Special Income and Investment Reporting Issues

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Special Income and Investment Reporting Issues

Chapter 12

Electronic Presentation by Douglas Cloud

Pepperdine University

Electronic Presentation by Douglas Cloud

Pepperdine University

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1. Describe the accounting for and interpretation of deferred income taxes.

2. Prepare an income statement reporting the following unusual items: discontinued operations, extraordinary items, and changes in accounting principles.

3. Describe the accounting for and interpretation of fixed asset impairments and restructuring charges.

Learning GoalsLearning GoalsLearning GoalsLearning Goals

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:

ContinuedContinuedContinuedContinued

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4. Prepare an income statement reporting earnings per share data.5. Describe the concept and the reporting of comprehensive income.6. Describe the accounting for investments in stocks.7. Describe alternative methods of combining businesses and how

consolidated financial statements are prepared.


ContinuedContinuedContinuedContinued

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8. Describe financial statement presentations of stockholders’ equity.

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1Learning GoalLearning GoalLearning GoalLearning Goal

Describe the accounting for and interpretation of deferred income taxes.

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Payment of Income TaxesPayment of Income TaxesPayment of Income TaxesPayment of Income Taxes

Most corporations are required to pay

estimated federal income taxes in four

installments throughout the year.

Most corporations are required to pay

estimated federal income taxes in four

installments throughout the year.

At year-end, the actual taxable income and the related taxes are determined. If additional taxes are owed, the additional liability is recorded.

At year-end, the actual taxable income and the related taxes are determined. If additional taxes are owed, the additional liability is recorded.

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Payment of Income TaxesPayment of Income TaxesPayment of Income TaxesPayment of Income Taxes

Year Ended June 30, 2001 (Amounts in millions)

Net Sales $39,244Cost of products sold 22,102Marketing, research, and administrative expenses 12,406Operating income $ 4,736Interest expense 794Other income, net 674Earnings Before Income Taxes $ 4,616Income taxes 1,694Net earnings $ 2,922

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Temporary DifferencesTemporary DifferencesTemporary DifferencesTemporary Differences• Revenues or gains are taxed after they are

reported in the income statement.• Expenses or losses are deducted in determining

taxable income after they are reported in the income statement.

• Revenues and gains are taxed before they are reported in the income statement.

• Expenses or losses are deducted in determining taxable income before they are reported in the income statement.

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Allocation of Income TaxesAllocation of Income TaxesAllocation of Income TaxesAllocation of Income Taxes

A corporation has $300,000 of income before income taxes, a 40% tax rate, and

$100,000 of taxable income.

A corporation has $300,000 of income before income taxes, a 40% tax rate, and

$100,000 of taxable income.

Income Tax Expense 120,000Income Taxes Payable 40,000Deferred Income Taxes Payable 80,000

$100,000 x .40$100,000 x .40$300,000 x .40$300,000 x .40

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Allocation of Income TaxesAllocation of Income TaxesAllocation of Income TaxesAllocation of Income Taxes

In the second year, $48,000 of the deferred tax reverses and becomes due.

In the second year, $48,000 of the deferred tax reverses and becomes due.

Deferred Income Taxes Payable 48,000Income Taxes Payable 48,000

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A corporation’s taxable income and its income before taxes may also differ because certain revenues are exempt

from taxes…

A corporation’s taxable income and its income before taxes may also differ because certain revenues are exempt

from taxes…

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…and certain expenses are not deducted in determining taxable income. Such differences are called

permanent differences.

…and certain expenses are not deducted in determining taxable income. Such differences are called

permanent differences.

• Interest on municipal bonds

• Fines for overloading delivery trucks

ExamplesExamplesExamplesExamples

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Prepare an income statement reporting the following unusual items: discontinued operations, extraordinary items, and changes in accounting principles.


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Discontinued OperationsDiscontinued OperationsDiscontinued OperationsDiscontinued Operations

A gain or loss from disposing of a business segment or component of an

entity is reported on the income statement as a gain or loss from

discontinued operations.

A gain or loss from disposing of a business segment or component of an

entity is reported on the income statement as a gain or loss from

discontinued operations.A business segment refers to a major line of business for a company.

A business segment refers to a major line of business for a company.

A component of an entity is the lowest level at which

the operations and cash flows can be clearly

distinguished from the rest of the entity.

A component of an entity is the lowest level at which

the operations and cash flows can be clearly

distinguished from the rest of the entity.

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Extraordinary ItemExtraordinary ItemExtraordinary ItemExtraordinary Item

Extraordinary items result from events and transactions that (1) are significantly different from the typical or the normal operating activities of the business and

(2) occur infrequently.

Extraordinary items result from events and transactions that (1) are significantly different from the typical or the normal operating activities of the business and

(2) occur infrequently.

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Changes in Accounting PrinciplesChanges in Accounting PrinciplesChanges in Accounting PrinciplesChanges in Accounting Principles

1. The nature of the change.

2. The justification for the change.

3. The effect on the current year’s net income.

4. The cumulative effect of the change on the net income of prior periods.

Changes in GAAP disclosures should include the following:

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Describe the accounting for and interpretation of fixed asset impairments and restructuring charges.


