Income Statement and Related Information

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Chapter 4 Income Statement and Related Information

QUESTIONS

1. What kinds of questions about future cash flows do investors and creditors attempt to answer with information in the income statement?

2. How can information based on past transactions be used to predict future cash flows?

3. Identify at least two situations in which important changes in value are not reported in the income statement.

4. Identify at least two situations in which application of different accounting methods or accounting estimates results in difficulties in comparing companies.

5. Explain the transaction approach to measuring income.

Why is the transaction approach to income measurement preferable to other ways of measuring income?

6. What is earnings management?

7. How can earnings management affect the quality of earnings?

8. Why should caution be exercised in the use of the net income figure derived in an income statement? What are the objectives of generally accepted accounting principles in their application to the income statement?

9. A Wall Street Journal article noted that Apple reported higher income than its competitors by using a more aggressive policy for recognizing revenue on future upgrades to its products. Some contend that Apples quality of earnings is low. What does the term quality of earnings mean?

10. What is the major distinction (a) between revenues and gains and (b) between expenses and losses?

11. What are the advantages and disadvantages of the singlestep income statement?

12. What is the basis for distinguishing between operating and nonoperating items?

13. Distinguish between the modified all-inclusive income statement and the current operating performance income statement. According to present generally accepted accounting principles, which is recommended? Explain.

14. How should correction of errors be reported in the financial statements?

15. Discuss the appropriate treatment in the financial statements of each of the following.

(a) An amount of $113,000 realized in excess of the cash surrender value of an insurance policy on the life of one of the founders of the company who died during the year.

(b) A profit-sharing bonus to employees computed as a percentage of net income.

(c) Additional depreciation on factory machinery because of an error in computing depreciation for the previous year.

(d) Rent received from subletting a portion of the office space.

( e) A patent infringement suit, brought 2 years ago against the company by another company, was settled this year by a cash payment of $725,000.

( f) A reduction in the Allowance for Doubtful Accounts balance because the account appears to be considerably in excess of the probable loss from uncollectible receivables.

1 6. Indicate where the following items would ordinarily appear on the financial statements of Boleyn, Inc. for the year 2014.

( a) The service life of certain equipment was changed from 8 to 5 years. If a 5-year life had been used previously, additional depreciation of $425,000 would have been charged.

( b) In 2014, a flood destroyed a warehouse that had a book value of $1,600,000. Floods are rare in this locality.

( c) In 2014, the company wrote off $1,000,000 of inventory that was considered obsolete.

( d) An income tax refund related to the 2011 tax year was received.

( e) In 2011, a supply warehouse with an expected useful life of 7 years was erroneously expensed.

( f) Boleyn, Inc. changed from weighted-average to FIFO inventory pricing.

1 7. Indicate the section of a multiple-step income statement in which each of the following is shown.

( a) Loss on inventory write-down.

( b) Loss from strike.

( c) Bad debt expense.

( d) Loss on disposal of a component of the business.

( e) Gain on sale of machinery.

( f) Interest revenue.

( g) Depreciation expense.

( h) Material write-offs of notes receivable.

1 8. Perlman Land Development, Inc. purchased land for $70,000 and spent $30,000 developing it. It then sold the land for $160,000. Sheehan Manufacturing purchased land for a future plant site for $100,000. Due to a change in plans, Sheehan later sold the land for $160,000. Should these two companies report the land sales, both at gains of $60,000, in a similar manner?

1 9. You run into Greg Norman at a party and begin discussing financial statements. Greg says, I prefer the single-step income statement because the multiple-step format generally overstates income. How should you respond to Greg?

2 0. Santo Corporation has eight expense accounts in its general ledger which could be classified as selling expenses.

Should Santo report these eight expenses separately in its income statement or simply report one total amount for selling expenses?

2 1. Cooper Investments reported an unusual gain from the sale of certain assets in its 2014 income statement. How does intraperiod tax allocation affect the reporting of this unusual gain?

2 2. Discuss the appropriate treatment in the income statement for the following items:

( a) Loss on discontinued operations.

