Chapter 14

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NEIL BRAKE/ASSOCIATED PRESS
Income Taxes,
Unusual Income Items,
and Investments in Stocks
objectives
After studying this chapter, you should be able to:
1
Journalize the entries for corporate income

taxes, including deferred income taxes.
Describe the concept and the reporting of

comprehensive income.
Describe and illustrate the reporting of unusual

items on the income statement.
Describe the accounting for investments in

stocks.
Prepare an income statement reporting

earnings per share data.
14
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Gaylord Entertainment Co.
f you apply for a bank loan, you will be required

to list your assets and liabilities on a loan application. In addition, you will be asked to indicate
your monthly income. Assume that the day you
fill out the application, you win $4,000 in the state
lottery. The $4,000 lottery winnings increase your
assets by $4,000. Should you also show your lottery
winnings as part of your monthly income?
The answer, of course, is no. Winning the lottery
is an unusual event and, for most of us, a nonrecurring event. In determining whether to grant the loan,
the bank is interested in your ability to make monthly
loan payments. Such payments depend upon your
recurring monthly income.
Businesses also experience unusual and nonrecurring events that affect their financial statements.
Such events should be clearly disclosed in the financial statements so that stakeholders in the business
will not misinterpret the financial effects of the
events.
Gaylord Entertainment Co. is an

example of such a company. Gaylord
has pioneered the self-contained all-inone-place hotel and resort concept, with
the Gaylord Opryland, Gaylord Texan, and
Gaylord Palms resorts. In addition, Gaylord owns
ResortQuest and Ryman Auditorim (the original Grand
Ole Opry) in Nashville, Tennessee. While Gaylords
operating income is positive, it has continued to report
net losses over a number of recent years, due to losses
from discontinued operations. Such unusual items are
identified on Gaylords income statement to alert users
of the nonrecurring nature of some of its activities.
In this chapter, we discuss unusual items that
affect income statements, such as those for Gaylord
Entertainment, and illustrate how such items should
be reported. We also discuss other specialized accounting and reporting topics, including accounting for income taxes, comprehensive income, and
investments.
Corporate Income Taxes

objective
Journalize the
entries for
corporate income
taxes, including
deferred income
taxes.
Under the U.S. tax code, corporations are taxable entities that must pay federal income
taxes.1 Depending upon where it is located, a corporation may also be required to pay
state and local income taxes. Although we limit our discussion to federal income taxes,
the basic concepts also apply to other income taxes.
PAYMENT OF INCOME TAXES

Most corporations are required to pay estimated federal income taxes in four installments throughout the year. For example, assume that a corporation with a calendaryear accounting period estimates its income tax expense for the year as $84,000. The
entry to record the first of the four estimated tax payments of $21,000 (1/4 of $84,000)
is as follows:
Individuals pay quarterly estimated taxes if the amount of

tax withholding is not sufficient to pay their taxes at the
end of the year. This usually
occurs when a significant portion of an individuals income
is from self-employment, rent,
dividends, or interest.
610
Apr.
15 Income Tax Expense

Cash
21 0 0 0 00
21 0 0 0 00
1 Limited liability companies (LLCs) are not separate taxable entities and thus are not subject to federal
(and most state) income taxes. For this reason, the material in this section would not generally apply to an
LLC.
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Chapter 14
Income Taxes, Unusual Income Items, and Investments in Stocks
At year-end, the actual taxable income and the related tax are determined.2 If
additional taxes are owed, the additional liability is recorded. If the total estimated
tax payments are greater than the tax liability based on actual taxable income, the
overpayment should be debited to a receivable account and credited to Income Tax
Expense.3
Income taxes are normally disclosed as a deduction at the bottom of the income
statement in determining net income, as shown below, in an excerpt from an income
statement for Procter & Gamble.
Year Ended June 30, 2005
(Amounts in Millions)
Net Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cost of products sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Marketing, research, and administrative expenses . . . . . . . . . . . . . . . . .
$56,741
27,804
18,010
Income from Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other income, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$10,927
(834)
346
Earnings Before Income Taxes

Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$10,439
3,182
Net Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 7,257
The ratio of reported income tax expense to earnings before taxes is shown for
selected industries, as follows:
Industry
Automobiles
Banking
Computers
Food
Integrated oil
Pharmaceuticals
Retail
Telecommunication
Transportation
Percent of Reported
Income Tax Expense to
Earnings before Taxes
33%
35
23
35
39
30
39
37
38
As you can see, the reported income tax expense is normally between 30%40% of
earnings before tax. Therefore, taxes are a significant expense for most companies
and must be considered when analyzing a company. Differences in tax rates between
industries can be due to tax regulations unique to certain industries.
ALLOCATING INCOME TAXES

The taxable income of a corporation is determined according to the tax laws and is
reported to taxing authorities on the corporations tax return.4 It is often different
from the income before income taxes reported in the income statement according to
2 A corporations income tax returns and supporting records are subject to audits by taxing authorities,
who may assess additional taxes. Because of this possibility, the liability for income taxes is sometimes
described in the balance sheet as Estimated income tax payable.
3 Another common term used for income taxes on the income statement and note disclosures is Provision
for income taxes.
4 Accounting for deferred income taxes is a complex topic that is treated in greater detail in advanced
accounting texts. The treatment here provides a general overview and conceptual understanding of the
topic.
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generally accepted accounting principles. As a result, the income tax based on taxable
income usually differs from the income tax based on income before taxes. This difference
may need to be allocated between various financial statement periods, depending on
the nature of the items causing the differences.
Some differences between taxable income and income before income taxes are
created because items are recognized in one period for tax purposes and in another
period for income statement purposes. Such differences, called temporary differences, reverse or turn around in later years. Some examples of items that create temporary differences are listed below.
1. Revenues or gains are taxed after they are reported in the income statement. Example: In
some cases, companies that make sales under an installment plan recognize revenue
for financial reporting purposes when a sale is made but defer recognizing revenue
for tax purposes until cash is collected.
2. Expenses or losses are deducted in determining taxable income after they are reported in the
income statement. Example: Product warranty expense estimated and reported in the
year of the sale for financial statement reporting is deducted for tax reporting when
paid.
3. Revenues or gains are taxed before they are reported in the income statement. Example:
Cash received in advance for magazine subscriptions is included in taxable income
when received but included in the income statement only when earned in a future
period.
4. Expenses or losses are deducted in determining taxable income before they are reported in
the income statement. Example: MACRS depreciation is used for tax purposes, and
the straight-line method is used for financial reporting purposes.
Since temporary differences reverse in later years, they do not change or reduce
the total amount of taxable income over the life of a business. Exhibit 1 illustrates the
reversing nature of temporary differences in which a business uses MACRS depreciation for tax purposes and straight-line depreciation for financial statement purposes.
Exhibit 1 assumes that MACRS recognizes more depreciation in the early years and
less depreciation in the later years. The total depreciation expense is the same for both
methods over the life of the asset.
As Exhibit 1 illustrates, temporary differences affect only the timing of when revenues and expenses are recognized for tax purposes. As a result, the total amount of
taxes paid does not change. Only the timing of the payment of taxes is affected. As
shown in Exhibit 1, most managers use tax-planning techniques so that temporary differences delay or defer the payment of taxes to later years. As a result, at the end of
EXHIBIT 1
Temporary Differences
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each year the amount of the current tax liability and the postponed (deferred) liability
must be recorded.
To illustrate, assume that at the end of the first year of operations a corporation reports $300,000 income before income taxes on its income statement. If we assume an
income tax rate of 40%, the income tax expense reported on the income statement is
$120,000 ($300,000 40%).5 However, to reduce the amount owed for current income
taxes, the corporation uses tax planning to reduce the taxable income to $100,000. Thus,
the income tax actually due for the year is only $40,000 ($100,000 40%). The $80,000
($120,000 $40,000) difference between the two tax amounts is created by temporary
differences in recognizing revenue. This amount is deferred to future years. The example is summarized below.
Income tax expense based on $300,000 reported income at 40%
Income tax payable based on $100,000 taxable income at 40%
Income tax deferred to future years
$120,000
40,000
$ 80,000
To match the current years expenses (including income tax) against the current
years revenue on the income statement, income tax is allocated between periods,
using the following journal entry:
Income Tax Expense

