ch13

CHAPTER 13CORPORATIONS: INCOME AND TAXES,

STOCKHOLDERS’ EQUITY, AND INVESTMENTS IN STOCKS

CLASS DISCUSSION QUESTIONS

1. a. Debit Income Tax Expense; credit In-come Tax Payable

b. Debit Income Tax Receivable; credit In-come Tax Expense

2. a. Current liabilityb. Long-term liability or deferred credit (fol-

lowing the Long-Term Liabilities section)3. An extraordinary item is unusual in nature

and infrequent in occurrence.4. Extraordinary items:

Gain on condemnation of land, net of appli-cable income tax of $60,000............$90,000

5. The urban renewal agency’s acquisition of the property may be viewed as a form of ex-propriation under paragraph 23 of Account-ing Principles Board Opinion No. 30, Report-ing the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transac-tions. Paragraph 23 says a gain or loss from sale or abandonment of property, plant, or equipment used in the business should be included as an extraordinary item if it is the direct result of an expropriation. Accordingly, the gain should be reported as an extraordi-nary item in the income statement.

6. The “loss on discontinued operations” of $42 million should be identified on the income statement as discontinued operations and should follow the presentation of the results of continuing operations (sales less the cus-tomary costs and expenses). The data on discontinued operations (identity of the seg-ment, date of disposal, etc.) should be dis-closed in a note.

7. Readers of the financial statements should be able to assume that the successive finan-cial statements of a business are based consistently on the same generally accepted accounting principles. Any changes revealed by the statements from one period to the

next are assumed to be the result of changes in business conditions or manage-rial effectiveness. Therefore, significant changes in accounting methods must be disclosed so that the reader is alerted to the effect of those changes on the financial statements.

8. a. Yes, the $0.45-per-share gain should be reported as an extraordinary item.

b. Operations appear to have declined. The earnings per share for the current year that is comparable to the preceding year’s earnings per share of $1.10 is $0.93 ($1.38 – $0.45).

9. The primary advantage of the combined in-come and retained earnings statement is that it emphasizes net income as the con-necting link between the income statement and the retained earnings portion of stock-holders’ equity.

10. The three classifications of appropriations are legal, contractual, and discretionary. Ap-propriations are normally reported in the notes to the financial statements.

11. Such prior period adjustments should be re-ported as an adjustment to the beginning balance of retained earnings.

12. The statement of stockholders’ equity is usually prepared in a columnar format, where each column represents a major stockholders’ equity classification.

13. Comprehensive income is net income plus or minus other comprehensive income items.

14. a. Examples of other comprehensive in-come items include foreign currency items, pension liability adjustments, and unrealized gains and losses on certain investments in debt and equity securi-ties.

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b. No. Comprehensive income does not af-fect the determination of net income or retained earnings.

15. A business may purchase stocks as a means of earning a return (income) on ex-cess cash that it does not need for its nor-mal operations. In other cases, a business may purchase the stock of another company as a means of developing or maintaining business relationships with the other com-pany. A business may also purchase com-mon stock as a means of gaining control of another company’s operations.

16. On the balance sheet, temporary invest-ments in marketable securities are reported at their fair market values, net of any appli-cable income taxes related to any unrealized gains or losses.

17. Unrealized gains or losses (net of applicable taxes) should be reported as either an addi-tion to or deduction from net income in arriv-ing at comprehensive income.

18. a. The cost method and the equity methodb. Investments

19. a. Dividend Revenueb. Investment in Gestalt Corporation

20. Equity method21. a. Purchase method (or sale-purchase)

b. Pooling-of-interests method (or joining of ownership interests)

22. The stockholders’ equity accounts of Strabo and the Investment in Strabo account of Polska are eliminated.

23. a. Minority interestb. Preceding stockholders' equity, usually

in the Long-Term Liabilities section.24. Investment in

Affiliates.....................2,400,000Income of Affiliates.................................2,400,000

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EXERCISES

Ex. 13–1

April 15 Income Tax Expense........................................... 80,000Cash................................................................. 80,000

June 15 Income Tax Expense........................................... 80,000Cash................................................................. 80,000

Sept. 15 Income Tax Expense........................................... 80,000Cash................................................................. 80,000

Dec. 31 Income Tax Expense........................................... 240,000*Income Tax Payable....................................... 100,000**Deferred Income Tax Payable....................... 140,000

*[($1,200,000 × 40%) – (3 × $80,000)] = $240,000**[($850,000 × 40%) – (3 × $80,000)] = $100,000

Jan. 15 Income Tax Payable............................................ 100,000Cash................................................................. 100,000

Ex. 13–2

No. Extraordinary items are events and transactions that are unusual and occur infrequently. It is not unusual for a company to insure the life of its president or to receive the proceeds of the policy upon his or her death. Since it does not meet both criteria, this gain is not an extraordinary item.

