Ch04.soln

Kieso, Weygandt, Warfield, Young, Wiecek Intermediate Accounting, Eighth Canadian Edition
CHAPTER 4
Posted with permission from John Wiley & Sons Canada, Ltd.
REPORTING FINANCIAL PERFORMANCE
ASSIGNMENT CLASSIFICATION TABLE
Brief
Exercises Exercises Problems
Writing
Assignments
1. Income measurement
concepts.
12, 14, 16 1
2. Calculation of net
income.
1, 7 1, 2, 3 6, 7, 8, 9
3. Single-step income
statements; earnings
per share.
1, 2, 4, 5,
8, 9
4, 5, 6, 7,
10, 13, 14
2, 3, 4, 5,
8, 9, 11,
12, 16
4. Multiple-step income
statements.
3 5, 6, 7, 8,
9, 10
1, 4, 6, 8,
15
5. Extraordinary items. 5 6, 8, 9,
10, 13
1, 3, 5, 6,
8, 11, 13,
15, 16
6. Disposal of a segment
(discontinued
operations).
4, 6 7, 11, 12,
14
1, 3, 6, 9,
10, 11
7. Retained earnings
statement.
10, 11 10, 15 1, 2, 4, 5,
7, 8, 15
8. Accounting principle
changes; changes in
estimates; errors.
11 10, 15 5, 7, 8, 9
Solutions Manual 4-1 Chapter 4
Copyright © 2007 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

ASSIGNMENT CLASSIFICATION TABLE (CONTINUED)
Brief
Exercises Exercises Problems
Writing
Assignments
9. Comprehensive
income.
7, 12 16, 17 11
10. Cash basis* 13 18 17, 18 2
* This material is covered in an Appendix to the chapter.

ASSIGNMENT CHARACTERISTICS TABLE
Item Description
Level of
Difficulty
Time
(minutes)
E4-1 Calculation of net income. Simple 18-20
E4-2 Calculation of net income – proprietorship Simple 18-20
E4-3 Income statement items. Simple 18-20
E4-4 Single-step income statement. Moderate 20-25
E4-5 Multiple-step and single-step. Simple 30-35
E4-6 Multiple-step and single-step. Moderate 30-40
E4-7 Combined single-step. Moderate 25-30
E4-8 Multiple-step and extraordinary items. Moderate 30-35
E4-9 Condensed income statement. Moderate 20-25
E4-10 Multiple-step statement, with retained
earnings.
Simple 30-40
E4-11 Discontinued operations. Moderate 15-20
E4-12 Discontinued operations. Moderate 20-25
E4-13 Earnings per share. Simple 20-25
E4-14 Earnings per share. Moderate 15-20
E4-15 Retained earnings statement. Simple 20-25
E4-16 Comprehensive income Simple 15-20
E4-17 Comprehensive income Simple 15-20
*E4-18 Cash and accrual basis Moderate 10-15
P4-1 Multiple-step income statement and retained
earnings statement.
Moderate 40-45
P4-2 Single-step income statement and retained
earnings statement.
Simple 25-30
P4-3 Irregular items. Moderate 35-45
P4-4 Multiple- and single-step income statement
and retained earnings
Moderate 45-55
P4-5 Irregular items. Moderate 30-35
P4-6 Comprehensive combined statement of
income and retained earnings
Moderate 45-50
P4-7 Retained earnings statement, correction of
error and change in accounting principle.
Moderate 25-35
P4-8 Income statement and irregular items. Moderate 35-45
P4-9 Income statement and irregular items. Moderate 25-35
P4-10 Discontinued operations. Moderate 35-45
P4-11 Identification of income statement
deficiencies.
Simple 35-45
P4-12 Identify income statement deficiencies. Simple 20-25
P4-13 Extraordinary items. Moderate 20-25

ASSIGNMENT CHARACTERISTICS TABLE
(CONTINUED)
Item Description
Level of
Difficulty
Time
(minutes)
P4-14 Earnings management. Moderate 20-25
P4-15 All-inclusive vs. current operating. Moderate 35-45
P4-16 Identification of income statement
weaknesses.
Moderate 30-40
*P4-17 Cash and accrual basis. Moderate 35-40
P4-18 Cash and accrual basis. Complex 40-50

SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 4-1
Portables Inc.
Income Statement
For the Year Ended December 31, 2008
Revenues
Sales $890,000
Expenses
Cost of goods sold $395,000
Wages expense 120,000
Other expenses 10,000
Income tax expense 115,000
Total expenses 640,000
Net income $250,000
Earnings per share $2.50

BRIEF EXERCISE 4-2
Alley Corporation
Income Statement
Revenues
Net sales $2,780,000
Investment revenue __103,000
Total revenues 2,883,000
Expenses
Cost of goods sold 2,190,000
Selling expenses 272,000
Administrative expenses 211,000
Interest expense 76,000
Total expenses 2,789,000
Net income $ 94,000

BRIEF EXERCISE 4-3
Alley Corporation
Income Statement
Gross profit 590,000
Operating expenses
Selling expenses $272,000
Administrative expenses 211,000 483,000
Income from operations 107,000
Other revenues and gains
Investment revenue 103,000
210,000
Other expenses and losses
Income before income tax 134,000
Net income $ 94,000
BRIEF EXERCISE 4-4
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
Earnings per share:
Income from continuing operations $1.26
Discontinued operations (.04 )
Net income $1.22

BRIEF EXERCISE 4-5
Income before income tax and extraordinary item $7,300,000
Income tax 2,190,000
Income before extraordinary item 5,110,000
Extraordinary loss from casualty, net of
$381,000 in taxes 889,000
Earnings per share:
Income before extraordinary item $1.02
Extraordinary loss (.18 )
Net income $ .84
BRIEF EXERCISE 4-6
In order to qualify for separate presentation as discontinued
operations on the income statement, the restaurants must be a
component of the entity where the operations, cash flows, and
financial elements are clearly distinguishable from the rest of
the company. A key element is that the group of assets
generates its own net cash flows and is operationally distinct.
Selling the corporate owned stores to franchisees would qualify
for discontinued operations treatment. The stores generate their
own cash flows and are operationally distinct from the
franchised restaurants.

BRIEF EXERCISE 4-7
DougieDoug Limited
Statement of Shareholders’ Equity
Total
Compre-hensive
Income
Retained
Earnings
Accumulated
Other
Comprehensive
Income
Common
Shares
Beginning balance $520,000 $ 90,000 $80,000 $350,000
Comprehensive income
Net income* 120,000 $120,000 120,000
Other comprehensive
income
Unrealized holding loss (60,000) (60,000 ) _______ (60,000) _______
Comprehensive income $ 60,000
Ending balance $580,000 $210,000 $20,000 $350,000
*($700,000 – $500,000 – $80,000).