Income Tax Payable
Deferred Income Tax Payable
120 0 0 0 00
40 0 0 0 00
80 0 0 0 00
The income tax expense reported on the income statement is the total tax, $120,000,
expected to be paid on the income for the year. In future years, the $80,000 in Deferred
Income Tax Payable will be transferred to Income Tax Payable as the temporary differences reverse and the taxes become due. For example, if $48,000 of the deferred tax
reverses and becomes due in the second year, the following journal entry would be
made in the second year:
Deferred Income Tax Payable

Income Tax Payable
48 0 0 0 00
48 0 0 0 00
REPORTING AND ANALYZING TAXES
Interest from investments in

municipal bonds is also tax exempt for individual taxpayers.
The balance of Deferred Income Tax Payable at the end of a year is reported as a liability.6 The amount due within one year is classified as a current liability. The remainder
is classified as a long-term liability or reported in a Deferred Credits section following
the Long-Term Liabilities section.7
Differences between taxable income and income (before taxes) reported on the income statement may also arise because certain revenues are exempt from tax and certain expenses are not deductible in determining taxable income. Such differences, which
will not reverse with the passage of time, are sometimes called permanent differences.
For example, interest income on municipal bonds may be exempt from taxation. Such
differences create no special financial reporting problems, since the amount of income
tax determined according to the tax laws is the same amount reported on the income
statement.
5 For purposes of illustration, the 40% rate is assumed to include all federal, state, and local income taxes.
6 In some cases, a deferred tax asset may arise for tax benefits to be received in the future. Such deferred
tax assets are reported as either current or long-term assets, depending on when the benefits are expected
to be realized.
7 Additional note disclosures for deferred income taxes are also required. These are discussed in advanced
accounting texts.
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Example Exercise 14-1
objective
A corporation has $200,000 of income before income taxes, a 40% tax rate, and $130,000 of taxable
income. Provide the journal entry for the current years taxes.
Follow My Example 14-1

Income Tax Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income Tax Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred Income Tax Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
80,000
Income tax expense based on $200,000 reported income at 40% . . . . . . . . . . . . . . . . . . . . . . . . . .

Income tax payable based on $130,000 taxable income at 40% . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income tax deferred to future years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
52,000
28,000
$80,000
52,000
$28,000
For Practice: PE 14-1A, PE 14-1B
Reporting Unusual Items on the

Income Statement
objective
Describe and
illustrate the
reporting of
unusual items on
the income
statement.
Generally accepted accounting principles require that certain unusual items be reported
separately on the current or prior periods income statement. These items can be classified into items affecting the current period income statement and those affecting prior
period income statements as shown below.
Unusual Items Affecting the Current Periods Income Statement
Fixed asset impairments
Restructuring charges
Discontinued operations
Extraordinary item
Unusual Items Affecting the Prior Periods Income Statement
Errors
Change in accounting principles
The first category of unusual items affects the current periods income statement.
However, the location of the disclosure on the income statement is different between
these items. Fixed asset impairment and restructuring charges are reported above
income from continuing operations as shown in item 1 of Exhibit 2. That is, fixed
asset impairment and restructuring charges are subtracted in arriving at income from
continuing operations. Although discontinued operations and extraordinary items
affect net income, they are reported below income from continuing operations as
shown in item 2 of Exhibit 2.
In the following paragraphs, we first describe and illustrate unusual items affecting the current periods income statement. We then discuss unusual items affecting
prior period income statements as shown in item 3 of Exhibit 2.
UNUSUAL ITEMS AFFECTING THE CURRENT PERIODS

INCOME STATEMENT
Unusual items affecting the current periods income statement include fixed asset impairments, restructuring charges, discontinued operations, and extraordinary items.
Fixed asset impairments and restructuring charges, sometimes termed special charges
when combined, will be discussed first. Following these, we will discuss discontinued
operations and extraordinary items.
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Reporting of Unusual Items on the Income Statement
1. Unusual items subtracted from

gross profit in determining income
from continuing operations.
2. Unusual items that adjust income

