Solutions manual intermediate accounting 18e by stice and stice ch04

To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER QUESTIONS (c) The current value of net assets acquired in exchange transactions as determined by either their replacement or market values (d) Some variation of the above (a through c) but including in assets all resources and claims to resources, not just those acquired in exchange transactions The objective of financial reporting is to provide useful information for users of the financial statements The relevant information for decision making is future data, especially information dealing with cash flows The primary financial statements reflect economic transactions and events that have taken place The past is used to help project the future Income, however, is only one of many sources of cash flow The balance sheet and statement of cash flows also furnish relevant information upon which the investor may project other future cash flows In summary, the income statement contains only some of the information that is relevant for making economic decisions Two approaches can be used to measure income: the capital maintenance approach and the transaction approach The capital maintenance approach uses the balance sheet elements to determine the change in total equity after eliminating any investments and withdrawals of resources by owners The transaction approach determines income by analyzing individual transactions and events and their effect on related assets, liabilities, and owners’ equity Although the method of determining income differs, both approaches arrive at the same total income figure if the same attributes and measurements are used However, the transaction approach produces more detail as to the composition of income than does the capital maintenance approach Measurement methods that could be applied to net assets in the capital maintenance approach to income determination are as follows: (a) The historical cost of net assets acquired in exchange transactions, reduced by an allowance for their use (b) The historical cost of net assets acquired in exchange transactions, reduced by an allowance for their use and adjusted for a change in price levels since original acquisition The objectives of reporting income for income tax purposes and for financial reporting to users are not the same Those formulating income tax laws are usually concerned with fairness among taxpayers and with their ability to pay taxes Users, on the other hand, are concerned with a measure that distinguishes between a return on investment and a return of investment They want a measure that matches expenses against recognized revenue In most cases, the same accounting method can be used for both purposes This will reduce both the cost and the confusion of using more than one accounting method for the same transaction In some cases, however, the generally accepted accounting method is different from that required by income tax regulations This results in a temporary difference between the tax return and the books and gives rise to interperiod income tax allocation A code law country is one in which rules, laws, and accounting standards are set by legal processes—from the top down A common law country is one in which rules, laws, and accounting standards evolve in response to societal and market forces— from the bottom up Revenues and expenses are related to the ongoing major or central activities of a business and are reported at gross amounts Gains and losses are associated with peripheral and incidental transactions and events and are reported as the difference between the selling price and the book value (often the depreciated cost) These classification and display distinctions will depend on the specific circumstances and activities of an enterprise 101 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 102 The following two factors must be considered when deciding at what point revenues and gains should be recognized: (a) The resources from the transaction are either already realized in cash or claims to cash or are readily realizable in cash, and (b) the revenues and gains have been earned through substantial completion of clearly identified tasks and activities Both factors are usually met when merchandise is delivered or services are rendered to customers This is referred to as the point of sale There are three specific exceptions to the general rule that were discussed in the chapter They are recognizing revenue (a) at the point of completed production, (b) at the time of cash collection, and (c) at various points in time during the operating cycle (e.g., percentage-of-completion method) The justification for the use of these exceptions is that, in each case, the realization and earning criteria established by the FASB are met Three expense recognition principles are applied in matching costs with revenues: (a) Direct matching—costs are associated directly with specific revenues and recognized as expenses of the period in which the revenues are recognized (b) Systematic and rational allocation— when costs cannot be associated directly with specific revenues, costs are associated in a systematic and rational manner with the periods or products benefited (c) Immediate recognition—those costs that cannot be related to revenues either by direct matching or by systematic and rational allocation must be recognized as expenses of the current period 10 The multiple-step income statement can contain too much information that might be confusing to the reader and require excess time to evaluate The detailed listing of purchases and inventory, for example, might best be displayed in a supplementary schedule 11 The major sections that may be included in a multiple-step income statement may be divided into two categories: (a) income from continuing operations, separated into six sections, and (b) irregular or extraordinary items, separated into two sections The Chapter 12 13 14 15 sections of income from continuing operations are Revenue from net sales Cost of goods sold Operating expenses Other revenues and gains Other expenses and losses Income taxes on continuing operations The sections of irregular or extraordinary items are Discontinued operations Extraordinary items A restructuring charge is a loss that arises when a company proposes a restructuring of