Question & Answer

The following financial statement was prepared by employees of Walters Corporation.

Note 1: New styles and rapidly changing consumer preferences resulted in a $71,500 loss on the disposal of discontinued styles and related accessories.

Note 2: The corporation sold an investment in marketable securities at a loss of $39,050. The corporation normally sells securities of this nature.

Note 3: The corporation sold one of its warehouses at an $86,350 loss.

Instructions

Identify and discuss the weaknesses in classification and disclosure in the single-step income statement above. You should explain why these treatments are weaknesses and what the proper presentation of the items would be in accordance with GAAP.

Simpson Corp. is an entertainment firm that derives approximately 30% of its income from the Casino Knights Division, which manages gambling facilities. As auditor for

Simpson Corp., you have recently overheard the following discussion between the controller and financial vice president.

Vice President: If we sell the Casino Knights Division, it seems ridiculous to segregate the results of the sale in the income statement. Separate categories tend to be absurd and confusing to the stockholders. I believe that we should simply report the gain on the sale as other income or expense without detail.

Controller: Professional pronouncements would require that we report this information separately in the income statement. If a sale of this type is considered unusual and infrequent, it must be reported as an extraordinary item. Vice President: What about the walkout we had last month when employees were upset about their commission income? Would this situation not also be an extraordinary item?

Controller: I am not sure whether this item would be reported as extraordinary or not.

Vice President: Oh well, it doesn’t make any difference because the net effect of all these items is immaterial, so no disclosure is necessary.

Instructions

(a) On the basis of the foregoing discussion, answer the following questions. Who is correct about handling the sale? What would be the correct income statement presentation for the sale of the Casino Knights Division?

(b) How should the walkout by the employees be reported?

(c) What do you think about the vice president’s observation on materiality?

(d) What are the earnings per share implications of these topics?

Charlie Brown, controller for Kelly Corporation, is preparing the company’s income statement at year-end. He notes that the company lost a considerable sum on the sale of some equipment it had decided to replace. Since the company has sold equipment routinely in the past, Brown knows the losses cannot be reported as extraordinary. He also does not want to highlight it as a material loss since he feels that will reflect poorly on him and the company. He reasons that if the company had recorded more depreciation during the assets’ lives, the losses would not be so great. Since depreciation is included among the company’s operating expenses, he wants to report the losses along with the company’s expenses, where he hopes it will not be noticed.

Instructions

(a) What are the ethical issues involved?

(b) What should Brown do?

Bobek Inc. has recently reported steadily increasing income. The company reported income of $20,000 in 2011, $25,000 in 2012, and $30,000 in 2013. A number of market analysts have recommended that investors buy the stock because they expect the steady growth in income to continue. Bobek is approaching the end of its fiscal year in 2014, and it again appears to be a good year.

However, it has not yet recorded warranty expense.

Based on prior experience, this year’s warranty expense should be around $5,000, but some managers have approached the controller to suggest a larger, more conservative warranty expense should be recorded this year. Income before warranty expense is $43,000. Specifically, by recording a $7,000 warranty accrual this year, Bobek could report an increase in income for this year and still be in a position to cover its warranty costs in future years.

Instructions

(a) What is earnings management?

(b) Assume income before warranty expense is $43,000 for both 2014 and 2015 and that total warranty expense over the 2-year period is $10,000. What is the effect of the proposed accounting in 2014? In

2015?

(c) What is the appropriate accounting in this situation?

O’Malley Corporation was incorporated and began business on January 1, 2014. It has been successful and now requires a bank loan for additional working capital to finance expansion. The bank has requested an audited income statement for the year 2014. The accountant for O’Malley Corporation provides you with the following income statement which O’Malley plans to submit to the bank.

Instructions

Indicate the deficiencies in the income statement presented above. Assume that the corporation desires a single-step income statement.

Wade Corp. has 150,000 shares of common stock outstanding.

In 2014, the company reports income from continuing operations before income tax of $1,210,000. Additional transactions not considered in the $1,210,000 are as follows.

1. In 2014, Wade Corp. sold equipment for $40,000. The machine had originally cost $80,000 and had accumulated depreciation of $30,000. The gain or loss is considered ordinary.

