Income Taxes, Unusual
Items, Investments in Stocks
BY RACHELLE AGATHA, CPA, MBA
Slides by Rachelle Agatha, CPA,
with excerpts from Warren, Reeve, Duchac
Objectives:
1. Journalize the entries for corporate
income taxes, including deferred
income taxes.
2. Describe and illustrate the
reporting of unusual items on the
income statement.
2
Objectives:
3. Prepare an income statement
reporting earnings per share data.
4. Describe the concept and the
reporting of comprehensive
income.
5. Describe the accounting for
investments in stocks.
3
Objective 1
Journalize the
entries for
corporate income
taxes, including
deferred income
taxes.
4
Corporate Income Taxes
Most corporations are required to pay estimated
federal income taxes in four installments throughout
the year. A corporation estimates its income tax
expense for the year to be $84,000. The first of four
estimated payments is journalized as follows:
Apr. 15 Income Tax Expense
Cash
21 000 00
21 000 00
5
Ratio of Reported Income Tax
Expense to Earnings Before Taxes
for Selected Industries
Automobiles
Banking
Computers
Food
Integrated oil
Pharmaceuticals
Retail
Telecommunication
Transportation
33%
35
23
35
39
30
39
37
38
6
Allocating Income Taxes
Some differences between taxable
income and income before income
taxes are created because items are
recognized in one period for tax
purposes and in another period for
income statement purposes. Such
differences are call temporary
differences because they reverse or
turn around in later years.
7
Examples of Items That Create
Temporary Differences
1.
Revenues or gains are taxed
after they are reported in
the income statement.
2. Expenses or losses are
deducted in determining
taxable income after they
are reported in the income
statement.
8
3. Revenues or gains are taxed
before they are reported
on the income statement.
4. Expenses or losses are
deducted in determining
taxable income before they
are reported in the income
statement.
9
Exhibit 1 Temporary Differences
MACRS (tax
depreciation)
Straight-line
(financial statement
depreciation)
Total
Total depreciation is the same for tax and financial purposes.
10
At the end of the first year of operations, a
corporation reports $300,000 of income
before income taxes. With a 40% tax rate,
the firm faces a tax of $120,000 ($300,000
x 40%). Using tax planning, the net income
is reduced to $100,000 and the actual
income tax due is $40,000 ($100,000 x
40%). The difference is deferred to future
years.
11
The entry to record income taxes reflects the
deferred amount of $80,000.
Income Tax Expense
120 000 00
Income Tax Payable
40 000 00
Deferred Income Tax Payable
80 000 00
12
If $48,000 of the deferred tax
reverses and becomes due in the
second year, the entry will reflect
this fact.
Deferred Income Tax Payable
Income Tax Payable
48 000 00
48 000 00
13
A corporation has $200,000 of income before
income taxes, a 40% tax rate, and $130,000 of
taxable income. Provide the journal entry for
the current year’s taxes.
14
Income Tax Expense
Income Tax Payable
Deferred Income Tax Payable
Income tax expense based on
$200,000 reported income at 40%
Income tax payable based on $130,000
taxable income at 40%
Income tax deferred to future years
80,000
52,000
28,000
$80,000
52,000
$28,000
15
Permanent Differences
 Differences between taxable
income and income before taxes
reported on the income statement
may be the result of differences
that are not “timing” differences.
These are permanent
differences that never reverse.
 Interest income that is exempt on
municipal bonds is an example of
this type of a permanent difference.
16
Objective 2
Describe and
illustrate the
reporting of unusual
items on the income
statement.
17
Reporting Unusual Items on the
Income Statement
Unusual items subtracted from
gross profit in determining
income from continuing
operations are:
Fixed asset impairments
Restructuring charges
18
Fixed Asset Impairment
A fixed asset
impairment occurs
when the fair value of a
fixed asset falls below its
book value and is not
expected to recover.
19
Examples of Events That Might
Cause an Asset Impairment
1. Decrease in market price of fixed
assets.
2. Significant changes in the business
or regulations related to fixed
assets.
3. Adverse conditions affecting the
use of fixed assets.
4. Expected cash flow losses using
fixed assets.
20
On March 1, Jones Corporation consolidates
operations by closing a factory. As a result of the
closing, plant and equipment is impaired by
$750,000.
