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Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Other Nonowner Items that AffectOwners’ Equity
© The McGraw-Hill Companies, Inc., 1999
10Part One: Financial Accounting
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Detailed Condensed Statement (Top) Slide 10-1
BASEL CORPORATIONCondensed Statement of Income and Retained Earnings
Year Ended December 31, 1998(in thousands)
Net sales and other revenue $60,281 Expenses 46,157 Income from continuing operations before
income taxes 14,124 Provision for income taxes 5,650
Income from continuing operations 8,474 Discontinued operations (Note A):
Loss from operations of Division X (less applicable income taxes of $320) $480
Loss on disposal of Division X (less applicableincome taxes of $640 960 (1,440)
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Extraordinary loss (less applicable income taxesof $400)(Note B) (600)
Cumulative effect of changes in accounting principles(less applicable income taxes of $125)(Note C) (400)
Net income $ 6,034 Retained earnings at beginning of year:
As previously reported $41,400 Adjustments (Note D) (1,200)As restated 40,200
Add net income 6,034 Deduct dividends (2,000)Retained earnings at end of year $44,234
Detailed Condensed Statement (Bottom) Slide 10-2
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
The event must be unusual; it should be highly abnormal and unrelated to, or only incidentally related to, the ordinary activities of the entity.
The event must occur infrequently; it should be of a type that would not reasonably be expected to recur in the foreseeable future.
Extraordinary Items Slide 10-3
In order to qualify as an extraordinary item, an event must satisfy two criteria:
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Write-down or write-off of accounts receivable, inventory, or intangible assets
Gains or losses from changes in the value of foreign currency
Gains or losses on disposal of a segment of a business
Gains or losses from the disposal of fixed assetsEffects of a strike
Write-down or write-off of accounts receivable, inventory, or intangible assets
Gains or losses from changes in the value of foreign currency
Gains or losses on disposal of a segment of a business
Gains or losses from the disposal of fixed assetsEffects of a strike
Extraordinary Items Slide 10-4
The following gains and losses are specifically not extraordinary:
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
• The transaction must involved a whole business
• Discontinuance may occur by abandoning the segment and selling off the assets
• Discontinuance may occur by selling the whole segment as a unit to some other company
Discontinued Operations Slide 10-5
ChairDivision
ABCFurniture
Mfg.Company
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
1. The net income or loss attributed to the operations of the segment until it is sold
2. The estimated net gain or loss on disposal after taking account of all aspects of the sale, including the amount received and the write-off of assets that are not sold
1. The net income or loss attributed to the operations of the segment until it is sold
2. The estimated net gain or loss on disposal after taking account of all aspects of the sale, including the amount received and the write-off of assets that are not sold
Discontinued Operations Slide 10-6
Two amounts are reported on the income statement after their income tax effect has
been taken into account:
Two amounts are reported on the income statement after their income tax effect has
been taken into account:
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Change in Accounting Principles Slide 10-7
Sometimes a change is required by a new FASB Statement.
Sometimes a change is required by a new FASB Statement.
The consistency concept requires that a company use the same accounting principle from one year
to the next.
The consistency concept requires that a company use the same accounting principle from one year
to the next.
If a company has a sound If a company has a sound reason for doing so, it reason for doing so, it may occasionally shift may occasionally shift
from one GAAP to from one GAAP to another one.another one.
If a company has a sound If a company has a sound reason for doing so, it reason for doing so, it may occasionally shift may occasionally shift
from one GAAP to from one GAAP to another one.another one.The cumulative effect of the
change is reported as one of the nonrecurring items on the
income statement in the year the changed is made.
The cumulative effect of the change is reported as one of the
nonrecurring items on the income statement in the year
the changed is made.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Adjustments to Retained Earnings Slide 10-8
Only correction of past periods errors is
allowed as an adjustmentto Retained Earnings.
Only correction of past periods errors is
allowed as an adjustmentto Retained Earnings.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
• Mathematical mistakes• Mistakes in the
application of accounting principles
• An oversight or misuse of facts
• Mathematical mistakes• Mistakes in the
application of accounting principles
• An oversight or misuse of facts
Adjustments to Retained Earnings Slide 10-8
So, what is an error?
So, what is an error?
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
• An amount representing the employee’s FICA contribution and medicare coverage
• An amount withheld from gross earnings to apply toward the employee’s personal state and federal income taxes
• Deductions for charitable contributions, savings plans, union dues, and a variety of other items
Personnel Costs Slide 10-9
Deductions from an employee’s paychecks:
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Personnel Costs Slide 10-10
If an employee with three dependents earned $600 for work in a certain week in 1998, $45.90 for FICA and $63.00 for withholding tax would be deducted from this $600. The
employer incurs a matching expense of $45.90 for FICA plus $54 for federal and state unemployment insurance taxes.
If an employee with three dependents earned $600 for work in a certain week in 1998, $45.90 for FICA and $63.00 for withholding tax would be deducted from this $600. The
employer incurs a matching expense of $45.90 for FICA plus $54 for federal and state unemployment insurance taxes.
