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CHAPTER 4
QUESTIONS
(c) The current value of net assets acquired in exchange transactions as determined by either their replacement or
market values.
(d) Some variation of the above (a through
c) but including in assets all resources
and claims to resources, not just those
acquired in exchange transactions.

1. The objective of financial reporting is to
provide useful information for users of the
financial statements. The relevant information for decision making is future data, especially information dealing with cash flows.
The primary financial statements reflect
economic transactions and events that
have taken place. The past is used to help
project the future. Income, however, is only
one of many sources of cash flow. The balance sheet and statement of cash flows
also furnish relevant information upon
which the investor may project other future
cash flows. In summary, the income statement contains only some of the information
that is relevant for making economic decisions.
2. Two approaches can be used to measure
income: the capital maintenance approach
and the transaction approach. The capital
maintenance approach uses the balance
sheet elements to determine the change in
total equity after eliminating any investments and withdrawals of resources by
owners. The transaction approach determines income by analyzing individual
transactions and events and their effect on

related assets, liabilities, and owners’ equity. Although the method of determining
income differs, both approaches arrive at
the same total income figure if the same attributes and measurements are used. However, the transaction approach produces
more detail as to the composition of income
than does the capital maintenance approach.
3. Measurement methods that could be applied to net assets in the capital maintenance approach to income determination
are as follows:
(a) The historical cost of net assets acquired in exchange transactions, reduced by an allowance for their use.
(b) The historical cost of net assets acquired in exchange transactions, reduced by an allowance for their use
and adjusted for a change in price levels since original acquisition.

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

response to societal and market forces—
from the bottom up.
6. Revenues and expenses are related to the
ongoing major or central activities of a
business and are reported at gross
amounts. Gains and losses are associated
with peripheral and incidental transactions
and events and are reported as the difference between the selling price and the
book value (often the depreciated cost).
These classification and display distinctions
will depend on the specific circumstances
and activities of an enterprise.

101


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102

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

chapter. They are recognizing revenue (a)
at the point of completed production, (b) at
the time of cash collection, and (c) at
various points in time during the operating
cycle (e.g., percentage-of-completion method). The justification for the use of these
exceptions is that, in each case, the realization and earning criteria established by
the FASB are met.
9. Three expense recognition principles are
applied in matching costs with revenues:
(a) Direct matching—costs are associated
directly with specific revenues and recognized as expenses of the period in
which the revenues are recognized.
(b) Systematic and rational allocation—
when costs cannot be associated directly with specific revenues, costs are
associated in a systematic and rational
manner with the periods or products
benefited.
(c) Immediate recognition—those costs
that cannot be related to revenues either by direct matching or by systematic and rational allocation must be
recognized as expenses of the current
period.
10. The multiple-step income statement can
contain too much information that might be
confusing to the reader and require excess
time to evaluate. The detailed listing of purchases and inventory, for example, might
best be displayed in a supplementary
schedule.
11. The major sections that may be included in
a multiple-step income statement may be
divided into two categories: (a) income from

continuing operations, separated into six
sections, and (b) irregular or extraordinary
items, separated into two sections. The

Chapter 4

12.

13.

14.

15.

sections of income from continuing operations are
1. Revenue from net sales
2. Cost of goods sold
3. Operating expenses
4. Other revenues and gains
5. Other expenses and losses
6. Income taxes on continuing operations
The sections of irregular or extraordinary
items are
7. Discontinued operations
8. Extraordinary items
A restructuring charge is a loss that arises
when a company proposes a restructuring
of its operations. The charge is composed
of the loss in value associated with assets
that no longer fit in the company’s strategic

plans. The charge also includes the additional costs associated with the termination
or relocation of employees. Restructuring
charges are controversial because companies exercise considerable discretion in determining the amount of a restructuring
charge and thus can use restructuring
charges as a tool for manipulating the
amount of reported net income. This flexibility in the timing of the recognition of restructuring charges is reduced by FASB
ASC Topic 420 (Exit or Disposal Cost Obligations).
Intraperiod income tax allocation involves
the separation of income tax expense between income from continuing operations
and transitory, irregular, or extraordinary
items. Under this concept, each section of
the transitory, irregular, or extraordinary
items category is reported net of its income
tax effect.
Pop-Up must separately disclose the current year’s income related to the operations
of the segment that will be discontinued together with the $10,000 loss resulting from
the sale. This total would be reported on
the income statement, along with any associated income tax impact, immediately
following income from continuing operations.
The following items would not normally
qualify as extraordinary items:
(a) The write-down or write-off of receivables.
(b) Major devaluation of foreign currency.
(c) Loss on sale of plant and equipment.


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(d) Gain from early extinguishment of debt.

