Kieso, Weygandt, Warfield, Young, Wiecek, McConomy
Intermediate Accounting, Eleventh Canadian Edition
CHAPTER 4
REPORTING FINANCIAL PERFORMANCE
ASSIGNMENT CLASSIFICATION TABLE
Topics
Brief
Exercises
Exercises
Problems
1. Creating value and
managing
performance.
1, 2
2. Using performance
information.
2, 3
17
3. Earnings quality.
4, 5, 6
1
4. Measuring income.
7,8
1,2
6, 7
5. Discontinued
operations
9,10, 11
3,4
2, 3, 9, 10, 13
6. Statements of income/ 12, 13, 14,
comprehensive
15
income
5, 6, 7, 8, 9,
10, 11, 12,
13, 14
3, 4, 5, 8, 9, 10,
11, 12, 13, 14
7. Statement of retained
earnings/changes in
equity.
16, 17,18
10, 15, 16
4, 5, 8, 10, 11,
12, 15
8. Disclosure and
analysis.
12, 13, 14,
15, 19, 20
12, 17, 18
16
9. Differences between
IFRS and ASPE.
11
2, 3, 4, 10
10. Cash basis*
21
19
17, 18
* This material is covered in an Appendix to the chapter.
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ASSIGNMENT CHARACTERISTICS TABLE
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Level of
Difficulty
Time
(minutes)
Simple
Moderate
Moderate
Moderate
Simple
Simple
Simple
Moderate
Moderate
Simple
15-20
40-45
15-20
20-25
15-20
15-20
15-20
30-40
25-30
30-40
Moderate
20-25
Simple
30-35
Multiple-step and unusual items.
Moderate
30-35
Condensed income statement.
Moderate
20-25
Retained earnings statement.
Simple
20-25
Comprehensive income.
Simple
15-20
Earnings per share.
Simple
20-25
Earnings per share.
Moderate
15-20
Item
Description
E4-1
E4-2
E4-3
E4-4
E4-5
E4-6
E4-7
E4-8
E4-9
E410
E411
E412
E413
E414
E415
E416
E417
E418
*E4-19
Comprehensive income.
Comprehensive income.
Discontinued operations.
Discontinued operations.
Calculation of net income.
Calculation of net income – proprietorship.
Income statement items.
Multiple-step and single-step.
Combined single-step.
Multiple-step statement, with retained
earnings.
Single-step income statement.
Cash and accrual basis.
Moderate
10-15
P4-1
P4-2
P4-3
P4-4
P4-5
Earnings management.
Discontinued operations.
Multiple-step income statement
Irregular items.
Single-step income statement and retained
earnings statement.
Unusual items.
Identification of income statement
weaknesses.
Multiple- and single-step income statement
and retained earnings.
Irregular items.
Comprehensive combined statement of
Moderate
Moderate
Moderate
Moderate
Simple
20-25
35-45
40-45
35-45
25-30
Moderate
Moderate
20-25
30-40
Moderate
45-55
Moderate
Moderate
30-35
45-50
P4-6
P4-7
P4-8
P4-9
P4-
Multiple-step and single-step.
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10
P411
P412
P413
P414
Intermediate Accounting, Eleventh Canadian Edition
income and retained earnings.
Income statement and irregular items.
Moderate
35-45
All-inclusive vs. current operating.
Moderate
35-45
Income statement and irregular items.
Moderate
25-35
Simple
35-45
Level of
Difficulty
Time
(minutes)
Moderate
25-35
Simple
Moderate
Complex
20-25
35-40
40-50
Identification of income statement
deficiencies.
ASSIGNMENT CHARACTERISTICS TABLE
(CONTINUED)
Item
Description
P4-15
Retained earnings statement, correction of
error and change in accounting principle.
Identify income statement deficiencies.
Cash and accrual basis.
Cash and accrual basis.
P4-16
*P4-17
P4-18
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Intermediate Accounting, Eleventh Canadian Edition
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 4-1
(a)Pharmedical would have higher gross profit percentage
because it follows a cost differentiation strategy. Sunmart
is a discount retailer and follows a low cost/high volume
strategy.
(b)Pharmedical would have higher selling expense as a
percentage of sales because it likely has a sizeable sales
force that markets and educates customers about its
products.
(c)Pharmedical would have higher research and development
expense as a percentage of sales because it develops
medications to prevent and treat diseases.
(d)Either Sunmart or Pharmedical may have higher net income.
Pharmedical has higher gross profit percentage, meaning
a higher amount of every dollar of sales is available to
cover operating expenses. However, Pharmedical also has
higher selling expense as a percentage of sales and
research and development expense as a percentage of
sales,
meaning
a higher amount of every dollar of sales is needed to cover
operating expenses.
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BRIEF EXERCISE 4-2
In the opinion paragraph, the auditor attests to the fair
presentation of the financial statements in accordance with
IFRS. In order to judge fairness, the auditor must have sufficient
understanding of the business model and environment to
assess and address the risks of material misstatement in the
financial statements. Without this understanding, the auditor
would not be able to competently carry out the responsibilities
of the audit, including evaluating the appropriateness of
accounting policies used, the reasonableness of estimates
made, and the overall presentation of the financial statements.
BRIEF EXERCISE 4-3
The purpose of a financial audit is to provide assurance to users
that the financial statements are fairly presented and free from
material error.
Users (typically investors) may be concerned that the preparers
of the financial statements (typically management) are biased in
their reporting. The availability of an audit provides users with
an independent, objective opinion that confirms the fairness of
management’s presentation.
The additional credibility of
audited financial statements allows users to make their
investment decisions with more confidence, thereby enabling a
lower cost of capital for the firm and improving overall market
efficiency.
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BRIEF EXERCISE 4-4
(a)
The information provided by Kimper appears to be of lower
quality. Several of Kimper’s major customers experienced
cash flow problems in 2017 for reasons that may persist.
However, Kimper decreased the estimated percentage of
its outstanding accounts receivable that will become
uncollectible. Kimper also did not disclose any additional
information in the notes to financial statements regarding
potentially higher risk of uncollectible accounts. Kimper’s
reporting of accounts receivable (net) and bad debt
expense appears to be incomplete and may be biased,
resulting in lower quality of information.
(b)
The earnings reported by Kimper will likely be discounted
by the capital markets. Financial statement users,
including investors and analysts, will likely note that the
company’s accounts receivable turnover ratio decreased
significantly in 2017, but that bad debt expense as a
percentage of sales decreased in the same period. This is a
signal of a potentially overly optimistic valuation of
accounts receivable, resulting in lower bad debt expense
and earnings which may not be replicated.
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BRIEF EXERCISE 4-5
(a)
From the perspective of an investor, the earnings reported
by Environmental appear to be of lower quality. The
company’s net income includes a significant gain on sale
of investments, which means that earnings do not primarily
reflect the earnings generated from ongoing core business
activities. Environmental also changed from the declining
balance method to the straight line method for depreciation
of its equipment (which is non-typical for companies in the
industry). According to GAAP, the depreciation method
must reflect the pattern in which the economic benefits are
expected to be consumed. Unless Environmental’s pattern
of use of the equipment is better reflected by the straight
line method, the measurement of equipment (net) and
depreciation expense may be biased.
(b)
The earnings reported by Environmental will likely be
discounted by the capital markets. Financial statement
users, including investors and analysts, will likely note that
the company’s net income included a significant gain
generated from non-core business activities, and lower
depreciation expense as a result of change to a
depreciation method which may be biased. As a result,
content of the earnings reported appears to be lower
quality, and the capital markets will likely discount the
earnings reported.
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BRIEF EXERCISE 4-6
(a)
The earnings reported by Cyan appear to be of lower
quality. Cyan’s expected value of the loss on the lawsuit
and the liability of $500,000 appears to be based on the
estimate
of the lawyer who provided the second opinion. Cyan’s
management sought the second legal opinion because of
the potentially significant impact of the original estimate on
2017 net income. This is a form of earnings management,
and is unethical because the resulting financial statements
included an estimate that was not reliably determined and
based on all of the reliable information available at the
time. After representing Cyan and disputing the claim,
Cyan’s original legal counsel would have provided the
most informed and reliable estimate of the loss and the
liability.
(b)
If Cyan did not fully disclose all estimates of the loss on
the lawsuit and the liability, the capital markets may not
immediately see through Cyan’s attempt to mask the
underlying economic reality. However, the earnings
reported by Cyan will likely be discounted by the capital
markets eventually, if or when it becomes apparent that the
estimate of the loss on the lawsuit and the liability were in
fact biased and misleading.
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BRIEF EXERCISE 4-7
(a) Net income = $18,000 (dividend revenue)
(b) Other comprehensive income = $25,000
(c) Comprehensive income = Net income + Other
comprehensive income = $18,000 + $25,000 = $43,000
(d) Accumulated other comprehensive income = Beginning
balance + Other comprehensive income = $0 + $25,000 =
$25,000
BRIEF EXERCISE 4-8
(a) Income from continuing operations = Income from
operations + Gain on sale of FV-NI investments – Income
tax on income from continuing operations = $220,000 +
$15,000 – $63,000 = $172,000
(b)
Net income = Income from continuing operations – Loss
from operation of discontinued division (net of tax) – Loss
from disposal of discontinued division (net of tax) =
$172,000 – $42,000 – $75,000 = $55,000
(c)
Other comprehensive income = Unrealized holding gain –
OCI (net of tax) = $12,000
(d)
Comprehensive = Net income + Other comprehensive
income = $55,000 + $12,000 = $67,000
(e)
Under ASPE, other comprehensive income and
comprehensive income do not apply, and investments that
are not quoted in an active market are accounted for at
cost.
BRIEF EXERCISE 4-9
A component of an entity comprises operations, cash flows, and
financial elements that can be clearly distinguished from the
rest of the enterprise. Selling the corporate-owned stores to a
franchisee would not qualify for discontinued operations
treatment, because the corporate-owned stores are not a
separate major line of business.
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BRIEF EXERCISE 4-10
(a)
There is a formal plan to sell the head office tower (which
has been approved by the Board of Directors) and this
supports classification as Held for Sale. However, there are
other criteria that must be met: the building must be
available for immediate sale in its present state, there must
be an active plan to find a buyer, the sale must be
probable, the selling price reasonable and it must be likely
that the plans to sell will stand. In this case, because the
company plans to continue to use the building until its new
head office is built, and because construction has not yet
started, all of the criteria are not met. Specifically, the
building is not available for immediate sale.
Therefore, the building would not be segregated on the
balance sheet as an “Asset held for sale”. If the building
meets the impairment test, then the building would be
remeasured to its fair value of $49 million (minus costs to
sell). The company would continue to depreciate the asset
and should consider whether impairment exists.
(b)
Assuming that the criteria noted in (a) are now met, the
company will record the building as Held for Sale. This
means that the asset will be written down to its fair value
of $42 million and a loss of $3 million will be reported in
the income statement. It does not appear that this building
qualifies as a discontinued operation, since operations are
still continuing in the new building. Depreciation on the
old building will be stopped at the time it is classified as
Held for Sale.’
Under ASPE, the old building will continue to be presented
as a long term asset, but will be shown separately on the
balance sheet as Assets Held for Sale.
Under IFRS, the old building will be shown under current
assets, in a category called Assets Held for Sale.
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BRIEF EXERCISE 4-11
(a)
The $100,000 (net of tax) loss from operation of the
discontinued division, and the $200,000 (net of tax) loss on
impairment of net assets of the discontinued division
should be shown in the discontinued operations section of
the income statement for the year ended December 31,
2017.
The discontinued operations section follows income from
continuing operations. Under ASPE, the assets and
liabilities related to the discontinued manufacturing
division should be segregated on the balance sheet
according to their nature (e.g. current assets related to the
discontinued manufacturing division should be presented
as current assets held for sale/related to discontinued
operations,
and noncurrent assets related to the discontinued
manufacturing division should be presented as noncurrent
assets held for sale/related to discontinued operations).
(b)
Under IFRS, the income statement presentation would
be the same. However, on the balance sheet, all assets
and liabilities related to the discontinued manufacturing
division should be presented as held for sale, and
classified as current assets and current liabilities,
respectively.
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BRIEF EXERCISE 4-12
Sierra Corporation
Income Statement
For the Year Ended December 31, 2017
Revenues
Net sales revenue
Investment revenue
Total revenues
Expenses
Cost of merchandise sold
Salaries and wages
Advertising and promotion
Entertainment
Rent
Utilities
Interest
Total expenses
Income before income tax
$5,850,000
227,000
6,077,000
4,610,000
668,000
126,000
78,000
101,000
44,000
160,000
5,787,000
290,000
Income tax
84,000
Net income
$206,000
Earnings per share
$2.06
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BRIEF EXERCISE 4-13
Sierra Corporation
Income Statement
For the Year Ended December 31, 2017
Net sales revenue
Cost of goods sold
Gross profit
Operating expenses
Selling expenses
Administrative expenses
Income from operations
Other revenues and gains
Investment income
Other expenses and losses
Interest expense
Income before income tax
Income tax
Net income
Earnings per share
$5,850,000
4,610,000
1,240,000
$572,000
445,000
1,017,000
223,000
227,000
450,000
160,000
290,000
84,000
$ 206,000
$2.06
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BRIEF EXERCISE 4-14
Blue Collar Corporation
Partial Statement of Comprehensive Income
For the Year Ended December 31, 2017
Income from continuing operations
$12,600,000
Discontinued operations
Loss from operation of discontinued
restaurant division (net of tax)
$315,000
Loss from disposal of restaurant
division (net of tax)
89,000
404,000
Net income
12,196,000
Other comprehensive income
Items that may be reclassified
subsequently to net income or loss:
Unrealized gain on fair value-OCI
investments (net of tax)
Comprehensive income
Earnings per share:
Income from continuing operations
Discontinued operations
Net income
43,000
$12,239,000
$1.26
(.04)
$1.22
Note: Earnings per share information related to comprehensive
income is not required under IFRS.
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BRIEF EXERCISE 4-15
Big and Rich Corporation
Partial Statement of Income
For the year ended December 31, 2017
Income from operations
Other expenses and losses
Loss from tornado
Loss on disposal of building
$4,400,000
Income before income tax
Income tax
Net Income
Earnings per share:
3,490,000
1,047,000
$2,443,000
$1.22
760,000
150,000
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BRIEF EXERCISE 4-16
Parfait Limited
Statement of Changes in Shareholders’ Equity
For the Year Ended December 31, 2017
Common
Shares
Beginning balance
Comprehensive income
Net income*
Other comprehensive
income
Unrealized gain – OCI
Dividends
Comprehensive income
Ending balance
$600,000
Retained
Earnings
$900,000
Accumulated
Other
Comprehensiv
e Income
$250,000
50,000
60,000
$650,000
$1,750,000
50,000
(300,000)
$600,00
0
Total
$310,000
*($900,000 – $750,000 – $100,000).