its operations The charge is composed of the loss in value associated with assets that no longer fit in the company’s strategic plans The charge also includes the additional costs associated with the termination or relocation of employees Restructuring charges are controversial because companies exercise considerable discretion in determining the amount of a restructuring charge and thus can use restructuring charges as a tool for manipulating the amount of reported net income This flexibility in the timing of the recognition of restructuring charges is reduced by FASB ASC Topic 420 (Exit or Disposal Cost Obligations) Intraperiod income tax allocation involves the separation of income tax expense between income from continuing operations and transitory, irregular, or extraordinary items Under this concept, each section of the transitory, irregular, or extraordinary items category is reported net of its income tax effect Pop-Up must separately disclose the current year’s income related to the operations of the segment that will be discontinued together with the $10,000 loss resulting from the sale This total would be reported on the income statement, along with any associated income tax impact, immediately following income from continuing operations The following items would not normally qualify as extraordinary items: (a) The write-down or write-off of receivables (b) Major devaluation of foreign currency (c) Loss on sale of plant and equipment To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter (d) Gain from early extinguishment of debt Before the issuance of SFAS No 145 in April 2002, gains and losses from early extinguishment of debt were required to be classified as extraordinary (f) Loss due to extensive earthquake damage to a furniture company in Los Angeles, California (Earthquakes are not unusual in the Los Angeles area.) (g) Farming loss due to heavy spring rains in the Northwest (Spring rains are not unusual in the Northwest.) Item (e) is classified as extraordinary because flood damage is both unusual and infrequent in Las Vegas 16 a The effects of a change in accounting principle that is applied to past periods are disclosed in the financial statements as a direct adjustment to beginning retained earnings of the earliest year reported The financial statements are prepared using the new accounting principle for all years being presented b The effect of a change in accounting estimate is disclosed entirely in the current period or in the current and future periods No adjustments are made to prior periods’ statements as may be done for a change in principle The change in an estimate should be sufficiently disclosed in the financial statements so that readers are alerted to those changes that will materially affect future periods 17 Under International Accounting Standard (IAS) 8, the cumulative effect of a change in accounting principle is reported as a direct adjustment to beginning retained earnings of the earliest year reported All income statements presented are retroactively adjusted to reflect the newly adopted accounting principle This is the same approach adopted by the FASB in 2005 and now contained in FASB ASC Topic 250 103 18 19 20 21 (Accounting Changes and Error Corrections) Generally accepted accounting principles require entities to report earnings-per-share information for income from continuing operations and for each section of the transitory, irregular, or extraordinary items category of an income statement The computation is made by dividing the income or loss from each of these sections by the weighted average number of common shares outstanding during the reporting period If a potential dilution of earnings exists due to the existence of convertible securities, stock options, or stock warrants, additional earnings-per-share information must also be presented “Comprehensive income is the change in equity of a business enterprise during a period from transactions and other events and circumstances from nonowner sources It includes all changes in equity during a period except those resulting from investments by owners and distributions to own1 ers.” Net income is the reported income as required by GAAP Currently, GAAP does not require all components of comprehensive income to be disclosed in the income statement For example, it does not include the effect of error corrections, asset valuation changes, or some effects of accounting changes The starting point for the preparation of forecasted financial statements is the forecast of sales In forecasting depreciation expense, one first must forecast how much property, plant, and equipment will be needed in the future This amount is then used, along with an assumption about how rapidly the plant and equipment will depreciate, to estimate future depreciation expense Statement of Financial Accounting Concepts No 6, “Elements of Financial Statements” (Stamford, CT: Financial Accounting Standards Board, December 1985), par 70 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 104 Chapter PRACTICE EXERCISES PRACTICE 4−1 FINANCIAL CAPITAL MAINTENANCE Net assets, end of period Net assets, beginning of period Increase in net assets Deduct investment by owners Income PRACTICE 4−2 $345,000 135,000 $210,000 100,000 $110,000 PHYSICAL CAPITAL MAINTENANCE Net assets, end of period Net assets, beginning of period Increase in net assets Deduct investment by owners Income, financial capital maintenance Deduct increase necessary to maintain physical capital Income, physical capital maintenance PRACTICE 4−3 $345,000 135,000 $210,000 100,000 $110,000 72,000 $ 38,000 COMPUTATION OF INCOME USING MATCHING Revenue ($125,000 + $72,000) Cost of goods sold ($67,000 + $41,000) Income $197,000 108,000 $ 89,000 The $240,000 in costs incurred in the production of Machines B and D will not yet be recognized as an expense This expense is matched and reported in the income statement in the same year in which the revenue from the sale of the machines is reported In the meantime, this $240,000 cost is shown as an asset, Inventory, in the balance sheet PRACTICE 4−4 REVENUE RECOGNITION Cash Collected or Collectibility Reasonably Assured? a b c No Yes Yes Total revenue to be recognized this year Work Completed? Yes No Yes Amount of Revenue to Be Recognized $ 0 170,000 $170,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 