BRIEF EXERCISE 4-8
The number of common shares outstanding at December 31,
2008 is 44,000 (40,000 – 8,000 + 12,000)
Weighted average number of shares:
January 1 – April 1 40,000 X 3/12 = 10,000
April 1 – August 31 32,000 X 5/12 = 13,333
August 31 – Dec. 31 44,000 X 4/12 = 14,667
38,000
BRIEF EXERCISE 4-9
$1,200,000 – $250,000 190,000 = $5.00 per share
BRIEF EXERCISE 4-10
Global Corporation
Retained Earnings Statement
Balance, January 1 $ 529,000
Add: Net income 1,646,000
2,175,000
Deduct: Dividends declared 660,000
Balance, December 31 $1,515,000

BRIEF EXERCISE 4-11
Global Corporation
Balance, January 1, as reported $ 529,000
Correction for amortization error (net of tax) 25,000
Balance, January 1, as adjusted 554,000
Add: Net income 1,646,000
2,200,000
Less: Dividends declared 660,000
BRIEF EXERCISE 4-12
(a) Net Income = $8,000 (dividend revenue)
(b) Comprehensive Income = Net income + Other
Comprehensive Income = $8,000 + $5,000 = $13,000
(c) Other Comprehensive Income = $5,000
(d) Accumulated Other Comprehensive Income = Beginning
Balance + Other Comprehensive Income = $0 + $5,000 =
$5,000

*BRIEF EXERCISE 4-13
(a)
Cash Receipts
from Customers
- Beginning accounts
receivable
+ Ending accounts
receivable
= Revenue on
accrual basis
$152,000 - 13,000 + 18,600 = $157,600
(b)
Cash payments
for operating
expenses
+ Beginning prepaid
expenses
- Ending prepaid
expenses
= Operating
expenses on
accrual basis
$97,000 + 17,500 - 23,200 = $91,300

SOLUTIONS TO EXERCISES
EXERCISE 4-1 (18-20 minutes)
Calculation of net income:
Increase in assets: $74,000 + $45,000 +$137,000 – $47,000 = $209,000
Increase in liabilities: $82,000 – $56,000 = 26,000
Increase in shareholders’ equity: $183,000
Change in shareholders’ equity accounted
for as follows:
Net increase $183,000
Increase in common shares $125,000
Increase in contributed surplus 13,000
Decrease in retained earnings due to
dividend declaration (19,000)
Net increase accounted for 119,000
Increase in retained earnings due to net income $ 64,000

Jan. 1,
2008
Dec. 31,
2008
Chang
e
Cash $23,000 $ 20,000 $ 3,000
Accounts receivable 19,000 36,000 17,000
Other assets (derived) 33,000 45,000 12,000
Total assets 75,000 101,000 26,000
Liabilities (1/1/08 derived) (37,000 ) (41,000 ) (4,000 )
Capital (12/31/08 derived) $38,000 $ 60,000 $22,000
Capital account Dec. 31, 2008 $60,000
Capital account Jan. 1, 2008 38,000
Increase 22,000
Add: Withdrawals made $11,000
Less: Cash investment made 5,000 6,000
Net income $28,000

(a) Total net revenue:
Sales $390,000
Less: Sales discounts $ 7,800
Sales returns 12,400 20,200
Net sales 369,800
Dividends earned 71,000
Rental revenue 6,500
Total net revenue $447,300
(b) Net income:
Net revenues (from a) $447,300
Expenses:
Cost of goods sold 184,400
Income before taxes 68,300
Income taxes 31,000
Net income $ 37,300
(c) Dividends declared:
Ending retained earnings $134,000
Beginning retained earnings 114,400
Net increase 19,600
Less net income (37,300 )
Dividends declared $ 17,700

EXERCISE 4-3 (Continued)
ALTERNATE SOLUTION
Beginning retained earnings $114,400
Add net income 37,300
151,700
Deduct dividends declared (derive) ?___
Ending retained earnings $134,000
Dividends declared must be $17,700
($151,700 – $134,000)

Geneva Inc.
Income Statement
For Year Ended December 31, 2008
Sales $2,100,000
Less sales discounts 15,000
Net sales 2,085,000
Expenses
Income before taxes 1,225,000
Income taxes 428,750
Net income $ 796,250
Determination of amounts:
Administrative
expenses
=
20% of cost of good sold
$84,000 = 20% of $420,000
Gross sales X 4% = administrative expenses
Gross sales = $2,100,000 ($84,000 / 4%)
Selling expenses = four times administrative expenses.
(operating expenses consist of selling
and administrative expenses; since
selling expenses are 4/5 of operating
expenses, selling expenses are 4
times administrative expenses.)
= 4 X $84,000
= $336,000
Per share $53.08 ($796,250 ¸ 15,000)

(a) Multiple-Step Form
Singh Corp.
Income Statement
(In thousands, except earnings per share)
Sales $106,500
Gross profit 47,930
Operating Expenses
Selling expenses
Sales commissions $7,280
Amortization of sales
equipment
6,48
0
Transportation-out 2,290 $16,050
Administrative expenses
Officers’ salaries 3,900
Amortization of office
furniture and equipment 3,560 7,460 23,510
Other Revenues and Gains
39,650
Other Expenses and Losses
Income taxes 9,070
Net income $28,720
Earnings per share $.94*

*($28,720,000 ¸ 30,550,000)

(b) Single-Step Form
Singh Corp.
Income Statement
(In thousands, except earnings per share)
Revenues
Net sales $ 106,500
Total revenues 121,730
Expenses
Income taxes 9,070
Net income $ 28,720
Earnings per share $.94
(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.
Multiple-step:
1. Provides more information through segregation of
operating and non-operating items.
2. Expenses are matched with related revenue.

(a) Multiple-Step Form
Ying-Wai Corporation
Income Statement
Sales Revenue
Sales $930,000
Less: Sales returns and allowances 15,000
Net sales 915,000
Cost of Goods Sold
Merchandise inventory, January 1, 2008 $120,000
Purchases $600,000
Less purchase discounts 10,000
Net purchases 590,000
Add transportation-in 14,000 604,000
Total merchandise available for sale 724,000
Less merchandise inventory,
December 31, 2008
137,00
0
Operating Expenses
Selling expenses
Sales salaries 71,000
Amortization expense—store
equipment
18,00
0
Store supplies expense 9,000 98,000
Administrative expenses
Officers’ salaries 39,000
Amortization expense—building 28,500
Office supplies expense 9,500 77,000 175,000
Dividends revenue 20,000
173,000

Income before taxes and extraordinary item 164,000
Income taxes 55,760
Income before extraordinary item 108,240
Extraordinary item
Loss from flood damage 50,000
Less applicable income tax reduction 17,000 33,000
Net income $ 75,240
Earnings per share:
Extraordinary item (1.65)
Net income $3.76

(b) Single-Step Form
Ying-Wai Corporation
Income Statement
Revenues
Net sales $915,000
Expenses
Income taxes 55,760
Extraordinary item
Loss from flood damage $50,000
Net income $ 75,240
Earnings per share:
Net income $3.76

(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.
Multiple-step:
1. Provides more information through segregation of
operating and non-operating items.
2. Expenses are matched with related revenue.

