Find more at www.downloadslide.com Chapter 11 The Income Statement and the Statement of Stockholders’ Equity Short Exercises (5-10 min.) S 11-1 There are several ways that companies improperly recognize revenue which results in financial statement fraud a ―Channel stuffing‖ where a company may ship inventory to regular customers in amounts in excess of the amounts ordered by the customer This usually occurs near the end of the reporting period so that the excess merchandise cannot be returned to the seller prior to the preparation of the financial statements b Reporting revenue when a significant portion of the services are still to be performed or goods are still to be delivered c Providing incentives for customers to purchase more inventory than is needed in return for future discounts or other benefits d Reporting sales to fictitious or nonexistent customers, this may also include the falsification of shipping and inventory records Chapter 11 The Income Statement and the Statement of Stockholders’ Equity 11-1 Find more at www.downloadslide.com (10 min.) S 11-2 Req Gross profit = $703,935 thousand ($1,825,425 − $1,121,490) Income from continuing operations = $63,026 thousand Net income = $60,626 thousand Req Income from continuing operations = $63,026 thousand Continuing operations will continue from period to period Their continuity makes income from continuing operations a good predictor of future net income 11-2 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (10-15 min.) S 11-3 Amazing Way, Inc Income Statement Year Ended December 31, 2012 (Thousands) Net sales revenue $181,000 Cost of goods sold 73,000 Gross profit 108,000 Operating expenses ……………………………… 55,000 Operating income 53,000 Other gains (losses) (19,000) Income from continuing operations before income tax 34,000 Income tax expense (35%) 11,900 Income from continuing operations 22,100 Loss on discontinued operations, $13,000, less income tax savings of $4,550 Income before extraordinary item (8,450) 13,650 Extraordinary gain, $3,000, less income tax of $1,050 1,950 Net income $ 15,600 Chapter 11 The Income Statement and the Statement of Stockholders’ Equity 11-3 Find more at www.downloadslide.com (10-15 min.) S 11-4 Estimated value of one share of Mango stock = Earnings per share Investment capitalization rate = $2.20 05 = $44.00 Mango’s stock is quoted at $94.02 At that price, an investor should sell because the investor believes the stock is worth only $44.00 Student responses will vary depending on the market price accessed by the student (10 ) S 11-5 Journal DATE Sept 12 Oct 18 Nov 15 11-4 ACCOUNT TITLES AND EXPLANATION DEBIT Accounts Receivable (200,000 x $.34) Sales Revenue 68,000 Cash (100,000 x $.30) Foreign-Currency Transaction Loss Accounts Receivable ($68,000 x ½) 30,000 4,000 Cash (100,000 x $.36) Accounts Receivable Foreign-Currency Transaction Gain 36,000 Financial Accounting 9/e Solutions Manual CREDIT 68,000 34,000 34,000 2,000 Find more at www.downloadslide.com (10-15 min.) S 11-6 Req Journal DATE Apr ACCOUNT TITLES AND EXPLANATION DEBIT 24 Cash (900,000 pesos × $0.099) Accounts Receivable (900,000 pesos × $0.094) Foreign-Currency Transaction Gain Collection on account 89,100 CREDIT 84,600 4,500 Req Oct 25 Accounts Payable (21,000 Swiss francs × $1.12)… Foreign-Currency Transaction Loss…… Cash (21,000 Swiss francs × $1.14) Payment on account 23,520 420 23,940 Req Both the Mexican peso and the Swiss franc strengthened against the U.S dollar Chapter 11 The Income Statement and the Statement of Stockholders’ Equity 11-5 Find more at www.downloadslide.com (15 min.) E 11-7 Req The discontinued operations were more like a revenue This is clear from the fact that their amount is added in determining net income Req The discontinued operations should be included in net income because they represent revenues, which are a basic component of net income Req Use Income from continuing operations ($12,400 million) to predict future income because that amount of income is most likely to repeat in future years 11-6 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (5-10 min.) S 11-8 Journal ACCOUNT TITLES AND EXPLANATION DATE DEBIT Income Tax Expense ($117,000 × 30)……… Income Tax Payable ($91,000 × 30) Deferred Income Tax Liability…………… Recorded income tax for the year CREDIT 35,100 27,300 7,800 INCOME STATEMENT Income before income tax………………… Income tax expense……………………… Net income………………………………… $117,000 (35,100) $ 81,900 BALANCE SHEET Current liabilities: Income tax payable…………………… $ 27,300 Long-term liabilities: Deferred income tax liability………… 7,800 (10-15 min.) S 11-9 Earnings per share of common stock (10,000 shares of common stock outstanding): Income from continuing operations [($22,100 − $6,000) / 10,000]………………………… $1.61 Loss on discontinued operations, net of tax ($8,450 / 10,000)…………………………………… (0.85) Income before extraordinary item [($13,650 − $6,000) / 10,000]………………………… 76 Extraordinary gain, net of tax ($1,950 / 10,000)…… .20 Net income [($15,600 − $6,000) / 10,000]…………… $0.96 Chapter 11 The Income Statement and the Statement of Stockholders’ Equity 11-7 Find more at www.downloadslide.com (5-10 min.) S 11-10 Req Amazing Way, Inc Income Statement (partial) Year Ended December 31, 2012 Net income…………….