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60,000
(300,000)
$1,560,000
Kieso, Weygandt, Warfield, Young, Wiecek, McConomy
Intermediate Accounting, Eleventh Canadian Edition
BRIEF EXERCISE 4-17
Global Corporation
Statement of Retained Earnings
For the Year Ended December 31, 2017
Balance, January 1
Add: Net income
Less: Dividends
Balance, December 31
$1,038,000
335,000
1,373,000
70,000
$1,303,000
BRIEF EXERCISE 4-18
Global Corporation
Statement of Retained Earnings
For the Year Ended December 31, 2017
Balance, January 1, as reported
Correction for overstatement of depreciation
in 2014 (net of tax)
Balance, January 1, as adjusted
Add: Net income
Less: Dividends
Balance, December 31
$1,038,000
40,000
1,078,000
335,000
1,413,000
70,000
$1,343,000
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Intermediate Accounting, Eleventh Canadian Edition
BRIEF EXERCISE 4-19
The number of common shares outstanding at December 31,
2017 is 44,000 (40,000 – 8,000 + 12,000)
Weighted average number of shares:
January 1 – April 1
April 1 – August 31
August 31 – Dec. 31
40,000 X 3/12 =
32,000 X 5/12 =
44,000 X 4/12 =
10,000
13,333
14,667
38,000
BRIEF EXERCISE 4-20
$8,600,000 – $3,200,000
=
900,000
$6.00 per share
*BRIEF EXERCISE 4-21
(a)
Cash Receipts
from Customers
- Beginning accounts
receivable
+ Ending accounts
receivable
= Revenue on
accrual basis
$152,000
- 13,000 + 18,600
= $157,600
Cash payments
for operating
expenses
+ Beginning prepaid
expenses
- Ending prepaid
expenses
= Operating
expenses on
accrual basis
$97,000
+ 17,500 - 23,200
= $91,300
(b)
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SOLUTIONS TO EXERCISES
EXERCISE 4-1 (15-20 minutes)
Reach Out Card Company Limited
Statement of Comprehensive Income
For the Year Ended December 31, 2017
Net sales revenue
Cost of goods sold
Gross profit
Operating expenses
Selling and administrative expenses
Income from operations
Gain on disposal of building
Net income
Other comprehensive income
Items that may be reclassified
subsequently to net income or loss:
Unrealized gain on fair-value OCI investments
Comprehensive income
$1,200,000
750,000
450,000
320,000
130,000
250,000
380,000
18,000
$398,000
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EXERCISE 4-2 (40-45 minutes)
(a) Calculation of net income:
Income from operations
Other revenues and gains
Gain on sale of equipment
Gain on sale of land
Gain on sale of FV-NI investments
Gain on sale of FV- OCI investments
Other expenses and losses
Loss on disposal of building
Unrealized loss on FV-NI
investments
Income before income tax
Income tax
Net income
$375,000
$27,000
1,000*
33,000
71,000**
132,000
507,000
68,000
54,000
122,000
385,000
99,000
$286,000
(b) Calculation of retained earnings:
Balance, January 1
Add: Net income
Add: Reclassification adjustment for
realized gains on land
Balance, December 31
$410,000
286,000
696,000
74,000
$770,000
* $216,000 - $215,000
** $55,000 + ($126,000 - $110,000)
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EXERCISE 4-2 (CONTINUED)
(c)
Accumulated other comprehensive income (AOCI) had a
balance of $129,000 ($74,000 + $55,000) at January 1, 2017.
The balance in AOCI at December 31, 2017 is zero.
$74,000 of the opening AOCI balance was related to
revaluation surplus (land). This amount represents the
cumulative revaluation gains/(losses) related to the piece
of land accounted for under the revaluation model. Under
the revaluation model, revaluation gains are recorded as
revaluation surplus (OCI), and accumulated in AOCI until
the asset is retired or disposed of. Pike sold the piece of
land in 2017, and upon sale, Pike would have recorded a
gain on sale of the land equal to $1,000 [the difference
between the proceeds ($216,000) and the carrying amount
of the land ($215,000)]. The balance in AOCI related to
previous revaluations of the land to fair value should be
transferred directly to retained earnings in the year of sale
(2017).
$55,000 of the opening AOCI balance was related to
cumulative
unrealized
gains/(losses)
related
to
measurement of fair value through OCI (FV-OCI)
investments at fair value. Pike sold the related FV-OCI
investments in 2017, and upon sale, Pike would have
captured any unrealized gain to date ($126,000 - $110,000)
in OCI, and transferred the cumulative unrealized
gains/(losses) from OCI [$55,000 + ($126,000 - $110,000)] to
net income (according to company policy).
(d)
Under ASPE, other comprehensive income is not
recognized. The revaluation model is not permitted under
ASPE. Investments that are traded in an active market are
accounted for as FV-NI under ASPE.
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EXERCISE 4-2 (CONTINUED)
(d) (continued)
Calculation of net income:
Income from operations
Other revenues and gains
Gain on sale of equipment
Gain on sale of land
Gain on sale of FV-NI investments
Other expenses and losses
Loss on disposal of building
Unrealized loss on FV-NI
investments
Income before income tax
Income tax
Net income
$375,000
$27,000
75,000*
49,000**
151,000
526,000
68,000
54,000
122,000
404,000
99,000
$305,000
Calculation of retained earnings:
Balance, January 1
Add: Net income
Balance, December 31
$465,000
305,000
$770,000
* $74,000 + ($216,000 - $215,000)
** $33,000 + ($126,000 - $110,000)
Note: under ASPE, retained earnings at January 1, 2017 would
be $465,000 ($410,000 + $55,000), because all investments
designated as FV-OCI under IFRS would be accounted for as FVNI under ASPE because the investments are traded in an active
market. Under ASPE, all previously recognized unrealized gains/
(losses) on those investments ($55,000) would have been
recorded in net income and closed to retained earnings in those
years.
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Kieso, Weygandt, Warfield, Young, Wiecek, McConomy
Intermediate Accounting, Eleventh Canadian Edition
EXERCISE 4-3 (20-25 minutes)
(a)
2017:
Loss Jan. 1 to Sept. 30 (net of tax)
Loss Sept. 30 to Dec. 31 (net of tax)
Estimated impairment loss on net assets (net of
tax)
Total loss from discontinued operations
$1,900,000
700,000
150,000
$2,750,000
(b)
Discontinued operations (2017):
Loss from operation of discontinued
subsidiary, net of tax
Loss on impairment of net assets, net of tax
Loss from discontinued operations
$2,600,000
150,000
$2,750,000
(c) The correction of the gain or loss from disposal of the subsidiary
reported in 2017 should be reported in 2018 in the discontinued
operations section of the income statement, net of tax and with
separate EPS disclosure, supported by an explanation in a note
to the financial statements. The correction would receive the
same treatment as a change in estimate.
(d) Under IFRS, all assets and liabilities related to the
discontinued subsidiary should be presented as held for
sale, and classified as current assets and current liabilities,
respectively.
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Intermediate Accounting, Eleventh Canadian Edition
EXERCISE 4-3 (CONTINUED)
(e)
Under ASPE, the solution to parts (a) through (c) would
remain the same, except that earnings per share
calculations are not required under ASPE. On the balance
sheet, the assets and liabilities relating to the discontinued
subsidiary should be segregated according to their nature
(e.g. current assets related to the discontinued subsidiary
should be presented as current assets held for sale/related
to discontinued operations, and noncurrent assets related to
the discontinued subsidiary should be presented as
noncurrent assets held for sale/related to discontinued
operations).
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Intermediate Accounting, Eleventh Canadian Edition
EXERCISE 4-4 (20-25 minutes)
(a) The income statement and related footnote are as follows:
Income from continuing operations before income tax
Income tax
Income from continuing operations
Discontinued operations (Note XX)
Income from operations of the discontinued
Blue Division, less applicable
income tax of $1,800
$4,200
Loss from impairment of assets of
discontinued operations, less applicable
(14,000)
income tax recovery of $6,000
Net income
$144,000
43,200
100,800
(9,800)
$91,000
Note XX—Discontinued Operations. On October 5, 2017, the
board of directors decided to dispose of the Blue Division by
auction.
(Note that earnings per share calculations are not required
under ASPE)
(b)
The office equipment would be shown separately on the
balance sheet as part of noncurrent assets as “noncurrent
assets held for sale/related to discontinued operations”.
The assets would be valued at the lower of their carrying
amount and fair value less costs to sell. In this case, this
means the office equipment would be remeasured to
$5,000, which is its estimated selling price, net of costs to
sell.
(c)
Under IFRS, the office equipment should be presented as
held for sale, and classified as current assets on the
balance sheet.
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Intermediate Accounting, Eleventh Canadian Edition
EXERCISE 4-4 (CONTINUED)
(d)
If Diamond did not have a formal plan in place to dispose
of Blue Division, Blue Division would not qualify for
treatment as a discontinued operation, and the related net
loss (after tax) of $9,800 should be included in income from
continuing operations. Based on that presentation and
disclosure, an investor would appropriately interpret that
the net loss relates to operations that are expected to
continue.
Without a formal plan in place to dispose of the Blue
Division, presenting the Blue Division as a discontinued
operation is not in compliance with GAAP and it would not
be faithfully representative. Diamond’s quality of earnings
would be low, as loss/earnings related to operations that
are expected to continue would be inappropriately
excluded from income from continuing operations.
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Intermediate Accounting, Eleventh Canadian Edition
EXERCISE 4-5 (15-20 minutes)
Calculation of net income:
Increase in assets:
$76,000 + $59,000 + $140,000 – $23,000 = $252,000
Increase in liabilities:
$(64,000) +18,000 + $69,000 = 23,000
Increase in shareholders’ equity:
$229,000
Change in shareholders’ equity accounted
for as follows:
Net increase
$229,000
Increase in common shares
$105,000
Increase in contributed surplus
63,000
Decrease in retained earnings due to
dividend declaration
(16,000)
Net increase accounted for
152,000
Increase in retained earnings due to net income
$ 77,000
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Intermediate Accounting, Eleventh Canadian Edition
EXERCISE 4-6 (15-20 minutes)
Cash
Accounts receivable
Other assets (derived)
Total assets
Liabilities (1/1/17 derived)
Capital (12/31/17 derived)
Jan. 1,
2017
Dec. 31,
2017
$23,000
19,000
33,000
75,000
(37,000)
$38,000
$ 20,000
36,000
45,000
101,000
(41,000)
$ 60,000
Calculation of net income:
Capital account Dec. 31, 2017
Capital account Jan. 1, 2017
Increase
Add: Withdrawals made
Less: Cash investment made
Net income
Chang
e
($ 3,000)
17,000
12,000
26,000
(4,000)
$22,000
$60,000
38,000
22,000
$11,000
5,000
6,000
$28,000
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Intermediate Accounting, Eleventh Canadian Edition
EXERCISE 4-7 (15-20 minutes)
(a) Total net revenue:
Sales revenue
Less: Sales discounts
Sales returns and
allowances
Net sales revenue
Dividend revenue
Rent revenue
Total net revenue
(b) Net income:
Net revenue (from a)
Expenses:
Cost of goods sold
Selling expenses
Administrative expenses
Interest expense
Total expenses
Income before income tax
Income tax
Net income
(c) Dividends declared:
Ending retained earnings
Beginning retained earnings
Net decrease
Less: net income
Dividends declared
$490,000
$ 17,800
22,400
40,200
449,800
91,000
8,500
$549,300
$549,300
384,400
79,400
82,500
2,700
549,000
300
100
$ 200
$74,000
114,400
(40,400)
200
$40,600
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Intermediate Accounting, Eleventh Canadian Edition
EXERCISE 4-7 (CONTINUED)
(c) (continued)
ALTERNATE SOLUTION
Beginning retained earnings
Add net income
Less: dividends declared (derived) *
Ending retained earnings
$114,400
200
114,600
40,600
$74,000
* Dividends declared must be $40,600
($114,600 – $74,000)
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Intermediate Accounting, Eleventh Canadian Edition
EXERCISE 4-8 (30-40 minutes)
(a)
Multiple-Step Form
Flett Tire Repair Corporation
Income Statement
For the Year Ended December 31, 2017
Sales Revenue
Sales revenue
Less: Sales returns and allowances
Net sales revenue
$930,000
15,000
915,000
Cost of Goods Sold
Merchandise inventory, January 1, 2017
Purchases
$600,000
Less purchase discounts
10,000
Net purchases
590,000
Add freight-in
14,000
Total merchandise available for sale
Less merchandise inventory,
December 31, 2017
Cost of goods sold
Gross profit
Operating Expenses
Service expenses
Service salaries and wages
Depreciation expense—garage
equipment
Garage supplies expense
Administrative expenses
Administrative salaries and
wages
Depreciation expense—building
Office supplies expense
Income from operations
Other revenues and gains
Dividend revenue
Gain on sale of equipment
$120,000
604,000
724,000
137,00
0
587,000
328,000
71,000
18,00
0
9,000
98,000
39,000
28,500
9,500
77,000
175,000
153,000
20,000
5,500
178,500
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Intermediate Accounting, Eleventh Canadian Edition
EXERCISE 4-8 (CONTINUED)
(a) (continued)
Other expenses and losses
Interest expense
Loss from flood damage
9,000
50,000
59,000
Income before income tax
Income tax
119,500
29,875
Net Income
$89,625
(b)
Single-Step Form
Flett Tire Repair Corporation
Income Statement
For the Year Ended December 31, 2017
Revenues
Net sales revenue
Dividend revenue
Gain on sale of equipment
Total revenues
$915,000
20,000
5,500
940,500
Expenses
Merchandise inventory consumed*
Salaries and wages
Depreciation expense
Supplies expense
Loss from flood damage
Interest expense
Total expenses
587,000
110,000
46,500
18,500
50,000
9,000
821,000
Income before income tax
Income tax
Net income
119,500
29,875
$ 89,625
* This is the same as cost of goods sold in this case since the
installation service expense is shown separately.
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Intermediate Accounting, Eleventh Canadian Edition
EXERCISE 4-8 (CONTINUED)
(c)
Single-step:
1.
Simplicity and conciseness.
2.
Probably better understood by user.
3.
Emphasis on total costs and expenses and net
income.
4.
Does not imply priority of one expense over another.
5.
Showing expenses by nature does not require
allocation between functions.
Multiple-step:
1.
Provides more information through segregation of
operating and non-operating items.
2.
Expenses are matched with related revenue.
3.
Highlights components of income used for ratio
analysis (e.g., Cost of Goods Sold)
4.
Showing expenses by function requires allocation of
costs between functions. More judgement is required.
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Intermediate Accounting, Eleventh Canadian Edition
EXERCISE 4-9 (25-30 minutes)
(a)
Biscay Inc.
Income Statement
for the Year Ended December 31, 2017
Revenues
Sales revenue
$6,000,000
Rent revenue
130,000
Gain from expropriation
300,000
Total revenues
6,430,000
Expenses
Cost of goods sold
2,680,000
Selling expenses
950,000
Administrative expenses
750,000
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Loss from flood damage
190,000
Total expenses
4,570,000
Income from continuing operations before income tax
1,860,000
Income tax
465,000
Income from continuing operations
1,395,000
Discontinued operation:
Loss from operation of discontinued Rochelle Division
(net of $60,000 income tax recovery)
180,000
Net income
$1,215,000
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Intermediate Accounting, Eleventh Canadian Edition
EXERCISE 4-9 (CONTINUED)
(b)
Biscay Inc.