105 PRACTICE 4−5 a b c d e f EXPENSE RECOGNITION Amount of Cost Expense Recognition Method Expense to Be Recognized This Year $30,000 70,000 27,000 27,000 45,000 50,000 Direct matching Immediate recognition Rational allocation Immediate recognition Rational allocation Direct matching $ 30,000 70,000 9,000 27,000 9,000 Total expense recognized this year PRACTICE 4−6 $145,000 MULTIPLE-STEP INCOME STATEMENT Sales Cost of goods sold Gross profit $10,000 6,000 $ 4,000 Operating expenses: Selling and administrative expense Operating income Interest expense Income before extraordinary items and income taxes Income tax expense Income before extraordinary items Extraordinary gain (net of income taxes) Net income 750 $ 3,250 1,100 $ 2,150 1,200 $ 950 250 $ 1,200 PRACTICE 4−7 MULTIPLE-STEP INCOME STATEMENT Sales Cost of goods sold Gross profit $13,000 8,000 $ 5,000 Operating expenses: Selling and administrative expense Operating income Interest expense Income before income taxes Income tax expense Net income 1,000 $ 4,000 900 $ 3,100 1,000 $ 2,100 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 106 PRACTICE 4−8 Chapter COMPUTATION OF GROSS PROFIT PERCENTAGE 2007 Gross profit/Revenues = $41,729/$98,786 = 42.2% 2008 Gross profit/Revenues = $45,661/$103,630 = 44.1% 2009 Gross profit/Revenues = $43,785/$95,758 = 45.7% PRACTICE 4−9 INCOME FROM CONTINUING OPERATIONS 2007 Income from Continuing Operations/Revenues = $10,418/$98,786= 10.6% 2008 Income from Continuing Operations /Revenues = $12,334/$103,630= 11.9% 2009 Income from Continuing Operations /Revenues = $13,425/$95,758= 14.0% PRACTICE 4−10 COMPUTATION OF INCOME FROM CONTINUING OPERATIONS Sales Cost of goods sold Gross profit Less: Selling and administrative expense Operating income Interest expense Income before income taxes Income tax expense (40%) Income from continuing operations PRACTICE 4−11 $ 12,000 5,000 $ 7,000 1,450 $ 5,550 900 $ 4,650 1,860 $ 2,790 COMPUTATION OF INCOME FROM DISCONTINUED OPERATIONS Sales Expenses Income before income taxes Income tax expense (30%) Income from continuing operations Discontinued operations: Income (loss) from operations (including loss on disposal in 2013 of $2,000) Income tax expense (benefit)⎯30% Income (loss) on discontinued operations Net income 2013 $ 5,000 4,400 $ 600 180 $ 420 $(2,400) (720) 2012 $4,600 4,100 $ 500 150 $ 350 $600 180 (1,680) $(1,260) 420 $ 770 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 107 PRACTICE 4−12 COMPUTATION OF INCOME FROM DISCONTINUED OPERATIONS Sales Expenses Income before income taxes Income tax expense (benefit)⎯30% Income from continuing operations Discontinued operations: Income from operations (including gain on disposal in 2013 of $1,500) $ 2,100 Income tax expense⎯30% 630 Income on discontinued operations Net income 2013 $3,500 3,900 $ (400) (120) $ (280) 2012 $5,100 4,500 $ 600 180 $ 420 $ 500 150 1,470 $1,190 350 $ 770 PRACTICE 4−13 GAINS AND LOSSES ON EXTRAORDINARY ITEMS Sales Cost of goods sold Gross profit Operating expenses and gains/losses: Selling and administrative expense Operating income Other revenues and expenses: Loss from an unusual but frequent event Gain from a normal but infrequent event Interest expense Income before income taxes Income tax expense (35%) Income from continuing operations Extraordinary loss (net of tax benefit of $280) Net income $25,000 14,000 $11,000 (2,250) $ 8,750 $(3,000) 1,350 (2,400) (4,050) $ 4,700 1,645 $ 3,055 (520) $ 2,535 PRACTICE 4−14 CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE Sales Oil and gas exploration expense Income before income taxes Income tax expense (30%) Net income 2013 $ 5,000 700 $ 4,300 1,290 $ 3,010 2012 $ 3,000 1,200 $ 1,800 540 $ 1,260 2011 $ 2,000 1,500 $ 500 150 $ 350 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 108 PRACTICE 4−15 Chapter ACCOUNTING FOR CHANGES IN ESTIMATES Original depreciation = $100,000/20 years = $5,000 per year Accumulated depreciation as of January 1, 2013 = $5,000 per year × years = $25,000 Revised depreciation = Remaining depreciable book value/Remaining life = ($100,000 − $25,000)/(30 years − years elapsed already) = $75,000/25 years = $3,000 per year PRACTICE 4−16 RETURN ON SALES Return on sales = Net income/Sales = $320/$15,000 = 2.1% PRACTICE 4−17 EARNINGS PER SHARE Net income Average shares outstanding 2013 $12,250 3,500 2012 $9,000 3,000 2011 $5,500 2,000 Earnings per share $3.50 $3.00 $2.75 Percentage increase in 2012: ($3.00 − $2.75)/$2.75 = 9% Percentage increase in 2013: ($3.50 − $3.00)/$3.00 = 17% PRACTICE 4−18 PRICE-EARNINGS (P/E) RATIO Price-earnings ratio = Market price per share/Earnings per share = $20.00/$1.67 = 12.0 PRACTICE 4−19 COMPREHENSIVE INCOME Income from continuing operations Extraordinary loss Net income $ 9,000 (1,200) $ 7,800 Net income Unrealized loss on available-for-sale securities Foreign currency translation adjustment (equity increase) Comprehensive income $ 7,800 (1,700) 1,500 $ 7,600 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter PRACTICE 4−20 109 FORECASTED BALANCE SHEET Cash Accounts receivable Inventory Land Plant and equipment (net) Total assets PRACTICE 4−21 2013 Actual $ 100 500 1,000 2,500 5,000 $ 9,100 2014 Forecasted $ 125 625 1,250 2,500 7,000 $11,500 natural increase of 25% natural increase of 25% natural increase of 25% no increase needed 40% increase FORECASTED INCOME STATEMENT 2013 Actual Sales $10,000 Cost of goods sold 6,000 Depreciation expense 1,000 Interest expense 400 Income before income taxes $ 2,600 Income tax expense 910 Net income $ 1,690 2014 Forecasted $13,000 30% increase (given) 7,800 30% natural increase 1,200 same proportion with PPE 500 same apparent 10% interest rate $ 3,500 1,225 same tax rate ($910/$2,600) = 35% $ 2,275 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 110 Chapter EXERCISES 4–22 Debit changes in accounts during 2013 other than Retained Earnings: Cash Accounts Receivable Buildings and Equipment (net) Accounts Payable Credit changes in accounts during 2013 other than Retained Earnings: Inventory Patents Bonds Payable Capital Stock Additional Paid-In Capital Change in Retained Earnings for 2013 Add: Dividends declared Net income $ 38,500 57,000 160,000 45,000 $ 32,500 4,000 135,000 25,000 35,000 $300,500 231,500 $ 69,000 18,000 $ 87,000 4–23 (a) The receipt of an order from a customer does not constitute