( b) Noncontrolling interest allocation.

( c) Earnings per share.

( d) Gain on sale of equipment.

2 3. Lebron Co. owns most but not all of the shares of its subsidiary Bryant Inc. Lebron reported net income of $124,700. The amount to be attributed to the noncontrolling interest in Bryant is $30,000. Indicate how Lebron will report the noncontrolling interest in its income statement.

2 4. What effect does intraperiod tax allocation have on reported net income?

2 5. Neumann Company computed earnings per share as follows.

Net income

Common shares outstanding at year-end

Neumann has a simple capital structure. What possible errors might the company have made in the computation?

Explain.

2 6. Qualls Corporation reported 2014 earnings per share of $7.21. In 2015, Qualls reported earnings per share as follows.

O n income before extraordinary item $6.40

On extraordinary item 1.88

On net income $8.28

I s the increase in earnings per share from $7.21 to $8.28 a favorable trend?

2 7. What is meant by tax allocation within a period? What is the justification for such practice?

2 8. When does tax allocation within a period become necessary?

How should this allocation be handled?

2 9. During 2014, Liselotte Company earned income of $1,500,000 before income taxes and realized a gain of $450,000 on a government-forced condemnation sale of a division plant facility. The income is subject to income taxation at the rate of 34%. The gain on the sale of the plant is taxed at 30%.

Proper accounting suggests that the unusual gain be reported as an extraordinary item. Illustrate an appropriate presentation of these items in the income statement.

3 0. On January 30, 2013, a suit was filed against Frazier

Corporation under the Environmental Protection Act. On

August 6, 2014, Frazier Corporation agreed to settle the action and pay $920,000 in damages to certain current and former employees. How should this settlement be reported in the 2014 financial statements? Discuss.

3 1. Linus Paper Company decided to close two small pulp mills in Conway, New Hampshire, and Corvallis, Oregon.

Would these closings be reported in a separate section entitled Discontinued operations after income from continuing operations? Discuss.

3 2. What major types of items are reported in the retained earnings statement?

3 3. Generally accepted accounting principles usually require the use of accrual accounting to fairly present income. If the cash receipts and disbursements method of accounting will clearly reflect taxable income, why does this method not usually also fairly present income?

3 4. State some of the more serious problems encountered in seeking to achieve the ideal measurement of periodic net income. Explain what accountants do as a practical alternative.

3 5. What is meant by the terms elements and items as they relate to the income statement? Why might items have to be disclosed in the income statement?

3 6. What are the two ways that other comprehensive income may be displayed (reported)?

3 7. How should the disposal of a component of a business be disclosed in the income statement?

BRIEF EXERCISES

BE4- 1 Starr Co. had sales revenue of $540,000 in 2014. Other items recorded during the year were:

C ost of goods sold $330,000

Salaries and wages expense 120,000

Income tax expense 25,000

Increase in value of company reputation 15,000

Other operating expenses 10,000

Unrealized gain on value of patents 20,000

P repare a single-step income statement for Starr for 2014. Starr has 100,000 shares of stock outstanding.

BE4- 2 Brisky Corporation had net sales of $2,400,000 and interest revenue of $31,000 during 2014.

Expenses for 2014 were cost of goods sold $1,450,000; administrative expenses $212,000; selling expenses $280,000; and interest expense $45,000. Briskys tax rate is 30%. The corporation had 100,000 shares of common stock authorized and 70,000 shares issued and outstanding during 2014. Prepare a single-step income statement for the year ended December 31, 2014.

BE4- 3 Using the information provided in BE4-2, prepare a condensed multiple-step income statement for Brisky Corporation.

BE4- 4 Finley Corporation had income from continuing operations of $10,600,000 in 2014. During 2014, it disposed of its restaurant division at an after-tax loss of $189,000. Prior to disposal, the division operated at a loss of $315,000 (net of tax) in 2014. Finley had 10,000,000 shares of common stock outstanding during 2014.

Prepare a partial income statement for Finley beginning with income from continuing operations.

