1 Click to edit Master title style 14 Income Taxes, Unusual Income Items, and Investments in Stocks 1 2 Click to edit Master title style After studying this chapter, you should be able to: 1. Journalize the entries for corporate income taxes, including deferred income taxes. 2. Describe and illustrate the reporting of unusual items on the income statement. 2 3 Click to edit Master title style After studying this chapter, you should be able to: 3. Prepare an income statement reporting earnings per share data. 4. Describe the accounting for investments in stocks. 3 4 Click to edit Master title style Objective 1 14-1 Journalize the entries for corporate income taxes, including deferred income taxes. 4 5 Corporate Income Taxes Click to edit Master title style 14-1 Most corporations are required to pay estimated monthly income taxes in twelve installments throughout the year. A corporation estimates its income tax expense for the year to be Rp84,000,000. The first of twelve estimated payments is journalized as follows: Apr. 15 Income Tax Expense Cash 7 000 000 7 000 000 55 6 Ratio of Reported Income Tax Expense to Earnings Before Taxes for Selected Industries in Indonesia Click to edit Master title style Agriculture Mining Basic Industry Miscellaneous Industry Consumer Goods Property Infrastructure, Utility and Transportation 14-1 29% 33 33 28 31 26 27 66 7 Allocating Income Taxes Click to edit Master title style 14-1 Some differences between taxable income and income before income taxes are created because items are recognized in one period for tax purposes and in another period for income statement purposes. Such differences are call temporary differences because they reverse or turn around in later years. 7 8 Examples of Items That Create Temporary Differences Click to edit Master title style 14-1 1. Revenues or gains are taxed after they are reported in the income statement. 2. Expenses or losses are deducted in determining taxable income after they are reported in the income statement. 8 9 Click to edit Master title style 14-1 3. Revenues or gains are taxed before they are reported on the income statement. 4. Expenses or losses are deducted in determining taxable income before they are reported in the income statement. 9 10 Exhibit 1 Temporary Differences Click to edit Master title style 14-1 Double Declining Balance Method (tax depreciation) Straight-line (financial statement depreciation) Total 10 10 Total depreciation is the same for tax and financial purposes. 11 Click to edit Master title style 14-1 At the end of the first year of operations, a corporation reports Rp300,000,000 of income before income taxes. With a 30% tax rate, the firm faces a tax of Rp90,000,000 (Rp300,000,000 x 30%). Using tax planning, the net income is reduced to Rp100,000,000 and the actual income tax due is Rp30,000,000 (Rp100,000,000 x 30%). The difference is deferred to future years. 11 12 14-1 Click to edit Master title style The entry to record income taxes reflects the deferred amount of Rp60,000,000. Income Tax Expense Income Tax Payable Deferred Income Tax Payable 90 000 000 30 000 000 60 000 000 12 12 13 Click to edit Master title style 14-1 If Rp48,000,000 of the deferred tax reverses and becomes due in the second year, the entry will reflect this fact. Deferred Income Tax Payable Income Tax Payable 48 000 000 48 000 000 13 13 14 14-1 Click to edit Master title style Example Exercise 14-1 A corporation has Rp200,000,000 of income before income taxes, a 30% tax rate, and Rp130,000,000 of taxable income. Provide the journal entry for the current year’s taxes. 14 14 15 14-1 Click to edit Master title style Follow My Example 14-1 Income Tax Expense 60,000,000 Income Tax Payable 39,000,000 Deferred Income Tax Payable 21,000,000 Income tax expense based on Rp200,000 reported income at 30% Rp60,000,000 Income tax payable based on Rp130,000,000 taxable income at 30% 39,000,000 Income tax deferred to future years Rp21,000,000 For Practice: PE 14-1A, PE 14-1B 15 15 16 Permanent Differences Click to edit Master title style 14-1 Differences between taxable income and income before taxes reported on the income statement may be the result of differences that are not “timing” differences. These are permanent differences that never reverse. Interest income that is exempt on municipal bonds is an example of this type of a permanent difference. 16 17 Click to edit Master title style Objective 2 14-2 Describe and illustrate the reporting of unusual items on the income statement. 17 18 Reporting Unusual Items on the Income Statement Click to edit Master title style 14-2 Unusual items subtracted from gross profit in determining income from continuing operations are: Fixed asset impairments Restructuring charges 18 19 Fixed Asset Impairment Click to edit Master title style 14-2 A fixed asset impairment occurs when the fair value of a fixed asset falls below its book value and is not expected to recover. 