Mar. 1 Loss on Fixed Asset Impairment
Equipment
To record impairment
750 000 00
750 000 00
of fixed assets due to
plant closing.
21
Reporting of Unusual Items
on the Income Statement
Fixed asset
impairments
22
Unusual Items in the
Income Statement
23
23
Reporting Unusual Items on the
Income Statement
Unusual items subtracted from
gross profit in determining
income from continuing
operations are:
Fixed asset impairments
Restructuring charges
24
Restructuring Charges
Restructuring charges
are costs incurred with
actions such as canceling
contracts, laying off or
relocating employees, and
combining operations.
25
The management of Jones Company
communicates a plan to terminate 200
employees from the closed
manufacturing plant effective March 1.
The restructuring plan calls for a
termination benefit of $5,000 per
employee. The employees have the
right to work 60 days beyond March 1,
but may elect to leave the firm earlier.
26
The fair value of this plan would be
$1,000,000 (200 x $5,000), which is the
aggregate expected cost of terminating the
employees. The restructuring charge would be
recorded as follows:
Mar. 1 Restructuring Charge
Employee Termination
Obligation
1,000 000 00
1,000 000 00
To record impairment
of fixed assets due to
plant closing.
27
14-2
Twenty five employees find
employment elsewhere and
leave the company on March
25. Payment is made to these
employees on that date.
28
On March 25, the entry to record a
severance payment of $125,000 to 25 of
the terminated employees would be as
follows:
Mar. 25 Employee Termination Obligation 125 000 00
Cash
125 000 00
To record payment to
25 employees as
severance
compensation.
29
Reporting of Unusual Items
on the Income Statement
Restructuring
charges
30
Unusual Items in the
Income Statement
31
On December 20 of the current year. Torro
Corporation determined that equipment had
been impaired so that the book value of the
equipment was reduced by $180,000. In
addition, the senior management of the
company communicated an employee
severance plan whereby 80 employees could
receive a termination benefit of $7,000 per
employee. Provide the journal entries for the
asset impairment and the restructuring
charge.
32
32
Dec. 20 Loss on Fixed Asset
Impairment
Equipment
20
Restructuring Charge
Employee Termination
Obligation
180,000
180,000
560,000*
560,000
*80 employees x $7,000
33
Reporting Unusual Items on the
Income Statement
Unusual items that may add or
subtract income from continuing
operations in determining net
income are:
Discontinued operations
Extraordinary items
34
Discontinued Operations
A gain or loss from disposing
of a business segment or
component of an entity is
reported on the income
statement as a gain or loss
from discontinued
operations.
35
Reporting of Unusual Items
on the Income Statement
Discontinued
operations
36
Unusual Items in the
Income Statement
14-2
37
37
Reporting Unusual Items on the
Income Statement
14-2
Unusual items that adjust income
from continuing operations in
determining net income are:
Discontinued operations
Extraordinary items
38
Extraordinary Items
14-2
Extraordinary items result
from events and transactions
that—
(1) are significantly different
(unusual) from the typical or
the normal operating activities
of the business, and
(2) occur infrequently.
39
Reporting of Unusual Items
Insert
Exhibit
here also,
on the
Income 2
Statement
p. 13
14-2
Extraordinary
items
40
40
Unusual Items in the
Income Statement
41
Retroactive Restatement
In addition to unusual items impacting the
income statement, there are two major
items that require a retroactive restatement
of prior period earnings. These two items
are:
1. errors in the recognition,
measurement, presentation, or
disclosure of financial statements, and
2. changes from one generally accepted
accounting principle to another
generally accepted accounting
principle.
42
Reporting of Unusual Items
on the Income Statement
Unusual items affecting prior period income
statements
43
Objective 3
Prepare an
income
statement
reporting
earnings per
share data.
44
Earnings per Common Share
The profitability of companies is often
expressed as earnings per share.
Earnings per common share
(EPS), sometimes called basic
earnings per share, is the net
income per share of common stock
outstanding during a period.
45
If there is no preferred stock:
Earnings per common
=
share
Net Income
Number of common shares outstanding
If there is preferred stock:
Earnings per common
=
share
Net Income – Preferred stock dividends
Number of common shares outstanding
46
Income Statement with
Earnings per Share
47
Manning Company had net income of $250,000 during the year.