(a) Evelyn Roberts Inc.
Income Statement
for the Year Ended December 31, 2008
Revenues
Sales $1,900,000
Rent revenue 40,000
Expenses
Administrative and general expenses 240,000
Income from continuing operations before taxes 550,000
Income from continuing operations 363,000
Discontinued operations:
Loss from operation of Micron Division
(net of $25,000 in tax recovery) 50,000
Income before extraordinary items 313,000
Extraordinary items:
Gain from expropriation (net of $29,000 in taxes) 66,000
Loss from flood (net of $18,000 in tax recovery) (42,000)
Net Income $ 337,000
Earnings per share:
Discontinued operations (2.00 )
Income before extraordinary items 12.52
Extraordinary items 0.96
Net income $13.48

(b) Evelyn Roberts Inc.
Statement of Income and Retained Earnings
for the Year Ended December 31, 2008
Revenues
Sales $1,900,000
Rent revenue 40,000
Expenses
Administrative and general expenses 240,000
Income from continuing operations before taxes 550,000
Loss from operation of Micron Division
(net of $25,000 in tax recovery) 50,000
Income before extraordinary items 313,000
Extraordinary items
Gain from expropriation (net of $29,000 in taxes) 66,000
Loss from flood (net of $18,000 in tax recovery) (42,000)
Net Income $ 337,000
Retained earnings, January 1 600,000
937,000
Retained earnings, December 31 $ 867,000
Earnings per share:
Discontinued operations (2.00)
Extraordinary items 0.96
Net income $13.48

Voisine Corp.
Income Statement
Sales Revenue
Sales $1,380,000
Less: Sales returns and allowances $150,000
Sales discounts 45,000 195,000
Net sales revenue 1,185,000
Gross profit on sales 564,000
Operating Expenses
Administrative and general expenses 97,000 291,000
Other Revenue and Gains
Interest revenue 86,000
359,000
Extraordinary item
Loss from earthquake damage 150,000
Less applicable tax reduction 66,000 84,000
Net income $ 83,440
Earnings per share:
Extraordinary item (0.42 )
Net income $0.42

Sooyoun Corporation
Income Statement
Gross profit 1,497,000
Selling expense $636,000
Administrative expense 491,000 1,127,000
Other revenue 240,000
Other expense 176,000 64,000
Income taxes* 147,560
Extraordinary loss, net of $23,800 taxes 46,200
Earnings per share:
Income before extraordinary item** $3.18
Net income $2.67
Supporting calculations:
* Income taxes ($434,000 x 34%) = $147,560
** $286,440 divided by 90,000 common shares.
Sales Revenue
Sales $4,275,000
Less: Sales discounts $34,000

Cost of Goods Sold:
Merchandise inventory, Jan. 1, 2007 $535,000
Purchases $2,786,000
Less purchase returns (15,000)
Less purchase discounts (27,000)
Net purchases 2,744,000
Add transportation-in 72,000 2,816,000
Total merchandise available for sale 3,351,000
Less merchandise inventory Dec. 31, 2007 686,000
Cost of Goods Sold $2,665,000
Selling expenses:
Sales salaries $284,000
Sales commissions 83,000
Travel and entertainment 69,000
Advertising 54,000
Transportation-out 93,000
Amortization of sales equipment 36,000
Telephone - sales 17,000 $636,000
Administrative Expenses:
Office salaries $346,000
Accounting and legal services 33,000
Insurance 24,000
Amortization of office 48,000
Utilities - office 32,000
Miscellaneous office expenses 8,000 $491,000

(a) Gottlieb Corp.
Income Statement
Sales Revenue
Operating Expenses
Dividend revenue 20,000
Interest revenue 7,000 27,000
434,000
Write-off of inventory due to
obsolescence
80,000
Extraordinary item
Casualty loss 50,000
Less applicable tax reduction 22,000 28,000
Earnings per share:
Net income $4.26

(b) Gottlieb Corp.
Balance, January 1, as reported $ 980,000
Correction for overstatement of net income in prior
period (amortization error) (net of $24,200 tax) (30,800)
Balance, January 1, as restated 949,200
Add: Net income 170,240
1,119,440
(c)
Dr) Retained Earnings 30,800
Dr) Income taxes payable/receivable 24,200
Cr) Accumulated Amortization 55,000

(d) Gottlieb Corp.
Sales Revenue
Operating Expenses
Interest revenue 7,000 27,000
434,000
Write-off of inventory due to obsolescence 80,000
Extraordinary item:
Casualty loss (net of $22,000 in taxes) 28,000
Net income 170,240
Retained earnings, January 1, as
previously reported 980,000
Correction for overstatement of net
income in prior period
(amortization error)
(net of $24,200 tax) 30,800
Retained earnings, January 1, as restated 949,200
1,119,440
Retained earnings, December 31 $1,074,440

Earnings per share:
Net income $4.26
(e) Advantages: Since typically few transactions or adjustments
are made to retained earnings, users have all of the changes
to shareholders’ equity (except for share transactions) on
one page. The combined statement also shows how net
income flows to the balance sheet since the bottom number
is the ending retained earnings balance that corresponds to
the balance sheet. The format can also save on printing costs
by eliminating an extra page.
Disadvantage: The presentation is not as comprehensible
when the combined statements are too long or when
adjustments are required to the opening balance of retained
earnings. The presentation would also not be useful where
the company reports comprehensive income since the other
comprehensive income flows to accumulated other
comprehensive income, whereas net income is closed to
retained earnings.

(a)
2007:
Loss from beginning of year to September 30 $(1,900,000)
Loss from September 30 to December 31 (700,000)
Estimated loss on impairment of net assets on
June 1, 2008, net of tax (150,000)
Total loss $(2,750,000)
2008:
No gain or loss on disposal reported in 2008. However, if
applicable, any gains or losses from operating the subsidiary
from January 1, 2008 to the disposal date would be reported in
2008.
(b)
Discontinued operations (2007):
Loss from operations of CBTV subsidiary,
net of tax $2,600,000
Loss on impairment of net assets of CBTV,
net of tax 150,000
Loss from discontinued operations $2,750,000
(c)
The correction of the gain or loss from disposal of a segment
reported in 2007 should be reported in 2008 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 receives the same
treatment as a change in estimate.

(a) The income statement and related footnote are as follows:
Income from continuing operations before income taxes $144,000
Income taxes 43,200
Discontinued operations (Note XX)
Income from operations of the discontinued
Song and Elwood Division, less applicable
income taxes $1,800 $4,200
Loss on impairment of assets of
discontinued operations, less applicable
income taxes of $6,000 (14,000) (9,800)
Net income $91,000
Note XX—Discontinued Operations. On October 5, 2008, the
board of directors decided to dispose of the Song and Elwood
Division by auction on May 10, 2009.
(b)
The cleaning equipment would be shown separately on the
balance sheet as part of noncurrent assets as “noncurrent asset
related to discontinued operations. The asset would be valued at
the lower of its carrying value and fair value less cost to sell. In
this case this means the cleaning equipment would be
remeasured at its estimated selling price of $5,000, which is net
of selling costs.