19 20 Examples of Events That Might Cause an Asset Impairment Click to edit Master title style 14-2 1. Decrease in market price of fixed assets. 2. Significant changes in the business or regulations related to fixed assets. 3. Adverse conditions affecting the use of fixed assets. 4. Expected cash flow losses using fixed assets. 20 21 Click to edit Master title style 14-2 On March 1, PT Joko Jaya consolidates operations by closing a factory. As a result of the closing, plant and equipment is impaired by Rp750,000,000. Mar. 1 Loss on Fixed Asset Impairment Equipment To record impairment of 750 000 000 750 000 000 fixed assets due to plant closing. 21 21 22 Reporting of Unusual Items on the Income Statement Click to edit Master title style 14-2 Fixed asset impairments 22 22 23 Click to edit Master title style Unusual Items in the Income Statement 14-2 23 23 24 Reporting Unusual Items on the Income Statement Click to edit Master title style 14-2 Unusual items subtracted from gross profit in determining income from continuing operations are: Fixed asset impairments Restructuring charges 24 25 Restructuring Charges Click to edit Master title style 14-2 Restructuring charges are costs incurred with actions such as canceling contracts, laying off or relocating employees, and combining operations. 25 26 Click to edit Master title style 14-2 The management of PT Joko Jaya communicates a plan to terminate 200 employees from the closed manufacturing plant effective March 1. The restructuring plan calls for a termination benefit of Rp5,000,000 per employee. The employees have the right to work 60 days beyond March 1, but may elect to leave the firm earlier. 26 27 14-2 Click to edit Master title style The fair value of this plan would be Rp1,000,000,000 (200 x Rp5,000,000), which is the aggregate expected cost of terminating the employees. The restructuring charge would be recorded as follows: Mar. 1 Restructuring Charge Employee Termination Obligation 1,000 000 000 1,000 000 000 To record impairment of fixed assets due to plant closing. 27 27 28 Click to edit Master title style 14-2 Twenty five employees find employment elsewhere and leave the company on March 25. Payment is made to these employees on that date. 28 29 Click to edit Master title style 14-2 On March 25, the entry to record a severance payment of Rp125,000,000 to 25 of the terminated employees would be as follows: Mar. 25 Employee Termination Obligation Cash To record payment to 25 125 000 000 125 000 000 employees as severance compensation. 29 29 30 Reporting of Unusual Items on the Income Statement Click to edit Master title style 14-2 Restructuring charges 30 30 31 Unusual Items in the Income Statement Click to edit Master title style 14-2 31 31 32 14-2 Click to edit Master title style Example Exercise 14-2 On December 20 of the current year. PT Toto Putra determined that equipment had been impaired so that the book value of the equipment was reduced by Rp180,000,000. In addition, the senior management of the company communicated an employee severance plan whereby 80 employees could receive a termination benefit of Rp7,000,000 per employee. Provide the journal entries for the asset impairment and the restructuring charge. 32 32 33 14-2 Click to edit Master title style Follow My Example 14-2 Dec. 20 Loss on Fixed Asset Impairment 180,000,000 Equipment 180,000,000 20 Restructuring Charge 560,000,000* Employee Termination Obligation 560,000,000 *80 employees x Rp7,000,000 For Practice: PE 14-2A, PE 14-2B 33 33 34 Reporting Unusual Items on the Income Statement Click to edit Master title style 14-2 Unusual items that may add or subtract income from continuing operations in determining net income are: Discontinued operations Extraordinary items 34 35 Discontinued Operations Click to edit Master title style 14-2 A gain or loss from disposing of a business segment or component of an entity is reported on the income statement as a gain or loss from discontinued operations. 35 36 Reporting of Unusual Items on the Income Statement Click to edit Master title style 14-2 Discontinued operations 36 36 37 Unusual Items in the Income Statement Click to edit Master title style 14-2 37 37 38 Reporting Unusual Items on the Income Statement Click to edit Master title style 14-2 Unusual items that adjust income from continuing operations in determining net income are: Discontinued operations Extraordinary items 38 39 Extraordinary Items Click to edit Master title style 14-2 Extraordinary items result from events and transactions that— (1) are significantly different (unusual) from the typical or the normal operating activities of the business, and (2) occur infrequently. 