from continuing operations in
determining net income.
XYZ Co.
Income Statement
For the Year Ended December 31, 2005
XYZ Co.
Sales
. . . . . . .Statement
..................................
Income
Cost ofEnded
goods sold
. . . . . . . . 31,
. . . .2006
.................
For the Year
December
XYZ Co.Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Sales
..................................
$ XXX
Income
Cost ofEnded
goods sold
. . . . . . . . 31,
. . . .2007
.................
XXX
For the Year
December
XYZ Co.Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ XXX
Sales
..................................
$ XXX
Income
XXX
Cost ofEnded
goods sold
. . . . . . . . 31,
. . . .2008
. . . . Income
. . . . . . .from
. . . . continuing
..
XXX
For the Year
December
operations. . . . . . . . . . . . . . . .
XXX
Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ XXX
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
XXX
$ XXX
XXX
Cost of goods sold . . . . . . . . . . . . . . . . Income
. . . . . . .from
. . . . .continuing
.
XXX
$ XXX
operations. . . . . . . . . . . . . . . .
XXX
Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ XXX
XXX
Net income . . . . . . . . . .XXX
.........................
Restructuring charges . . . . . . . . . . . . . . . . . . . . . . . . . .
XXX
XXX
$ XXX
Income from continuing operations. . . . . . . . . . . . . . . .
XXX
XXX
Fixed asset impairments. . . . . . . . . . . . . . . . . . . . . . . . .
XXX
XXX
$ XXX
Net income . . . . . . . . . . . . . . . . . . . . . . . . . .XXX
.........
$ XXX
Income from continuing operations. . . . . . . . . . . . . . . .
XXX
XXX
Discontinued operations . . . . . . . . . . . . . . . . . . . . . . . .
$ XXX
Net income . . . . . . . . . . . . . . . . . . . . . . . . . .XXX
.........
Extraordinary items. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
XXX
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ XXX
XXX
$ XXX
XXX
XXX
XXX
$ XXX
XXX
XXX
XXX
$ XXX
$ XXX
3. Unusual items affecting prior period income statements.
Fixed Asset Impairments A fixed asset impairment occurs when the fair value of a
fixed asset falls below its book value (cost less accumulated depreciation) and is not
expected to recover.8 Examples of events that might cause an asset impairment are
(1) decreases in the market price of fixed assets, (2) significant changes in the business
or regulations related to fixed assets, (3) adverse conditions affecting the use of fixed
assets, or (4) expected cash flow losses from using fixed assets.9 For example, on March
1, assume that Jones Corporation consolidates operations by closing a factory. As a
result of the closing, plant and equipment is impaired by $750,000. The journal entry
to record the impairment is as follows:
Mar.
Loss on Fixed Asset Impairment

Equipment
750 0 0 0 00
750 0 0 0 00
The loss on fixed asset impairment is reported as a separate expense item deducted
from gross profit in determining income from continuing operations, as illustrated for
Jones Corporation in Exhibit 3. In addition, note disclosure should describe the nature
of the asset impaired and the cause of the impairment.
The loss reduces the book value of the fixed asset and thus reduces the depreciation expense for future periods. If the asset is later sold, the gain or loss on the sale
would be based on the lower book value. Thus, asset impairment accounting recognizes the loss when it is first identified, rather than when the asset is later sold.
8 Fixed assets that are discontinued components, such as an operating segment, subsidiary, or asset
group, should be treated as discontinued items, as discussed in a later section.
9 Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of LongLived Assets (Norwalk, CT: Financial Accounting Standards Board, 2001).
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EXHIBIT 3
Jones Corporation
Income Statement
Unusual Items in the

Income Statement
Net sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cost of merchandise sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Selling and administrative expenses . . . . . . . . . . . . . . . . . . . . . . .
Loss from asset impairment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Restructuring charge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income from continuing operations before
income tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income from continuing operations . . . . . . . . . . . . . . . . . . . . . . .
Loss on discontinued operations (net of
applicable income tax benefit of $50,000) . . . . . . . . . . . . . . . .
Income before extraordinary items . . . . . . . . . . . . . . . . . . . . . . .
Extraordinary item:
Gain on condemnation of land (net of applicable
income tax of $65,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$12,350,000
5,800,000
$ 6,550,000
$3,490,000
750,000
1,000,000
5,240,000
$ 1,310,000
620,000
$ 690,000
100,000
590,000
150,000
740,000
Integrity, Objectivity, and Ethics in Business

WHEN IS AN ASSET IMPAIRED?
The asset impairment principle is designed to reduce the
subjectivity of timing asset write-downs. That is, writedowns should occur when the impairment is deemed
permanent. In practice, however, judgment is still needed
in determining when such impairment has occurred. Ethical managers will recognize asset write-downs when they
occur, not when it is most convenient. For example, the

SEC investigated Avon Products, Inc., for delaying the
write-off of a computer software project. In settling the
formal investigation, Avon had to restate its earnings to
reflect the earlier write-off date.
Restructuring Charges Restructuring charges are costs incurred with actions such as
canceling contracts, laying off or relocating employees, and combining operations. Often, these events incur initial one-time costs in order to obtain long-term savings. For
example, terminated employees often receive a one-time termination or severance
benefit at the time of their dismissal. Employee termination benefits are normally the
most significant restructuring charges; thus, they will be the focus of this section.
Employee termination benefits arise when a plan specifying the number of terminated employees, the benefit, and the benefit timing has been authorized by senior
management and communicated to the employees.10 To illustrate, assume that the
management of Jones Corporation communicates a plan to terminate 200 employees
from the closed manufacturing plant on March 1. The plan calls for a termination
benefit of $5,000 per employee. Once the plan is communicated to employees, they
have the legal right to work for 60 days but may elect to leave the firm earlier. That
is, employees may be paid severance at the end of 60 days or at any time in between.
10 Statement of Financial Accounting Standards No. 146, Accounting for Costs Associated with Exit or Disposal Activities (Norwalk, CT: Financial Accounting Standards Board, 2002).
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The expense and liability to provide employee benefits should be recognized at fair
value on the plan communication date.11 The fair value of this plan would be $1,000,000
(200 employees $5,000), which is the aggregate expected cost of terminating the employees. Thus, the $1,000,000 restructuring charge would be recorded as follows:
Mar.
Restructuring Charge
Employee Termination Obligation
1000 0 0 0 00
1000 0 0 0 00
The restructuring charge is reported as a separate expense deducted from gross profit
in determining income from continuing operations, as shown in Exhibit 3. The employee termination obligation would be shown as a current liability. If the plan called
for expected severance payments beyond one year, then a long-term liability would
be recognized. In addition, a note should disclose the nature and cause of the restructuring event and the costs associated with the type of restructuring event.
The actual benefits paid to terminated employees should be debited to the liability as employees leave the firm. For example, assume that 25 employees find other
employment and leave the company on March 25. The entry to record the severance
payment to these employees would be as follows:
Mar. 25 Employee Termination Obligation

Cash
125 0 0 0 00
125 0 0 0 00
objective
On December 20 of the current year, Torre Corporation determined that equipment had been impaired so
that the book value of the equipment was reduced by $180,000. In addition, the senior management of
the company communicated an employee severance plan whereby 80 employees could receive a
termination benefit of $7,000 per employee. Provide the journal entry for the asset impairment and the
restructuring charge.