Ex. 13–3

To be classified as an extraordinary item for income statement reporting pur-poses, the item (event) must be (1) unusual from the typical operating activities of the business and (2) occurring infrequently. Although it would seem that the crash of Flight 592 would meet this criteria, ValuJet’s accountants (auditors) did not allow the company to report the crash as an extraordinary item.

Ex. 13–4

a. NRb. NRc. NRd. NR

e. Ef. NRg. Eh. NR

Ex. 13–5

TRAFALGAR INC.Income Statement

For the Year Ended June 30, 2003

Sales.................................................................................... $ 1,050,000Cost of merchandise sold................................................. 684,500 Gross profit......................................................................... $ 365,500Operating expenses:

Selling expenses......................................................... $75,750Administrative expenses............................................ 26,750 102,500

Income from continuing operations before income tax. $ 263,000Income tax expense........................................................... 105,200 Income from continuing operations................................. $ 157,800Loss on discontinued operations, net of applicable

income tax of $56,000................................................. 69,000 Income before extraordinary item and cumulative

effect of a change in accounting principle............... $ 88,800Extraordinary item:

Gain on condemnation of land, net of applicableincome tax of $7,750............................................... 30,000

Less: Cumulative effect on prior years of changing to adifferent depreciation method, net of applicableincome tax reduction of $18,200................................ (41,800 )

Net income.......................................................................... $ 77,000 Earnings per common share:

Income from continuing operations.......................... $ 15.78Loss on discontinued operations............................. 6.90 Income before extraordinary item and cumulative

effect of a change in accounting principle........... $ 8.88Extraordinary item....................................................... 3.00Less: Cumulative effect on prior years of changing

to a different depreciation method........................ (4.18 )Net income................................................................... $ 7.70

Ex. 13–6

1. The income tax expense related to continuing operations ($420,000) is incor-rectly subtracted from income from continuing operations ($1,050,000). The correct amount is $630,000, not $730,000.

2. The order of presentation of the unusual items is incorrect. The order should be as follows:Income from continuing operationsLoss on discontinued operations

Income before extraordinary items and cumulative effect of a change in accounting method

Extraordinary itemCumulative effect of change in accounting methodNet income

3. The correction of error in the preceding year’s (2002) physical inventory is a prior period adjustment and should not appear on the income statement. Such corrections should appear on the retained earnings statement as an ad-justment to the beginning Retained Earnings.

4. The earnings per share data are presented in the incorrect order—see (2) above.

5. The earnings per share computations are incorrect. The amount of preferred stock dividends ($20,000) should be subtracted from “income from continu-ing operations,” “income before extraordinary item and cumulative effect of change in accounting principle,” and “net income” in computing the earn-ings per share of common stock. In addition, earnings per share of common stock should be computed by dividing by 40,000 shares—the number of shares outstanding (50,000 shares less the 10,000 shares held as treasury stock).

6. A corrected presentation appears on the next page.

Ex. 13–6 Concluded

BOSS SOUND INC.Income Statement

For the Year Ended December 31, 2003

Net sales.............................................................................. $ 9,450,000Cost of merchandise sold................................................. 7,100,000 Gross profit......................................................................... $ 2,350,000Operating expenses:

Selling expenses......................................................... $920,000Administrative expenses............................................ 380,000 1,300,000

Income from continuing operations before income tax. $ 1,050,000Income tax expense........................................................... 420,000 Income from continuing operations................................. $ 630,000Loss on discontinued operations (net of applicable

income tax of $76,000)................................................ (184,000 )Income before extraordinary items and cumulative effect

of change in accounting method............................... $ 446,000Extraordinary item:

Gain on condemnation of land, net of applicableincome tax of $80,000............................................. 120,000

