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CHAPTER 12
UNDERSTANDING THE ISSUES
back period and any “more likely than not”
pretax income in the carryforward periods.
If the pretax income in these periods were
not sufficient to absorb the remaining pretax loss, then some of the third-quarter pretax loss would not recognize a benefit. In
order to fully recognize the benefit associated with an interim period pretax loss,
there must be some combination of the following: sufficient pretax income in other
quarters of the current year, sufficient pretax income in the carryback period, and/or
sufficient “more likely than not” pretax income in the carryforward period.

1. Viewing an interim period as an integral
part of a larger annual period has several
benefits. The allocation of expense under
this viewpoint provides information that allows for more meaningful and insightful
predictions of annual results. Furthermore,
the effect of certain interim conditions that
are not expected to exist at year-end may
be given special accounting treatment. Examples of this include special accounting
for temporary inventory liquidations and
temporary unfavorable variances. If special
accounting treatment were not available,
projections of annual amounts would be
distorted.

4. There are a number of reasons why the
total operating profit of the reportable segments does not normally equal the consolidated operating profit. First of all, not all
operating segments are reportable and yet
such amounts are included in consolidated

amounts. Second, there are a number of
intersegment transactions whose effect
would be included in operating profits of
reportable segments but eliminated from
consolidated amounts. Third, not all elements of consolidated income are allocated
to reportable segments. This is traceable
to the fact that not all elements are used
by the chief operating decision maker in
evaluating segment performance and/or
because allocation is not possible on a reasonable basis. Finally, the accounting
employed from a management approach
perspective may be different from the requirement to use GAAP in the measurement of consolidated amounts.

2. A number of factors are necessary in order
to determine the estimated effective annual
tax rate. First of all, the rate should reflect
conditions to be experienced for the entire
year. Therefore, in addition to year-to-date
pretax income/loss, such amounts must be
projected for the balance of the year. Statutory tax rates are applied to these annual
amounts after considering the presence of
possible annual permanent differences between book and tax income. The resulting
taxes must also be reduced by possible tax
credits. The applicability of the above factors becomes more complex in situations
where there is an estimated annual pretax
loss. This situation requires the consideration of possible tax loss and/or tax credit
carrybacks and carryforwards.
3. Several factors may explain this situation. If
the third-quarter loss were greater than the
pretax income in the first two quarters plus

the forecasted pretax income for the fourth
quarter, then some of the benefit traceable
to the loss may not be recognized. However, if this were the case, one would consider any known pretax income in the carry-

559


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Ch. 12—Exercises

EXERCISES
EXERCISE 12-1
(1)

Wert Company
Income Statement
For 3-Month Period Ended June 30, 20X2
Sales .............................................................................
Cost of goods sold:
Standard cost of goods manufactured .....................
Add finished goods inventory, April 1, 20X2,
at standard cost ..................................................
Deduct finished goods inventory, June 30, 20X2,
at standard cost ..................................................
Cost of goods sold at standard cost .........................
Add net unfavorable cost variances .........................
Adjusted cost of goods sold ...............................
Gross profit ...............................................................
Selling and administrative expenses:

Selling expenses ................................................
General and administrative expenses ................
Net income ...............................................................

$860,000
$600,000
71,000
(98,000)
$573,000
1,700*
574,700
$285,300
$

68,000
117,000

185,000
$100,300

*Purchase price variances or volume or capacity cost variances that are planned and expected to be absorbed by the end of the annual period should ordinarily be deferred at
interim reporting dates. Therefore, the net unfavorable cost variance recognized is
$1,700 ($2,600 – $900).

(2)

Wert Company
Income Statement
For 3-Month Period Ended June 30, 20X2
Sales .............................................................................

Cost of goods sold ........................................................
Gross profit ...................................................................
Selling and administrative expenses:
Selling expenses ......................................................
General and administrative expenses ......................
Net income....................................................................

$860,000
648,000**
$212,000
$

68,000
117,000
$

185,000
27,000

**$596,000 + [13,000 units × ($11 – $7)] = $648,000. Inventory at the interim reporting date
should not give effect to the LIFO liquidation, and the cost of goods sold should include
the expected cost of replacement of the liquidated LIFO base. Since it is expected that
2,000 units of beginning inventory will be part of the 20X2 cost of goods sold, only 13,000
units need to be adjusted.

560


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Ch. 12—Exercises

Exercise 12-1 Concluded
(3)

Wert Company
Income Statement
For 3-Month Period Ended June 30, 20X2
Sales .............................................................................
Cost of goods sold ........................................................
Gross profit ...................................................................
Selling and administrative expenses:
Selling expenses ......................................................
General and administrative expenses ......................
Net income....................................................................

$860,000
493,300‡
$366,700
$

68,000
117,000

185,000
$181,700

‡

Recoveries of inventory losses from market declines in earlier interim periods of the same

fiscal year should be recognized as gains; such gains should not exceed previously recognized losses.

Cost of goods sold:
Inventory, April 1, 20X2 ............................................
Purchases (18,000 × $28) ........................................
Inventory, June 30, 20X2 .........................................
Write-up to offset first-quarter write-down ................
Cost of goods sold ...................................................

$

52,000
504,000
(60,500)
$495,500
(2,200)
$493,300

EXERCISE 12-2
(1) Although research and development (R&D) costs are generally expensed in the year in
which such costs are incurred, the question at hand is how they should be treated for interim reporting purposes. Because an interim period is considered to be an integral part of a
larger annual period, interim data are viewed as a possible predictor of annual values.
Therefore, the R&D recognized in a given interim period might become the basis for estimating an annual amount. If all the R&D were expensed in a single quarter, one might suggest that annual R&D is four times that amount. In order to avoid this incorrect conclusion,
the R&D should be amortized over the current and remaining quarters within the annual period. In this specific case, the $130,000 of costs should be allocated to each of the four
quarters in the amount of $32,500 per quarter.