realization, nor does it qualify as an earnings activity Therefore, no revenue is recognized (b) There has been no sale of the asset to support the recognition of revenue Production remains to be performed, followed by sale of the finished product Accretion may give rise to revenue in certain instances in which it can be objectively determined and the product has a ready market at a definite price (c) The rendering of services is the earning activity, and it is assumed that a valid claim exists against the client The recognition criteria are met (d) The appreciation in value of the land is generally not recognized because it is not yet realized (e) The receipt of cash meets the realization criteria; however, the revenue is generally not reported as earned because the product has not yet been delivered Some argue that an estimate of the costs incurred to honor the certificate can be made so that revenue could be recognized at the time of certificate sale (f) Collection of cash on the subscriptions is realization However, the earning activity has yet to take place (g) The retirement of debt at less than the recorded liability results in the recognition of a gain The retirement of the debt meets the recognition criterion for gains To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 130 Chapter 4–48 (Concluded) COMPUTATIONS: (a) Sales: $645,000 + $8,700 – $5,300 + $9,400 + $2,800 – $13,300 = $647,300 (b) (c) Depreciation: Stores and store equipment, $64,000 × 0.40 = $25,600 Office building and equipment, $64,000 × 0.60 = $38,400 The total pretax gain of $32,000 is included in income from continuing operations The sale of land and building does not constitute the disposal of a business component 4–49 Sayer Sporting Goods Multiple-Step Income Statement For the Year Ended December 31, 2013 Sales Cost of goods sold: Beginning inventory Purchases Goods available for sale Less: Ending inventory Gross profit Operating expenses: Selling expenses General and administrative expenses Income before taxes Income taxes Net income Earnings per share ($14,340 ÷ 5,000 shares) $102,030 (a) $12,180 49,491 (b) COMPUTATIONS: (a) Cash collections Accounts receivable, December 31, 2012 Accounts receivable, December 31, 2013 Sales $61,671 21,401 (d) $12,352 25,508 (e) $105,260 (22,150) 18,920 $102,030 40,270 $ 61,760 (c) 37,860 $ 23,900 9,560 (f) $ 14,340 $ 2.87 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 4–49 (b) 131 (Concluded) Cash payments Accounts payable, December 31, 2012 Accounts payable, December 31, 2013 Cash general and administrative expenses Selling expenses Wages and salaries payable, December 31, 2012 Purchases *Total general and administrative expenses (0.25 × $102,030) Less depreciation on store equipment Cash general and administrative expenses $ 92,450 (10,830) 7,120 (22,447)* (12,352) (4,450) $ 49,491 $ 25,508 3,061 (g) $ 22,447 (c) Selling expense $12,352 ÷ 0.20 = $61,760 gross profit (d) Sales (a) Gross profit (c) Cost of goods sold Beginning inventory Purchases (b) Ending inventory (e) Sales $102,030 × 0.25 = $25,508 general and administrative expenses (f) Income before income taxes $23,900 × 0.40 tax rate = $9,560 income taxes (g) General and administrative expenses $25,508 × 0.12 = $3,061 depreciation $102,030 61,760 $ 40,270 (12,180) (49,491) $ (21,401) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 132 Chapter 4–50 Sunset Cosmetics Inc Multiple-Step Income Statement For the Year Ended December 31, 2013 Revenue: Sales Less: Sales returns and allowances Sales discounts Cost of goods sold: Inventory, January Net purchases: Purchases Less: Purchase returns and allowances Freight-in Cost of goods available for sale Less: Inventory, December 31 Gross profit Operating expenses: Selling expenses: Sales salaries and commissions Advertising expense Depreciation expense—sales/delivery equipment Freight expense Travel expense—sales representatives Miscellaneous selling expenses General and administrative expenses: Officers’ salaries expense Insurance and licenses Bad debt expense Utilities expense Depreciation expense—office equipment Legal services Telephone and postage expense Supplies expense Operating income Other revenues and gains: Interest revenue Dividend revenue Gain on sale of assets Other expenses and losses: Interest expense Income from continuing operations before income taxes Income taxes Income from continuing operations Discontinued operations: Gain from discontinued operations (net of income taxes of $14,000) Extraordinary loss (net of income tax savings of $25,410) Net income $499,400 (a) $ 11,200 880 12,080 $487,320 $ 89,700 $173,000 10,380 (b) 162,620 6,325 (c) $258,645 54,150 (d) 204,495 $282,825 $ 35,108 (e) 16,696 (f) 6,750 (g) 4,200 4,560 $ 69,514 2,200 $ 36,600 8,500 7,460 (i) 6,400 4,800 2,225 1,475 580 (h) $ 68,040 137,554 $145,271 1,390 (j) 7,150 $ 27,040 18,500 (4,520) 22,520 $167,791 58,727 (k) $109,064 26,000 (47,190) $ 87,874 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 4–50 133 (Concluded) Earnings per common share: Income from continuing operations ($109,064 ÷ 39,000 shares) Gain from discontinued operations ($26,000 ÷ 39,000 shares) Extraordinary loss ($47,190 ÷ 39,000 shares) Net income ($87,874 ÷ 39,000 shares = $2.25*) $ 2.80 0.67 (1.21) $ 2.26* *Difference due to rounding COMPUTATIONS: (a) Sales: $495,200 + $4,200 = $499,400 (b) Purchase returns and allowances: $173,000 × 0.06 = $10,380 (c) Freight-in: $5,525 + $800 = $6,325 (d) Inventory: $20,550 + $33,600 = $54,150 (e) Sales salaries and commissions: $35,000 + ($3,600 × 0.03) = $35,108 (f) Advertising expense: $16,090 + ($1,818 × 2/6) = $16,696 (g) Depreciation expense: $6,100 + ($7,800 × 10/120) = $6,750 (h) Supplies expense: $2,180 – $1,600 = $580 (i) Bad debt expense: ($261,000 × 0.03) – $370 = $7,460 (j) Interest revenue: $700 + $690 = $1,390 (k) Income taxes: $167,791 × 0.35 = $58,727 Sunset Cosmetics Inc Retained Earnings Statement For the Year Ended December 31, 2013 Retained earnings, January Add: Net income Deduct: Dividends Retained earnings, December 31 $440,670 87,874 $528,544 29,000 $499,544 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 134 Chapter 4–51 Before preparing the statement of comprehensive income, net income must be computed, as follows: Revenues and gains: Sales Gain on sale of investment Total revenues and gains Expenses and