BE4- 5 Stacy Corporation had income before income taxes for 2014 of $6,300,000. In addition, it suffered an unusual and infrequent pretax loss of $770,000 from a volcano eruption. The corporations tax rate is 30%.

Prepare a partial income statement for Stacy beginning with income before income taxes. The corporation had 5,000,000 shares of common stock outstanding during 2014.

BE4- 6 During 2014, Williamson Company changed from FIFO to weighted-average inventory pricing.

Pretax income in 2013 and 2012 (Williamsons first year of operations) under FIFO was $160,000 and $180,000, respectively. Pretax income using weighted-average pricing in the prior years would have been $145,000 in

2013 and $170,000 in 2012. In 2014, Williamson Company reported pretax income (using weighted-average pricing) of $180,000. Show comparative income statements for Williamson Company, beginning with Income before income tax, as presented on the 2014 income statement. (The tax rate in all years is 30%.)

BE4- 7 Vandross Company has recorded bad debt expense in the past at a rate of 1?% of net sales. In 2014,

Vandross decides to increase its estimate to 2%. If the new rate had been used in prior years, cumulative bad debt expense would have been $380,000 instead of $285,000. In 2014, bad debt expense will be $120,000 instead of $90,000. If Vandrosss tax rate is 30%, what amount should it report as the cumulative effect of changing the estimated bad debt rate?

BE4- 8 In 2014, Hollis Corporation reported net income of $1,000,000. It declared and paid preferred stock dividends of $250,000. During 2014, Hollis had a weighted average of 190,000 common shares outstanding.

Compute Holliss 2014 earnings per share.

BE4-9 Portman Corporation has retained earnings of $675,000 at January 1, 2014. Net income during 2014 was $1,400,000, and cash dividends declared and paid during 2014 totaled $75,000. Prepare a retained earnings statement for the year ended December 31, 2014.

BE4- 10 Using the information from

BE4-9, prepare a retained earnings statement for the year ended

December 31, 2014. Assume an error was discovered: land costing $80,000 (net of tax) was charged to maintenance and repairs expense in 2011.

BE4- 11 On January 1, 2014, Richards Inc. had cash and common stock of $60,000. At that date, the company had no other asset, liability, or equity balances. On January 2, 2014, it purchased for cash $20,000 of equity securities that it classified as available-for-sale. It received cash dividends of $3,000 during the year on these securities. In addition, it has an unrealized holding gain on these securities of $4,000 net of tax.

Determine the following amounts for 2014: (a) net income, (b) comprehensive income, (c) other comprehensive income, and (d) accumulated other comprehensive income (end of 2014).

EXERCISES

E 4-1 (Computation of Net Income) Presented below are changes in all the account balances of Fritz

Reiner Furniture Co. during the current year, except for retained earnings.

I ncrease Increase

(Decrease) (Decrease)

Cash $ 79,000 Accounts Payable $ (51,000)

Accounts Receivable (net) 45,000 Bonds Payable 82,000

Inventory 127,000 Common Stock 125,000

Investments (47,000) Paid-In Capital in Excess of ParCommon Stock 13,000

I nstructions

C ompute the net income for the current year, assuming that there were no entries in the Retained Earnings account except for net income and a dividend declaration of $19,000 which was paid in the current year.

E 4-2 (Compute Income Measures) Presented below is information related to Viel Company at December

31, 2014, the end of its first year of operations.

S ales revenue $310,000

Cost of goods sold 140,000

Selling and administrative expenses 50,000

Gain on sale of plant assets 30,000

Unrealized gain on available-for-sale investments 10,000

Interest expense 6,000

Loss on discontinued operations 12,000

Allocation to noncontrolling interest 40,000

Dividends declared and paid 5,000

I nstructions

C ompute the following: (a) income from operations, (b) net income, (c) net income attributable to Viel Companys controlling shareholders, (d) comprehensive income, and (e) retained earnings balance at December 31, 2014.

E 4-3 (Income Statement Items) Presented below are certain account balances of Paczki Products Co.