561


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Ch. 12—Exercises

Exercise 12-2, Concluded
(2) In interim reporting, the year-to-date (YTD) tax expense represents the best estimate of the
annual estimated effective tax rate. The YTD tax expense is allocated to the current and
prior quarters. If the estimated effective tax rate has been revised from a previous estimate,
this change in estimate is recognized in the new YTD values and also in the current quarter’s tax expense. Therefore, a given quarter’s tax expense reflects the tax on the quarter’s
income and the effect of a rate change on previous quarters. To illustrate, assume the following:
Quarter
1
2

Current
YTD
Income
Income
$50,000 $
50,0
70,000
120,000

Tax
Rate
30%
35

YTD Tax
Expense
$15,000

42,000

Current Tax
Expense
$15,000
27,000

The tax expense in quarter 2 reflects the tax on $70,000 at 35%, or $24,500, and the 5%
increase in taxes traceable to quarter 1, or $50,000 at 5%, or $2,500. The total current tax
expense of $27,000 for quarter 2 is approximately 39% (versus the effective rate of 35%) of
the second-quarter income.

EXERCISE 12-3
Granger Supply, Inc.
Interim Income Statements
For the Periods Ending Quarter 1 and 2, 20X7
Net sales ..............................................................................
Cost of sales (See Schedule A) ...........................................
Gross profit ..........................................................................
Selling, general, and administrative .....................................
Income before taxes ............................................................
Income tax expense (See Schedule B) ................................
Net income ...........................................................................

Quarter 1
Quarter 2
$12,000,000
$9,000,000
7,900,000
7,805,0

$
4,100,000
$1,195,000
2,100,000
1,800,0
$
2,000,000
$
(605,00
700,800
(217,15
$
1,299,200
$
(387,84

Schedule A—Cost of Sales
Quarter 1
As stated:
Cost of sales—industrial supplies ..................................
Cost of sales—cleaning equipment................................
Adjustment for replacement cost:
400 units × ($2,700 – $1,500) ........................................
Adjustment for loss due to market decline ...........................
New cost of sales .................................................................

562

Quarter 2


$4,300,000
3,000,000

$4,700,000
3,200,0

480,000
120,000
$7,900,000

(95,000
$7,805,000


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Ch. 12—Exercises

Exercise 12-3, Concluded
Schedule B—Income Tax Schedule
YTD income before tax ........................................................
Projected income .................................................................
Estimated annual income.....................................................
Permanent differences .........................................................
Estimated adjusted taxable income .....................................
Statutory tax rate ..................................................................
Tax on estimated adjusted taxable income ..........................
Tax credits ...........................................................................
Net tax..................................................................................
Effective tax rate ..................................................................


Interim
Period
First
Second

Ordinary Pretax Income (Loss)
Current
Effective Tax
Period
Year-to-Date
Rate
$2,000,000
$2,000,00035.04%
(605,000)
1,395,00034.67

Quarter 1
Quarter 2
$2,000,000
$1,395,000
5,100,000
4,000,000
$7,100,000
$5,395,000
60,000
35,000
$7,160,000
$5,430,000
35.00%


35.00%

$2,506,000
18,000
$2,488,000
35.04%

34.67%

Tax Expense (Benefit)
Previously
Current
Year-to-Date
Reported
Period
$700,800 $
—
$
700,800
483,646
700,800
(217,154)

EXERCISE 12-4
(1)
YTD income (loss) ............................................
Projected income (loss) ....................................
Total annual ......................................................
Less exempt income .........................................

Taxable income ................................................
Estimated tax:
On first $50,000 @ 10% ...............................
On next $50,000 @ 20% ..............................
On next $50,000 @ 30% ..............................
On next $50,000 @ 40% ..............................
Remaining income @ 35%...........................

Before
After
Change
Change
$100,000
$120,000
110,000
135,000
$210,000
255,000
(5,000)
(5,000)
$205,000
$250,000

Less tax credit...................................................
Net tax ..............................................................
Effective tax rate ...............................................

5,000 $
5,000
10,000

10,000
15,000
15,000
20,000
20,000
1,750
17,500
$
51,750 $
67,500
(8,000)
(8,000)
$
43,750 $
59,500
20.83%
23.33%

First 6 months’ tax expense (benefit):
Pretax income (loss) ....................................
Effective tax rate per above .........................
Tax expense (benefit) ..................................

$100,000
$120,000
× 20.83%
× 23.33%
$
20,833 $
27,996


$

The change in accounting principle resulted in an increase in tax expense for the first 6
months of $7,163 ($27,996 vs. $20,833).