39 40 Reporting of Unusual Items Insert Exhibit here also, on the Income 2 Statement p. 13 style Click to edit Master title 14-2 Extraordinary items 40 40 41 Unusual Items in the Income Statement Click to edit Master title style 14-2 41 41 42 Retroactive Restatement Click to edit Master title style 14-2 In addition to unusual items impacting the income statement, there are two major items that require a retroactive restatement of prior period earnings. These two items are: 1. errors in the recognition, measurement, presentation, or disclosure of financial statements, and 2. changes from one generally accepted accounting principle to another generally accepted accounting principle. 42 43 Reporting of Unusual Items on the Income Statement Click to edit Master title style Unusual items affecting prior period income statements 14-2 43 43 44 Click to edit Master title style Objective 3 14-3 Prepare an income statement reporting earnings per share data. 44 45 Earnings per Common Share Click to edit Master title style 14-3 The profitability of companies is often expressed as earnings per share. Earnings per common share (EPS), sometimes called basic earnings per share, is the net income per share of common stock outstanding during a period. 45 46 14-3 Click to edit Master title style If there is no preferred stock: Net Income Earnings per = common share Number of common shares outstanding If there is preferred stock: Net Income – Preferred stock dividends Earnings per = common share Number of common shares outstanding 46 46 47 Income Statement with Earnings per Share Click to edit Master title style 14-3 47 47 48 14-3 Click to edit Master title style Example Exercise 14-3 PT Montana Karya had net income of Rp250,000,000 during the year. There were 580,000 common shares outstanding during the year. There were 2,000 shares of Rp100,000 par value, 9% preferred stock outstanding during the year. Determine the basic earnings per share. Follow My Example 14-3 Earnings per share: Rp250,000,000 – Rp18,000,000* Rp400 per = share 580,000 *2,000 shares x Rp100,000 par value x 9% = Rp18,000,000 For Practice: PE 14-3A, PE 14-3B 48 48 49 Click to edit Master title style Objective 4 14-5 Describe the accounting for investments in stocks. 49 50 Accounting for Investments in Stocks Click to edit Master title style 14-5 Like individuals, businesses have a variety of reasons for investing in stocks, called equity securities. A business may purchase stocks as a means of earning a return on excess cash that it does not need for its normal operations. 50 51 Click to edit Master title style 14-5 Trading securities are securities that management intends to actively trade for profit. Available-for-sale securities are securities that management expects to sell in the future, but which are not actively traded for profit. 51 52 Click to edit Master title style 14-5 When a business invests in available-for-sale securities, such investments are classified as temporary investments or marketable securities. 52 53 Click to edit Master title style 14-5 Marketable securities must meet two conditions: 1. The securities must be readily marketable, and can be sold for cash at any time. 2. Management must intend to sell the securities when the business needs cash for operations. 53 54 Click to edit Master title style 14-5 On June 1, Kepiting Nusantara purchased 2,000 shares of PT Inez common stock at Rp89,750 per share plus a brokerage fee of Rp500,000. The firm paid Rp180,000,000 [(Rp89,750 x 2,000 shares) + Rp500,000]. June 1 Marketable Securities Cash Purchased 2,000 shares of Inis 180 000 000 180 000 000 Corporation common stock. 54 62 55 Click to edit Master title style 14-5 On October 1, PT Inez declared a Rp900 per share dividend payable on November 30. Nov 30 Cash Dividend Revenue 1 800 000 1 800 000 Received dividends on Inis Corporation common stock (2,000 shares x Rp900). 55 63 56 Unrealized Holdings Gain or Loss Click to edit Master title style 14-5 On the balance sheet, temporary investments are reported at their fair market value. Any difference between the fair market value and their cost is an unrealized holding gain or loss. 56 57 Click to edit Master title style 14-5 PT Kepiting Nusantara.’s portfolio of temporary investments was purchased during 2008 and has the following fair market values and unrealized gains and losses on December 31, 2008 (in ‘000 Rp). Unrealized Common Stock Cost Market Gain (Loss) PT Udang Nusa Rp150,000 $190,000 Rp40,000 PT Gurita Abadi 200,000 200,000 — PT Penyu Ria 180,000 210,000 30,000 PT Pesut Putra 160,000 150,000 (10,000) Total Rp690,000 Rp750,000 Rp60,000 57 65 58 Temporary Investments on the Balance Sheet Click to edit Master title style 14-5 58 66 59 14-5 Click to edit Master title style Example Exercise 14-5 PT Dimori began operations on January 1, 2008 and purchased temporary investments in marketable securities during the year at a cost of Rp75,000,000. The end-of-period market value for these investments was Rp110,000,000. Net income was Rp180,000,000 for 2008. Determine (a) the reported amount of marketable securities on the December 31, 2008 balance sheet, and (b) the comprehensive income for 2008. Assume a tax rate of 30%. 