Solution manual intermediate accounting 15e by stice ch04

CHAPTER 4
QUESTIONS
1. The objective of financial reporting is to
provide useful information for users of the
financial
statements.
The
relevant
information for decision making is future
data, especially information dealing with
cash flows. The primary financial
statements reflect economic transactions
and events that have taken place. The
past is used to help project the future.
Income, however, is only one of many
sources of cash flow. The balance sheet
and statement of cash flows also furnish
relevant information upon which the
investor may project other future cash
flows. In summary, the income statement
contains only some of the information that
is relevant for making economic decisions.

(c) The current value of net assets
acquired in exchange transactions as
determined by either their replacement
or market values.
(d) Some variation of the above (a
through c) but including in assets all
resources and claims to resources, not
just those acquired in exchange

transactions.
4. The objectives of reporting income for
income tax purposes and for financial
reporting to users are not the same. Those
formulating income tax laws are usually
concerned with fairness among taxpayers
and with their ability to pay taxes. Users,
on the other hand, are concerned with a
measure that distinguishes between a
return on investment and a return of
investment. They want a measure that
matches expenses against recognized
revenue. In most cases, the same
accounting method can be used for both
purposes. This will reduce both the cost
and the confusion of using more than one
accounting
method
for the same
transaction. In some cases, however, the
generally accepted accounting method is
different from that required by income tax
regulations. This results in a temporary
difference between the tax return and the
books and gives rise to interperiod income
tax allocation.

2. Two approaches can be used to measure
income: the capital maintenance approach
and the transaction approach. The capital

maintenance approach uses the balance
sheet elements to determine the change in
total
equity
after
eliminating
any
investments and withdrawals of resources
by owners. The transaction approach
determines income by analyzing individual
transactions and events and their effect on
related assets, liabilities, and owners’
equity.
Although
the
method
of
determining
income
differs,
both
approaches arrive at the same total
income figure if the same attributes and
measurements are used. However, the
transaction approach produces more
detail as to the composition of income
than does the capital maintenance
approach.

5. A code law country is one in which rules,

laws, and accounting standards are set by
legal processes—from the top down. A
common law country is one in which rules,
laws, and accounting standards evolve in
response to societal and market forces—
from the bottom up.
6. Revenues and expenses are related to the
ongoing major or central activities of a
business and are reported at gross
amounts. Gains and losses are associated
with peripheral and incidental transactions
and events and are reported as the
difference between the selling price and
the book value (often the depreciated
cost). These classification and display
distinctions will depend on the specific

3. Measurement methods that could be
applied to net assets in the capital
maintenance
approach
to
income
determination are as follows:
(a) The historical cost of net assets
acquired in exchange transactions,
reduced by an allowance for their use.
(b) The historical cost of net assets
acquired in exchange transactions,
reduced by an allowance for their use

and adjusted for a change in price
levels since original acquisition.

121


circumstances
enterprise.

and

activities

of

an

7. The following two factors must be
considered when deciding at what point
revenues and gains should be recognized:
(a) The resources from the transaction are
either already realized in cash or claims to
cash or are readily realizable in cash, and
(b) the revenues and gains have been
earned through substantial completion of
clearly identified tasks and activities. Both
factors are usually met when merchandise
is delivered or services are rendered to
customers. This is referred to as the point
of sale.

8. There are three specific exceptions to the
general rule that were discussed in the
chapter. They are recognizing revenue (a)
at the point of completed production, (b) at
the time of cash collection, and (c) at
various points in time during the operating cycle (e.g., percentage-of-completion
method). The justification for the use of
these exceptions is that, in each case, the
realization and earning criteria established
by the FASB are met.
9. Three expense recognition principles are
applied in matching costs with revenues:
(a) Direct matching—costs are associated
directly with specific revenues and
recognized as expenses of the period
in which the revenues are recognized.
(b) Systematic and rational allocation—
when costs cannot be associated
directly with specific revenues, costs
are associated in a systematic and
rational manner with the periods or
products benefited.
(c) Immediate recognition—those costs
that cannot be related to revenues
either by direct matching or by
systematic and rational allocation
must be recognized as expenses of
the
current
period.

10. The multiple-step income statement can
contain too much information that might
be confusing to the reader and require
excess time to evaluate. The detailed
listing of purchases and inventory might
best be displayed in a supplementary
schedule.
The single-step income statement can be
too brief. Information required for

122

investment
decisions
is
sometimes
presented in supporting schedules or not
reported. Because of these factors, the
statement could also be confusing, and
valuable time could be lost by the
statement reader in seeking additional
information.
11. The major sections that may be included
in a multiple-step income statement may
be divided into two categories: (a) income
from continuing operations, separated into
six sections, and (b) irregular or
extraordinary items, separated into three
sections. The sections of income from
continuing operations are

