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Chapter Chapter 1414Income Taxes, Unusual Income Taxes, Unusual Income Tax Items, and Income Tax Items, and Investments in StocksInvestments in Stocks
Accounting, 21st Edition
Warren Reeve Fess
PowerPoint Presentation by Douglas CloudProfessor Emeritus of AccountingPepperdine University
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1. Journalize the entries for corporate income taxes, including deferred income taxes.
2. Prepare an income statement reporting the following unusual items: fixed asset impairments, restructuring charges, discontinued operations, extraordinary items, and changes in accounting principles.
3. Prepare an income statement reporting earnings per share data.
ObjectivesObjectivesObjectivesObjectives
After studying this After studying this chapter, you should chapter, you should
be able to:be able to:
After studying this After studying this chapter, you should chapter, you should
be able to:be able to:
4. Describe the concept and the reporting of comprehensive income.
ObjectivesObjectivesObjectivesObjectives
5. Describe the accounting for investments in stocks.
6. Describe alternative methods of combining businesses and how consolidated financial statements are prepared.
7. Compute and interpret the price-earnings ratio.
Corporate Income TaxesCorporate Income TaxesCorporate Income TaxesCorporate Income Taxes
A corporation makes four income tax installment payments
throughout the year.
A corporation makes four income tax installment payments
throughout the year.
Assume that a corporation estimates its taxes for the
year to be $84,000.
Assume that a corporation estimates its taxes for the
year to be $84,000.
Corporate Income TaxesCorporate Income TaxesCorporate Income TaxesCorporate Income Taxes
Corporate Income TaxesCorporate Income TaxesCorporate Income TaxesCorporate Income Taxes
Apr. 15 Income Tax Expense 21 000 00
To record quarterly payment of
estimated income tax.
Cash 21 000 00
On April 15, the first of four estimated annual tax payments of $21,000 is made.
On April 15, the first of four estimated annual tax payments of $21,000 is made.
Corporate Income TaxesCorporate Income TaxesCorporate Income TaxesCorporate Income Taxes
Ratio of Reported Income Tax Expense to Earnings Before Taxes for Selected Industries
At the end of the first year of operations, a corporation reports $300,000 income before income taxes. With a 40% tax rate, the firm faces a tax of $120,000. Using tax planning, the net income is
reduced to $100,000 and the actual income tax due is $40,000. The difference is deferred to future years.
Another type of accounting change occurs when businesses are required to change the way they treat an accounting situation when the FASB issues a new accounting standard.
Another type of accounting change occurs when businesses are required to change the way they treat an accounting situation when the FASB issues a new accounting standard.
Accounting for Investments in Accounting for Investments in StocksStocks
Trading securities are securities that management intends to actively trade for profit.
Available-for-sale securities are securities that management expects to sell in the future, but which are not actively traded for profit.
Short-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in Stocks
Temporary investments are recorded in the current
asset account, Marketable Securities, at their cost.
Temporary investments are recorded in the current
asset account, Marketable Securities, at their cost.
Short-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in Stocks
On June 1, Crabtree Company purchased 2,000 shares of Inis Corporation common stock at
$89.75 per share plus a brokerage fee of $500.
On June 1, Crabtree Company purchased 2,000 shares of Inis Corporation common stock at
$89.75 per share plus a brokerage fee of $500.
June 1 Marketable Securities 180 000 00
Purchased 2,000 shares of Inis
Corporation common stock.
Cash 180 000 00
$89.75 x 2,000 shares + $500$89.75 x 2,000 shares + $500
Short-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in Stocks
On October 1, Inis declared a $0.90 per share dividend payable on November 30.
On October 1, Inis declared a $0.90 per share dividend payable on November 30.
Nov.30 Cash 1 800 00
Received dividend on Inis
Corporation common stock.
Dividend Revenue 1 800 00
2,000 shares x $0.902,000 shares x $0.90
Short-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in Stocks
On the balance sheet, temporary investments are reported at their fair market
value. Any difference between the fair market value and the cost is an unrealized
holding gain or loss.
On the balance sheet, temporary investments are reported at their fair market
value. Any difference between the fair market value and the cost is an unrealized
holding gain or loss.
Short-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in Stocks
At year-end, the total cost of Crabtree Co.’s four temporary investments is
$690,000. The current market for these four items totaled $750,000 at year-end.
Thus, Crabtree Co. had a before tax unrealized gain of $60,000.
At year-end, the total cost of Crabtree Co.’s four temporary investments is
$690,000. The current market for these four items totaled $750,000 at year-end.
Thus, Crabtree Co. had a before tax unrealized gain of $60,000.
Short-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in Stocks
Crabtree Co.Balance Sheet
December 31, 2006
Crabtree Co.Balance Sheet
December 31, 2006Current assets:
Cash$119,500Temporary investments in
marketable securities at cost $690,000Plus unrealized gain (net of applicable income tax of $18,000) 42,000
732,000
Current assets:Cash$119,500Temporary investments in
marketable securities at cost $690,000Plus unrealized gain (net of applicable income tax of $18,000) 42,000
732,000Stockholders’ Equity
Accumulated other comprehensive income 42,000
Stockholders’ EquityAccumulated other comprehensive income 42,000
Short-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in Stocks
Crabtree Co.Statement of Comprehensive Income
For the Year Ended December 31, 2006
Crabtree Co.Statement of Comprehensive Income
For the Year Ended December 31, 2006
Net income$720,000
Other comprehensive income:Unrealized gain on temporary investments
in marketable securities (net ofapplicable tax of $18,000)
42,000Comprehensive income
$762,000
Net income$720,000
Other comprehensive income:Unrealized gain on temporary investments
in marketable securities (net ofapplicable tax of $18,000)
42,000Comprehensive income
$762,000
Long-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in Stocks
Long-term investments are those investments made by a firm that are not intended as a source of cash in the normal operations of the business.
