CHAPTER 14

INCOME TAXES, UNUSUAL INCOME ITEMS, AND

INVESTMENTS IN STOCKS
QUESTION INFORMATION
Number
EO14-1
EO14-2
EO14-3
EO14-4
EO14-5
EO14-6
EO14-7
EO14-8
EO14-9
EO14-10
EO14-11
EO14-12
EO14-13
EO14-14
EO14-15
EO14-16
PE14-1A
PE14-1B
PE14-2A

Objective
14-1
14-2
14-2
14-2
14-2
14-2
14-2
14-3
14-4
14-5
14-5
14-5
14-5
14-5
14-5
14-5
14-1
14-1
14-2

PE14-2B

14-2

PE14-3A

14-3

PE14-3B

14-3

PE14-4A

14-4

PE14-4B

14-4

PE14-5A

14-5

PE14-5B

14-5

PE14-6A
PE14-6B
Ex14-1
Ex14-2

14-5
14-5
14-1
14-1

Ex14-3

14-1

Ex14-4

14-2

Ex14-5

14-2

Ex14-6

14-2

Description

Deferred tax entries

Deferred tax entries
Journalize fixed asset
impairment and restructuring charge
Journalize fixed asset
impairment and restructuring charge
Calculate earnings
per share
Calculate earnings
per share
Comprehensive income
Comprehensive income
Temporary investments
Temporary investments
Equity method
Equity method
Income tax entries
Deferred income
taxes
Deferred income
taxes
Fixed asset impairment
Fixed asset impairment
Restructuring charge

Difficulty
Easy
Easy
Easy
Easy
Easy
Easy
Easy
Easy
easy
Easy
Easy
Easy
Easy
Easy
Easy
Easy
Easy
Easy
Easy

Time
5 min
5 min
5 min
5 min
5 min
5 min
5 min
5 min
5 min
5 min
5 min
5 min
5 min
5 min
5 min
5 min
5 min
5 min
5 min

AACSB
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic

AICPA
FN-Measurement
FN-Measurement
FN-Measurement
FN-Measurement
FN-Measurement
FN-Measurement
FN-Measurement
FN-Measurement
FN-Measurement
FN-Measurement
FN-Measurement
FN-Measurement
FN-Measurement
FN-Measurement
FN-Measurement
FN-Measurement
FN-Measurement
FN-Measurement
FN-Measurement

Easy

5 min

Analytic

FN-Measurement

Easy

5 min

Analytic

FN-Measurement

Easy

5 min

Analytic

FN-Measurement

Easy

5 min

Analytic

FN-Measurement

Easy

5 min

Analytic

FN-Measurement

Easy

5 min

Analytic

FN-Measurement

Easy

5 min

Analytic

FN-Measurement

Easy
Easy
Easy
Easy

5 min
5 min
15 min
10 min

Analytic
Analytic
Analytic
Analytic

FN-Measurement
FN-Measurement
FN-Measurement
FN-Measurement

Easy

10 min

Analytic

FN-Measurement

Easy

15 min

Analytic

FN-Measurement

Easy

10 min

Analytic

FN-Measurement

Easy

15 min

Analytic

FN-Measurement

767
This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. This may not be
resold, copied, or distributed without the prior consent of the publisher.

Number
Ex14-7
Ex14-8

Objective
14-2
14-2

Ex14-9
Ex14-10
Ex14-11
Ex14-12

14-2
14-2
14-2
14-2

Ex14-13
Ex14-14
Ex14-15

14-2, 14-3
14-2, 14-3
14-3

Ex14-16

14-4

Ex14-17

14-4, 14-5

Ex14-18

14-4, 14-5

Ex14-19

14-4, 14-5

Ex14-20

14-5

Ex14-21

14-4, 14-5

Ex14-22

14-5

Ex14-23

14-5

Ex14-24

14-5

Ex14-25
Ex14-26

FAI
FAI

Pr14-1A
Pr14-2A

14-1
14-2, 14-3,
14-4
14-1, 14-2,
14-3, 14-4,
14-5

Pr14-3A

Pr14-4A

14-5

Pr14-1B
Pr14-2B

14-1
14-2,143,14-4
14-1,142,14-3,144,14-5

Pr14-3B

Pr14-4B

14-5

Description
Restructuring charge
Restructuring charges
and asset impairment
Extraordinary item
Extraordinary item
Extraordinary items
Identifying extraordinary items
Income statement
Income statement
Earnings per share
with preferred stock
Comprehensive income
Comprehensive income and temporary
investments
Comprehensive income and temporary
investments
Temporary investments and other comprehensive income
Temporary investments in marketable
securities
Financial statement
reporting of temporary
investments
Entries for investment
in stock, receipt of
dividends, and sale of
shares
Entries for using equity method for stock
investment
Equity method for
stock investment
Price-earnings ratio
Price-earnings ratio
calculations
Income tax allocation
Income tax; income
statement
Income statement;
retained earnings
statement; balance
sheet
Entries for investments in stock
Income tax allocation
Income tax; income
statement
Income statement;
retained earnings
statement; balance
sheet
Entries for investments in stock

Difficulty
Moderate
Easy

Time
20 min
15 min

AACSB
Analytic
Analytic

AICPA
FN-Measurement
FN-Measurement

Easy
Easy
Easy
Easy

5 min
5 min
5 min
10 min

Analytic
Analytic
Analytic
Analytic

FN-Measurement
FN-Measurement
FN-Measurement
FN-Measurement

Easy
Moderate
Easy

15 min
20 min
5 min

Analytic
Analytic
Analytic

FN-Measurement
FN-Measurement
FN-Measurement

Easy

10 min

Analytic

FN-Measurement

Moderate

15 min

Analytic

FN-Measurement

Moderate

20 min

Analytic

FN-Measurement

Moderate

15 min

Analytic

FN-Measurement

Easy

10 min

Analytic

FN-Measurement

Moderate

20 min

Analytic

FN-Measurement

Easy

10 min

Analytic

FN-Measurement

Easy

10 min

Analytic

FN-Measurement

Easy

5 min

Analytic

FN-Measurement

Easy
Moderate

5 min
10 min

Analytic
Analytic

FN-Measurement
FN-Measurement

Moderate
Moderate

45 min
1 hr

Analytic
Analytic

FN-Measurement
FN-Measurement

Difficult

1 1/2
hr

Analytic

FN-Measurement

Moderate

45 min

Analytic

FN-Measurement

Moderate
Moderate

45 min
1 hr

Analytic
Analytic

FN-Measurement
FN-Measurement

Difficult

1 1/2
hr

Analytic

FN-Measurement

Moderate

45 min

Analytic

FN-Measurement

768
This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. This may not be
resold, copied, or distributed without the prior consent of the publisher.

Number
SA14-1

Objective
14-5

SA14-2

14-2

SA14-3

14-4

SA14-4

14-2

SA14-5

14-2

SA14-6

14-2

Description
Equity method disclosure
Special charges
analysis
Comprehensive income
Ethics and professional behavior
Reporting extraordinary item
Extraordinary items
and discontinued operations

Difficulty
Easy

Time
5 min

AACSB
Analytic

AICPA
FN-Measurement

Moderate

20 min

Analytic

FN-Measurement

Easy

10 min

Analytic

FN-Measurement

Easy

5 min

Ethics

BB-Industry

Easy

5 min

Analytic

FN-Measurement

Moderate

45 min

Analytic

FN-Measurement

769
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resold, copied, or distributed without the prior consent of the publisher.