2. The company discontinued operations of one of its subsidiaries during the current year at a loss of $190,000 before taxes. Assume that this transaction meets the criteria for discontinued operations.

The loss from operations of the discontinued subsidiary was $90,000 before taxes; the loss from disposal of the subsidiary was $100,000 before taxes.

3. An internal audit discovered that amortization of intangible assets was understated by $35,000 (net of tax) in a prior period. The amount was charged against retained earnings.

4. The company had a gain of $125,000 on the condemnation of much of its property. The gain is taxed at a total effective rate of 40%. Assume that the transaction meets the requirements of an extraordinary item.

Instructions

Analyze the above information and prepare an income statement for the year 2014, starting with income from continuing operations before income tax. Compute earnings per share as it should be shown on the face of the income statement. (Assume a total effective tax rate of 38% on all items, unless otherwise indicated.)

Below is the Retained Earnings account for the year 2014 for Acadian Corp.

Retained earnings, January 1, 2014 $257,600

Add:

Gain on sale of investments (net of tax) $41,200

Net income 84,500

Refund on litigation with government, related to the year 2011

(net of tax) 21,600

Recognition of income earned in 2013, but omitted from income statement in that year (net of tax) 25,400 172,700

430,300

Deduct:

Loss on discontinued operations (net of tax) 35,000

Write-off of goodwill (net of tax) 60,000

Cumulative effect on income of prior years in changing from

LIFO to FIFO inventory valuation in 2014 (net of tax) 23,200

Cash dividends declared 32,000 150,200

Retained earnings, December 31, 2014 $280,100

Instructions

(a) Prepare a corrected retained earnings statement. Acadian Corp. normally sells investments of the type mentioned above. FIFO inventory was used in 2014 to compute net income.

(b) State where the items that do not appear in the corrected retained earnings statement should be shown.

Presented below is a combined single-step income and retained earnings statement for Nerwin Company for 2014.

(000 omitted)

Net sales revenue $640,000

Costs and expenses

Cost of goods sold $500,000

Selling, general, and administrative expenses 66,000

Other, net 17,000 583,000

Income before income tax 57,000

Income tax 19,400

Net income 37,600

Retained earnings at beginning of period, as previously reported 141,000

Adjustment required for correction of error (7,000)

Retained earnings at beginning of period, as restated 134,000

Dividends on common stock (12,200)

Retained earnings at end of period $159,400

Additional facts are as follows.

1. “Selling, general, and administrative expenses” for 2014 included a charge of $8,500,000 that was usual but infrequently occurring.

2. “Other, net” for 2014 included an extraordinary item (charge) of $6,000,000. If the extraordinary item (charge) had not occurred, income taxes for 2014 would have been $21,400,000 instead of

$19,400,000.

3. “Adjustment required for correction of an error” was a result of a change in estimate (useful life of certain assets reduced to 8 years and a catch-up adjustment made).

4. Nerwin Company disclosed earnings per common share for net income in the notes to the financial statements.

Instructions

Determine from these additional facts whether the presentation of the facts in the Nerwin Company income and retained earnings statement is appropriate. If the presentation is not appropriate, describe the appropriate presentation and discuss its theoretical rationale. (Do not prepare a revised statement.)

The following account balances were included in the trial balance of Twain Corporation at June 30, 2014.

Sales revenue $1,578,500 Depreciation expense (offi ce

Sales discounts 31,150 furniture and equipment) $ 7,250

Cost of goods sold 896,770 Property tax expense 7,320

Salaries and wages expense (sales) 56,260 Bad debt expense (selling) 4,850

Sales commissions 97,600 Maintenance and repairs

Travel expense (salespersons) 28,930 expense (administration) 9,130

Delivery expense 21,400 Offi ce expense 6,000

Entertainment expense 14,820 Sales returns and allowances 62,300

Telephone and Internet expense (sales) 9,030 Dividends received 38,000

Depreciation expense (sales equipment) 4,980 Interest expense 18,000

Maintenance and repairs expense (sales) 6,200 Income tax expense 102,000

Miscellaneous selling expenses 4,715 Depreciation understatement

Offi ce supplies used 3,450 due to error—2011 (net of tax) 17,700

Telephone and Internet expense Dividends declared on (administration) 2,820 preferred stock 9,000

Dividends declared on common stock 37,000

The Retained Earnings account had a balance of $337,000 at July 1, 2013. There are 80,000 shares of common stock outstanding.