563

$1,900,500
30,000
$1,870,500


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Ch. 12—Exercises

Exercise 12-4, Concluded
(2)

First 6 months continuing..............
Third quarter continuing ................
Projected continuing .....................
Nonordinary loss ...........................
Nonordinary gain ..........................
Pretax income (loss) .....................
Tax expense (benefit) ...................
35,400

Total

Total
Excluding
Excluding
Ordinary
Total
Nonordinary Nonordinary
Income
Income
Loss
Gain
$120,000
$120,000
$120,000 $120,000
80,000
80,000
80,000
80,000
20,000
20,000
20,000
20,000
(40,000)
(40,000)
60,000
60,000
$220,000
$240,000
$280,000 $180,000
$


50,600

$

Incremental tax expense (benefit) traceable to:
All nonordinary items ($57,600 – $50,600) ..........................
All nonordinary losses ($71,600 – $57,600) .........................
All nonordinary gains [$7,000 – ($14,000)] ..........................
Taxable income:
Pretax accounting income ........
Less exempt income ................
(4,000)
Taxable income ........................
Estimated tax:
On first $50,000 @ 10% ...........
5,000
On next $50,000 @ 20% ..........
On next $50,000 @ 30% ..........
On next $50,000 @ 40% ..........
Remaining income @ 35%.......
—

$240,000

$216,000

$236,000

$


5,000
10,000
15,000
20,000
5,600

$
40,400
Less tax credit...............................
(5,000)
Net tax ..........................................
35,400

$220,000
(4,000)

55,600

$
10,000
15,000
20,000

$

(5,000)
$

50,600


564

$

57,600 $

$
$
$

71,600 $

7,000
(14,000)
21,000

$280,000 $180,000
(4,000)
(4,000)
$276,000

5,000

$

$176,000

5,000

$


10,000
10,000
15,000
15,000
20,000
10,400
12,600
26,600
62,600 $

76,600 $

(5,000)

(5,000)

57,600 $

71,600 $


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Ch. 12—Exercises

EXERCISE 12-5
Corporation A
YTD realized income (loss) .........
Projected income (loss) ..............

Total income (loss)......................
Income adjustments ....................
Total taxable income (loss) .........
Statutory tax rate .........................
Tax expense (benefit) .................
Tax credit ....................................
Net tax expense (benefit) ............

$

×
$
$

95,000
30,000
$125,000
$125,000
40%
50,000
(2,000)
48,000

$

×

Corporation C Corporation D

5,000 $

(70,000)
$(65,000)
(7,000)*
$(72,000)
40%
×
$(28,800) $
(3,500)
$(32,300) $
$(14,400)b $

Limit to tax benefits .....................
Effective annual tax rate .............

Corporation B

38.4%a

22.2%b

(80,000) $
20,000
(50,000)
(35,000)
$(130,000)
$(15,000)
2,000
$(128,000)
$(15,000)
40%

× 40%
(51,200) $(
6,000)
(1,000)
(51,200) $
(7,000)
(38,860)c $
29.9%c

(5,000)d
33.3%d

*$15,000 text exempt municipal income—$8,000 deductions not allowed.
a

$48,000 ÷ $125,000 = 38.4%
$14,400 ÷ $65,000 = 22.2%
The tax benefit is traceable to carrying back $32,000 at 30% to 20X1 and $15,000 at 32% to
20X2.
c
$38,860 ÷ $130,000 = 29.9%
The prior two years’ income totals $140,000, of which $128,000 may be offset by the NOL
carryback, resulting in a tax benefit of $38,860 [($105,000 × 30%) + ($23,000 × 32%)].
d
$5,000 ÷ $15,000 = 33.3%
b

Tax benefit limited to projected carryforward ($12,500 × 40%).

565



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Ch. 12—Exercises

EXERCISE 12-6
Quarter 1

Quarter 2

YTD pretax income (loss) .............................
Projected pretax income (loss) .....................
Estimated annual income..............................
Permanent differences ..................................
Estimated adjusted income ...........................

Originally
Stated
$ 800,000
1,100,000
$1,900,000
—
$1,900,000

Continuing
$1,020,000
1,420,000
$2,440,000
—

$2,440,000

Statutory tax:
At 30% rate on first $1,500,000...............
At 35% rate thereafter .............................
Total statutory tax....................................
Tax credits ....................................................
Net tax...........................................................

$ 450,000
140,000
$ 590,000
29,500
$ 560,500

$ 450,000
329,000
$ 779,000
29,500
$ 749,500

$ 450,000
383,250
$ 833,250
15,000
$ 818,250

Effective tax rate ...........................................

29.50%


30.72%

31.53%

Interim Quarter
First
First—Restated
First—Restated
Second
Second

Type of
Income
Continuing Op.
Continuing Op.
Discontinued
Continuing Op.
Discontinued

Discontinued
$(220,000)
(320,000)
$(540,000)
$(540,000)

Pretax Income (Loss)
Current
Effective
Period

Year-to-Date
Tax Rate
$
800,000 $
800,000 29.50%
1,020,000
1,020,00030.72%
(220,000)
(220,000) Note A
525,000
1,545,00031.53%
(480,000)
(700,000) Note B

Continuing
$1,545,000
1,050,000
$2,595,000
—
$2,595,000

Discontinued
$(700,000)
—
$(700,000)
$(700,000)

Tax Expense (Benefit)
Previously
Current

Year-to-Date
Reported
Period
$
236,000 $
—
$
236,000
313,344
—
313,344
(77,344)
—
(77,344)
487,139
313,344
173,795
(245,000)
(77,344)
(167,656)

Note A: The difference between the first and first restated continuing operations is the tax benefit attributed to the discontinued
operations.
Note B:
Annual income (loss) ............................
Annual net tax expense (benefit)..........

Continuing
Operations
$2,595,000

818,250

All Sources
$1,895,000
573,250

[(30% × $1,500,000) + (35% × $395,000) – $15,000]

The difference between $818,250 and $573,250 represents the tax benefit associated with the discontinued operation.