Cumulative effect on prior years’ income (decrease) ofchanging to a different depreciation method (net ofapplicable income tax reduction of $86,000)............ (204,000 )


Income from continuing operations[($630,000 – $20,000) ÷ 40,000 shares].................. $ 15.25

Loss on discontinued operations............................. (4.60 )Income before extraordinary item and cumulative

effect of change in accounting principle.............. $ 10.65Extraordinary item....................................................... 3.00Cumulative effect on prior years’ income (decrease)

of changing to a different depreciation method... (5.10 )Net income................................................................... $ 8.55

Ex. 13–7

Stockholders’ EquityPaid-in capital:

Preferred $2 stock, $100 par(70,000 shares authorized,10,000 shares issued)........................ $ 1,000,000

Excess of issue price over par............. 120,000 $ 1,120,000Common stock, no par, $5 stated

value (300,000 shares authorized,150,000 shares issued)...................... $ 750,000

Excess of issue price over par............. 100,000 850,000From sale of treasury stock.................. 85,000Donated capital...................................... 270,000

Total paid-in capital........................... $2,325,000

Ex. 13–8


Common stock, $10 par(50,000 shares authorized,37,500 shares issued)........................ $ 375,000

Excess of issue price over par............. 60,000 $ 435,000From sale of treasury stock.................. 12,500

Total paid-in capital........................... $ 447,500Retained earnings......................................... 675,000

Total........................................................ $ 1,122,500Deduct treasury stock

(1,000 shares at cost)............................ 40,000 Total stockholders’ equity........................... $1,082,500

Ex. 13–9


Preferred $2 stock, $100 par(10,000 shares authorized, 4,000 shares issued).......................... $400,000

Excess of issue price over par............. 65,000 $ 465,000Common stock, $5 par

(350,000 shares authorized,100,000 shares issued)...................... $500,000

Excess of issue price over par............. 175,000 675,000From sale of treasury stock.................. 35,000

Total paid-in capital........................... $ 1,175,000Retained earnings......................................... 3,252,500

Total........................................................ $ 4,427,500Deduct treasury common stock

(4,000 shares at cost)............................ 100,000 Total stockholders’ equity........................... $4,327,500

Ex. 13–10

MOHAWK CORPORATIONRetained Earnings Statement

For the Year Ended August 31, 2003

Retained earnings, September 1, 2002............................. $ 1,475,600Net income.......................................................................... $372,000Less dividends declared.................................................... 220,000 Increase in retained earnings............................................ 152,000 Retained earnings, August 31, 2003................................. $ 1,627,600

Ex. 13–11

1. Retained earnings is not part of paid-in capital.2. The cost of treasury stock should be deducted from the total stockholders’

equity.3. Dividends payable should be included as part of current liabilities and not as

part of stockholders’ equity.4. Common stock should be included as part of paid-in capital.5. The amount of shares of common stock issued of 40,000 times the par value

per share of $25 should be extended as $1,000,000, not $1,278,000. The dif -ference, $278,000, probably represents paid-in capital in excess of par.

6. Donated capital should be listed as part of paid-in capital.7. Organization costs should be included as part of intangible assets and not

as a part of stockholders’ equity.

One possible corrected stockholders’ equity section of the balance sheet is as follows:


Preferred $2 stock, cumulative, $100 par(3,500 shares authorized and issued).................... $ 350,000

Excess of issue price over par................................... 60,000 $ 410,000Common stock, $25 par (50,000 shares

authorized, 40,000 shares issued)......................... $ 1,000,000Excess of issue price over par................................... 278,000 1,278,000Donated capital............................................................ 75,000

Total paid-in capital................................................. $ 1,763,000Retained earnings.............................................................. 540,000

$ 2,303,000Deduct treasury stock (4,000 shares at cost).................. 75,000 Total stockholders’ equity................................................. $ 2,228,000

Ex. 13–12

GALAPAGOS CORPORATIONStatement of Stockholders’ Equity

For the Year Ended December 31, 2003

Paid-InCommon Capital in

Stock, Excess Treasury Retained$2 Par of Par Stock Earnings Total

Balance, Jan. 1, 2003.... $500,000 $400,000 — $1,075,000 $1,975,000Issued 50,000 shares

of common stock... 100,000 45,000 145,000Purchased 10,000

shares as treasurystock....................... $(25,000) (25,000)