EYE OPENERS
1. a. Current liability
b. Long-term liability or deferred credit (following the Long-Term Liabilities section)
2. This is an example of a fixed asset impairment. Thus, a loss of $100 million should be
disclosed on the income statement as a
separate line item above the income from
continuing operations, and the plant and
equipment should be written down to their
appraised value ($20 million).
3. The severance costs are a current period
expense associated with downsizing operations. Thus, a restructuring charge should
be recognized on the income statement
(above income from continuing operations)
and any liability recognized. As payments
are made to employees, the liability is decreased.
4. Extraordinary items:
Gain on condemnation of land, net of applicable income tax of $48,000.............$72,000
5. The urban renewal agencys acquisition of
the property may be viewed as a form of expropriation under paragraph 23 of Accounting Principles Board Opinion No. 30, Reporting the Results of Operations
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions. Paragraph 23 says a gain or
loss from sale or abandonment of property,
plant, or equipment used in the business
should be included as an extraordinary item
if it is the direct result of an expropriation.
Accordingly, the gain should be reported as
an extraordinary item in the income statement.
6. The loss from discontinued operations of
$2.3 billion should be identified on the income statement as discontinued operations
and should follow the presentation of the results of continuing operations (sales less the
customary costs and expenses). The data
on discontinued operations (identity of the
segment, date of disposal, etc.) should be
disclosed in a note.
7. A change from one acceptable accounting
method to another acceptable accounting
method is treated as a retroactive restate-

8.

9.

10.

11.

12.

13.
14.
15.

16.

ment of prior period financial statements, as

if the new accounting principle had been
used at inception.
a. Yes, the $0.40-per-share gain should be
reported as an extraordinary item.
b. Operations appear to have declined.
The earnings per share for the current
year that is comparable to the preceding
years earnings per share of $1.10 is
$0.98 ($1.38 $0.40).
a. Examples of other comprehensive income items include foreign currency
items, pension liability adjustments, and
unrealized gains and losses on certain
investments in debt and equity securities.
b. No. Other comprehensive income does
not affect the determination of net income or retained earnings.
A business may purchase stocks as a
means of earning a return (income) on excess cash that it does not need for its normal operations. In other cases, a business
may purchase the stock of another company
as a means of developing or maintaining
business relationships with the other company. A business may also purchase common stock as a means of gaining control of
another companys operations.
On the balance sheet, temporary investments in marketable securities are reported
at their fair market values, net of any applicable income taxes related to any unrealized gains or losses.
Unrealized gains or losses (net of applicable
taxes) should be reported as either an addition to or deduction from net income in arriving at comprehensive income.
a. The equity method
b. Investments
Investment in Gestalt Corporation
Investment in
Affiliates ............... 2,400,000
Income of
Affiliates ......
2,400,000
The financial statements of the parent and
subsidiary are consolidated, or combined,
into a single unified disclosure.

770
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resold, copied, or distributed without the prior consent of the publisher.

PRACTICE EXERCISES
PE 141A
Income Tax Expense............................................................
Income Tax Payable........................................................
Deferred Income Tax Payable ........................................

189,000
168,000
21,000

Income tax expense based on $540,000 reported income at 35% ..

Income tax payable based on $480,000 taxable income at 35%......
Income tax deferred to future years ..................................................

$189,000
168,000
$ 21,000

PE 141B
Income Tax Expense............................................................
Income Tax Payable........................................................
Deferred Income Tax Payable ........................................

36,000
30,400
5,600

Income tax expense based on $90,000 reported income at 40% ....

Income tax payable based on $76,000 taxable income at 40%........
Income tax deferred to future years ..................................................

$ 36,000
30,400
$ 5,600

PE 142A
Dec. 15 Loss on Fixed Asset Impairment.......................
Equipment ......................................................
Restructuring Charge .........................................
Employee Termination Obligation ...............

46,000
46,000
60,000*
60,000

*15 employees 4,000

PE 142B
Dec. 23 Loss on Fixed Asset Impairment.......................
Land................................................................
Restructuring Charge .........................................
Employee Termination Obligation ...............

320,000
320,000
405,000*
405,000

*45 employees 9,000

771
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resold, copied, or distributed without the prior consent of the publisher.

PE 143A
Earnings per share:

$2,430,000 $270,000 *
= $9.00 per share
240,000

*30,000 shares $100 par value 9% = $270,000

PE 143B
Earnings per share:

$350,000 $35,000 *
= $0.75 per share
420,000

*5,000 shares $100 par value 7% = $35,000

PE 144A
a.

$117,400 = $104,000 + $13,400

b. $669,000 = $565,000 + $104,000

c.

$84,400 = $71,000 + $13,400

PE 144B
a.

$979,500 = $856,000 + $123,500

b. $4,316,000 = $3,460,000 + $856,000

c.

$747,500 = $624,000 + $123,500

772
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resold, copied, or distributed without the prior consent of the publisher.

PE 145A
a.

b.

Initial cost ......................................................................

Unrealized gain ($137,000 $123,000) ........................
Less: Tax on unrealized gain ($14,000 40%)............
Unrealized gain, net of tax............................................
Reported amount of marketable securities.................
Net income.....................................................................
Unrealized gain ($137,000 $123,000) ........................
Less: Tax on unrealized gain ($14,000 40%)............
Other comprehensive income, net of tax ....................
Comprehensive income................................................

$123,000
$14,000
5,600
8,400
$131,400
$151,000
$14,000
5,600
8,400
$159,400

PE 145B
a.

b.

Initial cost ......................................................................

Unrealized loss ($56,000 $49,700).............................
Less: Tax benefit on unrealized loss ($6,300 35%)
Unrealized loss, net of tax ............................................
Reported amount of marketable securities.................
Net income.....................................................................
Unrealized loss ($56,000 $49,700).............................
Less: Tax benefit on unrealized loss ($6,300 35%)
Other comprehensive loss, net of tax .........................
Comprehensive income................................................

$56,000
$6,300
2,205
4,095
$51,905
$97,500
$6,300
2,205
4,095
$93,405

PE 146A
Gilliam share of Forrester reported net income (35% $675,000)...
Less Gilliam share of the Forrester dividend (35% $155,000) .......
Increase in the investment in Forrester Company stock..................

$236,250
54,250
$182,000

PE 146B
Miranda share of Orson reported net loss (25% $300,000)............
Miranda share of the Orson dividend (25% $40,000) .....................
Decrease in the investment in Orson Company stock......................

$ 75,000
10,000
$ 85,000

773
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resold, copied, or distributed without the prior consent of the publisher.

EXERCISES
Ex. 141
Apr.

15 Income Tax Expense ..........................................

Cash................................................................

90,000

June 15 Income Tax Expense ..........................................

Cash................................................................

90,000

Sept. 15 Income Tax Expense ..........................................

Cash................................................................

90,000

Dec. 31 Income Tax Expense ..........................................