566


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Ch. 12—Exercises

EXERCISE 12-7

First-quarter income (loss) ...................
Second-quarter income (loss) ..............
YTD income (loss) ...............................
Projected income (loss) .......................
Total annual .........................................
Estimated tax benefit:
Carryback to 20X5:
On first $50,000 @ 15% ...........
On next $25,000 @ 25% ..........
On next $25,000 @ 34% ..........
Carryback to 20X6:

On first $50,000 @ 15% ...........
On next $25,000 @ 25% ..........
Total tax benefit..............................
Estimated rate of benefit ......................
Quarter tax expense (benefit):
YTD pretax income (loss)...............
Effective tax rate per above ...........
YTD tax expense (benefit) .............
Prior quarter expense (benefit) ......
Current quarter expense (benefit) ..

Quarter 1, 20X7
Quarter 2, 20X7
Before
After
Before
After
Change
Change
Change
Change
$
40,000
$
70,000 $
40,000 $
—
—
(30,000)
$

40,000
$
70,000 $
10,000 $
(155,000)
(150,000)
(210,000)
$(170,000)
$
(85,000)
$(140,000)
$

$

7,500 $
6,250
8,500
7,500
2,500
$32,250

18.97%

$
40,000
× 18.97%
$
7,588
—

$
7,588

567

7,500 $
6,250
3,400
—
—
$17,150

20.18%

$
70,000
× 20.18%
$
14,126
—
$
14,126

7,500 $
6,250
8,500
6,000
—
$28,250


20.18%

7,500
5,000
—
—
—
$12,500

17.86%

$
10,000 $
60,000
× 20.18%
× 17.86%
$
2,018 $
10,716
7,588
14,126
$
(5,570) $
(3,410)

70,000
(10,000
60,000
(130,00
(70,000



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Ch. 12—Exercises

EXERCISE 12-8

Continuing income (loss) ..................
60,000
Nonordinary item A ...........................
Nonordinary item B ...........................
Nonordinary item C ...........................
Pretax income (loss) .........................
30,000
Tax expense (benefit) .......................
4,500
Estimated tax:
On first $50,000 @ 15% ..............
On next $25,000 @ 25% .............
On next $25,000 @ 34% .............
Total estimated tax ......................

Ordinary
Total
Income
Income
$60,000
$
—

—
—
$60,000
$10,000

$

7,500 $
2,500
—
$10,000

Total
Total
Excluding
Excluding
Nonordinary
Nonordinary
Loss (A)
Gain (B & C)
60,000
$60,000$

(30,000)
25,000
5,000
$
$

7,500 $

2,500
—
$10,000

Incremental tax expense (benefit) traceable to:
All nonordinary items ($10,000 – $10,000) ................................
All nonordinary losses ($10,000 – $18,850)...............................
All nonordinary gains [$0 – ($8,850)] .........................................

Continuing income (loss) ..................
60,000
Nonordinary item A ...........................
Nonordinary item B ...........................
Nonordinary item C ...........................
—
Pretax income (loss) .........................
55,000
Tax expense (benefit) .......................
8,750
Calculation of tax expense (benefit):
On first $50,000 @ 15% ..............
On next $25,000 @ 25% .............
Total estimated tax ......................

Ordinary
Total
Income
Income
$60,000
$

—
—
—

$

$
$

—
25,000
5,000
60,000

(30,000)
—
—
$90,000$

10,000

$18,850$

7,500
6,250
5,100
$18,850
0
(8,850)
8,850


Total
Excluding
Item B
60,000 $

(30,000)
25,000
5,000

$4,500
—
—
$4,500

(30,000)
—

Total
Excluding
Item C
60,000 $
(30,000)
25,000
5,000

$60,000

$


60,000 $

35,000 $

$10,000

$

10,000 $

5,250 $

7,500 $
2,500
$10,000

Incremental tax expense (benefit) traceable to:
Item B ($10,000 – $5,250) .................................
Item C ($10,000 – $8,750) .................................
Total ...................................................................

568

7,500
2,500
$10,000
$4,750
1,250
$6,000


$5,250
—
$5,250
Percent of Total
79.2%
20.8
100.0%

$7,500
1,250
$8,750


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Ch. 12—Exercises

Ratable allocation of $8,850 tax expense on nonordinary gains (items B and C):
Item B ..........................................
Item C..........................................

(79.2% × $8,850)
(20.8% × $8,850)

569

$7,009
1,841
$8,850



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Ch. 12—Exercises

EXERCISE 12-9
The key to defining the segments of Norfo International is to analyze how information might be
structured for purposes of decision making by the chief operating decision maker. Possible alternatives would be to organize the information around products or services, geographic areas,
or product/service groups within geographic areas. For example, a product/service approach
might suggest major segments of foodstuffs (including food processing, citrus groves, and
packaging), resort and travel, and paper products. The paper products and food packaging
areas could be combined to form a separate segment. Organizing the information around geographic areas might suggest the following: southeastern United States, eastern seaboard, Great
Lakes region, the Bahamas, and Europe (Spain and Italy).
Obviously, various combinations are possible and students should be encouraged to think about
which combinations seem most relevant for addressing the issues of how to evaluate performance and allocate resources among the various activities of an enterprise. Attention should
also be focused on organizing information in such a way that the aggregation guidelines of the
FASB are not violated. For example, does it really make sense to analyze information structured
around the eastern seaboard region when that segment would include hotels, travel agencies,
and the manufacture of paper products? Would it make more sense to separate the eastern
seaboard into two segments: hotels/travel agencies and paper products? For example, if unemployment in the eastern seaboard is high, the travel and leisure area would probably be affected
differently than the paper manufacturing division.

