Chap 004

Chapter 4
The Income Statement, Comprehensive Income, and

the Statement of Cash Flows
AACSB assurance of learning standards in accounting and business education require documentation
of outcomes assessment. Although schools, departments, and faculty may approach assessment and
its documentation differently, one approach is to provide specific questions on exams that become the
basis for assessment. To aid faculty in this endeavor, we have labeled each question, exercise, and
problem in Intermediate Accounting, 7e, with the following AACSB learning skills:
Questions
41
42
43
44
45
46
47
48
49
410
411
412
413
414
415
416
417
418
419
420
421
AACSB Tags
Reflective thinking
Reflective thinking
Reflective thinking
Reflective thinking
Reflective thinking
Reflective thinking
Reflective thinking
Reflective thinking
Reflective thinking
Reflective thinking
Reflective thinking, Commun.
Reflective thinking
Reflective thinking
Reflective thinking
Reflective thinking
Reflective thinking
Reflective thinking
Reflective thinking
Reflective thinking
Reflective thinking
Reflective thinking
Brief Exercises
41
42
43
44
45
46
47
48
49
410
411
412
413
Solutions Manual, Vol.1, Chapter 4
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Brief Exercise
AACSB Tags
414
Reflective thinking, Commun.
Exercises
41
42
43
44
45
46
47
48
49
410
411
412
413
414
415
416
417
418
419
420
421
422
CPA/CMA
1
2
3
4
5
6
7
8
1
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Reflective thinking
Analytic
Reflective thinking
Analytic
Diversity, Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Communications
Communications
Reflective thinking
Reflective thinking
Analytic
Analytic
Analytic
Reflective thinking
Reflective thinking
Reflective thinking
Reflective thinking
Reflective thinking
The McGraw-Hill Companies, Inc., 2013

41
CPA/CMA
AACSB Tags
2
3
Reflective thinking
Reflective thinking
Problems
41
42
43
45
46
47
48
49
410
411
Analytic
Analytic, Reflective thinking
Analytic, Reflective thinking
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic

42
Intermediate Accounting, 7/e
QUESTIONS FOR REVIEW OF KEY TOPICS

Question 41
The income statement is a change statement that reports transactionsrevenues, expenses,
gains, and lossesthat cause owners equity to change during a specified reporting period.
Question 42
Income from continuing operations includes the revenue, expense, gain, and loss transactions
that will probably continue in future periods. It is important to segregate the income effects of these
items because they are the most important transactions in terms of predicting future cash flows.
Question 43
Operating income includes revenues and expenses and gains and losses that are directly related
to the principal revenue generating activities of the company. Nonoperating income includes items
that are not directly related to these activities.
Question 44
The single-step format first lists all revenues and gains included in income from continuing
operations to arrive at total revenues and gains. All expenses and losses are then grouped and
subtotaled, subtracted from revenues and gains to arrive at income from continuing operations. The
multiple-step format reports a series (multiple) of intermediate totals such as gross profit, operating
income, and income before taxes. Very often income statements adopt variations of these formats,
falling somewhere in between the two extremes.
Question 45
The term earnings quality refers to the ability of reported earnings (income) to predict a
companys future earnings. After all, an income statement simply reports on events that already have
occurred. The relevance of any historical-based financial statement hinges on its predictive value.
Question 46
Restructuring costs include costs associated with shutdown or relocation of facilities or
downsizing of operations. They are reported as an operating expense in the income statement.
Question 47
The process of intraperiod tax allocation matches tax expense or tax benefit with each major
component of income, specifically continuing operations and any item reported below continuing
operations. The process is necessary to achieve the desired result of separating the total income
effects of continuing operations from the two separately reported itemsdiscontinued operations and
extraordinary itemsand also to show the after-tax effect of each of those two components.

43
Answers to Questions (continued)

Question 48
The net-of-tax income effects of a discontinued operation must be disclosed separately in the
income statement, below income from continuing operations. The income effects include income
(loss) from operations and gain (loss) on disposal. The gain or loss on disposal must be disclosed
either on the face of the statement or in a disclosure note. If the component is held for sale but not
sold by the end of the reporting period, the income effects will include income (loss) from operations
and an impairment loss if the fair value less costs to sell is less than the book value of the components
assets. The income (loss) from operations of the component is reported separately in discontinued
operations on prior income statements presented for comparative purposes.
Question 49
Extraordinary items are material gains and losses that are both unusual in nature and infrequent
in occurrence, taking into account the environment in which the entity operates.
Question 410
Extraordinary gains and losses are presented, net of tax, in the income statement below
discontinued operations, if any.

44

Question 411
GAAP permit alternative treatments for similar transactions. Common examples are the choice
among FIFO, LIFO, and average cost for the measurement of inventory and the choice among
alternative revenue recognition methods. A change in accounting principle occurs when a company
changes from one generally accepted treatment to another.
In general, we report voluntary changes in accounting principles retrospectively. This means
revising all previous periods financial statements as if the new method were used in those periods. In
other words, for each year in the comparative statements reported, we revise the balance of each
account affected. Specifically, we make those statements appear as if the newly adopted accounting
method had been applied all along. Also, if retained earnings is one of the accounts whose balance
requires adjustment (and it usually is), we revise the beginning balance of retained earnings for the
earliest period reported in the comparative statements of shareholders equity (or statements of
retained earnings if theyre presented instead). Then we create a journal entry to adjust all account
balances affected as of the date of the change. In the first set of financial statements after the change,
a disclosure note would describe the change and justify the new method as preferable. It also would
describe the effects of the change on all items affected, including the fact that the retained earnings
balance was revised in the statement of shareholders equity along with the cumulative effect of the
change in retained earnings.
An exception is a change in depreciation, amortization, or depletion method. These changes are
accounted for as a change in estimate, rather than as a change in accounting principle. Changes in
estimates are accounted for prospectively. The remaining book value is depreciated, amortized, or
depleted, using the new method, over the remaining useful life.
Question 412
A change in accounting estimate is accounted for in the year of the change and in subsequent
periods; prior years financial statements are not restated. A disclosure note should justify that the
change is preferable and should describe the effect of a change on any financial statement line items
and per share amounts affected for all periods reported.
Question 413
Prior period adjustments are accounted for by restating prior years financial statements when
those statements are presented again for comparison purposes. The beginning of period retained
earnings is increased or decreased on the statement of shareholders equity (or the statement of
retained earnings) as of the beginning of the earliest period presented.

45

Question 414
Earnings per share (EPS) is the amount of income achieved during a period for each share of
common stock outstanding. If there are different components of income reported below continuing
operations, their effects on earnings per share must be disclosed. If a period contains discontinued
operations and extraordinary items, EPS data must be reported separately for income from continuing
operations and net income. Per share amounts for discontinued operations and extraordinary items
would be disclosed on the face of the income statement.
Question 415
Comprehensive income is the total change in equity for a reporting period other than from
transactions with owners. Reporting comprehensive income can be accomplished with a continuous
statement of comprehensive income that includes an income statement and other comprehensive
income items or in two statements, an income statement and a separate statement of comprehensive
income.
Question 416
The purpose of the statement of cash flows is to provide information about the cash receipts and
cash disbursements of an enterprise during a period. Similar to the income statement, it is a change
statement, summarizing the transactions that caused cash to change during a particular period of time.
Question 417
The three categories of cash flows reported on the statement of cash flows are:
1. Operating activitiesInflows and outflows of cash related to the transactions entering into
the determination of net income from operations.
2. Investing activitiesInvolve the acquisition and sale of (1) long-term assets used in the
business and (2) nonoperating investment assets.
3. Financing activitiesInvolve cash inflows and outflows from transactions with creditors
and owners.
Question 418
Noncash investing and financing activities are transactions that do not increase or decrease cash
but are important investing and financing activities. An example would be the acquisition of property,
plant, and equipment (an investing activity) by issuing either long-term debt or equity securities (a
financing activity). These activities are reported either on the face of the statement of cash flows or in
a disclosure note.
Question 419
The direct method of reporting cash flows from operating activities presents the cash effect of
each operating activity directly on the statement of cash flows. The indirect method of reporting cash
flows from operating activities is derived indirectly, by starting with reported net income and adding
and subtracting items to convert that amount to a cash basis.