Income Tax Payable ......................................
Deferred Income Tax Payable.......................

110,000*

90,000
90,000
90,000
50,000**
60,000

*[($950,000 40%) (3 $90,000)] = $110,000

**[($800,000 40%) (3 $90,000)] = $50,000
Jan.

15 Income Tax Payable............................................

Cash................................................................

50,000
50,000

Ex. 142
2007
Dec. 31 Income Tax Expense ..........................................
Deferred Income Tax Payable.......................
Income Tax Payable ......................................

1,208,000
168,000*
1,040,000**

*$420,000 40% = $168,000

**$2,600,000 40% = $1,040,000
2008
Dec. 31 Income Tax Expense ..........................................
Deferred Income Tax Payable ............................
Income Tax Payable ......................................

1,032,000
168,000
1,200,000*

*$3,000,000 40% = $1,200,000

774
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resold, copied, or distributed without the prior consent of the publisher.

Ex. 143
2007
Dec. 31 Income Tax Expense ..........................................
Deferred Income Tax Asset................................
Income Tax Payable ......................................

91,000*
31,500
122,500**

*$260,000 35% = $91,000

**$350,000 35% = $122,500
2008
Dec. 31 Income Tax Expense ..........................................
Deferred Income Tax Asset ..........................
Income Tax Payable ......................................

141,750*
31,500
110,250

*$405,000 35%

Ex. 144
a.
Depreciation expense per year:

$90,000,00 0 $10,000,00 0
= $8,000,000 per year
10 years

December 31, 2008, net book value (carrying value) prior to impairment adjustment:
Fiber optic network cost ...........................................
Less accumulated depreciation ...............................
Fiber optic net book value ........................................

$ 90,000,000
16,000,000
$ 74,000,000

b.
2008
Dec. 31 Loss from Fixed Asset Impairment ...................
Fixed AssetsFiber Optic Network.............

24,000,000*
24,000,000

*$74,000,000 $50,000,000
c.
Balance sheet:
Fixed assetsFiber optic network ..........................
Less accumulated depreciation ...............................
Fixed assetsFiber optic network net book value

$ 66,000,000*
16,000,000
$ 50,000,000

*$90,000,000 $24,000,000

775
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resold, copied, or distributed without the prior consent of the publisher.

Ex. 145
a.
2008
Dec. 31 Loss from Fixed Asset Impairment ..................... 152,000,000
Fixed AssetsBuildings and Improvements
120,000,000
Fixed AssetsLand ........................................
13,000,000
Fixed AssetsEquipment ..............................
19,000,000

b. On December 31, 2008, management determined that one of the resort properties was permanently impaired due to the discovery of an adjacent toxic
chemical waste site. Bookings to this property have dropped significantly,
and it was determined that the property had to be abandoned. As a result, a
$152 million asset impairment loss was recognized in 2008, reflecting the fair
value of assets associated with this site, as detailed in the following table:

Land .............................................
Buildings and improvements .....
Equipment....................................
Total..........................................

Original
Impairment
Fair
Loss
Value
Cost
$ 30,000,000 $ 13,000,000 $ 17,000,000
120,000,000
120,000,000
0
25,000,000
19,000,000
6,000,000
$ 175,000,000 $ 152,000,000 $ 23,000,000

776
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Ex. 146
a.
2008
Nov.

1 Restructuring Charge .........................................

Employee Termination Obligation ...............

4,680,000
4,680,000

Average salary.....................................................................................
Planned number of positions to be eliminated.................................
Total annual salary eliminated......................................................
Average tenure ....................................................................................
Severance rate.....................................................................................
Total severance..............................................................................

$
65,000

180
$ 11,700,000

8 yrs.

5%
$ 4,680,000

b.
2008
Dec. 21 Employee Termination Obligation.....................
Cash................................................................

1,300,000

Average salary.....................................................................................
Number of positions eliminated.........................................................
Average tenure ....................................................................................
Severance rate.....................................................................................
Total severance paid .....................................................................

1,300,000
$ 65,000

50

8 yrs.

5%
$1,300,000

c.
Balance sheet disclosure:
Current liabilities:
Employee termination obligation

$3,380,000

Note disclosure:
On November 1, 2008, the board of directors approved a plan to eliminate 180
headquarter positions due to a decline in demand for the companys products. A
severance plan was approved and communicated to employees providing termination benefits to employees terminated between December 1, 2008, and April 1,
2009. Accordingly, a restructuring charge of $4,680,000 was recognized in 2008
for the accrued termination benefits. Of this amount, $1,300,000 was distributed
to terminated employees in 2008. The remaining $3,380,000 was recognized as a
current liability and will be paid to employees terminated during the first three
months of 2009.
777
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Ex. 147
a.
Closing and relocation costs
Employee severance costs
Contract termination costs
Total restructuring charge

600,000
3,024,000*
150,000
$ 3,774,000

*Employee severance costs:

Number of hours per month
Labor rate per hour
Monthly wage per employee
Number of employees
Total monthly wages
Severance rate
Total termination benefit

180 hrs.

$14.00
$
2,520

300
$ 756,000

400%
$ 3,024,000

b.
2008
July

1 Restructuring Charge .........................................

Restructuring Obligation ..............................

3,774,000
3,774,000

Note: The obligation is not employee termination obligation because there are several types of restructuring charges included in the total. Thus, the account Restructuring Obligation is used to represent the total obligation.
c.
2008
Oct. 15 Restructuring Obligation....................................
Cash................................................................

756,000
756,000

$756,000 = $3,024,000/4
d. Balance sheet disclosure:
Current liability:
Restructuring obligation

$2,268,000

$2,268,000 = $756,000 3 remaining installments

Note: All other estimated restructuring payments were made in 2008.

778
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Ex. 147
e.

Concluded

Note disclosure:
On July 1, 2008, the board of directors of the company approved and announced a restructuring plan that resulted in a $3,774,000 charge in 2008 consisting of the following items:
Closing and relocation costs
Employee severance costs
Contract termination costs
Total restructuring charge

600,000
3,024,000
150,000
$ 3,774,000

The restructuring was caused by unfavorable publicity regarding the caffeine

content of our juice products. The adverse publicity reduced the demand for
our products, requiring us to consolidate operations by closing one of our
juice plants and eliminating 300 direct labor positions. On December 31, 2008,
there remains a current restructuring obligation of $2,268,000, primarily related to employee severance agreements.
Note: While no information was provided in the exercise, it is likely that the
factory building is also impaired requiring a write-down and appropriate disclosures.

779
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Ex. 148
a.
2008
Dec. 31 Loss from Fixed Asset Impairment ...................
Fixed AssetsTractor-Trailers ....................

13,600,000*
13,600,000

*($48,000,000 $14,000,000) (1 60%)

Note: The planned sale of 50 trucks is a future event. The asset impairment impacts all trucks, and thus should be recognized currently.
Dec. 31 Restructuring Charge .........................................
Employee Termination Obligation ...............

780,000*
780,000

*65 employees $12,000

b. December 31, 2008, balance sheet disclosures:
Fixed assets:
Tractor-trailers ..............................................................................
Less accumulated depreciation ..................................................
Tractor-trailer net book value ......................................................