losses: Cost of goods sold Selling expenses General and administrative expenses Income tax expense Total expenses and losses Income from continuing operations Extraordinary gain, net of income taxes Net income $530,000 10,800 $540,800 $305,600 76,200 57,300 20,100 459,200 $ 81,600 36,800 $ 118,400 Note: The sale of the land did not produce a gain or a loss; therefore, the proceeds are not included in the statement Dividends paid are part of the retained earnings statement and are also excluded from the preceding statement The correction of the inventory error is a prior-period adjustment and is shown as a direct adjustment to the beginning balance in retained earnings; it does not enter into the computation of net income or of comprehensive income Calle Company Statement of Comprehensive Income For the Year Ended December 31, 2013 Net income Other comprehensive income: Foreign translation adjustment, net of income taxes Comprehensive income $118,400 51,000 $ 67,400 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 135 4–52 Lorien Company Forecasted Balance Sheet December 31, 2014 Cash Other current assets Property, plant, and equipment, net 2013 $ 40 350 1,000 2014 Forecasted $ 48 420 800 Total assets $1,390 $1,268 Accounts payable Bank loans payable Paid-in capital Retained earnings Total liabilities and stockholders’ equity $ 100 1,000 100 190 $ 120 1,000 (147) 295 $1,390 $1,268 20% natural increase 20% natural increase $1,000 – $200; no replacements 20% natural increase no new loans, item (c) to balance $190 + $120 – $15 Lorien Company Forecasted Income Statement For the Year Ended December 31, 2014 Sales Cost of goods sold 2013 $ 1,000 350 2014 Forecasted $ 1,200 420 Gross profit Depreciation expense $ 650 200 $ 780 200 Other operating expenses 250 300 Operating profit Interest expense $ 200 120 $ 280 120 Income before taxes Income taxes $ 80 20 $ 160 40 Net income $ 60 $ 120 given, item (a) 35% of sales, same as last year same as last year; no replacements* 25% of sales, same as last year 12% of bank loan, same as last year 25% of pretax, same as last year *One could also argue that depreciation expense will be lower in 2014 because the net amount of property, plant, and equipment will decline To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 136 Chapter 4–52 (Concluded) Yes, it is possible for paid-in capital to be negative This means that a company has spent more to repurchase shares of its own stock than was initially invested by shareholders This is possible when share prices have increased significantly since shares were first issued As with this example, negative paid-in capital is symptomatic of a company that has generated much excess cash and has used it to buy back shares Coca-Cola is an example of a real world company with net negative paid-in capital 4–53 The correct answer is c The operating loss for the discontinued operation was $600,000 in 2013 No disposal gains or losses were recognized in 2013 Accordingly, the net amount reported for discontinued operations in 2013, after income taxes, is ($360,000) [($600,000) + income tax benefit of $240,000] Hart’s net gain on the discontinued operation in 2014 was $850,000 ($900,000 disposal gain – $50,000 operating loss) After income taxes, the reported amount is $510,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 137 CASES Discussion Case 4–54 Two different aspects of this case should be explored with students First, there is no necessary connection between income and cash Cash payments may be made for purposes other than expenses, such as equipment purchases In addition, changes in the amounts of accounts receivable and accounts payable affect cash but usually not income Second, the increasing cost of inventory and supplies means that if a company maintains the same quantity and quality of inventory and supplies, more cash will be required The replacement cost of goods sold in the past two years has been $90,000 more than what it cost originally to buy those goods This alone could account for the cash flow shortage This case can be used to emphasize the difference between financial capital maintenance income and physical capital maintenance income Because the company’s financial statements are prepared on the basis of a financial capital maintenance concept, and Stevenson is withdrawing most of the reported net income, it is not possible to maintain the company’s physical capital when prices are rising unless he invests more money into the business Discussion Case 4–55 This case presents some interesting points for class discussion The final decision will probably be prefaced by “It depends ” Students should use the revenue recognition criteria of the conceptual framework as a basis for their decision The first suggested revenue recognition point, completion of production, probably fails the realized or realizable test Until the product is actually sold, the asset is not readily convertible to cash If the artist’s reputation is established, sales could be made from design drawings or small sample sculptures If the sales contract is firm, the realizability test could be met prior to actual delivery It appears clear that the second criterion, substantial completion of the activity or task, occurs upon completion of the sculpture as it is cast in bronze Thus, revenue could be recognized at completion of production The revenue recognition decision thus depends on when the sale is actually made However, as discussed in Chapter 8, SAB 101 typically requires delivery to the customer before a sale can be recognized The second suggested revenue recognition point, point of delivery of the product to the customer, implies that both criteria are met The sale has been made, and substantial completion must have occurred because delivery is made The remaining uncertainty revolves around the return privilege If there is a high likelihood of return, it could be argued that no sale has really occurred until the year is over The buyer may be considered to be a borrower of the sculpture—an agent who has a year to decide whether to buy or not The matching principle requires that an estimate of sales returns be made and recorded as an offset to recognized revenue If past experience provides a basis for this estimate, revenue recognition at the point of delivery seems justified If, however, an estimate