10
The Balance Sheet and Income
Statement: A Closer Look
Discussion Questions
10-1. The detailed information provided by the classified balance
sheet is more useful in predicting cash flows than the simple
format. You students may come up with a variety of examples
to support this conclusion. Among the possible examples are:
-- The simple format shows total assets of $1,516,800. The
classified balance sheet tells readers that approximately 1/3
of that amount ($600,000) is held in current assets. Unlike the
long-term assets, the current assets can be expected to
become cash in the upcoming year.
-- Total liabilities for the company are $851,000. However, the
simple format of the balance sheet provides no information
about when cash will be needed to pay these debts. From the
classified balance sheet presentation, readers can learn that
more than 2 of the liabilities ($551,000) are current, and
therefore, are expected to use up cash in the next year.
-- The classified balance sheet shows that more than half of
the company=s stockholders= equity is a result of the sale of
stock. Retained earnings, generated from profitable business
activity, accounts for only $265,800 of the $665,800 total
stockholders= equity.
10-2. The prepaid expenses ($50,000) represent amounts that will
most likely never be converted to cash. As an example,
prepaid insurance will be used up as time passes, but no
cash flow will result. These items are classified as current
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
F10-1
assets because the benefit they provide is expected to be
received and used by the company within the next year.
10-3. The classification of plant and equipment as long-term assets
on the 2007 balance sheet indicates the company intended at
that time to hold them longer than a year. Certainly, if
circumstances change and management decides they should
sell the assets during 2008, they may do so.
10-4. A company may set aside funds in a long-term account for
various reasons. One reason is a sinking fund set up to retire
bonds payable. Funds may also be established to provide a
compensating balance for a long-term obligation. Another
reason would be funds set up to replace fixed assets.
Students may come up with other original ideas.
10-5. Students should understand that intangible assets do have
value and at times the value may be very significant.
Companies spend large sums of money to hire attorneys to
defend their rights in the intangible assets. Ask students to
think about trademarks and logos and to recognize the value
inherent in McDonald=s Golden Arches, the Coke trademark,
or the Nike symbol.
10-6. The maximum economic life of many intangibles is defined by
law. The economic life is the length of time the intangible will
benefit the company. The useful life is the shorter of the legal
life or the economic life of the asset. One must also look at
the economic life in terms of technology improvements and
obsolescence. Computer software serves as a good example
of this particular problem.
10-7. NOTE TO INSTRUCTOR: The exposure many of your
students have had to the balance sheet may be limited to the
examples presented throughout this textbook and the
F10-2
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
companies they have examined on the Internet and annual
report project. Some students will be hard pressed to come
up with the examples needed to answer Discussion Question
10-7. If you think this is the case, invite them to analyze the
balance sheet presentations included in the annual reports of
Family Dollar (included in the text). Be sure to have the
students explain what the items mean.
Examples of current liabilities are: Wages Payable, Taxes
Payable, Customer deposits (Unearned Revenue),
Utilities Payable, and Current Portion of Long-Term Debt
(the part that must be paid during the next year).
Examples of long-term liabilities are: Long-Term Notes,
Mortgages, and Deferred Income Taxes.
10-8. Several parties, both internal and external to the company,
will be interested in the amounts of current assets and current
liabilities. Examples include:
-- Management of the company who will certainly be watching
to see that sufficient current assets are available to meet the
current liabilities of the company. Individuals within the
company may be specifically assigned to monitor the
relationship of current assets to current liabilities, and to
manage payment of debts arising from the day-to-day
operations of the business.
-- Creditors, especially those to whom the $501,000 of
accounts payable are owed, will be interested in the amount
of current assets the company has available to meet its
obligations.
-- If the company tries to borrow more funds on a short-term
basis, a potential lender will be interested in seeing that the
company will have sufficient current assets to be able to
repay the loan.
-- Even potential investors considering buying stock in the
company on the secondary market will be interested in the
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
F10-3
relationship between the company=s current assets and
current liabilities. As we have said before, if a company
cannot pay its debts in the short term, it will not even be
around in the long term.
10-9. The amount for retained earnings represents the sum of all
profits and losses of the company over its life less all
dividends declared. Students must understand that the
retained earnings account does not represent a cash fund.
10-10. Eliason received cash or other assets of $400,000 in
exchange for the 10,000 shares of stock. The Common Stock
account balance of $400,000 divided by the total number of
shares of stock (10,000) equals $40 per share.
10-11. The current market value of the stock cannot be determined
from the balance sheet information alone. If the company=s
stock is publicly traded, an investor can acquire this
information from a stockbroker, the Internet with Yahoo! or
another search engine, a current business paper such as The
Wall Street Journal, an on-line computer service offering
current market prices for stocks, or television. If Eliason=s
stock is privately held, there is no way to determine the
current market value.
