1-1 INCOME STATEMENT Introduction The income statement provides investors and creditors with information about the performance of a business. In its basic format, the income statement provides information about revenues, expenses, gains, and losses of a business. Net income usually does not equal the cash flows generated from the operations of the business. Statement of Financial Accounting Concepts No. 1 states that “information about earnings and its components... generally provides a better indication of enterprise performance than information about current cash receipts and payments.” Businesses pay income taxes based on their income. However, the income number calculated for tax purposes is usually different from that calculated using the generally accepted accounting principles (GAAP) for financial reporting purposes. This is so because tax rules are based on laws enacted by Congress, which do not necessarily follow GAAP. Income Statement Format The income statement may be prepared in single-step or multiple-step format. In the single-step income statement , all operating revenues and gains are listed first, followed by all operating expenses and losses. The differences between revenues/gains and expenses/losses represent income from continuing operations. An example of a single- step income statement follows: Revenues Sales revenue $10,000 Interest revenue 500 Gain on sale of land 1,200 Other income 300 Total revenue $12,000 Expenses Cost of goods sold $ 7,000
Transcript
1-1
INCOME STATEMENT
Introduction
The income statement provides investors and creditors with information about the performance of a business. In its basic format, the income statement provides information about revenues, expenses, gains, and losses of a business.
Net income usually does not equal the cash flows generated from the operations of the business. Statement of Financial Accounting Concepts No. 1 states that “information about earnings and its components... generally provides a better indication of enterprise performance than information about current cash receipts and payments.”
Businesses pay income taxes based on their income. However, the income number calculated for tax purposes is usually different from that calculated using the generally accepted accounting principles (GAAP) for financial reporting purposes. This is so because tax rules are based on laws enacted by Congress, which do not necessarily follow GAAP.
Income Statement Format
The income statement may be prepared in single-step or multiple-step format. In the single-step income statement, all operating revenues and gains are listed first, followed by all operating expenses and losses. The differences between revenues/gains and expenses/losses represent income from continuing operations. An example of a single-step income statement follows:
Revenues Sales revenue $10,000 Interest revenue 500 Gain on sale of land 1,200 Other income 300 Total revenue $12,000Expenses Cost of goods sold $ 7,000 Selling and administrative expenses 2,500 Other operating expenses 200 Loss on sale of equipment 800 Income tax expense 600 Total expenses $11,100
Income from continuing operations $ 900
Loss on discontinued operations (net of tax) (200)Income before extraordinary items and cumulative effect of change in accounting principle 700
1-2
Extraordinary gain (net of tax) 250Cumulative effect of change in accounting principle (net of tax) 300Net income $ 1,250
Note:1. In the single-step format, revenues and gains are combined and shown as a single category (similarly, expenses and losses are combined).2. Discontinued operations, extraordinary items, and the cumulative effect of accounting principle change are presented net of tax.
In the multiple-step income statement, operating revenues are listed first, followed by operating expenses. The difference between the two gives operating income. To this number, gains are added and losses are subtracted giving income from continuing operations. An example of a multiple-step income statement follows:
Sales revenue $10,000Cost of goods sold (7,000)Gross profit $3,000Operating expenses Selling and administrative expenses 2,500 Other expenses 200 (2,700)Income from operations $ 300
Other revenue and gains Interest revenue 500 Gain on sale of land 1,200 Other income 300 2,000Other expenses and losses Loss on sale of equipment (800)Net income before taxes 1,500Income tax expense (600)Income from continuing operations $ 900
Loss on Discontinued operations (net of tax) (200)Income before extraordinary item and cumulative effect of change in accounting principle 700Extraordinary gain (net of tax) 250Cumulative effect of change in accounting principle (net of tax) 300Net income $1,250
Note:1. In the multiple-step format, information is divided into operating and other (nonoperating) sections.