1. Revenue from net sales
2. Cost of goods sold
3. Operating expenses
4. Other revenues and gains
5. Other expenses and losses
6. Income
taxes
on
continuing
operations
The sections of irregular or extraordinary
items are
7. Discontinued operations
8. Extraordinary items
9. Cumulative effects of changes in
accounting principles
12. A restructuring charge is a loss that arises
when a company proposes a restructuring
of its operations. The charge is composed
of the loss in value associated with assets
that no longer fit in the company’s
strategic plans. The charge also includes
the additional costs associated with the
termination or relocation of employees.
Restructuring charges are controversial
because companies exercise considerable
discretion in determining the amount of a
restructuring charge and thus can use
restructuring charges as a tool for
manipulating the amount of reported net

income.
13. This flexibility in the timing of the
recognition of restructuring charges is
reduced by SFAS No. 146. Intraperiod
income tax allocation involves the
separation of income tax expense
between
income
from
continuing
operations and transitory, irregular, or
extraordinary items. Under this concept,
each section of the transitory, irregular, or
extraordinary items category is reported
net of its income tax effect.


14. Pop-Up must separately disclose the
current year’s income related to the
operations of the segment that will be
discontinued together with the $10,000
loss resulting from the sale. This total
would be reported on the income
statement, along with any associated
income tax impact, immediately following
income from continuing operations.
15. The following items would not normally
qualify as extraordinary items:
(a) The write-down or write-off of
receivables.

(b) Major devaluation of foreign currency.
(c) Loss on sale of plant and equipment.
(d) Gain from early extinguishment of
debt. Before the issuance of SFAS No.
145 in April 2002, gains and losses
from early extinguishment of debt
were required to be classified as
extraordinary.
(f) Loss due to extensive earthquake
damage to furniture company in Los
Angeles, California. (Earthquakes are
not unusual in the Los Angeles area.)
(g) Farming loss due to heavy spring
rains in the Northwest. (Spring rains
are not unusual in the Northwest.)
Item (e) is classified as extraordinary
because flood damage is both unusual
and infrequent in Las Vegas.
16. a. The effects of a change in accounting
principle that is applied to past periods
are disclosed in the financial
statements of the period of change.
The effects of the change are
computed for past periods and
disclosed either as a cumulative effect
on current net income or as an
adjustment to the beginning retained
earnings. The FASB has specified
criteria to determine which approach is
appropriate.

b. The effect of a change in accounting
estimate is disclosed entirely in the
current period or in the current and
future periods. No adjustments are
made to prior periods’ statements as
may be done for a change in principle.
The change in an estimate should be
sufficiently disclosed in the financial
statements so that readers are alerted
to those changes that will materially
affect future periods.
17. Under International Financial Reporting
Standard (IFRS) 8, the cumulative effect of

18. a change in accounting principle is
reported as a direct adjustment to
beginning retained earnings of the
current year.
18. Generally accepted accounting principles
require entities to report earnings-pershare information for income from
continuing operations and for each section
of the transitory, irregular, or extraordinary
items category of an income statement.
The computation is made by dividing the
income or loss from each of these
sections by the weighted average number
of common shares outstanding during the
reporting period. If a potential dilution of
earnings exists due to the existence of
convertible securities, stock options, or

stock warrants, additional earnings-pershare information must also be presented.
19. “Comprehensive income is the change in
equity of a business enterprise during a
period from transactions and other events
and
circumstances
from
nonowner
sources. It includes all changes in equity
during a period except those resulting
from investments by owners and
distributions to owners.” 1 Net income is
the reported income as required by GAAP.
Currently, GAAP does not require all
components of comprehensive income to
be disclosed in the income statement. For
example, it does not include the effect of
error corrections, asset valuation changes,
or some effects of accounting changes.
20. The starting point for the preparation of
forecasted financial statements is the
forecast of sales.
21. In forecasting depreciation expense, one
first must forecast how much property,
plant, and equipment will be needed in the
future. This amount is then used, along
with an assumption about how rapidly the
plant and equipment will depreciate, to
estimate future depreciation expense.

123


1Statement of Financial Accounting Concepts No. 6, “Elements of Financial Statements” (Stamford, CT:
Financial Accounting Standards Board, December 1985), par. 70.

124


PRACTICE EXERCISES
PRACTICE 41

FINANCIAL CAPITAL MAINTENANCE

Net assets, end of period
Net assets, beginning of period
Increase in net assets
Deduct investment by owners
Income
PRACTICE 42

$345,000
170,000
$175,000
100,000
$75,000

PHYSICAL CAPITAL MAINTENANCE

Net assets, end of period

Net assets, beginning of period
Increase in net assets
Deduct investment by owners
Income, financial capital maintenance
Deduct increase necessary to maintain physical
Income, physical capital maintenance
PRACTICE 43

$345,000
170,000
$175,000
100,000
$ 75,000
capital
$ 10,000

65,000

COMPUTATION OF INCOME USING MATCHING

Revenue ($150,000 + $91,000)
Cost of goods sold ($79,000 + $46,000)
Income

$241,000
125,000
$116,000

The $350,000 in costs incurred in the production of Machines B and D will not yet be
recognized as an expense. This expense is matched and reported in the income statement

in the same year in which the revenue from the sale of the machines is reported. In the
meantime, this $350,000 cost is shown as an asset, Inventory, in the balance sheet.
PRACTICE 44

REVENUE RECOGNITION

Cash Collected
or Collectibility
Reasonably Assured?
a.
b.
c.