46
Answers to Questions (concluded)

Question 420
There are two possible separately reported items that could appear in income statements,
discontinued operations and extraordinary items. International Financial Reporting Standards (IFRS)
prohibit reporting extraordinary items.
Question 421
U.S. GAAP designates cash outflows for interest payments and cash inflows from interest and
dividends received as operating cash flows. Dividends paid to shareholders are classified as financing
cash flows. IFRS allows more flexibility. Companies can report interest and dividends paid as either
operating or financing cash flows and interest and dividends received as either operating or investing
cash flows. Interest and dividend payments usually are reported as financing activities. Interest and
dividends received normally are classified as investing activities.
BRIEF
EXERCISES
Brief
Exercise 41
PACIFIC SCIENTIFIC CORPORATION
Income Statement
For the Year Ended December 31, 2013
($ in millions)
Revenues and gains:

Sales ..................................................................
Gain on sale of investments ...............................
Total revenues and gains ................................
Expenses and losses:
Cost of goods sold .............................................
Selling................................................................
General and administrative.................................
Interest...............................................................
Total expenses and losses ..............................
Income before income taxes ................................
Income tax expense*............................................
Net income ...........................................................
$2,106
45
2,151
$1,240
126
105
35
1,506
645
258
$ 387

47
* $645 x 40% = $258
Brief Exercise 42
(a)
Sales revenue
$2,106
Less: Cost of goods sold

(1,240)
Gross profit
866
Less: Selling expenses
(126)
General and administrative expenses
(105)
Operating income
$ 635
(b)
Gain on sale of investments

Interest expense
Nonoperating income
45
(35)
$10
Brief Exercise 43
PACIFIC SCIENTIFIC CORPORATION

Income Statement
($ in millions)
Sales revenue .......................................................

Cost of goods sold ...............................................
Gross profit ..........................................................
Operating expenses:
Selling................................................................
Total operating expenses ................................
Operating income .................................................
Other income (expense):
Interest expense .................................................
Total other income, net ..................................
Income before income taxes ...............................
Income tax expense* ............................................
Net income ...........................................................
48
$2,106
1,240
866
$126
105
231
635
45
(35)
10
645
258
$ 387
*$645 x 40%
Brief Exercise 44
(a)
Less: Cost of goods sold

General and administrative expenses
Restructuring costs
Selling expenses
Operating income
Sales revenue
$300,000
(160,000)
(40,000)
(50,000)
(25,000)
$ 25,000
(b)
Operating income
Add: Interest revenue
Deduct: Loss on sale of investments
Income before income taxes and
Income tax expense (40%)
Income before extraordinary item
$25,000
4,000
(22,000)
7,000
(2,800)
$ 4,200
(c)
Income before extraordinary item

Extraordinary item:
Loss from flood damage, net of $20,000
tax benefit
Net loss
$ 4,200
(30,000)
(25,800)
Brief Exercise 45
MEMORAX COMPANY
Partial Income Statement
Income before income taxes and extraordinary item............
Income tax expense* ...........................................................
Income before extraordinary item .......................................
Extraordinary item:
Loss from earthquake, net of $208,000 tax benefit...........
Net income ...........................................................................
$ 790,000
316,000
474,000
(312,000)
$ 162,000

49
*$790,000 x 40%
Brief Exercise 46
WHITE AND SONS, INC.
Income before income taxes and extraordinary item............
Income tax expense* ...........................................................
Income before extraordinary item .......................................
Extraordinary item:
Loss from earthquake, net of $160,000 tax benefit...........
Net income ...........................................................................
$ 850,000
340,000
510,000
(240,000)
$ 270,000
Earnings per share:

Income before extraordinary item........................................
Loss from earthquake ..........................................................
Net income ..........................................................................
$ 5.10
(2.40)
$ 2.70
*$850,000 x 40%
Note: Restructuring costs, interest revenue, and loss on sale of investments are
included in income before income taxes and extraordinary item.
Brief Exercise 47
CALIFORNIA MICROTECH CORPORATION
Income from continuing operations before income taxes.....
Income tax expense* ............................................................
Income from continuing operations .....................................
Discontinued operations:
410
$ 5,800,000
1,740,000
$ 4,060,000
Loss from operations of discontinued component

(including gain on disposal of $2,000,000)** ...........................
Income tax benefit ............................................................
Loss on discontinued operations .......................................
Net income ...........................................................................
(1,600,000)
480,000
(1,120,000)
$ 2,940,000
* $5,800,000 x 30%
** Loss from operations of discontinued component:
Gain on sale of assets
Loss from operations
Total before-tax loss
$ 2,000,000 ($10 million less $8 million)

(3,600,000)
$(1,600,000)
Brief Exercise 48
Loss from operations of discontinued component** .........
Net income ...........................................................................
$ 5,800,000
1,740,000
$ 4,060,000
(3,600,000)
1,080,000
(2,520,000)
$ 1,540,000
* $5,800,000 x 30%
** Includes only the loss from operations. There is no impairment loss.
Brief Exercise 49

411

(including impairment loss of $1,000,000)** ............................
Net income ...........................................................................
$ 5,800,000
1,740,000
$ 4,060,000
(4,600,000)
1,380,000
(3,220,000)
$ 840,000
* $5,800,000 x 30%
** Loss from operations of discontinued component:
Impairment loss ($8 million book value less
$7 million net fair value)

412
$(1,000,000)
(3,600,000)
$(4,600,000)
Brief Exercise 410

OREILLY BEVERAGE COMPANY
Statement of Comprehensive Income
Net income ...........................................................
Other comprehensive income (loss):
Deferred loss on derivatives, net of tax ............
Unrealized gains on investment securities,
net of tax ........................................................
Total other comprehensive loss ............................
Comprehensive income ........................................
$650,000
$(36,000)
24,000
(12,000)
$638,000
Brief Exercise 411

Cash flows from operating activities:
Collections from customers
Interest on note receivable
Interest on note payable
Payment of operating expenses
Net cash flows from operating activities
$ 660,000
12,000
(18,000)
(440,000)
$214,000
Only these four cash flow transactions relate to operating activities. The others are
investing and financing activities.
Brief Exercise 412

Cash flows from investing activities:
Proceeds from note receivable collection
Sale of land
$100,000
40,000
413
Purchase of equipment
Net cash flows from investing activities
Cash flows from financing activities:
Issuance of common stock
Payment of dividends
Net cash flows from financing activities
(120,000)
$20,000
$200,000
(30,000)
170,000
Brief Exercise 413

Net income
Adjustments for noncash effects:
Depreciation expense
Changes in operating assets and liabilities:
Increase in prepaid rent
Increase in salaries payable
Increase in income taxes payable
Net cash inflows from operating activities
Brief Exercise
$45,000
80,000
(60,000)
15,000
12,000
$92,000
Under IFRS, interest received and interest paid usually

414 are classified as investing and financing cash flows,
respectively, not operating cash flows as with U.S. GAAP.
The revised cash flow categories usually would appear as
follows:
Proceeds from note receivable collection
Sale of land
414
$ 660,000
(440,000)
$220,000
$100,000
40,000
12,000
(120,000)
$32,000
$200,000
(30,000)
(18,000)
152,000
EXERCISES
Exercise 41
Requirement 1
GREEN STAR CORPORATION
Income Statement
Revenues and gains:
Sales ..................................................................
Interest ..............................................................
Selling................................................................
Interest...............................................................
Income before income taxes ................................
Income tax expense .............................................
Net income ...........................................................
Earnings per share ...............................................
$1,300,000
30,000
50,000
1,380,000
$720,000
160,000
75,000
40,000
995,000
385,000
130,000
$ 255,000
$2.55

415
Exercise 41 (concluded)
Requirement 2
GREEN STAR CORPORATION
Income Statement
Sales revenue .......................................................
Gross profit ..........................................................
Operating expenses:
Selling................................................................
Interest revenue .................................................
Total other income, net ..................................
Income before income taxes ...............................
Net income ...........................................................
Earnings per share ...............................................

416
$1,300,000
720,000
580,000
$160,000
75,000
235,000
345,000
30,000
50,000
(40,000)
40,000
385,000
130,000
$ 255,000
$2.55
Exercise 42
Requirement 1
GENERAL LIGHTING CORPORATION

Income Statement
Revenues and gains:
Sales ..................................................................
Rental revenue ..................................................
Selling ...............................................................
Interest...............................................................
Loss on sale of investments ...............................
Loss from inventory write-down .......................
Income before income taxes and extraordinary
Item .
Income tax expense * .
Income before extraordinary item ........................
Extraordinary item:
Loss from flood damage (net of $48,000 tax benefit)
Net income ...........................................................
Earnings per share:
Extraordinary loss ................................................
Net income ...........................................................
$2,350,000
80,000
2,430,000
$1,200,300
300,000
150,000
90,000
22,500
200,000
1,962,800
467,200
186,880
280,320
(72,000)
$ 208,320
$ .93
(.24)
$ .69
* 40% x $467,200

417
Requirement 2
GENERAL LIGHTING CORPORATION
Income Statement
Sales revenue .......................................................
Gross profit ..........................................................
Operating expenses:
Selling ...............................................................
General and administrative ................................
Loss from inventory write-down .......................
Rental revenue ..................................................
Loss on sale of investments ...............................
Total other income (expense), net ..................
item....................................................................
Income tax expense *............................................
Extraordinary item:
Loss from flood damage (net of $48,000 tax benefit)
Net income ...........................................................
Earnings per share:
Extraordinary loss ................................................
Net income ...........................................................
$2,350,000
1,200,300
1,149,700
$300,000
150,000
200,000
650,000
499,700
80,000
(22,500)
(90,000)
(32,500)
467,200
186,880
280,320
(72,000)
$ 208,320
$ .93
(.24)
$ .69
* 40% x $467,200