There were 580,000 common shares outstanding during the
year. There were 2,000 shares of $100 par value, 9% preferred
stock outstanding during the year. Determine the basic earnings
per share.
Earnings per share =
$250,000 – $18,000*
580,000
$0.40 per
=
share
*2,000 shares x $100 par value x 9% = $18,000
48
Objective 4
Describe the
concept and the
reporting of
comprehensive
income.
49
Comprehensive Income
Comprehensive income is
defined as all changes in
stockholders’ equity during a
period, except those resulting
from dividends and
stockholders’ investments.
50
Other comprehensive
income items include
foreign currency items,
pension liability adjustments,
and unrealized gains and
losses on investments.
51
The cumulative effects of other
comprehensive income items must
be reported separately from
retained earnings and paid-in
capital, on the balance sheet as
accumulated other
comprehensive income.
52
Statement of Comprehensive
Income
Triple-A Enterprises, Inc. reported comprehensive income on a
separate statement as follows:
Triple-A Enterprises, Inc.
Statement of Comprehensive Income
For the Year Ended December 31, 2008
Net income
Other comprehensive income, net of tax
Total comprehensive income
$8 500 00
90 00
$8 590 00
53
Stockholders’ Equity Section of
Triple-A Enterprises’ Balance Sheet
Triple-A Enterprises, Inc.
Stockholders’ Equity
For the Year Ended December 31, 2008
2008
2007
Stockholders’ equity:
Common stock
Paid-in capital in excess of par
Retained earnings
Accumulated other
comprehensive income
Total stockholders’ equity
54
$ 20 000 00$ 20 000 00
36 000 00 36 000 00
165 500 00 157 000 00
1 290 00
1 200 00
$222 790 00 $214 200 00
Myers Company had a net income of $74,000,
and other comprehensive income of $12,500
for 2008. On January 1, 2008 the Retained
Earnings balance was $425,000 and the
Accumulated Other Comprehensive Income
balance was $57,000. Determine the (a)
comprehensive income for 2008, (b) Retained
Earnings balance on December 31, 2008, and
(c) Accumulated Other Comprehensive
Income balance on December 31, 2008.
55
a) $86,500 = $74,000 + $12,500
b) $499,000 = $425,000 + $74,000
c) $69,500 = $57,000 + $12,500
56
Objective 5
Describe the
accounting for
investments in
stocks.
57
Accounting for Investments in Stocks
Like individuals, businesses have a
variety of reasons for investing in
stocks, called equity securities. A
business may purchase stocks as a
means of earning a return on excess
cash that it does not need for its
normal operations.
58
Trading securities are securities
that management intends to
actively trade for profit.
Available-for-sale securities are
securities that management
expects to sell in the future, but
which are not actively traded for
profit.
59
When a business invests in
available-for-sale securities,
such investments are
classified as temporary
investments or
marketable securities.
60
Marketable securities must meet
two conditions:
1. The securities must be readily
marketable, and can be sold for
cash at any time.
2. Management must intend to sell
the securities when the business
needs cash for operations.
61
On June 1, Crabtree Company purchased 2,000
shares of Inis Corporation common stock at
$89.75 per share plus a brokerage fee of $500.
The firm paid $180,000 [($89.75 x 2,000
shares) + $500].
June 1 Marketable Securities
Cash
Purchased 2,000 shares of
Inis Corporation common
stock.
180 000 00
180 000 00
62
On October 1, Inis declared a $0.90 per share
dividend payable on November 30.
Nov 30 Cash
Dividend Revenue
1 800 00
1 800 00
Received dividends on Inis
Corporation common stock
(2,000 shares x $0.90).
63
Unrealized Holdings Gain or Loss
On the balance sheet, temporary
investments are reported at their
fair market value. Any difference
between the fair market value and
their cost is an unrealized
holding gain or loss.
64
The Crabtree Co.’s portfolio of temporary investments was
purchased during 2008 and has the following fair market values
and unrealized gains and losses on December 31, 2008.
Common Stock
Cost
Edwards Inc.
SWS Corp.
Inis Corporation
Bass Co.