Dec. 20
Loss on Fixed Asset Impairment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
180,000
Restructuring Charge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Employee Termination Obligation . . . . . . . . . . . . . . . . . . . . . . . . . . . .
560,000*
180,000
560,000
*80 employees $7,000
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. The term business segment refers to a major line of business for a
company, such as a division, department, or certain class of customer. A component of
an entity is the lowest level at which the operations and cash flows can be clearly
distinguished, operationally and for financial reporting purposes, from the rest of the
11 For long-term severance agreements, present value concepts may be required to determine fair value.
We will assume short-term agreements where the time value of money is assumed to be immaterial.
Present value concepts are discussed in Chapter 15.
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entity.12 Examples would be a store for a retailer, a territory for a sales organization,
or a product category for a consumer products company.
To illustrate the disclosure, assume that Jones Corporation has separate divisions
that produce electrical products, hardware supplies, and lawn equipment. Jones sells
its electrical products division at a loss. As shown in Exhibit 3 on page 616, this loss is
deducted from Joness income from continuing operations (income from its hardware
and lawn equipment divisions). In addition, a note should disclose the identity of the
segment sold, the disposal date, a description of the segments assets and liabilities,
and the manner of disposal.
Extraordinary Items An extraordinary item results from events and transactions that
(1) are significantly different (unusual) from the typical or the normal operating activities of the business and (2) occur infrequently. The gains and losses resulting from
natural disasters that occur infrequently, such as floods, earthquakes, and fires, are
extraordinary items. Gains or losses from condemning land or buildings for public use
are also extraordinary. Such gains and losses, other than those from disposing of a business segment, should be reported in the income statement as extraordinary items, as
shown in Exhibit 3.
Sometimes, extraordinary items result in unusual financial results. For example,
Delta Air Lines once reported an extraordinary gain of over $5.5 million as the result of
the crash of one of its 727s. The plane that crashed was insured for $6.5 million, but its
book value in Deltas accounting records was $962,000. Gains and losses on the disposal
of fixed assets are not extraordinary items. This is because (1) they are not unusual and
(2) they recur from time to time in the normal operations of a business. Likewise, gains
and losses from the sale of investments are usual and recurring for most businesses.
UNUSUAL ITEMS AFFECTING THE PRIOR PERIODS

INCOME STATEMENT
In addition to unusual items impacting the income statement, there are two major items
that require a retroactive restatement of prior period earnings. These two items are:
1. Errors in the recognition, measurement, presentation, or disclosure of financial
statements, and
2. Changes from one generally accepted accounting principle to another generally accepted accounting principle.13
A retroactive restatement requires previously issued financial statements to be adjusted
for the impact of errors and changes in accounting principle. If an error is discovered
that impacts a prior period financial statement, the prior period statement, and all following statements, should be restated to reflect the correction. If there is a change from
one generally accepted accounting principle to another generally accepted accounting
principle, then the change is applied to prior period financial statements. That is, the
prior period financial statements are restated as if the new accounting principle had
always been used.14 Thus, in both cases, these changes do not impact current period
earnings, but will impact the earnings reported in past periods. As a result, the present Retained Earnings and other balance sheet accounts will be restated to reflect
these prior period changes. Illustrations of these types of adjustments are provided in
advanced accounting courses.
12 Statement of Financial Accounting Standards No. 144, op. cit., par. 41.
13 Statement of Financial Accounting Standards No. 154, Accounting Changes and Error Corrections
(Norwalk, CT: Financial Accounting Standards Board, 2005).
14 Changes from one acceptable depreciation method to another acceptable depreciation method are an
exception to this general rule and are to be treated prospectively as a change in estimate, as discussed in
Chapter 10.
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Earnings per Common Share

objective
Prepare an income
statement
reporting earnings
per share data.
The amount of net income is often used by investors and creditors in evaluating a
companys profitability. However, net income by itself is difficult to use in comparing
companies of different sizes. Also, trends in net income may be difficult to evaluate,
using only net income, if there have been significant changes in a companys stockholders equity. Thus, the profitability of companies is often expressed as earnings per
share. Earnings per common share (EPS), sometimes called basic earnings per share, is
the net income per share of common stock outstanding during a period.
Because of its importance, earnings per share is reported in the financial press and
by various investor services, such as Moodys and Standard & Poors. Changes in earnings per share can lead to significant changes in the price of a corporations stock in
the marketplace. For example, the stock of eBay Inc. fell by over 19% to $83 per share
after the company announced earnings per share of 33 as compared to Wall Street
analysts estimate of 34 per share.
Corporations whose stock is traded in a public market must report earnings per
common share on their income statements.15 If no preferred stock is outstanding, the
earnings per common share is calculated as follows:
Net Income
Number of Common Shares Outstanding
When the number of common shares outstanding has changed during the period,
a weighted average number of shares outstanding is used. If a company has preferred
stock outstanding, the net income must be reduced by the amount of any preferred
dividends, as shown below.
Net Income Preferred Stock Dividends
Number of Common Shares Outstanding
Comparing the earnings per share of two or more years, based on only the net incomes of those years, could be misleading. For example, assume that Jones Corporation, whose partial income statement was presented in Exhibit 3, reported $700,000
net income for 2007. Also assume that no extraordinary or other unusual items were
reported in 2007. Jones has no preferred stock outstanding and has 200,000 common
shares outstanding in 2007 and 2008. The earnings per common share is $3.50
($700,000/200,000 shares) for 2007 and $3.70 ($740,000/200,000 shares) for 2008. Comparing the two earnings per share amounts suggests that operations have improved.
However, the 2008 earnings per share comparable to the $3.50 is $3.45, which is the
income from continuing operations of $690,000 divided by 200,000 shares. The latter
amount indicates a slight downturn in normal earnings.
When unusual items reported below income from continuing operations exist,
earnings per common share should be reported for those items. To illustrate, a partial
income statement for Jones Corporation, showing earnings per common share, is
shown in Exhibit 4. In this income statement, Jones reports all the earnings per common share amounts on the face of the income statement. However, only earnings per
share amounts for income from continuing operations and net income are required
to be presented on the face of the statement. The other per share amounts may be
presented in the notes to the financial statements.16
In the preceding paragraphs, we have assumed a simple capital structure with
only common stock or common stock and preferred stock outstanding. Often, however, corporations have complex capital structures with various types of securities
outstanding, such as convertible preferred stock, options, warrants, and contingently
15 Statement of Financial Accounting Standards No. 128, Earnings per Share (Norwalk, CT: Financial Accounting Standards Board, 1997).
16 Ibid., pars. 36 and 37.
619
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EXHIBIT 4
Jones Corporation
Income Statement
Income Statement
with Earnings
per Share
Earnings per common share:

Income from continuing operations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loss on discontinued operations, net of $50,000 tax benefit . . . . . . . . . . . . . . . .
Income before extraordinary items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Extraordinary item:
Gain on condemnation of land, net of applicable income
tax of $65,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 3.45
0.50
$ 2.95
0.75
$ 3.70
issuable shares. In such cases, the possible effects of converting such securities to
common stock must be calculated and reported as earnings per common share assuming dilution or diluted earnings per share.17 This topic is discussed further in advanced
accounting texts.
objective
Manning Company had net income of $250,000 during the year. There were 580,000 common shares and
2,000 shares of $100 par value, 9% preferred stock outstanding during the year. Determine the basic
earnings per share.