When wages are earned:
Wages Cost 600.00Wages Payable 600.00
Employment Tax Cost 99.90FICA Taxes Payable 45.90Unemployment Taxes Payable 54.00
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Personnel Costs Slide 10-11
When wages are paid:
Wages Payable 600.00Cash 491.10FICA Taxes Payable 45.90Withholding Taxes Payable 63.00
When the government is paid:
FICA Taxes Payable 91.80Unemployment Taxes Payable 54.00Withholding Taxes Payable 63.00
Cash 208.80
$45.90 + $45.90
$45.90 + $45.90
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
• The year’s service cost element• The year’s interest cost element• The actual return on plan assets element• The amortization of several other pension-related
items
Pensions Slide 10-12
A company’s pension cost is the sum of four elements.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Pensions Slide 10-13
The net pension cost using a defined benefit plan are $500,000
The net pension cost using a defined benefit plan are $500,000
Net Pension Cost 500,000Unfunded Accrued Pension Cost 500,000
A liabilityA liabilityA subsequent contribution of
$450,000 is made to the plan by the employer.
A subsequent contribution of $450,000 is made to the plan by the
employer.
Unfunded Accrued Pension Cost 450,000Cash 450,000
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Income Taxes Slide 10-14
A company buys personal computers costing over $15,000 each. For tax purposes it elects to use an
accelerated depreciation method. For financial reporting purposes it decides to use the straight-
line method.
A company buys personal computers costing over $15,000 each. For tax purposes it elects to use an
accelerated depreciation method. For financial reporting purposes it decides to use the straight-
line method.In the first year the depreciation charge for
tax purposes will be higher than the depreciation for
financial reporting purposes.
In the first year the depreciation charge for
tax purposes will be higher than the depreciation for
financial reporting purposes.
If all other items are accounted for in the
same way, the company’s taxable
income for the year will be lower than its book
pre-tax income.
If all other items are accounted for in the
same way, the company’s taxable
income for the year will be lower than its book
pre-tax income.At the end of the year the net carrying amount of the computers on the company’s tax books will be lower than their net carry
amount on the company’s financial reporting books.
At the end of the year the net carrying amount of the computers on the company’s tax books will be lower than their net carry
amount on the company’s financial reporting books.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Deferred Income Taxes Slide 10-15
Because of temporary differences, in 1998 a corporation reported $1 million pre-tax income to its shareholders and $800,000 taxable income to the IRS (resulting in an income tax expense of $340,000 and a tax liability of only $272,000).
Because of temporary differences, in 1998 a corporation reported $1 million pre-tax income to its shareholders and $800,000 taxable income to the IRS (resulting in an income tax expense of $340,000 and a tax liability of only $272,000).
Assets = Liabilities + Owners’ Equity
- $272,000 Retained Earnings - $340,000
Reflecting actual tax bill
paid
Reflecting tax expense used to measure book
income
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Deferred Income Taxes Slide 10-16
Because of temporary differences, in 1998 a corporation reported $1 million pre-tax income to its shareholders and $800,000 taxable income to the IRS (resulting in an income tax expense of $340,000 and a tax liability of only $272,000).
Because of temporary differences, in 1998 a corporation reported $1 million pre-tax income to its shareholders and $800,000 taxable income to the IRS (resulting in an income tax expense of $340,000 and a tax liability of only $272,000).
Income Tax Expense--Current 272,000Income Tax Expense--Deferred 68,000
Cash 272,000Deferred Income Taxes Liability 68,000
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Deferred Tax Measurement Slide 10-17
1998 $1,000.0 $ 333.3 $ 666.7 $ 266.7
1999 1,000.0 266.7 733.3 293.3
2000 1,000.0 200.0 800.0 320.0
2001 1,000.0 133.3 866.7 346.7
2002 1,000.0 66.7 933.3 373.3
$5,000.0 $1,000.0 $4,000.0 $1,600.0
Income before Depreciation Taxable Taxes Due Year Depreciation and Taxes Charge Income (at 40 percent rate)
Calculation of Taxes Due (thousands of dollars)
Calculation of Taxes Due (thousands of dollars)
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Deferred Tax Measurement Slide 10-18
1998 $1,000.0 $333.3 $333.3 $666.7
1999 1,000.0 266.7 600.0 400.0
2000 1,000.0 200.0 800.0 200.0
2001 1,000.0 133.3 933.3 66.7
2002 1,000.0 66.7 1,000.0 -0-
Original Annual Cumulative Year Depreciable Cost Tax Depreciation Tax Depreciation Tax Basis
Tax Basis Calculation (thousands of dollars)
Tax Basis Calculation (thousands of dollars)
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Deferred Tax Measurement Slide 10-19
1998 $1,000.0 $200.0 $200.0 $800.0
1999 1,000.0 200.0 400.0 600.0
2000 1,000.0 200.0 600.0 400.0
2001 1,000.0 200.0 800.0 200.0
2002 1,000.0 200.0 1,000.0 -0-
Original Annual Book Cumulative Book Net Book Year Book Cost Depreciation Depreciation Value
Net Book Value Calculation (thousands of dollars)
Net Book Value Calculation (thousands of dollars)
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Deferred Tax Measurement Slide 10-20
When the taxes are paid:Income Tax Payable 266,700
Cash 266,700
Combining all three 1998 entries:Income Tax Expense 320,000
Cash 266,700Deferred Income Taxes Liability 53,300
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Chapter 10
The End