Work
Completed?

No
Yes
Yes

Yes
No
Yes

Total revenue to be recognized this year

Amount of
Revenue to Be
Recognized
$

0
0
170,000

$170,000

125


PRACTICE 45

EXPENSE RECOGNITION

Expense
Amount of
Recognition
Cost
Method
a.
$30,000
Direct matching
b.
70,000 Immediate recognition
c.
15,000
Rational allocation
d.
27,000 Immediate recognition
e.

45,000
Rational allocation
f.
50,000
Direct matching
Total expense recognized this year
PRACTICE 46

Expense
to Be Recognized
This Year
$ 30,000
70,000
5,000
27,000
9,000
0
$141,000

SINGLE-STEP INCOME STATEMENT
Sales

$10,000

Less expenses:
Cost of goods sold
6,000
Selling and administrative expense
750
Interest expense

1,100
Income before income taxes
$ 2,150
Income tax expense
Net income
PRACTICE 47

$

1,200
950

MULTIPLE-STEP INCOME STATEMENT
Sales
Cost of goods sold
Gross profit

$10,000
6,000
$4,000

Operating expenses:
Selling and administrative expense
750
Operating income
$3,250
Interest expense
1,100
Income before income taxes
$2,150

Income tax expense
1,200
Net income
$ 950
PRACTICE 48

COMPUTATION OF GROSS PROFIT
Revenues..............................................

$9,488.8

Cost of sales..........................................

5,784.9

Gross profit....................................

$3,703.9

Gross profit/Sales = $3,703.9/$9,488.8 = 39.0%

126


PRACTICE 49

COMPUTATION OF OPERATING INCOME
Revenues............................................................

$9,488.8

Operating expenses:
Cost of sales.................................................

5,784.9

Selling and administrative............................

2,689.7

Restructuring charge, net (Note 13).............

(0.1)

Total operating expenses.....................................

$8,474.5

Operating income...............................................

$1,014.3

Operating income/Sales = $1,014.3/$9,488.8 = 10.7%

PRACTICE 410

COMPUTATION OF INCOME FROM CONTINUING OPERATIONS

Sales
Cost of goods sold

Gross profit
Less: Selling and administrative expense
Operating income
Interest expense
Income before income taxes
Income tax expense (40%)
Income from continuing operations

PRACTICE 411

$10,000
4,000
$ 6,000
1,750
$ 4,250
1,100
$ 3,150
1,260
$ 1,890

COMPUTATION OF INCOME FROM DISCONTINUED OPERATIONS

Sales
Expenses
Income before income taxes
Income tax expense (30%)
Income from continuing operations
Discontinued operations:
Income (loss) from operations
(including loss on disposal

in 2005 of $2,000)
Income tax expense (benefit)30%
Income (loss) on discontinued operations
Net income

2005
$ 5,000
4,400
$ 600
180
$ 420

$(2,400)
(720)

$600
180
(1,680)
$(1,260)

127

2004
$4,600
4,100
$ 500
150
$ 350

420

$ 770


PRACTICE 412

COMPUTATION OF INCOME FROM DISCONTINUED OPERATIONS
2005
$ 3,500
3,900
$ (400)
(120)
$ (280)

Sales
Expenses
Income before income taxes
Income tax expense (benefit) 30%
Income from continuing operations
Discontinued operations:
Income from operations
(including gain on disposal
in 2005 of $1,500)
Income tax expense30%
Income on discontinued operations
Net income

PRACTICE 413

2,100
630

2004
$5,100
4,500
$ 600
180
$ 420

500
150
1,470
$ 1,190

350
$ 770

GAINS AND LOSSES ON EXTRAORDINARY ITEMS

Sales
$20,000
Cost of goods sold
11,000
Gross profit
$ 9,000
Operating expenses and gains/losses:
Selling and administrative expense
(1,750)
Operating income
$ 7,250
Other revenues and expenses:

Loss from an unusual but frequent event$(1,000)
Gain from a normal but infrequent event 1,250
Interest expense
(2,100)
(1,850)
Income before income taxes
$ 5,400
Income tax expense (40%)
2,160
Income from continuing operations
$ 3,240
Extraordinary loss (net of tax benefit of $160)
(240)
Net income
$ 3,000

PRACTICE 414

CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE

Sales
Oil and gas exploration expense
Income before income taxes
Income tax expense (30%)
Income from continuing operations
Cumulative effect of change
in accounting principle (net of income
tax benefit of $510)
Net income

