Intermediate accounting answer chapter4.doc

The McGraw Hill Companies Inc 2009 Solutions Manual Vol 1 Chapter 44 1 AACSB assurance of learning standards in accounting and business education require documentation of outcomes assessment Although schools departments and faculty may approach assessment and its documentation differently one approach is to provide specific questions on exams that become the basis for assessment To aid faculty in this endeavor we have labeled each question exercise and problem in Intermediate Accounting 5e with the following AACSB learning skills QuestionsAACSB TagsExercises cont AACSB Tags 4 1Reflective thinking4 6Analytic 4 2Reflective thinking4 7Analytic 4 3Reflective thinking4 8Analytic 4 4Reflective thinking4 9Analytic Reflective thinking Communications 4 5Reflective thinking4 10Analytic Reflective thinking Communications 4 6Reflective thinking4 11Reflective thinking 4 7Reflective thinking4 12Analytic 4 8Reflective thinking4 13Diversity 4 9Reflective thinking4 14Reflective thinking 4 10Reflective thinking4 15Analytic 4 11Reflective thinking Communications4 16Diversity Communications 4 12Reflective thinking4 17Analytic 4 13Reflective thinking4 18Analytic 4 14Reflective thinking4 19Analytic 4 15Reflective thinking4 20Analytic 4 16Reflective thinking4 21Reflective thinking 4 17Reflective thinking CPA CMA 4 18Reflective thinking4 1Reflective thinking 4 19Reflective thinking4 2Analytic Brief Exercises 4 3Analytic 4 1Analytic4 4Analytic 4 2Analytic4 5Reflective thinking 4 3Analytic4 6Reflective thinking 4 4Analytic4 7Reflective thinking 4 5Analytic4 1Reflective thinking 4 6Analytic4 2Reflective thinking 4 7Analytic4 3Reflective thinking 4 8Analytic Problems 4 9Reflective thinking Communications4 1Analytic 4 10Analytic Communications4 2Analytic Reflective thinking 4 11Analytic4 3Analytic Reflective thinking 4 12Analytic4 4Communications Reflective thinking 4 13Analytic4 5Analytic Chapter 4 The Income Statement and Statement of Cash Flows The McGraw Hill Companies Inc 2009 4 2Intermediate Accounting 5 e 4 14Analytic4 6Analytic ExercisesProblems cont 4 1Analytic4 7Analytic 4 2Analytic4 8Analytic 4 3Analytic4 9Analytic 4 4Analytic4 10Analytic 4 5Analytic4 11Analytic The McGraw Hill Companies Inc 2009 Solutions Manual Vol 1 Chapter 44 3 Question 4 1 The income statement is a change statement that reports transactions revenues expenses gains and losses that cause owners equity to change during a specified reporting period Question 4 2 Income from continuing operations includes the revenue expense gain and loss transactions that will probably continue in future periods It is important to segregate the income effects of these items because they are the most important transactions in terms of predicting future cash flows Question 4 3 Operating income includes revenues and expenses that are directly related to the principal revenue generating activities of the company Nonoperating income includes items that are not directly related to these activities Question 4 4 The single step format first lists all revenues and gains included in income from continuing operations to arrive at total revenues and gains All expenses and losses are then grouped and subtotaled subtracted from revenues and gains to arrive at income from continuing operations The multiple step format reports a series multiple of intermediate totals such as gross profit operating income and income before taxes Very often income statements adopt variations of these formats falling somewhere in between the two extremes Question 4 5 The term earnings quality refers to the ability of reported earnings income to predict a company s future earnings After all an income statement simply reports on events that already have occurred The relevance of any historical based financial statement hinges on its predictive value Question 4 6 Restructuring costs include costs associated with shutdown or relocation of facilities or downsizing of operations They are reported as an operating expense in the income statement Question 4 7 The process of intraperiod tax allocation matches tax expense or tax benefit with each major component of income specifically continuing operations and any item reported below continuing operations The process is necessary to achieve the desired result of separating the total income effects of continuing operations from the two separately reported items discontinued operations and extraordinary items and also to show the after tax effect of