418
Exercise 43
LINDOR CORPORATION
Sales revenue ....................................................................
Cost of goods sold ............................................................
Gross profit .......................................................................
$2,300,000
1,400,000
900,000
Operating expenses:
Selling and administrative...............................................
Operating income .............................................................
420,000
480,000

Interest expense ................................................................
Income before income taxes and extraordinary item.........
Income tax expense *........................................................
Income before extraordinary item .....................................
Extraordinary item:
Gain on litigation settlement (net of $120,000
tax expense) ...................................................................
Net income
Other comprehensive income:
Unrealized holding gains on investment securities,
net of tax ....................................................................
Comprehensive income .....................................................
56,000
$644,000
Earnings per share:

Extraordinary gain ............................................................
Net income .......................................................................
$ 0.31
0.28
$ 0.59
(40,000)
440,000
132,000
308,000
280,000
588,000
* 30% x $440,000
Exercise 44
AXEL CORPORATION
Income Statement
Sales revenue ....................................................................
$ 592,000
419

Gross profit .......................................................................
Operating expenses:
Selling ...........................................................................
Administrative ..............................................................
Restructuring costs ........................................................
Total operating expenses ............................................
Interest and dividends ....................................................
Interest expense .............................................................
Total other income, net ..................................................
Income before income taxes and extraordinary item.........
Income tax expense* ........................................................
Extraordinary item:
Gain on litigation settlement (net of $34,400
tax expense) ...................................................................
Net income .......................................................................
325,000
267,000
$67,000
87,000
55,000
209,000
58,000
32,000
(26,000)
Earnings per share:

Net income .......................................................................
6,000
64,000
25,600
38,400
51,600
$ 90,000
$ .38
.52
$0.90
* 40% x $64,000
Exercise 45
CHANCE COMPANY
(including loss on disposal of $400,000)* ................................
Net income ...........................................................................
420
$ 350,000
(530,000)
212,000
(318,000)
$ 32,000
Earnings per share:

Loss from discontinued operations ......................................
Net income ..........................................................................
$ 3.50
(3.18)
$ .32
* Loss on discontinued operations:

Loss on sale of assets
Less: Income tax benefit (40%)
Net-of-tax loss
$(400,000)
(130,000)
(530,000)
212,000
$(318,000)
Exercise 46
ESQUIRE COMIC BOOK COMPANY
Income from continuing operations * ...................................
$ 552,000
Income from operations of discontinued component
(including loss on disposal of $350,000) ..................................
Income tax expense ...........................................................
Income on discontinued operations ...................................
Net income............................................................................
150,000
60,000
90,000
$642,000
* Income from continuing operations:

Income before considering additional items
Decrease in income due to restructuring costs
Before-tax income from continuing operations
Income tax expense (40%)
Income from continuing operations
$1,000,000
(80,000)
920,000
(368,000)
$ 552,000
421
Exercise 47
Requirement 1
KANDON ENTERPRISES, INC.

$ 400,000
(including impairment loss of $50,000) * ...............................
Income tax benefit.............................................................
Net income ..........................................................................
(190,000)
76,000
(114,000)
$ 286,000
* Loss on discontinued operations:

Impairment loss ($250,000 200,000)
Net before-tax loss
Income tax benefit (40%)
Net after-tax loss on discontinued operations
$(140,000)
(50,000)
(190,000)
76,000
$(114,000)
Requirement 2
KANDON ENTERPRISES, INC.
$ 400,000
Loss from operations of discontinued component *..........
Net income ..........................................................................
(140,000)
56,000
(84,000)
$ 316,000
*Includes only the operating loss during the year. There is no impairment loss.
422
Exercise 48
Pretax income from continuing operations
Income tax expense
Less: Net income
Loss from discontinued operations
$14,000,000
(5,600,000)
8,400,000
7,200,000
$1,200,000
$1,200,000 60%* = $2,000,000 = Before-tax loss from discontinued

operations.
*1 tax rate of 40% = 60%
Pretax income of division
Add: Loss from discontinued operations
Impairment loss
Fair value of divisions assets
Add: Impairment loss
Book value of divisions assets
Exercise 49
$4,000,000
2,000,000
$6,000,000
$11,000,000
6,000,000
$17,000,000
Earnings per share:

Loss from discontinued operations
Extraordinary gain
Net income
$5.00
(1.60)
2.20
$5.60
Exercise 410
THE MASSOUD CONSULTING GROUP

423
Net income ...........................................................

Foreign currency translation gain, net of tax .....
Unrealized losses on investment securities,
net of tax ........................................................
Total other comprehensive income ......................
Comprehensive income ........................................
1.___ b
Exercise 411cash.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
a_
a_
c_
b_
c_
b_
a_
d_
c_
c_
$1,354,000
$168,000
(56,000)
112,000
$1,466,000
Purchase of equipment for
Payment of employee salaries.

Collection of cash from customers.
Cash proceeds from a note payable.
Purchase of common stock of another corporation for cash.
Issuance of common stock for cash.
Sale of machinery for cash.
Payment of interest on note payable.
Issuance of bonds payable in exchange for land and building.
Payment of cash dividends to shareholders.
Payment of principal on note payable.
Bluebonnet Bakers
Exercise 412
Statement of Cash Flows

$ 380,000
6,000
Purchase of inventory
(160,000)
(5,000)
Payment of salaries
(90,000)
Collection of note receivable
424
$131,000
50,000
Sale of investments
Proceeds from note payable
Payment of note payable
Net increase in cash
Cash and cash equivalents, January 1
Cash and cash equivalents, December 31
30,000
(85,000)
(5,000)
100,000
(25,000)
(20,000)
55,000
181,000
17,000
$ 198,000

425
Exercise 413
Cash collected for interest, considered an operating cash flow

by U.S. GAAP, could be classified as either an operating cash flow
or an investing cash flow according to International Accounting
Standards.
Cash paid for interest, considered an operating cash flow by U.S. GAAP, could be
classified as either an operating cash flow or a financing cash flow according to
International Accounting Standards.
Cash paid for dividends, considered a financing cash flow by U.S. GAAP, could
be classified as either an operating cash flow or a financing cash flow according to
International Accounting Standards.
Accordingly, the statement of cash flows prepared according to IFRS could be the
same as under U.S. GAAP (E412) or could be presented as follows:
BLUEBONNET BAKERS
$ 380,000
(160,000)
Payment of salaries
(90,000)
(20,000)
Sale of investments
50,000
6,000
30,000
(85,000)

Payment of note payable
100,000
(25,000)
(5,000)


426
$110,000
1,000
70,000
181,000
17,000
$ 198,000
Exercise 414
Net income
Increase in accounts receivable
Decrease in inventory
Decrease in prepaid insurance
Decrease in salaries payable
Increase in interest payable
$17,300
7,800
(4,000)
5,500
1,200
(2,700)
800
$25,900
Requirement 1
Exercise 415
1.
2.
3.
4.
5.
6.
7.
8.
9.
Financing
$300,000
Investing
Operating
$(10,000)
$ (5,000)
(6,000)
(70,000)
55,000
__________
__________
__________
$300,000
$(10,000)
$(26,000)
$264,000

427

Requirement 2
WAINWRIGHT CORPORATION
For the Month Ended March 31, 2013
Payment of rent
Payment of one-year insurance premium
Payment to suppliers of merchandise for sale
Cash and cash equivalents, March 1
Cash and cash equivalents, March 31
$ 55,000
(5,000)
(6,000)
(70,000)
$ (26,000)
(10,000)
(10,000)
300,000
300,000
264,000
40,000
$ 304,000
Noncash investing and financing activities:

Acquired $40,000 of equipment by paying cash and issuing a note as follows:
Cost of equipment
$40,000
Cash paid
10,000
Note issued
$30,000
Exercise 416
Net income
Depreciation and amortization expense
Decrease in accounts receivable
Increase in inventories
Increase in prepaid expenses
Increase in salaries payable
Decrease in income taxes payable
428
$624,000
87,000
22,000
(9,200)
(8,500)
10,000
(14,000)

$711,300
Consistent with U.S. GAAP, international standards also
require a statement of cash flows. Consistent with U.S. GAAP, cash
Exercise 417flows are classified as operating, investing, or financing. However,
the U.S. standard designates cash outflows for interest payments
and cash inflows from interest and dividends received as operating
cash flows. Dividends paid to shareholders are classified as financing cash flows.
IAS No. 7, on the other hand, allows more flexibility. Companies can report
interest and dividends paid as either operating or financing cash flows and interest and
dividends received as either operating or investing cash flows. Interest and dividend
payments usually are reported as financing activities. Interest and dividends received
normally are classified as investing activities.
Accordingly, the statement of cash flows prepared according to IFRS mostly likely
would be presented as follows (differences from U.S. GAAP in italics):
BRONCO METALS
$ 353,000
(186,000)
(67,000)
$100,000