$ 34,400,000
(14,000,000)
$ 20,400,000

Current liabilities:
Employee termination obligation ................................................

$780,000

Note disclosure:
On December 31, 2008, the board of directors approved and communicated a
restructuring plan in response to low-cost competition in the companys service market. The plan calls for the sale of 50 tractor-trailers and elimination of
50 drivers and 15 staff personnel. Due to the general overcapacity in the
transportation market, tractor-trailer market values are estimated to be 60% of
the existing book value, causing us to recognize an unrecoverable loss on
fixed asset impairment of $13,600,000 in 2008 for the entire fleet. In addition, a
severance plan was approved for the eliminated positions. The charge for
employee severance was $780,000 for 2008, all of which is currently payable
at the end of the fiscal year. It is estimated that all severance obligations will
be satisfied by the end of the first quarter in 2009.
c.
2009
Mar. 14 Employee Termination Obligation.....................
Cash................................................................

780,000
780,000

780
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Ex. 149
No. Extraordinary items are events and transactions that are unusual and occur
infrequently. It is not unusual for a company to insure the life of its president or
to receive the proceeds of the policy upon his or her death. Since it does not
meet both criteria, this gain is not an extraordinary item.

Ex. 1410
To be classified as an extraordinary item for income statement reporting purposes, the item (event) must be (1) unusual from the typical operating activities of
the business and (2) occurring infrequently. Although it would seem that the income from the Stabilization Act would meet these criteria, the airline industry (including Delta) did not report the income as an extraordinary item. Indeed, the
complete costs and income from the September 11, 2001, terrorist incident were
not accounted for as extraordinary items as explained below.
The text from the Emerging Issues Task Force, Accounting for the Impact of the
Terrorist Attacks of September 11, 2001, explains the reason for the decision:
The EITF reached a consensus that losses or costs resulting from the September
11 events should be included in the determination of income from continuing operations; thus, they should not be classified as extraordinary items. In the opinion
of the Task Force, it would not be possible to isolate the effects of the September
11 events in a single line item, because of the difficulty in distinguishing losses
that are directly attributable to such events from those that are not. Losses or
costs associated with the events of September 11 may, however, be reported as a
separate component of income from continuing operations if they are deemed to
be either unusual or infrequently occurring in nature.
In the final analysis, the Task Force reached the foregoing decision based on its
conclusion that users of financial statements would not be well served by separate reporting as an extraordinary item of only a portion of the impact of the September 11 events that strictly qualify for extraordinary classification under APB
No. 30, Reporting the Results of Operations. Pursuant to Opinion 30, only losses
or costs that can be clearly measured and irrefutably attributed to a specific event
may be shown as an extraordinary item.
The Task Force acknowledges that, while the September 11 events no doubt contributed to the pace and severity of the economic slowdown, identifying the impact of those events would be subjective and difficultif at all possible. Moreover, the Task Force points out that the most significant financial statement impact for many affected companies might be lost or reduced revenues; in accordance with Opinion 30, the measurement of an extraordinary item does not reflect
an estimate of forgone sales or income.
781
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Ex. 1411
a.

The Weyerhaeuser loss was reported as extraordinary. The Mount St. Helens
eruption was deemed extraordinary because the losses from its impact were
specific and isolated. In addition, Mount St. Helens had not erupted for over
130 years, making it infrequent.

b. All losses associated with the 9/11 incident were not reported as extraordinary. See the extensive EITF (Emerging Issues Task Force) quote in Exercise
1410, which in summary states that while the incident was unusual and
infrequent, it would not be possible to limit the scope of possible losses
associated with this event. The concern was that companies would identify as
extraordinary indirect business losses as a result of the general decline in
the economy as a result of this event. In the words of the EITF, it would not
be possible to isolate the effects of the September 11 events in a single line
item, because of the difficulty in distinguishing losses that are directly
attributable to such events from those that are not.
c.

Hurricane Katrina losses are not reported as extraordinary, mostly because

hurricanes are not unusual or infrequent events on the Gulf Coast. The following is an excerpt that captures the basic essence of the argument.
Katrina Was Not Extraordinary
However, from a financial reporting standpoint, Hurricane Katrina was not an
extraordinary event, according to at least two of the most prominent
accounting bodies.
The American Institute of Certified Public Accountants (AICPA) advised its
members that because a hurricane is a natural disaster that is reasonably
expected to reoccur, the losses it causes should not be considered extraordinary from a bookkeeping perspective, said a Bloomberg report. This is
significant, because extraordinary events are separated from the usual runof-business expenses in financial reports, and are typically ignored or downplayed by investors when they judge the financial performance of a company.
There are people who say its the magnitude of what Hurricane Katrina did
that was extraordinary, AICPA director of accounting standards Daniel Noll
told the wire service. You can find accountants on the same block who will
disagree on this guidance.
So, what does it take for a natural disaster to be deemed extraordinary? An
earthquake that strikes an area with no known fault line or documented
history of quake activity, Noll told Bloomberg.

782
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Ex. 1411

Concluded

The Financial Accounting Standards Board (FASB) also considers Katrina

ordinary for accounting purposes. Larry Smith, the chairman of FASBs
Emerging Issues Task Force, said on Wednesday that there were no plans to
have the task force consider whether to label Katrina an extraordinary event,
reported Bloomberg, citing board spokesman Gerard Carney.
Source: Stephen Taub, Experts Advise Accountants Not to Classify KatrinaRelated Expenses as Extraordinary, CFO.com, September 19, 2005.

Ex. 1412
a.
b.
c.
d.

NR
NR
NR
NR

e.
f.
g.
h.

NR
E
NR
E

783
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Ex. 1413
WIND SURFER INC.
Income Statement
For the Year Ended June 30, 2008
Sales....................................................................................
Cost of merchandise sold .................................................
Gross profit.........................................................................
Operating expenses:
Selling expenses .........................................................
Administrative expenses ............................................
Special charges:
Loss from fixed asset impairment .............................
Restructuring charge ..................................................
Income from continuing operations before income tax
Income tax expense ...........................................................
Income from continuing operations .................................
Loss on discontinued operations, net of applicable
income tax of $32,000 .................................................
Income before extraordinary items...................................
Extraordinary item:
Gain on condemnation of land, net of applicable
income tax of $23,200 .............................................
Net income..........................................................................
Earnings per common share:
Income from continuing operations ..........................
Loss on discontinued operations..............................
Income before extraordinary item .............................
Extraordinary item ......................................................
Net income...................................................................

$ 1,100,000
467,500
$ 632,500
$125,500
104,000

229,500

120,000
50,000
233,000
93,200
139,800

48,000
91,800

34,800
126,600

$
$
$

6.99
2.40
4.59
1.74
6.33

784
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Ex. 1414
1.

The order of presentation of the unusual items is incorrect. The order should
be as follows:
Income from continuing operations
Loss on discontinued operations
Income before extraordinary items
Extraordinary items
Net income

2.

The restructuring charge is not an extraordinary item but should be disclosed

above income from continuing operations. The associated tax benefit should
not be net against this amount but should be part of the tax on continuing
operations.

3.

The fixed asset impairment should be disclosed above income from continuing operations.

4.

The earnings per share data are presented in the incorrect ordersee (1)
above.

5.