Before the issuance of SFAS No. 145
in April 2002, gains and losses from
early extinguishment of debt were required to be classified as extraordinary.
(f) Loss due to extensive earthquake
damage to a furniture company in Los
Angeles, California. (Earthquakes are
not unusual in the Los Angeles area.)
(g) Farming loss due to heavy spring rains
in the Northwest. (Spring rains are not
unusual in the Northwest.)
Item (e) is classified as extraordinary because flood damage is both unusual and infrequent in Las Vegas.
16. a. The effects of a change in accounting
principle that is applied to past periods
are disclosed in the financial statements as a direct adjustment to beginning retained earnings of the earliest
year reported. The financial statements
are prepared using the new accounting
principle for all years being presented.
b. The effect of a change in accounting
estimate is disclosed entirely in the current period or in the current and future
periods. No adjustments are made to
prior periods’ statements as may be
done for a change in principle. The
change in an estimate should be sufficiently disclosed in the financial statements so that readers are alerted to
those changes that will materially affect
future periods.
17. Under International Accounting Standard
(IAS) 8, the cumulative effect of a change
in accounting principle is reported as a
direct adjustment to beginning retained
earnings of the earliest year reported. All

income statements presented are retroactively adjusted to reflect the newly adopted
accounting principle. This is the same approach adopted by the FASB in 2005 and
now contained in FASB ASC Topic 250

1

103

18.

19.

20.

21.

(Accounting Changes and Error Corrections).
Generally accepted accounting principles
require entities to report earnings-per-share
information for income from continuing operations and for each section of the transitory, irregular, or extraordinary items category of an income statement. The computation is made by dividing the income or loss
from each of these sections by the
weighted average number of common
shares outstanding during the reporting period. If a potential dilution of earnings exists
due to the existence of convertible securities, stock options, or stock warrants, additional earnings-per-share information must
also be presented.
“Comprehensive income is the change in
equity of a business enterprise during a period from transactions and other events and
circumstances from nonowner sources. It
includes all changes in equity during a period except those resulting from investments by owners and distributions to own1
ers.” Net income is the reported income as

required by GAAP. Currently, GAAP does
not require all components of comprehensive income to be disclosed in the income
statement. For example, it does not include
the effect of error corrections, asset valuation changes, or some effects of accounting
changes.
The starting point for the preparation of forecasted financial statements is the forecast of sales.
In forecasting depreciation expense, one
first must forecast how much property,
plant, and equipment will be needed in the
future. This amount is then used, along with
an assumption about how rapidly the plant
and equipment will depreciate, to estimate
future depreciation expense.

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


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104

Chapter 4

PRACTICE EXERCISES
PRACTICE 4−1

FINANCIAL CAPITAL MAINTENANCE

Net assets, end of period.........................................................
Net assets, beginning of period ..............................................

Increase in net assets ..............................................................
Deduct investment by owners.................................................
Income...............................................................................
PRACTICE 4−2

$345,000
135,000
$210,000
100,000
$110,000

PHYSICAL CAPITAL MAINTENANCE

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

$345,000
135,000
$210,000
100,000
$110,000
72,000
$ 38,000


COMPUTATION OF INCOME USING MATCHING

Revenue ($125,000 + $72,000) .................................................
Cost of goods sold ($67,000 + $41,000) .................................
Income...............................................................................

$197,000
108,000
$ 89,000

The $240,000 in costs incurred in the production of Machines B and D will not yet be
recognized as an expense. This expense is matched and reported in the income
statement in the same year in which the revenue from the sale of the machines is reported. In the meantime, this $240,000 cost is shown as an asset, Inventory, in the
balance sheet.
PRACTICE 4−4

REVENUE RECOGNITION

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

No
Yes
Yes

Total revenue to be recognized this year


Work
Completed?
Yes
No
Yes

Amount of
Revenue to Be
Recognized
$

0
0
170,000

$170,000


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105

PRACTICE 4−5

a.
b.
c.
d.

e.
f.

EXPENSE RECOGNITION

Amount of
Cost

Expense
Recognition
Method

Expense
to Be Recognized
This Year

$30,000
70,000
27,000
27,000
45,000
50,000

Direct matching
Immediate recognition
Rational allocation
Immediate recognition
Rational allocation
Direct matching


$ 30,000
70,000
9,000
27,000
9,000
0

Total expense recognized this year
PRACTICE 4−6

$145,000

MULTIPLE-STEP INCOME STATEMENT

Sales ..........................................................................................
Cost of goods sold ...................................................................
Gross profit ...............................................................................

$10,000
6,000
$ 4,000

Operating expenses:
Selling and administrative expense ...............................
Operating income .....................................................................
Interest expense .......................................................................
Income before extraordinary items and income taxes .........
Income tax expense..................................................................
Income before extraordinary items.........................................
Extraordinary gain (net of income taxes)...............................