570


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Ch. 12—Exercises

EXERCISE 12-10

Determination of whether segments are reportable:
Segment
Film Studios ............................................
Software Development ............................
Leisure Clothing ......................................
Office Design Group ...............................
Total ........................................................

Revenues
Reported
Intersegment
Total
Profit (Loss)
Assets
82,000,000
$
0
$
82,000,000
$(11,000,000)
12,000,000
3,400,000
15,400,000
(2,600,000)
5,400,000
45,000,000
0
45,000,000
23,000,000
13,000,000

22,000,000
2,700,000
24,700,000
6,700,000
5,000,0
$161,000,000
$6,100,000
$167,100,000
$
16,100,000

External
$

Total of all reported profits ...........................................................................
Total of all reported losses ...........................................................................

Segment
Film Studios ............................................
Software Development ............................
Leisure Clothing ......................................
Office Design Group ...............................

$

Is Segment’s
Absolute Value
of Profit or
Loss 10% or
More of

$29,700,000?
Yes
No
Yes
Yes

Revenue
10% or
More of
$167,100,000?
Yes
No
Yes
Yes

29,700,000
(13,600,000)

Assets
10% or
More of
$61,400,000?
Yes
No
Yes
No

Significance of reportable segments:
Consolidated revenue ...............................................................................................................
Percentage requirement............................................................................................................

Dollar requirement.....................................................................................................................
External revenue of all reportable segments.............................................................................
Conclusion: The reportable segments represent a significant portion of the enterprise.

571

×

Is Segment
Reportable?
Yes
No
Yes
Yes

$177,000,000
75%
$132,750,000
$149,000,000


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Ch. 12—Exercises

EXERCISE 12-11
Determination of whether segments are reportable:
Segment
Publishing ...............................................
Talent Agency .........................................

Cable Networks..................................... ..
Radio Stations.........................................
Film Production .......................................
Total ........................................................

Revenues
Intersegment
$1,200,000
$110,000
850,000
0
3,771,500
672,000
810,700
0
1,090,000
57,800
$7,722,200
$839,800

External

Total

Total of all reported profits ...........................................................................
Total of all reported losses ...........................................................................

Segment
Publishing ...............................................
Talent Agency .........................................

Cable Networks.......................................
Radio Stations.........................................
Film Production .......................................

Is Segment’s
Absolute
Value of Profit
or Loss 10%
or More of
$4,530,800?
Yes
No
Yes
No
No

Revenue 10%
or More of
$8,562,000?
Yes
No
Yes
No
Yes

Reported
Profit (Loss)
Assets
$1,310,000
$

925,000 $
970,000
850,000
(449,000)
670,000
4,443,500
3,185,800
3,893,500
810,700
(238,000)
770,000
1,147,800
420,000
720,500
$8,562,000
$3,843,800
$7,024,000
$4,530,800
(687,000)

Assets 10%
or More of
$7,024,000?
Yes
No
Yes
Yes
Yes

Significance of reportable segments:

Consolidated revenue ...............................................................................................................
Percentage requirement............................................................................................................
Dollar requirement.....................................................................................................................
External revenue of all reportable segments.............................................................................
Conclusion: The reportable segments represent a significant portion of the enterprise.

572

×

Is Segment
Reportable?
Yes
No
Yes
Yes
Yes
$9,074,000
75%
$6,805,500
$6,872,200


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Ch. 12—Exercises

Exercise12-11, Concluded
Reconciliation to Consolidated Revenue and Profit:


Revenues
Total revenues for reportable segments ............................................................
Revenues for nonreportable segments ..............................................................
Elimination of intersegment revenue ..................................................................
Corporate-level revenues (Note A) ....................................................................
Total consolidated revenues ..............................................................................

Profit or loss
Total profit or loss for reportable segments .......................................................
Profit or loss of nonreportable segments ...........................................................
Corporate-level:
Revenues (Note A).......................................................................................
Expenses (Note B) .......................................................................................
Total consolidated income .................................................................................

$7,712,000
850,000
(839,800)
1,351,800
$9,074,000

$4,292,800
(449,000)
1,351,800
(756,100)
$4,439,500

Note A:

The corporate-level revenue is calculated by taking the consolidated revenue of

$9,074,000 less the external revenues from all segments of $7,722,200.

Note B:

The expenses for all segments total $4,718,200 ($8,562,000 – $3,843,800). This
total includes the cost of goods/services acquired on an intersegment basis of
$839,800. Assuming there was no intercompany profit in ending inventory, the real
total expense after eliminating intercompany costs is $3,878,400 ($4,718,200 –
$839,800). Therefore, the corporate-level expenses are $756,100 ($4,634,500 –
$3,878,400).

573


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Ch. 12—Problems

EXERCISE 12-12
(1) Determination of whether segments are reportable:
Revenues
Reported
Segment
External
Intersegment
Total
Profit (Loss)
Assets
1
$1,540,000

$1,540,000
$
602,000
2
724,500 $
80,500
805,000
(208,000)
870,000
3
1,948,000
1,948,000
530,000
1,250,000
4
963,000
107,000
1,070,000
375,000
1,800,000
5
684,000
76,000
760,000
220,000
965,000
6
980,000
980,000
402,000

1,400,000
7
1,071,000
1,071,000
(106,000)
Total
$7,910,500 $263,500
$8,174,000
$1,815,000
$9,265,000
Total of all reported profits ..................................................
Total of all reported losses..................................................