2005
$5,000
700
$4,300
1,290
$3,010

2004
$3,000
600
$2,400
720
$1,680

2003
$2,000
400
$1,600
480
$1,120

(1,190)
$1,820

0
$1,680

0
$1,120

Cumulative effect = [($400 + $600) – ($1,500 + $1,200)] = ($1,700)

128


PRACTICE 415

ACCOUNTING FOR CHANGES IN ESTIMATES

Original depreciation = $100,000/20 years = $5,000 per year
Accumulated depreciation as of January 1, 2005 = $5,000 per year  5 years = $25,000
Revised depreciation
= Remaining depreciable book value/Remaining life
= ($100,000  $25,000)/(30 years  5 years elapsed already)
= $75,000/25 years
= $3,000 per year
PRACTICE 416

RETURN ON SALES

Return on sales = Net income/Sales = $200/$13,000 = 1.5%
PRACTICE 417

EARNINGS PER SHARE

Net income
Average shares outstanding
Earnings per share

2005

$10,000
2,500

2004
$6,000
2,000

2003
$2,500
1,000

$4.00

$3.00

$2.50

Percentage increase in 2004: ($3.00  $2.50)/$2.50 = 20%
Percentage increase in 2005: ($4.00  $3.00)/$3.00 = 33%
PRACTICE 418

PRICE-EARNINGS (P/E) RATIO

Price-earnings ratio = Market price per share/Earnings per share = $20.00/$1.67 = 12.0
PRACTICE 419

COMPREHENSIVE INCOME

Income from continuing operations
$ 11,000

Extraordinary loss
(1,000)
Cumulative effect of a change in accounting principle
(400)
Net income
$ 9,600
Net income
$ 9,600
Unrealized loss on available-for-sale securities
(2,100)
Foreign currency translation adjustment (equity increase)
Comprehensive income
$ 8,750

129

1,250


PRACTICE 420

FORECASTED BALANCE SHEET

Cash
Accounts receivable
Inventory
Land
Plant and equipment (net)
Total assets
PRACTICE 421

2005
Actual
$ 100
500
1,000
2,500
5,000
$9,100

natural increase of 25%
natural increase of 25%
natural increase of 25%
no increase needed
40% increase

FORECASTED INCOME STATEMENT

2005
Actual
Sales
$10,000
Cost of goods sold
6,000
Depreciation expense
1,000
Interest expense
400
Income before income taxes$ 2,600
Income tax expense

910
Net income
$ 1,690

130

2006
Forecasted
$
125
625
1,250
2,500
7,000
$11,500

2006
Forecasted
$13,000
7,800
1,200
500
$ 3,500
1,225
$ 2,275

30% increase (given)
30% natural increase
same proportion with PPE
same apparent 10% interest rate

same tax rate ($910/$2,600) = 35%


EXERCISES
4–22.
Debit changes in accounts during 2005 other
than Retained Earnings:
Cash..........................................................................
Accounts Receivable..............................................
Buildings and Equipment (net)...............................
Accounts Payable...................................................
Credit changes in accounts during 2005 other
than Retained Earnings:
Inventory..................................................................
Patents.....................................................................
Bonds Payable.........................................................
Capital Stock............................................................
Additional Paid-In Capital.......................................
Change in Retained Earnings for 2005........................
Add: Dividends declared..............................................
Net income.....................................................................

$ 95,500
92,000
190,000
75,000

$ 30,000
5,000
150,000

100,000
50,000

$ 452,500

335,000
$ 117,500
25,000
$ 142,500

4–23.
(a) The receipt of an order from a customer does not constitute realization,
nor does it qualify as an earnings activity. Therefore no revenue is
recognized.
(b) There has been no sale of the asset to support the recognition of
revenue. Production remains to be performed, followed by sale of the
finished product. Accretion may give rise to revenue in certain
instances in which it can be objectively determined and the product has
a ready market at a definite price.
(c) The rendering of services is the earning activity, and it is assumed that a
valid claim exists against the client. The recognition criteria are met.
(d) The appreciation in value of the land is generally not recognized
because it is not yet realized.
(e) The receipt of cash meets the realization criteria; however, the revenue
is generally not reported as earned because the product has not yet
been delivered. Some argue that an estimate of the costs incurred to
honor the certificate can be made so that revenue could be recognized
at the time of certificate sale.
(f) Collection of cash on the subscriptions is realization. However, the
earning activity has yet to take place.

(g) The retirement of debt at less than the recorded liability results in the
recognition of a gain. The retirement of the debt meets the recognition
criterion for gains.