2009 net income after tax $43,000,000
2009 net income before tax
[$43,000,000 ¸ (1 – .44)] 76,785,714
Add back major casualty loss 15,000,000
Income from operations 91,785,714
Income taxes (44% X $91,785,714) 40,385,714
Extraordinary item:
Casualty loss 15,000,000
Less applicable income tax reduction 6,600,000
8,400,000
Less cumulative preferred dividends
(8% of $4,500,000) 360,000
Income available for common 42,640,000
Common shares ¸ 10,000,000
Income statement presentation
Earnings per share:
Income before extraordinary item $5.10a
Extraordinary item (0.84)b
Net income $4.26
a $51,400,000 – $360,000 = $5.10 10,000,000
b $8,400,000 = $0.84 10,000,000

Net income:
Income from continuing operations
before taxes
$23,650,000
Income taxes (35%) 8,277,500
Income from continuing operations 15,372,500
Loss before taxes $3,225,000
Less applicable income tax 1,128,750 2,096,250
Preferred dividends declared: $ 1,075,000
Weighted average common shares outstanding:
12/31/07–3/31/08 (4,000,000 x 3/12) 1,000,000
4/1/08–12/31/08 (4,400,000 x 9/12) 3,300,000
Weighted average 4,300,000
Earnings per share:
Income from continuing operations $3.33*
Discontinued operations (.49 )**
Net income $2.84***
*($15,372,500 – $1,075,000) ¸ 4,300,000.
**$2,096,250 ¸ 4,300,000.
***($13,276,250 – $1,075,000) ¸ 4,300,000.

Holiday Corporation
Balance, January 1, as reported $270,000*
Correction for amortization error
(34,7
(net of $22,230 tax)
70)
Retroactive adjustment for change in inventory
method (net of $14,430 tax) 22,570
Add net income 207,400 **
465,200
Deduct dividends declared 100,000
Balance, December 31 $365,200
*($55,000 + $135,000 + $160,000) – ($30,000 + $50,000)
**[$340,000 – (39% X $340,000)]

Rosy Randall Corporation
Income Statement
Operating expenses
Selling and administrative expenses 320,000
Net income 130,000
Other comprehensive income
Unrealized holding gains, net of tax 18,000
Comprehensive income $148,000

Kelly Corporation
Statement of Shareholders' Equity
For the Year Ended December 31, 2008 (all amounts in thousands)
Total
Comp.
Income
Preferred
Shares
Common
Shares
Contr.
Surplus
Retained
Earnings
Acc.
Other
Comp.
Inc.
Beginning Balance $22,240 $1,526 $2,591 $2,425 $13,692 $2,006
Comprehensive Income:
Net income 4,352 $4,352 4,352
Other comprehensive
income
Unrealized holding loss (348) (348) (348)
Comprehensive Income $4,004
Dividends to shareholders:
Preferred (23) (23)
Common (7) (7)
Issue of Common shares 170 170
Ending Balance $26,384 $1,526 $2,761 $2,425 $18,014 $1,658

(b) Kelly Corporation
Balance Sheet (Partial)
December 31, 2008
(‘000)
Share capital:
Preferred shares $ 1,526
Common shares 2,761
Total share capital 4,287
Contributed surplus 2,425
Total paid-in capital 6,712
Retained earnings 18,014
Accumulated other comprehensive income 1,658
Total shareholders’ equity $26,384

*EXERCISE 4-18 (10-15 minutes)
(a) Portmann Corp.
Income Statement (Cash Basis)
For the Year Ended December 31,
2007 2008
Sales $320,000 $515,000
Expenses 225,000 247,000
Net income $ 95,000 $268,000
(b) Portmann Corp.
Income Statement (Accrual Basis)
For the Year Ended December 31,
2007 2008
Sales* $510,000 $445,000
Expenses** 277,000 230,000
Net income $233,000 $215,000
*2007: $320,000 + $160,000 + $30,000 = $510,000
2008: $355,000 + $90,000 = $445,000
**2007: $185,000 + $67,000 + $25,000 = $277,000
2008: $40,000 + $135,000 + $55,000 = $230,000

TIME AND PURPOSE OF PROBLEMS
Problem 4-1 (Time 40-45 minutes)
Purpose—to provide the student with an opportunity to prepare an income
statement and a retained earnings statement. A number of special items such as
loss from discontinued operations, unusual items, and extraordinary losses are
presented in the problem for analysis purposes. The problem also requires
calculating the tax effect of special item from a net-of-tax amount.
Purpose—to provide the student with an opportunity to prepare an income
statement and retained earnings statement using the single-step format.
Purpose—to provide the student with an opportunity to analyse a number of
transactions and to prepare a partial income statement. The problem includes
discontinued operations, extraordinary 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.
Purpose—to provide the student with the opportunity to prepare a multiple-step
and single-step income statement and a retained earnings statement from the
same underlying information. The problem emphasizes the differences between
the multiple-step and single-step income statement.
Purpose—to provide the student with a problem on the income statement
treatment of (1) a usual but infrequently occurring charge, (2) an extraordinary
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.

TIME AND PURPOSE OF PROBLEMS (CONTINUED)
Purpose—to provide the student the opportunity to distinguish between different
scenarios involving discontinued operations, extraordinary 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.
Purpose—to provide the student with an opportunity to prepare a retained
earnings statement. 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 retained earnings statement, although the income reported would be
different.
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.
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.
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.

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.
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.
Purpose—to provide the student with an understanding of conditions where
extraordinary item classification is appropriate. In this problem, it should be
emphasized that in situations where extraordinary item classification is not
permitted, a classification as an unusual item may still be employed.
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.
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 retained
earnings statement.

Purpose—to provide the student with the opportunity to comment on deficiencies
in a single-step income statement. This case includes discussion of extraordinary
items, tax reassessments, and ordinary gains and losses. The problem provides
a broad overview to a number of items discussed in the textbook.
*Problem 4-17 (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.