each of those two components QUESTIONS FOR REVIEW OF KEY TOPICS The McGraw Hill Companies Inc 2009 4 4Intermediate Accounting 5 e Answers to Questions continued Question 4 8 A component of an entity comprises operations and cash flows that can be clearly distinguished operationally and for financial reporting purposes The net of tax income effects of a discontinued operation must be disclosed separately in the income statement below income from continuing operations The income effects include income loss from operations and gain loss on disposal The gain or loss on disposal must be disclosed either on the face of the statement or in a disclosure note If the component is held for sale but not sold by the end of the reporting period the income effects will include income loss from operations and an impairment loss if the fair value less costs to sell is less than the book value of the component s assets The income loss from operations of the component is reported separately in discontinued operations on prior income statements presented for comparative purposes Question 4 9 Extraordinary items are material gains and losses that are both unusual in nature and infrequent in occurrence taking into account the environment in which the entity operates Question 4 10 Extraordinary gains and losses are presented net of tax in the income statement below discontinued operations if any The McGraw Hill Companies Inc 2009 Solutions Manual Vol 1 Chapter 44 5 Answers to Questions continued Question 4 11 GAAP permit alternative treatments for similar transactions Common examples are the choice among FIFO LIFO and average cost for the measurement of inventory and the choice among alternative revenue recognition methods A change in accounting principle occurs when a company changes from one generally accepted treatment to another In general we report voluntary changes in accounting principles retrospectively This means revising all previous periods financial statements as if the new method were used in those periods In other words for each year in the comparative statements reported we revise the balance of each account affected Specifically we make those statements appear as if the newly adopted accounting method had been applied all along Also if retained earnings is one of the accounts whose balance requires adjustment and it usually is we revise the beginning balance of retained earnings for the earliest period reported in the comparative statements of shareholders equity or statements of retained earnings if they re presented instead Then we create a journal entry to adjust all account balances affected as of the date of the change In the first set of financial statements after the change a disclosure note would describe the change and justify the new method as preferable It also would describe the effects of the change on all items affected including the fact that the retained earnings balance was revised in the statement of shareholders equity An exception is a change in depreciation amortization or depletion method These changes are accounted for as a change in estimate rather than as a change in accounting principle Changes in estimates are accounted for prospectively The remaining book value is depreciated amortized or depleted using the new method over the remaining useful life Question 4 12 A change in accounting estimate is accounted for in the year of the change and in subsequent periods prior years financial statements are not restated A disclosure note should justify that the change is preferable and should describe the effect of a change on any financial statement line items and per share amounts affected for all periods reported Question 4 13 Prior period adjustments are accounted for by restating prior years financial statements when those statements are presented again for comparison purposes The beginning of period retained earnings is increased or decreased on the statement of shareholders equity or the statement of retained earnings in the year the error is discovered The McGraw Hill Companies Inc 2009 4 6Intermediate Accounting 5 e Answers to Questions concluded Question 4 14 Earnings per share EPS is the amount of income achieved during a period for each share of common stock outstanding If there are different components of income reported below continuing operations their effects on earnings per share must be disclosed If a period contains discontinued operations and extraordinary items EPS data must be reported separately