1-3
2. Income from operations is different from income from continuing operations. 3. The items after income from continuing operations are presented similarly in the single- and multiple-step formats.
The order of appearance of the items is important. Use this acronym to memorize the order.I = Income from continuing operationsD = Discontinued operationsE = Extraordinary itemsA = Accounting principle change
Discontinued Operations
A company may decide to discontinue the operations of a business segment for a variety of reasons. The segment could be a product line, a division, or a subsidiary. To qualify for special treatment as a discontinued operation, the assets and liabilities of the segment should be clearly distinguishable from other activities of the company.
Information about discontinued operations is required to be presented separately from other operations. For such measurement and reporting, it is important to identify the measurement date and the disposal date. The Measurement date is the date on which the management decides on a plan to dispose of a segment of the business. The Disposal date is the date on which the segment is actually disposed of, either by closing a sale or by stopping the operations. The Phase-out period is the period between the measurement date and the disposal date.
Sometimes management may decide to discontinue a segment, but the actual process of phasing it out may take some time. For example, it is possible that management of a company with a December 31 fiscal year-end decided on October 1, 2002 to discontinue a segment, but the actual liquidation process of the segment is not completed until March 15, 2003. In such instances, there are three relevant periods, and each of these three periods has an associated income or loss. They are as follows:
A. Income (or loss) related to the operations of the segment from the beginning of the period to the measurement date (in our example, this is the period from January 1, 2002 to September 30, 2002).
B. Realized gains (or losses) of the segment from the measurement date to the end of period (in our example, this is the period from October 1, 2002 to December 31, 2002). This period in turn includes two components: the operating income or loss from continuing to operate the segment as it is being phased out and the gain or loss on disposal of segment as the process of disposing of it proceeds from the measurement date to the end of the period.
C. Unrealized gains (or losses) of the segment from the beginning of the next period until the date the disposal is complete (in our example, this is the period from January 1, 2003 to March 15, 2003). Since these are future numbers as of December 31, 2002, they must be estimated because under certain circumstances unrealized gains (or losses) may have to be included in the income statement for the period ending December 31, 2002. As with item B, the estimated gains or losses for this period also include two components: estimated operating income or loss
1-4
and estimated gain or loss on the disposal of the segment, both from the end of the current period to the date of disposal.
The rules for the recognition of gains or losses related to disposal of a segment, when the measurement date is in the first year and disposal is completed in the second year, are as follows: Income or loss related to the period before the measurement date is always recognized in
year 1. Income or loss related to the period from the measurement date to the end of the period are
always recognized in the first year.Thus, measurement and recognition related to two of the three relevant periods is straightforward. However, measurement and recognition related to the estimated future costs (in year 2) are more difficult. The rules related to the estimated future amount from the operation and disposal of the segment (these two numbers must be added together) are as follows: If the combined amount is a loss, the estimated loss amount must be recognized in the first
year (in our example, if the results of operation and disposal from January 1, 2003 to March 15, 2003 together lead to an estimated loss, that amount must be recognized in the income statement for the period ending December 31, 2002).
If the combined amount is a gain, the estimated gain amount can be recognized only to offset losses, if any, from the operations and disposal of the segment in the first year. The remainder of the gains are recognized only in year 2, after the actual disposal.
Extraordinary Items
Extraordinary items are both unusual in nature and infrequent in occurrence.Unusual means the event must be highly abnormal and must be clearly unrelated to the ordinary activities of the entity. Infrequent means that the event would not reasonably be expected to occur again in the foreseeable future. However, the environment in which an entity functions must be considered when applying these definitions. This means that what may be considered extraordinary for one company may not be extraordinary for another company. (For example, an earthquake may be infrequent in New York but not in California.)
The following items do not qualify as extraordinary (because they are not unusual or may be expected to occur regularly):1. Write-downs or write-offs of receivables, inventories, or intangible assets.2. Gains or losses from foreign currency translations.3. Gains or losses from disposal of a segment of a business.4. Gains or losses from sale or abandonment of property, plant, or equipment.5. Effects of a strike.