Segment
1
2
3
4
5
6
7

Revenue 10%
or More of
$8,174,000?
Yes
No
Yes
Yes
No

Yes
Yes

Is Segment’s
Absolute
Value of Profit
or Loss 10%
or More of
$2,129,000?
Yes
No
Yes
Yes
Yes
Yes
No

Assets 10%
or More of
$9,265,000?
Yes
No
Yes
Yes
Yes
Yes
Yes

$2,129,000
(314,000)


Is Segment
Reportable?
Yes
No
Yes
Yes
Yes
Yes
Yes

(2) Significance of reportable segments:
Consolidated revenue ...........................................................................
Percentage requirement .......................................................................
Dollar requirement ................................................................................

$8,715,700
×
75%
$6,536,775

External revenue of all reportable segments ........................................

$7,186,000

Conclusion: The reportable segments represent a significant portion of the enterprise.
(3) Information traceable to nonreportable segments should be combined into one segment
that has been referred to in the text as the “all other” segment. Information regarding this
“all other” segment would be disclosed in the reconciliations of total reportable segment
amounts to the respective consolidated enterprise amounts.

(4) Because revenues with a single external customer amount to 10% or more of enterprise
revenues, special disclosure is required. Such a disclosure might appear as follows:
Staven Supplies’ consolidated revenues include $1,230,000 of revenues traceable to
sales made to the federal government. The sales were generated by segment 3.

574


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Ch. 12—Problems

PROBLEMS
PROBLEM 12-1
(1) When publicly traded companies report summarized interim financial information to their
stockholders at interim dates, the following data should be reported, as a minimum:
(a) Sales or gross revenues, provision for income taxes, extraordinary items, cumulative
effects of changes in accounting principles, and net income.
(b) Primary and fully diluted earnings-per-share data for each period presented.
(c) Seasonal revenues, costs or expenses, and contingent items.
(d) Disposal of a segment of a business and extraordinary, unusual, or infrequently occurring items (including related income tax effects).
(e) Changes in accounting principles or estimates, including significant changes in estimates or provisions for income taxes.
(f)

Significant changes in financial position.

When summarized interim financial data are regularly reported on a quarterly basis, the

foregoing information for the current quarter and the current YTD or the last 12 months to
date should be furnished, as well as comparable data for the preceding year. When a separate fourth-quarter report or disclosure of the fourth-quarter results is not included in the
annual report, material year-end adjustments, extraordinary items, and disposal of segments of a business should be disclosed in the annual report in a note to the financial
statements.
Management should provide commentary relating to the effects of significant events upon
the interim financial results, similar to its commentary in annual reports. Published balance
sheet and funds flow data at interim dates are desirable, but disclosure of significant
changes in financial position or funds flow should be presented as a minimum.
(2) There are two general weaknesses in the form and content of presentation of the firstquarter information: (1) some information in the statement needs further explanation, and
(2) additional financial statements or summarized data should be presented and explained
as appropriate in the circumstances. [See discussion presented in entry (1).]
The major weakness in the first-quarter report is that it is misleading because the company
is expecting a profit for the year, not a loss as normally would be assumed from the published report alone. Both sales and production were equal to the units budgeted for the first
quarter, and if actual activity continues as planned for the rest of the year, Mikelson will
show a profit of $371,250 {$450,000 – [$175,000 × (1 – 0.55)]} for 20X5. Thus, Mikelson
should indicate in the interim report that sales, production, and net income (loss) are in line
with expectations, as related to budgeted data and first quarters of prior years.
No other weakness in form and content is evident, except as discussed below in entry (3).

576


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Ch. 12—Problems

Problem 12-1, Concluded
(3) (a) The treatment of underapplied fixed factory overhead as an asset in this situation is
the preferred method of accounting. The expected year-end result is that actual production will exactly equal budgeted production upon which the standard was based;
thus, no volume variance should exist at year-end.

(b) The manner in which the selling, general, and administrative expenses were handled
in the report is the preferred method. These costs cannot be inventoried, they cannot
be associated directly with the product, and they have been incurred at expected levels. Thus, they should be expensed as period costs when incurred or be allocated
among interim periods based on the estimate of time expired, benefit received, or activity associated with the periods.
(c) The warehouse fire loss is an extraordinary item that should be appropriately disclosed
in the interim financial report, net of income tax effect. In this situation, the $175,000
loss should be reduced by the effective income tax benefit of $96,250. Thus, the loss
should reduce net income by $78,750 ($175,000 – $96,250), and the nature of the loss
should be appropriately explained in the commentary accompanying the quarterly data.
(d) A negative income tax expense (an income tax benefit) should have been included in
the interim report. The $35,000 loss from regular operations should have been reduced by $19,250 ($35,000 × 55%), the expected tax reduction to be realized from
profitable operations during the remaining three quarters of 20X5. The tax benefits resulting from losses that arise in the early portion of the year should be recognized only
when realization is more likely than not. An established seasonal pattern of losses in
early interim periods, offset by income in later interim periods, should constitute sufficient evidence that realization is more likely than not—unless other evidence contradicts this conclusion.

577


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Ch. 12—Problems

PROBLEM 12-2

YTD income ........................................................
Projected income ................................................
Estimated annual income....................................

Quarter 1
Original

$(45,000)
(25,000)
$(70,000)

Quarter 1
Continuing
$(30,000)
15,000
$(15,000)

Statutory tax rate .................................................

32%

32%
a

Tax (benefit) of NOL carryback to prior 2 years
Tax expense on estimated income .....................
Tax credits ..........................................................
Net tax expense (benefit) ....................................