of the extent of returns is not possible, revenue recognition may have to wait until the end of the return period The FASB has considered the right of return as a separate issue It is discussed in Chapter The case as written does not contain enough information to know whether an estimate of the expected returns is possible To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 138 Chapter Discussion Case 4–56 This case presents to students an interesting problem when adjustments to the financial statements are made based on estimates Since the product line did not qualify as a business component, any losses would be reported as part of ordinary income unless it was decided they met the criteria for an extraordinary loss If the expected loss is probable and if a reliable estimate of the amount can be made, accounting standards would require accruing the loss in 2012 If either of these conditions is not met, disclosure by note to the financial statements would be sufficient to meet the standards When the line is not discontinued in 2013, a reversal of the accrual would be necessary The reversal should be reported in the same way as the accrual Due to the nature of the item, separate line disclosure of the accrual and the reversal should probably be made (Note: According to FASB ASC Topic 420 (Exit of Disposal Cost Obligations), estimates of losses associated with asset write-downs should be included in a restructuring charge, but estimates of future liabilities expected to be created by the restructuring may not be included in the initial recorded amount of the restructuring charge.) Discussion Case 4–57 The question of how to record research costs for computer software has been a controversial one It is similar to the question of how to record research and development costs in general The arguments to support deferring the costs center on better matching of costs against revenues Until the software is developed and marketed, no revenue is generated By deferring the costs associated with the software, amortization of the costs against revenues can be made as sales are made If a company has a history that permits reasonable estimates of the probability of success, use of these statistics to defer software development costs could lead to more useful financial statements Arguments to support expensing these costs center on the uncertainty of knowing whether a given piece of software will be successful in the marketplace Until the prospects of sales are probable, any costs associated with development of software should be expensed A company with past successes can give no assurance that such success will continue Class discussion might address the issue of whether increased comparability occurs just because a uniform method of accounting treatment is used Companies differ in their ability to generate successful software; any accounting method that ignores these differences by developing uniform criteria could produce misleading financial statements The FASB statement on software costs [FASB ASC Subtopic 98520 (Software—Costs of Software to Be Sold, Leased, or Marketed)] requires the expensing of all costs incurred before technological feasibility is established Costs incurred after technological feasibility and before production are capitalized and amortized Discussion Case 4–58 Revenues can be booked in advance by a company recording the journal entry prior to meeting the revenue recognition criteria The typical journal entry would involve debiting a receivable account and crediting a revenue account Expenses can be deferred using two methods The first is simply not to make any journal entry The second is to record the expense as prepaid and to classify it as an asset on the balance sheet rather than as an expense on the income statement It would then be expensed at some future time In many cases, top executives encourage misleading accounting practices because their compensation is based, in part, on accounting numbers If the numbers can be manipulated to portray favorable news, the executives receive raises, bonuses, and so forth Again, students should be made aware that the business world presents ethical dilemmas While textbooks provide the rules to be applied in a sterile environment, the dynamic environment of life often presents individuals with quandaries for which there are no easy solutions This question can lead to an interesting difference in opinion among students To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter Discussion Case 4–58 139 (Concluded) Independent auditors have a responsibility to prepare an audit to detect material misstatements The objective of an audit is not to guarantee the accuracy of financial statements but to ensure that the financial statements are prepared in accordance with GAAP Some frauds are so carefully constructed and concealed that auditors could not reasonably be expected to uncover the fraud The legal system is called on to evaluate the auditor’s liability Typically, the courts evaluate the auditor using three qualifying questions: (1) Were the auditor’s actions in accordance with the duty expected of a professional? (2) Did individuals rely on the information audited by the auditor? and (3) Were damages incurred as a result of this reliance? The answers to these questions determine the extent of the auditor’s liability, especially under common law Under some statutory law, criteria (2) and (3) are not required Discussion Case 4–59 The purpose of this case is to help students understand the relationships between net income, gross profit percentage, and return on sales and the different ways in which profitability may be determined Drug store: Net income Gross profit percentage Return on sales $1,050,000 − $950,000 – $39,500 = $60,500 $100,000/$1,050,000 = 9.5% $60,500/$1,050,000 = 5.8% Department store: Net income Gross profit percentage Return on sales $670,000 – $560,000 – $66,500 = $43,500 $110,000/$670,000 = 16.4% $43,500/$670,000 = 6.5% The drug store has the higher net income, but the department store has a higher profit percentage and return on sales As to which is more profitable, additional information would be required However, this case illustrates that using only one measure of profitability can often lead to an incomplete picture Case 4–60 In 2009, Disney had no below-the-line items Decreased revenues