SOLUTIONS TO PROBLEMS
PROBLEM 4-1
Barkley Corp.
Income Statement
Sales $36,500,000
Less cost of goods sold 28,500,000
Less selling and administrative expenses 4,700,000
Other revenues and gains
Interest revenue $170,000
Gain on the sale of investments in trading
securities 110,000 280,000
3,580,000
Other expenses and losses
Write-off of goodwill 520,000
Assessment of additional income taxes 500,000 1,020,000
Income from continuing operations before
income taxes 2,560,000
Income taxes**** 1,074,000
Loss from operations, net of taxes of
$38,571* 90,000
Loss from disposition, net of taxes of
$188,571** 440,000 530,000
Extraordinary loss from flood damage, net of
taxes of $167,143*** 390,000
Earnings per share:
Income from continuing operations $ 1.77a
Discontinued operations (0.66)b
Extraordinary loss (0.49) c
Net income $ 0.62d

PROBLEM 4-1 (Continued)
a $1,486,000 – $70,000 800,000 shares = $1.77
b ($530,000) = ($0.66) 800,000 shares
c ($390,000) = ($0.49) 800,000 shares
d $566,000 – $70,000 = $0.62 800,000 shares
* $38,571 = [$90,000 / (100% - 30%)] - $90,000
** $188,571 = [$440,000 / (100% - 30%)] - $440,000
*** $167,143 = [$390,000 / (100% - 30%)] - $390,000
**** Income tax expense = ($2,560,000 + $520,000 + $500,000) X
30% = $1,074,000. The goodwill and 2006 additional income
taxes are not tax-deductible.
Barkley Corp.
Beginning balance of retained earnings $1,980,000
Add net income 566,000
2,546,000
Less dividends
Preferred shares $ 70,000
Common shares 250,000 320,000
Ending balance of retained earnings $ 2,226,000

PROBLEM 4-2
McLean Corporation
Income Statement
Revenues
Net sales* $1,368,000
Gain on sale of land 30,000
Rent revenue 18,000
Expenses
Cost of goods sold** 785,000
Income taxes 38,500
Net income $ 61,500
* ($1,400,000 – $14,500 – $17,500)
**Cost of goods sold:
Merchandise inventory, January 1 $ 89,000
Purchases $810,000
Add freight-in 20,000 820,000
Merchandise available for sale 909,000
Less merchandise inventory, December 31 124,000
Cost of goods sold $785,000

McLean Corporation
Retained earnings at beginning of the year $ 260,000
Plus net income 61,500
321,500
Less cash dividends declared 45,000
Retained earnings at end of the year $ 276,500

PROBLEM 4-3
(a) Charyk Inc.
Income Statement (Partial)
Income from continuing operations before taxes $1,738,500*
Income taxes 673,800 **
Income from continuing operations: 1,064,700
Loss from disposal of recreational division $115,000
Extraordinary item:
Major casualty loss 80,000
Net income $947,700
Earnings per share:
Net income $11.85
*Calculation of income from continuing operations before taxes:
As previously stated $1,790,000
Loss on sale of securities (107,000)
Gain on proceeds of life insurance policy
($100,000 – $46,000) 54,000
Error in calculation of amortization:
As calculated ($54,000 ¸ 6) $9,000
Corrected ($54,000 – $9,000) ¸ 6 7,500 1,500
As restated $1,738,500
**Calculation of income tax:
Income from continuing operations before income tax $1,738,500
Nontaxable income (gain on life insurance) (54,000 )
Taxable income 1,684,500
Tax rate X .40
Tax expense $673,800

(b) Charyk Inc.
Retained earnings, January 1, 2008, as reported $2,540,000
Correction of amortization overstatement
(net of tax of $1,200) * 1,800
Retroactive adjustment for change in inventory
method (net of tax of $16,000) ** 24,000
Retained earnings, January 1, 2008, as adjusted $2,565,800
3,513,500
Deduct Dividends declared 175,000
Retained earnings, December 31, 2008 $3,338,500
* Error in calculation of amortization:
As calculated ($54,000 ¸ 6) $9,000
Corrected ($54,000 – $9,000) ¸ 6 7,500
Understatement of net income per year 1,500
X 2
Total understatement of beginning retained earnings 3,000
After-tax understatement ($3,000 X [1-40%]) $1,800
**Understatement of 2006 income $60,000
Overstatement of 2007 income (20,000)
Net understatement of beginning retained earnings 40,000
After-tax understatement ($40,000 X [1-40%]) $24,000

(c) The GAAP classification rules assist in assessing the quality
of earnings by separating extraordinary items and
discontinued operations from continuing and non-extraordinary
results of operations. Extraordinary items
involve non-recurring unusual transactions and separating
them from regular operations helps users assess the results
of transactions within management’s control. Discontinued
operations are also 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.
The GAAP classification rules also apply to financial
statement elements and separate revenues and expenses
from gains and losses. This separation helps users assess
the past performance and profitability based on recurring,
regular transactions and predict sustainability of earnings.
GAAP also requires various other items of the income
statement to be disclosed. These also provide information to
users to assess the quality, recurrence and sustainability of
earnings and management’s performance. For example:
government assistance, goodwill impairment, income taxes,
etc.

PROBLEM 4-4
(a) Reid Corporation
Income Statement
For the Year Ended June 30, 2008
Sales Revenue
Sales $1,928,500
Less: Sales discounts $31,150
Net sales 1,835,050
Cost of Goods Sold 1,071,770
Operating Expenses
Selling expenses
Sales commissions $97,600
Sales salaries 56,260
Travel expense 28,930
Entertainment expense 14,820
Freight-out 21,400
Telephone and Internet 9,030
Amortization of sales equipment 4,980
Building expense 6,200
Bad debt expense 4,850
Miscellaneous selling expense 4,715 248,785
Administrative Expenses
Real estate and other local taxes 7,320
Building expense 9,130
Amortization of office
furniture and equipment 7,250
Office supplies used 3,450
Telephone and Internet 2,820
Miscellaneous office expenses 6,000 35,970 284,755
516,525
Bond interest expense 18,000
Earnings per share* $1.98
* ($365,525 – $9,000 of preferred dividends ¸ 180,000 shares)

Reid Corporation
Retained earnings, July 1, 2007, as reported $292,000
Correction of amortization understatement
(net of tax) 17,700
Balance July 1, 2004 adjusted $274,300
639,825
Deduct:
Dividends declared on preferred shares 9,000
Dividends declared on common shares 32,000 41,000
Retained earnings, June 30, 2008 $598,825
(b) Reid Corporation
Income Statement
Revenues
Expenses
Bond interest expense 18,000

PROBLEM 4-5
(a)
1. The usual but infrequently occurring charge of $10,500,000
should be disclosed separately, assuming it is material.
This charge is shown above income before extraordinary
items and would not be reported net of tax. This item
should be separately disclosed to inform the user 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 extraordinary because it is usual
in nature.
2. The extraordinary item of $9,000,000 should be reported
net of tax in a separate section for extraordinary items. An
adjustment should be made to income taxes to report this
amount at $22,400,000. The $3,000,000 tax effect of this
extraordinary item should be reported with the
extraordinary item. 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 may be unusual and infrequent such that
their likelihood for affecting operations again in the future
is unlikely. Separate earnings per share information must
also be presented for the extraordinary item.
3. The adjustment required for correction of an error is
inappropriately labelled and also should not be reported in
the retained earnings statement. Changes in estimate
should be handled in current and prospective periods
through the income statement. Catch-up adjustments are
not permitted. To restate financial statements every time a
change in estimate occurred would be extremely costly
and confusing. In addition, adjusting the beginning balance
of retained earnings is inappropriate, as the increased
charge in this case would never be run through current or
future income statements.