10-12. The detailed income statement for Eliason and Company
follows the multi-step format. The two items unique to this
format are: (1) Gross Profit on Sales (also called simply
Gross Profit or Gross Margin); and (2) Operating Income
(also sometimes called Income From Operations).
10-13. At this point in their study, students should be familiar with
everything except the extraordinary item. In trying to predict
the future profitability of Eliason and Company, a case can be
F10-4
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
made for considering several different numbers on the
income statement.
-- Net Loss of $87,900. This is Athe bottom line@ of the
company=s results of operations for the year and may be
considered the most reliable number in predicting the future
because it includes all rewards (revenues and gains) and all
sacrifices (expenses and losses) Eliason experienced during
the period. However, the bottom line may include items not
representative of what can be expected to happen in the
future.
-- Income Before Extraordinary Item of $147,890. Even
without reading ahead, your students should suspect that an
extraordinary item may not be repeatable. When predicting
the future profitability of Eliason and Company, an
extraordinary item (good or bad) should not be considered.
Both interest expense and income taxes are Anecessary
evils@ and should probably be expected to happen in the
future. The $147,890 considers the impact of both these
items.
-- Operating Income of $243,200. Some argue that when
predicting future profitability of the operation, we should focus
on this item because it represents the results of the activity for
which the company is really in business. However, it does
ignore interest expense and income taxes.
10-14. In order to be classified as an extraordinary item, the gain or
loss must be BOTH unusual and infrequent. The
determination of an item as unusual or infrequent must be
made within the physical and business environment of the
operation. The following explanations are based on those
offered by the Financial Accounting Standards Board in AINAPB30, #1:
(a) Frost damage in Florida is unfortunate, but certainly not
unusual or infrequent. Citrus growers in the area should
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
F10-5
(b)
(c)
(d)
expect this type of loss from time to time, and would
expect this event to recur in the future.
The criterion of infrequency of occurrence has not been
met since past experience indicates that such sales may
reasonably be expected to recur in the foreseeable
future.
Since the company owns several securities held for
investment purposes (it has a portfolio), it should be
concluded that sales of such types of securities are
related to its ordinary and typical activities in the
environment in which it operates and thus the criterion of
unusual nature would not be met.
Notwithstanding the infrequency of occurrence of the
event as it relates to this particular company, moving
from one location to another is an occurrence which is a
consequence of customary and continuing business
activities (i.e., finding more favorable labor markets,
more modern facilities, proximity to customers or
suppliers).
10-15. Based on the balance sheet, it appears that Pursifull received
a total of $1,850,000 from the sale of all stock. Pursifull
received $100 per share from the sale of the preferred stock
($500,000 / 5,000 shares) and $13.90 per share from the sale
of common stock ($1,240,000 / 85,000 shares) prior to the
year 2000. During 2000 Pursifull sold no preferred stock, but
sold 5,000 shares of common stock at an average price of
$22 per share ($110,000 / 5,000).
10-16. It appears that Pursifull declared $90,000 in dividends in the
year 2000 because of the following calculation:
Beginning Retained Earnings
Add: Net Income
F10-6
$675,580
208,470
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
Ending Retained Earnings
Dividends Declared
$884,050
794,050
$ 90,000
The dividend on the preferred stock was 9% or $9 per share
on 5,000 shares. The total preferred dividend was $45,000
leaving $45,000 for the common shareholders or $.50 per
share on 90,000 shares of common stock.
10-17. The ending balance in retained earnings for 2007 is the
beginning balance for 2008, so:
NORTON INC.
STATEMENT OF RETAINED EARNINGS
FOR THE YEAR ENDED DECEMBER 31, 2008
Beginning Retained Earnings, January 1, 2008
Add: Net Income for 2008
$1,032,000
494,000
$1,526,000
Less: Dividends
137,000
Ending Retained Earnings, December 31, 2008 $1,389,000
NOTE: The ending balance in retained earnings is the
amount shown on the 2008 balance sheet. Net income for the
year increased retained earnings, but since the ending
balance is retained was $1,389,000, as shown on the balance
sheet, something must have caused a decrease in retained
earnings. At this point, students should deduce that dividends
in the amount of $137,000 caused the decrease.
10-18. The comparative balance sheets show beginning and ending
balances in retained earnings, but do not provide information
about what caused the changes. Retained earnings was
affected by both net income and dividends. Net income was
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
F10-7
reported on the income statement, but dividend information is
not specifically shown on either the balance sheets or the
income statements. The statement of retained earnings
provides the information about dividends declared during
2008.