However, material gains and losses from extinguishment of debt are considered to be extraordinary.
Extraordinary items are reported net of tax. For example, assume that a firm has an extraordinary loss of $100,000. If the tax rate is 30%, the extraordinary loss reduces the taxable income by $100,000, which in turn means that the income tax is reduced by $30,000. Hence, the after-tax loss is only $70,000, and the extraordinary item is reported on the income statement
1-5
as a net of tax loss of $70,000.
What if an item is unusual but not infrequent, or infrequent but not unusual? Such items are reported separately but are included before calculating income from continuing operations. Note that such items cannot be reported net of tax but must be shown at their gross amount.
Change in Accounting Principles and Estimates
A company may adopt an accounting method that is different from the one it previously used. This may occur for two reasons. First, a standard-setting body (for example, the Financial Accounting Standard Board, FASB) may issue a new pronouncement that requires a change in principle. Second, circumstances may change and the company may want to change accounting principles so that financial reporting is more representative of the new conditions in which it operates. For example, a company may change from FIFO to LIFO for inventory accounting or from the straight-line method to the double-declining balance method for depreciation of plant assets.
When there is a change in accounting principle, the cumulative effect of the change must be considered. The cumulative effect is the difference between the value of an asset or liability on the balance sheet when using the old principle and the value of the same asset or liability when using the new principle. The cumulative effect of adopting the new principle on net income is reported, net of tax, on the income statement. In addition, for all periods for which comparative data are presented in the income statement, pro forma net income and earnings per share under the new method must be reported. That is, for such prior periods, the net income and earnings per share must be calculated and reported according to the new principle.
In some special cases, prior period financial statements need to be restated. In addition, if the change in accounting principle is required (because of a new FASB standard), the FASB specifies the method to use to report the cumulative effect of the change in accounting principle.
Changes in accounting estimates are different from changes in accounting principle. For example, the estimated useful lives of machines may be changed during the period. This has an impact on the depreciation expense calculated during the current and future periods, but the previously reported numbers are not changed. Another example of a change in accounting estimate is the percentage used to estimate the allowance for doubtful accounts or the estimated warranty expenses.
Earnings per share (EPS)
Basic earnings per share are calculated as follows:Basic EPS = (Net income – Preferred dividends) / Weighted average number of common shares outstanding
Per share numbers are disclosed in the income statement for the following separate amounts: Income from continuing operations.
1-6
Income related to special situations (such as discontinued operations, extraordinary items, and the cumulative effect of changes in accounting principle).
Net income.
Statement of Changes in Retained Earnings
Many companies include a statement of changes in retained earnings. The format of this statement follows:
Beginning retained earnings + or – Prior period adjustment+ net income + or – Adjustments due to certain types of changes in accounting principles– Dividends declared during the period= Ending retained earnings.
Prior period adjustments usually occur when errors from prior periods are discovered (for example, an inventory overstatement). In this situation, the beginning balance of retained earnings is adjusted for the amount of the discovered error. Prior period adjustments are reported net of tax on the retained earnings statement.
Certain types of changes in accounting principles made during the current year require a direct adjustment to the (ending) balance of retained earnings.
Note that dividends declared (not dividends paid, which may or may not equal the dividends declared during a specific period) are subtracted to calculate the ending retained earnings. Dividends declared for both preferred stock and common stock must be subtracted.
Glossary
Cumulative effect is the difference between the value of an asset or liability shown on the balance sheet when using the old principle to determine value and the value of that asset or liability when using the new principle.
Disposal date is the date when the segment is actually disposed of either by closing a sale or by stopping the operations.
Extraordinary items are events that are both unusual in nature and infrequent in occurrence.
Infrequent refers to an event that is not reasonably expected to occur again in the foreseeable future.