…………………… $15,600 Other comprehensive income: Unrealized gain on investments…………… $1,100 Foreign-currency translation adjustment… 2,400 Comprehensive income………………………… 3,500 $19,100 Req Earnings per share is not reported for other comprehensive income; it is reported only for net income and its components 11-8 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (10 min.) S 11-11 Req Earnings per share = Net income − preferred dividends Average number of common shares outstanding Req Earnings per share of common stock: Income (loss) from continuing operations…………… $X.XX Income (loss) from discontinued operations…………… .XX Income (loss) before extraordinary item…………… X.XX Extraordinary gain or loss………………………………… .XX Net income (net loss)………………………………………… $X.XX Req Earnings per share is useful because it relates a company’s income to one share of the company’s stock Since stock prices are quoted at an amount per share, earnings per share is useful to help determine the value of one share of stock Chapter 11 The Income Statement and the Statement of Stockholders’ Equity 11-9 Find more at www.downloadslide.com (10 min.) S 11-12 iLife Inc Statement of Retained Earnings Year Ended December 31, 2012 Retained earnings balance, December 31, 2011, as originally reported……………………………………… $70,000 Prior period adjustment — debit to correct error in 2011…………………………………………………… (18,000) Retained earnings balance, December 31, 2011, as adjusted……………………………………………… 52,000 Net income for 2012……………………………………… 85,000 137,000 Dividends for 2012……………………………………………… Retained earnings balance, December 31, 2012…………… 11-10 Financial Accounting 9/e Solutions Manual (29,000) $108,000 Find more at www.downloadslide.com (continued) P 10-59B Req This problem demonstrates that the final amount of a cash receipt or cash payment on an international transaction may differ from the initial dollar amount of the transaction You can learn the need to hedge receivable and payable positions denominated in foreign currencies This will help to minimize foreign-currency transaction losses 11-48 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (20-25 min.) P 11-60B Req Earnings per share: Income from continuing operations [($219,000 − $22,500) / 123,000]…………………………… $1.60 Loss on discontinued operations ($65,000 / 123,000)…… (.53) Income before extraordinary items [($154,000 − $22,500) / 123,000]…………………………… 1.07 Extraordinary gain ($49,000 / 123,000)……………………… 40 Net income [($203,000 − $22,500) / 123,000]……………… _ $1.47 Computations: Preferred dividends: 10,000 × $2.25 = $22,500 Req Investment Capitalization Rates 6% 8% 10% Estimated value of BEL common stock = $1.60 06 $1.60 08 $1.60 10 = $26.67 $20.00 $16.00 The 10% rate presumes the investment is the most risky At this rate, the investor is willing to pay the least for BEL stock Chapter 11 The Income Statement and the Statement of Stockholders’ Equity 11-49 Find more at www.downloadslide.com (30-40 min.) P 11-61B Confection Pies, Inc Statement of Comprehensive Income Year Ended June 30, 2012 Revenues: Sales revenue Less: $904,000 Sales returns $21,000 Sales discounts 12,000 Net sales revenue Expenses: (33,000) 871,000 Cost of goods sold $383,000 Selling expenses 103,000 General expenses 90,000 Income tax expense 33,000 Total expenses 609,000 Income from continuing operations 262,000 Loss on discontinued operations, $28,000, less income tax saving, $8,400 Income before extraordinary item (19,600) 242,400 Extraordinary gain, $44,000, less income tax of $13,200……………….…… Net income 30,800 273,200 Other comprehensive income: Unrealized loss on available-for-sale investments, $14,000, less income tax savings, $4,200 (9,800) Comprehensive income $263,400 11-50 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (continued) P 11-61B Earnings per share: Income from continuing operations ($262,000 / 20,000*)… $13.10 Loss from discontinued operations ($19,600 / 20,000)…… (0.98) Income before extraordinary item ($242,400 / 20,000)…… 12.12 Extraordinary gain ($30,800 / 20,000)……………………… 1.54 Net income ($273,200 / 20,000) …………… _ $13.66 Computation: *28,000 shares issued − 8,000 treasury shares = 20,000 shares outstanding Chapter 11 The Income Statement and the Statement of Stockholders’ Equity 11-51 Find more at www.downloadslide.com (25-35 min.) P 11-62B Req Pretax accounting income of 2012…………… + Additional taxable income for income earned in 2013 but taxed in 2012…………… − Additional depreciation expense for MACRS tax depreciation……………………… Taxable income of 2012………………………… $140,000 14,000 (25,000) $129,000 Req Journal DATE ACCOUNT TITLES AND EXPLANATION Income Tax Expense ($140,000 × 32)…… Income Tax Payable ($129,000 × 32)… Deferred Tax Liability ($11,000 × 32)… 2012 DEBIT CREDIT 44,800 41,280 3,520 Req Johnson Publications, Inc Income Statement For the Year 2012 Total revenue………………………………… $850,000 Expenses: Cost of goods sold………………………… Operating expenses……………………… Income tax expense……………………… Total