Combined Income Statement and Statement of Retained
Earnings
For the Year Ended December 31, 2017
Revenues
Sales revenue
$6,000,000
Rent revenue
130,000
Gain from expropriation
300,000
Total revenues
6,430,000
Expenses
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Cost of goods sold
2,680,000
Selling expenses
950,000
Administrative expenses
750,000
Loss from flood damage
190,000
Total expenses
4,570,000
Income from continuing operations before income tax
1,860,000
Income tax
465,000
Income from continuing operations
1,395,000
Discontinued operations:
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Loss from operation of discontinued Rochelle Division
(net of $60,000 income tax recovery)
180,000
Net income
1,215,000
Retained earnings, January 1
1,900,000
3,115,000
Less: Cash dividends
220,000
Retained earnings, December 31
$2,895,000
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Kieso, Weygandt, Warfield, Young, Wiecek, McConomy
Intermediate Accounting, Eleventh Canadian Edition
EXERCISE 4-10 (35-40 minutes)
(a)
Gottlieb Corp.
Statement of Comprehensive Income
For the Year Ended December 31, 2017
Sales revenue
Net sales revenue
Cost of goods sold
Gross profit
Operating expenses
Selling expenses
Administrative expenses
Income from operations
$1,300,000
780,000
520,000
$65,000
48,000
Other revenues and gains
Dividend revenue
Interest income
20,000
7,000
Other expenses and losses
Loss on inventory due to decline in
net realizable value
Loss on sale of equipment
Loss from expropriation
80,000
35,000
60,000
Income before income tax
Income tax
Net income
Other comprehensive income
Items that may be reclassified
subsequently to net income or loss:
Unrealized gain on FV-OCI investments
(net of $10,500 income tax)
Comprehensive income
113,000
407,000
27,000
434,000
175,000
259,000
64,750
194,250
31,500
$225,750
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Intermediate Accounting, Eleventh Canadian Edition
EXERCISE 4-10 (CONTINUED)
(b)
Gottlieb Corp.
Excerpt from Statement of Changes in Equity
For the Year Ended December 31, 2017
Retained earnings balance, January 1, as reported
Correction for overstatement of net income in prior
period (depreciation error) (net of tax of $13,750)
Balance, January 1, as restated
Add: Net income
Less: Dividends declared
Retained earnings balance, December 31
$
980,000
(41,250)
938,750
194,250
1,133,000
45,000
$1,088,000
(c)
Retained Earnings………………….
Income Tax Payable/Receivable…
Accumulated Depreciation……
41,250
13,750
55,000
(d)
Under ASPE, other comprehensive income is not recognized. All
investments designated as fair value through OCI (FV-OCI)
under IFRS would be accounted for as fair value through net
income (FV-NI) under ASPE as long as they trade in an active
market. Under ASPE, the unrealized gain on FV-OCI investments
of $42,000 would be included in net income for the year ended
December 31, 2017. As well, all previously recognized unrealized
gains/(losses) on the related investments would have been
recorded in net income and closed to retained earnings in those
prior years. This would result in a different balance in retained
earnings at December 31, 2016.
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Intermediate Accounting, Eleventh Canadian Edition
EXERCISE 4-11 (20-25 minutes)
Geneva Inc.
Income Statement
For Year Ended December 31, 2017
Sales revenue
Less sales discounts
Net sales revenue
Expenses
Cost of goods sold
Selling expenses
Administrative expenses
Interest expense
Total expenses
Income before income tax
Income tax
Net income
Earnings per share
$2,100,000
15,000
2,085,000
420,000
336,000
84,000
20,000
860,000
1,225,000
306,250
$ 918,750
$61.25
Determination of amounts:
Administrative
expenses
$84,000
= 20% of cost of goods sold
= 20% of $420,000
Gross sales X 4%
Gross sales
= administrative expenses
= ($84,000 / 4%) = $2,100,000
Selling expenses
= 4/5 of cost of goods sold
= 4/5 X $420,000
= $336,000
Per share $61.25 ($918,750  15,000)
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EXERCISE 4-12 (30-35 minutes)
(a)
Multiple-Step Format
P. Bride Company
Income Statement
For the Year Ended December 31, 2017
(In thousands, except earnings per share)
Sales revenue
Cost of goods sold
$ 96,500
60,570
Gross profit
Operating expenses
Selling expenses
Sales commissions
Depreciation - sales equipment
Delivery
Administrative expenses
Officers’ salaries
Depreciation - office furniture
and equipment
35,930
$ 7,980
6,480
2,690 $ 17,150
4,900
3,960
8,860
26,010
Income from operations
9,920
Other revenues and gains
Rent revenue
17,230
27,150
Other expenses and losses
Interest expense
Income before income tax
Income tax
Net income
1,860
25,290
9,070
$16,220
Earnings per share
*($16,220  30,550)
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$0.53*
Kieso, Weygandt, Warfield, Young, Wiecek, McConomy
Intermediate Accounting, Eleventh Canadian Edition
EXERCISE 4-12 (CONTINUED)
(b)
Single-Step Format
P. Bride Company
Income Statement
For the Year Ended December 31, 2017
(In thousands, except earnings per share)
Revenues
Sales revenue
Rent revenue
Total revenues
Expenses
Cost of goods sold
Selling expenses
Administrative expenses
Interest expense
Total expenses
Income before income tax
Income tax
Net income
Earnings per share
$ 96,500
17,230
113,730
60,570
17,150
8,860
1,860
88,440
25,290
9,070
$16,220
$0.53
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Intermediate Accounting, Eleventh Canadian Edition
EXERCISE 4-12 (CONTINUED)
(c)
An investor interested in information about operating vs.
non-operating items would prefer the multiple-step format
because income from operations is calculated before other
revenues and gains are added and before other expenses
and losses are subtracted, to arrive at net income. Both
income statement formats show the same amount of
income before income tax and net income. However, the
single-step formats tend to be more straightforward,
requiring no judgement in allocating revenues and
expenses between operating and non-operating categories.
Further, it does not imply priority of one revenue or
expense over another. The multiple-step format matches
expenses with related revenue and tends to require more
judgement.
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Intermediate Accounting, Eleventh Canadian Edition
EXERCISE 4-13 (30-35 minutes)
Quality Fabrication Limited
Income Statement
For the Year Ended December 31, 2017
Sales revenue
Sales revenue
Less: Sales returns and allowances
Sales discounts
Net sales revenue
$1,120,000
$118,000
40,000
Cost of goods sold
Gross profit
Operating expenses
Selling expenses
Administrative expenses
Depreciation expense
Income from operations
Other revenues and gains
Interest revenue
Other expenses and losses
Interest expense
Loss from storm damage
Income before income tax
Income tax
Net income
Earnings per share:
158,000
962,000
504,000
458,000
160,000
80,000
50,000
290,000
168,000
70,000
238,000
50,000
124,000
64,000
16,000
$ 48,000
$0.32
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Intermediate Accounting, Eleventh Canadian Edition
EXERCISE 4-14 (20-25 minutes)
Holland Rose Corporation
Income Statement
For the Year Ended December 31, 2017
Net sales revenue
Cost of goods sold
Gross profit
Selling expense
Administrative expense
Income from operations
Other revenue
Other expense
Income before income tax
Income tax*
Net income
$4,162,000
2,665,000
1,497,000
$636,000
491,000
240,000
246,000
1,127,000
370,000
6,000
364,000
91,000
$ 273,000
Earnings per share**:
$3.03
Supporting calculations:
* Income tax ($364,000 x 25%) = $91,000
** $273,000 divided by 90,000 common shares.
Sales Revenue
Sales revenue
Less: Sales discounts
Sales returns and allowances
Net sales revenue
$4,275,000
$34,000
79,000
113,000
$4,162,000
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EXERCISE 4-14 (CONTINUED)
Cost of Goods Sold:
Inventory, Jan. 1, 2017
Purchases
Less purchase returns and
allowances
Less purchase discounts
Net purchases
Add freight-in
Total goods available for sale
Less inventory, Dec. 31, 2017
Cost of Goods Sold
$535,000
$2,786,000
(15,000)
(27,000)
2,744,000
72,000
2,816,000
3,351,000
686,000
$2,665,000
Selling expenses:
Salaries and wages
Sales commission expense
Entertainment expense
Advertising expense
Freight-out
Depreciation of sales equipment
Telephone and internet expense
$284,000
83,000
69,000
54,000
93,000
36,000
17,000
$636,000
Administrative expenses:
Salaries and wages
Office expense
Insurance expense
Depreciation of office equipment
Utilities expenses
Miscellaneous expense
$346,000
33,000
24,000
48,000
32,000
8,000
$491,000
Other expenses:
Interest expense
Loss on disposal of equipment
$176,000
70,000
$246,000
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Intermediate Accounting, Eleventh Canadian Edition
EXERCISE 4-15 (20-25 minutes)
(a)
Eddie Zambrano Corporation
Statement of Retained Earnings
For the Year Ended December 31, 2017
Balance, January 1, as reported
Correction for depreciation error
(net of $10,000 income tax recovery)
Retroactive adjustment for change in inventory
method (net of $14,000 income tax)
Balance, January 1, as adjusted
Add net income
Deduct dividends declared
Balance, December 31
$225,000*
(15,0
00)
21,000
231,000
144,000**
375,000
100,000
$275,000
* ($40,000 + $125,000 + $160,000) – ($50,000 + $50,000)
** [$240,000 – (40% X $240,000)]
(b) Total retained earnings would still be reported as $275,000. A
restriction does not affect total retained earnings; it merely
labels part of the retained earnings as being unavailable for
dividend distribution. Retained earnings would be reported as
follows:
Retained earnings:
Appropriated
Unappropriated
Total
$ 70,000
205,000
$275,000
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Intermediate Accounting, Eleventh Canadian Edition
EXERCISE 4-16 (15-20 minutes)
Rainy Day Umbrella Corporation
Statement of Changes in Equity
For the Year Ended December 31, 2017 (all amounts in thousands)
Preferred Common
Shares
Shares
Beginning Balance
Comprehensive Income:
Net income
Other comprehensive income
Unrealized holding gain
Comprehensive Income
Dividends to shareholders:
Preferred
Common
Issue of Common shares
Ending Balance
$3,375
$8,903
Contr.
Surplus
$3,744
Retained Acc. Other
Earnings Comp. Inc.
$23,040
$2,568
7,320
$3,375
$3,744
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$30,310
$41,630
7,320
585
585
$3,153
(30)
(20)
285
$49,770
(30)
(20)
285
$9,188
Total
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Intermediate Accounting, Eleventh Canadian Edition
EXERCISE 4-16 (CONTINUED)
Rainy Day Umbrella Corporation
Balance Sheet (Partial)
December 31, 2017 (all amounts in thousands)
Share capital:
Preferred shares
Common shares
Total share capital
Contributed surplus
Total paid-in capital
Retained earnings
Accumulated other comprehensive income
Total shareholders’ equity
$ 3,375
9,188
12,563
3,744
16,307
30,310
3,153
$49,770
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Intermediate Accounting, Eleventh Canadian Edition
EXERCISE 4-17 (20-25 minutes)
Calculation of net income:
2017 net income after tax
2017 net income before tax
[$24,000,000  (1 – .25)]
Add back loss from discontinued operations
Income from continuing operations
Income tax (25% X $47,000,000)
Income before discontinued operations
Discontinued operations
Loss from operations
Less applicable income tax reduction
Net income
Net income
Less cumulative preferred dividends
(8% of $4,500,000)
Income available for common
Common shares
Earnings per share
Income statement presentation
Earnings per share:
Continuing operations
Discontinued operations
Net income
a
b
$24,000,000
32,000,000
15,000,000
47,000,000
11,750,000
35,250,000
15,000,000
3,750,000
11,250,000
$24,000,000
$24,000,000
360,000
23,640,000

10,000,000


$2.36
$3.49a
(1.13)b
$2.36
$35,250,000 – $360,000
= $3.49
10,000,000
$15,000,000 x (1-.25)
10,000,000
= $1.13
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EXERCISE 4-18 (15-20 minutes)
Net income:
Income from continuing operations
$23,650,000
before tax
Income tax (30%)
Income from continuing operations
Discontinued operations
Loss before tax
Less income tax recovery
Net income
7,095,000
16,555,000
$3,225,000
967,500
Preferred dividend entitlement
($10,750,000 x10%):
Weighted average common shares outstanding:
12/31/16–3/31/17 (3,600,000 x 3/12)
4/1/17–12/31/17 (4,000,000 x 9/12)
Weighted average
Earnings per share:
Income from continuing operations
Discontinued operations
Net income
2,257,500
$14,297,500
$ 1,075,000
900,000
3,000,000
3,900,000
$3.97*
(.58)**
$3.39***
*($16,555,000 – $1,075,000)  3,900,000.
**$2,257,500  3,900,000.
***($14,297,500 – $1,075,000)  3,900,000.
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Intermediate Accounting, Eleventh Canadian Edition
*EXERCISE 4-19 (10-15 minutes)
(a)
Canviar Corp.
Income Statement (Cash Basis)
For the Year Ended December 31,
Sales
Expenses
Net income
(b)
2016
$320,000
225,000
$ 95,000
$515,000
247,000
$268,000
Canviar Corp.
Income Statement (Accrual Basis)
For the Year Ended December 31,
Sales*
Expenses**
Net income
*2015:
2016:
**2015:
2016:
2015
2015
2016
$510,000
277,000
$233,000
$445,000
230,000
$215,000
$320,000 + $160,000 + $30,000 = $510,000
$355,000 + $90,000 = $445,000
$185,000 + $67,000 + $25,000 = $277,000
$40,000 + $135,000 + $55,000 = $230,000
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Intermediate Accounting, Eleventh Canadian Edition
TIME AND PURPOSE OF PROBLEMS
Problem 4-1
(Time 20-25 minutes)
Purpose—to provide the student an illustration of how earnings can be managed.
The case allows students to see the effects of warranty expense timing on the
trend of income and illustrates the potential use of accruals to smooth earnings.
Problem 4-2
(Time 35-45 minutes)
Purpose—to provide the student with a discontinued operations problem that
requires discussion of balance sheet and income statement disclosure along with
an illustration of the income statement presentation. The student is also required to
discuss the factors applied to justify the use of the discontinued operations
treatment and the impact on users of financial information.
Problem 4-3
(Time 40-45 minutes)
Purpose—to provide the student with an opportunity to prepare an income
statement and a statement of retained earnings. A number of special items such as
loss from discontinued operations, unusual items, and unusual losses are
presented in the problem for analysis purposes. The problem also requires
calculating the tax effect of a special item from a net-of-tax amount.
Problem 4-4
(Time 35-45 minutes)
Purpose—to provide the student with an opportunity to analyze a number of
transactions and to prepare a partial income statement. The problem includes
discontinued operations, unusual item, and earnings per share. The student must
also prepare a statement of retained earnings and then discuss the impact of
GAAP classification rules on the assessment of the quality of earnings.