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

750
$ 3,250
1,100
$ 2,150
1,200
$ 950
250
$ 1,200

PRACTICE 4−7

MULTIPLE-STEP INCOME STATEMENT

Sales ..........................................................................................
Cost of goods sold ...................................................................
Gross profit ...............................................................................

$13,000
8,000
$ 5,000

Operating expenses:
Selling and administrative expense ...............................
Operating income .....................................................................
Interest expense .......................................................................
Income before income taxes ...................................................
Income tax expense..................................................................
Net income ........................................................................


1,000
$ 4,000
900
$ 3,100
1,000
$ 2,100


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PRACTICE 4−8

Chapter 4

COMPUTATION OF GROSS PROFIT PERCENTAGE

2007 Gross profit/Revenues = $41,729/$98,786 = 42.2%
2008 Gross profit/Revenues = $45,661/$103,630 = 44.1%
2009 Gross profit/Revenues = $43,785/$95,758 = 45.7%
PRACTICE 4−9

INCOME FROM CONTINUING OPERATIONS

2007 Income from Continuing Operations/Revenues = $10,418/$98,786= 10.6%
2008 Income from Continuing Operations /Revenues = $12,334/$103,630= 11.9%
2009 Income from Continuing Operations /Revenues = $13,425/$95,758= 14.0%
PRACTICE 4−10


COMPUTATION OF INCOME FROM CONTINUING OPERATIONS

Sales ..........................................................................................
Cost of goods sold ...................................................................
Gross profit ...............................................................................
Less: Selling and administrative expense .............................
Operating income .....................................................................
Interest expense .......................................................................
Income before income taxes ...................................................
Income tax expense (40%) .......................................................
Income from continuing operations .......................................
PRACTICE 4−11

$ 12,000
5,000
$ 7,000
1,450
$ 5,550
900
$ 4,650
1,860
$ 2,790

COMPUTATION OF INCOME FROM DISCONTINUED OPERATIONS

Sales ....................................................................
Expenses .............................................................
Income before income taxes .............................
Income tax expense (30%) .................................
Income from continuing operations .................

Discontinued operations:
Income (loss) from operations
(including loss on disposal
in 2013 of $2,000).....................................
Income tax expense (benefit)⎯30%............
Income (loss) on discontinued operations
Net income ..........................................................

2013
$ 5,000
4,400
$ 600
180
$ 420

$(2,400)
(720)

2012
$4,600
4,100
$ 500
150
$ 350

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


420
$ 770


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107

PRACTICE 4−12 COMPUTATION OF INCOME FROM DISCONTINUED OPERATIONS

Sales ..........................................................................
Expenses ...................................................................
Income before income taxes ...................................
Income tax expense (benefit)⎯30% .......................
Income from continuing operations .......................
Discontinued operations:
Income from operations
(including gain on disposal
in 2013 of $1,500)........................................... $ 2,100
Income tax expense⎯30% .................................
630
Income on discontinued operations .................
Net income ................................................................

2013
$3,500
3,900
$ (400)
(120)

$ (280)

2012
$5,100
4,500
$ 600
180
$ 420

$ 500
150
1,470
$1,190

350
$ 770

PRACTICE 4−13 GAINS AND LOSSES ON EXTRAORDINARY ITEMS
Sales ................................................................................
Cost of goods sold .........................................................
Gross profit .....................................................................
Operating expenses and gains/losses:
Selling and administrative expense ........................
Operating income .....................................................
Other revenues and expenses:
Loss from an unusual but frequent event ..............
Gain from a normal but infrequent event ...............
Interest expense........................................................
Income before income taxes .........................................
Income tax expense (35%) .............................................

Income from continuing operations .............................
Extraordinary loss (net of tax benefit of $280) ............
Net income ......................................................................

$25,000
14,000
$11,000
(2,250)
$ 8,750
$(3,000)
1,350
(2,400)

(4,050)
$ 4,700
1,645
$ 3,055
(520)
$ 2,535

PRACTICE 4−14 CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE

Sales .................................................................
Oil and gas exploration expense ...................
Income before income taxes ..........................
Income tax expense (30%) ..............................
Net income .......................................................

2013
$ 5,000

700
$ 4,300
1,290
$ 3,010

2012
$ 3,000
1,200
$ 1,800
540
$ 1,260

2011
$ 2,000
1,500
$ 500
150
$ 350


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PRACTICE 4−15

Chapter 4

ACCOUNTING FOR CHANGES IN ESTIMATES

Original depreciation = $100,000/20 years = $5,000 per year

Accumulated depreciation as of January 1, 2013 = $5,000 per year × 5 years = $25,000
Revised depreciation = Remaining depreciable book value/Remaining life
= ($100,000 − $25,000)/(30 years − 5 years elapsed already)
= $75,000/25 years
= $3,000 per year
PRACTICE 4−16

RETURN ON SALES

Return on sales = Net income/Sales = $320/$15,000 = 2.1%
PRACTICE 4−17

EARNINGS PER SHARE

Net income ..........................................
Average shares outstanding .............