Net income.................... 220,000 220,000Dividends....................... (45,000 ) (45,000 )Balance, Dec. 31, 2003. $600,000 $ 445,000 $ (25,000 ) $ 1,250,000 $ 2,270,000

Ex. 13–13

a. Marketable Securities..................................................... 61,000Cash ............................................................................... 61,000

b. Cash ............................................................................... 2,000Dividend Revenue.......................................................... 2,000

Ex. 13–14

a.GENOTYPE CORPORATION

Balance SheetDecember 31, 2003

AssetsCurrent assets:

Temporary investments in marketable securities,at cost....................................................................... $61,000

Plus unrealized gain (net of applicable income tax of $800)............................................................... 1,200 * $62,200

*Computation:Market:

Research Inc.: 1,000 shares × $28......................... $28,000Crisp Corp.: 2,500 shares × $14............................. 35,000

$63,000Cost ($25,000 + $36,000)............................................. 61,000 Unrealized gain............................................................ $ 2,000Taxes on unrealized gain ($2,000 × 40%).................. 800 Unrealized gain, net of applicable tax....................... $ 1,200

b.GENOTYPE CORPORATION

Statement of Income and Comprehensive IncomeFor the Year Ended December 31, 2003

Net income............................................................................................ $80,000Other comprehensive income:

Unrealized gain on temporary investments in marketablesecurities (net of applicable income tax of $800).................. 1,200

Comprehensive income...................................................................... $81,200

Ex. 13–15

a. Investment in Goulash Co. Stock................................. 174,420Cash ............................................................................... 174,420

b. Cash................................................................................. 3,000Dividend Revenue.......................................................... 3,000

(No entry for stock dividends; carrying amount per share of stock is now$174,420 ÷ 3,060, or $57.)

c. Cash................................................................................. 61,625Investment in Goulash Co. Stock................................. 57,000Gain on Sale of Investments......................................... 4,625

Ex. 13–16

Yes. In this case the equity method is required because Goodyear owns enough of the voting stock of the investee to have a significant influence over its operat-ing and financing policies.

Ex. 13–17

a. Investment in Northern Corp. Stock............................. 2,550,000Income of Northern Corp............................................... 2,550,000

($8,500,000 × 150,000/500,000)b. Cash................................................................................. 187,500

Investment in Northern Corp. Stock............................. 187,500

Ex. 13–18

a. (1) $80,000; Consolidated sales should be $8,820,000($8,150,000 + $750,000 – $80,000).

(2) $80,000; Consolidated cost of merchandise sold should be$5,360,000 ($5,000,000 + $440,000 – $80,000).

b. $1,950,000 ($8,820,000 – $5,360,000 – $875,000 – $635,000)Sales Cost of Selling Admin.

Merch. Exp. Exp.Sold

Ex. 13–19

a. 2000: 183.2 ($71.44 ÷ $0.39)1999: 111.8 ($33.53 ÷ $0.30)*

*The 1999 common stock price is adjusted for a 2-for-1 stock split that was effective March 2000.

b. The increase in the price-earnings ratio from 1999 to 2000 indicates a favor-able trend. An increasing price-earnings ratio generally indicates an improv-ing expectation of the market for growth of Cisco Systems’ earnings in the future. Cisco Systems’ price-earnings ratio, however, should also be com-pared with its industry competitors to assess how the market expects Cisco Systems to perform relative to other companies.

PROBLEMS

Prob. 13–1A

1. and 2.1. and 2.

Deferred IncomeIncome Tax Income Tax Tax Payable Deducted Payments

on for Year’s Year-Income the Addition End

Year Statement Year (Deduction) Balance

First $120,000 $100,000 $20,000 $20,000Second 180,000 120,000 60,000 80,000Third 160,000 168,000 (8,000) 72,000Fourth 200,000 204,000 (4,000 ) 68,000

Total $660,000 $592,000 $ 68,000

Prob. 13–2A

MANTRA GREENHOUSES INC.Income Statement

For the Year Ended June 30, 2003

Sales............................................................... $665,000Cost of merchandise sold............................ 266,000 Gross profit................................................... $399,000Operating expenses:

Selling expenses:Sales commissions expense............ $140,000Advertising expense.......................... 40,000Depreciation expense—store equipment 29,000Miscellaneous selling expense......... 5,000

Total selling expenses................... $214,000Administrative expenses:

Office salaries expense..................... $ 50,000Rent expense...................................... 21,000Insurance expense............................. 8,000Depreciation expense—office equipment 5,000Miscellaneous administrative expense 6,000

Total administrative expenses...... 90,000 Total operating expenses..................... 304,000

Income from operations............................... $ 95,000Other expense:

Interest expense.................................... 15,000 Income from continuing operations before

income tax.............................................. $ 80,000Income tax expense...................................... 32,000 Income from continuing operations........... $ 48,000Gain from disposal of a segment of the

business................................................. $ 37,500Less applicable income tax......................... 15,000 22,500 Income before extraordinary item............... $ 70,500Extraordinary item:

Loss on condemnation of land............ $ 22,500Less applicable income tax.................. 9,000 13,500

Net income..................................................... $ 57,000 Earnings per share:

Income from continuing operations.... $ 0.64Gain on discontinued operations........ 0.30 Income before extraordinary item........ $ 0.94Extraordinary item................................. 0.18 Net income.............................................. $ 0.76

Prob. 13–3A

1.PUSHKIN CORPORATION

Income StatementFor the Year Ended October 31, 2003

Sales.................................................................................... $1,820,000Cost of merchandise sold................................................. 732,000 Gross profit......................................................................... $1,088,000Operating expenses:

Selling expenses......................................................... $400,000Administrative expenses............................................ 100,000 Total operating expenses........................................... 500,000

Income from operations.................................................... $ 588,000Other expenses and income:

Interest expense.......................................................... $ 8,000Interest revenue........................................................... 5,000 3,000

Income from continuing operations before income tax. $ 585,000Income tax expense........................................................... 234,000 Income from continuing operations................................. $ 351,000Loss from disposal of a segment of the business.......... $ 92,500Less applicable income tax............................................... 37,000 55,500 Income before extraordinary item..................................... $ 295,500Extraordinary item:

Gain on condemnation of land.................................. $ 30,000Less applicable income tax........................................ 12,000 18,000


Income from continuing operations.......................... $1.84*Loss on discontinued operations............................. 0 .37 Income before extraordinary item............................. $1.47Extraordinary item....................................................... 0 .12 Net income................................................................... $1 .59

*($351,000 – $75,000 preferred dividends) ÷ 150,000 common shares

Prob. 13–3A Continued


Retained Earnings StatementFor the Year Ended October 31, 2003

Retained earnings, November 1, 2002........ $ 2,548,150Net income..................................................... $313,500Less dividends declared:

Cash dividends...................................... $195,000Stock dividends..................................... 60,000 255,000

Increase in retained earnings...................... 58,500 Retained earnings, October 31, 2003.......... $ 2,606,650


Balance SheetOctober 31, 2003


Cash........................................................ $ 145,500Accounts receivable.............................. $309,050Less allowance for doubtful accounts 21,500 287,550Notes receivable.................................... 77,500Merchandise inventory, at lower of

cost (fifo) or market........................... 425,000Interest receivable................................. 2,500Prepaid expenses.................................. 15,900

Total current assets........................... $ 953,950Property, plant, and equipment:

Equipment.............................................. $ 9,541,050Less accumulated depreciation........... 3,050,000

Total property, plant, and equipment 6,491,050Intangible assets:

Organization costs................................ 55,000 Total assets................................................... $ 7,500,000

Prob. 13–3A Concluded

LiabilitiesCurrent liabilities:

Accounts payable.................................. $ 149,500Income tax payable................................ 55,900Dividends payable................................. 30,000Deferred income taxes payable............ 4,700

Total current liabilities....................... $ 240,100Deferred credits:

Deferred income taxes payable............ 21,000 Total liabilities............................................... $ 261,100


Preferred 5% stock, $100 par (30,000 shares authorized; 15,000 shares issued)........................ $1,500,000

Excess of issue price over par............. 240,000 $ 1,740,000Common stock, $15 par (400,000

shares authorized; 152,000 shares issued)................................................. $2,280,000

Excess of issue price over par............. 666,250 2,946,250From sale of treasury stock.................. 16,000