Interim Period
(quarter)
First
First—Restated
First—Restated
Second
Second
Third

Third

Type of
Income
Continuing Op.
(6,400)
Continuing Op.
Discontinued
Continuing Op.
Discontinued
Continuing Op.
Discontinued

$28,800
(5,000)
$23,800

42.67%

Pretax Income (Loss)
Current
YearPeriod
to-Date
$(45,000)
$(45,000)
(30,000)
(15,000)
58,000
(57,000)c
40,000

(13,000)d

32%

$(4,440)
—
(1,960)b
$(6,400)

—
$(6,400)
9.14%

Quarter 2
Continuing
$28,000
62,000
$90,000

Quarter 3
Continuing
$ 68,000
42,000
$110,000
32%

b

$(6,400)


Effective tax rate .................................................

Quarter 1
DISCO
$(15,000)
(40,000)
$(55,000)

(30,000)
(15,000)
28,000
(72,000)
68,000
(85,000)

Effective
Tax Rate
See a
See b
See b
26.44%
Note A
24.73%
Note B

26.44%

$35,200
(8,000)
$27,200

24.73%

Tax Expense (Benefit)
YearPreviously
Current
to-Date
Reported
Period
$
(6,400)
$
—
$
(6,400)
—
7,403
(23,040)
16,816
(27,200)

—
—
(6,400)
—
7,403
(23,040)

(6,400)
—
13,803

(23,040)
9,413
(4,160)

a

Because there is no future income that is “more likely than not” and there were carrybacks available, the tax benefit can only be
found by adding the tax expense in the past 2 years [($12,000 × 30%) + ($10,000 × 28%)].

b

Because there is no future income that is “more likely than not” and there were carrybacks available, the tax benefit can only be
found by carrying the $15,000 loss and tax credit back to the past 2 years [($12,000 × 30%) + ($3,000 × 28%) + $1,960 of tax credit].

c

($15,000) + ($42,000)

d

($30,000) + $25,000 + ($34,000 – $42,000) + ($16,000)

578


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Ch. 12—Problems

Problem 12-2, Concluded

Note A:

Ordinary
Income All Sources
Annual income (loss) .......................
$90,000 $18,000
Annual net tax expense (benefit).....
23,800 760 [(32% × $18,000) – $5,000]
The difference between $23,800 and $760 represents the tax benefit associated with
the discontinued operation.

Note B:

Ordinary
Income All Sources
Annual income (loss) .......................
$110,000 $25,000
Annual net tax expense (benefit).....
27,200
— [(32% × $25,000) – $8,000]
The difference between $27,200 and $0 represents the tax benefit associated with the
discontinued operation.

PROBLEM 12-3
Calculation of Incremental Tax Impact

Pretax income (loss) ...................
Tax expense (benefit) .................

Ordinary

Income
$220,000
69,050a

Total Income
Total Income
Excluding
Excluding
Total
Nonordinary
Nonordinary
Income
Losses
Gains
$65,000
$230,000
$55,000
b
c
11,250
72,950
7,350d

a

($50,000 × 15%) + ($25,000 × 25%) + ($25,000 × 34%) + ($120,000 × 39%)
($50,000 × 15%) + ($15,000 × 25%)
c
($50,000 × 15%) + ($25,000 × 25%) + ($25,000 × 34%) + ($130,000 × 39%)
d

The total of all nonordinary items has an incremental tax benefit of $57,800 ($11,250 –
$69,050). Of this total incremental tax benefit, $61,700 is traceable to nonordinary losses.
Therefore, the nonordinary gains have an incremental tax expense of $3,900 ($61,700 –
$57,800). The incremental tax expense of $3,900 means that the tax on nonordinary gains
must be $7,350 ($11,250 – $3,900).
b

Incremental tax expense (benefit) traceable to:
All nonordinary items ($11,250 – $69,050) ..................................................
All nonordinary losses ($11,250 – $72,950).................................................
All nonordinary gains ($11,250 – $7,350) ....................................................

579

$(57,800)
(61,700)
3,900


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Ch. 12—Problems

Problem 12-3, Concluded
Calculation of Incremental Tax Benefit
Traceable to Each Individual Loss Category

Pretax income (loss) ...................
Tax expense (benefit) .................


Total Income
Total Income
Total Income
Excluding
Excluding
Excluding
Total
Nonordinary
Nonordinary
Nonordinary
Income
Losses
Loss B
Loss C
$65,000
$230,000
$145,000
$150,000
11,250
72,950
39,800e
41,750f

e
f

($50,000 × 15%) + ($25,000 × 25%) + ($25,000 × 34%) + ($45,000 × 39%)
($50,000 × 15%) + ($25,000 × 25%) + ($25,000 × 34%) + ($50,000 × 39%)

Incremental tax expense (benefit) traceable to:

All nonordinary losses ($11,250 – $72,950).................................................
Nonordinary loss—Category B ($11,250 – $39,800) ...................................
Nonordinary loss—Category C ($11,250 – $41,750) ...................................

$(61,700)
(28,550)
(30,500)

Apportionment of Tax Benefit
Traceable to Nonordinary Losses

Loss—Category B ....................................................
Loss—Category C ....................................................
...................................................................... 31,868

Each Loss Category
Incremental
Benefit
Percent
$28,55048.35%
30,500
$59,050100.00%

Apportioned
Amount
$29,832
51.65
$61,700

Calculation of Incremental Tax

Expense Traceable to Gain Category
Because there is only one gain category, the incremental tax impact is $3,900 ($11,250 –
$7,350).