2013
$12,250
3,500

2012
$9,000
3,000

2011
$5,500
2,000

Earnings per share .............................


$3.50

$3.00

$2.75

Percentage increase in 2012: ($3.00 − $2.75)/$2.75 = 9%
Percentage increase in 2013: ($3.50 − $3.00)/$3.00 = 17%
PRACTICE 4−18

PRICE-EARNINGS (P/E) RATIO

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

COMPREHENSIVE INCOME

Income from continuing operations .......................................
Extraordinary loss ....................................................................
Net income ........................................................................

$ 9,000
(1,200)
$ 7,800

Net income ................................................................................
Unrealized loss on available-for-sale securities ...................
Foreign currency translation adjustment (equity increase)
Comprehensive income...................................................


$ 7,800
(1,700)
1,500
$ 7,600


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PRACTICE 4−20

109

FORECASTED BALANCE SHEET

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

2013
Actual
$ 100
500
1,000
2,500

5,000
$ 9,100

2014
Forecasted
$ 125
625
1,250
2,500
7,000
$11,500

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

FORECASTED INCOME STATEMENT

2013
Actual
Sales ...................................... $10,000
Cost of goods sold ...............
6,000
Depreciation expense ..........
1,000
Interest expense ...................
400
Income before income taxes $ 2,600

Income tax expense..............
910
Net income....................... $ 1,690

2014
Forecasted
$13,000 30% increase (given)
7,800 30% natural increase
1,200 same proportion with PPE
500 same apparent 10% interest rate
$ 3,500
1,225 same tax rate ($910/$2,600) = 35%
$ 2,275


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Chapter 4

EXERCISES
4–22.
Debit changes in accounts during 2013 other
than Retained Earnings:
Cash .........................................................................
Accounts Receivable..............................................
Buildings and Equipment (net)..............................
Accounts Payable ...................................................
Credit changes in accounts during 2013 other
than Retained Earnings:

Inventory ..................................................................
Patents .....................................................................
Bonds Payable ........................................................
Capital Stock ...........................................................
Additional Paid-In Capital ......................................
Change in Retained Earnings for 2013.......................
Add: Dividends declared .............................................
Net income ....................................................................

$ 38,500
57,000
160,000
45,000

$ 32,500
4,000
135,000
25,000
35,000

$300,500

231,500
$ 69,000
18,000
$ 87,000

4–23.
(a) The receipt of an order from a customer does not constitute realization,
nor does it qualify as an earnings activity. Therefore, no revenue is recognized.

(b) There has been no sale of the asset to support the recognition of revenue. Production remains to be performed, followed by sale of the finished product. Accretion may give rise to revenue in certain instances
in which it can be objectively determined and the product has a ready
market at a definite price.
(c) The rendering of services is the earning activity, and it is assumed that
a valid claim exists against the client. The recognition criteria are met.
(d) The appreciation in value of the land is generally not recognized because it is not yet realized.
(e) The receipt of cash meets the realization criteria; however, the revenue
is generally not reported as earned because the product has not yet
been delivered. Some argue that an estimate of the costs incurred to
honor the certificate can be made so that revenue could be recognized
at the time of certificate sale.
(f) Collection of cash on the subscriptions is realization. However, the
earning activity has yet to take place.
(g) The retirement of debt at less than the recorded liability results in the
recognition of a gain. The retirement of the debt meets the recognition
criterion for gains.


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111

4–24.
(a) The revenue is unearned in 2013. The credit is to the liability account
Unearned Rent Revenue.
(b) Revenue of $60,000 is to be recognized in 2013: $10,000 in cash plus a
note for $50,000. In addition, interest revenue of $3,000 is recognized in
2013 ($50,000 × 0.12 × 1/2 year). The $3,000 interest revenue to be
earned in 2014 will not be recorded until 2014.