Instructions

(a) Using the multiple-step form, prepare an income statement and a retained earnings statement for the year ended June 30, 2014.

(b) Using the single-step form, prepare an income statement and a retained earnings statement for the year ended June 30, 2014.

Maher Inc. reported income from continuing operations before taxes during 2014 of $790,000. Additional transactions occurring in 2014 but not considered in the $790,000 are as follows.

1. The corporation experienced an uninsured flood loss (extraordinary) in the amount of $90,000 during the year. The tax rate on this item is 46%.

2. At the beginning of 2012, the corporation purchased a machine for $54,000 (salvage value of $9,000) that had a useful life of 6 years. The bookkeeper used straight-line depreciation for 2012, 2013, and

2014 but failed to deduct the salvage value in computing the depreciation base.

3. Sale of securities held as a part of its portfolio resulted in a loss of $57,000 (pretax).

4. When its president died, the corporation realized $150,000 from an insurance policy. The cash surrender value of this policy had been carried on the books as an investment in the amount of $46,000 (the gain is nontaxable).

5. The corporation disposed of its recreational division at a loss of $115,000 before taxes. Assume that this transaction meets the criteria for discontinued operations.

6. The corporation decided to change its method of inventory pricing from average-cost to the FIFO method. The effect of this change on prior years is to increase 2012 income by $60,000 and decrease 2013 income by $20,000 before taxes. The FIFO method has been used for 2014. The tax rate on these items is 40%.

Instructions

Prepare an income statement for the year 2014 starting with income from continuing operations before taxes. Compute earnings per share as it should be shown on the face of the income statement. Common shares outstanding for the year are 120,000 shares. (Assume a tax rate of 30% on all items, unless indicated otherwise.)

Presented below is the trial balance of Thompson Corporation at December 31, 2014.

A physical count of inventory on December 31 resulted in an inventory amount of $64,000; thus, cost of goods sold for 2014 is $645,000.

Instructions

Prepare a single-step income statement and a retained earnings statement. Assume that the only changes in retained earnings during the current year were from net income and dividends. Thirty thousand shares of common stock were outstanding the entire year.

The following information is related to Dickinson Company for 2014.

Retained earnings balance, January 1, 2014 $ 980,000

Sales revenue 25,000,000

Cost of goods sold 16,000,000

Interest revenue 70,000

Selling and administrative expenses 4,700,000

Write-off of goodwill 820,000

Income taxes for 2014 1,244,000

Gain on the sale of investments (normal recurring) 110,000

Loss due to fl ood damage—extraordinary item (net of tax) 390,000

Loss on the disposition of the wholesale division (net of tax) 440,000

Loss on operations of the wholesale division (net of tax) 90,000Dividends declared on common stock $250,000

Dividends declared on preferred stock 80,000

Dickinson Company decided to discontinue its entire wholesale operations and to retain its manufacturing operations. On September 15, Dickinson sold the wholesale operations to Rogers Company. During 2014, there were 500,000 shares of common stock outstanding all year.

Instructions

Prepare a multiple-step income statement and a retained earnings statement.

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

Extraordinary gain $ 95,000 Cash dividends declared $ 150,000

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

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

Rent revenue 40,000 Selling expenses 300,000

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

Shares outstanding during 2014 were 100,000.

Instructions

(a) Prepare a single-step income statement.

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

(c) Prepare a retained earnings statement for 2014.

C. Reither Co. reports the following information for 2014: sales revenue

$700,000; cost of goods sold $500,000; operating expenses $80,000; and an unrealized holding loss on available-for-sale securities for 2014 of $60,000. It declared and paid a cash dividend of $10,000 in 2014.

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

Instructions

Prepare a statement of stockholders’ equity.

Roxanne Carter Corporation reported the following for 2014: net sales

$1,200,000; cost of goods sold $750,000; selling and administrative expenses $320,000; and an unrealized holding gain on available-for-sale securities $18,000.