Earnings per share:
$250,000 $18,000*
$0.40 per share
580,000
*2,000 shares $100 par value 9% $18,000
Comprehensive Income
objective
Describe the
concept and the
reporting of
comprehensive
income.
Comprehensive income is defined as all changes in stockholders equity during a

period, except those resulting from dividends and stockholders investments. Companies must report traditional net income plus or minus other comprehensive income
items to arrive at comprehensive income.
Other comprehensive income items include foreign currency items, pension liability adjustments, and unrealized gains and losses on investments. Generally accepted
accounting principles (GAAP) require these items to be disclosed separately from
earnings. To the extent that other comprehensive income items give rise to tax effects,
the taxes should be allocated to these items similar to that illustrated in Exhibit 4 for
extraordinary items. The cumulative effects of other comprehensive income items
must be reported separately from retained earnings and paid-in capital, on the balance sheet, as accumulated other comprehensive income. When other comprehen-
17 Ibid., pars. 1139.
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In the 2005 edition of Accounting Trends & Techniques,

over 95% of the surveyed
companies reported other
comprehensive income, and the
majority of these companies
disclosed it in the statement of
stockholders equity.
621
sive income items are not present, the income statement and balance sheet formats are
similar to those we have illustrated in this and preceding chapters.
Companies may report comprehensive income on the income statement, in a separate statement of comprehensive income, or in the statement of stockholders equity.
In addition, companies may use terms other than comprehensive income, such as
total nonowner changes in equity.
To illustrate reporting for comprehensive income, assume that Triple-A Enterprises
Inc. reported comprehensive income on a separate statement, called the statement of
comprehensive income, as follows:
Triple-A Enterprises Inc.

Statement of Comprehensive Income
Net income
Other comprehensive income, net of tax
Total comprehensive income
$8 5 0 0 00
9 0 00
$8 5 9 0 00
The Stockholders Equity section of the balance sheet for Triple-A Enterprises is
as follows:
Triple-A Enterprises Inc.

Stockholders' Equity
December 31, 2008 and 2007
Stockholders equity:
Common stock
Paid-in capital in excess of par
Retained earnings
Accumulated other comprehensive income
Total stockholders equity
2008
2007
$ 20 0 0 0 00
36 0 0 0 00
165 5 0 0 00
1 2 9 0 00
$222 7 9 0 00
$ 20 0 0 0 00
36 0 0 0 00
157 0 0 0 00
1 2 0 0 00
$214 2 0 0 00
Accumulated other comprehensive income is the cumulative effect of other comprehensive income items. Thus, the additional other comprehensive income of $90 for
2008 is added to the accumulated other comprehensive income on December 31, 2007,
to yield the December 31, 2008, balance of $1,290.
You should note that comprehensive income does not affect net income or retained
earnings. In the next section, we will illustrate the determination of other comprehensive income, using unrealized gains and losses on investments.
objective
Myers Company had a net income of $74,000 and other comprehensive income of $12,500 for 2008. On
January 1, 2008, the Retained Earnings balance was $425,000, and the Accumulated Other Comprehensive
Income balance was $57,000. Determine the (a) comprehensive income for 2008, (b) Retained Earnings
balance on December 31, 2008, and (c) Accumulated Other Comprehensive Income balance on December 31,
2008.
(continued)
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a.
b.
c.
$86,500 $74,000 $12,500

$499,000 $425,000 $74,000
$69,500 $57,000 $12,500
Accounting for Investments in Stocks

objective
Describe the
accounting for
investments in
stocks.
Corporations not only issue stock, but they also purchase stocks of other companies
for investment purposes. Like individuals, businesses have a variety of reasons for investing in stocks, called equity securities. A business may purchase stocks as a means
of earning a return (income) on excess cash that it does not need for its normal operations. Such investments are usually for a short period of time. In other cases, a business may purchase the stock of another company as a long-term investment. Such
investments can be as a means of developing or maintaining business relationships
with another company. Sometimes, a business will purchase most, if not all, of the common stock of another company for purposes of owning and controlling another entity.
This is termed a business combination. In this section, we will discuss short-term investments in equity securities, long-term investments in equity securities, sales of investments, and business combinations. First, however, we will introduce two major equity
security classifications according to generally accepted accounting principles.
The equity securities in which a business invests may be classified as trading securities or available-for-sale securities. Trading securities are securities that management
intends to actively trade for profit. Businesses holding trading securities are those whose
normal operations involve buying and selling securities. Examples of such businesses
include banks and insurance companies. Available-for-sale securities are securities
that management expects to sell in the future but which are not actively traded for
profit. For example, Warren Buffett, one of the wealthiest men in the world, invests
through a public company called Berkshire Hathaway Inc. In a recent annual report,
Berkshire Hathaway reported over $35 billion of equity investment holdings listed on
its balance sheet as available-for-sale securities. Some of these investments include The
Coca-Cola Company, McDonalds, and American Express Company. In this section,
we describe and illustrate the accounting for available-for-sale equity securities. The
accounting for trading securities is described and illustrated in advanced accounting
texts.
SHORT-TERM INVESTMENTS IN STOCKS

Rather than allow excess cash to be idle until it is needed, a business may invest in
available-for-sale securities. These investments are classified as temporary investments
or marketable securities. Although such investments may be retained for several years,
Integrity, Objectivity, and Ethics in Business

WHAT DOES IT TAKE TO SUCCEED IN LIFE?
The answer to this question, according to Warren Buffett,
the noted investment authority, is three magic ingredients:
intelligence, energy, and integrity. According to Buffett,
If you lack the third ingredient, the other two will kill
you. In other words, without integrity, your intelligence