(c) Transactions in a company’s own stock are not considered an incomegenerating activity. The amount received above par is credited to Additional Paid-In Capital.
(d) Because a claim against the customer (an asset) is created when the
merchandise is shipped and actions to prepare and ship the inventory
are felt to represent the earning activity, revenue is recognized at the
time of sale. In theory, the possibility of return should be evaluated and
recorded as a reduction of revenue if some return is probable and the
value of the return can be estimated. Similarly, the probability of a customer’s taking a cash discount should be considered and a reduction
made to revenue for estimated cash discounts. In practice, both sales
returns and cash discounts are usually not recorded until they actually
occur.
(e) This is a difficult one. As discussed in Chapter 8, under the provisions
of SAB No. 101 the SEC generally does not allow the recognition of revenue until title transfers. In such a case, the receipt of the 15% down
payment would be recorded as a debit to Cash and a credit to a liability
such as Deposit Liability.
(f) The initial agreement does not represent a claim against the client until
the contract is at least partially complete. Because part of the work was
accomplished in 2013, a portion of the revenue could be recognized in
2013 on a percentage basis. However, because the bulk of the work will
be done in 2014, revenue could be deferred until the audit is completed
and billed.
4–25.
(a) Immediate recognition. The future benefits of the new drug are highly
uncertain.
(b) Direct matching. The warranty costs are anticipated expenses that are
directly related to revenues.
(c) Systematic and rational allocation. The lease agreement benefits several accounting periods in a systematic and rational way.
(d) Direct matching. Labor associated with assembling a product is
matched with revenues and reported in the period the goods are sold.
(e) Systematic and rational allocation. The delivery trucks are expected to
benefit several accounting periods in a systematic and rational way.

(f) Immediate recognition. The advertising indirectly helps to generate revenues and is not related to specific revenues.


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Chapter 4

4–26.
Original cost of patent.....................................................................
Amortization for 3 years ($60,000 per year 2010–2012)...............
Remaining unamortized balance ...................................................

$600,000
180,000
$420,000

New estimated life from January 1, 2013 ......................................
Amortization expense for each year (2013–2016) ........................

4 years
$105,000

Separate disclosure of the $45,000 increase ($105,000 – $60,000) due to the
change in estimate would be required in 2013 if it is considered a material
amount.
4–27.
(a) Subtracted or included in determining net purchases in the Cost of
Goods Sold section
(b) Other revenues and gains

(c) Other revenues and gains
(d) Other expenses and losses
(e) Either extraordinary items or other expenses and losses depending on
whether unusual and infrequent
(f) Operating expenses—selling expenses
(g) Discontinued operations
(h) Deduction from income from continuing operations before income taxes
(i) Other revenues and gains
(j) Subtraction from sales
(k) Other expenses and losses
(l) Cost of goods sold (an item entering into cost of goods manufactured)
(m) Operating expenses—general and administrative
(n) Cost of goods sold


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113

4–28.
Caribou Inc.
Income Statement
For the Year Ended December 31, 2013
Sales ....................................................................
$1,600,000 (a)
Cost of goods sold:
Beginning inventory ........................................ $ 136,000
Net purchases ..................................................
919,200 (b)

Cost of goods available for sale..................... $1,055,200
Less: Ending inventory ...................................
95,200
Cost of goods sold ..........................................
960,000
Gross profit on sales..........................................
$ 640,000
Operating expenses:
Selling expenses.............................................. $ 208,000 (c)
General expenses (including bad debts).......
272,000 (d)
480,000
Income before income taxes
and extraordinary items ..................................
$ 160,000
Income taxes .......................................................
48,000
Income before extraordinary items...................
$ 112,000
Extraordinary gain (net of income taxes
of $9,000) ..........................................................
21,000
Net income ..........................................................
$ 133,000
Earnings per share (e):
Income before extraordinary items................
Extraordinary gain ...........................................
Net income........................................................

$0.86

0.16
$1.02

COMPUTATIONS:
(a) Sales
Income before income taxes as a percentage of sales:
Sales ..............................................................
100%
Cost of goods sold (see below) ..................
60
Gross profit on sales ...................................
40%
Selling expenses ..........................................
13%
General expenses, including bad debts ..
17
30
Income before income taxes..........................
10%
Sales: $160,000 (income before income taxes) ÷ 0.10 = $1,600,000
Cost of goods sold:
General expenses, excluding bad debts = 15% of sales and 25% of
cost of goods sold: therefore, 0.15 × sales = 0.25 × Cost of goods sold
Cost of goods sold = 0.15 ÷ 0.25 = 0.60 of sales


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4–28.


Chapter 4

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

4–29.
Nephi Corporation
Income Statement (Partial)
For the Year Ended December 31, 2013
Income from continuing operations before income taxes ............. $ 260,000
Income tax expense on continuing operations ($260,000 × 0.35)
91,000
Income from continuing operations ................................................. $ 169,000
Discontinued operations:
Loss from operations of discontinued business
component (including gain on disposal of $40,000) $ (30,000)
Net income tax benefit ..............................................