expenses…………………………… Net income…………………………………… $470,000 240,000 44,800 754,800 $ 95,200 11-52 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (15-20 min.) P 11-63B Req Income before income tax: $350 million $350 million = = $500 million − Tax rate − 30 Req Par value of common stock: $80 million par value 40 million shares issued = $2 per share Req $180 million received = $4.50 per share 40 million shares issued Price per share of stock issuance: Req Cost of treasury stock sold: $7 million Selling price of treasury stock sold: $19 million Increase in total stockholders’ equity: $19 million Req Stock dividend percentage: Chapter 11 $55 million $470 million + $80 million The Income Statement and the Statement of Stockholders’ Equity = 10% 11-53 Find more at www.downloadslide.com Challenge Exercises and Problem (20 min.) E11-64 Req The two components of accumulated other comprehensive income are: Unrealized gains (losses) on available-for-sale investments Foreign-currency translation adjustments Req An unrealized gain (loss) on available-for-sale investments produces a positive (negative) balance A foreign-currency translation adjustment is positive when the assets of a foreign subsidiary are translated into more dollars than the equities (liabilities plus stockholders’ equity) The foreign-currency translation adjustment is negative when the equities of a foreign subsidiary are translated into more dollars than the assets Req Millions Accumulated other comprehensive income (loss) at December 31, 2012………………………………………… $(57) Foreign-currency translation adjustment……………… 25 Unrealized loss on available-for-sale investments…… (15) Accumulated other comprehensive income (loss) at December 31, 2013………………………………………… 11-54 Financial Accounting 9/e Solutions Manual $(47) Find more at www.downloadslide.com (20 min.) P 11-65 Req Operating Transaction Income Income before Tax Net Income Earnings per Share a.* NE NE NE NE b + $45,000 + $45,000 + $27,000 + c NE NE NE NE d NE - $3,000 - $1,800 - e NE NE NE - f - $5,000 - $5,000 - $3,000 - g NE + $20,000 + $12,000 + h NE NE NE - i NE NE NE - *Assuming the company uses the perpetual inventory method, the omitted entry only affects balance sheet accounts (Inventory and Accounts Payable) Req Operating Income Totals $440,000 Income before Tax $507,000 Net income $304,200 Earnings per Share $4.24* *($304,200 - $50,000)/ (50,000 + 5,000 + 5,000) Chapter 11 The Income Statement and the Statement of Stockholders’ Equity 11-55 Find more at www.downloadslide.com Decision Cases (15-20 min.) Decision Case EPS to use for predicting future profits: Unaudited EPS $1.19 Include: Gain on sale of building .05 Restructuring expenses (.29) Loss on lawsuit settlement (.12) Lost income due to employee labor strike (.24) EPS to use for prediction $0.59 Include all the preceding items for your prediction because all are labeled by GAAP as normal business occurrences and are thus part of income from continuing operations None is an extraordinary item, and none is part of discontinued operations Exclude the following items:  unrealized loss on available-for-sale investments because this is not even part of net income (it is included in comprehensive income)  income from discontinued operations because that income will not be part of this company in the next period and beyond 11-56 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (15-20 min.) Decision Case Magid’s earnings are of higher quality than those of Bay Area Magid follows more conservative (and more realistic) accounting policies than Bay Area Here are some examples: SALES REVENUE Magid records sales revenue when it receives a sale contract and a cash down payment from a customer In contrast, Bay Area records revenue when it receives a sale contract regardless of whether Bay Area receives a customer down payment or not Therefore, Magid’s receivables appear to be more collectible than Bay Area’s receivables, and as a result, Magid’s revenues look stronger INSURANCE REVENUE Magid records insurance revenue over the life of the policy, while Bay Area records insurance revenue up front when the customer signs the insurance contract Magid’s policy is more realistic because both companies earn the insurance revenue over the life of the contract as they provide insurance coverage for policyholders They not earn the revenue at the beginning of the contract period, which is when Bay Area records the revenue Overall, Bay Area’s policies for recording revenue suggest that the company may be overstating its revenue Magid’s accounting policies make Magid appear to be the safer investment Chapter 11 The Income Statement and the Statement of Stockholders’ Equity 11-57 Find more at www.downloadslide.com Ethical Issue Req The ethical issue: Does it matter how a company reports its operating results as long as the totals are accurate? May all items of income and loss be combined or should items from recurring and non-recurring sources be reported separately? Req and Req The stakeholders in this case include the company, its officers and directors, shareholders, prospective shareholders, and stock