Measurement date is the date on which the management decides on a plan to dispose of a segment of the business.
Multiple-step income statement is an income statement format that lists operating revenues l first, followed by operating expenses. The difference between the two gives operating income.
1-7
To this number, gains are added and losses are subtracted, giving income from continuing operations.
Phase-out period is the period between the measurement date and the disposal date.
Prior period adjustments usually occur when errors from prior periods are discovered (for example, an inventory overstatement). In this situation, the beginning balance of retained earnings is adjusted for the discovered error.
Single-step income statement an income statement presentation that lists all operating revenues and gains first, followed by all operating expenses and losses. The differences between revenues/gains and expenses/losses represents income from continuing operations.
Unusual describes an event that is highly abnormal and clearly unrelated to the ordinary activities of the entity.
1-8
Demonstration Problem 1Cargill Company
Prepare a single-step income statement for the year ending December 31, 2002 using the following data for Cargill Company.
Cost of goods sold $50,000Gain on sale of land 7,000Income tax expense 7,000Gain on discontinued operations, net of tax 4,000Other income 2,000Sales revenue 80,000Loss on sale of equipment 1,000Selling and administrative expenses 18,000Extraordinary loss, net of tax 3,000Other operating expenses 2,000Interest revenue 3,000Cumulative credit effect of change in accounting principle, net of tax 2,000
1-9
Solution to Demonstration Problem 1, Cargill Company
Note: The cumulative effect of a change in accounting principle is considered to have a “credit” effect. Remember that credits (such as revenues and gains) increase net income, debits (such as expenses and losses) decrease net income. Hence, the change in accounting principle in this instance should be added to arrive at the net income.
Revenues Sales revenue $80,000 Interest revenue 3,000 Gain on sale of land 7,000 Other income 2,000 Total revenue $92,000Expenses Cost of goods sold $50,000 Selling and administrative expenses 18,000 Other operating expenses 2,000 Loss on sale of equipment 1,000 Income tax expense 7,000 Total expenses $78,000
Income from continuing operations $14,000
Gain on discontinued operations, net of tax 4,000Income before extraordinary item and cumulative effect of change in accounting principle $18,000Extraordinary loss, net of tax (3,000)Cumulative effect of change in accounting principle, net of tax 2,000Net income $17,000
1-10
Demonstration Problem 2Kohl Company
Prepare a multiple-step income statement for the year ending December 31, 2002 using the following data for Kohl Company.
Cost of goods sold $160,000Gain on sale of land 12,000Income tax expense 21,000Loss on discontinued operations, net of tax 4,000Other income 3,000Sales revenue 250,000Loss on sale of equipment 3,000Selling and administrative expenses 40,000Extraordinary gain, net of tax 7,000Other operating expenses 6,000Interest revenue 7,000Cumulative debit effect of change in accounting principle, net of tax 5,000
1-11
Solution to Demonstration Problem 1, Kohl Company
Note: The cumulative effect of a change in accounting principle is considered to have a “debit” effect. Hence, the change in accounting principle in this instance should be subtracted to arrive at the net income.
Sales revenue $250,000Cost of goods sold (160,000)Gross profit $90,000Operating expenses Selling and administrative expenses 40,000 Other operating expenses 6,000 (46,000)Income from operations $44,000
Other revenue and gains Interest revenue 7,000 Gain on sale of land 12,000 Other income 3,000 22,000Other expenses and losses Loss on sale of equipment (3,000)Net income before taxes 63,000Income tax expense (21,000)Income from continuing operations $42,000
Loss on discontinued operations, net of tax (4,000)Income before extraordinary item and cumulative effect of change in accounting principle 38,000Extraordinary gain, net of tax 7,000Cumulative effect of change in accounting principle, net of tax (5,000)Net income $40,000
1-12
Demonstration Problem 3Keck Company
The following are four possible scenarios related to the discontinuation of a segment by Keck Company during the year ending December 31, 2002. Assume that in each instance, the decision to discontinue the segment was made on September 1, 2002, and that the actual disposal of the segment was completed on April 15, 2003. Each of the numbers given is in thousands of dollars and is net of tax. Calculate the gain or loss of the discontinued segment to be reported in the income statement for the year ended December 31, 2002.