and increased restructuring and impairment charges are the major reasons for the decrease in net income from 2008 to 2009 Disney reported net income of $3,307 million in 2009 If all of the income statement items reported in 2009 are viewed as permanent aspects of Disney’s operations, then income of $3,307 million is a good first guess in terms of forecasting 2010 net income The $492 million in restructuring charges are significantly larger than those from previous years; therefore, these losses are unlikely to be repeated in 2010 and should be backed out of net income This item is reported before income taxes because it is an above-the-line item The average charges during the previous two years are $33 million Therefore, $459 million ($492 million – $33 million) should be taken out of net income In Note 10 to the financial statements, we learn that Disney’s income tax rate is 36.2% (federal plus state), so the after-tax amount of the charges needing to be removed is $293 million [$459 × (1 − 0.362)] A first estimate of 2010 net income is then computed as follows: Net income reported in 2009 (in millions) $3,307 Add: After-tax amount of charges 293 Initial estimate of 2010 net income $3,600 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 140 Chapter Case 4–60 (Concluded) At the bottom of its statement of stockholders’ equity, Disney provides a brief statement of comprehensive income For 2009, comprehensive income was $1,644 million, computed as follows: Net income Market value adjustments for investments and hedges Foreign currency translation and other Pension and postretirement medical plan adjustments: Reclassification of prior net gains to net income Net actuarial loss Comprehensive income 3,307 (57) (33) (4) (1,569) 1,644 In Note to the financial statements, we learn that the media networks segment had both the highest reported revenue ($16,209 million) and the highest operating income ($4,765 million) The media networks segment also had the highest operating profit margin; the operating profit margins for the four segments are as follows: Media networks Parks and resorts Studio entertainment Consumer products 29.4% 13.3 2.9 25.1 In Note relating to segments, Disney discloses that 76.1% ($27,508/$36,149) of its revenues originate in the United States and Canada Note details the company’s revenue recognition policies “Broadcast advertising revenues are recognized when commercials are aired … Revenues from advance theme park ticket sales are recognized when the tickets are used.” In Note 2, Disney reports that “Film and television production and participation costs are expensed based on the ratio of the current period’s gross revenues to estimated remaining total gross revenues (Ultimate Revenues) from all sources on an individual production basis.” From this note, we can conclude that Disney uses a method of systematic and rational allocation Note states that parks, resorts, and other properties are expensed on a straight-line basis over a time period ranging from to 40 years Case 4–61 In 2009, Coca-Cola’s comprehensive income ($8,872 million) was greater than its net income ($6,906 million) There is an addition for foreign currency translation adjustments in the computation of Coca-Cola’s 2009 comprehensive income This addition indicates that the U.S dollar value of the equity of these foreign subsidiaries increased during the year Accordingly, during the year, these foreign currencies strengthened relative to the U.S dollar Coca-Cola’s available-for-sale securities portfolio decreased in value during 2009, as evidenced by the subtraction of an unrealized loss of $52 million in the computation of comprehensive income (Note: As explained in Chapter 14, the liquidation of a portion of the available-for-sale securities portfolio during the year can make the interpretation of the overall unrealized gain or loss for the year somewhat difficult.) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 141 Case 4–62 Financial statements for a financial institution are a lot different than those produced by a manufacturing firm Revenues and expenses are partitioned as to those relating to interest and those not relating to interest Net interest income would probably be the term most closely related to the concept of gross profit In simple terms, a manufacturing business generates profits by selling a product at a price greater than its cost—gross profit A bank makes money by loaning money at a greater rate than it pays on deposit accounts—net interest income a Total Interest Expense Total Interest Income Ratio 2009 $ 9,950 ÷ 56,274 17.68% 2008 $ 9,755 ÷ 34,898 27.95% 2007 $ 14,203 ÷ 35,177 40.38% b Incentive Compensation Salaries Ratio $ 8,021 ÷ 13,757 58.30% $ 2,676 ÷ 8,260 32.40% $ 3,284 ÷ 7,762 42.31% c Employee Benefits Salaries Ratio $ 4,689 ÷ 13,757 34.08% $ 2,004 ÷ 8,260 24.26% $ 2,322 ÷ 7,762 29.91% If you think of the relationship between total interest expense and total interest income as the fundamental measure of operating profitability for a bank, then the performance of Wells Fargo increased substantially from 2007 to 2009 In 2009, total interest expense was 17.68% of total interest income down from 40.38% in 2007 Because Wells Fargo’s income statement provides line-item detail about the different components of employee compensation, we can see how big both incentive compensation and fringe benefits are relative to base salaries The year 2009 seems to have been a good one for Wells Fargo employees; incentive compensation provided an extra 58% over and above salaries In each year, the cost of employee benefits was around 30% of the amount of salaries that are paid Interest expense on deposits Average amount of deposits Average interest rate $3,774 $802,710 0.5% Interest income on loans Average loan balance Average interest rate $41,589 $801,036 5.2% The cost of the money Wells Fargo gets from its depositors is only 0.5%, which is much less than the 5.2% that Wells Fargo gets from lending this same money This 4.7% interest rate spread must be enough to cover all of the operating costs of the bank Price-earnings ratio: 2009—15.4 ($26.99/$1.75) 2008—42.1 ($29.48/$0.70) 2007—12.7 ($30.19/$2.38) (Note: These P/E ratios are calculated using the diluted earnings per share numbers The P/E ratio increased dramatically during 2008 Fundamentally, a company’s P/E ratio increases if investors have increased optimism about the chances of future earnings being high relative to current earnings The P/E ratio decreased dramatically in 2009 This pattern most likely occurred because investors knew that 2008 was an unusually bad year for Wells Fargo, as it was for the entire worldwide economy, and that earnings would increase substantially in future years.) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 142 Chapter Case 4–63 In 2009, Apple generated 44.0% of its total net sales from its Americas segment; the Americas segment also generated 56.5% of its total operating income Operating income/Net sales Americas: Europe: Japan: Retail: Other Segments (c): 2009 35.14% 36.38% 42.17% 25.20% 34.25% 2008 29.63% 32.73% 31.77% 22.78% 27.77% 2007 25.18% 24.68% 21.49% 20.08% 22.15% The Japan segment has the highest profitability for each dollar of net sales in 2009 , but the Europe segment and Americas segment had the highest profitability for each dollar of net sales in 2008 and 2007, respectively Net sales/Assets Americas: Europe: Japan: Retail: Other Segments (c): 2009 10.04 8.74 4.72 4.95 6.03 2008 9.80 8.64 6.35 6.40 6.89 2007 9.53 9.33 6.86 4.80 7.05 The segment with the highest asset turnover, in 2009, is Apple’s Americas segment Operating income/Assets 2009 2008 2007 Americas: 352.7% 290.5% 239.8% Europe: 317.8% 282.7% 230.4% Japan: 199.0% 201.8% 147.5% Retail: 124.8% 145.8% 96.5% Other Segments (c): 206.4% 191.4% 156.2% Apple’s Americas segment has the highest return on assets, a combination of high profitability and high efficiency These computations understate the contribution of Apple’s retail stores Remember that these stores allow consumers to view and experiment with the computers and other products Even though most of Apple’s sales don’t come through the Retail segment, it is still an important part of the company’s success Case 4–64 Ford partitions its revenues and expenses into those relating to the Automotive division and those relating to the Financial Services division 2009 2008 2007 Cost of Sales/Sales 94.45% 98.40% 92.36% Clearly, it is difficult to report an overall profit when cost of sales is equal to 98.4%% of sales, as it was in Ford’s Automotive division in 2008 Sales decreased by 18% from 2008 to 2009 However, cost of sales decreased by 21.3% As a result, the operating loss for 2009 was $2,706 million, by far the best it had been for the 3-year period If the trend continues, the company could conceivably be reporting gains for its Automotive division in the near future To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter Case 4–64 143 (Concluded) The Automotive division manufactures and sells vehicles In this division, depreciation is a product cost, accounted for as part of manufacturing overhead Accordingly, the amount of Automotive division depreciation is included in cost of sales Over the 3-year period, cumulative before tax profits in the Financial Services division were greater than cumulative profits in the Automotive division At this point, Ford is generating its income through the financing of the cars it sells This question should cause you to realize that Ford makes a great deal of profit from nonautomotive sources In fact, for the years 2007−2009, Ford made significantly more profit from financial services It is also interesting to note that prior to the 1980s, the Financial Services division of Ford was virtually nonexistent Case 4–65 The following points might be made in outlining the benefits of recognizing a restructuring charge Economic benefits A big-bath restructuring charge is sometimes evidence that a company has decided to cut its losses and deal decisively with a bad situation, rather than continue to put band-aids on a hopeless case Thus, the recognition of a big restructuring charge might be part of a campaign to convince investors that a company is committed to changing past unproductive operating practices Financial reporting benefits The rationale behind an accounting big bath is that the results in the restructuring year are going to be rotten anyway, so why not estimate as many future expenses as possible and recognize them this year? In this way, the reported results in the following years will look great for two reasons: (1) they will be compared to the terrible restructuring year and (2) remaining expenses will be small because they were estimated and recognized in the restructuring year Case 4–66 If Dwight revises the income statement to achieve the 5% increase in net income and uses biased information to so, he will be presenting information that has little representational faithfulness That is, the information will not represent an honest and accurate reflection of the performance of the company Another risk to Dwight is that if the company goes public and people invest in the company based on the financial statements produced by Dwight, those investors may have recourse to the company and Dwight if they should lose money If Dwight were to give in this time and revise the income statement to meet the requested “goals” of management, Dwight may find himself being asked to revise the income statement each period This may not be a one-time issue If Dwight does not revise the financial statements and cannot convince the members of the board of directors of the validity of his reasons for not doing so, he may find himself out of a job What Dwight needs to consider is how attractive it will be to continue to work in an organization where he is expected to manage earnings Case 4–67 Solutions to this problem can be found on the Instructor’s Resource CD-ROM or downloaded from the Web at www.cengage.com/accounting/stice To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ... reflect the newly adopted accounting principle This is the same approach adopted by the FASB in 2005 and now contained in FASB ASC Topic 250 103 18 19 20 21 (Accounting Changes and Error Corrections)... Financial Accounting Concepts No 6, “Elements of Financial Statements” (Stamford, CT: Financial Accounting Standards Board, December 1985), par 70 To download more slides, ebook, solutions and test... (b) Other revenues and gains (c) Other revenues and gains (d) Other expenses and losses (e) Either extraordinary items or other expenses and losses depending on whether unusual and infrequent (f)