Total
$150,000
200,000
180,000
160,000
$690,000
Market
$190,000
200,000
210,000
150,000
$750,000
Unrealized
Gain (Loss)
$40,000
—
30,000
(10,000)
$60,000
65
Temporary Investments on
the Balance Sheet
66
Drew Company began operations on January
1, 2008 and purchased temporary
investments in marketable securities during
the year at a cost of $75,000. The end-ofperiod market value for these investments was
$110,000. Net income was $180,000 for
2008. Determine (a) the reported amount of
marketable securities on the December 31,
2008 balance sheet, and (b) the
comprehensive income for 2008. Assume a
tax rate of 40%.
67
a. Initial costs
$ 75,000
Unrealized gain ($110,000 – $75,000)
$35,000
Less: Tax on unrealized gain ($35,000 x 40%) 14,000
Unrealized gain, net of tax
21,000
Reported amount of marketable securities
$ 96,000
b. Net income
$180,000
Unrealized gain ($110,000 – $75,000)
$35,000
Less: Tax on unrealized gain ($35,000 x 40%) 14,000
Other comprehensive income, net of tax
21,000
Net income
$201,000
68
Long-Term Investments in Stocks
Long-term investments
are not intended as a source
of cash in the normal
operations of the business.
Rather, such investments
are often held for their
income, long-term gain
potential, or influence over
another business entity.
69
Accounting for Long-Term Stock
Investments
Is there a significant influence over the
investee?
No
Yes
Account for the
investment as an
available-for-sale security
Account for the
investment by using the
equity method
70
On January 2, Hally Inc. pays cash of
$350,000 for 40% of the common stock
and net assets of Brock Corporation.
Jan. 2 Investment in Brock Corp. Stock
Cash
Purchased 40% of Brock
Corp. common stock.
350 000 00
350 000 00
71
For the year ending December 31, Brock
Corporation reports net income of $105,000.
Dec. 31 Investment in Brock Corp. Stock
Income of Brock Corp.
Recorded 40% share of
Brock Corp. net income of
$105,000.
42 000 00
42 000 00
72
On December 31, Brock
Corporation pays $45,000 in
dividends.
14-5
Dec. 31 Cash
18 000 00
Investment in Brock Corp.Stock
18 000 00
Recorded 40% share of
Brock Corp. dividends.
73
Investments and Dividends
74
Sale of Investments in Stocks
On March 1, an investment in Drey Inc.
stock that had a carrying amount of
$15,700 is sold for $17,500.
Mar. 1 Cash
Investment in Drey Inc. Stock
Gain on Sale of Investments
17 500 00
15 700 00
1 800 00
75
Phillips Company purchased 30% of the
outstanding stock of Singh Company on
January 1, 2008. Singh reported net income
of $90,000 and declared dividends of $15,000
during 2008. How much would Phillips
adjust their investment in Singh Company
under the equity method?
76
Phillips share of Singh reported net income
(30% x $90,000)
Less: Phillips share of the Singh dividend
(30% x $15,000)
Increase in Investment in Singh Company
Stock
$27,000
4,500
$22,500
77
Financial Analysis and Interpretation
14-5
A firm’s growth potential and
future earnings prospects are
indicated by how much the market
is willing to pay per dollar of a
company’s earnings. This ratio,
called the price-earnings ratio,
or P/E ratio, is commonly
included in stock market
quotations.
78
Earnings Per Share
Earnings per Share
= of Common Stock
Net Income
Common Shares
Price - Earnings Ratio
Market Price Per Share
of Common Stock
Earnings Per Share of
Common Stock
79
=
PriceEarnings
Ratio
The price-earnings ratio represents
how much the market is willing to
pay per dollar of a company’s
earnings. This indicates the
market’s assessment of a firm’s
growth potential and future
earnings prospects.
80
An example:
Market price per share
Earnings per share
Price-earnings ratio
2008
$24.60
$1.64
15.0
2007
$16.20
$1.35
12.0
The price-earnings ratio indicates that a share
of common stock was selling for 12 times the
amount of earnings per share at the end of
2007 and 15 times earnings per share at the
end of 2008.
81
Summary
 J/E’s for corporate income tax
 Unusual Items
 Income statement for EPS
 Comprehensive Income
 Accounting for Investments in stock