4. Earnings per share should be reported on the face of the
income statement or in the notes to the financial
statements according to the CICA Handbook Sec 3500.61.
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 both income
before extraordinary item, extraordinary item and net
income on a per share basis.

(b)
Pereira Corp.
Combined Statement of Income and Retained Earnings
($000 omitted)
Net sales $640,000
Cost and expenses:
Selling, general and administrative
expenses (a) 55,500
Loss due to write-down of inventory 10,500
Other, net (b) 8,000
574,000
Income taxes 22,400
Extraordinary item:
Extraordinary loss (net of taxes of $3,000) 6,000
Net income 37,600
Retained earnings, at beginning of the year 141,000
178,600
Less: Dividends on common shares 12,200
Retained earnings, at end of the year $166,400
(a) $66,000 - $10,500 = $55,500
(b) $17,000 - $9,000 = $8,000

PROBLEM 4-6
SITUATION A:
Olive Miller Ltd.
Sales ($5,700,000 - $1,200,000) $4,500,000
Cost of goods sold ($2,900,000 - $600,000) 2,300,000
Gross margin 2,200,000
Selling, general and administrative expenses
($1,800,000 - $450,000 - $620,000) 730,000
Income before income taxes 1,470,000
Income from apparel division (net of
income taxes of $45,000)* $105,000
Loss on disposal of apparel division
(net of income taxes of $186,000) 434,000 329,000
Extraordinary item:
Extraordinary loss (net of taxes of
$210,000) 490,000
Net income 210,000
Retained earnings, December 31 $910,000
* ($1,200,000 - $600,000 - $450,000)

SITUATION B:
Olive Miller Ltd.
Sales $5,700,000
Selling, general and administrative expenses* 1,902,600
Other losses:
Loss on disposal of equipment
($490,000 + $210,000) 700,000
Income before income taxes 197,400
Income taxes 59,220
Net income 138,180
* The amount recorded as bad debts expense
represents the 1.2% rate
($68,400 / $5,700,000 = 1.2%)
Revised bad debts expense = $5,700,000 X 3% = $171,000
Bad debts expense previously recorded 68,400
Increase in bad debts expense $102,600

SITUATION C:
Olive Miller Ltd.
Sales $5,700,000
Selling, general and administrative expenses* 1,786,000
Other expenses:
Loss due to labour disruption ($490,000 + $210,000) 700,000
Income before income taxes 314,000
Income taxes 94,200
Net income 219,800
Retained earnings, January 1, as
previously reported $700,000
Cumulative increase in prior years’
income from change in depreciation
policy (net of income taxes of
$24,000) 56,000
Retained earnings, January 1, restated 756,000
* Change in accounting policy:
Double-declining
Straight-line
2006: $500,000 X 2/10 $100,000 $50,000
2007: ($500,000 - $100,000) X 2/10 80,000 50,000
Total for prior years $180,000 $100,000
Net decrease in depreciation expense
= $180,000 - $100,000 = $80,000
2008: ($500,000 - $180,000) X 2/10 $64,000 $50,000
Net decrease in depreciation expense in 2008
= $64,000 - $50,000 = $14,000

PROBLEM 4-7
Byron Corp.
Retained Earnings, January 1, as reported $257,600
Correction of error from prior period (net of tax) 25,400
Retroactive adjustment for change in amortization
method (net of tax) (18,200)
Adjusted balance of retained earnings at January 1 264,800
Add net income 107,300 *
372,100
Deduct cash dividends declared 32,000
*$107,300 = ($129,500 + $41,200 + $21,600 – $25,000 – $60,000)
(b) 1. Gain on sale of investment in trading securities—
body of income statement, possibly unusual item
2. Refund of litigation—body of income statement,
possibly unusual item.
3. Loss on discontinued operations—body of the
income statement, following the caption, “Income
from continuing operations, shown net of tax”
4. Write-off of goodwill—body of income statement,
possibly unusual item.

PROBLEM 4-8
Hamad Corporation
Income Statement
Sales $9,500,000
Selling and administrative expenses $1,280,000 *
Loss due to write-down of inventory 112,000 **
Total operating expenses 1,392,000
Income before taxes and extraordinary item 2,208,000
Income taxes 662,400 ***
Extraordinary item:
Major casualty loss (net of taxes of
$69,429****) 162,000
Earnings per share:
Extraordinary item (.40 )
Net income $3.46
* The 2007 sales commissions of $20,000 are deducted.
** The $112,000 may be identified as an unusual item if
unusual or infrequent in nature. However, it cannot be
considered extraordinary.
*** (30% of $2,208,000).
**** The extraordinary loss before taxes = $162,000 / [100% -
30%] = $231,429. Income taxes = $231,429 - $162,000 =
$69,429.

Hamad Corporation
Sales $9,500,000
Selling and administrative expenses $1,280,000
Loss due to write-down of inventory 112,000
Total operating expenses 1,392,000
Income before taxes and extraordinary item 2,208,000
Extraordinary item:
Major casualty loss (net of taxes of
$69,429) 162,000
Net income 1,383,600
Retained earnings, January 1,
as reported 2,800,000
Cumulative effect on prior years of
change in amortization method
(net of taxes of $36,563) 85,312
Correction of error in prior year’s
income (net of taxes of $6,000) 14,000
Retained earnings, January 1, as restated 2,700,688
4,084,288
Less: Cash dividends 700,000
Retained earnings, December 31 $3,384,288
Earnings per share:
Extraordinary item (.40 )
Net income $3.46

(c) The income tax is allocated in the same manner as the
underlying irregular item or adjustment to opening retained
earnings. Since income taxes are a major expense for
companies, it is important to reflect the individual impact
of taxes for discontinued operations, extraordinary items,
corrections of errors and changes in accounting policies.
This helps users assess the quality of earnings and their
related tax impact. Earnings per share information is also
highlighted separately, net of taxes, for discontinued
operations and extraordinary items. Intra period tax
allocation also helps readers in trend analysis of income
tax expense, and income from continuing operations by
making the current year amount on a comparable basis
with prior years.

PROBLEM 4-9
Fadime Corp.
Income Statement (Partial)
Income from continuing operations before taxes $3,272,000*
Income taxes 1,243,600 **
Loss from operations of
discontinued subsidiary $ 90,000
Less applicable income tax
reduction 34,200 $55,800
Loss from disposal of subsidiary 200,000
Less applicable income tax
reduction 76,000 124,000 179,800
Earnings per share:
Net income $18.49
*Income from continuing operations before taxes:
As previously stated $2,710,000
Write-off of account receivable (54,000)
Gain on sale of equipment 96,000
Settlement of lawsuit 520,000
Restated $3,272,000
**Income tax expense: $3,272,000 X .38 = $1,243,360
Note: The prior year error related to the intangible asset was correctly
charged to retained earnings.