Problem 4-5
(Time 25-30 minutes)
Purpose—to provide the student with an opportunity to prepare an income
statement and statement of retained earnings using the single-step format.
Problem 4-6
(Time 20-25 minutes)
Purpose—to provide the student with an understanding of conditions where
unusual item classification is appropriate. In this problem, it should be emphasized
that in situations where unusual item classification is not permitted, a classification
as an unusual item may still be employed.
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Intermediate Accounting, Eleventh Canadian Edition
TIME AND PURPOSE OF PROBLEMS (CONTINUED)
Problem 4-7
(Time 30-40 minutes)
Purpose—to provide the student with the opportunity to comment on deficiencies in
a single-step income statement. This case includes discussion of unusual items,
tax reassessments, and ordinary gains and losses. The problem provides a broad
overview to a number of items discussed in the textbook.
Problem 4-8
(Time 45-55 minutes)
Purpose—to provide the student with the opportunity to prepare a multiple-step
and single-step income statement and a statement of retained earnings from the
same underlying information. The problem emphasizes the differences between
the multiple-step and single-step income statement.
Problem 4-9
(Time 30-35 minutes)
Purpose—to provide the student with a problem on the income statement
treatment of (1) a usual but infrequently occurring charge, (2) an unusual item and
its related tax effect, (3) a change in estimate, and (4) earnings per share. The
student is required to identify the proper income statement treatment and to
provide the rationale for such treatment. A revised income statement must be
prepared.
Problem 4-10
(Time 45-50 minutes)
Purpose—to provide the student the opportunity to distinguish between different
scenarios involving discontinued operations, unusual items and changes in
accounting policy. Three different scenarios are proposed and a combined
statement of income and retained earnings must be prepared. The problem
involves intraperiod tax allocation. This problem is comprehensive.
Problem 4-11
(Time 35-45 minutes)
Purpose—to provide the student with the opportunity to correct a multi-step income
statement. The student must determine which of the items presented should be
presented in the income statement and must prepare a proper income statement.
A combined statement of income and retained earnings is also required. This
statement includes an adjustment to the beginning retained earnings balance for a
change in policy. The student must also discuss the purpose of intraperiod tax
allocation.
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Intermediate Accounting, Eleventh Canadian Edition
TIME AND PURPOSE OF PROBLEMS (CONTINUED)
Problem 4-12
(Time 35-45 minutes)
Purpose—to provide the student with an understanding of the difference between
the current operating and all-inclusive income statement. In addition, the student is
to comment on the income statement presentation of a number of special items.
Presentation of the proper earnings per share is also emphasized. A revised
income statement presentation is required as well as a revised statement of
retained earnings.
Problem 4-13
(Time 25-35 minutes)
Purpose—to provide the student with a problem to determine the reporting of
several items, which may get special treatment as irregular items. This is a good
problem for a group assignment.
Problem 4-14
(Time 35-45 minutes)
Purpose—to provide the student with the opportunity to comment on deficiencies in
an income statement format. The student is required to comment on such items as
inappropriate heading, incorrect classification of special items, proper net of tax
treatment, and presentation of per share data. The student is also required to
prepare a correct income statement.
Problem 4-15
(Time 25-35 minutes)
Purpose—to provide the student with an opportunity to prepare a statement of
changes in equity. A number of special items must be reclassified and reported in
the income statement. This problem illustrates the fact that ending retained
earnings is unaffected by the choice of disclosing items in the income statement or
the statement of retained earnings, although the income reported would be
different.
Problem 4-16
(Time 20-25 minutes)
Purpose—to provide the student a real company context to identify factors that
make income statement information useful. The focus is on overly aggregated
information in a condensed income statement. Additional detail would seem to be
warranted either on the face of the statement or with reference to the notes.
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Intermediate Accounting, Eleventh Canadian Edition
TIME AND PURPOSE OF PROBLEMS (CONTINUED)
*Problem 4-17
(Time 35-40 minutes)
Purpose—to provide an opportunity for the student to prepare and compare (a)
cash basis and accrual basis income statements, (b) cash basis and accrual basis
balance sheets, and (c) to discuss the weaknesses of cash basis accounting.
*Problem 4-18
(Time 40-50 minutes)
Purpose—to provide an opportunity for the student to determine income on an
accrual basis. The student is asked to write a letter indicating what was done to
arrive at an accrual basis net income.
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Intermediate Accounting, Eleventh Canadian Edition
SOLUTIONS TO PROBLEMS
PROBLEM 4-1
(a) Earnings management may be defined as the process of targeting
certain earnings levels (whether current or future) or desired
earnings trends and then working backwards to determine what
has to be done to ensure that these targets are met. Earnings
management often involves planned timing of revenues, expenses,
gains and losses to smooth out bumps in earnings. In many cases,
earnings management is used to increase income in the current
year at the expense of income in future years. For example,
companies inappropriately recognize revenue before it is earned in
order to boost income. Earnings management can also be used to
decrease current income in order to increase income in the future.
This is done through the creation of inappropriate reserves using
unrealistic assumptions to estimate liabilities for such items as
sales returns, loan losses, and warranty returns.
(b) Proposed Accounting Income:
2014
2015
2016
2017
2018
Income before
$43,00 $43,00
warranty expense
0
0
Warranty expense
8,000
2,000
Income
$20,000 $25,000 $30,000 $35,000 $41,000
Assuming the same income before warranty expense for both 2017
and 2018 and total warranty expense over the 2-year period of
$10,000, this proposed accounting results in steadily increasing
income over the two-year period.
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Intermediate Accounting, Eleventh Canadian Edition
PROBLEM 4-1 (COTINUED)
(c) Appropriate Accounting Income:
2014
2015
2016
2017
2018
Income before
$43,00 $43,00
warranty expense
0
0
Warranty
5,000
5,000
expense
Income
$20,000 $25,000 $30,000 $38,000 $38,000
The appropriate accounting would be to record $5,000 in 2017,
resulting in income of $38,000. However, with the same amount of
warranty expense in 2018, Grace no longer shows an increasing trend
in income. Thus, by taking more expense in 2017, Grace can maintain
its growth trend in income.
(d)
If Grace records a larger, more conservative warranty expense
this year, and provides full disclosure of the warranty accrual, a
potential investor should see through the company’s attempts to
mask the underlying economic reality that the growth trend in
income may not be maintained. The investor may view the
company’s larger warranty accrual as an attempt to manage
earnings. The investor may be wary of the company’s accounting
practices and quality of earnings. The investor may discount the
value of the company’s shares or forego investing in the
company altogether.
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Intermediate Accounting, Eleventh Canadian Edition
PROBLEM 4-2
(a)
The Rocketeer Division’s assets should be identified separately
on Campbell Corporation’s balance sheet as of May 31, 2017 as
held for sale current assets and carried at fair value less costs to
sell of $36 million.
(b)
The operating loss must be reported as a separate component
after income from continuing operations. The operating loss up
to year end is presented as a loss from discontinued operations
on a net of tax basis. The division assets would be measured at
the lower of carrying value and fair value less costs to sell. The
related loss would be presented as a separate component of
discontinued operations, on a net of tax basis. Separate earnings
per share figures for the discontinued operations are also
required under IFRS.
All figures in thousands, except earnings per share:
Income from continuing operations (Note–):
Loss from operation of the Rocketeer
Division less applicable income tax recovery of
$1,025
Loss on impairment of Rocketeer Division
assets less applicable income tax recovery of
$1,500*
$XXX
$(3,075)
(4,500)
$(7,575)
Net income
* Book value of assets
Fair value less costs to sell
Impairment loss
Applicable tax (25%)
After-tax loss
$XXX
$42,000,000
36,000,000
$(6,000,000 )
1,500,000
$(4,500,000 )
(Note to instructor: We have presented the calculations in this format in
order for the student to better understand how the loss on impairment was
calculated. Other formats are acceptable.)
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PROBLEM 4-2 (CONTINUED)
(c)
The operating loss from June 1- July 5, 2017 is reported as
a separate component after income from continuing operations.
The operating loss is presented as a loss from discontinued
operations on a net of tax basis. The gain on the disposal of
the division assets would be presented as a separate component
of discontinued operations, on a net of tax basis. The amounts
would be disclosed on a comparative basis with the results of
the year ended 2017. Separate earnings per share figures for the
discontinued operations are also required under IFRS.
All figures in thousands, except earnings per share:
Income from continuing operations (Note–):
Loss from operation of the Rocketeer
Division less applicable income tax recovery of $75
Gain from disposal of the Rocketeer Division
assets less applicable income tax of $1,000
Net income
(d)
$XXX
$(225)
3,000
$2,775
$XXX
The Rocketeer Division financial results should be shown as a
discontinued operation according to the following factors:
 Management has “formally” decided to dispose of the
Rocketeer Division
 The division represents a separate major line of business
(as noted – it is a major portion of the company’s
operations). It is a separate component of the entity and is
operationally distinct, where the operations, cash flows, and
financial elements are clearly distinguishable from the rest
of the enterprise (as evidenced by the measurement of the
division losses) – thus the accountants will be able to
measure the loss from operations and disposition of the
assets.
 There is an active program to find a buyer (negotiations are
in process)
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Intermediate Accounting, Eleventh Canadian Edition
PROBLEM 4-2 (CONTINUED)
(d) (continued)
Management could argue the following points against using
discontinued operations treatment:
 Changes to the plan are possible or likely, and
 The assets are not available for immediate sale in their
current state
Management would usually prefer using the discontinued operations
treatment. This separates the financial results of the division from
continuing operations and allows users to concentrate on continuing
financial results and to assess management performance on the more
profitable parts of the business. This also allows users to see the
unprofitable impact of the Rocketeer Division on prior years’ results
since comparative figures are presented. For a user, showing
discontinued operations at the bottom of the income statement after
income tax expense and with its own earnings per share information
provides more information about the quality and recurrence of
earnings.
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Intermediate Accounting, Eleventh Canadian Edition
PROBLEM 4-3
Rolling Thunder Corp.
Statement of Comprehensive Income
For the Year Ended December 31, 2017
Sales revenue
Less cost of goods sold
Gross profit
Less selling and administrative expenses
Income from operations
Other revenues and gains
Interest income
Gain on sale of FV-NI
investments
Other expenses and losses
Loss on impairment of goodwill
Loss from flood damage
Income from continuing operations before income
tax
Income tax expense:
For 2017
Tax assessment related to 2015
Income from continuing operations
Discontinued operations
Loss from operations, net of income tax
recovery of $55,000
Loss from disposal, net of income tax
recovery of $87,500
Net income
$36,500,000
28,500,000
8,000,000
4,700,000
3,300,000
$170,000
110,000
520,000
390,000
280,000
3,580,000
910,000
2,670,000
797,500
500,000
1,297,500
1,372,500
165,000
262,500
427,500
$ 945,000
Other comprehensive income
Items that may be reclassified subsequently to net
income or loss:
Unrealized gain on FV-OCI investments, net of
income tax of $80,000
Comprehensive income
240,000
$ 1,185,000
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PROBLEM 4-3 (CONTINUED)
Earnings per share:
Income from continuing operations
Discontinued operations
Net income
a
b
c
$1,372,500 – $70,000
800,000 shares
= $1.62*
($427,500)
800,000 shares
= ($0.53)
$ 945,000 – $70,000
800,000 shares
*rounded to make it
add
$ 1.62a
(0.53)b
$ 1.09c
= $1.09
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PROBLEM 4-4
(a)
Wavecrest Inc.
Income Statement (Partial)
For the Year Ended December 31, 2017
Income from continuing operations before income
tax
Income tax
Income from continuing operations
Discontinued operations:
Loss on disposal of recreational division
Less applicable income tax reduction
Net income
$1,738,500*
505,350**
1,233,150
$115,000
34,500
Earnings per share:
Income from continuing operations
Discontinued operations
Net income
80,500
$1,152,650
$15.41
(1.00)
$14.41
*Calculation of income from continuing operations before income tax:
As previously stated
$1,790,000
Loss on sale of FV-NI investments
(107,000)
Gain on proceeds of life insurance policy
($100,000 – $46,000)
Error in calculation of depreciation:
As calculated ($54,000  6)
Corrected ($54,000 – $9,000)  6
As restated
**Calculation of income tax:
Income from continuing operations before income tax
Non-taxable income (gain on life insurance)
Taxable income
Tax rate
Income tax expense
54,000
$9,000
7,500
1,500
$1,738,500
$1,738,500
(54,000)
1,684,500
X
.30
$505,350
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PROBLEM 4-4 (CONTINUED)
(b)
Wavecrest Inc.
Excerpt from Statement of Changes in Equity
For the Year Ended December 31, 2017
Retained earnings, January 1, 2017, as reported
Correction of depreciation overstatement
(net of tax of $900) *
Retroactive adjustment for change in inventory
method (net of tax of $12,000) **
Retained earnings, January 1, 2017, as adjusted
Add: Net income
$2,540,000
$ 2,100
Less: Dividends declared
Retained earnings, December 31, 2017
* Error in calculation of depreciation:
As calculated ($54,000  6)
Corrected ($54,000 – $9,000)  6
Understatement of net income per year
Total understatement of beginning retained earnings
After-tax understatement ($3,000 X [1-30%])
**Pretax understatement of 2015 income
Pretax overstatement of 2016 income
Net pretax understatement of beginning retained earnings
After-tax understatement ($40,000 X [1-30%])
28,000
30,100
$2,570,100
1,152,650
3,722,750
175,000
$3,547,750
$9,000
7,500
1,500
X2
3,000
$2,100
$60,000
(20,000)
$40,000
$28,000
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PROBLEM 4-4 (CONTINUED)
(c) Proper classification of items on the income statement includes
appropriate separation of discontinued operations from continuing
operations. Discontinued operations are presented separately to
provide predictive value. By separating the results of operations
that are being discontinued from ongoing operations, users can
assess ongoing operations and more easily predict future
performance. Results from continuing operations usually have
greater significance for predicting future performance than do
results from nonrecurring activities.
Appropriate separation of operating from non-operating items (e.g.
separation of revenues and expenses from gains and losses) also
helps users to assess past performance and profitability based on
recurring, regular transactions, and to predict sustainability of
earnings.
Proper disclosure of other items on the income statement (e.g.
government assistance, loss on impairment of goodwill, loss on
inventory due to decline in NRV, income tax) also helps users to
assess the quality, recurrence, and sustainability of earnings, and
management’s performance.
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PROBLEM 4-5
Thompson Corporation
Income Statement
For the Year Ended December 31, 2017
Revenues
Net sales revenue*
Gain on sale of land
Rent revenue
Total revenues
$1,068,000
30,000
18,000
1,116,000
Expenses
Cost of goods sold**
Selling expenses
Administrative expenses
Total expenses
645,000
232,000
99,000
976,000
Income before income tax
Income tax
Net income
140,000
53,900
$ 86,100
* ($1,100,000 – $14,500 – $17,500 = $1,068,000)
**Cost of goods sold:
Inventory, January 1
Purchases
Less purchase discounts
Net purchases
Add freight-in
Cost of goods available for sale
Less inventory, December 31
Cost of goods sold
$ 89,000
$610,000
10,000
600,000
20,000
620,000
709,000
64,000
$645,000
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Intermediate Accounting, Eleventh Canadian Edition
PROBLEM 4-5 (CONTINUED)
Thompson Corporation
Statement of Retained Earnings
For the Year Ended December 31, 2017
Retained earnings, January 1
Plus net income
Less: cash dividends
Retained earnings, December 31
$ 160,000
86,100
246,100
45,000
$201,100
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Intermediate Accounting, Eleventh Canadian Edition
PROBLEM 4-6
1.