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Fixed Asset ImpairmentFixed Asset ImpairmentFixed Asset ImpairmentFixed Asset Impairment

Fixed asset impairment occurs when the fair value of a fixed asset that is held

or used falls below its book value and is not expected to recover.

Fixed asset impairment occurs when the fair value of a fixed asset that is held

or used falls below its book value and is not expected to recover.

Such impairments should be recognized on the

income statement as a loss at the time of the

impairment.

Such impairments should be recognized on the

income statement as a loss at the time of the

impairment.

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Restructuring ChargesRestructuring ChargesRestructuring ChargesRestructuring Charges

Restructuring charges are the accrued employee termination benefits associated with a management-

approved employee termination plan.

Restructuring charges are the accrued employee termination benefits associated with a management-

approved employee termination plan.

Restructuring Charge xxxxxEmployee Termination Benefit Obligation xxxxx

A current or long-term liability

A current or long-term liability

An expenseAn expense

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Restructuring ChargesRestructuring ChargesRestructuring ChargesRestructuring Charges

Later, the actual benefits are paid to the terminated employees.

Later, the actual benefits are paid to the terminated employees.

Employee Termination Benefit Obligation xxxxx

Cash xxxxx

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Prepare an income statement reporting earnings per share data.4

Learning GoalLearning GoalLearning GoalLearning Goal

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Earnings per Common ShareEarnings per Common ShareEarnings per Common ShareEarnings per Common Share

No preferred stock outstandingNo preferred stock outstanding

EPCS = Net incomeNumber of common shares outstanding

Preferred stock outstandingPreferred stock outstanding

EPCS = Net income – Preferred stock dividendNumber of common shares outstanding

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Jones CorporationIncome Statement

For the Year Ended December 31, 2005

Earnings per common share:Income from continuing operations $3.45Loss on discontinued operations (Note A) 0.50Income before extraordinary items and cumulative effect of a change in accounting principle $2.95

Extraordinary item:Gain on condemnation of land, net of applicable income tax of $65,000 0.75Cumulative effect on prior years of changing to a different depreciation method (Note B) 0.46

Net income $4.16

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Describe the concept and the reporting of comprehensive income.

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Comprehensive income is defined as all changes in

stockholders’ equity during a period except those resulting

from dividends and stockholders’ investments.

Comprehensive income is defined as all changes in

stockholders’ equity during a period except those resulting

from dividends and stockholders’ investments.

Foreign currency items Pension liability

adjustments Unrealized gains and

losses on investments

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Note that the “other comprehensive income” items do not affect net

income or retained earnings.

Note that the “other comprehensive income” items do not affect net

income or retained earnings.

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Describe the accounting for investments in stocks.6

Learning GoalLearning GoalLearning GoalLearning Goal

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Trading securities are securities that

management intends to actively trade for profit.

Trading securities are securities that

management intends to actively trade for profit.

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Available-for-sale securities are securities that management expects to sell

in the future, but are not actively traded for profit.

Available-for-sale securities are securities that management expects to sell

in the future, but are not actively traded for profit.

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Available-for-Sale Equity Available-for-Sale Equity InvestmentsInvestments


On June 1 Crabtree Co. purchased 2,000 shares of Inis Corporation common stock at $89.75

per share plus a brokerage fee of $500.

On June 1 Crabtree Co. purchased 2,000 shares of Inis Corporation common stock at $89.75

per share plus a brokerage fee of $500.

June 1 Marketable Securities 180,000Cash 180,000

($89.75 x 2,000) + $500

($89.75 x 2,000) + $500

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On October 1, Inis declared a $0.90 per share cash dividend payable on November 30.

On October 1, Inis declared a $0.90 per share cash dividend payable on November 30.

Nov.30 Cash 1,800Dividend Revenue 1,800

2,000 x $0.902,000 x $0.90

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UnrealizedCommon Stock Cost Market Gain (Loss) Edward, Inc. $150,000 $190,000 $40,000SWS Corp. 200,000 200,000 —Inis Corporation 180,000 210,000 30,000Bass Co. 160,000 150,000 (10,000) Total $690,000 $750,000 $60,000

$60,000 – (.30 x $60,000) = $42,000$60,000 – (.30 x $60,000) = $42,000Appears on the balance sheet

Appears on the balance sheet

Appears on both the balance sheet and the statement of income and comprehensive

income

Appears on both the balance sheet and the statement of income and comprehensive

income

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Equity MethodEquity MethodEquity MethodEquity Method

Equity

The equity method is used for long-term investments in stocks

where the investor has a significant influence over the

activities of the investee.

The equity method is used for long-term investments in stocks

where the investor has a significant influence over the

activities of the investee.

Generally, if the investor owns 20% or more of the voting stock

of the investee, the investor is assumed to have significant influence over the investee.

Generally, if the investor owns 20% or more of the voting stock

of the investee, the investor is assumed to have significant influence over the investee.

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On January 2 Hally Inc. pays cash of $350,000 for 40% of the common stock

and net assets of Brock Corporation.