Dividends received from investments
4,000
2,400
100,000
(154,000)
(47,600)

Payment of interest on note payable
Proceeds from issuance of common stock
Dividends paid
Exercise 418
(8,000)
200,000
(40,000)
152,000
204,400
28,600
$233,000
TIGER ENTERPRISES

429

($ in thousands)
Net income
$ 900
240
Decrease in accounts receivable
80
Increase in inventory
(40)
Increase in prepaid insurance
(30)
Decrease in accounts payable
(60)
Decrease in administrative and other payables (100)
Increase in income taxes payable
50
$1,040
Purchase of plant and equipment
(300)

Proceeds from issuance of common stock
100
200
Payment of dividends (1)
(940)
Net cash flows from financing activities(640)
100
Cash, January 1
Cash, December 31
200
$ 300
(1)
Retained earnings, beginning
+ Net income
Dividends
Retained earnings, ending
900
x
$500
$540
x = $940
The T-account analysis of the transactions related to operating

Exercise 419cash flows is shown below. To derive the cash flows, the beginning
and ending balances in the related assets and liabilities are inserted,
together with the revenue and expense amounts from the income
statements. In each balance sheet account, the remaining (plug) figure is the other half
of the cash increases or decreases.
430
Based on the information in the T-accounts above, the operating activities section
of the SCF for Tiger Enterprises would be as shown next.

431

TIGER ENTERPRISES
($ in thousands)
Prepayment of insurance
Payment to inventory suppliers
Payment for administrative & other exp.
Payment of income taxes
$ 7,080
(130)
(3,460)
(1,900)
(550)
$ 1,040
Exercise 420Requirement 1
FASB ASC 260: Earnings per Share.
Requirement 2
The specific citation that describes the additional information for earnings per
share that must be included in the notes to the financial statements is FASB ASC 260
10501: Earnings per ShareOverallDisclosure.
Requirement 3
For each period for which an income statement is presented, an entity discloses all
of the following:
a. A reconciliation of the numerators and the denominators of the basic and diluted
per-share computations for income from continuing operations. The reconciliation
includes the individual income and share amount effects of all securities that affect
earnings per share (EPS). Example 2 (see paragraph 260105551) illustrates
that disclosure. (See paragraph 26010453.) An entity is encouraged to refer to
pertinent information about securities included in the EPS computations that is
provided elsewhere in the financial statements as prescribed by Subtopic 505-10.
b. The effect that has been given to preferred dividends in arriving at income available
to common stockholders in computing basic EPS.

432
c. Securities (including those issuable pursuant to contingent stock agreements) that

could potentially dilute basic EPS in the future that were not included in the
computation of diluted EPS because to do so would have been antidilutive for the
period(s) presented. Full disclosure of the terms and conditions of these securities is
required even if a security is not included in diluted EPS in the current period.
For the latest period for which an income statement is presented, an entity must
provide a description of any transaction that occurs after the end of the most recent
period but before issuance of the financial statements that would have changed
materially the number of common shares or potential common shares outstanding at the
end of the period if the transaction had occurred before the end of the period. Examples
of those transactions include the issuance or acquisition of common shares; the issuance
of warrants, options, or convertible securities; the resolution of a contingency pursuant
to a contingent stock agreement; and the conversion or exercise of potential common
shares outstanding at the end of the period into common shares.
Exercise 421
1.
The FASB Accounting Standards Codification represents the

single source of authoritative U.S. generally accepted accounting
principles. The specific citation for each of the following items is:
The criteria for determining if a gain or loss should be reported as an

extraordinary item:
FASB ASC 22520452: Income StatementExtraordinary and Unusual
ItemsOther Presentation MattersCriteria for Presentation as Extraordinary.
Extraordinary items are events and transactions that are distinguished by their
unusual nature and by the infrequency of their occurrence. Thus, both of the
following criteria shall be met to classify an event or transaction as an
extraordinary item:
a. Unusual nature. The underlying event or transaction should possess a high
degree of abnormality and be of a type clearly unrelated to, or only incidentally
related to, the ordinary and typical activities of the entity, taking into account the
environment in which the entity operates.
b. Infrequency of occurrence. The underlying event or transaction should be of a
type that would not reasonably be expected to recur in the foreseeable future,
taking into account the environment in which the entity operates.
2.
The calculation of the weighted average number of shares for basic earnings
per share purposes:

433
FASB ASC 26010552: Earnings per ShareOverallImplementation

Guidance and IllustrationComputing a Weighted Average.
The weighted-average number of shares is an arithmetical mean average of
shares outstanding and assumed to be outstanding for EPS computations. The
most precise average would be the sum of the shares determined on a daily basis
divided by the number of days in the period. Less-precise averaging methods
may be used, however, as long as they produce reasonable results. Methods that
introduce artificial weighting, such as the Rule of 78 method, are not acceptable
for computing a weighted-average number of shares for EPS computations.

434
Exercise 421 (continued)

The alternative formats permissible for reporting comprehensive income:
3.
FASB ASC 22010451: Comprehensive IncomeOverallOther Presentation

ItemsReporting Comprehensive Income.
1A. An entity reporting comprehensive income in a single continuous financial

statement shall present its components in two sections, net income and other
comprehensive income. If applicable, an entity shall present the following in that
financial statement:
a. A total amount for net income together with the components that make up net
income.
b. A total amount for other comprehensive income together with the components
that make up other comprehensive income. As indicated in paragraph 22010
153, an entity that has no items of other comprehensive income in any period
presented is not required to report comprehensive income.
c. Total comprehensive income.
1B. An entity reporting comprehensive income in two separate but consecutive
statements shall present the following:
a. Components of and the total for net income in the statement of net income
b. Components of and the total for other comprehensive income as well as a
total for comprehensive income in the statement of other comprehensive income,
which shall be presented immediately after the statement of net income. A
reporting entity may begin the second statement with net income.
1C. An entity shall present, either in a single continuous statement of
comprehensive income or in a statement of net income and statement of other
comprehensive income, all items that meet the definition of comprehensive
income for the period in which those items are recognized. Components included
in other comprehensive income shall be classified based on their nature.

435

4.
The classifications of cash flows required in the statement of cash flows:

FASB ASC 23010451: Statement of Cash FlowsOverallOther
Presentation MattersForm and Content.
A statement of cash flows shall report the cash effects during a period of an
entity's operations, its investing transactions, and its financing transactions.
Exercise 422
436
List A
f
1. Intraperiod tax allocation
2. Comprehensive income
a 3. Extraordinary items
l
4. Operating income
k 5. A discontinued operation
j
6. Earnings per share
d 7. Prior period adjustment

e 8. Financing activities
h 9. Operating activities (SCF)
i 10. Investing activities
c 11. Direct method
b 12. Indirect method
List B
a. Unusual, infrequent, and material gains
and losses.
b. Starts with net income and works
backwards to convert to cash.
c. Reports the cash effects of each operating
activity directly on the statement.
d. Correction of a material error of a prior
period.
e. Related to the external financing of the
company.
f. Associates tax with income statement
item.
g. Total nonowner change in equity.
h. Related to the transactions entering into
the determination of net income.
i. Related to the acquisition and disposition
of long-term assets.
j. Required disclosure for publicly traded
corporation.
k. A component of an entity.
l. Directly related to principal revenuegenerating activities.

437
CPA / CMA REVIEW QUESTIONS

CPA Exam Questions
1. c. U.S. GAAP requires that discontinued operations be disclosed separately
below income from continuing operations.
2. d. Other than sales, COGS, and administrative expenses, only the gain or loss
from disposal of equipment is considered part of income from continuing
operations. Income from continuing operations was ($5,000,000 3,000,000
1,000,000 + 200,000) = $1,200,000.
3. a. In a single-step income statement, revenues include sales as well as other
revenues and gains.
Sales revenue
Interest revenue
Gain on sale of equipment
Total
$187,000
10,200
4,700
$201,900
The discontinued operations and the extraordinary gain are reported below
income from continuing operations.
4. a. The $400,000 impairment loss and the $1,000,000 loss from operations should
be combined for a total loss of $1,400,000.
5. a. Dividends paid to shareholders is considered a financing cash flow, not an
operating cash flow.
6. c. Issuing common stock for cash is considered a financing cash flow, not an
investing cash flow.
7. b. IFRS prohibits reporting extraordinary items, and restructuring costs are not
separately reported under both IFRS and U.S. GAAP. Both IFRS and U.S.
GAAP report discontinued operations as a separate item, net of tax.
438
8. c. Interest paid can be classified as either an operating or financing cash flow.