Case A Case B Case C Case DRealized results of operations from 1/1/2002 to 8/31/2002 $50,000 $50,000 $50,000 $50,000Realized results of operations from 9/1/2002 to 12/31/2002 30,000 30,000 30,000 30,000Realized gains/losses on disposal of assets from 9/1/2002 to 12/31/2002 70,000 70,000 (40,000) (25,000)Estimated results of operations of segment from 1/1/2003 to 4/15/2003 10,000 (15,000) 12,000 8,000Estimated gains/losses on disposal of assets from 1/1/2003 to 4/15/2003 20,000 (45,000) 14,000 (11,000)
1-13
Solution to Demonstration Problem 3, Keck Company
We can partition the period from 1/1/2002 to 4/15/2003 as follows:Period A: From 1/1/2002 to 8/31/2002 (measurement date).Period B: From 9/1/2002 to 12/31/2002 (actual results for the current year).Period C: From 1/1/2003 to 4/15/2003 (up to the estimated disposal date).
Case A
Period Amount Include?
Reported in income statement for year
ending 12/31/20021/1/2002 –8/31/2002 $50,000 Yes $ 50,0009/1/2002 –12/31/2002 100,000 Yes 100,0001/1/2003 –4/15/2003 30,000 No 0Total reported $150,000Note:1. Net result of segment during period B is a gain of $100,000 ($30,000 + $70,000).2. Expected net result of segment during period C is a gain of $30,000 ($10,000 + $20,000).
Case B
Period Amount Include?
Reported in income statement for year
ending 12/31/20021/1/2002 –8/31/2002 $50,000 Yes $50,0009/1/2002 –12/31/2002 100,000 Yes 100,0001/1/2003 –4/15/2003 (60,000) Yes (60,000)Total reported $90,000Note:1. Net result of segment during period B is a gain of $100,000 ($30,000 + $70,000).2. Expected net result of segment during period C is a loss of $60,000 ($15,000 and $45,000).
Case C
Period Amount Include?
Reported in income statement for year
ending 12/31/20021/1/2002 –8/31/2002 $50,000 Yes $50,0009/1/2002 –12/31/2002 (10,000) Yes (10,000)1/1/2003 –4/15/2003 26,000 Yes 10,000Total reported $50,000Note:1. Net result of segment during period B is a loss of $10,000 ($30,000 – $40,000).2. Expected net result of segment during period C is a gain of $26,000 ($12,000 + $14,000).3. Because the estimated future amount is a gain and the loss after the measurement date in year 1 was only $10,000, only $10,000 of the $26,000 estimated future gain is recognized in
1-14
year 1.
Case D
Period Amount Include?
Reported in income statement for year
ending 12/31/20021/1/2002 –8/31/2002 $50,000 Yes $50,0009/1/2002 –12/31/2002 5,000 Yes 5,0001/1/2003 –4/15/2003 (3,000) Yes (3,000)Total reported $52,000Note:1. Net result of segment during period B is a gain of $5,000 ($30,000 – $25,000).2. Expected net result of segment during period C is a loss of $3,000 ($8,000 – $11,000).3. Because the estimated future amount is a loss, the entire expected future loss of $3,000 is recognized in year 1.
1-15
Practice Problem 1Patel Company
Prepare a single-step income statement for the year ending December 31, 2002, using the following data for Patel Company.