10,500
(19,500)
Extraordinary gain (net of income taxes of $38,500)
71,500
Net income .......................................................................................... $ 221,000
4–30.
(a) Discontinued operations:
Loss from operations of discontinued business
component (including gain on disposal of
$23,000) ............................................................
$(187,000)
Income tax benefit ..............................................
74,800 $(112,200)
(b) If Stafford Manufacturing were reporting using the accounting standards of the United Kingdom, it would also disclose information about
sales and operating profits for the continuing and discontinued operations. This additional information allows financial statement users to
compare the relative size and operating profitability of the continuing
and discontinued operations. This practice is also similar to the reporting requirements of IAS 35.


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115

4–31.
2013
$60,000
26,000
14,000
$20,000

7,000
$13,000

Sales ......................................................
Cost of goods sold ...............................
Other expenses.....................................
Income before income taxes ...............
Income tax expense (35%) ...................
Income from continuing operations ...
Discontinued operations:
Income (loss) from operations
(including gain on disposal
in 2013 of $15,000) ................ $7,000
Income tax expense (benefit)
—35% .....................................
2,450
Income (loss) on discontinued
operations........................................
4,550
Net income ............................................
$17,550

2012
$ 48,000
22,000
13,000
$ 13,000
4,550
$ 8,450


2011
$ 40,000
18,000
12,000
$ 10,000
3,500
$ 6,500

$(5,000)

$17,000

(1,750)

5,950

(3,250)
$ 5,200

11,050
$17,550

4–32.
1.
Reported net income ............................
Divided by (1 – tax rate) .......................
Reported income before tax ................
Add back old cost of goods sold ........
Subtract new cost of goods sold ........
Revised income before tax ..................

Tax expense (0.3)..................................
Revised net income ..............................
2.

2013
$ 128,000
÷
0.70
$ 182,857

2012
$ 119,000
÷
0.70
$ 170,000

2011
$ 98,000
÷
0.70
$ 140,000

25,000
$ 207,857
19,000
$ 188,857
56,657
$ 132,200

29,000

$ 199,000
21,000
$ 178,000
53,400
$ 124,600

31,000
$ 171,000
24,000
$ 147,000
44,100
$ 102,900

The adjustment to January 1, 2011, Retained Earnings would summarize the effect of the different inventory valuation methods for all years prior to 2011. The
amount of the adjustment would be a $9,100 increase [$13,000 × (1 – 30% tax effect)].


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4–33.
(a) Sales revenue.
(b) Loss on disposal of discontinued operations; a separate component of
income shown net of taxes before extraordinary items but after income
from continuing operations.
(c) Extraordinary item, net of taxes.
(d) Prior-period adjustment (error correction); retained earnings adjustment.
(e) Operating expense (or reduction in revenue)—it is a change in estimate.

(f) Asset.
(g) Results of discontinued operations: a separate component of income
shown net of taxes before extraordinary items but after income from
continuing operations.
(h) Asset (possibly could be expensed).
(i)

Prior-period adjustment (error correction); retained earnings adjustment.

(j)

Other Revenues and Gains section of income statement.

(k) Other Expenses and Losses section of income statement unless the
event is considered unusual and infrequent, in which case it would be
reported as an extraordinary item.
(l)

Operating expense; it is a change in estimate.

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



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117

4–34.
Income Statement
Revenue:
Sales
Less: Sales discounts
Sales returns and allowances
Cost of goods sold:
Inventory—beginning
Net purchases:
Purchases
Less: Purchase discounts
Purchase returns and allowances
Freight-in
Cost of goods available for sale
Less: Inventory—ending
Gross profit
Operating expenses:
Selling expenses:
Advertising expense
Sales salaries and commissions
Miscellaneous selling expense
General and administrative expenses:
Officers’ salaries expense

Office salaries expense
Office supplies expense
Depreciation expense—office building
Depreciation expense—office furniture and fixtures
Bad debt expense
Insurance expense
Property taxes expense
Miscellaneous general expense
Operating income
Other revenues and gains:
Dividend revenue
Interest revenue
Royalty revenue
Other expenses and losses:
Interest expense—Bonds
Interest expense—Other
Income from continuing operations before income taxes
Income tax expense
Income from continuing operations
Loss from discontinued operations (net of income taxes of _____ )
Extraordinary gain (net of income taxes of _____ )
Net income
Earnings per common share:
Income from continuing operations
Loss from discontinued operations
Extraordinary gain
Net income


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4–35.
Jacksonville Window Co.
Income Statement
For the Year Ended December 31, 2013
Sales revenue............................................................
Cost of goods sold ...................................................
Gross profit ...............................................................
Operating expenses:
Selling expenses....................................................
General and administrative expenses .................
Operating income .....................................................
Interest expense .......................................................
Income before income taxes ...................................
Income taxes (0.40 × $100,900) ...............................
Net income ................................................................
Earnings per share ($60,540 ÷ 30,000 shares) .......