for income from continuing operations and net income Per share amounts for discontinued operations and extraordinary items would be disclosed on the face of the income statement Question 4 15 Comprehensive income is the total change in equity for a reporting period other than from transactions with owners Reporting comprehensive income can be accomplished with a separate statement or by including the information in either the income statement or the statement of changes in shareholders equity Question 4 16 The purpose of the statement of cash flows is to provide information about the cash receipts and cash disbursements of an enterprise during a period Similar to the income statement it is a change statement summarizing the transactions that caused cash to change during a particular period of time Question 4 17 The three categories of cash flows reported on the statement of cash flows are 1 Operating activities Inflows and outflows of cash related to the transactions entering into the determination of net income from operations 2 Investing activities Involve the acquisition and sale of 1 long term assets used in the business and 2 nonoperating investment assets 3 Financing activities Involve cash inflows and outflows from transactions with creditors and owners Question 4 18 Noncash investing and financing activities are transactions that do not increase or decrease cash but are important investing and financing activities An example would be the acquisition of property plant and equipment an investing activity by issuing either long term debt or equity securities a financing activity These activities are reported either on the face of the statement of cash flows or in a disclosure note Question 4 19 The direct method of reporting cash flows from operating activities presents the cash effect of each operating activity directly on the statement of cash flows The indirect method of reporting cash flows from operating activities is derived indirectly by starting with reported net income and adding and subtracting items to convert that amount to a cash basis The McGraw Hill Companies Inc 2009 Solutions Manual Vol 1 Chapter 44 7 Brief Exercise 4 1 PACIFIC SCIENTIFIC CORPORATION Income Statement For the Year Ended December 31 2009 in millions Revenues and gains Sales 2 106 Gain on sale of investments 45 Total revenues and gains 2 151 Expenses and losses Cost of goods sold 1 240 Selling 126 General and administrative 105 Interest 35 Income tax expense 258 Total expenses and losses 1 764 Net income 387 2 151 1 240 126 105 35 645 x 40 258 Brief Exercise 4 2 a Sales revenue 2 106 Less Cost of goods sold 1 240 Gross profit866 Less Selling expenses 126 General and administrative expenses 105 Operating income 635 b Gain on sale of investments45 Interest expense 35 Nonoperating income 10 BRIEF EXERCISES The McGraw Hill Companies Inc 2009 4 8Intermediate Accounting 5 e Brief Exercise 4 3 PACIFIC SCIENTIFIC CORPORATION Income Statement For the Year Ended December 31 2009 in millions Sales revenue 2 106 Cost of goods sold 1 240 Gross profit 866 Operating expenses Selling 126 General and administrative 105 Total operating expenses 231 Operating income 635 Other income expense Gain on sale of investments 45 Interest expense 35 Total other income net 10 Income before income taxes 645 Income tax expense 258 Net income 387 645 x 40 The McGraw Hill Companies Inc 2009 Solutions Manual Vol 1 Chapter 44 9 Brief Exercise 4 4 a Sales revenue 300 000 Less Cost of goods sold 160 000 General and administrative expenses 40 000 Restructuring costs 50 000 Selling expenses 25 000 Operating income 25 000 b Operating income 25 000 Add Interest revenue4 000 Deduct Loss on sale of investments 22 000 Income before income taxes and Extraordinary item7 000 Income tax expense 40 2 800 Income before extraordinary item 4 200 c Income before extraordinary item 4 200 Extraordinary item Loss from flood damage net of 20 000 tax benefit 30 000 Net loss 25 800 The McGraw Hill Companies Inc 2009 4 10Intermediate Accounting 5 e Brief Exercise 4 5 WHITE AND SONS INC Partial Income Statement For the Year Ended December 31 2009 Income before income taxes and extraordinary item 850 000 Income tax expense 340 000 Income before extraordinary item 510 000 Extraordinary item Loss from earthquake net of 160 000 tax benefit 240 000 Net income 270 000 Earnings per share Income before extraordinary item 5 10 Loss from earthquake 2 40 Net income 2 70 850 000 x 40 Note Restructuring costs