PROBLEM 4-10
(a) The Rocketeer Division’s assets should be identified
separately on Campbell Corporation’s balance sheet as of
May 31, 2008 and carried at their net realizable value of $87
million, i.e., the amount of cash sale. This identification can
be made in the body of the statement by showing the
assets of the Rocketeer Division as a separate listing or by
disclosure in a note to the financial statement.
(b) The operating loss must be reported as a separate
component after income from continuing operations and
before extraordinary items. The operating loss up to year
end is presented as a loss from discontinued operations.
The operating loss from a discontinued segment is
presented net of tax. Separate earnings per share figures
would also be required. The division assets would be
measured at the lower of net book value and fair market
value less costs to sell. The loss would be presented as a
separate component of discontinued operations, on an
after-tax basis.
All figures in thousands, except earnings per share:
Income from continuing operations (Note–): $XXX
Loss from operations of the Rocketeer
division less applicable income taxes of $4,000 $(6,000)
Loss from impairment of Rocketeer division
assets less applicable income taxes of $3,600* (5,400) $(11,400)
Net income $XXX
* Book value of assets $96,000,000
Fair value 87,000,000
Impairment loss $(9,000,000 )
Applicable taxes (40%) 3,600,000
After-tax loss $(5,400,000 )
(Note to instructor: We have presented the calculations in this format
in order for the student to better understand how the loss on
disposal was calculated. Other formats are acceptable.)

(c) The operating loss from June 1-30, 2008 is reported as a
separate component after income from continuing
operations and before extraordinary items. The operating
loss is presented as a loss from discontinued operations
on a net of tax basis. The loss on the disposal of the
division assets would be presented as a separate
component of discontinued operations, on an after-tax
basis. The amounts would be disclosed on a comparative
basis with the results of 2007. Separate earnings per share
figures for the discontinued operations would also be
required.
All figures in thousands, except earnings per share:
Income from continuing operations (Note–): $XXX
Loss from operations of the Rocketeer
division less applicable income taxes of $300 $(450)
Loss from disposal of Rocketeer division
assets less applicable income taxes of $1,200* (1,800) $(2,250)
Net income $XXX
(d) 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 is a separate component of the entity and is
operationally distinct as evidenced by the measurement of
the division losses;
· There is an active program to find a buyer (negotiations are
in process).
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 the
treatment is applied retroactively. 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.

PROBLEM 4-11
The deficiencies of Amos Corporation income statement are as
follows:
1. The heading is inappropriate. The heading should include
the name of the company and the period of time for which
the income statement is presented.
2. Gain on recovery of insurance proceeds should be classified
as an extraordinary item in a separate section of the income
statement.
3. The unrealized holding gain should be shown after net
income as part of other comprehensive income, on a net of
tax basis.
4. Cost of goods sold is usually listed as the first expense,
followed by selling, administrative, and other expenses.
5. Advertising expense is a selling expense and should usually
be classified as such, unless this expense is unusually
different from previous periods.
6. Loss on obsolescence of inventories might be classified as
an unusual item and separately disclosed if it is unusual or
infrequent but not both.
7. Loss on discontinued operations requires a separate
classification after income from continuing operations and
before presentation of income before extraordinary items.
8. Intraperiod income tax allocation is required to relate income
tax expense to income from continuing operations, loss on
discontinued operations, and the extraordinary item.
9. Per share data is a required presentation for income from
continuing operations, loss from discontinued operations,
extraordinary gain, and net income.

Amos Corporation
Statement of Income and Comprehensive Income
Revenues
Sales $850,000
Dividends 32,300
Expenses
Selling expenses ($100,100 + $13,700) 113,800
Loss on obsolescence of inventories 34,000
Income from continuing operations before
income taxes 151,100
Income taxes* 60,440
Loss from operations, (net of taxes of
$19,440)** 29,160
Extraordinary item
Gain from earthquake, (net of taxes of $10,920) 16,380
Net income 77,880
Other comprehensive income
Unrealized holding gain, (net of taxes of
$2,000) 3,000
Comprehensive income 80,880
Earnings per share:
Income from continuing operations $0.91 a
Discontinued operations (0.29) b
Extraordinary gain 0.16 c
Net income $0.78 d
* The income tax rate is inferred as 40% by comparing the income tax
expense to the income before income tax = $53,920 / $134,800.
** $19,440 = $48,600 X 40%.
a $90,600/ 100,000 shares`
b ($29,160) / 100,000 shares
c $16,380 / 100,000 shares
d $77,880/ 100,000 shares

PROBLEM 4-12
(a) The main deficiency in the Baring statement is that
important information is being aggregated, particularly in
the “Costs and Expenses” line item. More detail likely
could be found in Baring’s published financial statements.
However, the condensed income statement may be the one
that investors and creditors rely upon. Also, the statement
is missing the earnings per share information.
(b) Baring could provide additional details on 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
could be referenced on the face of the income statement.
Mandatory disclosure is required somewhere in the
financial statements for the items such as amortization and
interest expense. The company should also provide the
earnings per share information.
(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 GAAP requirements as the required
disclosure rather than the minimum amount required.
Management may also use minimal disclosure to avoid
questions on its management practices and assessment or
its stewardship abilities or to hide financial engineering
transactions that could prove embarassing.

PROBLEM 4-13
1. Classify as an extraordinary item because all three
conditions of an extraordinary item are met: unusual in
nature and infrequent in occurrence does not depend
primarily on decisions or determinations by management or
owners.
2. Classify as a loss, but not extraordinary. Such losses would
not be considered unusual for a business enterprise.
3. Classify as an extraordinary loss because the three
conditions of an extraordinary item are met: unusual in
nature and infrequent in occurrence, and event did not
depend primarily on decisions or determinations by
management or owners.
4. Classify as gain or loss, but not extraordinary. Because the
company maintains a portfolio of such securities, the gain or
loss would not be considered unusual in nature. The sale
was also the result of a management decision.
5. Classify as an unusual gain or loss but not extraordinary
because the third condition has not been met for
extraordinary item treatment, since management decided to
enter into the sale of the shares.
6. Classify as a gain or loss, but not extraordinary. Company
practices indicate such sales are not unusual or infrequent
in occurrence.
7. Classify as an expense with appropriate disclosure.
Relocation costs are not considered an extraordinary item
nor a cost associated with the disposal of a segment of the
business. Relocation is a consequence of customary and
continuing business activities and therefore is not
considered unusual in nature.

8. Material losses on extinguishment of debt does not qualify
for extraordinary item treatment as the loss was incurred as
a result of a management decision and are not an infrequent
occurrence in this case.
9. Classify as a loss, but not extraordinary. The loss is not an
infrequent occurrence taking into account the environment
in which the entity operates.
10. Classify as a gain, but not extraordinary. Although the sale
of the land is unusual and infrequent, it is also the result of a
decision of management.