Long-term investments are those investments made by a firm that are not intended as a source of cash in the normal operations of the business.
EquityMethod
CostMethod
Not significantinfluence
Significantinfluence
Ownership %
Controlling Interest
100%100%
CostMethod
Not significantinfluence
0%0%
20%20%
50%50%With less than 20% ownership the buyer
does not usually have significant influence. The buyer uses the cost method
to account for the investment.
With less than 20% ownership the buyer does not usually have significant
influence. The buyer uses the cost method to account for the investment.
Long-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in Stocks
EquityMethod
CostMethod
No significantinfluence
Significantinfluence
Ownership %
Controlling Interest
0%0%
EquityMethod 50%50%
Ownership over 20% usually indicates significant influence. The buyer uses
the equity method to account for the investment.
Ownership over 20% usually indicates significant influence. The buyer uses
the equity method to account for the investment.
100%100%
20%20%
Long-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in Stocks
Jan. 2 Investment in Brock Corp. Stock 350 000 00
Purchased 40% of Brock Corp.
common stock.
Cash 350 000 00
On January 2, Hally Inc. pays cash of $350,000 for 40% of Brock Corporation’s common stock.
On January 2, Hally Inc. pays cash of $350,000 for 40% of Brock Corporation’s common stock.
Long-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in Stocks
Dec. 31 Investment in Brock Corp. Stock 42 000 00
Recorded share (40%) of Brock
Corp. net income of $105,000.
Income of Brock Corp. 42 000 00
For the year ending December 31, Brock Corporation reports net income of $105,000.
For the year ending December 31, Brock Corporation reports net income of $105,000.
Long-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in Stocks
Dec. 31 Cash 18 000 00
Recorded share (40%) of
dividends of $45,000 paid by
Brock Corp.
Investment in Brock Crop. Stock 18 000 00
On December 31, Brock Corporation declared a $45,000 dividend, payable on December 31.
On December 31, Brock Corporation declared a $45,000 dividend, payable on December 31.
Long-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in Stocks
Mar. 1 Cash 17 500 00
Sold investment in Drey Inc.
stock.
Investment in Drey Inc. Stock 15 700 00
Gain on Sale of Investments1 800 00
On March 1, an investment in Drey Inc. stock that had a carrying amount of
$15,700 is sold for $17,500.
On March 1, an investment in Drey Inc. stock that had a carrying amount of
$15,700 is sold for $17,500.
Long-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in Stocks
EquityMethod
CostMethod
No significantinfluence
Significantinfluence
Ownership %
0%0%
20%20%
Controlling Interest
Controlling Interest
Controlling Interest
100%100%
50%50%
Business CombinationsBusiness CombinationsBusiness CombinationsBusiness Combinations
The corporation owning all or a majority of the voting stock is called the parent company. The controlled
corporation is the subsidiary company. Consolidated financial statements are prepared which combines the
operating results of the two entities.
The corporation owning all or a majority of the voting stock is called the parent company. The controlled
corporation is the subsidiary company. Consolidated financial statements are prepared which combines the
operating results of the two entities.
Business CombinationsBusiness CombinationsBusiness CombinationsBusiness CombinationsA merger combines two corporations by one
acquiring the properties of another that is then dissolved.
Many businesses combine in order to produce more efficiently or to diversify product lines.
A consolidation is the creation of a new corporation, to which the combined assets and liabilities of the old corporations are transferred to the new corporation.
Mergers: Company A acquires company B. The assets and liabilities of B are transferred to A and B is then dissolved.
Mergers
A
B
Consolidations: Company A acquires company B. The assets and liabilities of both A and B are transferred to a new company C and A and B are then dissolved.
Consolidations
CA
B
Business CombinationsBusiness CombinationsBusiness CombinationsBusiness Combinations
FINANCIAL ANALYSIS AND
INTERPRETATION
A firm’s growth potential and future earnings prospects are indicated by how
much the market is willing to pay per dollar of a company’s earnings.
A firm’s growth potential and future earnings prospects are indicated by how
much the market is willing to pay per dollar of a company’s earnings.
Accounting: Earnings Per ShareAccounting: Earnings Per Share
Net Income
Common Shares
Earnings per Share of Common
Stock=
Investing: Price - Earnings RatioInvesting: Price - Earnings Ratio
Market Price Per Share
of Common StockEarnings Per Share of
Common Stock
Price-Earnings
Ratio=
The price-earnings ratio represents how much the market is willing to pay per dollar of a company’s earnings. This indicates the market’s assessment of a firm’s growth potential and future earnings prospects.
The price-earnings ratio indicates that a share of common stock was selling for 10 times earnings for 2005 and 12.5 times for 2006.
An example: 2006 2005
Market price per share $20.50 $13.50
Earnings per share $1.64 $1.35
Price-earnings ratioPrice-earnings ratio 12.5 12.5 10.0 10.0