Review the Facts
A.
Accounting records were originally used to assist in
conducting operations rather than to report on operations of
the company. The emphasis was on balance sheet data and
the income and expense information were considered
incidental.
B.
The evolution of the stock markets caused a change in focus
from creditor to investor and the realization that the balance
sheet and income statement are best used together.
C.
A decision maker would prefer a classified balance sheet
because it provides more detailed information about the
decreasing liquidity of assets. The liabilities are classified
based on when they are due. These classifications provide
much useful information to the user of the balance sheet.
D.
Current assets are assets that are either cash or will become
cash within one year. Examples are cash, accounts
receivable, and inventory. Long-term assets are assets
expected to benefit the company or to become cash in more
than one year. Examples are fixed assets and investments.
F10-8
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
E.
Assets are presented on the balance sheet in the order of
their liquidity. The assets that are the most liquid are
classified first.
F.
Investments represent long-term commitments to ownership
of other entities or funds set aside for specific purposes.
Intangible assets are assets consisting of contractual rights
such as patents, franchises, trademarks and copyrights.
G.
Current liabilities are those that require settlement within one
year. Examples are accounts payable and taxes payable.
Long-term liabilities are amounts not due for settlement until
at least one year from now. Bonds payable and mortgages
payable would be examples of long-term liabilities.
H.
Recurring items are those that are expected to occur on a
regular basis while nonrecurring items are not expected to
occur again and should not be used to predict future
performance. These items are reported separately because
the separate classification of these items is crucial to the
usefulness of the accounting information.
I.
The two major items on the income statement that are shown
net of tax are extraordinary items and discontinued
operations.
J.
Income taxes have the effect of reducing the amount of the
gain on an income statement and the effect on losses is to
increase the amount of income because of the tax saving
associated with the loss.
K.
A business component is a portion of the business for which
assets, results of operations, and activities can be identified.
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
F10-9
L.
For an item to be considered extraordinary it must be both
unusual in nature and infrequent in occurrence. The operating
environment must be considered as what may be unusual for
one company may be ordinary for another company.
M.
Discontinued operations consists of three possible items:
1) the income or loss from business component for the year;
2) an impairment loss for the assets of the component; and 3)
the gain or loss from the disposal of the business component.
The combination of these three items minus the tax increase
or savings must be reported in a special disclosure.
N.
Comprehensive income is the change in equity from
nonowner transactions. Comprehensive Income = Ending
Equity – Beginning Equity – Owners’ Contributions + Owners’
Distributions.
O.
The earnings per share (EPS) amount indicates how much of
a company’s total earnings is attributable to each share of
common stock. Basic EPS is based on shares outstanding at
the balance sheet date. Diluted EPS is based on all
potentially dilutive securities, including consideration of
convertible securities (debt or equity securities that can be
converted into shares of the company’s common stock).
P.
Comparative financial statements show results for two or
more periods. Comparative statements are useful to develop
a history of performance over a period of time and they allow
readers to develop trends that may not be discernible in a
single period.
F10-10
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
Apply What You Have Learned
10-19.
1. f
2. c
3.
4.
5.
a
g
i
6.
7.
8.
d
h
b
9.
e
10.
j
Obligations not requiring payment within the next year
Items controlled by a company that are not expected to
become cash within the next year
Describes an items nearness to cash
The owner’s residual interest in a corporation
Long-lived tangible assets less all the depreciation
expense ever recognized on those assets
Obligations that must be retired within the next year
Equal to total assets
Items controlled by a company that are expected to
become cash within the next year
An investment in a contractual arrangement such as a
patent
A long-term commitment to ownership of other entities
10-20.
a. Investments represent long-term commitments to ownership
of other entities, called subsidiaries; or investments in trust
funds, bond sinking funds, or bonds of other corporations.
Investments are assets not intended to be used within the
next year and are classified as long-term assets.
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
F10-11
b.
Examples of investments include a bond sinking fund,
investments in the common stock of a subsidiary company, or
bonds that have been issued by another company. All these
investments would be classified as long-term assets.
10-21.
a. Intangible assets are those that provide special revenueproducing benefits and protection to a company (through
contracts), but do not have a physical form. We amortize the
cost of intangible assets over their economic lives.
b. Intangible assets would include patents, copyrights,
trademarks, trade names, and purchased goodwill. These
items are classified as long-term assets under the heading of
Intangibles or Intangible Assets.
c. Amortization is the term applied to the process of matching
the cost of the asset with the time periods benefited or with
the revenue it helps to create (similar to depreciation).
10-22.
1.
2.
3.
4.