131


4–24.
(a) The revenue is unearned in 2005. The credit is to the liability account
Unearned Rent Revenue.
(b) Revenue of $60,000 is to be recognized in 2005: $10,000 in cash plus a
note for $50,000. In addition, interest revenue of $3,000 is recognized in
2005 ($50,000  0.12  1/2 year). The $3,000 interest revenue to be
earned in 2006 will not be recorded until 2006.
(c) Transactions in a company’s own stock are not considered an incomegenerating activity. The amount received above par is credited to
Additional Paid-In Capital.
(d) Because a claim against the customer (an asset) is created when the
merchandise is shipped and actions to prepare and ship the inventory
are felt to represent the earning activity, revenue is recognized at the
time of sale. In theory, the possibility of return should be evaluated and
recorded as a reduction of revenue if some return is probable and the
value of the return can be estimated. Similarly, the probability of a
customer’s taking a cash discount should be considered and a
reduction made to revenue for estimated cash discounts. In practice,
both sales returns and cash discounts are usually not recorded until
they actually occur.
(e) This is a difficult one. As discussed in Chapter 8, under the provisions
of SAB No. 101 the SEC generally does not allow the recognition of
revenue until title transfers. In such a case, the receipt of the 15% down
payment would be recorded as a debit to cash and a credit to a liability

such as Deposit Liability.
(f) The initial agreement does not represent a claim against the client until
the contract is at least partially complete. Because part of the work was
accomplished in 2005, a portion of the revenue could be recognized in
2005 on a percentage basis. However, because the bulk of the work will
be done in 2006, revenue could be deferred until the audit is completed
and billed.
4–25.
(a) Immediate recognition. The future benefits of the new drug are highly
uncertain.
(b) Direct matching. The warranty costs are anticipated expenses that are
directly related to revenues.
(c) Systematic and rational allocation. The lease agreement benefits
several accounting periods in a systematic and rational way.
(d) Direct matching. Labor associated with assembling a product is
matched with revenues and reported in the period the goods are sold.
(e) Systematic and rational allocation. The delivery trucks are expected to
benefit several accounting periods in a systematic and rational way.
(f) Immediate recognition. The advertising indirectly helps to generate
revenues and is not related to specific revenues.

132


4–26.
Original cost of patent....................................................................
Amortization for 5 years ($30,000 per year 2000–2004)...............
Remaining unamortized balance...................................................

$450,000

150,000
$ 300,000

New estimated life from January 1, 2005.......................................
Amortization expense for each year (2005–2008)........................

4 years
$75,000

Separate disclosure of the $45,000 increase due to the change in estimate
would be required in 2005 if it is considered a material amount.
4–27.
(a) Subtracted or included in determining net purchases in the Cost of
Goods Sold section
(b) Other revenues and gains
(c) Other revenues and gains
(d) Other expenses and losses
(e) Either extraordinary items or other expenses and losses depending on
whether unusual and infrequent
(f) Operating expenses—selling expenses
(g) Discontinued operations
(h) Deduction from income from continuing operations before income
taxes
(i) Other revenues and gains
(j) Subtraction from sales
(k) Other expenses and losses
(l) Cost of goods sold (an item entering into cost of goods manufactured)
(m) Cumulative effect of change in accounting principle
(n) Operating expenses—general and administrative
(o) Cost of goods sold

133


4–28.

Caribou Inc.
Income Statement
For the Year Ended December 31, 2005
Sales.....................................................................
$1,600,000 (a)
Cost of goods sold:
Beginning inventory......................................... $ 136,000
Net purchases...................................................
919,200 (b)
Cost of goods available for sale..................... $ 1,055,200
Less: Ending inventory....................................
95,200
Cost of goods sold...........................................
960,000
Gross profit on sales..........................................
$ 640,000
Operating expenses:
Selling expenses.............................................. $ 208,000 (c)
General expenses (including bad debts ).........
272,000 (d)
480,000
Income before income taxes
and extraordinary items...................................
$ 160,000

Income taxes.......................................................
48,000
Income before extraordinary items...................
$ 112,000
Extraordinary gain (net of income taxes
of $9,000)...........................................................
21,000
Net income...........................................................
$ 133,000
Earnings per share (e):
Income before extraordinary items................
Extraordinary gain............................................
Net income........................................................

$0.86
0.16
$1.02

COMPUTATIONS:
(a) Sales
Income before income taxes as a percentage of sales:
Sales..............................................................
100%
Cost of goods sold (see below)..................
60
Gross profit on sales...................................
40%
Selling expenses..........................................
13%
General expenses, including bad debts. . .

17
30
Income before income taxes.........................
10%
Sales: $160,000 (income before income taxes) ÷ 0.10 = $1,600,000
Cost of goods sold:
General expenses, excluding bad debts = 15% of sales and 25% of
cost of sales: therefore, 0.15  sales = 0.25  Cost of goods sold
Cost of goods sold = 0.15 ÷ 0.25 = 0.60 of sales

134


4–28.

(Concluded)
(b) Net purchases
Cost of goods sold = Beginning inventory  Net purchases less
ending inventory
Let X equal net purchases.
0.60  $1,600,000 = $136,000 + X  0.70 ($136,000)
$960,000 = $40,800 + X
X = $919,200
(c) 0.13  $1,600,000 = $208,000
(d) (0.15  $1,600,000) + (0.02  $1,600,000) = $272,000
(e) Earnings per share (130,000 shares of common stock outstanding):
Income before extraordinary gain: $112,000 ÷ 130,000 shares = $0.86
Extraordinary gain: $21,000 ÷ 130,000 shares = $0.16
Net income: $133,000 ÷ 130,000 shares = $1.02

4–29.

