however, it should have been reported as a separate item rather than as part of "selling, general and administrative expenses" because it meets the criteria of being material and infrequently occurring.
An extraordinary item should not be presented in the ordinary operations section of the income statement because it is not part of the ordinary
operations of Horizon Company. An extraordinary item should be presented in the income statement as a separate item, net of income taxes. The Horizon Company statements of income and retained earnings should be revised as follows:
(a) "Other, net" and "total costs and expenses" should be decreased by
$10,000 to exclude the extraordinary item (charge).
(b) "Income before income taxes" should be increased by $10,000 to exclude the extraordinary item (charge) and the caption "income before income taxes" should be changed to "income before income taxes and
extraordinary item (charge)."
(c) "Income taxes" should be increased by $3,000 to exclude the income tax reduction applicable to the extraordinary item (charge).
(d) A new caption "income before extraordinary item (charge)" should be added ($27,200).
P5 -3 ( co n tinue d) 1. (co n tin ut d) P5-6 (continued)
1. (continued)
(e) A new caption "extraordinary item (charge)" should be added showing the extraordinary item (charge) of $10,000, applicable income taxes of
$3,000, and the net extraordinary item (charge) of $7,000.
A change from an accounting principle that is not generally accepted to one that is generally accepted is a correction of an error and should be reported as a prior period adjustment. Therefore, the presentation in the Horizon Company statements of income and retained earnings is appropriate.
Because of the significance attached by investors and others to earnings-per- share data, together with the importance of evaluating the data in conjunction with the financial statements, earnings per common share should be shown on the face of the income statement. Furthermore, earnings per common share for income before extraordinary items should be presented as well as earnings per common share for net income.
2. (a) The quick (acid-test) ratio tests the ability to meet sudden demands upon liquid current assets.
(b) Inventory turnover provides information about the number of times inventory is replaced each year.
(c) The return on stockholders' equity indicates the percentage return
accruing to the owners based upon the book value of their interest in the company.
3. The quick (acid-test) ratio for 2004 is determined by dividing the sum of "cash"
($3,500), "marketable securities" ($13,000), and "accounts receivable" ($105,000) on the Horizon Company balance sheet by the "total current liabilities" ($75,000) on the Horizon Company balance sheet.
Inventory turnover for 2004 is determined by dividing the "cost of goods sold"
($480,000) on the Horizon Company statements of income and retained
earnings by the average "inventory" ($126,000 and $154,000 2) during the year on the Horizon Company balance sheet. If possible, the average monthly inventory should be used.
The return on stockholders' equity for 2004 is determined by dividing the "net income" ($20,200) on the Horizon Company statements of income and retained earnings by the "total stockholders' equity" ($263,000) or the average "total stockholders' equity" ($263,000 and $255,000 2) on the Horizon Company balance sheet.
P5-4 Note to Instructor: Students must use the retail inventory method (average cost) ofestimating inventory to solve this problem. Many elementary accounting books discuss this method; it is also explained in Chapter 8. E5-12 P5-7 (AICPA adapted solution)
Note to Instructor: This problem includes the computation of earnings per share using a weighted-average (including a stock dividend) for common shares outstanding, not discussed until Chapter 16.
1. PITT CORP.
Income Statement
For the Year Ended December 31, 2004
Net sales $6,250,000
Cost of sales (3,750,000)
Gross profit $2,500,000
Selling and administrative expenses (1,212,500)
Operating income $1,287,500
Other expenses
Interest expense (122,500)
Income before unusual or infrequent items and income tax $1,165,000 Unusual or infrequent items
Loss on disposition of plant assets $(225,000)
Gain on sale of long-term investments 130,000 (95,000) Income before income tax and extraordinary item $1,070,000 Income tax
Current $ 342,000 [1]
Deferred 27,000 [2] (369,000)
Income before extraordinary item $ 701,000
Extraordinary item--loss from earthquake (net of
applicable income tax benefit of $142,500) (332,500)[3]
Net income $ 368,500
Earnings per share
Income before extraordinary item $2.98 [4]
Extraordinary loss (1.41)*
Net income $1.57 [5]
*Optional
P5 -3 ( co n tinue d) 1. (co n tin ut d) P5-7 (continued)
2. PITT CORP.
Reconciliation of Net Income to Taxable Income per Tax Return For the Year Ended December 31, 2004
Net income $ 368,500
Add: Income tax on continuing operations 369,000
Officers' life insurance expense 70,000
$ 807,500 Deduct: Income tax benefit--extraordinary loss (142,500)
Taxable income per tax return $ 665,000
Explanation of amounts
[1] Total income tax excluding extraordinary item for 2004:
Income before income tax and extraordinary item $1,070,000
Officers' life insurance expense 70,000
Income subject to tax $1,140,000
Income tax rate x 30%
Income tax excluding extraordinary item $ 342,000 [2] Deferred income tax for 2004:
Excess of book basis over tax basis in depreciable assets
(Expected to reverse equally over next 5 years) $ 90,000 Deferred income tax liability, 12/31/04
($90,000 x 30%) $ 27,000
Less: beginning balance, 1/1/04 -0- Net change in deferred tax liability for 2004 $ 27,000 [3] Extraordinary item--Loss from earthquake damage
(net of income tax) for 2004:
Loss from earthquake damage $ 475,000
Income tax benefit (30% x $475,000) (142,500)
Net of income tax effect $332,500
[4] Earnings per share on income before extraordinary item for 2004:
Income before extraordinary item $ 701,000
Weighted average number of shares outstanding for 2004
[200,000 + 20,000 + 15,000 (ẵ x 30,000)] 235,000 Earnings per share ($701,000 235,000) $2.98 [5] Earnings per share on net income for 2004:
Net income $ 368,500
Weighted average number of shares 235,000
P5-4 Note to Instructor: Students must use the retail inventory method (average cost) ofestimating inventory to solve this problem. Many elementary accounting books discuss this method; it is also explained in Chapter 8. E5-12 P5-8
1. Gross profit, 2001: $14,048 million (p. 57). Operating income, 2001: $5,352 million (p. 57).
2. 2001 net income: $3,969 million; Basic EPS: $1.60; Diluted EPS: $1.60 (p. 57).
3. Total assets, December 31, 2001: $22,417 million (p. 58).
Current assets: $7,171 million (p. 58).
4. Total liabilities, December 31, 2001: $11,051 million (p. 59); ($22,417 million total liabilities and share-owners' equity - $11,366 million total share-owners' equity.
5. Total share-owners' equity, December 31, 2001: $11,366 million (p. 59); Treasury stock: $13,682 million (p. 59); the company uses the cost method to account for treasury stock (p. 59).
6. Net increase in cash and cash equivalents, 2001: $47 million (p. 60);
Net cash provided by operating activities: $4,110 million (p. 60).