Inventory, 1/1/2002 $ 40,000Purchases 125,000Purchase returns 2,000Inventory, 12/31/2002 35,000Gain on sale of equipment 8,000Loss on discontinued operations, net of tax 6,000Sales 215,000Sales returns 9,000Interest revenue 3,000Dividend revenue 5,000Selling and administrative expenses 37,000Extraordinary gain, net of tax 4,000Other operating expenses 12,000Income tax expense 15,000
1-16
Solution to Practice Problem 1, Patel Company
Cost of goods sold = Beginning inventory + Net Purchases – Ending inventory= $40,000 + ($125,000 – $2,000) – $35,000= $128,000
Revenues Sales revenue $206,000 Interest revenue 3,000 Dividend revenue 5,000 Gain on sale of equipment 8,000 Total revenue $222,000Expenses Cost of goods sold $128,000 Selling and administrative expenses 37,000 Other operating expenses 12,000 Income tax expense 15,000 Total expenses $192,000
Income from continuing operations $ 30,000
Loss on discontinued operations, net of tax (6,000)Income before extraordinary item $ 4,000Net income $ 28,000
1-17
Practice Problem 2McNett Company
Prepare a multiple-step income statement for the year ending December 31, 2002 using the following data for McNett Company.
Cost of goods sold $100,000Dividend revenue 4,000Income tax expense 14,000Loss on discontinued operations, net of tax 6,000Sales revenue 180,000Loss on sale of building 5,000Selling and administrative expenses 30,000Extraordinary loss, net of tax 2,500Other income 1,000Other operating expenses 12,000Interest revenue 2,000Cumulative debit effect of change in accounting principle, net of tax 3,500
1-18
Solution to Practice Problem 2, McNett Company
Note: The cumulative effect of change in accounting principle is considered to have a “debit” effect. Hence, the change in accounting principle in this instance should be subtracted to arrive at the net income.
Sales revenue $180,000Cost of goods sold (100,000)Gross profit $ 80,000Operating expenses Selling and administrative expenses 30,000 Other operating expenses 12,000 (42,000)Income from operations $ 38,000
Other revenue and gains Interest revenue 2,000 Dividend revenue 4,000 Other income 1,000 7,000Other expenses and losses Loss on sale of building (5,000)Net income before taxes 40,000Income tax expense (14,000)Income from continuing operations $ 26,000
Loss on discontinued operations, net of tax (6,000)Income before extraordinary item and cumulative effect of change in accounting principle 20,000Extraordinary loss, net of tax (2,500)Cumulative effect of change in accounting principle, net of tax (3,500)Net income $ 14,000
1-19
Practice Problem 3Jennett Company
Following are four possible scenarios related to the discontinuation of a segment by Jennett Company during the year ending December 31, 2002. Assume that in each instance, the decision to discontinue the segment was made on August 1, 2002, and that the actual disposal of the segment was completed on May 1, 2003. Each of the numbers given is in thousands of dollars and is net of tax. Calculate the gain or loss of the discontinued segment to be reported in the income statement for the year ended December 31, 2002.
Case A Case B Case C Case DRealized results of operations from 1/1/2002 to 7/31/2002 $20,000 $20,000 $20,000 $20,000Realized results of operations from 8/1/2002 to 12/31/2002 14,000 16,000 18,000 15,000Realized gains/losses on disposal of assets from 8/1/2002 to 12/31/2002 (20,000) (9,000) (14,000) 2,000Estimated results of operations of segment from 1/1/2003 to 5/1/2003 (4,000) (8,000) 3,000 4,000Estimated gains/losses on disposal of assets from 1/1/2003 to 5/1/2003 (12,000) 12,000 7,000 (9,000)
1-20
Solution to Practice Problem 3, Jennett Company
Period A: From 1/1/2002 to 7/31/2002 (measurement date).Period B: From 8/1/2002 to 12/31/2002 (actual results for the current year).Period C: From 1/1/2003 to 5/1/2003 (up to the estimated disposal date).