5.
6.
7.
8.
9.
c
f
d
a
c
a
f
e
g
10.
11.
f
h
F10-12
Accounts payable
Common stock
Franchise
Accounts receivable
Note payable due within one year
Prepaid expense
Preferred stock
Note payable due in two years
Amounts earned by the company but not yet distributed to
the owners of the business
Amounts received in excess of par value on the sale of stock
Bonds held for the interest to be earned
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
12.
13.
14.
15.
16.
17.
18.
19.
20.
b
h
c
b
d
a
b
e
d
Land
Stock of a subsidiary
Wages payable
Vehicles
Copyright
Cash
Buildings
Bonds Payable
Trademark
10-23.
a. The par value of Dana’s stock is $4 per share. There is a par
value because there is an Additional Paid-in Capital amount
shown. The amount of the par value is determined by dividing
the total dollar amount shown as Common Stock by the
number of shares outstanding:
$300,000
= $4.00 per share par value
75,000 shares
b.
The amount Dana received from the sale of its common stock
is the amount listed under Common Stock plus the amount of
Additional Paid-in Capital:
$300,000 + $10,000 = $310,000 total cash received
c.
Dana Corporation
Balance Sheet
As of December 31, 2007
ASSETS
Current Assets
Cash
Accounts Receivable
Inventory
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
$ 14,600
92,300
118,000
F10-13
Prepaid Expenses
Total Current Assets
Long-Term Assets
Land
Buildings and Equipment
Less: Accumulated Depreciation
Buildings and Equipment, Net
Total Long-Term Assets
Total Assets
11,200
$236,100
$210,000
$400,000
142,000
258,000
468,000
$704,100
10-23. (Continued)
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities
Accounts Payable
$ 74,000
Wages Payable
35,800
Taxes Payable
17,000
Short Term Note Payable
50,000
Total Current Liabilities
$176,800
Long-Term Liabilities
Bonds Payable
100,000
Total Liabilities
$276,800
Stockholders’ Equity
Common Stock, $4 par value, 75,000
shares issued and outstanding
$300,000
Additional Paid-in Capital – Common Stock
10,000
Retained Earnings
117,300
Total Stockholders’ Equity
427,300
Total Liabilities and Stockholders’ Equity
$704,100
10-24.
a. Wesnidge has 200,000 shares of common stock outstanding
at December 31, 2008. The number of shares outstanding is
determined by dividing the total dollar amount of Common
Stock by the par value (per share) of the stock:
$400,000
F10-14
= 200,000 shares outstanding
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
$2.00 par value
b.
The amount Wesnidge received from the sale of its common
stock is the amount listed under Common Stock plus the
amount of Additional Paid-in Capital:
$400,000 + $240,000 = $640,000 total cash received
10-24. (Continued)
c.
Wesnidge Corporation
Balance Sheet
As of December 31, 2008
ASSETS
Current Assets
Cash
Accounts Receivable
Inventory
Prepaid Expenses
Total Current Assets
Long-Term Assets:
Land
Buildings and Equipment
Less: Accumulated Depreciation
Buildings and Equipment, Net
Total Long-Term Assets
Total Assets
$124,200
212,000
338,000
9,800
$684,000
$490,000
$875,000
271,000
604,000
1,094,000
$1,778,000
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities
Accounts Payable
$172,000
Wages Payable
77,600
Taxes Payable
47,000
Short Term Note Payable
70,000
Total Current Liabilities
$366,600
Long-Term Liabilities
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
F10-15
Bonds Payable
Total Liabilities
Stockholders’ Equity
Common Stock, $2 par value, 200,000
shares issued and outstanding
$400,000
Additional Paid-in Capital–Common Stock 240,000
Retained Earnings
463,700
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
307,700
$674,300
1,103,700
$1,778,000
10-25.
a. Marple has 400,000 shares of common stock outstanding at
December 31, 2007. The number of shares outstanding can
be determined by dividing the total dollar amount of Common
Stock by the par value (per share) of the stock:
$800,000
= 400,000 shares outstanding
$2.00 par value
b.
The amount Marple received from the sale of its common
stock is the amount listed under Common Stock plus the
amount of Additional Paid-in Capital:
$800,000 + $240,000 = $1,040,000 total cash received
F10-16
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
10-25. (Continued)
c.