Present loss separately if material, because the users of
the financial statements would not expect losses from
earthquakes.
2.
Since the company appears to issue bonds/shares frequently and
since finance costs are generally separately presented, these
might be grouped and presented with finance costs.
3.
Present loss separately if material, because hail storms and
therefore losses due to hailstorms are rare in the locality.
4.
The cumulative unrealized holding gain/(loss) – OCI previously
reported for these investments should be reported in net income
separately as gain/(loss) on sale of investments. However, the
gain/loss on sale of investments is not classified as unusual.
5.
The cumulative unrealized holding gain/(loss) – OCI for this
investment should be reported in net income separately as
gain/(loss) on sale of investments.
6.
Present related gain/(loss) on sale of land separately if material,
because the company is not in the business of selling land.
7.
May present costs separately since the company does not
frequently relocate. This would provide greater transparency since
relocation is not a normal part of operations.
8.
Loss might be grouped with finance costs since the company
appears to enter into this type of transaction frequently.
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PROBLEM 4-6 (CONTINUED)
9. The loss is not an infrequent occurrence taking into account the
environment in which the entity operates. Whether this is
separately presented would be a judgement call since these floods
happen every three years. The entity knows this and could avoid
the loss by insuring itself against this type of loss. If insured, the
insurance expense would be booked every year as an ongoing cost
of doing business.
10. Present gain/(loss) on sale of land separately if material, because
sale of land is not part of normal recurring activities.
Note that as a general rule, if the item is unusual and material,
(consider size, nature and frequency), the item is presented separately
but included in income from continuing operations. If the item is
unusual and immaterial, the item is combined with other items in
income from continuing operations. There is a trade-off here between
additional disclosures of relevant information and too much disclosure
which might result in information overload. Certain items are already
separately disclosed as part of other comprehensive income. These
items are presented net of tax whereas unusual items are presented
before tax. Care should be taken to review the current accounting
standards as certain specific items may be required to be presented
separately. Note that IFRS and ASPE mandate that different items be
separately presented. These standards change over time.
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Intermediate Accounting, Eleventh Canadian Edition
PROBLEM 4-7
The Income Statement of Klein Corporation contains the following
weaknesses in classification and disclosure:
1. Sales taxes: sales taxes have been erroneously added to gross
sales revenue. Failure to deduct these taxes directly from customer
billings results in a deceptive inflation of the amount of sales
revenue. These taxes should be deducted from gross sales
revenue because the Corporation acts as an agent in collecting
and remitting such taxes to the government.
2. Purchase discounts: purchase discounts should not be treated as
revenue by being lumped with other revenue such as dividend
revenue and interest income. A purchase discount is more logically
a reduction of the cost of purchases because revenue is not
created by purchasing goods and paying for them. In a cash
transaction, cost is measured by the amount of the cash paid. In a
credit transaction, however, cost is measured by the amount of
cash required to settle the obligation immediately. The discount
should reduce the cost of goods purchased to the amount of cash
that would be required to settle the obligation immediately.
3. Recoveries of accounts written off in prior years: these collections
should be credited to allowance for doubtful accounts unless the
direct write-off method was used in accounting for bad debt
expense, in which case the recovery would offset the current year’s
bad debt expense. Generally, the direct write-off method is not
allowed, as it does not result in faithfully representative valuation of
accounts receivable (net).
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Intermediate Accounting, Eleventh Canadian Edition
PROBLEM 4-7 (CONTINUED)
4. Freight-in and freight-out: freight-out is an expense of selling and is
therefore reported properly in the statement, although freight-in is a
cost related to the acquisition of merchandise for resale, and
should have been included in the calculation of cost of goods sold.
The value assigned to inventory should represent the value of the
economic resources given up in obtaining goods and readying
them for sale.
5. Appropriation of retained earnings for possible inventory losses:
appropriations of retained earnings should not be treated as
operating expenses. An appropriation is not an operating expense
because
it
is
only
an
anticipated
loss
from
a future event. It does not represent a reduction in future benefits.
It is a notification to shareholders that $3,800 of earnings retained
for use in the business is designated for a stated purpose and is
not available for dividends.
6. Loss on discontinued styles: this type of loss, though often
substantial, should not be treated as an unusual item because it is
apparently typical of the customary business activity of the
corporation. It should be reported and included as an operating
expense.
7. Loss on sale of FV-NI investments: this item should be presented
as a separate component of income from operations. As the
company appears to trade investments frequently, the loss should
not be labelled as unusual.
8. Loss on sale of warehouse: this item may be presented separately
since the company is not in the business of selling warehouses.
However, it should be shown at the pre-tax amount.
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Intermediate Accounting, Eleventh Canadian Edition
PROBLEM 4-7 (CONTINUED)
9. Tax reassessments for 2016 and 2015: the company may wish to
show this as a separate line item within income tax expense for
greater transparency. Reassessments are not uncommon as
companies often have to interpret the income tax act. These
interpretations are audited by the government and the tax auditors
may have differing interpretations which may result in
reassessments.
10. Income tax: the income statement is missing income tax as an
expense.
11. The amount identified as Income before unusual items should be
labelled income from operations.
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Intermediate Accounting, Eleventh Canadian Edition
PROBLEM 4-8
(a)
Reid Corporation
Income Statement
For the Year Ended June 30, 2017
Sales revenue
Sales revenue
Less: Sales discounts
Sales returns and allowances
Net sales revenue
Cost of goods sold
Gross profit
Operating expenses
Selling expenses
Sales commissions expense
Salaries and wages expense
Advertising expense
Entertainment expense
Freight-out
Telephone and internet expense
Depreciation expense
Maintenance and repairs expense
Supplies expense
Miscellaneous expense
Administrative expenses
Salaries and wages expense
Maintenance and repairs expense
Depreciation expense
Supplies expense
Telephone and internet expense
Miscellaneous expense
Income from operations
Other revenues
Dividend revenue
Other expenses
Interest expense
Income before income tax
Income tax
Net income
Earnings per share
*($365,525 - $9,000)/180,000 shares
$1,928,500
$31,150
62,300
$97,600
56,260
28,930
14,820
21,400
9,030
4,980
6,200
4,850
4,715
248,785
7,320
9,130
7,250
3,450
2,820
6,000
35,970
93,450
1,835,050
1,071,770
763,280
284,755
478,525
38,000
516,525
18,000
498,525
133,000
$ 365,525
$1.98*
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Intermediate Accounting, Eleventh Canadian Edition
PROBLEM 4-8 (CONTINUED)
(b)
Reid Corporation
Excerpt from Statement of Changes in Equity
For the Year Ended June 30, 2017
Retained earnings, July 1, 2016, as reported
Correction of depreciation understatement
(net of tax)
Balance July 1, 2016 adjusted
Add: Net income
Deduct:
Dividends declared on preferred shares
Dividends declared on common shares
Retained earnings, June 30, 2017
$292,000
17,700
$274,300
365,525
639,825
$ 9,000
32,000
41,000
$598,825
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Intermediate Accounting, Eleventh Canadian Edition
PROBLEM 4-8 (CONTINUED)
(c)
Reid Corporation
Income Statement
For the Year Ended June 30, 2017
Revenues
Net sales
Dividend revenue
Total revenues
Expenses
Raw materials and supplies consumed
Increase in work-in-process and finished
goods inventories (see note)
Employee benefit expense
Advertising expense
Transportation expense
Maintenance and repairs expense
Entertainment expense
Depreciation expense
Telephone and internet expense
Miscellaneous expense
Finance costs
Total expenses
Net income before income tax
Income tax
Net income
Earnings per share
($365,525 - $9,000)/ 180,000 shares
*$474,670 + $3,450 + $4,850 = $482,970
** $97,600 + $56,260 + $7,320 + $710,000 = $871,180
$1,835,050
38,000
1,873,050
$482,970*
(112,900)
871,180**
28,930
21,400
15,330
14,820
12,230
11,850
10,715
18,000
1,374,525
498,525
133,000
$365,525
$1.98
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Intermediate Accounting, Eleventh Canadian Edition
PROBLEM 4-8 (CONTINUED)
Note: The functional classification includes the salaries and wages and
all overhead costs incurred by function as well as the raw materials
that went into production. However, to the extent that there are more of
these costs in ending work-in-process and finished goods inventory
than at the beginning of the period, the increase in those inventories
must be deducted from the costs going into production to bring the
amounts back to cost of goods sold in the period. If the work-inprocess and finished goods inventories at the end of the period are
lower than at the beginning of the period, then the additional costs
must have been included in cost of goods sold – therefore, a decrease
in those inventories is added to the raw materials and other supplies
consumed and the production salary and wage costs incurred to come
to the cost of goods sold amount. Note that the change in raw
materials inventory is not required as an adjustment because the figure
we’re adjusting is raw materials consumed or used in the period, not
the cost of materials purchased.
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Intermediate Accounting, Eleventh Canadian Edition
PROBLEM 4-9
(a)
1.
The usual but infrequently occurring charge of $10,500,000
should be disclosed separately, assuming it is material. This
charge should be shown as part of income from continuing
operations and would not be reported net of tax. This item should
be separately disclosed to inform the users of the financial
statements that this item is not frequently recurring and therefore
may not impact next year's results. Furthermore, trend
comparisons may be misleading if such an item is not highlighted
and adjustments made. The item should not be considered
unusual because it is usual in nature.
2.
The loss of $9,000,000 from discontinued operations should be
reported net of tax in a separate section following income from
continuing operations. The $3,000,000 tax effect related to the
discontinued operations should be reflected as part
of the discontinued operations. The reason for the separate
disclosure is much the same as that given above for the separate
disclosure of the usual, but infrequently occurring item. Readers
must be informed that certain revenue and expense items are not
part of the future operations of the business and thus should be
segregated from the results of operations that are continuing.
Under ASPE, the assets and liabilities related to the discontinued
component should be segregated on the balance sheet
according to their nature (e.g. current assets related to the
discontinued component should be presented as current assets
held for sale/related to discontinued operations, and noncurrent
assets related to the discontinued component should be
presented as noncurrent assets held for sale/related to
discontinued operations). Under IFRS, all assets and liabilities
related to the discontinued component should be presented as
held for sale, and classified as current assets and current
liabilities, respectively.
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Intermediate Accounting, Eleventh Canadian Edition
PROBLEM 4-9 (CONTINUED)
(a) (continued)
3.
4.
The “Adjustment required for correction of an error” is
inappropriately labelled and also should not be reported
in the statement of retained earnings. Changes in estimate
should be handled in current and prospective periods through
the income statement. Catch-up adjustments are not permitted.
The depreciation expense for the current year would also have
to be adjusted (although there is insufficient information given to
do so).
Under ASPE, EPS is not required to be disclosed since the
shares are often held by one or a few shareholders who are
closely related to the company and therefore have access to
information beyond the financial statements. Having said this,
the entity may choose to provide additional disclosures (beyond
what is required by ASPE). Under IFRS, where discontinued
operations are reported, IAS 33 states that basic EPS and
diluted EPS may be presented on the statement of
comprehensive income or in the notes. Because such
importance is ascribed to this ratio, the profession believes it
necessary to highlight the earnings per share figure. In this case
it should report earnings per share for both income from
continuing operations and discontinued operations.
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Intermediate Accounting, Eleventh Canadian Edition
PROBLEM 4-9 (CONTINUED)
(b)
California Tanning Salon Corp.
Combined Statement of Income and Retained Earnings
For the Year Ended December 31, 2017
($000 omitted)
Net sales revenue
Cost and expenses:
Cost of goods sold
Selling, general and administrative
expenses (a)
Loss on inventory due to decline in NRV
Other, net (b)
$640,000
500,000
55,500
10,500
8,000
574,000
Income before income tax and discontinued operations
Income tax
Income before discontinued operations
Discontinued operations
Loss from discontinued operations (net of tax of
$3,000)
Net income
Retained earnings, January 1
Less: Dividends on common shares
Retained earnings, December 31
66,000
22,400
43,600
6,000
37,600
141,000
178,600
12,200
$166,400
(a) $66,000 - $10,500 = $55,500
(b) $17,000 - $9,000 = $8,000
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Intermediate Accounting, Eleventh Canadian Edition
PROBLEM 4-10
SITUATION 1:
DC 5 Ltd.
Combined Statement of Income and Retained Earnings
For the Year Ended December 31, 2017
Sales revenue ($7,300,000 - $1,500,000)
$5,800,000
Cost of goods sold ($3,700,000 - $750,000)
2,950,000
Gross profit
2,850,000
Selling, general and administrative expenses
($2,300,000 - $580,000 - $790,000)
930,000
Income from operations
1,920,000
Other expenses and losses
Loss from tornado ($630,000 + $270,000*)
900,000
Income before income tax and discontinued
operations
1,020,000
Income tax
306,000
Income before discontinued operations
714,000
Discontinued operations
Income from operations of apparel
division ** (net of tax of $51,000)
$119,000
Loss from disposal of apparel division
(net of tax of $237,000)
553,000
434,000
Net income
280,000
Retained earnings, January 1
1,250,000
Retained earnings, December 31
$1,530,000
*Tax on ($630,000 ÷ [100% - 30%]) X 30% = $270,000
** $1,500,000 - $750,000 - $580,000 = $170,000
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Intermediate Accounting, Eleventh Canadian Edition
PROBLEM 4-10 (CONTINUED)
SITUATION 2:
DC 5 Ltd.
Combined Statement of Income and Retained Earnings
For the Year Ended December 31, 2017
Sales revenue
Cost of goods sold
Gross profit
Selling, general and administrative expenses*
Income from operations
Other losses:
Loss from tornado ($630,000 + $270,000)
Income before income tax
Income tax
Net income
Retained earnings, January 1
Retained earnings, December 31
* The amount recorded as bad debt expense represents
the 1.2% rate
($87,600 / $7,300,000 = 1.2%)
Revised bad debt expense = $7,300,000 X 2.6% =
Bad debt expense recorded to date
Increase in bad debt expense
$7,300,000
3,700,000
3,600,000
2,402,200
1,197,800
900,000
297,800
89,340
208,460
1,250,000
$1,458,460
$189,800
87,600
$102,200
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Intermediate Accounting, Eleventh Canadian Edition
PROBLEM 4-10 (CONTINUED)
SITUATION 3:
DC 5 Ltd.