439
CMA Exam Questions

1.
d. Discontinued operations and extraordinary gains and losses are shown

separately in the income statement, below income from continuing operations.
The cumulative effect of most voluntary changes in accounting principle is
accounted for by retrospectively revising prior years financial statements.
2.
c. The operating section of a retailers income statement includes all

revenues and costs necessary for the operation of the retail establishment, for
example, sales, cost of goods sold, administrative expenses, and selling
expenses.
3.
a. Extraordinary items should be presented net of tax after income from

operations.
Problem
41
PROBLEMS
REED COMPANY
Comparative Income Statements
For the Years Ended December 31
Sales revenue .........................................................[1]
Cost of goods sold ................................................ [2]
Gross profit ...........................................................
2013
$4,000,000
2,570,000
1,430,000
Operating expenses:
Administrative .....................................................[3]
Selling ................................................................. [4]
Loss from fire damage .........................................
Loss from write-down of obsolete inventory .......
Total operating expenses .................................
Operating income ..................................................
750,000
340,000
50,000
35,000
1,175,000
255,000

Interest revenue ....................................................
Interest expense ...................................................
Total other expenses (net) ...............................
Income from continuing operations before
income taxes and extraordinary item................
Income tax expense ...............................................
440
[6]
[7]
[8]
[9]
2012
$3,000,000
1,680,000
1,320,000
635,000
282,000
--917,000
403,000
150,000
(200,000)
(50,000)
140,000
(200,000)
(60,000)
205,000
82,000
343,000
137,200

extraordinary item..............................................
Income (loss) from operations of discontinued
component (including loss on disposal of
$50,000 in 2013) ................................................
Income tax benefit (expense).................................
Income (loss) on discontinued operations ..........[5]
Income before extraordinary item .........................
Extraordinary item:
Loss from earthquake (net of $40,000 tax benefit) .
Net income ............................................................
Earnings per share:
extraordinary item.....................................................
Discontinued operations .............................................
Extraordinary loss ......................................................
Net income ...................................................................
123,000
205,800
(10,000)
4,000
(6,000)
117,000
110,000
(44,000)
66,000
271,800
(60,000)
$ 57,000
.41
(.02)
(.20)
$ .19
-$ 271,800
.69
.22
-$ .91

441
Problem 41 (concluded)
[1] $4,400,000 400,000
[2]
$2,860,000 290,000
[3]
$800,000 50,000
[4]
$360,000 20,000
[5] Loss in 2011:

Income from operations
Loss on sale of assets
Loss before tax benefit
Tax benefit (40% x $10,000)
Loss on discontinued operations, net of tax benefit
$ 40,000
(50,000)
(10,000)
4,000
$ (6,000)
[6]
$3,500,000 500,000 (sales from discontinued operation)
[7]
$2,000,000 320,000 (cost of goods sold from discontinued operation)
[8]
$675,000 40,000 (administrative expenses from discontinued operations)
[9]
$312,000 30,000 (selling expenses from discontinued operations)
Problem 42
Requirement 1
JACKSON HOLDING COMPANY

Comparative Income Statements (in part)
For the Years Ended December 31
2013
income taxes [1] .......................................... $3,000,000
Income tax expense ..........................................
1,200,000
Income from continuing operations ..................
1,800,000

442
2012
$1,300,000
520,000
780,000
Income (loss) from operations of discontinued

component (including gain on disposal of
$600,000 in 2011) [2] ........................................
Income tax benefit (expense)..........................
Income (loss) on discontinued operations ......
Net Income .......................................................
200,000
(80,000)
120,000
$1,920,000
(300,000)
120,000
(180,000)
$ 600,000
[1]
Income from continuing operations before income taxes:

2013
2012
Unadjusted
$2,600,000 $1,000,000
Add: Loss from discontinued operations
400,000
300,000
Adjusted
$3,000,000 $1,300,000
[2]
Income from discontinued operations:

2013
$(400,000)
Gain on disposal
600,000
Total
$ 200,000
2012
$(300,000)
$(300,000)

443
Requirement 2
The 2013 income from discontinued operations would include only the loss from
operations of $400,000. Since no impairment loss is indicated ($5,000,000 4,400,000
= $600,000 anticipated gain), none is included. The anticipated gain on disposal is not
recognized until it is realized, presumably in the following year.
Requirement 3
The 2013 income from discontinued operations would include the loss from
operations of $400,000 as well as an impairment loss of $500,000 ($4,400,000 book
value of assets less $3,900,000 fair value).
Problem 43Requirement 1
MICRON CORPORATION
income taxes and extraordinary item.........
Income tax expense .....................................
extraordinary item........................................
Loss from operations of discontinued
component (including loss on disposal of
$300,000)
...................................................................
Income tax benefit
...................................................................
Loss on discontinued operations ...............
Income before extraordinary item ...............
Extraordinary item:
Loss from earthquake
(net of $240,000 tax benefit) ......................
444
[1] $1,300,000
390,000
910,000
$(140,000)
42,000
[2]
(98,000)
812,000
(560,000)
$ 252,000
Net Income ..................................................
[1] Income from continuing operations before taxes:

Unadjusted
$1,200,000
Add: Gain from sale of factory
100,000
Adjusted
$1,300,000
[2] Loss on discontinued operations:
Income from operations
Deduct: Loss on sale of assets
Loss before tax
Tax benefit (30% x $140,000)
Loss on discontinued operations
$ 160,000
(300,000)
(140,000)
42,000
$ (98,000)
Requirement 2
These events will not, or are unlikely to occur again in the near future. By
segregating them, users are better able to predict future cash flows.
1. Restructuring is an example of an event that is either unusual or
Problem 44 infrequent, but not both. Restructuring costs should be included in
income from continuing operations but reported as a separate
income statement component. The item is reported gross, not net
of tax as with extraordinary gains and losses.
2. The extraordinary gain should be presented, net of tax, in the income statement
below income from continuing operations. Also, earnings per share for income from
continuing operations and for the extraordinary item should be disclosed.
3. The correction of the error should be treated as a prior period adjustment to
beginning retained earnings, not as an adjustment to current year's cost of goods
sold. In addition, the 2012 financial statements should be restated to reflect the
correction, and a disclosure note is required that communicates the impact of the
error on 2012 income.
Problem 45
ALEXIAN SYSTEMS, INC.
Income Statement
($ in millions except per share date)
Net sales revenue .................................................

[1]
$425
265

445
Gross profit ..........................................................

Operating expenses:
Selling and administrative .................................
Restructuring costs ............................................
160
[2] $128
26
154
6
Other income:
Interest revenue .................................................
Total other income .........................................
item...................................................................
Extraordinary gain (net of $48 tax expense) ................
Net income ...........................................................
3
6
9
[3]
[4]
Earnings per share:

Extraordinary gain ...............................................
Net income ...........................................................
15
6
9
72
$ 81
$ 0.45
3.60
$ 4.05
[1] $270 5 (prior period adjustment)

[2] $154 26 (restructuring costs)
[3] 40% x $15
[4] $120 less taxes of $48 (40% x $120)
Note: The difference in net income of $3 million ($81 million compared to $78 million on the
original income statement) is the effect of the inventory error of $5 million, less the 40% tax effect.
Problem 46
REMBRANDT PAINT COMPANY
Income Statement
($ in thousands, except per share

amounts)
Sales revenue ....................................................................

Gross profit .......................................................................
Operating expenses:
446
$18,000
10,500
7,500
Selling and administrative ..............................................

Restructuring costs ........................................................
Interest income (expense), net ..........................................
Income from continuing operations before income taxes
and extraordinary item....................................................
Income tax expense ..........................................................
Income from continuing operations before extraordinary
item ...............................................................................
$2,500
800
(including gain on disposal of $2,000) ...................................
400
120
Income tax expense .......................................................