Marple Corporation
Balance Sheet
As of December 31, 2007
ASSETS
Current Assets
Cash
Accounts Receivable
Inventory
Prepaid Expenses
Total Current Assets
Long-Term Assets
Land
Buildings and Equipment
Less: Accumulated Depreciation
Buildings and Equipment, Net
Total Long-Term Assets
Total Assets
$124,200
212,000
338,000
29,400
$703,600
$690,000
$985,000
385,000
600,000
1,290,000
$1,993,600
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities
Accounts Payable
$ 516,000
Wages Payable
132,800
Taxes Payable
141,000
Short Term Note Payable
210,000
Total Current Liabilities
$ 999,800
Long-Term Liabilities
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
F10-17
Bonds Payable
Total Liabilities
Stockholders’ Equity
Common Stock, $2 par value, 400,000
shares issued and outstanding
Additional Paid-in Capital – Common Stock
Retained Earnings (deficit)
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
923,100
$1,922,900
$800,000
240,000
(969,300)
70,700
$1,993 ,600
10-26.
a.
b.
F10-18
Current assets are those assets that are either cash or are
expected to become cash within one year. Any asset not
expected to be settled within one year is classified as a long-term
asset. Current liabilities are those debts that require settlement
within one year. Any liability that will not be settled within one year
is classified as a long term liability.
1.
Short-term creditors expect payment within one year. These
parties are interested in which assets and liabilities are
classified as current because that information can indicate
whether a company has sufficient current assets to settle its
current liabilities.
2.
Long-term creditors are interested in the amount of current
liabilities a company has in relation to its current assets
because, if a company cannot meet its current obligations, it
will likely not be able to meet its long-term obligations. A
long-term creditor may also be interested in the company’s
overall level of long-term debt because the company may
have long-term obligations as well.
3.
Stockholders receive a return on their investment when a
company pays dividends and when the company’s stock
appreciates in value. If a company cannot settle its current
liabilities, it may not be able to pay dividends or meet its
long-term liabilities. If the company fails to meet these
obligations and pay dividends, its stock is not likely to
appreciate in value. The separation of assets and liabilities
into current and long-term indicates to the stockholders the
company’s ability to meet its current and long-term debts
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
4.
and pay dividends.
The separation of assets and liabilities into current and longterm allows a company’s management to plan for the
retirement of its obligations in a timely manner. Additionally,
management has a vested interest in presenting a balance
sheet to its creditors and stockholders that will instill
confidence in the way management is conducting the affairs
of the company.
10-27.
a.
b.
Contributed capital represents the amount invested by the owners
of the business. Retained earnings represents the equity built by
the company through profitable operation. It is the portion of
accumulated net earnings of the company since it was organized
that has not been distributed back to the owners in the form of
dividends.
1.
Short-term creditors have little interest in the relative
proportions of contributed capital and retained earnings
shown in the stockholders’ equity section of the balance
sheet. They are concerned about the company’s ability to
meet its short-term obligations, which is usually evaluated by
comparing current assets and current liabilities. Short-term
creditors would be more interested in cash flow and
earnings performance.
2.
Long-term creditors have little interest in the relative
proportions of contributed capital and retained earnings
shown in the stockholders’ equity section of the balance
sheet. They are concerned about the company’s ability to
meet its long-term obligations. Long -term creditors would be
more interested in other debt, cash flow, and earnings
performance.
3.
Stockholders are interested in the relative proportions of
contributed capital and retained earnings shown in the
stockholders’ equity section of the balance sheet for a
number of reasons. The equity a company has built through
profitable operations is indicated by the retained earnings
balance. Stockholders may be interested in seeing a
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
F10-19
sufficiently large retained earnings balance to support the
payment of future dividends. The contributed capital section
indicates results of external equity financing, whereas
retained earnings indicates internal financing. In the long
run, a healthy business will support its operations through
internal financing (generation of profits). The stock market’s
evaluation of a company’s health impacts its stock value,
which is of great concern to the stockholders.
10-27. (Continued)
4.
10-28.
1. n
2.
c
3. a, b
4.
c
5.
d
6.
7.
c
e
F10-20
Management’s interest in the relative proportions of
contributed capital and retained earnings shown in the
stockholders’ equity section of the balance sheet is often a
concern about the reaction of creditors and the company’s
stockholders. Management’s performance may be evaluated
on its ability to generate company profits and increase the
balance in retained earnings. Also, members of
management are usually shareholders in the company. They
would share the concerns about dividends and stock
appreciation of other stockholders.
A manufacturing company sells a warehouse with a
book value of $20,000 for $20,000.
A company located on the Gulf coast experiences
damage from a hurricane.
A company sells units of inventory in the normal course
of its business operation.
A company located in San Francisco, California
experiences a loss from earthquake damage. This loss
is determined to be a “special” item.
A company disposes of a major component of its
business.
A company pays wages, rent, utilities and so forth.