Brigham Corporation
Income Statement (Partial)
For the Year Ended December 31, 2005
Income from continuing operations before income taxes............. $ 210,000
Income tax expense on continuing operations ($210,000  0.35).
73,500
Income from continuing operations................................................. $ 136,500
Discontinued operations:
Loss from operations of discontinued business
component (including gain on disposal of $20,000) $ (30,000)
Net income tax benefit...............................................
10,500
(19,500)
Extraordinary gain (net of income taxes of $49,000).
91,000
Net income.......................................................................................... $ 208,000

4–30.
(a) Discontinued operations:
Loss from operations of discontinued business
component (including gain on disposal of
$15,000).................................................................... $(115,000)
Income tax benefit...................................................
34,500 $ (80,500)
(b) If Garrison Manufacturing were reporting using the accounting
standards of the United Kingdom, it would also disclose information
about sales and operating profits for the continuing and discontinued
operations. This additional information allows financial statement users

to compare the relative size and operating profitability of the continuing
and discontinued operations. This practice is also similar to the
reporting requirements of IFRS 35.
4–31.

135


2005
2004
2003
Sales
$50,000
$43,000
$35,000
Cost of goods sold
20,000
18,000
15,000
Other expenses
13,000
12,000
11,000
Income before income taxes
$17,000
$13,000
$ 9,000
Income tax expense (35%)
5,950
4,550

3,150
Income from continuing operations
$11,050
$ 8,450
$ 5,850
Discontinued operations:
Income (loss) from operations
(including gain on disposal
in 2005 of $10,000)
$3,000
$(5,000)
$20,000
Income tax expense (benefit)
—35%
1,050
(1,750)
7,000
Income (loss) on discontinued
operations
1,950
(3,250)
13,000
Net income
$13,000
$ 5,200
$18,850
4–32.
(a)

(In millions

of dollars)
Income from continuing operations...........................................
$1,032.3
Cumulative effect of change in accounting for income taxes
(net of applicable taxes)...............................................................
544.2
Net income....................................................................................
$ 1,576.5
Earnings per common share:
Income from continuing operations........................................
Cumulative effect of accounting change.................................
Net income.................................................................................

(b)

$ 2.06
1.09
$ 3.15

If Sears were a non-U.S. company reporting under the provisions of IFRS 8, the
$544.2 million “gain” from the cumulative effect of the change in accounting
principle would not be shown in the income statement at all. Instead, the $544.2
million amount would be shown as a direct adjustment (an increase) to the
beginning balance in retained earnings for the year.

4–33.
(a)
(b)

Sales revenue.

Loss on disposal of discontinued operations; a separate component of income
shown net of taxes before extraordinary items but after income from continuing
operations.
(c) Extraordinary item, net of taxes.
4–33. (Concluded)
(d)
(e)
(f)

136

Prior-period adjustment (error correction); retained earnings adjustment.
Operating expense (or reduction in revenue)—it is a change in estimate.
Asset.


(g)

Results of discontinued operations: a separate component of income shown net
of taxes before extraordinary items but after income from continuing
operations.
(h) Asset (possibly could be expensed).
(i) Prior-period adjustment (error correction); retained earnings adjustment.
(j) Other Revenues and Gains section of income statement.
(k) Other Expenses and Losses section of income statement unless the event is
considered unusual and infrequent, in which case it would be reported as an
extraordinary item.
(l) Cumulative effect of change in accounting principle; a separate component of
income shown net of taxes as last item before net income.
(m) Operating expense; it is a change in estimate.

(n) Other Revenues and Gains section of income statement.
(o) Operating Expense or Other Expenses and Losses section, depending on
nature of business unless the event is considered unusual and infrequent, in
which case, it would be reported as an extraordinary item.
(p) Operating expense or adjustment to cost of goods sold.
(q) Included with current-year tax expense.
(r) Other Expenses and Losses section because the sale is only a portion of
business segment.
(s) Operating expense because the move does not qualify as discontinued
operations.
(t) Operating expense.

137


4–34.

Income Statement
Revenue:
Sales
Less: Sales discounts
Sales returns and allowances
Cost of goods sold:
Inventory—beginning
Net purchases:
Purchases
Less: Purchase discounts
Purchase returns and allowances
Freight-in
Cost of goods available for sale

Less: Inventory—ending
Gross profit
Operating expenses:
Selling expenses:
Advertising expense
Sales salaries and commissions
Miscellaneous selling expense
General and administrative expenses:
Officers’ salaries expense
Office salaries expense
Office supplies expense
Depreciation expense—office building
Depreciation expense—office furniture and fixtures
Bad debt expense
Insurance expense
Property taxes expense
Miscellaneous general expense
Operating income
Other revenues and gains:
Dividend revenue
Interest revenue
Royalty revenue
Other expenses and losses:
Interest expense—bonds
Interest expense—other
Income from continuing operations before income taxes
Income tax expense
Income from continuing operations
Loss from discontinued operations (net of income taxes of _____ )
Extraordinary gain (net of income taxes of _____ )

Net income
Earnings per common share:
Income from continuing operations
Loss from discontinued operations
Extraordinary gain
Net income

4–35.