and energy may very well misguide you.
Source: Eric Clifford, University of Tennessee Torchbearer, Summer 2002.
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623
they continue to be classified as temporary, provided they meet two conditions. First,
the securities are readily marketable and can be sold for cash at any time. Second, management intends to sell the securities when the business needs cash for operations.
Temporary investments in available-for-sale securities are recorded in a current
asset account, Marketable Securities, at their cost. This cost includes all amounts spent
to acquire the securities, such as brokers commissions. Any dividends received on
the investment are recorded as a debit to Cash and a credit to Dividend Revenue.18
To illustrate, assume that 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. On October
1, Inis declared a $0.90 per share cash dividend payable on November 30. Crabtrees
entries to record the stock purchase and the receipt of the dividend are as follows:
June
Nov.
Marketable Securities
Cash
Purchased 2,000 shares of Inis Corporation
common stock [($89.75 2,000 shares)
$500].
30 Cash
Dividend Revenue
Received dividend on Inis Corporation
common stock (2,000 shares $0.90).
180 0 0 0 00
180 0 0 0 00
1 8 0 0 00
1 8 0 0 00
On the balance sheet, temporary investments are reported at their fair market
value. Market values are normally available from stock quotations in financial newspapers, such as The Wall Street Journal. Any difference between the fair market values
of the securities and their cost is an unrealized holding gain or loss. This gain or loss
is termed unrealized because a transaction (the sale of the securities) is necessary
before a gain or loss becomes real (realized).
To illustrate, assume that Crabtree Co.s portfolio of temporary investments was
purchased during 2008 and has the following fair market values and unrealized gains
and losses on December 31, 2008:
Common Stock
Cost
Market
Unrealized
Gain (Loss)
Edwards Inc.
SWS Corp.
Inis Corporation
Bass Co.
Total
$150,000
200,000
180,000
160,000
$690,000
$190,000
200,000
210,000
150,000
$750,000
$ 40,000
30,000
(10,000)
$ 60,000
If income taxes of $18,000 are allocated to the unrealized gain, Crabtrees temporary
investments should be reported at their total cost of $690,000, plus the unrealized gain
(net of applicable income tax) of $42,000 ($60,000 $18,000), as shown in Exhibit 5.
The unrealized gain (net of applicable taxes) of $42,000 should also be reported as an
other comprehensive income item, as we mentioned in the preceding section. For example,
assume that Crabtree Co. has net income of $720,000 for the year ended December 31,
2008. Crabtree elects to report comprehensive income in the statement of comprehensive
income, as shown in Exhibit 6. In addition, the accumulated other comprehensive income
on the balance sheet would also be $42,000, representing the beginning balance of zero
plus other comprehensive income of $42,000, as shown in Exhibit 5.
18 Stock dividends received on an investment are not journalized, since they have no effect on the investors assets and revenues.
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EXHIBIT 5
Crabtree Co.
Balance Sheet (selected items)
December 31, 2008
Temporary
Investments on the
Balance Sheet
Assets
Current assets:
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Temporary investments in marketable
securities at cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unrealized gain (net of applicable
income tax of $18,000) . . . . . . . . . . . . . . . . . . . . . . . .
$119,500
$690,000
42,000
Stockholders' Equity
Accumulated other comprehensive income . . . . . . . . . . . . . .
EXHIBIT 6
732,000
$ 42,000
Crabtree Co.
Statement of
Comprehensive
Income
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other comprehensive income:
Unrealized gain on temporary investments in marketable
securities (net of applicable income tax of $18,000) . . . . . . . . . . . . . . . . .
Comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$720,000
42,000
$762,000
Unrealized losses are reported in a similar manner. Unrealized gains and losses are
reported as other comprehensive income items until the related securities are sold.
When temporary securities are sold, the unrealized gains or losses become realized and
are included in determining net income.
objective
Drew Company began operations on January 1, 2008, and purchased temporary investments in marketable
securities during the year at a cost of $75,000. The end-of-period market value for these investments was
$110,000. Net income was $180,000 for 2008. Determine (a) the reported amount of marketable securities on
the December 31, 2008, balance sheet and (b) the comprehensive income for 2008. Assume a tax rate of 40%.

a.
b.
Initial cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unrealized gain ($110,000 $75,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less: Tax on unrealized gain ($35,000 40%) . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unrealized gain, net of tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Reported amount of marketable securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unrealized gain ($110,000 $75,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less: Tax on unrealized gain ($35,000 40%) . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other comprehensive income, net of tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 75,000
$35,000
14,000
21,000
$ 96,000
$180,000
$35,000
14,000
21,000
$201,000
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LONG-TERM INVESTMENTS IN STOCKS

Long-term investments in stocks are not intended as a source of cash in the normal
operations of the business. Rather, such investments are often held for their income,
long-term gain potential, or influence over another business entity. They are reported
in the balance sheet under the caption Investments, which usually follows the Current
Assets section.
Long-term investments in stock are treated as available-for-sale securities, as we
illustrated previously for short-term available-for-sale securities. Thus, a long-term investment treated as an available-for-sale security is recorded at cost and reported at
fair market value net of any applicable income tax effects. In addition, any
Accounting for Long-Term
unrealized gains and losses are reported as part of the comprehensive inStock Investments
come.19 For example, Delta Air Lines disclosed investments in Priceline.com
preferred stock as a noncurrent investment at the appraised fair market value.
Is there a significant influence
However, if the investor (the buyer of the stock) has significant influover the investee?
ence over the operating and financing activities of the investee (company
whose stock is owned), the equity method is used. When the equity
method
is used, a stock purchase is recorded at cost, as shown previously.
No
Yes
Evidence of significant influence includes the percentage of ownership, the
existence of intercompany transactions, and the interchange of managerial personnel. Generally, if the investor owns 20% or more of the voting
Account for the
Account for the
stock of the investee, it is assumed that the investor has significant influinvestment as an
investment by
ence over the investee.
available-for-sale
using the equity
security
method
Under the equity method, the investment is not subsequently adjusted
to fair value. Rather, the book value of the investment is adjusted as follows:
1. The investors share of the periodic net income of the investee is recorded as an increase in the investment account and as income for the period. Likewise, the investors
share of an investees net loss is recorded as a decrease in the investment account and
as a loss for the period.
2. The investors share of cash dividends from the investee is recorded as an increase
in the cash account and a decrease in the investment account.
To illustrate, assume that on January 2, Hally Inc. pays cash of $350,000 for 40% of
the common stock and net assets of Brock Corporation. Assume also that, for the year
ending December 31, Brock Corporation reports net income of $105,000 and declares
and pays $45,000 in dividends. Using the equity method, Hally Inc. (the investor)
records these transactions as follows:
Jan.
The 2005 edition of Accounting Trends & Techniques indicated that over 50% of the
companies surveyed used the
equity method to account for
investments.
Dec. 31
Dec. 31
Investment in Brock Corporation Stock

Cash
Purchased 40% of Brock Corporation stock.
350 0 0 0 00

Income of Brock Corporation
Recorded 40% share of Brock Corporation
net income of $105,000.
42 0 0 0 00
Cash
Recorded 40% share of Brock Corporation
dividends.
18 0 0 0 00
350 0 0 0 00
42 0 0 0 00
18 0 0 0 00
19 An exception to reporting unrealized gains and losses as part of comprehensive income is made if the
decrease in the market value for a stock is considered permanent. In this case, the cost of the individual
stock is written down (decreased), and the amount of the write-down is included in net income.
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The combined effect of recording 40% of Brock Corporations net income and dividends is to increase Hallys interest in the net assets of Brock by $24,000 ($42,000
$18,000), as shown below.
The equity method causes the investment account to mirror the proportional
changes in the book value of the investee. Thus, Brock Corporations book value increased by $60,000 ($105,000 $45,000), while the investment in Brock Corporation
stock account increased by Hallys proportional share of that increase, or $24,000
($60,000 40%). Thus, both the book value of Brock Corporation and Hallys investment in Brock increased at the same rate from the original cost.
objective
Phillips Company purchased 30% of the outstanding stock of Singh Company on January 1, 2008. Singh
reported net income of $90,000 and declared dividends of $15,000 during 2008. How much would Phillips
adjust its investment in Singh Company under the equity method?