A company located in Columbia, South Carolina,
experiences a loss from earthquake damage. This loss
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
is determined to be both unusual in nature and
infrequent in occurrence.
10-29.
1. e
2.
c
3.
4.
a
g
5.
b
6.
f
7.
d
A material gain or loss that is both unusual in nature and
infrequent in occurrence
Generally, the difference between normal ongoing
revenues and normal ongoing expenses
The difference between sales and cost of goods sold
Any item that should not be considered a normal part of
continuing operations because it is not expected to
happen again
Sacrifices incurred in the normal day-to-day running of a
business
Any item considered a normal part of continuing
operations because it is expected to happen on an
ongoing basis
The disposal of a business component
10- 30.
a.
b.
External economic decision makers attempt to predict the future
amount and timing of cash flows. The income statement helps
these economic decision makers predict a company’s ability to
generate positive cash flows in the future. On the income
statement, by showing discontinued operations, extraordinary
items, and the cumulative effect of changes in accounting
principles net of taxes separately, the decision makers can more
accurately predict the future based on the ongoing operations of
the business.
An item shown “net of tax” has been reduced by any income tax
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
F10-21
caused by that item. In the case of a gain, the actual amount of
the gain is reduced by the increased tax caused by the gain. In
the case of a loss, the actual amount of the loss is reduced by the
tax savings resulting from the loss. Net of tax presentations are
shown for nonrecurring items such as discontinued operations,
extraordinary items, and changes in accounting principles.
10-31.
The disposal of a component is treated as a nonrecurring item, to
be reported on the income statement below net income from
operations, but before extraordinary items and cumulative effects
of a change in accounting principle. In this case, the loss of
$150,000 from the operation of the component from January 1 to
February 28, 2001,and the $100,000 loss from the sale of the
component should be shown separately net of tax below the net
income from operations under the heading of discontinued
operations. The two items are then combined to show the net loss
from discontinued operations.
10-32.
The disposal of a component is treated as a nonrecurring item, to
be reported on the income statement below net income from
operations, but before extraordinary items. In this case, the loss
of $400,000 from the operation of the component from January 1
through June 30, 2008, and the $200,000 gain from the sale of
the component should be combined and shown net of tax below
the net income from operations under the heading of discontinued
operations.
10-33.
The disposal of a component is treated as a nonrecurring item, to
be reported on the income statement below net income from
operations, but before extraordinary items. In this case, the loss
of $1,000,000 from the operation of the component from January
1 through September 30, 2008, and the $300,000 gain from the
F10-22
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
sale of the component should be combined and shown net of tax
below the net income from operations under the heading of
discontinued operations.
10-34.
Kim Cook, Inc.
Income Statement
For the Year Ended December 31, 2007
Sales
Less: Cost of Goods Sold
Gross Profit on Sales
Less: Operating Expenses
Operating Income
Less: Interest expense
Income from Continuing Operations Before Taxes
Less: Income Taxes
Income from Continuing Operations
Extraordinary Loss (Less: Income Taxes of $42,400)
$665,000
271,000
$394,000
145,000
$249,000
27,000
$222,000
88,800
$133,200
( 63,600)
Net Income
$ 69,600
10-35.
Linda Doyle and Company
Income Statement
For the Year Ended December 31, 2008
Sales
Less: Cost of Goods Sold
Gross Profit on Sales
Less: Operating Expenses
Operating Income
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
$575,000
372,500
$202,500
121,500
$ 81,000
F10-23
Less: Interest expense
Income from Continuing Operations Before Taxes
Less: Income Taxes
Income from Continuing Operations
Extraordinary Gain (Less: Income Taxes of $15,000)
Net Income
16,000
$ 65,000
19,500
$ 45,500
35,000
$ 80,500
10-36.
Fred Cole Company
Income Statement
For the Year Ended December 31, 2008
Sales
Less: Cost of Goods Sold
Gross Profit on Sales
Less: Operating Expenses
Operating Income
Less: Interest expense
Income from Continuing Operations Before Taxes
Less: Income Taxes
Income from Continuing Operations
Discontinued Operations:
Loss from Discontinued Operations
(Less: Income Taxes of $32,000)
Net Income
F10-24
$1,075,000
667,000
$ 408,000
102,500
$ 305,500
43,000
$ 262,500
105,000
$ 157,500
(48,000)
$ 109,500
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
10-37.
Toni Bradshaw, Inc.