Combined Statement of Income and Retained Earnings
For the Year Ended December 31, 2017
Sales revenue
Cost of goods sold
Gross profit
Selling, general and administrative expenses*
Income from operations
Other expenses:
Loss from tornado ($630,000 + $270,000)
Income before income tax
Income tax
Net income
Retained earnings, January 1
$7,300,000
3,700,000
3,600,000
2,300,000
1,300,000
Retained earnings, December 31
$1,530,000
900,000
400,000
120,000
280,000
1,250,000
*Note: change in method of depreciation is a change in estimate and
is accounted for prospectively.
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PROBLEM 4-11
(a)
Zephyr Corporation
Income Statement
For the Year Ended December 31, 2017
Sales revenue
Cost of goods sold
Gross profit
Selling and administrative expenses
Loss on inventory due to decline in NRV
$9,500,000
5,900,000
3,600,000
$1,280,000*
112,000
Total operating expenses
Income before income tax and discontinued operations
Income tax
Income before discontinued operations
Discontinued operations
Loss from operation of discontinued
segment (net of tax of $69,429***)
Net income
1,392,000
2,208,000
662,400**
1,545,600
162,000
$1,383,600
*
The 2016 sales commissions of $20,000 are deducted.
** (30% of $2,208,000).
*** The loss from operation of discontinued segment before tax =
$162,000 / [100% - 30%] = $231,429. Income tax = $231,429 $162,000 = $69,429.
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Kieso, Weygandt, Warfield, Young, Wiecek, McConomy
Intermediate Accounting, Eleventh Canadian Edition
PROBLEM 4-11 (CONTINUED)
(b)
Zephyr Corporation
Statement of Income and Retained Earnings
For the Year Ended December 31, 2017
Sales revenue
Cost of goods sold
Gross profit
Selling and administrative expenses
Loss on inventory due to decline in NRV
$9,500,000
5,900,000
3,600,000
$1,280,000
112,000
Total operating expenses
Income before income tax and discontinued operations
1,392,000
2,208,000
662,400
1,545,600
Income tax
Income before discontinued operations
Discontinued operations
Loss from operation of discontinued
segment (net of income tax recovery of
$69,429)
162,000
Net income
$1,383,600
Retained earnings, January 1,
as reported
$2,800,000
Less: Decrease in prior year
income due to error in recording
sales commissions (net of tax of
$6,000)
14,000
Retained earnings, January 1, as restated
2,786,000
4,169,600
Less: Cash dividends
700,000
Retained earnings, December 31
$3,469,600
Note: change in method of depreciation is a change in estimate and is
accounted for prospectively.
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Intermediate Accounting, Eleventh Canadian Edition
PROBLEM 4-11 (CONTINUED)
(c)
The income tax is allocated in the same manner as the
underlying irregular item or adjustment to opening retained
earnings. Since income tax is a major expense for companies, it
is important to reflect the individual impact of tax for discontinued
operations, and corrections of errors. This helps users assess the
quality of earnings and their related tax impact. Intraperiod tax
allocation also helps readers in trend analysis of income tax
expense and income from continuing operations, by placing the
current year amount on a comparable basis with prior years.
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PROBLEM 4-12
ON TIME CLOCK COMPANY INC.
Statement of Comprehensive Income
For the Year Ended December 31, 2017
Sales revenues
Less: Sales returns and allowances
Net sales revenue
Cost of goods sold
Gross profit
Selling expenses
Administrative expenses
Operating income before income tax
Other revenues and gains
Dividend revenue
Gain on sale of long-term investments
Other expenses and losses
Loss on expropriation
Income before income tax
Income tax *
Net income
Other comprehensive income
Items that may be reclassified subsequently
to net income or loss:
Unrealized gain on FV-OCI
investments (net of tax*)
Comprehensive income
$377,852
16,320
361,532
198,112
163,420
$41,850
32,142
40,000
31,400
73,992
89,428
71,400
13,000
147,828
50,846
96,982
23,618
$120,600
* $56,900/$165,428 = 34.3956% tax rate
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Intermediate Accounting, Eleventh Canadian Edition
PROBLEM 4-12 (CONTINUED)
ON TIME CLOCK COMPANY INC.
Statement of Changes in Equity
For the Year Ended December 31, 2017
Retained
Earnings
Balance January 1
as reported
Correction of prior year
error (net of tax)
Balance January 1
restated
Net income
Unrealized gain on FVOCI investment*
Balance December 31
$216,000
Accumulated
Other
Comprehensive
Income
Comprehensive
Income
$120,000
(17,186)
198,814
96,982
96,982
23,618
$295,796
23,618
$120,600
$143,618
*May be reclassified subsequently to net income or loss.
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PROBLEM 4-13
Faldo Corp.
Income Statement (Partial)
For the Year Ended December 31, 2017
Income from continuing operations before income tax
Income tax
Income from continuing operations
Discontinued operations
Loss from operation of
discontinued subsidiary
$ 90,000
Less applicable income tax
reduction
22,500
Loss from disposal of subsidiary
200,000
Less applicable income tax
reduction
50,000
Net income
Earnings per share:
Income from continuing operations
Discontinued operations
Net income
*Income from continuing operations before income tax:
As previously stated
Write-off of accounts receivable
Gain on sale of equipment
Settlement of lawsuit
Restated
$3,272,000*
818,000**
2,454,000
$67,500
150,000
217,500
$2,236,500
$24.54
(2.18)
$22.36
$2,710,000
(54,000)
96,000
520,000
$3,272,000
**Income tax expense: $3,272,000 X .25 = $818,000
Note: The prior year error related to the intangible asset was correctly charged to
retained earnings.
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PROBLEM 4-14
The deficiencies of the Amos Corporation income statement are as
follows:
a)
1. The heading is inappropriate. The heading should include the
period of time for which the income statement is presented.
2. The unrealized holding gain on FV-OCI investments should
be shown after net income as part of other comprehensive income,
on a net of tax basis. The unrealized holding gain on FV-OCI
investments may be reclassified subsequently to net income or
loss.
3. Cost of goods sold is usually listed as the first expense, followed by
selling, administrative, and other expenses.
4. Advertising expense is a selling expense and should usually
be classified as such.
5. Loss on inventory due to decline in NRV might be classified as an
unusual item and separately disclosed if it is unusual or infrequent,
and material.
6. Loss on discontinued operations requires a separate classification
after income from continuing operations and shown net of tax.
7. Intraperiod income tax allocation is required to relate income tax
expense to income from continuing operations and loss on
discontinued operations.
8. Under IFRS, earnings per share data is a required presentation for
income from continuing operations, loss from discontinued
operations and net income.
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PROBLEM 4-14 (CONTINUED)
b)
Amos Corporation
Statement of Comprehensive Income
For the Year Ended December 31, 2017
Revenues
Sales revenue
Dividend revenue
Gain on recovery of earthquake loss
Total revenues
Expenses
Cost of goods sold
Selling expenses ($100,100 + $13,700)
Administrative expenses
Loss on inventory due to decline in NRV
Total expenses
Income from continuing operations before income tax
Income tax*
Income from continuing operations
Discontinued operations
Loss from operations, (net of income tax recovery of
$12,150)**
Net income
Other comprehensive income
Items that may be reclassified subsequently to net income
or loss:
Unrealized holding gain, (net of tax of $1,250)
Comprehensive income
Earnings per share:
Income from continuing operations
Discontinued operations
Net income
$850,000
32,300
27,300
909,600
510,000
113,800
73,400
34,000
731,200
178,400
44,600
133,800
36,450
97,350
3,750
$101,100
$1.34 a
(0.36) b
$0.98 c
* The income tax rate is inferred as 25% by comparing the income tax expense
to the income before income tax = $33,700 / $134,800.
** $12,150 = $48,600 X 25%.
a
$133,800 / 100,000 shares
b
($36,450) / 100,000 shares
c
$97,350 / 100,000 shares
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Intermediate Accounting, Eleventh Canadian Edition
PROBLEM 4-15
Good Karma Corp.
Statement of Changes in Equity
For the Year Ended December 31, 2017
Preferred
Shares
Beginning Balance
Comprehensive Income:
Net income
Other comp. income
Unrealized gains
Dividends to shareholders:
Preferred
Common
Issue of equity:
Preferred shares
Common shares
Adjustment to correct prior
error
$250,000
Ending Balance
$255,000
Common
Shares
$600,000
Contr.
Surplus
$300,000
Retained
Earnings
Acc.
Other
Comp.
Income
$257,600
$1,932,60
$525,000
0
325,000
325,000
82,000
(62,000)
(120,000)
5,000
300,000
_______
48,000
$900,000
$300,000
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$448,600
Total
82,000
(62,000)
(120,000)
5,000
300,000
48,00
0
$2,510,60
$607,000
0
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Intermediate Accounting, Eleventh Canadian Edition
PROBLEM 4-16
(a)
The main deficiency in the Graben statement is that important
information is being aggregated, particularly in the “Costs and
Expenses” line item. More detail likely could be found
in Graben’s published financial statements. However, the
condensed income statement may be the one that investors
and creditors rely upon. Also, the statement is missing earnings
per share information.
b)
Where material, Graben should provide additional details
regarding the expenses included in Costs and Expenses on the
face of the income statement. Alternatively, the company could
provide the information in the notes to the financial statements,
which should be referenced on the face of the income statement.
The company may provide detailed information about the
expenses classified by nature of expense (payroll, depreciation,
changes in inventories etc.) or by function (cost of sales,
distribution costs, administrative costs, and other). If the latter is
chosen, additional information about the nature should be
presented as well. The company could present the financial
information in billions of dollars.
(c)
Companies may provide minimal disclosure in order to
not reveal competitive or sensitive financial information.
Management may also not be aware of the type of detailed
information users would find useful since financial information is
prepared by management based on their assessment of users’
needs. Company management may also mistakenly view IFRS
requirements as the required disclosure rather than the minimum
disclosure required. Management may also use minimal
disclosure to avoid questions on its management practices and
assessment of its stewardship abilities, or to hide financial
engineering transactions that could prove embarrassing.
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Intermediate Accounting, Eleventh Canadian Edition
*PROBLEM 4-17
(a)
Razorback Sales and Service
Income Statement
For the Month Ended January 31, 2017
Sales revenue
Expenses
Cost of computers & printers:
Purchased and paid
Sold
Salaries and wages
Rent
Other Expenses
Total expenses
Net income (loss)
Cash
Basis
Accrual
Basis
$75,000
$105,750*
89,250**
9,600
6,000
8,400
113,250
$(38,250)
63,750***
12,600
2,000
10,400
88,750
$17,000
* ($2,550 X 30) + ($4,500 X 4) + ($750 X 15)
** ($1,500 X 40) + ($3,000 X 6) + ($450 X 25)
*** ($1,500 X 30) + ($3,000 X 4) + ($450 X 15)
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Intermediate Accounting, Eleventh Canadian Edition
PROBLEM 4-17 (CONTINUED)
(b)
Razorback Sales and Service
Balance Sheet
As of January 31, 2017
Cash
Basis
Assets
Cash
Accounts Receivable
Inventory
Prepaid rent
Total assets
$51,750a
Liabilities and Owners’ Equity
Accounts payable
Salaries and wages payable
Owners’ equity
Total liabilities and owners’
equity
a
Original investment
Cash sales revenue
Cash purchases
Rent paid
Salaries and wages paid
Other expenses
Cash balance Jan. 31
Accrual
Basis
______
$51,750
$ 51,750a
30,750
25,500b
4,000
$112,000
$51,750c
$51,75
0
$ 2,000
3,000
107,000d
$112,00
0
$ 90,000
75,000
(89,250)
(6,000)
(9,600)
(8,400)
$ 51,750
b
(10 X $1,500) + (2 X $3,000) + (10 X $450).
Initial investment minus net loss: $90,000 – $38,250.
d
Initial investment plus net income: $90,000 + $17,000.
c
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PROBLEM 4-17 (CONTINUED)
(c)
1.
The $30,750 in receivables from customers is an asset and a
future cash flow resulting from sales revenue that is ignored.
The cash basis understates the amount of sales revenue and
inflow of assets in January from the sale of computers and
printers by $30,750.
2.
The cost of computers and printers sold in January is
overstated by $25,500. The unsold computers and printers
are an asset of $25,500 in the form of inventory.
3.
The cash basis ignores $3,000 of the salaries that have been
earned by the employees in January and will be paid in
February.
4.
Rent expense on the cash basis is overstated by $4,000. This
prepayment is an asset in the form of two months’ future right
to the use of office, showroom, and repair space and should
appear on the balance sheet.
5.
Other operating expenses on the cash basis are understated
by $2,000 as is the liability for the unpaid portion of these
expenses.
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*PROBLEM 4-18
Dear Dr. Armstrong:
Last week, you asked me to calculate net income on the accrual basis
for Blood Sugar Clinic. For the year ending December 31, 2017, Blood
Sugar Clinic earned $99,610. The following explanation as well as the
attached schedule should help you to understand how I derived this
amount.
First, I determined how much of your cash collections resulted from
work which you actually performed during 2017. Obviously, the fees
receivable existing on January 1, 2017 could not have been earned
during 2017. Likewise, your ending receivables represent revenue,
which you earned during 2017 but were not paid for. Because cash
collections include payments made on beginning receivables but not
on year-end receivables, beginning fees receivable must be subtracted
from your cash collections while year-end fees receivable must be
added.
The same logic applies to your unearned fees. As of January 1, 2017,
these fees of $2,840 represent treatment that your patients had paid
for but had not yet received. At year-end, a $1,620 balance in this
account indicates revenue, which you collected but have not yet
earned. Because the beginning unearned fees were eventually earned
during 2017, they must be added to 2017 cash collections while the
ending fees must be deducted.
Next, I calculated your 2017 expenses. Accrued liabilities at the
beginning of the year represent those incurred but not paid during
2016. Likewise, those at year-end were incurred during 2017 but
not yet paid at year-end. Because cash disbursements include
payments made on 2016 liabilities but not on 2017 liabilities existing at
year-end, your 2017 disbursements must be adjusted
for these items. To determine expenses resulting from operations
during 2017, I subtracted the beginning accrued liabilities balance and
added the ending accrued liabilities balance.
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PROBLEM 4-18 (CONTINUED)
Finally, prepaid expenses represent money paid in advance for
services, which you have not yet received. Your beginning prepaid
expenses represent 2017 expenses paid in advance while ending
prepaid expenses indicate 2018 expenses. Thus, I added beginning
prepaid expenses and subtracted the ending ones to derive 2017
expenses.
As a result, your gross revenue for 2017 is $154,070, and your
operating expenses are $54,460, amounting to net income of $99,610.
The enclosed schedule provides supporting computations.
I hope that this information helps you. Thank you for giving me the
opportunity to serve you.
Sincerely,
Your Name, CPA.
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PROBLEM 4-18 (CONTINUED)
Blood Sugar Clinic
Conversion of Income Statement
From Cash Basis to Accrual Basis
For the Year 2017
Receipts from fees:
–Fees receivable, Jan. 1
+Fees receivable, Dec. 31
+Unearned fees, Jan. 1
–Unearned fees, Dec. 31
Revenue from fees
Disbursements:
–Accrued liabilities, Jan. 1
+Accrued liabilities, Dec. 31
+Prepaid expenses, Jan. 1
–Prepaid expenses, Dec. 31
Operating expenses
Receipts over disbursements
—cash basis
Net income—accrual basis
Cash
Basis
$146,000
Adjustments
Add
Ded.