R ent revenue $ 6,500 Sales discounts $ 7,800

Interest expense 12,700 Selling expenses 99,400

Beginning retained earnings 114,400 Sales revenue 390,000

Ending retained earnings 134,000 Income tax expense 31,000

Dividend revenue 71,000 Cost of goods sold 184,400

Sales returns and allowances 12,400 Administrative expenses 82,500

Allocation to noncontrolling interest 17,000

I nstructions

F rom the foregoing, compute the following: (a) total net revenue, (b) net income, (c) dividends declared, and (d) income attributable to controlling stockholders.

E 4-4 (Single-Step Income Statement) The financial records of LeRoi Jones Inc. were destroyed by fire at the end of 2014. Fortunately, the controller had kept certain statistical data related to the income statement as follows.

1 . The beginning merchandise inventory was $92,000 and decreased 20% during the current year.

2 . Sales discounts amount to $17,000.

3 . 20,000 shares of common stock were outstanding for the entire year.

4 . Interest expense was $20,000.

5 . The income tax rate is 30%.

6 . Cost of goods sold amounts to $500,000.

7 . Administrative expenses are 20% of cost of goods sold but only 8% of gross sales.

8 . Four-fifths of the operating expenses relate to sales activities.

I nstructions

F rom the foregoing information prepare an income statement for the year 2014 in single-step form.

E 4-5 (Multiple-Step and Single-Step) Two accountants for the firm of Elwes and Wright are arguing about the merits of presenting an income statement in a multiple-step versus a single-step format. The discussion involves the following 2014 information related to P. Bride Company ($000 omitted).

A dministrative expense

Offi cers salaries $ 4,900

Depreciation of offi ce furniture and equipment 3,960

Cost of goods sold 60,570

Rent revenue 17,230

Selling expense

Delivery expense 2,690

Sales commissions 7,980

Depreciation of sales equipment 6,480

Sales revenue 96,500

Income tax 9,070

Interest expense 1,860

I nstructions

( a) Prepare an income statement for the year 2014 using the multiple-step form. Common shares outstanding for 2014 total 40,550 (000 omitted).

( b) Prepare an income statement for the year 2014 using the single-step form.

( c) Which one do you prefer? Discuss.

E 4-6 (Multiple-Step and Extraordinary Items) The following balances were taken from the books of

Maria Conchita Alonzo Corp. on December 31, 2014.

I nterest revenue $ 86,000 Accumulated depreciationequipment $ 40,000

Cash 51,000 Accumulated depreciationbuildings 28,000

Sales revenue 1,380,000 Notes receivable 155,000

Accounts receivable 150,000 Selling expenses 194,000

Prepaid insurance 20,000 Accounts payable 170,000

Sales returns and allowances 150,000 Bonds payable 100,000

Allowance for doubtful accounts 7,000 Administrative and general expenses 97,000

Sales discounts 45,000 Accrued liabilities 32,000

Land 100,000 Interest expense 60,000

Equipment 200,000 Notes payable 100,000

Buildings 140,000 Loss from earthquake damage

Cost of goods sold 621,000 (extraordinary item) 150,000

Common stock 500,000

Retained earnings 21,000

A ssume the total effective tax rate on all items is 34%.

I nstructions

P repare a multiple-step income statement; 100,000 shares of common stock were outstanding during the year.

E 4-7 (Multiple-Step and Single-Step) The accountant of Latifa Shoe Co. has compiled the following information from the companys records as a basis for an income statement for the year ended December 31,

2014.

R ent revenue $ 29,000

Interest expense 18,000

Market appreciation on land above cost 31,000

Salaries and wages expense (selling) 114,800

Supplies (selling) 17,600

Income tax 37,400

Salaries and wages expense (administrative) 135,900

Cost of goods sold 496,000

Net sales 980,000

Depreciation on plant assets (70% selling, 30% administrative) 65,000

Cash dividends declared 16,000

T here were 20,000 shares of common stock outstanding during the year.