138

The Pensacola Awning Company
Income Statement


For the Year Ended December 31, 2005
Sales revenue............................................................
$1,380,000
Expenses:
Costs of goods sold.............................................. $765,000
Selling expenses....................................................
288,720
General and administrative expenses..................
236,400
Interest expense....................................................
13,390
Income taxes..........................................................
30,596 (a) 1,334,106
Net income................................................................
$ 45,894

Earnings per share ($45,894 ÷ 25,000 shares)........
$
1.84
(a) 0.40  $76,490 (Income before taxes)
The Pensacola Awning Company
Statement of Retained Earnings
For the Year Ended December 31, 2005
Retained earnings, January 1.........................................................
Add: Net income..............................................................................
490,394
Deduct: Dividends...........................................................................
Retained earnings, December 31...................................................
445,394
4–36.
1.

$444,500
45,894
$
$

45,000

Losser Corporation
Schedule of Corrected Net Income
For the Year Ended December 31, 2005
Reported net income (profit and loss)........................
Add: Change in amortization expense......................
Gain on sale of land...........................................
Interest revenue.................................................

Less: Increased depreciation—change in estimate..
Loss on sale of equipment...............................
Extraordinary casualty loss..............................
Corrected net income...................................................

139

$13,680
$ 2,800
18,350
4,500
$ 5,000
3,860
27,730

25,650
$39,330
36,590
$ 2,740


4–36.

(Concluded)

2.
Losser Corporation
Retained Earnings Statement
For the Year Ended December 31, 2005
Retained earnings, January 1, 2005................................................

85,949
Add: Net income...............................................................................
Deduct: Dividends declared.............................................................
Retained earnings, December 31, 2005..........................................
3.

$
2,740
$88,689
10,000
$ 78,689

All items except dividends declared during the year would be reported on the
income statement and included in net income. Extraordinary items would be
reported separately after income from continuing operations.

4–37 .
1.
The unrealized losses on available-for-sale securities will decrease
comprehensive income because the value of the securities decreased during
the year.
The foreign currency translation adjustment will decrease
comprehensive income because the value of the currencies of Svedin’s
foreign subsidiaries weakened relative to the U.S. dollar. The minimum
pension liability adjustment will decrease comprehensive income.
2.

140

Svedin Incorporated

Statement of Comprehensive Income
For the Year Ended December 31, 2005
Net income............................................................................
Unrealized losses on available for sale securities............
Foreign currency translation adjustment..........................
Minimum pension liability adjustment...............................
Comprehensive income......................................................

$17,650
(1,285)
(287)
(315)
$15,763


4-38.

Han Incorporated
Forecasted Income Statement
For the Year Ended December 31, 2006

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

2005
$2,000
700

Gross profit....................................
Depreciation expense....................

$1,300
120

Other operating expenses.............

1,010

Operating profit..............................
Interest expense.............................

$ 170
90

Income before taxes......................
Income taxes..................................

$

80
30

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

$

50

2006
Forecasted

$2,200
given
770
35% of sales,
as last year
$1,430
160
20% of PPE,
same as last year
1,111
50.5% of sales,
same as last year
$ 159
75
15% of bank loan,
same as last year
$ 84
32
37.5% of pretax,
same as last year
$ 52

4-39.
Ryan Company
Forecasted Balance Sheet
December 31, 2006
2005
$ 10
250

2006
Forecasted
$ 15
50% natural increase
375
50% natural increase

Cash................................................
Other current assets......................
Property, plant, and equipment,
net.................................................
Total assets....................................

800
$ 1,060

800
$ 1,190

more efficient, item (b)

Accounts payable..........................
Bank loans payable........................

$ 100
700

$ 150
900

Total stockholders’ equity.............
Total liabilities and
stockholders’ equities................

260

140

50% natural increase
new loan of $200,
item (c)
to balance

$ 1,060

$ 1,190

141


4-39.

(Concluded)
Ryan Company
Forecasted Income Statement
For the Year Ended December 31, 2006

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

2005
$1,000
750

Gross profit....................................
Depreciation expense....................

$ 250
40

Other operating expenses.............

80

Operating profit..............................
Interest expense.............................

$ 130
70

Income before taxes......................
Income taxes..................................