On January 2 Hally Inc. pays cash of $350,000 for 40% of the common stock

and net assets of Brock Corporation.

Jan. 2 Investment in Brock Corp. Stock 350,000

Cash 180,000

Unless there is evidence to the contrary, this should give Hally Inc. significant influence over the

operating or financial activities of Brock Corp.

Unless there is evidence to the contrary, this should give Hally Inc. significant influence over the

operating or financial activities of Brock Corp.

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For the year ending December 31, Brock Corporation reports net income of

$105,000 and pays $45,000 in dividends.

For the year ending December 31, Brock Corporation reports net income of

$105,000 and pays $45,000 in dividends.

Dec. 31 Investment in Brock Corp. Stock 42,000

Income of Brock Corp. 42,000

$105,000 x 40%$105,000 x 40% 31 Cash 18,000Investment in Brock Corp. Stock 18,000

$45,000 x 40%$45,000 x 40%

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Investment in Brock Corporation Stock

Jan. 2 350,000Dec.31 42,000

Dec. 31 18,000

$374,000$374,000

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Sale of Investments in StocksSale of Investments in StocksSale of Investments in StocksSale of Investments in Stocks

An investment in Drey Inc. stock has a carrying amount of $15,700 when it is

sold on March 1 for $17,500.

An investment in Drey Inc. stock has a carrying amount of $15,700 when it is

sold on March 1 for $17,500.

Mar. 1 Cash 17,500Investment in Drey. Inc. Stock 15,700Gain on Sale of Investment 1,800

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Describe alternative methods of combining businesses and how consolidated financial statements are prepared.


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Mergers and ConsolidationsMergers and ConsolidationsMergers and ConsolidationsMergers and Consolidations

When one corporation acquires all the assets

and liabilities of another corporation, which is

then dissolved, a merger has taken place.




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Mergers and ConsolidationsMergers and ConsolidationsMergers and ConsolidationsMergers and Consolidations







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Parent and Subsidiary Parent and Subsidiary CorporationsCorporations


The corporation owning all or a

majority of the voting stock of the other

corporation is called the parent company.

The corporation owning all or a

majority of the voting stock of the other

corporation is called the parent company.

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The corporation that is controlled is

called the subsidiary company.

The corporation that is controlled is

called the subsidiary company.

Two or more corporations closely related through stock

ownership are sometimes called the affiliated company.

Two or more corporations closely related through stock

ownership are sometimes called the affiliated company.

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At the end of the year, the financial statements of the parent and subsidiary are

combined and are referred to as consolidated financial

statements.

At the end of the year, the financial statements of the parent and subsidiary are

combined and are referred to as consolidated financial

statements.

If the parent owns less than 100% of the

subsidiary stock, the other parties’

ownership is referred to as minority interest.

If the parent owns less than 100% of the

subsidiary stock, the other parties’

ownership is referred to as minority interest.

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Compute and interpret the price-earnings ratio and price-book ratios.8Learning GoalLearning GoalLearning GoalLearning Goal

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Price-Earnings RatioPrice-Earnings RatioPrice-Earnings RatioPrice-Earnings Ratio

The price-earnings ratio indicates a firm’s growth

potential and future earnings prospects.

The price-earnings ratio indicates a firm’s growth

potential and future earnings prospects.

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It indicates how much the market is willing to pay per

dollar of a company’s earnings.

It indicates how much the market is willing to pay per

dollar of a company’s earnings.

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P/E ratio =Market price per share of common stock

Earnings per share of common stock

20012001

Market price per share = $26.10

Market price per share = $26.10

$26.10

Basic earnings

per share = $0.87

Basic earnings

per share = $0.87

$0.8730

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Price-Book RatioPrice-Book RatioPrice-Book RatioPrice-Book Ratio

The price-book ratio is the ratio of the market value of a share of

common stock to the book value of a share of common stock.

The price-book ratio is the ratio of the market value of a share of

common stock to the book value of a share of common stock.

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The first step is to determine the book value per share of common stock.

The first step is to determine the book value per share of common stock.

BVS =Total stockholders’ equity

Common shares outstanding

$10,519,000,000

854,000,000$12.32

Alcoa, Inc.Alcoa, Inc.Alcoa, Inc.Alcoa, Inc.

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The market price per share of Alcoa, Inc. was $34 on May 7, 2002.

The market price per share of Alcoa, Inc. was $34 on May 7, 2002.

P-B ratio =Market price per share

Book value per share

$34

$12.322.76

Alcoa, Inc.Alcoa, Inc.Alcoa, Inc.Alcoa, Inc.Alcoa, Inc.’s market price is Alcoa, Inc.’s market price is 2.76 times greater than the 2.76 times greater than the

book value of the firm.book value of the firm.

Alcoa, Inc.’s market price is Alcoa, Inc.’s market price is 2.76 times greater than the 2.76 times greater than the

book value of the firm.book value of the firm.

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The EndThe End

Chapter 12Chapter 12

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Special Income and Investment Reporting Issues

Documents

income statement

operating income

expense794other income

special income

income taxes payable40

corporations taxable

actual taxable income

income tax expense120