$1,420,000
790,000
$ 630,000
$ 290,200
224,800
$
$
$
$


515,000
115,000
14,100
100,900
40,360
60,540
2.02

Jacksonville Window Co.
Statement of Retained Earnings
For the Year Ended December 31, 2013
Retained earnings, January 1.........................................................
Add: Net income ..............................................................................
Deduct: Dividends ...........................................................................
Retained earnings, December 31 ...................................................

$335,200
60,540
$395,740
40,000
$355,740

4–36.
1.

Problems Inc.
Schedule of Corrected Net Income
For the Year Ended December 31, 2013


Reported net income (profit and loss)........................
Add: Change in amortization expense .....................
Gain on sale of land ..........................................
Interest revenue.................................................
Less: Increased depreciation—change in estimate .
Loss on sale of equipment ...............................
Extraordinary casualty loss .............................
Corrected net income...................................................

$12,760
$ 3,100
17,420
3,900
$ 6,400
2,490
25,310

24,420
$37,180

34,200
$ 2,980


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4–36.

119


(Concluded)
2.
Problems Inc.
Retained Earnings Statement
For the Year Ended December 31, 2013
Retained earnings, January 1, 2013 ..........................................
Add: Net income .........................................................................
Deduct: Dividends declared.......................................................
Retained earnings, December 31, 2013 ....................................

$76,843
2,980
$79,823
12,000
$67,823

3. All items except dividends declared during the year would be reported
on the income statement and included in net income. Extraordinary
items would be reported separately after income from continuing operations.
4–37.
1. The unrealized losses on available-for-sale securities will decrease
comprehensive income because the value of the securities decreased
during the year. The foreign currency translation adjustment will decrease comprehensive income because the value of the currencies of
Svedin’s foreign subsidiaries weakened relative to the U.S. dollar. The
deferred loss on derivatives adjustment will decrease comprehensive
income.
2.

Svedin Incorporated

Statement of Comprehensive Income
For the Year Ended December 31, 2013
Net income............................................................................
Unrealized losses on available-for-sale securities...........
Foreign currency translation adjustment ..........................
Deferred loss on derivatives adjustment ..........................
Comprehensive income ......................................................

$14,200
(1,285)
(287)
(315)
$12,313


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4–38.
Romney and Associates
Forecasted Income Statement
For the Year Ended December 31, 2014

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

2013
$3,000

1,200

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

$1,800
100

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

1,440

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

$ 260
50

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

$ 210
84

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

$ 126

2014
Forecasted

$ 3,600
given
1,440
40% of sales,
as last year
$ 2,160
140
20% of PPE,
same as last year
1,728
48% of sales,
same as last year
$ 292
40
10% of bank loan,
same as last year
$ 252
101
40% of pretax,
same as last year
$ 151

4–39.
Ryan Company
Forecasted Balance Sheet
December 31, 2014

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

net .................................................
Total assets ....................................

2013
$ 10
250

2014
Forecasted
$ 15
50% natural increase
375
50% natural increase

800
$1,060

800
$1,190

more efficient, item (b)

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

$ 100
700

$ 150
900


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

260

140

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

$1,060

$1,190


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121

(Concluded)
Ryan Company
Forecasted Income Statement
For the Year Ended December 31, 2014


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

2013
$1,000
750

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

$ 250
40

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

80

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

$ 130
70

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

$

60

20

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

$

40

2014
Forecasted
$1,500
given, item (a)
1,125
75% of sales,
same as last year
$ 375
40
5% of PPE,
same as last year
120
8% of sales,
same as last year
$ 215
90
10% of bank loan,
same as last year
$ 125
42
33.3% of pretax,
same as last year

$ 83

Note: Total stockholders’ equity is forecasted to decrease by $120 ($260 – $140). This
will happen even though net income will cause stockholders’ equity to increase by
$83. These forecasts imply that Ryan Company is either planning to pay out a large
cash dividend or to buy back a large amount of shares of its own stock.


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PROBLEMS
4–40.
McGrath Co.
Income Statement
For the Year Ended June 30, 2013
Sales ($2,870,000 less returns and
allowances, $120,000)..........................................
Cost of goods sold (net purchases,
$1,488,000 less increase in inventory, $25,000)
Gross profit ................................................................
Selling and general expenses ..................................
Operating income ......................................................
Interest revenue .........................................................
Income before income taxes ....................................
Income taxes ..............................................................
Net income .................................................................
Earnings per common share

($805,100 ÷ 275,000 shares) ................................