I nstructions

( a) Prepare a multiple-step income statement.

( b) Prepare a single-step income statement.

( c) Which format do you prefer? Discuss.

E 4-8 (Income Statement, EPS) Presented below are selected ledger accounts of Tucker Corporation as of

Administrative expenses 100,000

Cost of goods sold 210,000

Cash dividends declared (2014) 20,000

Cash dividends paid (2014) 15,000

Discontinued operations (loss before income taxes) 40,000

Depreciation expense, not recorded in 2013 30,000

Retained earnings, December 31, 2013 90,000

Effective tax rate 30%

I nstructions

( a) Compute net income for 2014.

( b) Prepare a partial income statement beginning with income from continuing operations before income tax, and including appropriate earnings per share information. Assume 10,000 shares of common stock were outstanding during 2014.

E 4-9 (Multiple-Step Statement with Retained Earnings) Presented below is information related to Ivan

Calderon Corp. for the year 2014.

N et sales $1,300,000 Write-off of inventory due to obsolescence $ 80,000

Cost of goods sold 780,000 Depreciation expense omitted by accident in 2013 55,000

Selling expenses 65,000 Casualty loss (extraordinary item) before taxes 50,000

Administrative expenses 48,000 Cash dividends declared 45,000

Dividend revenue 20,000 Retained earnings at December 31, 2013 980,000

Interest revenue 7,000 Effective tax rate of 34% on all items

I nstructions

( a) Prepare a multiple-step income statement for 2014. Assume that 60,000 shares of common stock are outstanding.

( b) Prepare a separate retained earnings statement for 2014.

E 4-10 (Earnings per Share) The stockholders equity section of Tkachuk Corporation appears below as of

December 31, 2014.

8 % preferred stock, $50 par value, authorized

100,000 shares, outstanding 90,000 shares $ 4,500,000

Common stock, $1.00 par, authorized and issued 10 million shares 10,000,000

Additional paid-in capital 20,500,000

Retained earnings $134,000,000

Net income 33,000,000 167,000,000 $202,000,000

N et income for 2014 reflects a total effective tax rate of 34%. Included in the net income figure is a loss of $18,000,000 (before tax) as a result of a major casualty, which should be classified as an extraordinary item. Preferred stock dividends of $360,000 were declared and paid in 2014. Dividends of $1,000,000 were declared and paid to common stockholders in 2014.

I nstructions

C ompute earnings per share data as it should appear on the income statement of Tkachuk Corporation.

E 4-11 (Condensed Income StatementPeriodic Inventory Method) The following are selected ledger accounts of Spock Corporation at December 31, 2014.

C ash $ 185,000 Salaries and wages expense (sales) $284,000

Inventory 535,000 Salaries and wages expense (offi ce) 346,000

Sales revenue 4,275,000 Purchase returns 15,000

Unearned sales revenue 117,000 Sales returns and allowances 79,000

Purchases 2,786,000 Freight-in 72,000

Sales discounts 34,000 Accounts receivable 142,500

Purchase discounts 27,000 Sales commissions 83,000

Selling expenses 69,000 Telephone and Internet expense (sales) 17,000

Accounting and legal services 33,000 Utilities expense (offi ce) 32,000

Insurance expense (offi ce) 24,000 Miscellaneous offi ce expenses 8,000

Advertising expense 54,000 Rent revenue 240,000

Delivery expense 93,000 Extraordinary loss (before tax) 70,000

Depreciation expense (offi ce equipment) 48,000 Interest expense 176,000

Depreciation expense (sales equipment) 36,000 Common stock ($10 par) 900,000

S pocks effective tax rate on all items is 34%. A physical inventory indicates that the ending inventory is $686,000.

I nstructions

P repare a condensed 2014 income statement for Spock Corporation.

E 4-12 (Retained Earnings Statement) Eddie Zambrano Corporation began operations on January 1, 2011.

During its first 3 years of operations, Zambrano reported net income and declared dividends as follows.