The earnings per share computations are incorrect. The amount of preferred
stock dividends ($20,000) should be subtracted from income from continuing operations, income before extraordinary item, and net income in
computing the earnings per share of common stock.

6.

A corrected presentation appears on the next page.

785
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Ex. 1414

Concluded
AUDIO AFFECTION INC.
Income Statement
For the Year Ended December 31, 2008

Net sales .............................................................................

Cost of merchandise sold .................................................
Gross profit.........................................................................
Operating expenses:
Selling expenses .........................................................
Administrative expenses ............................................
Special charges:
Restructuring charge ..................................................
Fixed asset impairment ..............................................
Income from continuing operations before income tax
Income tax expense ...........................................................
Income from continuing operations .................................
Loss on discontinued operations (net of applicable
income tax of $15,000) ................................................

$967,000
578,000
$389,000
$127,000
142,000
$ 20,000
24,000

269,000

44,000
$ 76,000
40,000*
$ 36,000
(22,500)

Income before extraordinary items...................................

Extraordinary item:
Gain on condemnation of land, net of applicable
income tax of $20,000 .............................................

$ 13,500

Net income..........................................................................

$ 43,500

Earnings per common share:

Income from continuing operations
[($36,000 $20,000)/50,000 shares] .......................
Loss on discontinued operations..............................

30,000

0.32
(0.45)

Income before extraordinary item .............................

Extraordinary item ......................................................

(0.13)
0.60

Net income...................................................................

0.47

*$48,000 $8,000 tax benefit from restructuring charge

786
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Ex. 1415
Basic earnings per share when there is preferred stock is determined as follows:
Earnings per Common Share =

Net Income Preferred Stock Dividends

Number of Common Shares Outstanding

Earnings per Common Share =

$150,600 (2,000 pref. shares $6 per share)

90,000 common shares

Earnings per Common Share = $1.54 per share

Ex. 1416
a.
Retained earnings, December 31, 2007........................................
Plus net income .............................................................................
Less dividends ...............................................................................
Retained earnings, December 31, 2008........................................

$ 1,483,000
460,000
$ 1,943,000
250,000
$ 1,693,000

b.
Accumulated other comprehensive income, December 31, 2007.....
Less unrealized loss from temporary investments............................
Accumulated other comprehensive income, December 31, 2008.....

$171,000
45,000
$126,000

Ex. 1417
a.
b.
c.
d.
e.
f.
g.
h.

$75,000
$9,000
$84,000
$41,000
$104,000
$45,000
$350,000
$5,000

$250,000 $175,000
$1,000 ($8,000)
$75,000 + $9,000
$32,000 + $9,000
$100,000 + $4,000
$41,000 + $4,000
$250,000 + $100,000
$1,000 + $4,000

787
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Ex. 1418
a.
MANGO CORPORATION
Statement of Comprehensive Income
For the Year Ended December 31, 2008
Net income.....................................................................................
Other comprehensive income:
Unrealized gain on investment portfolio, net of tax ...............
Total comprehensive income.......................................................

$150,000
55,000
$205,000

b.
MANGO CORPORATION
Stockholders Equity
December 31, 2008
Common stock ..............................................................................
Paid-in capital in excess of par value..........................................
Retained earnings .........................................................................
Accumulated other comprehensive income ...............................
Total............................................................................................

$ 35,000
350,000
585,000*
10,000**
$980,000

*$435,000 + $150,000
**($45,000) + $55,000

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Ex. 1419
a.

2008
Unrealized loss [10,000 shares ($20 $16)]...........
Less tax benefit on unrealized loss (40% rate).........
Unrealized loss, net of income tax benefit................

$40,000
16,000
$24,000

2009
Unrealized gain [10,000 shares ($25 $16)] ..........
Less taxes on unrealized gain (40% rate) .................
Unrealized gain, net of income tax ............................

$90,000
36,000
$54,000

Note: The tax benefit and expense give rise to temporary differences, since
gains and losses are only included for tax purposes at the time of sale.
b.
Dec. 31, 2008
Accumulated Other Comprehensive Loss

$24,000

Dec. 31, 2009

Accumulated Other Comprehensive Income

$30,000*

*($24,000) + $54,000 = $30,000

c.

The Accumulated Other Comprehensive Income or Deficit is disclosed in the

Stockholders Equity section of the balance sheet, separately from the retained earnings or paid-in capital accounts.

Ex. 1420
a.

Marketable Securities....................................................
Cash ..........................................................................

57,000

b. Cash................................................................................
Dividend Revenue ....................................................

2,150

57,000
2,150

789
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Ex. 1421
a.
GEO-METRICS CORPORATION
Balance Sheet
December 31, 2008
Assets
Current assets:
Temporary investments in marketable securities,
at cost.......................................................................
Plus unrealized gain (net of applicable income
tax benefit of $1,200) ...............................................

$57,000
1,800*

*Computation:
Market:
M-Labs Inc.: 1,000 shares $25 .............................
Spectrum Corp.: 2,500 shares $14 ......................
Cost ($19,000 + $38,000).............................................
Unrealized gain............................................................
Taxes on unrealized gain ($3,000 40%) ..................
Unrealized gain, net of applicable tax benefit...........

$58,800

$ 25,000
35,000
$ 60,000
57,000
$ 3,000
1,200
$ 1,800

b.
GEO-METRICS CORPORATION
Statement of Comprehensive Income
For the Year Ended December 31, 2008
Net income...........................................................................................
Other comprehensive income:
Unrealized gain on temporary investments in marketable
securities (net of applicable income tax of $1,200).....................
Comprehensive income......................................................................

$100,000

1,800
$101,800

790
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Ex. 1422
a.

Investment in Bat Co. Stock .........................................

Cash ..........................................................................
*(4,000 shares $40.75) + $200

b. Cash................................................................................
Dividend Revenue ....................................................
(No entry for stock dividends; carrying
amount per share of stock is now
$163,200/4,080, or $40.)
c.

Cash................................................................................
Investment in Bat Co. Stock....................................
Gain on Sale of Investments ...................................
*(1,000 shares $53) $65

163,200*
163,200
7,000
7,000

52,935*
40,000
12,935

Ex. 1423
a.

Investment in May Corp. Stock ....................................

Income of May Corp. ................................................
($3,000,000 70,000/280,000)

750,000

b. Cash................................................................................
Investment in May Corp. Stock ...............................
(70,000 shares $3.80)

266,000

750,000

266,000

Ex. 1424
(in millions)
Investment in Sour Company stock, December 31, 2007 ................
Plus equity earnings in Sour Company.............................................
Less dividends received.....................................................................
Investment in Sour Company stock, December 31, 2008 ................

$135
15
4*
$146

*The Sour Company investment is accounted for under the equity method, since
there are equity earnings from this investment. Since there were no purchases or
sales of Sour Company stock, there must have been a dividend received. This
would explain how the ending balance of the investment account went from $150
to $146. Since the investment is accounted for under the equity method, the market value is not used for valuation purposes.