59 67 60 14-5 Click to edit Master title style Follow My Example 14-5 a. Initial costs Rp 75,000,000 Unrealized gain (Rp110,000,000 – Rp75,000,000) Rp35,000,000 Less: Tax on unrealized gain (Rp35,000,000 x 30%) 10,500,000 Unrealized gain, net of tax 24,500,000 Reported amount of marketable securities Rp 99,500,000 b. Net income Rp180,000,000 Unrealized gain (Rp110,000,000 – Rp75,000,000) Rp35,000,000 Less: Tax on unrealized gain (Rp35,000,000 x 30%) 10,500,000 Other comprehensive income, net of tax 24,500,000 Net income Rp204,500,000 For Practice: 14-5A, 14-5B 60 68 61 Long-Term Investments in Stocks Click to edit Master title style 14-5 Long-term investments are not intended as a source of cash in the normal operations of the business. Rather, such investments are often held for their income, long-term gain potential, or influence over another business entity. 61 62 Accounting for Long-Term Stock Investments Click to edit Master title style 14-5 Is there a significant influence over the investee? No Yes Account for the investment as an available-for-sale security Account for the investment by using the equity method 62 70 63 Click to edit Master title style 14-5 On January 2, PT Hari Cerah pays cash of Rp350,000,000 for 30% of the common stock and net assets of PT Berdikari Jan. 2 Investment in PT Berdikari Stock Cash Purchased 40% of PT 350 000 000 350 000 000 Berdikari common stock. 63 71 64 Click to edit Master title style 14-5 For the year ending December 31, PT Berdikari reports net income of Rp105,000,000. Dec. 31 Investment in PT Berdikari Stock 42 000 000 Income of PT Berdikari. 42 000 000 Recorded 40% share of PT Berdikari. net income of Rp105,000,000. 64 72 65 Click to edit Master title style 14-5 On December 31, PT Berdikari pays Rp45,000,000 in dividends. Dec. 31 Cash Investment in PT Berdikari Stock Recorded 40% share of PT 18 000 000 18 000 000 Berdikari dividends. 65 73 66 Investments and Dividends Click to edit Master title style 14-5 66 74 67 Sale of Investments in Stocks Click to edit Master title style 14-5 On March 1, an investment in PT Doni Tata. stock that had a carrying amount of Rp15,700,000 is sold for Rp17,500,000. Mar. 1Cash 17 500 000 Investment in PT Doni Tata Stock Gain on Sale of Investments 15 700 000 1 800 000 67 75 68 14-5 Click to edit Master title style Example Exercise 14-6 PT Parkit purchased 30% of the outstanding stock of PT Sonya on January 1, 2008. PT Sonya reported net income of Rp90,000,000 and declared dividends of Rp15,000,000 during 2008. How much would PT Parkit adjust their investment in PT Sonya under the equity method? 68 76 69 14-5 Click to edit Master title style Follow My Example 14-6 Parkit share of Sonya reported net income (30% x Rp90,000,000) Rp27,000,000 Less: Parkit share of the Sonya dividend (30% x Rp15,000,000) 4,500,000 Increase in Investment in Sonya Company Stock Rp22,500,000 For Practice: 14-6A, 14-6B 69 77 70 Financial Analysis and Interpretation Click to edit Master title style 14-5 A firm’s growth potential and future earnings prospects are indicated by how much the market is willing to pay per dollar of a company’s earnings. This ratio, called the price-earnings ratio, or P/E ratio, is commonly included in stock market quotations. 70 71 Click to edit Master title style 14-5 Earnings Per Share Earnings per Net Income = Share of Common Common Shares Stock Price - Earnings Ratio Market Price Per Share Priceof Common Stock = Earnings Earnings Per Share of Ratio Common Stock 71 79 72 Click to edit Master title style 14-5 The price-earnings ratio represents how much the market is willing to pay per dollar of a company’s earnings. This indicates the market’s assessment of a firm’s growth potential and future earnings prospects. 72 73 Click to edit Master title style An example: Market price per share Earnings per share Price-earnings ratio 2008 Rp2,460 Rp1,640 15.0 14-5 2007 Rp1,620 Rp1,350 12.0 The price-earnings ratio indicates that a share of common stock was selling for 12 times the amount of earnings per share at the end of 2007 and 15 times earnings per share at the end of 2008. 73 81