N et Income Dividends Declared

2011 $ 40,000 $ 0

2012 125,000 50,000

2013 160,000 50,000

T he following information relates to 2014.

I ncome before income tax $240,000

Prior period adjustment: understatement of 2012 depreciation expense (before taxes) $ 25,000

Cumulative decrease in income from change in inventory methods (before taxes) $ 35,000

Dividends declared (of this amount, $25,000 will be paid on Jan. 15, 2015) $100,000

Effective tax rate 40%

I nstructions

( a) Prepare a 2014 retained earnings statement for Eddie Zambrano Corporation.

( b) Assume Eddie Zambrano Corp. restricted retained earnings in the amount of $70,000 on December

31, 2014. After this action, what would Zambrano report as total retained earnings in its December

31, 2014, balance sheet?

E 4-13 (Earnings per Share) At December 31, 2013, Shiga Naoya Corporation had the following stock outstanding.

1 0% cumulative preferred stock, $100 par, 107,500 shares $10,750,000

Common stock, $5 par, 4,000,000 shares 20,000,000

D uring 2014, Shiga Naoya did not issue any additional common stock. The following also occurred during

2014.

I ncome from continuing operations before taxes $23,650,000

Discontinued operations (loss before taxes) $ 3,225,000

Preferred dividends declared $ 1,075,000

Common dividends declared $ 2,200,000

Effective tax rate 35%

I nstructions

C ompute earnings per share data as it should appear in the 2014 income statement of Shiga Naoya Corporation.

(Round to two decimal places.)

E 4-14 (Change in Accounting Principle) Tim Mattke Company began operations in 2012 and for simplicity reasons, adopted weighted-average pricing for inventory. In 2014, in accordance with other companies in its industry, Mattke changed its inventory pricing to FIFO. The pretax income data is reported below.

W eighted-

Year Average FIFO

2012 $370,000 $395,000

2013 390,000 430,000

2014 410,000 450,000

I nstructions

( a) What is Mattkes net income in 2014? Assume a 35% tax rate in all years.

( b) Compute the cumulative effect of the change in accounting principle from weighted-average to

FIFO inventory pricing.

( c) Show comparative income statements for Tim Mattke Company, beginning with income before income tax, as presented on the 2014 income statement.

E 4-15 (Comprehensive Income) Roxanne Carter Corporation reported the following for 2014: net sales $1,200,000; cost of goods sold $750,000; selling and administrative expenses $320,000; and an unrealized holding gain on available-for-sale securities $18,000.

I nstructions

P repare a statement of comprehensive income, using (a) the one statement format, and (b) the two statement format. (Ignore income taxes and earnings per share.)

E 4-16 (Comprehensive Income) C. Reither Co. reports the following information for 2014: sales revenue $700,000; cost of goods sold $500,000; operating expenses $80,000; and an unrealized holding loss on available-for-sale securities for 2014 of $60,000. It declared and paid a cash dividend of $10,000 in 2014.

C. Reither Co. has January 1, 2014, balances in common stock $350,000; accumulated other comprehensive income $80,000; and retained earnings $90,000. It issued no stock during 2014.

I nstructions

P repare a statement of stockholders equity.

E 4-17 (Various Reporting Formats) The following information was taken from the records of Roland

Carlson Inc. for the year 2014. Income tax applicable to income from continuing operations $187,000; income tax applicable to loss on discontinued operations $25,500; income tax applicable to extraordinary gain $32,300; income tax applicable to extraordinary loss $20,400; and unrealized holding gain on availablefor- sale securities $15,000.

E xtraordinary gain $ 95,000 Cash dividends declared $ 150,000

Loss on discontinued operations 75,000 Retained earnings January 1, 2014 600,000

Administrative expenses 240,000 Cost of goods sold 850,000

Rent revenue 40,000 Selling expenses 300,000

Extraordinary loss 60,000 Sales revenue 1,900,000

S hares outstanding during 2014 were 100,000.

I nstructions

( a) Prepare a single-step income statement.

( b) Prepare a comprehensive income statement for 2014, using the two statement format.