791
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Ex. 1425
Earnings per Share =

Earnings per share:

Net Income Preferred Dividends

Common Shares Outstanding

$672,000 ($800,000 6%)

= $5.20 per common share
120,000

Price-Earnings Ratio =

Price-earnings ratio:

Price per Share

Earnings per Share

$72.80
= 14
$5.20

Ex. 1426
a.
Price-Earnings Ratio =

Market Price per Share of Common Stock

Earnings per Share of Common Stock (basic)

Price-earnings ratio, 2005:

$56
, 9.7
$5.76

Price-earnings ratio, 2004:

$51
, 13.0
$3.91

Price-earnings ratio, 2003:

$41
, 12.7
$3.24

b. The price-earnings ratio decreased from 12.7 to 9.7, or 24% [(12.7 9.7)/12.7].
During this time frame, the U.S. economy was expanding and the demand for
oil was increasing. In addition, the price of oil was increasing. As a result,
ExxonMobil had some of the strongest net income in its history during 2005.
The price-earnings ratio grew to reflect this favorable increase in net income.
It is interesting, however, that the price-earnings ratio declined over these last
three years. Since ExxonMobil is experiencing record net income, investors
are taking a more cautious tone. That is, they are not assuming this strong
net income will necessarily continue into the future. As a result, the priceearnings ratio is actually below the general market price-earnings ratio, which
during this time was around 17.

792
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PROBLEMS
Prob. 141A
1. and 2.
Deferred Income
Tax Payable

Year

Income Tax
Deducted
on Income
Statement

Income Tax
Payments for
the Year

Year's Addition
(Deduction)

Year-End
Balance

First
Second
Third
Fourth
Total

$100,000
120,000
200,000
160,000
$580,000

$ 80,000
112,000
216,000
172,000
$580,000

$ 20,000
8,000
(16,000)
(12,000)
$
0

$20,000
28,000
12,000
0

793
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Prob. 142A
XTREME WORLD INC.
Income Statement
For the Year Ended June 30, 2008
Sales....................................................................
Cost of merchandise sold .................................
Gross profit.........................................................
Operating expenses:
Selling expenses:
Sales commissions expense.....................
Advertising expense ..................................
Depreciation expensestore equipment.
Miscellaneous selling expense .................
Total selling expenses ...........................
Administrative expenses:
Office salaries expense .............................
Rent expense..............................................
Depreciation expenseoffice equipment
Insurance expense .....................................
Miscellaneous administrative expense ....
Total administrative expenses ..............
Special charges:
Loss from fixed asset impairment ................
Restructuring charge .....................................
Total special charges.................................
Total expenses ...................................................
Income from continuing operations before
other income and expenses ..........................
Other income and expenses:
Interest expense .............................................
Income from continuing operations before
income tax ..................................................
Income tax expense ...........................................
Income from continuing operations .................
Gain on discontinued operations .....................
Less applicable income tax...............................
Income before extraordinary item.....................
Extraordinary item:
Loss from condemnation of land..................
Less applicable income tax...........................
Net income..........................................................

$ 865,000
345,000
$ 520,000
$130,000
57,000
45,000
14,000
$246,000
$ 70,000
25,000
16,000
9,000
11,000
131,000
$ 40,000
50,000
90,000
467,000
$ 53,000
18,000
$ 35,000
10,500
$ 24,500
$ 38,000
11,400
$ 24,000
7,200

26,600
$ 51,100
(16,800)
$ 34,300

794
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Prob. 142A

Concluded

Earnings per share:

Income from continuing operations .............
Gain on discontinued operations .................
Income before extraordinary item.................
Extraordinary item..........................................
Net income...................................................

$
$
$

4.90
5.32
10.22
(3.36)
6.86

Note: Unrealized gain on temporary investments would be an other comprehensive

income item, not included on the income statement in determining net income.

795
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Prob. 143A
1.
AMANA BREAD CORPORATION
Income Statement
For the Year Ended October 31, 2008
Sales....................................................................................
Cost of merchandise sold .................................................
Gross profit.........................................................................
Operating expenses:
Selling expenses .........................................................
Administrative expenses ............................................
Loss from fixed asset impairment .............................
Restructuring charge ..................................................
Total expenses.........................................................
Income from operations ....................................................
Other expenses:
Interest expense..........................................................
Interest revenue ..........................................................
Income from continuing operations before income tax..
Income tax expense ...........................................................
Income from continuing operations .................................
Loss from discontinued operations .................................
Less applicable income tax...............................................
Income before extraordinary item.....................................
Extraordinary item:
Gain on condemnation of land...................................
Less applicable income tax........................................
Net income..........................................................................
Earnings per common share:
Income from continuing operations ..........................
Loss on discontinued operations..............................
Income before extraordinary item .............................
Extraordinary item ......................................................
Net income ...............................................................

$955,000
458,000
$497,000
$224,000
80,000
35,000
65,000
404,000
$ 93,000
$ (5,000)
4,000

$ 60,000
24,000

$ 80,000
32,000

(1,000)
$ 92,000
36,800
$ 55,200
36,000
$ 19,200

48,000
$ 67,200
$
$
$

0.49*
0.45
0.04
0.60
0.64

*($55,200 $16,000)/80,000 common shares

796
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Prob. 143A

Continued

2.
AMANA BREAD CORPORATION
Retained Earnings Statement
For the Year Ended October 31, 2008
Retained earnings, November 1, 2007........
Net income....................................................
Less dividends declared:
Cash dividends......................................
Stock dividends.....................................
Increase in retained earnings......................
Retained earnings, October 31, 2008..........

$1,277,250
$ 67,200
$ 51,000
12,000

63,000
4,200
$1,281,450

3.
AMANA BREAD CORPORATION
Balance Sheet
October 31, 2008
Assets
Current assets:
Cash .......................................................
Temporary investments in marketable
securities (at cost).............................
Less unrealized loss in temporary
investments........................................
Accounts receivable .............................
Less allowance for doubtful accounts
Notes receivable....................................
Merchandise inventory, at lower of cost
(FIFO) or market.................................
Interest receivable.................................
Prepaid expenses..................................
Total current assets ..........................
Property, plant, and equipment:
Equipment..............................................
Less accumulated depreciation...........
Total property, plant, and equipment
Intangible assets:
Patents ...................................................
Total assets ..................................................

$ 165,300
$122,000
28,000
$185,000
5,400

94,000
179,600
42,500
122,000
2,500
2,600
$

608,500

$1,958,000
465,000
1,493,000
14,000
$ 2,115,500

797
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Prob. 143A

Concluded
Liabilities

Current liabilities:
Accounts payable..................................
Employee termination obligation.........
Income tax payable ...............................
Dividends payable.................................
Deferred income taxes payable ...........
Total current liabilities ......................
Deferred credits:
Deferred income taxes payable ...........
Total liabilities ..............................................
Stockholders Equity
Paid-In capital:
Preferred 8% stock, $100 par
(10,000 shares authorized;
2,000 shares issued) .........................
$200,000
Excess of issue price over par.............
8,000
Common stock, $1 par (100,000
shares authorized; 82,000 shares
issued) ................................................
$ 82,000
Excess of issue price over par.............
451,000
From sale of treasury stock .................
Total paid-in capital...........................
Retained earnings ........................................
Deduct treasury common stock (2,000
shares at cost).......................................
Less accumulated other comprehensive
loss.........................................................
Total stockholders equity...........................
Total liabilities and stockholders
equity..................................................