interest revenue and loss on sale of investments are included in income before income taxes and extraordinary item The McGraw Hill Companies Inc 2009 Solutions Manual Vol 1 Chapter 44 11 Brief Exercise 4 6 CALIFORNIA MICROTECH CORPORATION Partial Income Statement For the Year Ended December 31 2009 Income from continuing operations before income taxes 5 800 000 Income tax expense 1 740 000 Income from continuing operations 4 060 000 Discontinued operations Loss from operations of discontinued component including gain on disposal of 2 000 000 1 600 000 Income tax benefit 480 000 Loss on discontinued operations 1 120 000 Net income 2 940 000 5 800 000 x 30 Loss from operations of discontinued component Gain on sale of assets 2 000 000 10 million less 8 million Operating loss 3 600 000 Total before tax loss 1 600 000 The McGraw Hill Companies Inc 2009 4 12Intermediate Accounting 5 e Brief Exercise 4 7 CALIFORNIA MICROTECH CORPORATION Partial Income Statement For the Year Ended December 31 2009 Income from continuing operations before income taxes 5 800 000 Income tax expense 1 740 000 Income from continuing operations 4 060 000 Discontinued operations Loss from operations of discontinued component 3 600 000 Income tax benefit 1 080 000 Loss on discontinued operations 2 520 000 Net income 1 540 000 5 800 000 x 30 Includes only the operating loss There is no impairment loss The McGraw Hill Companies Inc 2009 Solutions Manual Vol 1 Chapter 44 13 Brief Exercise 4 8 CALIFORNIA MICROTECH CORPORATION Partial Income Statement For the Year Ended December 31 2009 Income from continuing operations before income taxes 5 800 000 Income tax expense 1 740 000 Income from continuing operations 4 060 000 Discontinued operations Loss from operations of discontinued component including impairment loss of 1 000 000 4 600 000 Income tax benefit 1 380 000 Loss on discontinued operations 3 220 000 Net income 840 000 5 800 000 x 30 Loss from operations of discontinued component Impairment loss 8 million book value less 7 million net fair value 1 000 000 Operating loss 3 600 000 Total before tax loss 4 600 000 The McGraw Hill Companies Inc 2009 4 14Intermediate Accounting 5 e Brief Exercise 4 9 The change in inventory method is a change in accounting principle The depreciation method change is considered to be a change in accounting estimate that is achieved by a change in accounting principle and is accounted for prospectively exactly as we would account for any other change in estimate The inventory method change however is accounted for by retrospectively recasting prior years financial statements presented with the current year for comparative purposes applying the new inventory method FIFO in this case in those years Brief Exercise 4 10 This is a change in accounting estimate When an estimate is revised as new information comes to light accounting for the change in estimate is quite straightforward We do not restate prior years financial statements to reflect the new estimate Instead we merely incorporate the new estimate in any related accounting determinations from there on If the after tax income effect of the change in estimate is material the effect on net income and earnings per share must be disclosed in a note along with the justification for the change Depreciation for 2009 is 25 000 300 000Cost 50 000 Old annual depreciation 300 000 6 years x 2 years 100 000 Depreciation to date 2007 2008 200 000Book value 8 yrs Estimated remaining life 10 years 2 years 25 000New annual depreciation The McGraw Hill Companies Inc 2009 Solutions Manual Vol 1 Chapter 44 15 Brief Exercise 4 11 O REILLY BEVERAGE COMPANY Statement of Comprehensive Income For the Year Ended December 31 2009 Net income 650 000 Other comprehensive income loss Unrealized gains on investment securities net of tax 24 000 Deferred loss on derivatives net of tax 36 000 Total other comprehensive loss 12 000 Comprehensive income 638 000 The McGraw Hill Companies Inc 2009 4 16Intermediate Accounting 5 e Brief Exercise 4 12 Cash Flows from Operating Activities Collections from customers 660 000 Interest on note receivable 12 000 Interest on note payable 18 000 Payment of operating expenses 440 000 Net cash flows from operating activities 214 000 Only these four cash flow transactions relate to operating activities The others are investing and financing activities Brief Exercise 4 13 Cash Flows from Investing Activities Sale of land 40 000 Purchase of equipment 120 000 Net cash flows from inves