Instructions

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

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

Weighted-

Year Average FIFO

2012 $370,000 $395,000

2013 390,000 430,000

2014 410,000 450,000

Instructions

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

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

FIFO inventory pricing.

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

At December 31, 2013, Shiga Naoya Corporation had the following stock outstanding.

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

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

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

Income from continuing operations before taxes $23,650,000

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

Preferred dividends declared $ 1,075,000

Common dividends declared $ 2,200,000

Effective tax rate 35%

Instructions

Compute earnings per share data as it should appear in the 2014 income statement of Shiga Naoya Corporation. (Round to two decimal places.)

Eddie Zambrano Corporation began operations on January 1, 2011.

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

Net Income Dividends Declared

2011 $ 40,000 $ –0–

2012 125,000 50,000

2013 160,000 50,000

The following information relates to 2014.

Income before income tax $240,000

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

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

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

Effective tax rate 40%

Instructions

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

(b) Assume Eddie Zambrano Corp. restricted retained earnings in the amount of $70,000 on December 31, 2014. After this action, what would Zambrano report as total retained earnings in its December 31, 2014, balance sheet?

The following are selected ledger accounts of Spock Corporation at December 31, 2014.

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

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

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

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

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

Sales discounts 34,000 Accounts receivable 142,500

Purchase discounts 27,000 Sales commissions 83,000

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

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

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

Advertising expense 54,000 Rent revenue 240,000

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

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

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

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

Instructions

Prepare a condensed 2014 income statement for Spock Corporation.7

The stockholders’ equity section of Tkachuk Corporation appears below as of

December 31, 2014.

8% preferred stock, $50 par value, authorized

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

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

Additional paid-in capital 20,500,000

Retained earnings $134,000,000

Net income 33,000,000 167,000,000

$202,000,000

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

Instructions

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

Presented below is information related to Ivan Calderon Corp. for the year 2014.

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

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

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

Administrative expenses 48,000 Cash dividends declared 45,000

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

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

Instructions

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

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

Presented below are selected ledger accounts of Tucker Corporation as of

December 31, 2014.

Cash $ 50,000

Administrative expenses 100,000

Selling expenses 80,000

Net sales 540,000

Cost of goods sold 210,000

Cash dividends declared (2014) 20,000

Cash dividends paid (2014) 15,000

Discontinued operations (loss before income taxes) 40,000

Depreciation expense, not recorded in 2013 30,000

Retained earnings, December 31, 2013 90,000

Effective tax rate 30%

Instructions

(a) Compute net income for 2014.

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

The accountant of Latifa Shoe Co. has compiled the following information from the company’s records as a basis for an income statement for the year ended December 31, 2014.

Rent revenue $ 29,000

Interest expense 18,000

Market appreciation on land above cost 31,000

Salaries and wages expense (selling) 114,800

Supplies (selling) 17,600

Income tax 37,400

Salaries and wages expense (administrative) 135,90

5Other administrative expenses $ 51,700

Cost of goods sold 496,000

Net sales 980,000

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

Cash dividends declared 16,000

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

Instructions

(a) Prepare a multiple-step income statement.

(b) Prepare a single-step income statement.

(c) Which format do you prefer? Discuss.

The following balances were taken from the books of

Maria Conchita Alonzo Corp. on December 31, 2014.

Interest revenue $ 86,000 Accumulated depreciation—equipment $ 40,000

Cash 51,000 Accumulated depreciation—buildings 28,000

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

Accounts receivable 150,000 Selling expenses 194,000

Prepaid insurance 20,000 Accounts payable 170,000

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

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

Sales discounts 45,000 Accrued liabilities 32,000

Land 100,000 Interest expense 60,000

Equipment 200,000 Notes payable 100,000

Buildings 140,000 Loss from earthquake damage

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

Common stock 500,000

Retained earnings 21,000

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

Instructions

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

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

Administrative expense

Offi cers’ salaries $ 4,900

Depreciation of offi ce furniture and equipment 3,960

Cost of goods sold 60,570

Rent revenue 17,230

Selling expense

Delivery expense 2,690

Sales commissions 7,980

Depreciation of sales equipment 6,480

Sales revenue 96,500

Income tax 9,070

Interest expense 1,860

Instructions

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

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

(c) Which one do you prefer? Discuss.