analysts Economic analysis: Prospective investors want to predict the level of net income and cash flows that a company will generate from year to year Continuing operations are more predictable than extraordinary items and other non-recurring items This is why extraordinary gains and losses are highlighted on the income statement — to alert investors and creditors of their special, nonrecurring nature In this case, the company and its existing stockholders could be helped economically by management’s action By hiding the extraordinary gain, the second income statement makes the company look better than it really is By burying the extraordinary gain in income from continuing operations, the second income statement makes it appear that Royal Bank can earn more income each year than it really can Projecting this rosy picture of operations may enable the company to borrow on better terms, and its stock price may temporarily perform better than it should Lenders who loan money to Royal Bank 11-58 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (continued) Ethical Issue and stockholders who buy the company’s stock based on the second income statement can be hurt They may lend to the company on toofavorable terms, or they may pay too high a price for its stock When the truth comes out — in terms of actual results — Royal Bank may be unable to pay its loans Or the company’s stock price may fall, leaving the new stockholders with stock worth less than they paid for it Legal analysis: Generally accepted accounting principles as well as the SEC have legal and regulatory requirements for segregating recurring items from non-recurring items To depart from these rules violates International Financial Reporting Standards (IFRS) and can subject the company and its officers to civil and possibly criminal penalties Ethical analysis: The action being considered by Royal Bank is not truthful It violates the rights of prospective shareholders and creditors to all the information they need about the company to make informed decisions Req The bank should report their results of operations in a way that separates the recurring from the non-recurring items This course of action is not only the legal and ethical thing to do, but in the long run it is also in the best economic interest of the company, its management, and its existing shareholders Chapter 11 The Income Statement and the Statement of Stockholders’ Equity 11-59 Find more at www.downloadslide.com Focus on Financials: Amazon.com, Inc (20-30 min.) Req Amazon.com, Inc.’s income statement does not mention income from continuing operations because there are no special items of income, such as discontinued operations All of Amazon.com, Inc.’s net income results from continuing operations Amazon.com’s net sales revenue increased from 2008-2010 Cost of sales increased at approximately the same rate resulting in the same gross profit rate all three years Income from operations also increased each year The quality of Amazon’s earnings appears high Req Investment Capitalization Rates 5% 6% 7% Estimated value $2.58 of a share of = = $51.60 05 Amazon stock Safe investment $2.58 = $43.00 06 $2.58 = $36.86 07 Risky investment Req Student answers will vary depending on when this problem is assigned During 2011, Amazon’s stock traded between $176 and $222 If a student used a price of $200, this would be equivalent to capitalizing earnings at about 1.2%, making Amazon.com, Inc a very safe investment 11-60 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com Focus on Analysis: RadioShack, Corp (30 min.) Req RadioShack, Corp.’s statement of operations shows that the company has been profitable for the last three years, but the percentage profit has declined slightly from 2009 (4.8% to 4.6%) This decrease is largely due to a decrease in the gross profit rate The statement of operations does report consistent growth in sales, operating income, and net income Req 4% Estimated value $1.71 = = $42.75 of a share of 04 RadioShack, stock Investment Capitalization Rate 6% 8% 10% $1.71 $1.71 $1.71 = $28.50 = $21.38 = $17.10 06 08 10 Low Risk High Risk Req During 2011, RadioShack’s stock traded between $12 and $19 The estimate at 10% is closest to the actual price of the stock At a price of $15, the capitalization rate would be around 11% Chapter 11 The Income Statement and the Statement of Stockholders’ Equity 11-61 Find more at www.downloadslide.com Group Project 1-2 hours Student responses on this problem will vary 11-62 Financial Accounting 9/e Solutions Manual ... 2012 11-12 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (continued) S 11-14 Req The standard for conducting an audit is the standards of the Public Company Accounting. .. x $.36) Accounts Receivable Foreign-Currency Transaction Gain 36,000 Financial Accounting 9/e Solutions Manual CREDIT 68,000 34,000 34,000 2,000 Find more at www.downloadslide.com (10-15... income because that amount of income is most likely to repeat in future years 11-6 Financial Accounting 9/e Solutions Manual Find more at www.downloadslide.com (5-10 min.) S 11-8 Journal ACCOUNT TITLES