,000

If this was the original entry, how do we correct it? Can we just reverse it? Why or why not?

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Prior Period Adjustments Example

GENERAL JOURNAL
Date Description PR Debit Page: 180 Credit

2004 Entry 2004 Accumulated Depreciation 25,000

To correct the 2003 error in 2004, we can debit Accumulated Depreciation since it is a permanent account.

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Prior Period Adjustments Example

GENERAL JOURNAL
Date Description PR Debit Page: 180 Credit

2004 Entry 2004 Accumulated Depreciation Retained Earnings 25,000 17,500

We cant credit Depreciation Expense since it was closed in 2003, so we credit Retained Earnings.

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Prior Period Adjustments Example

GENERAL JOURNAL
Date Description PR Debit Page: 180 Credit

2004 Entry 2004 Accumulated Depreciation Income Taxes Payable Retained Earnings 25,000 7,500 17,500

Remember to consider the tax effects: $25,000 30% = $7,500 taxes payable

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Application Problem 21-14 SST Page 1071

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Next Time .
Coachs Cash Flows