Special Income and Investment Reporting Issues

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Chapter 12
Special Income and Investment Reporting Issues
Electronic Presentation by Douglas Cloud
Pepperdine University
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Learning Goals
1. Describe the accounting for and interpretation
of deferred income taxes. 2. Prepare an income
statement reporting the following unusual items
discontinued operations, extraordinary items, and
changes in accounting principles. 3. Describe
the accounting for and interpretation of fixed
asset impairments and restructuring charges.
After studying this chapter, you should be able
to
Continued
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Learning Goals
4. Prepare an income statement reporting earnings
per share data. 5. Describe the concept and the
reporting of comprehensive income. 6. Describe
the accounting for investments in
stocks. 7. Describe alternative methods of
combining businesses and how consolidated
financial statements are prepared.
Continued
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Learning Goals
8. Describe financial statement presentations of
stockholders equity.
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Learning Goal
1
Describe the accounting for and interpretation of
deferred income taxes.
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Payment of Income Taxes
Most corporations are required to pay estimated
federal income taxes in four installments
throughout the year.
At year-end, the actual taxable income and the
related taxes are determined. If additional
taxes are owed, the additional liability is
recorded.
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Payment of Income Taxes
Year Ended June 30, 2001 (Amounts in
millions)
Net Sales 39,244 Cost of products
sold 22,102 Marketing, research, and
administrative expenses 12,406 Operating
income 4,736 Interest expense 794 Other
income, net 674 Earnings Before Income
Taxes 4,616 Income taxes 1,694 Net
earnings 2,922
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Temporary Differences

• Revenues or gains are taxed after they are
  reported in the income statement.
• Expenses or losses are deducted in determining
  taxable income after they are reported in the
  income statement.
• Revenues and gains are taxed before they are
  reported in the income statement.
• Expenses or losses are deducted in determining
  taxable income before they are reported in the
  income statement.

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Allocation of Income Taxes
A corporation has 300,000 of income before
income taxes, a 40 tax rate, and 100,000 of
taxable income.
Income Tax Expense 120,000 Income Taxes
Payable 40,000 Deferred Income Taxes
Payable 80,000
300,000 x .40
100,000 x .40
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Allocation of Income Taxes
In the second year, 48,000 of the deferred tax
reverses and becomes due.
Deferred Income Taxes Payable 48,000 Income
Taxes Payable 48,000
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A corporations taxable income and its income
before taxes may also differ because certain
revenues are exempt from taxes
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and certain expenses are not deducted in
determining taxable income. Such differences are
called permanent differences.
Examples

• Interest on municipal bonds
• Fines for overloading delivery trucks

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Learning Goal
2
Prepare an income statement reporting the
following unusual items discontinued
operations, extraordinary items, and changes in
accounting principles.
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Discontinued Operations
A gain or loss from disposing of a business
segment or component of an entity is reported on
the income statement as a gain or loss from
discontinued operations.
A business segment refers to a major line of
business for a company.
A component of an entity is the lowest level at
which the operations and cash flows can be
clearly distinguished from the rest of the entity.
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Extraordinary Item
Extraordinary items result from events and
transactions that (1) are significantly different
from the typical or the normal operating
activities of the business and (2) occur
infrequently.
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Changes in Accounting Principles
Changes in GAAP disclosures should include the
following

1. The nature of the change.
2. The justification for the change.
3. The effect on the current years net income.
4. The cumulative effect of the change on the net
   income of prior periods.

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Learning Goal
3
Describe the accounting for and interpretation of
fixed asset impairments and restructuring charges.
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Fixed Asset Impairment
Fixed asset impairment occurs when the fair value
of a fixed asset that is held or used falls below
its book value and is not expected to recover.
Such impairments should be recognized on the
income statement as a loss at the time of the
impairment. ?
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Restructuring Charges
Restructuring charges are the accrued employee
termination benefits associated with a
management-approved employee termination plan.
Restructuring Charge xxxxx Employee Termination
Benefit Obligation xxxxx
An expense
A current or long-term liability
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Restructuring Charges
Later, the actual benefits are paid to the
terminated employees.
Employee Termination Benefit Obligation xxxxx
Cash xxxxx
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Learning Goal
4
Prepare an income statement reporting earnings
per share data.
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Earnings per Common Share
No preferred stock outstanding
Preferred stock outstanding
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Jones Corporation Income Statement For the Year
Ended December 31, 2005
Earnings per common share Income from
continuing operations 3.45 Loss on discontinued
operations (Note A) 0.50 Income before
extraordinary items and cumulative effect
of a change in accounting principle 2.95 Extraord
inary item Gain on condemnation of land, net of
applicable income tax of 65,000 0.75 Cumul
ative effect on prior years of changing to a
different depreciation method (Note B)
0.46 Net income 4.16
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Learning Goal
5
Describe the concept and the reporting of
comprehensive income.
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Comprehensive income is defined as all changes in
stockholders equity during a period except those
resulting from dividends and stockholders
investments.