47,800
45,000
11,200
12,750
5,400
$

122,150

22,900
145,050

$ 208,000

533,000
16,000
$ 757,000
1,281,450
$2,038,450
40,000
28,000
1,970,450
$ 2,115,500

798
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Prob. 144A
2006
Jan. 3
July
Dec.

2
5

2009
Jan. 2
July

Investment in Nichols Corporation Stock.........

Cash .................................................................

220,480

Cash .....................................................................
Dividend Revenue...........................................

5,000

Cash .....................................................................
Dividend Revenue...........................................

5,400

Investment in Telico Inc. Stock .........................

Cash .................................................................

540,000

Cash .....................................................................
Dividend Revenue...........................................

5,000

220,480
5,000
5,400

540,000
5,000

MemoReceived a dividend of 160 shares of

Nichols Corporation stock. Number of shares
held, 4,160. Cost basis per share,
$220,480/4,160 shares = $53.00.
Oct. 23

Dec. 10

31
31

Cash .....................................................................
Investment in Nichols Corporation Stock.....
Gain on Sale of Investments..........................
*800 shares $53 per share

54,260

Cash .....................................................................
Dividend Revenue...........................................
(4,160 800 = 3,360 shares;
3,360 $1.50 = $5,040).

5,040

Cash .....................................................................
Investment in Telico Inc. Stock .....................

38,000

Investment in Telico Inc. Stock .........................

Income of Telico Inc. ......................................
($260,000 25% = $65,000).

65,000

42,400*
11,860

5,040

38,000
65,000

[Note: 25% = 32,000 shares/128,000 shares from January 2, 2009.]

799
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Prob. 141B
1. and 2.
Deferred Income
Tax Payable

Year

Income Tax
Deducted
on Income
Statement

Income Tax
Payments for
the Year

First
Second
Third
Fourth
Total

$ 17,500
22,750
31,500
35,000
$106,750

$ 12,250
21,000
34,300
39,200
$106,750

Year's Addition
(Deduction)
$ 5,250
1,750
(2,800)
(4,200)
$
0

Year-End
Balance
$5,250
7,000
4,200
0

800
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Prob. 142B
ATV INC.
Income Statement
For the Year Ended March 31, 2008
Sales....................................................................
Cost of merchandise sold .................................
Gross profit.........................................................
Operating expenses:
Selling expenses:
Sales salaries expense ..............................
Advertising expense ..................................
Depreciation expensestore equipment.
Miscellaneous selling expense .................
Total selling expenses ............................
Administrative expenses:
Office salaries expense .............................
Rent expense..............................................
Depreciation expenseoffice equipment
Miscellaneous administrative expense ....
Total administrative expenses ...............
Special charges:
Loss from fixed asset impairment ................
Restructuring charge .....................................
Total special charges.................................
Total expenses ...................................................
Income from continuing operations before
other income and expenses ..........................
Other income and expenses:
Interest revenue .............................................
Income from continuing operations before
income tax ......................................................
Income tax expense ...........................................
Income from continuing operations .................
Loss from discontinued operations ...................
Less applicable income tax...............................
Income before extraordinary item.....................
Extraordinary item:
Gain on condemnation of land......................
Less applicable income tax...........................
Net income..........................................................
Earnings per share:
Income from continuing operations .............
Loss from discontinued operations .............
Income before extraordinary item.................
Extraordinary item..........................................
Net income..................................................

$2,800,000
1,640,000
$1,160,000
$160,000
36,000
145,000
25,000
$366,000
$230,000
100,000
32,000
41,000
403,000
$ 32,000
70,000
102,000
871,000
$ 289,000
25,000
$ 314,000
94,200
$ 219,800
$ 78,000
23,400
$ 54,000
16,200

54,600
$ 165,200
37,800
$ 203,000
$
$
$

10.99
(2.73)
8.26
1.89
10.15

Note: Unrealized loss on temporary investments would be an other comprehensive

income item, not included on the income statement in determining net income.
801
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Prob. 143B
1.
DISK N DAT CORPORATION
Income Statement
For the Year Ended August 31, 2008
Sales......................................................................................
Cost of merchandise sold ...................................................
Gross profit...........................................................................
Expenses:
Selling expenses.............................................................
Administrative expenses................................................
Loss from fixed asset impairment.................................
Restructuring charge......................................................
Total expenses ............................................................
Income from operations ......................................................
Other expenses:
Interest expense..............................................................
Interest revenue ..............................................................
Income from continuing operations before income tax....
Income tax expense .............................................................
Income from continuing operations ...................................
Loss from discontinued operations ...................................
Less applicable income tax.................................................
Income before extraordinary item.......................................
Extraordinary item:
Gain on condemnation of land ......................................
Less applicable income tax ...........................................
Net income............................................................................
Earnings per common share:
Income from continuing operations ............................
Loss on discontinued operations ................................
Income before extraordinary item................................
Extraordinary item.........................................................
Net income .................................................................

$550,000
232,000
$318,000
$ 60,000
23,000
14,000
45,000
142,000
$176,000
$ (3,000)
2,500

$ 36,000
14,400

$ 75,000
30,000

(500)
$175,500
70,200
$105,300
21,600
$ 83,700

45,000
$128,700
$
$
$

2.14*
0.48
1.66
1.00
2.66

*($105,300 $9,000)/45,000 shares

802
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Prob. 143B

Continued

2.
DISK N DAT CORPORATION
Retained Earnings Statement
For the Year Ended August 31, 2008
Retained earnings, September 1, 2007.......
Net income....................................................
Less dividends declared:
Cash dividends......................................
Stock dividends.....................................
Increase in retained earnings......................
Retained earnings, August 31, 2008 ...........

$397,950
$128,700
$ 30,000
5,000

35,000
93,700
$491,650

3.
DISK N DAT CORPORATION
Balance Sheet
August 31, 2008
Assets
Current assets:
Cash .......................................................
Temporary investments in marketable
equity securities (at cost) .................
Plus unrealized gain .............................
Accounts receivable .............................
Less allowance for doubtful accounts
Merchandise inventory, at lower of
cost (FIFO) or market ........................
Interest receivable.................................
Prepaid expenses..................................
Total current assets ..........................
Property, plant, and equipment:
Equipment..............................................
Less accumulated depreciation...........
Total property, plant, and equipment
Intangible assets:
Patents ...................................................
Total assets ..................................................

$
$125,000
9,000
$ 28,000
2,500

87,500

134,000
25,500
87,000
500
15,900
$ 350,400
$1,350,000
145,000
1,205,000
40,000
$1,595,400

803
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Prob. 143B

Concluded
Liabilities

Current liabilities:
Accounts payable..................................
Employee termination obligation.........
Income tax payable ...............................
Dividends payable.................................
Deferred income taxes payable ...........
Total current liabilities ......................
Deferred credits:
Deferred income taxes payable ...........
Total liabilities ..............................................