1. In a single-step income statement, extraordinary items are reporteda. before the discontinued operations but after the cumulative effect of changes in accounting principles.b. after the discontinued operations but before the cumulative effect of changes in accounting principles.c. after both the discontinued operations and the cumulative effect of changes in accounting principles.d. before both the discontinued operations and the cumulative effect of changes in accounting principles.
2. The normal order of presentation in the multiple-step income statement isa. Income from continuing operations, discontinued operations, extraordinary items, net income.b. Discontinued operations, Income from continuing operations, extraordinary items, net income.c. Income from continuing operations, discontinued operations, net income, extraordinary items.d. Income from continuing operations, cumulative effect of change in accounting principle, discontinued operations, net income
3. A flood damaged a factory in Flint, Michigan. This should be reported as a(n)a. loss from continuing operations.b. loss from discontinued operations.c. extraordinary item.d. cost of goods sold.
4. Prior period adjustments directly affecta. the beginning retained earnings and are reported net of tax.b. the beginning retained earnings and are reported net of tax.c. the net income and are reported on the income statement, net of tax.d. the net income and are reported on the income statement, not net of tax.
5. George Company changed the useful life of its factory equipment from 10 to 12 years. This is an example of a(n)a. extraordinary item.b. change in accounting principle.c. accounting error.d. change in accounting estimate.
6. Results from discontinued operations relating to the period from the measurement date to the fiscal year-end area. included only if there is a net loss from such operations and are reported net of tax.
1-22
b. included only if there is a net loss from such operations but are not reported net of tax.c. included regardless of gain or loss and are shown net of tax.d. included only if it is a gain and then only to offset other losses.
7. Which of the following is reported only in current and future periods?a. Change in accounting principle.b. Change in accounting estimate.c. Prior period adjustment.d. Change in accounting principle and in accounting estimate.
8. Which of the following would be reported as an extraordinary item?a. write-down of inventoriesb. abandonment of a propertyc. effects of a striked. loss from a flood
1-23
Homework Problem 1Lunce Company
Prepare a single-step income statement for the year ending December 31, 2002, using the following data for Lunce Company.
Cost of goods sold $240,000Loss on sale of building 20,000Income tax expense 30,000Gain on discontinued operations, net of tax 8,000Interest revenue 15,000Sales revenue 400,000Gain on sale of equipment 8,000Selling and administrative expenses 48,000Extraordinary gain, net of tax 5,000Other operating expenses 32,000Dividend revenue 10,000Cumulative debit effect of change in accounting principle, net of tax 12,000
1-24
Solution to Homework Problem 1, Lunce Company
Note: The cumulative effect of change in accounting principle is considered to have a “debit” effect. Remember that debits (such as expenses and losses) decrease net income. Hence, the change in accounting principle in this instance should be subtracted to arrive at the net income.
Revenues Sales revenue $400,000 Interest revenue 15,000 Dividend revenue 10,000 Gain on sale of equipment 8,000 Total revenue $433,000Expenses Cost of goods sold $240,000 Selling and administrative expenses 48,000 Other operating expenses 32,000 Loss on sale of building 20,000 Income tax expense 30,000 Total expenses $370,000
Income from continuing operations $ 63,000
Gain on discontinued operations, net of tax 8,000Income before extraordinary item and cumulative effect of change in accounting principle $ 71,000Extraordinary gain, net of tax 5,000Cumulative effect of change in accounting principle, net of tax (12,000)Net income $ 64,000
1-25
Homework Problem 2Gupta Company
Prepare a multiple-step income statement for the year ending December 31, 2002, using the following data for Gupta Company.
Cost of goods sold $210,000Dividend revenue 4,800Income tax expense 24,000Gain on discontinued operations, net of tax 7,000Sales revenue 340,000Loss on sale of machinery 5,000Selling and administrative expenses 42,000Extraordinary loss, net of tax 9,000Other income 1,200Other operating expenses 18,000Interest revenue 3,000Cumulative credit effect of change in accounting principle, net of tax 6,000
1-26
Solution to Homework Problem 2, Gupta Company
Note: The cumulative effect of change in accounting principle is considered to have a “debit” effect. Hence, the change in accounting principle in this instance should be subtracted to arrive at the net income.