580


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Ch. 12—Problems

PROBLEM 12-4
Item A

The first quarter is being restated due to a decision to discontinue an operation in the
second quarter. Therefore, the original pretax income (loss) reported for the first quarter must be allocated between continuing and discontinued operations. If the original
pretax income was $70,000 and the discontinued operation accounts for a $30,000
loss, then the amount traceable to the restated continuing component must be
$100,000 (the value of A). The two restated components, continuing and discontinued, now have pretax amounts that total the original amount [$100,000 + ($30,000) =
$70,000].

Item B

Effective tax rate for quarter 1—restated income from continuing operations:

YTD income (loss)—see item A above ....................................................
Projected income (loss) ($60,000 + $40,000) ..........................................
Total annual income (loss) .......................................................................
Carryforward of 20X3 loss ........................................................................
Estimated annual taxable income ............................................................


Quarter 1
Restated
$100,000
100,000*
$200,000
(80,000)
$120,000

*The original amount included a $40,000 loss that is now part of discontinued
operations.
Estimated tax:
On first $50,000 @ 15% .....................................................................
On next $50,000 @ 20% ....................................................................
On next $50,000 @ 25% ....................................................................
Remaining income @ 30% .................................................................

$

7,500
10,000
5,000
—
22,500
(5,000)
17,500

$

Item C


Less tax credit
Net tax ......................................................................................................

$

Effective tax rate ($17,500/$200,000) ......................................................
Quarter 1—restated continuing income....................................................
Tax expense (the value of B) ...................................................................

8.75%
$100,000
$
8,750

The tax expense (benefit) traceable to the continuing and discontinued components of
restated quarter 1 must total the tax expense originally reported for quarter 1 as follows:
Tax expense (benefit) traceable to restated:
Continuing operations ........................................................................
Discontinued operations (the value of C) ...........................................
Tax expense originally reported for quarter 1...........................................

581

$

8,750
(7,406)
$ 1,344



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Ch. 12—Problems

Problem 12-4 Continued
Item D

Tax expense for quarter 2 income from continuing operations:
Quarter 1—restated income (loss) ...........................................................
Quarter 2 income (loss) ............................................................................
YTD income (loss) ....................................................................................
Projected income (loss) ............................................................................
Total annual income (loss) .......................................................................
Carryforward of 20X3 loss ........................................................................
Estimated annual taxable income ............................................................
Estimated tax:
On first $50,000 @ 15% .....................................................................
On next $50,000 @ 20% ....................................................................
On next $50,000 @ 25% ....................................................................
Remaining income @ 30% .................................................................

Quarter 2
$100,000
50,000
$150,000
60,000
$210,000
(80,000)
$130,000


$

$

Item E

7,500
10,000
7,500
—
25,000
(5,000)
20,000

Less tax credit ..........................................................................................
Net tax ......................................................................................................

$

Effective tax rate ($20,000/$210,000) ......................................................
YTD income .............................................................................................
YTD tax expense (the value of D) ............................................................

9.52%
$150,000
$ 14,280

YTD income (loss) from discontinued operations consists of:
Quarter 1—restated..................................................................................

Quarter 2:
Operating loss ....................................................................................
Realized loss on disposal ...................................................................
Impairment loss ..................................................................................
The value of E ....................................................................................

582

$ (30,000)
(60,000)
(25,000)
(30,000)
$(145,000)


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Ch. 12—Problems

Problem 12-4 Concluded
Item F
Ordinary
Income
Pretax income (loss):
Continuing ..........................
Discontinued.......................
Extraordinary ......................
—
Pretax income (loss) ...........
Tax expense (benefit)......... $

Taxable income:
Pretax income (loss) ...........
20X3 loss............................
(80,000)
Taxable income ..................
Estimated tax:
On first $50,000 @ 15% .....
On next $50,000 @ 20% ....
On next $50,000 @ 25% ....
Remaining income @ 30% .
Less tax credit ..........................
Net tax ......................................

$

Total
Excluding
Total Nonordinary
Income
Loss

$210,000 $
—
—

210,000
(145,000)
20,000

$210,000 $

20,000 $

85,000
—
$

$210,000 $
(80,000)

85,000
(80,000)

$130,000 $

5,000

7,500
10,000
7,500
—
$25,000
(5,000)
$20,000

$ 750
—
—
—
$ —
(750)

$ —

Total
Excluding
Nonordinary
Gain

$210,000 $ 210,000
—
(145,000)
20,000
$230,000 $
25,000

$230,000 $ 65,000
(80,000)
$150,000

$

Incremental tax expense (benefit) traceable to:
All nonordinary items ($0 – $20,000) ..........................
All nonordinary losses ($0 – $25,000) .........................

65,000

$(15,000)

7,500
10,000

12,500
—
$30,000
(5,000)
$25,000

$(20,000)
$(25,000)

The discontinued operation is the only nonordinary loss. Therefore, there is a $25,000
tax benefit (the value of F) traceable to the discontinued item.

PROBLEM 12-5
(1)

Case A—Calculation of Year-to-Date Tax Expense or Benefit
Year-to-date income (loss) ...................................................................
Projected income (loss) ........................................................................
Total income (loss) ...............................................................................
Tax exempt income ..............................................................................
Taxable income (loss)...........................................................................

$(80,000)
60,000
$(20,000)
(3,000)
$(23,000)

Because the YTD loss is greater than the annual projected loss, the YTD tax benefit is limited to the amount that would be recognized if the YTD loss were the expected loss for
the entire fiscal year. Therefore, the YTD tax benefit is limited to $15,000 (the $80,000 YTD

loss can only be carried back against $50,000 of prior-year income that is taxed at 30%).

583