$ 7,308,900Deduct treasury common stock (2,000

shares at cost)....................................... 70,000 Total stockholders’ equity........................... 7,238,900 Total liabilities and stockholders’ equity. . . $7,500,000

Prob. 13–4A

2001Jan. 3 Investment in Perch Corporation Stock............ 267,594

Cash...................................................................... 267,594July 2 Cash...................................................................... 3,000

Dividend Revenue............................................... 3,000Dec. 5 Cash...................................................................... 3,300

Dividend Revenue............................................... 3,3002004Jan. 2 Investment in Villard Inc. Stock.......................... 890,000

Cash...................................................................... 890,000July 6 Cash...................................................................... 3,000

Dividend Revenue............................................... 3,0006 Memo—Received a dividend of 90 shares of

Perch Corporation stock. Number of sharesheld, 3,090. Cost basis per share,$267,594 ÷ 3,090 shares = $86.60 per share.

Oct. 23 Cash...................................................................... 67,360Investment in Perch Corporation Stock............ 64,950Gain on Sale of Investments.............................. 2,410

Dec. 10 Cash...................................................................... 2,574Dividend Revenue............................................... 2,574

(3,090 – 750 = 2,340 shares;2,340 × $1.10 = $2,574)

31 Cash...................................................................... 24,000Investment in Villard Inc. Stock......................... 24,000

31 Investment in Villard Inc. Stock.......................... 236,250Income of Villard Inc............................................ 236,250

($315,000 × 75% = $236,250)

Prob. 13–1B

1. and 2.1. and 2.

Deferred IncomeIncome Tax Income Tax Tax Payable Deducted Payments

on for Year’s Year-Income the Addition End

Year Statement Year (Deduction) Balance

First $140,000 $108,000 $32,000 $32,000Second 176,000 140,000 36,000 68,000Third 208,000 220,000 (12,000) 56,000Fourth 278,000 284,000 (6,000 ) 50,000

Total $802,000 $752,000 $ 50,000

Prob. 13–2B

SUV INC.Income Statement

For the Year Ended October 31, 2003

Sales.................................................................... $950,000Cost of merchandise sold................................. 553,500 Gross profit......................................................... $396,500Operating expenses:

Selling expenses:Sales salaries expense.............................. $120,000Advertising expense.................................. 60,000Depreciation expense—store equipment 21,500Store supplies expense............................. 4,000Miscellaneous selling expense................. 4,500

Total selling expenses........................... $210,000Administrative expenses:

Office salaries expense............................. $ 68,000Rent expense.............................................. 20,000Depreciation expense—office equipment 6,000Miscellaneous administrative expense.... 10,000

Total administrative expenses.............. 104,000 Total operating expenses.................................. 314,000 Income from operations.................................... $ 82,500Other income:

Interest revenue.............................................. 7,500 Income from continuing operations before

income tax....................................................... $ 90,000Income tax expense........................................... 36,250 Income from continuing operations................. $ 53,750Loss from disposal of a segment of the business $ 26,000Less applicable income tax............................... 5,000 21,000 Income before extraordinary item.................... $ 32,750Extraordinary item:

Gain on condemnation of land..................... $ 31,250Less applicable income tax........................... 12,500 18,750

Net income.......................................................... $ 51,500 Earnings per share:

Income from continuing operations....... $2.15Loss on discontinued operations........... 0.84 Income before extraordinary item........... $1.31Extraordinary item.................................... 0.75 Net income................................................. $2.06

Prob. 13–3B

1.ONYX CORPORATION

Income StatementFor the Year Ended July 31, 2003

Sales....................................................................................... $2,100,000Cost of merchandise sold.................................................... 884,000 Gross profit............................................................................ $1,216,000Operating expenses:

Selling expenses.............................................................. $540,000Administrative expenses................................................ 130,000 Total operating expenses............................................... 670,000

Income from operations....................................................... $ 546,000Other expenses and income:

Interest expense.............................................................. $ 7,500Interest revenue............................................................... 1,500 6,000

Income from continuing operations before income tax.... $ 540,000Income tax expense.............................................................. 220,000 Income from continuing operations.................................... $ 320,000Loss from disposal of a segment of the business............ $134,000Less applicable income tax................................................. 54,000 80,000 Income before extraordinary item....................................... $ 240,000Extraordinary item:

Gain on condemnation of land....................................... $ 25,000Less applicable income tax............................................ 10,000 15,000

Net income............................................................................. $ 255,000 Earnings per common share:

Income from continuing operations.......................... $0.80*Loss on discontinued operations............................. 0.32 Income before extraordinary item............................. $0.48Extraordinary item....................................................... 0.06 Net income................................................................... $0.54

*($320,000 – $120,000) ÷ 250,000 shares

Prob. 13–3B Continued

2.ONYX CORPORATION

Retained Earnings StatementFor the Year Ended July 31, 2003

Retained earnings, August 1, 2002............. $ 4,076,400Net income..................................................... $ 255,000Less dividends declared:

Cash dividends...................................... $200,000Stock dividends..................................... 40,000 240,000

Increase in retained earnings...................... 15,000 Retained earnings, July 31, 2003................ $ 4,091,400

3.ONYX CORPORATION

Balance SheetJuly 31, 2003


Cash........................................................ $ 125,500Accounts receivable.............................. $276,050Less allowance for doubtful accounts 11,500 264,550Merchandise inventory, at lower of

cost (fifo) or market........................... 522,500Interest receivable................................. 2,500Prepaid expenses.................................. 15,900

Total current assets........................... $ 930,950Property, plant, and equipment:

Equipment.............................................. $11,064,050Less accumulated depreciation........... 3,050,000

Total property, plant, and equipment 8,014,050Intangible assets:

Organization costs................................ 55,000 Total assets................................................... $ 9,000,000

Prob. 13–3B Concluded

LiabilitiesCurrent liabilities:

Accounts payable.................................. $ 149,500Income tax payable................................ 55,900Dividends payable................................. 25,000Deferred income taxes payable............ 4,700

Total current liabilities....................... $ 235,100Deferred credits:

Deferred income taxes payable............ 21,000 Total liabilities............................................... $ 256,100


Preferred 8% stock, $100 par (30,000 shares authorized; 15,000 shares issued)........................ $1,500,000

Excess of issue price over par............. 240,000 $ 1,740,000Common stock, $10 par (500,000

shares authorized; 251,000 shares issued)................................................. $2,510,000

Excess of issue price over par............. 437,500 2,947,500From sale of treasury stock.................. 5,000


$ 8,783,900Deduct treasury common stock (1,000

shares at cost)....................................... 40,000 Total stockholders’ equity........................... 8,743,900 Total liabilities and stockholders’ equity. . . $9,000,000

Prob. 13–4B

2001Feb. 10 Investment in Moore Corporation Stock........... 168,300

Cash...................................................................... 168,300June 15 Cash...................................................................... 3,200

Dividend Revenue............................................... 3,200Dec. 15 Cash...................................................................... 3,400

Dividend Revenue............................................... 3,4002004Jan. 3 Investment in Sirloin Inc. Stock......................... 750,000

Cash...................................................................... 750,000Apr. 1 Cash...................................................................... 3,200

Dividend Revenue............................................... 3,2001 Memo—Received a dividend of 80 shares

of Moore Corporation stock. Number of shares held, 4,080. Cost basis per share, $168,300 ÷ 4,080 = $41.25.

July 20 Cash...................................................................... 42,850Investment in Moore Corporation Stock........... 41,250Gain on Sale of Investments.............................. 1,600

Dec. 15 Cash...................................................................... 2,772Dividend Revenue............................................... 2,772

(4,080 – 1,000 = 3,080 shares; 3,080 × $0.90 = $2,772)

31 Cash...................................................................... 30,000Investment in Sirloin Inc. Stock......................... 30,000

31 Investment in Sirloin Inc. Stock......................... 196,000Income of Sirloin Inc. ......................................... 196,000

($245,000 × 80% = $196,000)

SPECIAL ACTIVITIES

Activity 13–1

As long as you pay your full amount of taxes owed on the due date of your re-turn, plus any interest or penalty for underpaying estimated taxes, it is appropri-ate to intentionally underpay your estimated taxes. Most individuals attempt to pay only the minimum amount for estimated taxes for the very reason that Steph indicated. That is, paying the minimum allows you to use your money as long as possible. Since the Internal Revenue Service does not pay interest on overpay-ments, it does not make sense to pay more than the minimum of estimated taxes. If you pay less than the minimum required, however, you will be subject to pay-ing IRS interest and penalties.