Sales revenue $ 340,000Cost of goods sold (210,000)Gross profit $130,000Operating expenses Selling and administrative expenses 42,000 Other operating expenses 18,000 (60,000)Income from operations $ 70,000
Other revenue and gains Interest revenue 3,000 Dividend revenue 4,800 Other income 1,200 7,000Other expenses and losses Loss on sale of machinery (5,000)Net income before taxes 72,000Income tax expense (24,000)Income from continuing operations $ 48,000
Gain on discontinued operations, net of tax 7,000Income before extraordinary item and cumulative effect of change in accounting principle 55,000Extraordinary loss, net of tax (9,000)Cumulative effect of change in accounting principle, net of tax 6,000Net income $ 52,000
1-27
Homework Problem 3Hong Company
The following are four possible scenarios related to the discontinuation of a segment by Hong Company during the year ending December 31, 2002. Assume that in each instance, the decision to discontinue the segment was made on October 1, 2002, and that the actual disposal of the segment was completed on May 1, 2003. Each of the numbers given is in thousands of dollars and is net of tax. Calculate the gain or loss of the discontinued segment to be reported in the income statement for the year ended December 31, 2002.
Case A Case B Case C Case DRealized results of operations from 1/1/2002 to 9/30/2002 $30,000 $30,000 $30,000 $30,000Realized results of operations from 10/1/2002 to 12/31/2002 8,000 6,000 4,000 9,000Realized gains/losses on disposal of assets from 10/1/2002 to 12/31/2002 (4,000) (8,000) 5,000
(2,000)
Estimated results of operations of segment from 1/1/2003 to 5/1/2003 (2,000) 1,000 2,000 (3,000)Estimated gains/losses on disposal of assets from 1/1/2003 to 5/1/2003 (1,000) 2,000 1,000 (1,000)
1. In a multiple-step income statement, discontinued operations are reporteda. before extraordinary items but after the cumulative effect of changes in accounting principles.b. after extraordinary items, but before the cumulative effect of changes in accounting principles.c. before both extraordinary items and the cumulative effect of changes in accounting principles.d. after both extraordinary items and the cumulative effect of changes in accounting principles.
2. When an item is unusual but not infrequent, it is reported as a. extraordinary.b. a discontinued operation.c. either extraordinary or a discontinued operation.d. neither extraordinary nor a discontinued operation.
3. The single-step income statement does not showa. cost of goods sold.b. gross profit.c. earnings per share.d. income from continuing operations.
4. To calculate the ending retained earnings, a. dividends paid during the period are subtracted.b. only dividends declared and paid during the period are subtracted.c. dividends declared during the period are subtracted.d. dividends declared during the period are added.
5. Smith Company decided to change from LIFO to FIFO for the valuation of its inventory. This is an example of a(n)a. change in accounting principle.b. change in accounting estimate.c. extraordinary item.d. accounting error.
6. On September 1, 2002, Thomas Company decided to dispose of a segment. It is expected that the disposal will be complete by March 1, 2003. Assuming a December 31 fiscal year-end, the phase-out period is a. January 1, 2002 to September 1, 2002.b. September 1, 2002 to December 31, 2002.c. January 1, 2003 to March 1, 2003.d. September 1, 2002 to March 1, 2003.
1-30
7. All of the following items are reported net of tax on the income statement excepta. a gain on sale of property, plant, and equipment.b. extraordinary items.c. discontinued operations.d. the cumulative effect of change in accounting principles.
8. Which of the following is not considered an extraordinary item?a. Material gains from extinguishment of debt.b. Losses from foreign currency translations. c. A fire in the company’s warehouse.d. Flood damage to the factory.