$2,750,000
1,463,000
$1,287,000
283,000
$1,004,000
72,000
$1,076,000
270,900
$ 805,100
$

2.93

McGrath Co.
Retained Earnings Statement
For the Year Ended June 30, 2013
Retained earnings, July 1, 2012 ...............................
Add: Net income ........................................................
Deduct: Dividends .....................................................
Retained earnings, June 30, 2013 ............................

$1,475,000
805,100
$2,280,100
300,000
$1,980,100



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4–41.
1. Income statement—time of shipment:
Manchester Company
Income Statement
For the Years Ended December 31
Sales ..............................................................................
Cost of goods sold .......................................................
Gross profit ...................................................................
Bad debt expense .........................................................
Selling expenses...........................................................
General and administrative expenses ........................
Net income (loss)..........................................................

2014
$266,000
152,000
$114,000
(10,640)
(21,000)
(16,000)
$ 66,360

2013
$224,000
128,000

$ 96,000
(8,960)
(30,000)
(16,000)
$ 41,040

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

2014
$ 224,000
112,000
$ 112,000
(2,240)
(21,000)
(16,000)
$ 72,760

2013
$144,000
72,000

$ 72,000
(1,440)
(30,000)
(16,000)
$ 24,560

2. Under the first dealer agreement, revenue is recognized when goods are
shipped to the dealers. The dealer makes payment after receipt of the
goods. Possible bad debt losses are greater under this agreement because the dealer may not have the cash to pay for the toys until they are
sold. The second type of dealer agreement is actually a consignment of
inventory. Because there is a right of return, the revenue should not be
recognized until the dealer makes a sale. The risk is borne by Manchester. To cover this risk, the sales price is higher for the toys.
In the problem, Manchester would have less income in 2013 under the
consignment agreement than under the sale agreement; however, in
2014 the consignment agreement would produce a greater profit. In addition, at the end of 2014 Manchester will still have 24,000 units out on
consignment, assuming that none of the units have been returned, with
a potential profit of $4 per unit less bad debt costs. Of course, if these
24,000 units are returned and cannot be resold, this profit will not be
realized. The uncertainty of the second type of dealer agreement justifies the delay of revenue recognition until the dealer makes a sale.


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4–42.
1.

(a) Revenue must be both earned and realized in order to be reported on

the income statement. Until Hadley ships the inventory, the $18,000 of
orders paid for in advance should not be reported on the income statement.
(b) Because customers are not returning the products, the earnings process can be considered substantially complete when the sale is made.
The $16,000 revenues and associated $7,500 cost of goods sold should
be included on the income statement.
(c) The rent will benefit several accounting periods and should be allocated
in a systematic fashion.
(d) It is difficult to determine the period of time that is benefited by general
advertising. Because the advertising costs cannot be related to specific
revenues, the costs are typically recognized as expenses immediately.
(e) Current cost information is currently not disclosed on the face of the
income statement. Some companies elect to provide supplemental information of this nature in the notes to the financial statements.
(f) If warranty costs can be reasonably estimated, the expenses are
matched directly to the period in which the revenue is generated. Using
the actual costs incurred to approximate warranty expense violates the
matching principle.

2.

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

Advertising expense: $6,000 + $18,000 = $24,000
Warranty expense: $183,000 × 0.05 = $9,150

$183,000
101,500
$ 81,500
(12,000)
(24,000)
(9,150)
(15,000)
$ 21,350


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4–43.
Spiker Manufacturing Inc.
Income Statement (Partial)
For the Fiscal Year Ended July 31, 2013
Income from continuing operations before income taxes .....................
Incomes taxes .............................................................................................
Income from continuing operations .........................................................
Extraordinary gain (net of income taxes of $36,300) ..............................
Loss from disposal of a business component (net of income tax
benefit of $39,000) ...................................................................................
Net income ..................................................................................................


$1,024,000 (a)
307,200 (b)
$ 716,800
84,700 (c)
(91,000) (d)
$ 710,500

COMPUTATIONS:
(a) $1,015,000 – $121,000 + $130,000 = $1,024,000
(b) $1,024,000 × 0.30 = $307,200
(c) $121,000 × 0.30 = $36,300; $121,000 – $36,300 = $84,700
(d) $130,000 × 0.30 = $39,000; $130,000 – $39,000 = $91,000

Spiker Manufacturing Inc.
Retained Earnings Statement
For the Fiscal Year Ended July 31, 2013
Retained earnings, August 1, 2012 ...........................................................
Less: Prior-period adjustment (net of income tax benefit of $27,000) ..
Adjusted retained earnings, August 1, 2012............................................
Add: Net income .........................................................................................
Retained earnings, July 31, 2013 ..............................................................
(a) $90,000 × 0.30 = $27,000; $90,000 – $27,000 = $63,000

$2,520,000
63,000 (a)
$2,457,000
710,500
$3,167,500