Income on discontinued operations ..............................
Extraordinary gain (net of $900 tax expense) ......................
Net income.........................................................................
Earnings per share:
item ................................................................................
Income on discontinued operations ..................................
Net income .......................................................................
3,300
4,200
(150)
4,050
1,215
2,835
280
3,115
2,100
5,215
$ 5.67
.56
4.20
$10.43

447
Problem 47
Requirement 1
SCHEMBRI MANUFACTURING CORPORATION
($ in 000s)
Sales revenue ...................................................................
Cost of goods sold ..........................................................
Gross profit .....................................................................
Operating expenses:
Selling ...........................................................................
General and administrative ...........................................
Restructuring costs .......................................................
Total operating expenses .........................................
Operating income ............................................................
$15,300
6,200
9,100
$1,300
800
1,200

Loss on sales of investments ............................................................
$(220)
Interest expense ...............................................................................
(180)
Interest revenue ............................................................................... 85
Other income (expense) ................................................................
Income from continuing operations before income taxes
and extraordinary item .
Income tax expense .........................................................
item ..............................................................................
(including gain on disposal of $1,400) .......................
840
Income tax expense ......................................................
(336)
Income from discontinued operations ..........................
Income before extraordinary item ...................................
Extraordinary item:
Loss from earthquake (net of $800 tax benefit) ...........
Net income.......................................................................
Other comprehensive income:
Unrealized gains from investments, net of tax
192
Loss from foreign currency translation, net of tax
(144)
Comprehensive income

448
3,300
5,800
(315)
5,485
2,194
3,291
504
3,795
(1,200)
2,595
48
$2,643
Earnings per share:*
item
Discontinued operations
Extraordinary loss
Net income
$2.74
.42
(1.00)
$2.16
*Weighted-average shares = 1,000,000 + (400,000/2) = 1,200,000
Note:
The depreciation expense error is a prior period adjustment (to retained earnings) and is not
reported in the income statement.
Requirement 2
SCHEMBRI MANUFACTURING CORPORATION

($ in 000s)
Net income .......................................................................
Unrealized gains from investments, net of tax.................
Loss from foreign currency translation, net of tax
Total other comprehensive income ...................................
Comprehensive income .....................................................
$2,595
$192
(144)
48
$2,643

449
Problem 48
DUKE COMPANY
Sales revenue ...................................................................
Cost of goods sold ..........................................................
Gross profit .....................................................................
Operating expenses:
General and administrative ...........................................
Selling ..........................................................................
Restructuring costs .......................................................
Loss from write-down of obsolete inventory
Total operating expenses ...........................................
Operating income ............................................................
Interest expense ............................................................
Income before income taxes and extraordinary item........
Income tax expense .........................................................
Income before extraordinary item ...................................
Extraordinary item:
Loss from expropriation of overseas plant (net
of $1,200,000 tax benefit) ............................................
Net Income.......................................................................
Foreign currency translation adjustment loss, net of tax
Unrealized gains on investment securities, net of tax
Total other comprehensive loss
Comprehensive income
$15,000,000
9,000,000
6,000,000
$1,000,000
500,000
300,000
400,000
2,200,000
3,800,000
(700,000)
3,100,000
1,240,000
1,860,000
(1,800,000)
60,000
(120,000)
108,000
(12,000)
$ 48,000
Notes:
1. The restructuring costs and the loss from write-down of inventory are not extraordinary items.
2. The depreciation expense error is a prior period adjustment and is not reported in the income
statement.
Problem 49
Requirement 1
DIVERSIFIED PORTFOLIO CORPORATION

450

Collections from customers (1)
Payment of operating expenses (2)
Payment of income taxes (3)
Sale of investments
Proceeds from issue of common stock
Increase in cash
$880,000
(660,000)
(85,000)
$135,000
50,000
50,000
100,000
(80,000)
20,000
205,000
70,000
$275,000
(1) $900,000 in service revenue less $20,000 increase in accounts receivable.

(2) $700,000 in operating expenses less $30,000 in depreciation less $10,000 increase
in accounts payable.
(3) $80,000 in income tax expense plus $5,000 decrease in income taxes payable.

451
Requirement 2
DIVERSIFIED PORTFOLIO CORPORATION
Net income
$120,000
30,000
(20,000)
Increase in accounts payable
10,000
(5,000)
$135,000
Problem 410
Requirement 1
2012 Cash:
2012 Cash + Net increase in cash = 2013 Cash
2012 Cash +
$86
= $145
2012 Cash = $59
2013 A/R:
2012 A/R + Cr. Sales Cash collections = 2013 A/R
$84 + 80
71
= $93
2012 Inventory:
2012 A/P + Purchases Cash paid = 2013 A/P
$30 + Purchases 30 = $40
Therefore, Purchases = $40
2012 Inventory + Purchases 2013 Inventory = Cost of goods sold
2012 Inventory +
$40
60
=
$32
2012 Inventory = $52
2012 Accumulated depreciation:
2013 accumulated depreciation less 2013 depreciation = 2012 accumulated depreciation
452
$65 10 = $55

453
Problem 410 (continued)

2012 Total assets:
$59 + 84 + 52 + 50 + 150 55 = $340
2013 Total assets:
$145 + 93 + 60 + 150 65 = $383
2012 Income taxes payable:
2012 Inc. taxes payable + Inc. tax expense Income taxes paid =
2013 Inc. taxes payable
2012 Inc. taxes payable =2013 Inc. taxes payable + Taxes paid Inc. tax expense
2012 Inc. taxes payable = $22 + 9 7 = $24
2013 Retained earnings:
2012 R/E + Net income Dividends = 2013 R/E
$47 +
28
3
=
$72
2012 Total liabilities and shareholders equity:
$30 + 9 + 24 + 230 + 47 = $340
2013 Total liabilities and shareholders equity:
$40 + 9 + 22 + 240 + 72 = $383

454

Requirement 2
GRANDVIEW CORPORATION
($ in millions)

Net income
Gain on sale of investments
Increase in accounts receivable1
Increase in inventory2
Increase in accounts payable3
Decrease in income taxes payable4
1
2
3
4
$ 28
10
(15)
(9)
(8)
10
(2)
$14
$93 84
$60 52
$40 30
$22 24
Problem 411
SANTANA INDUSTRIES
($ in thousands)

Net income
Increase in inventory
Decrease in prepaid rent
$ 3,850
1,600
(300)
(1,000)
150
455
Increase in accounts payable

Increase in interest payable
Increase in unearned service revenue
Sale of equipment
300
100
200
(250)
$4,650
(4,000)
500
(3,500)

Proceeds from loan payable
5,000
(1,000)
Net cash flows from financing activities 4,000
5,150
Cash, January 1
Cash, December 31
2,200
$7,350
CASES
Judgment Case 41
Requirement 1
The term earnings quality refers to the ability of reported earnings (income) to
predict a companys future earnings. After all, an income statement simply reports on
events that already have occurred. The relevance of any historical-based financial
statement hinges on its predictive value.
Requirement 2
To enhance predictive value, analysts try to separate a companys transitory
earnings effects from its permanent earnings. Transitory earnings effects result from
transactions or events that are not likely to occur again in the foreseeable future, or that
are likely to have a different impact on earnings in the future.
Requirement 3
An often-debated contention is that, within GAAP, managers have the power, to a
limited degree, to manipulate reported company income. And the manipulation is not
always in the direction of higher income. Many believe that manipulating income
reduces earnings quality because it can mask permanent earnings.
456
Requirement 4
You would consider the size of the gain in relation to net income, the size of the
companys investment portfolio, and the frequency of gains and losses from the sale of
investment securities in past years. The main objective is to determine the likelihood of
this type of gain occurring again in the future.
Judgment Case 42
Requirement 1
Restructuring costs include costs associated with shutdown or relocation of

facilities or downsizing of operations. Facility closings and related employee layoffs
translate into costs incurred for severance pay and relocation costs as well as asset
write-downs or write-offs.
Requirement 2
Prior to 2003, restructuring costs were recognized (expensed) in the period the
decision to restructure was made, not in the period or periods in which the actual
activities took place. Now, restructuring costs are expensed in the period(s) incurred.
Requirement 3
Restructuring costs would be included as an operating expense in a multi-step
income statement.
Requirement 4
An analyst must interpret restructuring charges in light of a companys past history
in this area. Information in disclosure notes describing the restructuring and
management plans related to the business involved also can be helpful.
No. Companies generally prefer to report earnings that
Judgment Case 43follow a smooth, regular, upward path. They try to avoid
declines, but they also want to avoid increases that vary
wildly from year to year. It is better to have two years of
15% earnings increases than a 30% gain one year and none the next. As a result, some
companies bank earnings by understating them in particularly good years and use the
banked profits to increase earnings in bad years.
Real World Case 44
Requirement 1
Companies often voluntarily provide a pro forma earnings number when they
announce annual or quarterly earnings calculated according to GAAP. These pro forma
earnings numbers are managements view of permanent earnings. These pro forma
earnings numbers are controversial as they represent managements biased view of
permanent earnings and should be interpreted in that light.