Phillips share of Singh reported net income (30% $90,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less Phillips share of the Singh dividend (30% $15,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Increase in the investment in Singh Company stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$27,000
4,500
$22,500
SALE OF INVESTMENTS IN STOCKS

Accounting for the sale of stock is the same for both short- and long-term investments.
When shares of stock are sold, the investment account is credited for the carrying
amount (book value) of the shares sold. The cash or receivables account is debited
for the proceeds (sales price less commission and other selling costs). Any difference
between the proceeds and the carrying amount is recorded as a gain or loss on the sale
and is included in determining net income.
To illustrate, assume that an investment in Drey Inc. stock has a carrying amount
of $15,700 when it is sold on March 1. If the proceeds from the sale of the stock are
$17,500, the entry to record the transaction is as follows:
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Mar.
627
Cash
Investment in Drey Inc. Stock
Gain on Sale of Investments
17 5 0 0 00
15 7 0 0 00
1 8 0 0 00
BUSINESS COMBINATIONS
A business may make an investment in another business by acquiring a controlling
share, often greater than 50%, of the outstanding voting stock of another corporation by paying cash or exchanging stock. This is termed a business combination.
Businesses may combine in order to produce more efficiently, diversify product lines,
expand geographically, or acquire know-how.
A corporation owning all or a majority of the voting stock of another corporation is
called a parent company. The corporation that is controlled is called the subsidiary company. For example, PayPal became a subsidiary of eBay Inc. when eBay exchanged eBay
common stock for all the outstanding common stock of PayPal. Although parent and
subsidiary corporations may operate as a single economic unit, they continue to maintain separate accounting records and prepare their own periodic financial statements.
At the end of the year, the financial statements of the parent and subsidiary are
combined and reported as a single company.20 These combined financial statements
are called consolidated financial statements. Such statements are usually identified
by adding and subsidiary(ies) to the name of the parent corporation or by adding
consolidated to the statement title. For example, eBays income statement is titled,
Consolidated Statement of Income. To the stockholders of the parent company, consolidated financial statements are more meaningful than separate statements for each
corporation. This is because the parent company, in substance, controls the subsidiaries,
even though the parent and its subsidiaries are separate entities. Accounting for business combinations and preparing consolidated financial statements are discussed in
greater detail in advanced accounting courses.
Business Connections
113
Companies merge in order to create synergy, which occurs when the value of the companies as a single unit is
greater than their value as separate companies. How do
mergers create synergy? The four basic strategies for creating value in a merger are explained below.
1. Reduce costs: When two companies combine, they may
be able to eliminate duplicate administrative expenses.
For example, the combined company does not need
two CEOs or two CFOs, or the company can run on a
single computer system or distribution network.
Hewlett-Packard Company, identified cost savings
such as these in justifying its acquisition of Compaq
Computer Corporation.
2. Replace management: If the target company has been
suffering from mismanagement, the acquirer can purchase the target for a low price and replace the target
companys management.
3. Horizontal integration: The acquirer may purchase the

target company because it has a complementary product line, territory, or customer base to its own. The new
combined entity is able to serve customers with a
broader reach than were two separate entities. For example, The Walt Disney Company purchased Pixar
in order to reestablish its presence as the premier animation movie studio in the era of digital animation.
4. Vertical integration: A vertical integration occurs when
a business acquires a supplier or customer. Acquiring
a supplier may provide a more stable source of supply
of a strategic resource and reduce coordination costs.
For example, Delta Air Lines acquired Comair Holdings Inc., a regional jet carrier, to supply passengers
from smaller cities into its large city hub system.
20 When a parent company owns less than 100% of the subsidiary stock, the amount owned by the outsiders is often termed a minority interest and is reported immediately following the consolidated total liabilities. Accounting for the minority interest is covered in advanced accounting texts.
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Financial Analysis and Interpretation

A firms growth potential and future earnings prospects are indicated by how much the market is willing
to pay per dollar of a companys earnings. This ratio, called the price-earnings ratio, or P/E ratio, is
commonly included in stock market quotations reported by the financial press. A high P/E ratio indicates that the market expects high growth and earnings in the future. Likewise, a low P/E ratio indicates lower growth and earnings expectations.
The price-earnings ratio on common stock is computed by dividing the stocks market price per
share at a specific date by the companys annual earnings per share, as shown below.
Market Price per Share of Common Stock
Price-Earnings Ratio
Earnings per Share of Common Stock
Investors that invest in high price-earnings ratio companies are often referred to as growth investors.
Growth investors pay a high price for shares because they expect the company to grow and provide a
superior return. That is, high price-earnings ratios can be related to investor optimism. Examples of
growth companies are Google (P/E 87), eBay Inc. (P/E 54), and Genentech, Inc. (P/E 72). Growth
companies are considered risky because high growth expectations are already reflected in the market
price. Thus, if the companys high growth expectations are not realized, the stock price will likely fall.
In contrast, investors in low price-earnings ratio companies are often referred to as value investors.
Value investors invest in companies with stable and predictable earnings. The value investor believes
that the low price-earnings ratio investment is safer than a high price-earnings investment, since the
stock is priced at a bargain level. Value investing is generally considered the tortoise strategy to
the growth investors hare strategy. Examples of value stocks are Bank of America Corporation
(P/E 11), H.J. Heinz Company (P/E 16), and Ford Motor Company (P/E 9).
To illustrate the calculation of the price-earnings ratio, assume that Harper Inc. reported earnings
per share of $1.64 in 2008 and $1.35 in 2007. The market prices per common share are $24.60 at the end
of 2008 and $16.20 at the end of 2007. The price-earnings ratio on this stock is computed as follows:
Price-Earnings Ratio
Year 2008
Year 2007
15 ($24.60/$1.64)
12 ($16.20/$1.35)
The price-earnings ratio indicates that a share of Harper Inc.s common stock was selling for 12
times the amount of earnings per share at the end of 2007. At the end of 2008, the common stock was
selling for 15 times the amount of earnings per share. These results would indicate a generally improving expectation of growth and earnings for Harper Inc. However, a prospective investor should also
consider the price-earnings ratios for competing firms in the same industry.
At a Glance
1. Journalize the entries for corporate income taxes, including deferred income taxes.
Key Points
Key Learning Outcomes
Corporations are subject to income tax and

are required to make estimated payments
throughout the year. The effects of temporary differences between taxable income and
income before income taxes must be allocated
between periods.
Journalize estimated tax

payments.
Journalize and interpret
temporary differences that
give rise to deferred taxes.
Example
Exercises
Practice
Exercises
14-1
14-1A, 14-1B
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629
2. Describe and illustrate the reporting of unusual items on the income statement.
Key Points
Fixed asset impairments and restructuring

charges are separately disclosed and deducted
as part of operating expenses in determining
income from continuing operations. The gain
or loss from disposal of a business and gains
and losses from unusual and infrequent (extraordinary) events are disclosed separately below
income from continuing operations. Errors and
changes from one generally accepted accounting method to another are treated as restatements of prior period financial statements.
Identify, journalize, and report

fixed asset impairments and
restructuring charges.
Identify and report gains and
losses from discontinued operations and extraordinary
items.
Describe unusual items affecting prior period financial
statements.
Example
Exercises
Practice
Exercises
14-2
14-2A, 14-2B
Example
Exercises
Practice
Exercises
14-3
14-3A, 14-3B
Example
Exercises
Practice
Exercises
14-4
14-4A, 14-4B
14-4
14-4A, 14-4B
Example
Exercises
Practice
Exercises
14-5
14-5A, 14-5B
14-6
14-6A, 14-6B
3. Prepare an income statement reporting earnings per share data.