Income Statement
For the Year Ended December 31, 2008
Sales
Less: Cost of Goods Sold
Gross Profit on Sales
Less: Operating Expenses
Operating Income
Less: Interest expense
Income from Continuing Operations before Taxes
Less: Income Taxes
Income from Continuing Operations
Discontinued Operations:
Gain from Discontinued Operations
(Less: Income Taxes of $10,500)
Net Income
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
$465,000
239,000
$226,000
113,200
$112,800
11,000
$101,800
30,540
$ 71,260
24,500
$ 95,760
F10-25
10-38.
a. External economic decision makers attempt to predict the
future amount and timing of cash flows. The income
statement helps these economic decision makers predict a
company’s ability to generate positive cash flows in the future.
On the income statement, by separating items into recurring
and nonrecurring, the multistep income statement allows
users to more accurately predict the items that are expected
to recur in the future.
b. An item shown “net of tax” has been reduced by any income
tax effect on that item. In the case of a gain, the actual
amount of the gain is reduced by the increased tax caused by
the gain. In the case of a loss, the actual amount of the loss
is reduced by the tax savings resulting from the loss. Net of
tax presentations are shown for nonrecurring items
(discontinued operations and extraordinary items).
Because the two major types of nonrecurring items are
presented in a section of the income statement separate from
continuing operations, lumping their tax effects with the tax
expense shown for continuing operations would distort the
information. On the other hand, to show two different income
tax expense amounts on the income statement (one for
recurring items and one for nonrecurring items) would be
confusing to statement users. The accounting profession
decided that the only income tax expense shown on the
F10-26
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
income statement as a separate line item will be the amount
associated with continuing operations. Therefore, the two
major types of nonrecurring items included on the income
statement will be shown net of tax.
10-39.
Basic EPS = Net income – Preferred Dividend Requirement
Weighted average shares common stock outstanding
EPS = $337,600 – $100,000*
40,000 shares
EPS = $5.94 per share
*(10,000 shares x $200 x 5%)
10-40.
Basic EPS = Net income – Preferred Dividend Requirement
Weighted average shares common stock outstanding
EPS = $337,600 – $100,000*
43,750 shares
EPS = $5.43 per share
*(10,000 shares x $200 x 5%)
(A)
Number of Shares
Date
Outstanding
January 1
40,000
April 1
`
45,000
Weighted Average Number of Shares
(B)
Period
of Time
3/12
9/12
(A) x (B)
10,000
33,750
43,750
10-41.
Basic EPS = Net income – Preferred Dividend Requirement
Weighted average shares common stock outstanding
EPS = $775,200 – $100,000*
85,000 shares
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
F10-27
EPS =
$7.94 per share
*(20,000 shares x $100 x 5%)
(A)
Number of Shares
Date
Outstanding
January 1
80,000
July 1
90,000
Weighted Average Number of Shares
F10-28
(B)
Period
of Time
6/12
6/12
(A) x (B)
40,000
45,000
85,000
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
10-42.
a.
Basic EPS = Net income – Preferred Dividend Requirement
Weighted average shares common stock outstanding
EPS = $337,600 – $100,000*
41,250 shares
EPS = $5.76 per share *(10,000 shares x $200 x 5%)
(A)
(B)
Number of Shares
Period
Date
Outstanding
of Time
January 1
40,000
9/12
October 1
45,000
3/12
Weighted Average Number of Shares
(A) x (B)
30,000
11,250
41,250
b.
Diluted EPS = Net income – Preferred Dividend Requirement
Weighted average shares common stock outstanding
$337,600 – $ -041,250 shares + 30,000 conversion shares
EPS = $4.74 per share
EPS =
(A)
Number of Shares
Date
Outstanding
January 1
40,000
October 1
45,000
Weighted Average Number of Shares
(B)
Period
of Time
9/12
3/12
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
(A) x (B)
30,000
11,250
41,250
F10-29
10-43.
a.
Basic EPS = Net income – Preferred Dividend Requirement
Weighted average shares common stock outstanding
EPS = $775,200 – $100,000*
85,000 shares
EPS = $7.94 per share *(20,000 shares x $100 x 5%)
(A)
Number of Shares
Date
Outstanding
January 1
80,000
July 1
90,000
Weighted Average Number of Shares
(B)
Period
of Time
6/12
6/12
(A) x (B)
40,000
45,000
85,000
b.
Diluted EPS = Net income – Preferred Dividend Requirement
Weighted average shares common stock outstanding
EPS =
$775,200 – $ -085,000 shares + 100,000 converted shares
EPS = $4.19 per share
(A)
Number of Shares
Date
Outstanding
January 1
80,000
July 1
10,000
Weighted Average Number of Shares
F10-30
(B)
Period
of Time
9/12
6/12
(A) x (B)
80,000
5,000
85,000
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
10-44.
a.