Activity 13–2

No. Although Reed will not be lying about the amount of total earnings per share of $1.05, it would be clearly misleading not to identify the impact of the extraordi-nary gain of $0.20 related to the selling of the land. In addition to being unethical and unprofessional, Reed may violate federal securities laws if he sells his stock after the announcement. In this case, it might be alleged that Reed traded on “in-sider” information for his own profit.

Activity 13–3

To be classified as an extraordinary item, an event must meet both of the follow-ing requirements:1. Unusual nature—the event should be significantly different from the typical

or the normal operating activities of the entity.2. Infrequent occurrence—the event should not be expected to recur often.

Events that meet both of the preceding requirements are uncommon. Usually, ex-traordinary items result from natural disasters, such as floods, earthquakes, and fires. Thus, your first impression might be that the frost damage for Ulster Inc. would qualify as an extraordinary item. However, this is not the case. In an ac-counting interpretation of a similar case, it was ruled that frost damage experi-enced by a Florida citrus grower did not meet the criterion of “infrequent” in oc-currence. Frost damage is normally experienced in Florida every three to four years. Thus, the history of past losses would suggest that such damage can be expected to occur again in the foreseeable future. The fact that Ulster Inc. had not had frost damage in the previous five years is not sufficient to meet the infre-quency of occurrence criterion.

Activity 13–4

1. a. A common means of achieving a business combination is by one corpo-ration owning a controlling share of the outstanding voting stock of one or more other corporations. When this method is used, none of the par-ticipants dissolve. All continue as legal entities. A company owning all or a majority of the voting stock of another corporation is known as the parent company, and the corporation that is controlled is known as the subsidiary company.Although the corporations composing a parent-subsidiary affiliation may operate as a single economic unit, they continue to maintain sepa-rate accounting records and prepare their own periodic financial state-ments. Because of the central managerial control factor and intertwining relationships, it is usually desirable to present the results of operations and the financial position of the parent company and its subsidiaries as if the group were a single company with one or more branches or divi-sions. Such statements are likely to be more meaningful to stockholders of the parent company than are separate statements for each corpora-tion. The financial statements resulting from the combining of parent and subsidiary statements are referred to generally as consolidated fi-nancial statements. Such statements may be identified by the addition of “and subsidiary(ies)” to the name of the parent corporation or by modification of the title of the respective statement, as in “consolidated balance sheet” or “consolidated income statement.”

b. The “excess of cost of business acquired over related net assets” (also called goodwill) results when the cost paid for the net assets of the ac-quired company exceeds the fair market value of those net assets. This difference (excess of cost of business acquired over related net assets) is attributable to an intangible asset that indicates prospects for high fu-ture earnings.

c. Minority interest refers to the stock owned by those “outside” the con-solidated companies. It represents the minority shareholders' interest in the net assets of the consolidated subsidiaries.

d. When the financial statements of two or more companies are consoli-dated into one set of financial statements, any intercompany transac-tions are eliminated. In essence, the consolidated entity is viewed as one business. Considered in this way, it would be illogical to think of the consolidated entity as owing itself money (the loan) or paying itself in-terest. On this basis, the loan and interest between affiliated companies are eliminated.

Activity 13–4 Concluded

e. Before the financial statements of the American company and the Ger-man company are consolidated, the statements for the German com-pany must be converted to U.S. dollars. After the German company's fi-nancial statements have been converted to U.S. dollars, the financial statements of the American company and the German company are con-solidated in the normal manner.

2. To reduce the risk of loss, it is usually better to diversify one's investments, even if all of the investment is to be placed into stocks. In addition to stocks, you might suggest that your grandmother consider investing in bonds, money market funds, or U.S. Treasury securities. In developing an invest-ment plan, your grandmother should carefully set out her investment objec-tives and then choose among the investment alternatives that have the best chance of achieving these objectives. You might also suggest that your grandmother consult with a professional investment counselor.

Activity 13–5

Note to Instructors: The purpose of this activity is to familiarize students with ex-traordinary items and discontinued operations reported by real companies and to determine the impact of these items on earnings per share.

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Documents

income statement

net income

combined income

comprehensive income

net of applicable income

extraordinary items

earnings statement

result of changes