Accrual
Basis
$9,250
$16,100
2,840
1,620
$154,070
55,470
3,435
2,200
2,000
1,775
______
54,460
$90,530
______
$ 99,610
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Kieso, Weygandt, Warfield, Young, Wiecek, McConomy
Intermediate Accounting, Eleventh Canadian Edition
CASES
See the Case Primer on the Student Website as well as the summary case primer
in the front of the text. Note that the first few chapters of the text lay the foundation
for financial reporting decision-making. Therefore the cases in the first few
chapters (1-5) are shorter with less depth. As such, they may not cover all aspects
of a full-blown case analysis.
CA 4-1 OSC
Overview
As a member of the OSC, your role is to ensure that company financial statements
provide good information to suppliers of capital so that they can make decisions
about where to invest. IFRS is a constraint since all of these companies would be
public companies if they were required to file financial statements with the OSC.
It is not possible to identify reporting biases for all these companies.
Analysis and Recommendations
1.
Description
Inventory overstated two years
ago.
Discussion
Error has "washed out"; that is,
subsequent income statement
compensated for the error. However,
prior year income statements should
be restated if presented for
comparative purposes and a
discussion of the error reported in the
notes, since the prior year’s
information has been restated.
2.
Unusual item.
May be treated as unusual due to its
size.
3.
Amortization period extended.
Changes in estimates are handled
using the prospective treatment. The
current and future years’ income will
be increased from the reduced charge
for amortization. Note disclosure is
important since the amortization is
materially lower. Care should be taken
to watch for a possible bias to
overstate net income.
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CA 4-1 OSC (CONTINUED)
4.
Description
Change in bad debt percentage
(lower).
Discussion
Change in estimate, considered part
of normal business activity and given
a prospective treatment. Care should
be taken to watch for a possible bias
to overstate net income.
5.
Potential discontinued operations.
Gain or loss on discontinued
operations reported on the income
statement, net of taxes and with
separate earnings per share
disclosure, if the criteria for
discontinued operation accounting are
met. As a separate subsidiary and
geographical area, it is viewed as a
separate component with separately
distinguishable operations and
financial information. Therefore it
qualifies for separate presentation.
6.
Change in accounting policy.
A change in depreciation methods is
a change in accounting estimate.
The change is applied prospectively.
7.
Expense related to failed proposal.
Consideration may be given to
treating as unusual.
8.
Strike.
Strikes are typical business risks for
companies that are unionized.
They may be seen as atypical if there
is no union and no history of strikes.
The losses may be reported in body of
the income statement, possibly as an
unusual item (in continuing
operations).
9.
Correction of error.
Corrections of errors relating to prior
years must be adjustments to prior
years’ income in the retained earnings
statements. Adjust beginning retained
earnings, net of any tax effect.
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CA 4-1 OSC (CONTINUED)
Description
10. Costs associated with loss due to
government decree.
Discussion
Material and unusual in nature
(atypical), therefore treat as an
unusual item.
11. Disposition of business.
As long as the business is a separate
component (could argue this since
major classes of customers) and is
operationally distinct (financial records
separate), may treat as discontinued
per IFRS 5. In addition to being a
separate component, the assets must
meet the definition of being held for
sale. Assuming all criteria are met for
treating as discontinued operation,
the gain or loss on discontinued
operations would be reported on the
income statement, net of taxes and
with separate earnings per share
disclosure.
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Intermediate Accounting, Eleventh Canadian Edition
INTEGRATED CASES
IC 4-1 SNOW SPRAY CORP.
Overview
-
-
-
The company is in bankruptcy proceedings and needs cash to effect a
change in strategy. The bank is therefore the key user and will look to
assess the ability of the company to repay loans. The higher the perceived
risk, the higher the interest rate that will be charged.
Management will therefore want to present the company in the best light as
there is a concern that the loan will be turned down. Note that management
will want to ensure transparency as well.
The overall reporting objective, given the role, will be more aggressive while
still being within ASPE and transparent.
Analysis and Recommendations
Sale of bindings to Cashco Ltd.
Recognize revenue as sale
No sale/financing
- Profits of $4 million material
- Economic substance is that this
(material since 5% of $20 million
is a loan – the company is short
loss = $1 million).
of cash and this is an alternate
- Legal title and possession
means of unlocking the cash
(control) have passed to Cashco
that is tied up in the inventory.
and therefore the performance
- No profit should be recognized.
obligation has been satisfied.
- Since the company has agreed
- Transaction is measurable and
to buy back the inventory in
cash is already collected - $10
January, they have an obligation
million.
which cannot be avoided. Thus
- Persuasive evidence of contract
this represents a liability.
= agreement.
- The inventory appears to have
- Other
little value since management is
unsure as to how much they can
resell it for and so the $6 million
cost should be written down.
- This is a material loss and will
make the company look even
worse.
- Other
Even though it is tempting to record the transaction as a sale and therefore make
the company look better, the economic substance is that this is a financing
transaction.
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IC 4-1 SNOW SPRAY CORP. (CONTINUED)
Sale of Snow Tubes to AGL
Recognize as a sale
- Since the goods are shipped
FOB shipping point in
December, a sale has occurred.
- Legal title and possession
(control) has therefore passed
and the performance obligation
has been settled.
- Persuasive evidence of contract
– agreement exists.
- The $1 million profit is material
(since it equals the $1 million
threshold noted earlier).
- There is a bona fide reason for
selling the inventory – i.e. need
the space as well as the cash
generated.
- It is not clear in the case what
the buyback price is. If it is
(future) market price, then this is
a separate deal.
- Other
No sale/financing transaction
- Even though the goods were
shipped FOB shipping point, the
company still retains the risk of
loss since they reimburse the
customer if there is damage.
- Since SSC will take back any
unsold merchandise – they still
have the risk of loss on the
goods.
- If this is estimable – may make
a case to recognize the sale as
well as an allowance for returns.
- The fact that the company will
end up paying storage and
insurance costs is further
evidence that they have retained
the risks of loss. This also
supports the fact that the
transaction is like a parking
transaction only.
- Although it is not clear in the
case, if the buyback price
reflects the original transaction
price, then this supports the fact
that the transaction is a
financing transaction.
- Other
In conclusion, this appears to be a bona fide sale transaction and should be
recorded as such. The only issue is how, if at all, to record the potential obligation
for buyback. If it is measurable, it could accrue any potential liability for items not
sold by AGL. Detailed disclosures should be provided.
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IC 4-1 SNOW SPRAY CORP. (CONTINUED)
Disposition of ski business
Present as discontinued operations
-
-
Ski business separate and
distinct from snow tubing.
Cash flows and records
separate – ($20 million loss)
Will no longer be involved in
selling skis.
Want to show this as separate
from new business since bank
interested in ability to generate
profits and cash flows in future.
Other.
Loss/costs part of continuing
operations
- Retaining facilities and people
(will be retrained) and therefore
will have continuing involvement
in the assets and related cash
flows.
- This is not a separate division or
subsidiary but really represents
the whole income statement – it
is therefore not really a
component therefore.
- Other.
In conclusion, this is not really a disposition of a division but rather the transitioning
of the whole business. Therefore, it should not be shown as discontinued
operations.
Minor issue —costs to refurbish the machinery. This may be capitalized since will
have future benefit.
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IC 4-2 BMI
Overview:
BMI is experiencing pressure from the overall economic conditions and has
already incurred losses from one of its segments. Despite being a private
company, BMI has strong intentions of going public in order to raise the necessary
equity financing and should therefore consider using IFRS.
BMI's management is an important user of the financial statements. As a result of
the economic environment and future IPO offering, Management may have an
increased bias to smooth earnings, separately disclose losses outside of
continuing operations and defer the recognition of liabilities in order to artificially
inflate BMI's share price.
Future investors will also be analyzing the statements very carefully to determine if
BMI's share price is overpriced.
The auditor will want the financial statements to be transparent and neutral.
Issue: Whether to classify the automotive division as held for sale
Classify as Held for Sale
- as the sale of the automotive and
automotive part division has not yet
been completed, the assets must
meet the held for sale criteria to be
designated as discontinued
operations.
- any future expected losses (the
additional $1M) are not allowed to
be classified as discontinued
operations.
- the automotive and automotive parts
can be identified as a separate
component of BMI because the
cash-flows can be easily
distinguished (ie: management is
able to separately track the
profitability of the automobiles and
automotive parts.
- the sale is highly probable as a
formal plan has been approved by
the Board of Directors before the
end of the year.
No separate classification
- the assets are not available for
immediate sale as BMI must spend
$500,000 to remove previous
modifications made to the
equipment for available use by
a third party.
- the sale has a contingency provision
whereby BMI must remove the
existing modifications to the
purchaser's satisfaction.
- it is unclear whether management
believes that 90% of its asking price
is representative of fair value. BMI
may be unwilling to accept the
supplier's bid as fair value for the
equipment.
- there is no evidence in the case that
the sale will be completed within one
year from the balance sheet date
(initial date of held for sale
classification).
- other.
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IC 4-2 BMI (CONTINUED)
Classify as Held for Sale
- the negotiation with the supplier is
evidence that management is
actively seeking a buyer for the
assets.
- management has already committed
to a plan to disassemble the
previous modifications before the
end of the year by hiring a
contractor.
- measurement of the plant (including
the equipment) should remain at CV
as there is no indication that FV is
lower than CV at year end.
- other.
No separate classification
Conclusion: The criteria for held for sale are not met as of the end of the year
and therefore the automotive division assets cannot be classified separately as
held for sale on the balance sheet and the losses from the division ($1M) cannot
be separated as discontinued operations on the income statement. Provided the
modifications are completed and BMI can come to an agreement with the
purchaser on a fair price before the Board authorizes the financial statements, the
transaction will be disclosed in the notes.
Issue: Whether to record a liability for the purchase commitments and/or the
contract penalty
Record liability
Do not record any liability
- the 'event' of not taking delivery of
- the purchase commitment
the spare parts represents a past
represents an executory contract
transaction.
which does not have to be recorded
- a contract exists and payment is
as a liability.
therefore enforceable.
- BMI's lawyer's believe that BMI will
- the $250,000 represents the minimal
not have to pay the penalty because
cash obligation to BMI each year
of a change in engineering of the
(for both the current and following
part specification required.
year).
- the supplier is willing to make
- there are unavoidable costs which
modifications to its spare part in
BMI will be responsible for despite
order to comply with BMI's new
not taking delivery of the parts from
safety standard - to enable BMI to
the truck supplier - this represents
accept delivery in the future.
an onerous obligation.
- other.
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IC 4-2 BMI (CONTINUED)
Classify as Held for Sale
- the case does not identify whether
the supplier has a legal obligation to
make any changes to its goods in
order to appease BMI into taking
future delivery, but it said the
supplier is willing to make the
necessary changes.
- other.
No separate classification
Conclusion: As it is not certain whether the supplier has operational capability,
legal obligation or is willing to adjust the spare part to conform to BMI's new safety
standard the minimum penalty (unavoidable cost) should be accrued i.e., $250,000
in both the current year and an accrual for the final year of the contract.
Minor Issue: How to classify the new building: as an investment property or as
PP&E.
BMI has independent evidence that the building can be clearly segregated into two
distinct components - 50% for operational use and 50% which can be separately
leased out or sold. Both sections of the building must initially be recorded at cost.
For the 50% that will be leased out and used as an investment property, BMI has
the choice of subsequently accounting for the property at fair value or to continue
to account at cost. Irrespective of the accounting policy choice, BMI must disclose
the fair value of the property in the notes of the statements. The 50% that will be
used in the operations of the business must be classified as PP&E. BMI has the
option of using the revaluation model or continue to account for that 50% of the
building at cost.
FV changes for only the 50% which is classified as investment property must flow
through net income. Changes in FV for the 50% classified as PP&E must flow
through a revaluation surplus in other comprehensive income. This will not impact
net income unless a change in use occurs or BMI sells the building.
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RESEARCH AND ANALYSIS
RA 4-1 MAPLE LEAF FOODS INC.
(a) Maple Leaf Foods Inc. uses a condensed multiple-step statement of net
earnings.
(b) Note 1 to the financial statements indicates that Maple Leaf is in the business
of producing a variety of food products, including prepared meats, ready-tocook and ready-to-serve meals as well as value-added fresh pork and poultry.
The note also indicates that the company’s results are reflected in three
segments:
a meat products group, an agribusiness group, and a bakery products group.
Note 1 and Note 25 also indicate that the operations of its 90% owned bakery
group were sold during 2014.
(c) Maple Leaf’s businesses are carried out by the parent company and its
subsidiaries. The financial statements presented, therefore, are consolidated
financial statements. This means that all the revenues and expenses of each
subsidiary are brought into Maple Leaf’s income statement and all the assets
and liabilities of the subsidiaries are reported on Maple Leaf’s balance sheet.
The balance sheet at December 31, 2014 reflects this business in the following
ways: inventories and property and equipment make up a significant portion of
the total assets, and one of the inventory-like assets is described as biological
assets, reflecting the fresh poultry and pork side of the business. It is interesting
to note that at December 31, 2014 there is no longer any non-controlling
interest in the company’s net assets. A logical assumption is that the noncontrolling interest reported at the end of 2013 was the 10% minority interest in
the bakery group sold by Maple Leaf during 2014.
The income statement (statement of net earnings) also reflects these
businesses as information is provided on sales and cost of sales. More
importantly perhaps, is the separate reporting of the earnings from disposition
of the operations discontinued during the year.
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RA 4-1 MAPLE LEAF FOODS INC. (CONTINUED)
(d) The company presents its expenses initially on a functional basis, but ends up
with a mixed presentation model: cost of goods sold, selling, general and
administrative expenses, other items affecting the results for the year from
continuing operation (restructuring charges, fair value changes related to
interest rate swaps, and 13 other items of income, expense, gains and losses
including impairment charges), and then separate reporting of interest and
other financing costs and income tax expense. Throughout the notes to the
statements, however, there is information to allow the reader to determine the
nature of some of the significant expenses: depreciation and amortization,
payroll related costs, lease costs, etc. After reporting the results of continuing
operations (a loss of $213,813 thousand), the earnings from discontinued
operations
are
reported
(a profit of $925,719 thousand) in coming to net earnings (net income of
$711,906).
This mixed presentation model is likely used because the company is a
manufacturer and the relationships between such items as sales and cost of
goods sold and other operating costs are important to look at in any ongoing
evaluation of operations. However items such as interest costs, income taxes,
and other expenses and income are difficult to allocate to basic operating
functions or are far more useful being identified separately on the face of the
statement.