$

60
20

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

$

40

2006
Forecasted
$1,500
given, item (a)
1,125
75% of sales,
same as last year
$ 375
40
5% of PPE,
same as last year
120
8% of sales,
same as last year
$ 215
90
10% of bank loan,
same as last year
$ 125
42
33.3% of pretax,
same as last year
$ 83

Note: Total stockholders’ equity is forecasted to decrease by $120 ($260  $140). This
will happen even though net income will cause stockholders’ equity to increase by

$83. These forecasts imply that Ryan Company is either planning to pay out a large
cash dividend or to buy back a large amount of shares of its own stock.

142


PROBLEMS
4–40.
Payette Co.
Income Statement
For the Year Ended June 30, 2005
Revenue:
Sales ($2,380,000 less returns and
allowances, $30,000)............................................
Interest revenue.......................................................
Expenses:
Cost of goods sold (net purchases,
$1,473,000 less increase in inventory, $10,000). $1,463,000
Selling and general expenses................................
238,000
Income taxes..............................................................
262,800
Net income..................................................................
Earnings per common share
($438,200 ÷ 325,000 shares)...................................

$2,350,000
52,000
$2,402,000

1,963,800
$ 438,200
$

1.35

Payette Co.
Retained Earnings Statement
For the Year Ended June 30, 2005
Retained earnings, July 1, 2004................................
Add: Net income.........................................................
Deduct: Dividends......................................................
Retained earnings, June 30, 2005.............................

143

$1,356,800
438,200
$1,795,000
260,000
$ 1,535,000


4–41.

1. Income statement–time of shipment:
Richmond Company
Income Statement
For the Years Ended December 31
Sales...............................................................................

Cost of goods sold.......................................................
Gross profit...................................................................
Bad debt expense.........................................................
Selling expenses...........................................................
General and administrative expenses.........................
Net income (loss)..........................................................

2006
$150,000
90,000
$ 60,000
(7,500)
(15,000)
(22,000)
$ 15,500

2005
$125,000
75,000
$ 50,000
(6,250)
(25,000)
(22,000)
$ (3,250)

2006
$132,000
66,000
$ 66,000
(660)

(15,000)
(22,000)
$ 28,340

2005
$ 84,000
42,000
$ 42,000
(420)
(25,000)
(22,000)
$ (5,420)

Income statement—time of sale:
Richmond Company
Income Statement
For the Years Ended December 31
Sales...............................................................................
Cost of goods sold.......................................................
Gross profit...................................................................
Bad debt expense.........................................................
Selling expenses...........................................................
General and administrative expenses.........................
Net income (loss)..........................................................

2. Under the first dealer agreement, revenue is recognized when goods are
shipped to the dealers. The dealer makes payment after receipt of the
goods. Possible bad debt losses are greater under this agreement
because the dealer may not have the cash to pay for the toys until they
are sold. The second type of dealer agreement is actually a

consignment of inventory. Because there is a right of return, the
revenue should not be recognized until the dealer makes a sale. The risk
is borne by Richmond. To cover this risk, the sales price is higher for
the toys.
In the problem, Richmond would have a larger loss in 2005 under the
consignment agreement than under the sale agreement; however, in
2006 the consignment agreement would produce a greater profit. In
addition, at the end of 2006 Richmond will still have 19,000 units out on
consignment, assuming that none of the units have been returned, with
a potential profit of $3 per unit less bad debt costs. Of course, if these
19,000 units are returned and cannot be resold, this profit will not be
realized. The uncertainty of the second type of dealer agreement
justifies the delay of revenue recognition until the dealer makes a sale.

144


4–42.
1.

(a) Revenue must be both earned and realized in order to be reported on
the income statement. Until Hadley ships the inventory, the $18,000 of
orders paid for in advance should not be reported on the income
statement.
(b) Because customers are not returning the products, the earnings
process can be considered substantially complete when the sale is
made. The revenues and associated cost of goods sold should be
included on the income statement.
(c) The rent will benefit several accounting periods and should be allocated
in a systematic fashion.

(d) It is difficult to determine the period of time that is benefited by general
advertising. Because the advertising costs cannot be related to specific
revenues, the costs are typically recognized as expenses immediately.
(e) Current cost information is currently not disclosed on the face of the
income statement. Some companies elect to provide supplemental
information of this nature in the notes to the financial statements.
(f) If warranty costs can be reasonably estimated, the expenses are
matched directly to the period in which the revenue is generated. Using
the actual costs incurred to approximate warranty expense violates the
matching principle.

2.

Sales.............................................................................................
Cost of goods sold.....................................................................
Gross profit.................................................................................
Rent expense...............................................................................
Advertising expense...................................................................
Warranty expense.......................................................................
Other expenses...........................................................................
Net income...................................................................................
Sales: $185,000 – $18,000 + $16,000 = $183,000
Cost of goods sold: $94,000 + $7,500 = $101,500
Rent expense: $18,000 – $6,000 = $12,000
Advertising expense: $6,000 + $18,000 = $24,000
Warranty expense: $183,000  0.05 = $9,150

145

$183,000

101,500
$ 81,500
(12,000)
(24,000)
(9,150)
(15,000)
$ 21,350