457
Requirement 2
The term earnings quality refers to the ability of reported earnings (income) to
predict a companys future earnings. Management believes that pro forma earnings are
of much higher quality than reported earnings because they are more indicative of
future profitability.
The critical question that student groups should
Communication Case 45address is whether or not the gain on the sale of the
timber tracts should be reported as an extraordinary
item on the 2013 income statement. There is no
right or wrong answer. The process of developing the proposed solutions will likely be
more beneficial than the solutions themselves. Students should benefit from
participating in the process, interacting first with other group members, then with the
class as a whole.
Solutions should address the following issues:
1. Is the gain material? A consensus should be reached that the gain is material.
2. Is the event both unusual and infrequent? Debate should center on the critical
issue of whether the event is likely to occur again in the foreseeable future.
3. If the event is deemed to require presentation as an extraordinary item, the gain
should be reported net of tax below income from continuing operations. A
disclosure note also is required and earnings per share disclosure should reflect
the income statement presentation.
As a real world example of a similar situation, in 1974 Johns Manville
Corporation, manufacturer of asbestos products, reported a $21 million extraordinary
gain from the sale of timber tracts. No disclosure note was provided to explain the
event, so we can only speculate as to the circumstances leading to the company's
presentation of the gain as extraordinary.
It is important that each student actively participate in the process. Domination by
one or two individuals should be discouraged. Students should be encouraged to
contribute to the group discussion by (a) offering information on relevant issues, and (b)
clarifying or modifying ideas already expressed, or (c) suggesting alternative direction.
Suggested Grading Concepts and Grading
Communication Case 46
Scheme:
Content (70%)
_______ 10 Is the loss material?
_______ 25 Lists the alternative treatments.
______ Present before-tax amount as a separate line item.
______ Present the after-tax amount as an extraordinary item.
______ In either case, disclosure is required.
458
_______ 25 Cites the appropriate authoritative pronouncement,

FASB ASC 2252045 (previously APBO No. 30), and
discuss the concepts of unusual and infrequent in
the context of the companys environment.
_______ 10 A clear, well-supported recommendation is made.
______
_______ 70 points
Writing (30%)
_______ 6 Terminology and tone appropriate to the audience of a chief
financial officer.
_______ 12 Organization permits ease of understanding.
______ Introduction that states purpose.
______ Paragraphs that separate main points.
_______ 12 English
______ Sentences grammatically clear and well organized,
concise.
______ Word selection.
______ Spelling.
______ Grammar and punctuation.
______
_______ 30 points

459
Case 46 (continued)
The following is provided as an example.
August 1990
TO:
Chief Financial Officer, Carter Hawley Hale Stores (CHHS)
FROM: John Doe, Controller (CHHS)

RE:
Income Statement treatment of October 17, 1989, earthquake damage costs.
A decision on the income statement treatment of the earthquake damage costs

involves a number of considerations. First, the damage costs are clearly material.
Inclusion of the costs in earnings results in an increase in the net loss for the fiscal year
ended August 4, 1990, from $9.47 million to $25.97 million. This leaves us only two
options for the income statement presentation of the loss:
1. Present the before-tax amount of the loss ($27.5 million) as a separate line
item in the income statement.
2. Present the after-tax effect of the loss ($16.5 million) as an extraordinary
item, below income from continuing operations.
In both cases, a disclosure note would be required to explain the loss.
The appropriate authoritative pronouncement pertaining to this case is FASB ASC
2252045: Income StatementExtraordinary and Unusual ItemsOther Presentation
Matters (previously Accounting Principles Board Opinion No. 30). It states that
judgment is required in determining whether or not an event warrants separate reporting
in the income statement as an extraordinary item. However, the following broad
guideline is provided in paragraph 2:
Extraordinary items are events and transactions
that are distinguished by their unusual nature and
by the infrequency of their occurrence.
The characteristics of unusual nature and infrequency of occurrence must be

considered in light of the environment in which the company operates.
These characteristics are only aids in answering the important question: What is
the likelihood that this event will occur again in the foreseeable future? If it is not
likely to occur again, then this should be communicated to financial statement users by
segregating the income effect of the event as an extraordinary item. This will help them
in using the income statement to predict future cash flows.

460
Case 46 (concluded)
RECOMMENDATION
I recommend that the earthquake damage costs be treated as an extraordinary loss,
net of tax, in the income statement for the fiscal year ended August 4, 1990. In
addition, earnings per share for income both before and after the loss must be
presented. While many earthquakes do occur in California, extremely large
earthquakes causing significant amounts of damage are both unusual and infrequent. I
do not believe that this type of loss will occur again in the foreseeable future.
Ethics Case 47
Discussion should include these elements.
Facts:
The company incurred $10 million in expenses related to a product recall. The
company had experienced product recalls in the past and they do occur in the industry.
To show a profit from continuing operations, Jim Dietz, the controller, wants to report
the $10 million as an extraordinary loss, rather than as an expense included in operating
income. He tells the CEO that the company has never had a product recall of this
magnitude and that the company fixed the design flaw and upgraded quality control.
Extraordinary items are gains and losses that are material, and result from events
that are both unusual and infrequent. These criteria must be considered in light of the
environment in which the entity operates. There obviously is a considerable degree of
subjectivity involved in the determination. The concepts of unusual and infrequent
require judgment. In making these judgments, an accountant should keep in mind the
overall objective of the income statement. The key question is how the event relates to
a firms future profitability. If it is judged that the event, because of its unusual nature
and infrequency of occurrence, is not likely to occur again, separate reporting as an
extraordinary item is warranted.
Ethical Dilemma:
It appears from the facts of the case that it would be difficult for the company to
come to the conclusion that a material product recall is not likely to occur again in the
foreseeable future. This type of event has occurred before and is common in the
industry. While a subjective judgment, extraordinary treatment of the $10 million does
not appear warranted. Is the obligation of Jim and the CEO to maximize income from
continuing operations, the company's position on the stock market, and management
bonuses stronger than their obligation to fairly present accounting information to the
users of financial statements?
Who is affected?

461
Jim Dietz
CEO and other managers
Other employees
Shareholders
Potential shareholders from the stock market
Creditors
Company auditors
Research Case 48
Requirement 1
The accounting standards topic number that addresses exit or disposal cost
obligations is FASB ASC 420: Exit or Disposal Cost Obligations.
Requirement 2
The specific citation that addresses the initial measurement of these obligations is
FASB ASC 42010301: Exit or Disposal Cost ObligationsOverallInitial
Measurement.
Requirement 3
A liability for a cost associated with an exit or disposal activity is measured initially
at its fair value in the period in which the liability is incurred.
Requirement 4
The specific citation that describes the disclosure requirements for exit or disposal
obligations is FASB ASC 42010501: Exit or Disposal Cost ObligationsOverall
Disclosure.

462
Case 48 (concluded)
Requirement 5
All of the following information is disclosed in notes to financial statements that
include the period in which an exit or disposal activity is initiated and any subsequent
period until the activity is completed:
a. A description of the exit or disposal activity, including the facts and
circumstances leading to the expected activity and the expected completion date.
b. For each major type of cost associated with the activity (for example, one-time
employee termination benefits, contract termination costs, and other associated
costs), both of the following are disclosed:
1. The total amount expected to be incurred in connection with the activity,
the amount incurred in the period, and the cumulative amount incurred to
date.
2. A reconciliation of the beginning and ending liability balances showing
separately the changes during the period attributable to costs incurred and
charged to expense, costs paid or otherwise settled, and any adjustments
to the liability with an explanation of the reason(s) why.
c. The line item(s) in the income statement or the statement of activities in which
the costs in (b) are aggregated.
d. For each reportable segment, as defined in Subtopic 280-10, the total amount of
costs expected to be incurred in connection with the activity, the amount incurred
in the period, and the cumulative amount incurred to date, net of any adjustments
to the liability with an explanation of the reason(s) why.
e. If a liability for a cost associated with the activity is not recognized because fair
value cannot be reasonably estimated, that fact and the reasons why.

463
Judgment Case 49
Situation
1.
2.
3.
4.
5.
6.
7.
8.
Treatment (ag)
b.
c.
f.
g.
a.
b.
e.
d.
Financial Statement
Presentation
(CO, BC, or RE)
CO
RE
CO
CO
BC
CO
BC
RE
1. The loss is not unusual or infrequent. It is included in

income from continuing operations along with other
nonoperating items.
The sale of the financing component is treated as a discontinued operation. The
gain or loss from the sale of the assets along with income or loss generated by the
component is presented below income from continuing operations.
A change in depreciation method is treated as a change in accounting estimate
achieved by a change in accounting principle. Changes in estimates are accounted
for prospectively. The remaining book value is depreciated, using the new method,
over the remaining useful life.
This event is not unusual but may be infrequent. It usually is presented as a separate
line item included in income from continuing operations.
The correction of an error is treated as a prior period adjustment. The effect of the
correction is not included in income, but as an adjustment to retained earnings.
Prior years financial statements are restated to correct the error.
This event requires no unusual treatment. The lipstick line does not qualify as a
component of an entity requiring treatment as a discontinued operation. The loss on
sale of the assets of the product line is included in continuing operations.
Judgment Case 410

2.
3.
4.
5.
6.
1. GSK reported interest received and dividends from

IFRS Case 411 associates and joint ventures as investing cash flows. U.S.
GAAP requires these items to be included with operating
cash flows.
2. Interest paid is reported as a financing cash flow. U.S. GAAP requires interest
paid to be included with operating cash flows

464
Judgment Case 412

1.
2.
3.
4.
5.
6.
7.
8.
Requirement 1
a. As a component of operating income.