(e) Maple Leaf reports earnings from discontinued operations of $925,719
thousand on the statement of net earnings, and the following detail in Note 25:
(all amounts in thousands of $)
Disposal of Canada Bread – May, 2014
Net earnings before tax (of which $996,994 is the
gain on disposal)
Income taxes
Net earnings
$1,039,843
(108,505)
931,338
Disposal of Olivieri – 2013
Net loss (after tax), adjustment of final proceeds
( 1,726)
Disposal of Rothsay – 2013
Net loss (after tax), adjustment of transaction costs
( 3,893)
Earnings from discontinued operations – 2014
$ 925,719
It is important to disclose this information separately from other results for the
year because users are interested in prospects for returns and cash flows in
the future. By separately reporting the results of those operations that will not
continue into the future, investors and creditors can make much more informed
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Intermediate Accounting, Eleventh Canadian Edition
RA 4-1 MAPLE LEAF FOODS INC. (CONTINUED)
decisions about the company’s future prospects. In this case, although the
company reported bottom-line earnings of $771,906 and earnings per share of
$5.03, the results related to operations that will continue were a loss of
($213,813) and EPS of ($1.51). This is a very different picture, and
emphasizes the need to look further than the bottom line!
(f) The company included the following gains and losses in other comprehensive
income: (all in thousands of $)
 Actuarial gains and losses (net of tax of $17,000) – ($50,869)
 A change in the accumulated foreign currency translation adjustment (net
of tax of $0) – ($557)
 The change in unrealized gains and losses on cash flow hedges (net of
tax of $1,500) - $4,125
All above amounts, totalling ($47,301) relate to continuing operations. In
addition, the following is reported:
 Other comprehensive loss from discontinued operations (net of tax of
$1,300) – ($569)
Total OCI reported = ($47,870)
Comprehensive income for the current year = $664,036
Comprehensive income is attributable to the following two groups:
Maple Leaf common shareholders -- $662,305
To non-controlling shareholders of subsidiary companies -- $1,731
(g) The EPS is calculated on net earnings available to common shareholders and
the weighted average number of shares outstanding. As Maple Leaf has only
common shares, all the earnings accrue to them. Two types of EPS numbers
are described on the statement of earnings: basic and diluted earnings per
share. The basic EPS and an equal diluted EPS are presented on the face of
the income statement, both for the current year and the previous comparative
year. Note 26 indicates that there is no adjustment to the basic EPS for
potentially dilutive securities because the result would have been anti-dilutive.
Note 26 also indicates that the $5.03 basic EPS can be broken down as
follows:
From continuing operations
($1.51)
From the gain on sale of a business, net of tax 6.33
From discontinued operations before the gain
on sale of the business
0.21
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$5.03
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Intermediate Accounting, Eleventh Canadian Edition
RA 4-2 ROYAL BANK OF CANADA
(a)
The core business activities of the bank are, and have traditionally been, to
lend money to businesses, individuals and governments. Increasingly banks
have expanded their core operations to include “wealth management,
insurance, investor services and capital market products and services” all on
a global basis. (See Note 1 to the Royal Bank’s financial statements.)
Interest income from loans and other sources is the single main source of
revenue for the Royal Bank. The financial statements also provide the
amounts generated from 13 other related sources (entitled “non-interest
income”) that account for an increasing proportion of total bank revenues.
The direct costs related to the earning of interest income are interest expense
and provision for credit losses. Other expenses incurred to generate revenue
include labour, occupancy, equipment, communication, and professional fees.
(b)
The presentation of the statement of income of Royal Bank highlights the
sub-total between revenue from its core activities, less the direct interest
expense incurred in generating that income. The caption is “Net interest
income”. This caption is highlighted in the income statement to make
comparisons easier between years and between banks. Other revenue
sources, which are of lesser significance in size, are itemized together as
“non-interest income. Net interest income and the non-interest income
together make up the total revenue reported. The bank then deducts three
types of major expenses – the provision for credit losses that apply to all of
the revenues reported, costs specific to its insurance operations, and a
variety of non-interest expenses – in coming to its income before income
taxes from continuing operations.
The next line items are required disclosures: income tax expense, net income
from continuing operations, net loss from discontinued operations (although
the last discontinued operation was reported in 2012), and net income.
(c)
The primary sources of income for the last three fiscal years for the Royal
Bank appear below (in millions of Canadian dollars).
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Intermediate Accounting, Eleventh Canadian Edition
RA 4-2 ROYAL BANK OF CANADA (CONTINUED)
(c)
(continued)
ROYAL BANK OF CANADA
2014
Primary sources Interest income:
Loans
Securities
Reverse repurchase agreements
Deposits and other
Sub-total
Primary sources Non-interest
revenue :
Insurance premiums
Trading revenue
Investment management and custodial
fees
Mutual fund revenue
Securities brokerage commissions
Service charges
Underwriting and other advisory fees
Foreign exchange other than trading
Card service revenue
Credit fees
Net gain (loss) on available-for-sale
securities
Share of profit in joint ventures and
associates
Other
Total
% of
total
2013
%
2012
%
16,979
3,993
971
76
40.4
9.5
2.3
0.2
52.4%
16,354
3,779
941
74
42.4
9.8
2.4
0.2
54.8%
15,940
3,838
937
54
42.5
10.2
2.5
0.1
55.3%
4,957
742
11.8
1.8
3,911
867
10.1
2.2
4,897
1,305
13.1
3.5
3,355
8.0
2,870
7.4
2,006
5.4
5
1,8
96
1,182
1,376
1,434
5
86
588
8
49
1
48
1
63
2
78
37,477
2,6
21
1,379
1,494
1,809
8
27
689
1,0
80
1
92
1
62
6
85
42,011
2014
6.2
3.3
3.6
4.2
2.0
1.6
2.6
0.5
0.4
1.6
100%
% of
total
2,2
01
1,337
1,437
1,569
7
48
632
1,0
92
1
88
1
59
4
22
38,581
2013
.7
3.5
3.7
4.1
1
.9
1.6
2
.8
0
.5
0
.4
1
.1
100%
%
2012
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5
.1
3.2
3.7
3.8
1
.6
1.6
2
.3
0
.4
0
.4
0
.7
100%
%
Kieso, Weygandt, Warfield, Young, Wiecek, McConomy
Intermediate Accounting, Eleventh Canadian Edition
RA 4-2 ROYAL BANK OF CANADA (CONTINUED)
(c)
(continued)
ROYAL BANK OF CANADA
The primary source of revenue by far continues to be interest income and
specifically, interest from loans. The primary sources of non-interest
revenues are insurance premiums, management fees, securities
commissions and mutual fund revenues, and underwriting and other advisory
fees. The percentages of total income/revenues coming from these noninterest sources are relatively consistent except for trading revenues and
investment management and custodial fees which have been increasing over
the three years, but these will vary depending on equity price trends.
(Although it appears that the total interest income has been decreasing
relative to total revenue in recent years, a comparison to the three year period
prior to 2012 indicates that they also were in a 52% to 55% range. These
numbers are highly dependent on interest rates in the economy which have
been unusually low in recent years.)
(d)
The following transactions were included in the Royal Bank’s Consolidated
Statement of Changes in Equity:











issuances of preferred shares;
issuances of common shares;
redemptions of preferred shares
purchases and cancellations of common shares
sales of treasury shares (both preferred and common);
purchases of treasury shares (both preferred and common);
share-based compensation awards;
net income for the year;
dividends declared on common shares;
dividends declared on preferred and other shares;
gains and losses recognized in Other Comprehensive Income
i. changes in unrealized gains and losses on available-for-sale
securities
ii. changes in unrealized gains and losses on foreign currency
translation amounts
iii. changes in gains and losses on derivatives designated as
cash flow hedges
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Intermediate Accounting, Eleventh Canadian Edition
RA 4-3 BROOKFIELD OFFICE PROPERTIES INC. AND
MAINSTREET EQUITY CORP.
(a)
Both Brookfield Office Properties Inc. and Mainstreet Equity Corp. are in
the real estate property business. Mainstreet’s strategy includes investing in
mid-market multiple unit residential buildings primarily in Western Canada.
The company buys under-performing properties, and through renovation
and implementation of operating efficiencies, enhances the assets’ values.
Therefore, the company earns revenue from rent or sale of buildings.
Brookfield is primarily in the business of owning, developing and managing
premier office properties in the United States, Canada, Australia and the U.K.
(b)
Brookfield Office Properties uses the single step format while Mainstreet
applies a condensed multi-step income statement format. Both statements
report their expenses initially by function, but end up with a mixed model.
Mainstreet reports the results of discontinued operations for both 2014 and
2013, while Brookfield has only continuing operations. Many of their line items
are similar, but Mainstreet reports six subtotals up to and including “Profit
from continuing operations before income tax” while Brookfield’s first subtotal
is “Income (loss) before income taxes.”
(c)
The main source of revenue for Mainstreet is rental revenues which
increased by almost 16% from 2013 to 2014. It also reports “ancillary rental
income” separately, but it is the “fair value gains” that make up 69% of pre-tax
profit from continuing operations. These gains are approximately 5% down
from
the previous year. Brookfield generates revenue primarily from commercial
property revenue, and similar to Mainstreet, also reports “fair value gains” that
make up 84% of its pre-tax profits. Its property revenue is about 1% higher in
2014 than 2013, while the fair value gains are over five times the 2013
amount.
(d)
Yes, the nature of the business is reflected in the balance sheets of both
companies. Investment properties make up 82.5% and 99% of total assets
for Brookfield and Mainstreet, respectively. Brookfield also has investments
in joint ventures making up another 5% of its assets and these could be in
real estate as well.
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RA 4-3 BROOKFIELD (CONTINUED)
(e)
Mainstreet has no other comprehensive income items, so comprehensive
income and net profit are the same amount. Brookfield has included the
following types of other comprehensive income, net of related taxes:
Unrealized foreign currency losses; gains on hedges of net investments
in foreign operations; losses on derivatives designated as cash flow hedges;
realized losses reclassified to net income; unrealized gains on available-forsale classified securities; and an addition to revaluation surplus for the year.
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RA 4-4 CANADIAN SECURITIES ADMINISTRATION
(a)
The documents that can be found on the SEDAR website listed for the Bank
of Montreal and the Royal Bank of Canada include:
1. Notices of annual filing
2. Auditors’ consent letters
3. Consent letters of issuer’s legal counsel
4. Consent letters of underwriters’ legal counsel
5. Prospectuses and related documents
6. Decision Documents
7. News releases
8. Interim financial statements/reports
9. Annual reports
10. Annual information form
11. Marketing materials
12. Certification of filings
13. Underwriting or agency agreements
14. Proxy forms
15. Meeting notices
(b)
The annual information form provides reference to and some of the
information required by National Policy Statement No. 47 of the Canadian
Securities Administrators and Schedule IX of the Quebec Securities Act
Regulation for filing various regulatory authorities in Canada.
The Annual Information Form (AIF) provides information on the recent
history of the business, description of the current business; names of
directors and executive officers, including the number of shares owned by
each; the interest of management and others in material transactions; the
composition and mandate of the audit committee and fees paid to the
auditors; a history of the share price and dividends paid; the capital
structure, and credit rating of the company.
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RA 4-4 CANADIAN SECURITIES ADMINISTRATION (CONTINUED)
(b)
(continued)
Some of the information is found in the company’s Management Discussion
& Analysis and is incorporated in the AIF by virtue of being cross-referenced
in the AIF itself.
Since the majority of the information provided is financial in nature, it would
most certainly be of interest to a financial statement analyst. Although the
information can be located through other means, the AIF is less likely to
have missing information. It can be relied upon for completeness and
accuracy, since it is also being closely monitored and used by the regulatory
authorities.
(c)
The auditor of the Bank of Montreal is KPMG LLP. The auditor of Royal
Bank of Canada is Deloitte LLP.
(d)
The stock of Bank of Montreal is traded on the Toronto Stock Exchange and
the New York Stock Exchange. The stock of the Royal Bank of Canada is
traded on the Toronto Stock Exchange and the New York Stock Exchange
and other.
(e)
The banks’ web sites with links for investor relations provide the most
current announcements and notices of the banks, and provide informatio n
such as the Annual Reports, but in segments. For example the web user
can select to read only the notes to the financial statements. While the
information is and should be the same as what is filed with the securities
authorities, it is being presented in a more user-friendly format, considering
the many possible users that gain access to this information through the
web site. The web presentation can also take advantage of some multimedia presentation techniques such as webcasts of the Annual General
Meetings that are not necessarily appropriate for the formal annual filings.
Information of a more promotional nature is being emphasized for marketing
and other purposes. Up-to-date information of company share prices on the
stock exchanges are available, as are the answers to “frequently asked
questions” (FAQs).
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RA 4-5 QUALITY OF EARNINGS ASSESSMENT
Student responses will vary depending on their sources. In short, the
assessment is required in order to determine how and when a company will
generate cash flows in the future, something that is not obvious from a quick
review of the company’s GAAP financial statements. This information is a
necessary input in determining the fair value of a company and its shares,
and in pricing its debt instruments. The key issue to keep in mind when
assessing earnings quality is that the higher its quality, the better the ability to
predict the company’s future cash flows. Recurring issues in the literature are
as follows:

the closer the earnings reflect underlying economic reality, the higher
the quality

earnings which are replicable or sustainable are higher quality than
unsustainable earnings

earnings which can be converted to positive cash flow more quickly are
higher quality than those which have a longer time lag or more
uncertainty with respect to the ultimate conversion to cash flow

the less risky the business environment and the better the risks are
managed, the higher the quality of earnings

more objectively determined earnings are higher quality than earnings
which involve a high degree of estimation, accounting alternative
choices and management bias

the more transparent and straightforward the presentation, the higher
the quality of earnings
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RA 4-6 BCE INC.
Management reporting of non-GAAP earnings numbers, outside of the traditional
audited financial statements, provides additional information that would not
otherwise be presented, or in some cases available, to investors and other users.
The presentation of such information can assist users in assessing results of
operations and financial position, and in predicting future earnings potential from a
management perspective. It allows users to focus specifically on what
management sees as relevant information, since it is tailored to that specific
company and circumstances. In the case of BCE, the company has explained, in
considerable detail, their reasons for using these measures and the reasoning
seems to be solid. Internally, employees have little control over interest,
depreciation and taxes, and therefore EBITDA is often a target used. Analysts and
users can then see how the company measures internal results.
The problem with reporting supplemental earnings numbers is not so much with
the practice, per se, as with how it is done. If the calculations and reasons for the
items selected for adjustment are not clearly disclosed, and if a reconciliation with
the GAAP net income is not provided, the additional information may be confusing
and/or misleading rather than aiding users in their decision making process.
However, in the case of BCE, all of these non-GAAP measures have been
reconciled to GAAP measurements. The other problem with these numbers is that
no standards exist to ensure that they are calculated consistently, which means
that
it
is
risky
to make comparisons between companies on the basis of these numbers. BCE
alerts readers to this shortcoming as part of its non-GAAP financial measures note.
Therefore, with details of the calculations provided, these weaknesses can be
overcome.
In the case of this company, I do think that this presentation provides good, useful
information because the company has provided detailed reconciliations and
reasons supporting the usage of these non-GAAP measures.
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rights reserved.
The data contained in these files are protected by copyright. This manual is
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photocopying, recording, scanning, or otherwise without the prior written
permission of John Wiley & Sons Canada, Ltd.
MMXV xi F1
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