12,000
30,000
21,450
7,500
4,700
$

75,650

8,100
83,750

Stockholders Equity
Paid-in capital:
Preferred 6% stock, $100 par
(30,000 shares authorized;
1,500 shares issued) .........................
$150,000
Excess of issue price over par.............
20,000 $ 170,000
Common stock, $1 par (100,000
shares authorized; 46,000 shares
issued) ................................................
$ 46,000
866,000
Excess of issue price over par.............
820,000
From sale of treasury stock .................
5,000
Total paid-in capital...........................
$1,041,000
Retained earnings ........................................
491,650
$1,532,650
Deduct treasury common stock (1,000
shares at cost).......................................
30,000
Plus accumulated other comprehensive
income....................................................
9,000
Total stockholders equity...........................
1,511,650
Total liabilities and stockholders
equity......................................................
$1,595,400

804
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Prob. 144B
2006
Feb. 10
July 15
Dec. 15
2009
Jan. 3
Apr. 14

Investment in Mode Corporation Stock ............

Cash .................................................................

288,864

Cash .....................................................................
Dividend Revenue...........................................

8,800

Cash .....................................................................
Dividend Revenue...........................................

9,200

Investment in Applause Inc. Stock....................

Cash .................................................................

675,000

Cash .....................................................................
Dividend Revenue...........................................

8,800

288,864
8,800
9,200

675,000
8,800

MemoReceived a dividend of 160 shares

of Mode Corporation stock. Number of
shares held, 8,160. Cost basis per share,
$288,864/8,160 shares = $35.40.
July 26

Dec. 15

31
31

Cash .....................................................................
Loss on Sales of Investments ...........................
Investment in Mode Corporation Stock ........

31,875
3,525

Cash .....................................................................
Dividend Revenue...........................................
(8,160 1,000 = 7,160 shares;
7,160 $1.20 = $8,592).

8,592

Cash .....................................................................
Investment in Applause Inc. Stock................

12,500

Investment in Applause Inc. Stock....................

Income of Applause Inc. ................................
($325,000 30% = $97,500).

97,500

35,400
8,592

12,500
97,500

[Note: 30% = 30,000 shares/100,000 shares from January 3, 2009.]

805
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SPECIAL ACTIVITIES
SA 141
Yes. In this case, the equity method is required because Goodyear owns enough
of the voting stock of the investee to have a significant influence over its operating and financing policies.

SA 142
1.
MERCURY SHOES INC.
Vertical Analysis of Income Statement
For the Years Ended December 31, 2008 and 2007
2008
Sales............................................................
Cost of merchandise sold .........................
Gross profit.................................................
Selling and administrative expenses........
Loss on fixed asset impairment................
Income from operations ............................
Income tax expense ...................................
Net income..................................................
2.

$510,000 100.0%
224,400
44.0
$285,600
56.0
122,400
24.0
127,500
25.0
$ 35,700
7.0
14,280
2.8
$ 21,420
4.2%

2007
$430,000 100.0%
193,500
45.0
$236,500
55.0
107,500
25.0
0.0
$129,000
30.0
51,600
12.0
$ 77,400
18.0%

The operating income is 30% of sales in 2007 but only 7% of sales in 2008.
Net income dropped from $77,400 to $21,420. This would seem to indicate a
large reduction in performance in 2008. However, the loss on the fixed asset
impairment, which is unusual, is 25% of sales. Without this loss, the income
from operations would have been 32% of sales, or 2 points better than 2007.
Combining this with growing sales from $430,000 to $510,000 would indicate
that the company is doing well on a recurring basis.
There is some concern that management was unable to successfully complete the software project. Order management is an important capability for a
retailer, so this event should not be completely ignored. The loss clearly indicates a failed effort at meeting an important operational objective. This need
is still outstanding, will require future effort, and may limit future growth.
However, the financial numbers would seem to indicate that the recurring, or
core, earnings and growth are on track.

806
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SA 143
a.

The other comprehensive income or loss for the period is the difference in
the accumulated other comprehensive income (loss) shown on the balance
sheet [($170) ($131)] between the two comparative periods, or a $39 other
comprehensive loss.

b. The other comprehensive loss items are adjustments to stockholders equity

that do not flow through the income statement. The FASB created this category of disclosure to recognize economic events that impact stockholders
equity but are considered too controversial to be included in earnings. In a
sense, this is a middle ground solution where the items are not ignored, nor
are they considered part of net income.
Note to Instructors: The common stock balance of $0 for December 31, 2005,
is the result of common stock repurchase and retirement. This does not mean
that there are no shares outstanding. Rather, the company has been able to
essentially eliminate the book value of the original equity investment through
share repurchases. This is highly unusual and an interesting item to point out
in discussing this activity.

SA 144
No. Although Dillon will not be lying about the amount of total earnings per share
of $1.05, it would be clearly misleading not to identify the impact of the extraordinary gain of $0.20 related to the selling of the land. In addition to being unethical
and unprofessional, Dillon may violate federal securities laws if he sells his stock
after the announcement. In this case, it might be alleged that Dillon traded on insider information for his own profit.

807
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SA 145
To be classified as an extraordinary item, an event must meet both of the following requirements:
a.

Unusual natureThe event should be significantly different from the typical

or the normal operating activities of the entity.

b. Infrequent occurrenceThe event should not be expected to recur often.

Events that meet both of the preceding requirements are uncommon. Usually, extraordinary items result from natural disasters, such as floods, earthquakes, and
fires. Thus, your first impression might be that the frost damage for Sunshine
Fruit would qualify as an extraordinary item. However, this is not the case. In an
accounting interpretation of a similar case, it was ruled that frost damage experienced by a Florida citrus grower did not meet the criterion of infrequent in occurrence. Frost damage is normally experienced in Florida every three to four
years. Thus, the history of past losses would suggest that such damage can be
expected to occur again in the foreseeable future. The fact that Sunshine Fruit
had not had frost damage in the previous five years is not sufficient to meet the
infrequency of occurrence criterion. It would, however, be acceptable to identify
the losses from frost damage as a separate line item above the income from continuing operations.

808
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SA 146
Note to Instructors: The purpose of this activity is to familiarize students with extraordinary items and discontinued operations reported by real companies and to
determine the impact of these items on earnings per share.
The following is an example from Reynolds American Inc.s comparative income
statements, beginning with income for continuing operations before taxes:
Reynolds American Inc.
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(Dollars in Millions, Except Per Share Amounts)
For the Years Ended
December 31,
2005
2004
2003
Income (loss) from continuing operations before
income taxes..................................................................
Provision for (benefit from) income taxes .......................
Income (loss) from continuing operations..................
Discontinued operations:
Gain on sale of discontinued businesses, net of
income taxes (2005$1; 2004$6; 2003$97).....
Income (loss) before extraordinary item.................
Extraordinary itemgain on acquisition .........................
Net income (loss) ......................................................

$ 1,416
431
985

$ 829
202
627

$(3,918)
(229)
(3,689)

2
987
55
$ 1,042

12
639
49
$ 688

122
(3,567)
121
$(3,446)

Basic income (loss) per share:

Income (loss) from continuing operations..................
Gain on sale of discontinued businesses...................
Extraordinary item.........................................................
Net income (loss) ......................................................

$ 6.68
0.01
0.38
$ 7.07

$ 5.66
0.111.46
0.44
$ 6.21

$(44.08)
1.45
$(41.17)

809
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This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. This may not be
resold, copied, or distributed without the prior consent of the publisher.