b. As a nonoperating income item.
d. As an other comprehensive income item.
b. As a nonoperating income item.
c. As a separately reported item.
a. As a component of operating income.
e. As an adjustment to retained earnings.
c. As a separately reported item.
Requirement 2
Situations 3, 5, and 8 would be reported in the statement of income and
comprehensive income net-of-tax. Also, the net-of-tax effect of the correction of the
amortization error, situation 7, would increase or decrease retained earnings.
It would be nice to think that management makes all

Judgment Case 413accounting choices in the best interest of fair and
consistent financial reporting.
Unfortunately, other
motives influence the choices among accounting methods
and whether to change methods. It has been suggested that the effect of choices on
management compensation, on existing debt agreements, and on union negotiations
each can affect managements selection of accounting methods. For instance, research
has suggested that managers of companies with bonus plans are more likely to choose
accounting methods that maximize their bonuses (often those that increase net income).
Other research has indicated that the existence and nature of debt agreements and other
aspects of a firms capital structure can influence accounting choices. Whether a
1
1 Watts, R.L., and J.L. Zimmerman, Towards a Positive Theory of the Determination of Accounting Standards, The
Accounting Review, January 1978, and Positive Accounting Theory: A Ten Year Perspective, The Accounting
Review, January 1990.
2 For example, see Healy, P.M., The Effect of Bonus Schemes on Accounting Decisions, Journal of Accounting and
Economics, April 1985, and Dhaliwal, D., G. Salamon, and E. Smith, The Effect of Owner Versus Management
Control on the Choice of Accounting Methods, Journal of Accounting and Economics, July 1982.
3 Bowen, R.M., E.W. Noreen, and J.M. Lacy, Determinants of the Corporate Decision to Capitalize Interest, Journal
of Accounting and Economics, August 1981.

465
company is forbidden from paying dividends if retained earnings fall below a certain
level, for example, can affect the choice of accounting methods.
Choices made are not always those that tend to increase income. As you will learn
in Chapter 8, many companies use the LIFO inventory method because it reduces
income and therefore reduces the amount of income taxes that must be paid currently.
Also, some very large and visible companies might be reluctant to report high income
that might render them vulnerable to union demands, government regulations, or higher
taxes.
4
Research Case
(Note: This case requires the student to reference a journal

414article.]
Requirement 2
The authors use the S&P 500 companies as their sample.
Requirement 3
77% in 2001 and only 54% in 2003.
Requirement 4
In 2001, 85% of firms have greater pro forma than GAAP earnings. This ratio
declined to 67% in 2003.
Requirement 5
In 2001, 136 firms reported Restructuring Charges, and the same number of
firms reported a Divestiture/Sale of Business Units. In 2003, the most frequently
reported adjustment was Amortization/Impairment of Goodwill and Other
Intangibles.
Requirement 6
The authors main conclusions are that the introduction of pro forma regulation is
associated with a substantial change in firms pro forma reporting. Notably, far fewer
firms are reporting pro forma earnings, while those that continue to report appear to do
so in a manner consistent with the intention of the regulation, to provide useful
information, not to mislead.
DEFICIENCIES:
Integrating Case 415
Balance Sheet:
1. The asset section of the balance sheet should be classified. Cash, short-term
investments, accounts receivable, and inventories should be included as current
assets.
4 This political cost motive is suggested by Watts, R.L.. and J.L. Zimmerman, Positive Accounting Theory: A Ten-
Year Perspective, The Accounting Review, January 1990, and Zmijewski, M., and R. Hagerman, An Income Strategy
Approach to the Positive Theory of Accounting Standard Setting/Choice, Journal of Accounting and Economics,
August 1981.
466
2.
3.
4.
5.
6.
7.
8.
9.
Accounts receivable should be shown net of the allowance for uncollectible

accounts.
Inventoriesthe method used to cost inventory should be disclosed in a note.
Marketable securities$21,000 of investments ($78,000 57,000) should be
classified in a noncurrent investments category.
Property and equipmentshould be classified in a separate category. Original
cost should be disclosed along with the accumulated depreciation to arrive at
the net amount. Also, the method used to compute depreciation should be
disclosed in a note.
The liability and shareholders' equity section of the balance sheet should be
classified into (1) current liabilities, (2) long-term liabilities, and (3)
shareholders' equity.
Current liabilities should include accounts payable and accruals, notes payable
(the $80,000 note due in 2014 and the $60,000 installment on note # 2 due in
2014). The latter should be classified as current maturities of long-term debt.
Also, note disclosure is required for the notes providing information such as
payment terms, interest rates, and collateral pledged as security for the debt.
Long-term liabilities should include the $60,000 second installment on note #2.
Common stockthe par value, if any, and the number of shares authorized,
issued, and outstanding should be disclosed.
Income Statement:
1. The miscellaneous expense should be classified as an extraordinary item and
shown net of tax below income from continuing operations. A note should
describe the event.
2. Earnings per share disclosure is required.
3. The restructuring charges should be shown as a separate operating expense
item in the income statement and described in a note.
Financial Analysis Case 416
Requirement 1
2010 to 2011: ($2,635 1,433) $1,433 =
83.9% increase
2009 to 2010: ($1,433 2,478) $2,478 =
42.2% decrease
Requirement 2
Provision for income taxes Income before taxes
$715 $3,350 = 21% = Approximate income tax rate

467
Requirement 3
$2,635 $61,494 = 4.3%
Answers to the questions will, of course, vary
Real World Case 417because students will research financial statements of
different companies.
No specific standards dictate how income from continuing operations must be
displayed, so companies have considerable latitude in how they present the components
of income from continuing operations. This flexibility has resulted in a considerable
variety of income statement presentations. However, we can identify two general
approaches, the single-step and the multiple-step formats that might be considered the
two extremes, with the income statements of most companies falling somewhere in
between.
The presentation of separately reported items, however, is mandated and students
should be able to easily identify them.
Air FranceKLM Case
Requirement 1
AF classifies its expenses by both natural descriptions (e.g., salaries and related
costs, taxes other than income taxes) and functions (e.g., external expenses). In the
United States, expenses are classified by function.
Requirement 2
AF classifies interest paid and interest received as operating cash flows, and
dividends received as an investing cash flow. Under IFRS, companies can report
interest paid as either an operating or financing cash flow and interest and dividends
received as either operating or investing cash flows.

468

Chap 004

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chap 004

Uploaded by

Copyright:

Available Formats

Chapter 4

The Income Statement, Comprehensive Income, and

Solutions Manual, Vol.1, Chapter 4

Reflective thinking, Commun.

The McGraw-Hill Companies, Inc., 2013

The McGraw-Hill Companies, Inc., 2013

Intermediate Accounting, 7/e

QUESTIONS FOR REVIEW OF KEY TOPICS

Solutions Manual, Vol.1, Chapter 4

The McGraw-Hill Companies, Inc., 2013

Answers to Questions (continued)

The McGraw-Hill Companies, Inc., 2013

Intermediate Accounting, 7/e

Answers to Questions (continued)

Solutions Manual, Vol.1, Chapter 4

The McGraw-Hill Companies, Inc., 2013

Answers to Questions (continued)

The McGraw-Hill Companies, Inc., 2013

Intermediate Accounting, 7/e

Answers to Questions (concluded)

Revenues and gains:

Solutions Manual, Vol.1, Chapter 4

The McGraw-Hill Companies, Inc., 2013

* $645 x 40% = $258

Less: Cost of goods sold

Gain on sale of investments

PACIFIC SCIENTIFIC CORPORATION

Sales revenue .......................................................

Intermediate Accounting, 7/e

Less: Cost of goods sold

Income before extraordinary item

The McGraw-Hill Companies, Inc., 2013

Earnings per share:

Loss from operations of discontinued component

$ 2,000,000 ($10 million less $8 million)

The McGraw-Hill Companies, Inc., 2013

For the Year Ended December 31, 2013

The McGraw-Hill Companies, Inc., 2013

Intermediate Accounting, 7/e

Brief Exercise 410

Brief Exercise 411

Brief Exercise 412

Brief Exercise 413

Under IFRS, interest received and interest paid usually

Solutions Manual, Vol.1, Chapter 4

The McGraw-Hill Companies, Inc., 2013

The McGraw-Hill Companies, Inc., 2013

Intermediate Accounting, 7/e

GENERAL LIGHTING CORPORATION

Solutions Manual, Vol.1, Chapter 4

The McGraw-Hill Companies, Inc., 2013

The McGraw-Hill Companies, Inc., 2013

Intermediate Accounting, 7/e

Other income (expense):

Earnings per share:

Cost of goods sold ............................................................

Earnings per share:

Earnings per share:

* Loss on discontinued operations:

* Income from continuing operations:

KANDON ENTERPRISES, INC.

* Loss on discontinued operations:

Intermediate Accounting, 7/e

$1,200,000 60%* = $2,000,000 = Before-tax loss from discontinued