• Foreign currency items
• Pension liability adjustments
• Unrealized gains and losses on investments

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Note that the other comprehensive income items
do not affect net income or retained earnings.
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Learning Goal
6
Describe the accounting for investments in stocks.
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Trading securities are securities that management
intends to actively trade for profit.
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Available-for-sale securities are securities that
management expects to sell in the future, but are
not actively traded for profit.
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Available-for-Sale Equity Investments
On June 1 Crabtree Co. purchased 2,000 shares of
Inis Corporation common stock at 89.75 per share
plus a brokerage fee of 500.
June 1 Marketable Securities 180,000 Cash 180
,000
(89.75 x 2,000) 500
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Available-for-Sale Equity Investments
On October 1, Inis declared a 0.90 per share
cash dividend payable on November 30.
Nov. 30 Cash 1,800 Dividend Revenue 1,800
2,000 x 0.90
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Available-for-Sale Equity Investments

Unrealized Common Stock
Cost Market Gain (Loss)
Appears on both the balance sheet and the
statement of income and comprehensive income
Edward, Inc. 150,000 190,000 40,000 SWS
Corp. 200,000 200,000 Inis Corporation 180,000 2
10,000 30,000 Bass Co. 160,000 150,000
(10,000) Total 690,000 750,000 60,000
Appears on the balance sheet
60,000 (.30 x 60,000) 42,000
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Equity Method
The equity method is used for long-term
investments in stocks where the investor has a
significant influence over the activities of the
investee.
Generally, if the investor owns 20 or more of
the voting stock of the investee, the investor is
assumed to have significant influence over the
investee.
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Equity Method
On January 2 Hally Inc. pays cash of 350,000 for
40 of the common stock and net assets of Brock
Corporation.
Jan. 2 Investment in Brock Corp.
Stock 350,000 Cash 180,000
Unless there is evidence to the contrary, this
should give Hally Inc. significant influence over
the operating or financial activities of Brock
Corp.
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Equity Method
For the year ending December 31, Brock
Corporation reports net income of 105,000 and
pays 45,000 in dividends.
Dec. 31 Investment in Brock Corp.
Stock 42,000 Income of Brock Corp. 42,000
45,000 x 40
105,000 x 40
31 Cash 18,000 Investment in Brock
Corp. Stock 18,000
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Equity Method
Investment in Brock Corporation Stock
Jan. 2 350,000 Dec. 31 42,000
Dec. 31 18,000
374,000
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Sale of Investments in Stocks
An investment in Drey Inc. stock has a carrying
amount of 15,700 when it is sold on March 1 for
17,500.
Mar. 1 Cash 17,500 Investment in Drey.
Inc. Stock 15,700 Gain on Sale of
Investment 1,800
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Learning Goal
7
Describe alternative methods of combining
businesses and how consolidated financial
statements are prepared.
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Mergers and Consolidations
When one corporation acquires all the assets and
liabilities of another corporation, which is then
dissolved, a merger has taken place.
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Mergers and Consolidations
When one corporation acquires all the assets and
liabilities of another corporation, which is then
dissolved, a merger has taken place.
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Parent and Subsidiary Corporations
The corporation owning all or a majority of the
voting stock of the other corporation is called
the parent company.
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Parent and Subsidiary Corporations
The corporation that is controlled is called the
subsidiary company.
Two or more corporations closely related through
stock ownership are sometimes called the
affiliated company.
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Parent and Subsidiary Corporations
At the end of the year, the financial statements
of the parent and subsidiary are combined and are
referred to as consolidated financial statements.
If the parent owns less than 100 of the
subsidiary stock, the other parties ownership is
referred to as minority interest.
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Learning Goal
8
Compute and interpret the price-earnings ratio
and price-book ratios.
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Price-Earnings Ratio
The price-earnings ratio indicates a firms
growth potential and future earnings prospects.
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Price-Earnings Ratio
It indicates how much the market is willing to
pay per dollar of a companys earnings.
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Price-Earnings Ratio
26.10
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P/E ratio
0.87
Market price per share 26.10
Basic earnings per share 0.87
2001
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Price-Book Ratio
The price-book ratio is the ratio of the market
value of a share of common stock to the book
value of a share of common stock.
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Price-Book Ratio
The first step is to determine the book value per
share of common stock.
10,519,000,000
12.32
BVS
854,000,000
Alcoa, Inc.
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Price-Book Ratio
The market price per share of Alcoa, Inc. was 34
on May 7, 2002.
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2.76
P-B ratio
12.32
Alcoa, Inc.s market price is 2.76 times greater
than the book value of the firm.
Alcoa, Inc.
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Chapter 12
The End
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