PROBLEM 4-14
(a) Earnings management is often defined as the planned timing
of revenues, expenses, gains and losses to smooth out
bumps in earnings. In most cases, earnings management is
used to increase income in the current year at the expense of
income in future years. For example, companies prematurely
recognize revenue before it is earned in order to boost
income. Earnings management can also be used to decrease
current earnings in order to increase income in the future.
This is done through the creation of reserves by using
unrealistic assumptions to estimate liabilities for such items
as sales returns, loan losses, and warranty returns.
(b) Proposed Accounting Income:
2005 2006 2007 2008 2009
Income before
warr. expense
$43,00
0
$43,00
0
Warr. 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
2008 and 2009 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.
(c) Appropriate Accounting Income:
2005 2006 2007 2008 2009
Income before
warr. expense
$43,00
0
$43,00
0
Warr. expense 5,000 5,000
Income $20,000 $25,000 $30,000 $38,000 $38,000
The appropriate accounting would be to record $5,000 in 2008,
resulting in income of $38,000. However, with the same amount
of warranty expense in 2009, Grace no longer shows an
increasing trend in income. Thus, by taking more expense in
2008, Grace can maintain its growth trend in income.

PROBLEM 4-15
(a) The controller is using the current operating concept of
income because non-operating items are charged directly to
retained earnings. These non-operating items are: gain from
casualty (net of tax) and loss from expropriation (net of tax).
The gain on the sale of plant assets should be shown as a
separate component of income from continuing operations.
The correction of an error should be shown as an adjustment
to the beginning balance of retained earnings.
(b) The answer to this question is dependent upon the reasons
the student gives in support of his/her position. The current
operating performance concept implies that (1) extraordinary
gains and losses are not considered as either representative
or reflective of earning power, and that (2) many users are
not trained to differentiate between ordinary and
extraordinary items. Therefore, extraordinary items are
charged directly to retained earnings to avoid confusion. The
all-inclusive concept implies that extraordinary items should
be included along with regular operating income to reflect
the long-range income-producing ability of the enterprise.
Advocates of this approach state that any gain or loss
experienced by the firm, whether directly or indirectly related
to operations, contributes to long-run profitability and
should be included in the calculation of net income. Also, it
is contended that if judgement is permitted in the
classification of extraordinary items, differences develop in
the treatment of questionable items, which permit the
manipulation of net income.
(c) The modified all-inclusive concept must be employed. The
income statement and statement of retained earnings are as
follows:

Problem 4-15 (Continued)
Tatooed Heart Inc.
Income Statement
Sales Revenue
Sales $377,852
Less sales returns and allowances 16,320
Net sales revenue 361,532
Cost of Goods Sold
Merchandise inventory, January 1, 2008 $ 50,235
Purchases $192,143
Total merchandise available for sale 239,236
Less merchandise inventory,
December 31, 2008
41,12
4
Operating Expenses
Gain on sale of plant assets 21,400 61,400
Income tax 43,900
Extraordinary items:
Gain from casualty (net of tax) 10,000
Loss on expropriation (net of tax) (13,000 ) (3,000 )
Net income $103,928
Earnings per share:
Income before extraordinary items $2.14
Extraordinary items (.06 )
Net income $2.08

Problem 4-15 (Continued)
Tatooed Heart Inc.
Balance, January 1, as reported $216,000
Correction of a mathematical error (net of tax) (17,186 )
Net income 103,928
Balance, December 31 $302,742

PROBLEM 4-16
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 on the Income Statement of Klein Corporation.
Failure to deduct these taxes directly from customer billings
results in a deceptive inflation of the amount of sales. These
taxes should be deducted from gross sales 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 dividends and interest. 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 consideration. In a credit transaction, however,
cost is measured by the amount of cash required to settle
immediately the obligation incurred. The discount should
reduce the cost of goods sold to the amount of cash that
would be required to settle the obligation immediately.
3. Recoveries of amounts written off in prior years: these
collections should be credited to the 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 expenses.
Generally, the direct write-off method is not allowed, as it
does not adhere to the matching principle.

4. Freight-in and freight-out: although freight-out is an expense
of selling and is therefore reported properly in the statement,
freight-in is a cost related to the acquisition of merchandise
for resale 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. Addition to reserve for possible inventory losses: additions
to inventory reserves 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,
which is neither more nor less probable because of a past
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 extraordinary item
because it is apparently typical of the customary business
activity of the corporation. It should be reported in "Costs
and Expenses" as an operating expense.
7. Loss on sale of trading securities: this item should be
reported as a separate component of income from
operations and not as an extraordinary item. The conditions
are not unusual in nature and management had influence
over the outcome of this transaction.
8. Loss on sale of warehouse: this loss cannot be classified as
an extraordinary item unless such a loss is the direct result
of a major casualty, an expropriation, or a prohibition under
a newly enacted law or regulation. This item should be
separately disclosed as an unusual item, if either unusual in
nature or infrequent in occurrence.

9. Tax reassessments for 2006 and 2005: a recurring settlement
of income taxes should not be treated as an extraordinary
item. The loss should be recognized as a charge to expense
from operations before extraordinary items.
10. Income taxes: the income statement is missing income tax
as an expense.

*PROBLEM 4-17
(a) Razorback Sales and Service
Income Statement
For the Month Ended January 31, 2008
Cash
Basis
Accrual
Basis
Revenues $75,000 $105,750*
Expenses
Cost of computers & printers:
Purchased and paid 89,250**
Sold 63,750***
Salaries 9,600 12,600
Rent 6,000 2,000
Other Expenses 8,400 10,400
Total expenses 113,250 88,750
Net income (loss) $(38,250) $ 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 X30) + ($3,000 X 4) + ($450 X 15)

*PROBLEM 4-17 (Continued)
(b) Razorback Sales and Service
Balance Sheet
As of January 31, 2008
Cash
Basis
Accrual
Basis
Assets
Cash $51,750a $ 51,750a
Accounts Receivable 30,750
Inventory 25,500b
Prepaid rent ______ 4,000
...Total
assets
$51,750 $112,000
Liabiliti
es and
Owner
s’
Equity
Accounts payable $ 2,000
Salaries payable 3,000
Owners’ equity $51,750c 107,000 d
Total liabilities and owners’
equity
$51,75
0
$112,00
0
aOriginal investment $90,000
Cash sales 75,000
Cash purchases (89,250)
Rent paid (6,000)
Salaries paid (9,600)
Other expenses (8,400)
Cash balance Jan. 31 $51,750
b(10 X $1,500) + (2 X $3,000) + (10 X $450).
cInitial investment minus net loss: $90,000 – $38,250.
dInitial investment plus net income: $90,000 + $17,000.

*PROBLEM 4-17 (Continued)
(c) 1. The $30,750 in receivables from customers is an
asset and a future cash flow resulting from sales that
is ignored. The cash basis understates the amount of
revenues 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 under the cash basis. 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 a cash basis are
understated by $2,000 as is the liability for the unpaid
portion of these expenses incurred in January.

Ch04.soln

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Ch04.soln