Basic EPS = Net income – Preferred Dividend Requirement
Weighted average shares common stock outstanding
EPS = $775,200 – $100,000*
88,750 shares
EPS = $7.61 per share
*(20,000 shares x $100 x 5%)
(A)
Number of Shares
Date
Outstanding
January 1
80,000
April 1
90,000
October 1
95,000
Weighted Average Number of Shares
(B)
Period
of Time
3/12
6/12
3/12
(A) x (B)
20,000
45,000
23,750
88,750
b.
Diluted EPS = Net income – Preferred Dividend Requirement
Weighted average shares common stock outstanding
$775,200 – $-088,750 shares + 100,000 converted shares
EPS = $4.11 per share
EPS =
(A)
Number of Shares
Date
Outstanding
January 1
80,000
April 1
90,000
October 1
95,000
Weighted Average Number of Shares
(B)
Period
of Time
3/12
6/12
3/12
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
(A) x (B)
20,000
45,000
23,750
88,750
F10-31
*10-45.
Hassenfuss Company
General Journal
Date
Description
Dec
31
Page 243
Post
Ref.
Income Tax Expense
Prepaid Income Taxes
Income Taxes Payable
To record income tax expense
Debit
Credit
154,000
87,000
67,000
and unpaid liability.
$385,000 x 40% = $154,000
*10-46.
Warren Company
General Journal
Date
Description
Dec
31
Page 247
Post
Ref.
Income Tax Expense
Prepaid Income Taxes
Income Taxes Payable
To record income tax expense
and unpaid tax liability.
($160,000 + $10,000) x 30%
Debit
Credit
51,000
25,000
26,000
*10-47.
Xena Corporation
General Journal
Date
Description
Dec
F10-32
31
Income Tax Expense
Prepaid Income Taxes
Income Taxes Payable
To record income tax expense
and unpaid tax liability.
($200,000 – 25,000 – 70,000)x 35%
Page 152
Post
Ref.
Debit
Credit
36,750
10,000
26,750
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
Note to Instructor: Students’ answers to the Financial Reporting
Cases will vary depending upon timing. The answers below relate
to the latest information available at publication.
10-48.
Target Corporation – Year Ended January 28, 2006
a.
b.
c.
d.
e.
f.
There are no extraordinary items reported for the fiscal year
ended January 28, 2006.
There were no disposals of segments reported for the fiscal
year ended January 28, 2006.
EPS - Basic for FY 2006 is: $2.73
EPS - Diluted for FY 2006 is: $2.71
Current Assets at 1-28-2006: $14,405,000,000
Current Liabilities at 1-28-206: $9,588,000,000
Current assets represent the probable future economic
benefits that are either (1) cash or expected to become cash
within one year or (2) provide economic benefits that will be
used within one year.
Current liabilities are probable future sacrifices of assets
arising from present obligations of an entity as a result of past
transactions or events that must be paid or satisfied within
one year.
On this year’s report there are no items of other
comprehensive income reported in the income statement or
the statement of stockholders’ equity. The company reports
comprehensive income on the statement of stockholders’
equity.
Students’ responses vary depending upon article chosen.
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
F10-33
10-49.
Darden Restaurants - Year Ended 05-28-2006
a.
b.
c.
d.
e.
f.
F10-34
There are no extraordinary items reported on the FYE 5-282006 income statement.
There are no disposals of segments reported on the FYE 528-2006 income statement. There are no cumulative effects
from changes in accounting principles reported on the 2006
income statement.
Earnings per share:
Basic
$2.26
Diluted
$2.16
Current Assets @ 5-28-2006
$ 377,607,000
Current Liabilities @ 5-28-2006
$1,026,078,000
Accumulated other comprehensive income items are reported
on the statement of stockholders’ equity. There are items of
comprehensive for the current year. Darden reports foreign
currency adjustment, change in fair value of derivatives, and
minimum pension liability adjustment.
Students’ responses vary depending upon article chosen.
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
10-50.
Ford Motor Co. - For Year Ended 12-31-2005
a.
b.
c.
d.
e.
f.
There are no extraordinary items reported on the 2005
income statement.
There are disposals of segments reported on the 2005
income statement in the amount of $47,000,000
The income statement reported:
Basic EPS: $1.10
Diluted EPS: $1.05
Retained Earnings: $12,461,000,000
Retained earnings represent the total of all earnings of the
corporation since its inception minus any dividends declared.
Comprehensive Income is reported in the statement of
stockholders’ equity. Ford has three types of other
comprehensive income:
Foreign currency translation
Minimum pension liability
Derivative Instruments (holding gains and losses)
Students’ responses vary depending upon article chosen.
Chapter 10 – The Balance Sheet and Income Statement: A Closer Look
F10-35