Key Points
Earnings per share is a required disclosure.

Basic earnings per share removes preferred
dividends in the numerator of the calculation.
Earnings per share should be separately disclosed for discontinued operations and extraordinary items.
Calculate basic earnings per

share.
Prepare earnings per share
disclosures for discontinued
operations and extraordinary
items.
4. Describe the concept and the reporting of comprehensive income.

Key Points
Comprehensive income is all the changes in

stockholders equity during a period except
those resulting from dividends and stockholders investments. Total comprehensive income
includes other comprehensive income, which
consists of items excluded from net income,
such as unrealized gains and losses on certain
investments in debt or equity securities.
is separately reported in the Stockholders
Equity section of the balance sheet.
Prepare a statement of comprehensive income.

Determine and report accumulated other comprehensive
income.
5. Describe the accounting for investments in stocks.

Key Points
Short- and long-term investments in marketable securities may be accounted for as

available-for-sale securities. Available-for-sale
securities are recognized at fair value on the
balance sheet, with changes in fair value being
recognized as other comprehensive income.
Long-term investments in equity securities
in which there is a significant influence are
accounted for under the equity method.
Investments as the result of a business combination are accounted for as consolidations.

changes in market value for
available-for-sale securities.
investments under the equity
method.
Define and describe the
accounting for a business
combination.
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Key Terms
accumulated other comprehensive
income (620)
available-for-sale securities (622)
business combinations (627)
comprehensive income (620)
consolidated financial statements
(627)
discontinued operations (617)
earnings per common share (EPS)
(619)
equity method (625)

equity securities (622)
extraordinary item (618)
fixed asset impairment (615)
investments (625)
other comprehensive income
items (620)
parent company (627)
permanent differences (613)
price-earnings ratio (628)
restructuring charges (616)

subsidiary company (627)
taxable income (611)
temporary differences (612)
temporary investments (622)
trading securities (622)
unrealized holding gain or loss
(623)
Illustrative Problem
The following data were selected from the records of Botanica Greenhouses Inc. for the
current fiscal year ended August 31:
Administrative expenses
Cost of merchandise sold
Fixed asset impairment
Gain on condemnation of land
Income tax:
Applicable to continuing operations
Applicable to gain on condemnation of land
Applicable to loss on discontinued operations (reduction)
Interest expense
Loss on discontinued operations
Restructuring charge
Sales
Selling expenses
82,200
750,000
115,000
25,000
27,200
10,000
24,000
15,200
60,200
40,000
1,252,500
182,100
Instructions
Prepare a multiple-step income statement, concluding with a section for earnings per
share in the form illustrated in this chapter. There were 10,000 shares of common stock
(no preferred) outstanding throughout the year. Assume that the gain on condemnation of land is an extraordinary item.
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Solution
Botanica Greenhouses Inc.
Income Statement
For the Year Ended August 31, 2008
Sales
Gross profit
Operating expenses:
Selling expenses
Total operating expenses
Income from operations
Other expense:
Interest expense
Income from continuing operations before
income tax
Income tax expense
Income from continuing operations
Less applicable income tax
Income before extraordinary item
Extraordinary item:
Less applicable income tax
Net income
Earnings per share:
Income from continuing operations
Income before extraordinary item
Extraordinary item
Net income
Self-Examination Questions
1. During its first year of operations, a corporation
elected to use the straight-line method of depreciation
for financial reporting purposes and MACRS in determining taxable income. If the income tax rate is 40%
and the amount of depreciation expense is $60,000
under the straight-line method and $100,000 under
MACRS, what is the amount of income tax deferred to
future years?
A. $16,000
C. $40,000
B. $24,000
D. $60,000
$1,252,500
750,000
$ 502,500
$182,100
82,200
115,000
40,000
$
419,300
83,200
15,200
$
$
68,000
27,200
40,800
36,200
4,600
15,000
19,600
$ 60,200
24,000
$ 25,000
10,000
$4.08
3.62
$0.46
1.50
$1.96
(Answers at End of Chapter)

2. A material gain resulting from condemning land for
public use would be reported on the income statement
as a(n):
A. extraordinary item.
B. other income item.
C. restructuring charge.
D. fixed asset impairment.
3. Gwinnett Corporations temporary investments cost
$100,000 and have a market value of $120,000 at the
end of the accounting period. Assuming a tax rate of
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40%, the difference between the cost and market value

would be reported as a:
A. $12,000 realized gain.
B. $12,000 unrealized gain.
C. $20,000 realized gain.
D. $20,000 unrealized gain.
4. Cisneros Corporation owns 75% of Harrell Inc. During the current year, Harrell Inc. reported net income
of $150,000 and declared dividends of $40,000. How
much would Cisneros Corporation increase Investment in Harrell Inc. Stock for the current year?
A. $0
B. $30,000
C. $82,500
D. $112,500
5. Harkin Company has a market price of $60 per share

on December 31. The total stockholders equity is
$2,400,000, and the net income is $800,000. There are
200,000 shares outstanding. Preferred dividends are
$50,000. The price-earnings ratio would be:
A. 3.
B. 15.
C. 16.
D. 20.
Eye Openers
1. How would the amount of deferred income tax payable be reported in the balance sheet
if (a) it is payable within one year and (b) it is payable beyond one year?
2. Darnell Company owns plant and equipment that has a book value of $120 million.
Due to a permanent decline in consumer demand for the products produced by this
plant, the market value of the plant and equipment is appraised at $20 million. Describe
the accounting treatment for this impairment.
3. How should the severance costs of terminated employees be accounted for?
4. During the current year, 40 acres of land that cost $200,000 were condemned for construction of an interstate highway. Assuming that an award of $320,000 in cash was
received and that the applicable income tax on this transaction is 40%, how would this
information be presented in the income statement?
5. Mann Corporation realized a material gain when its facilities at a designated floodway
were acquired by the urban renewal agency. How should the gain be reported in the
income statement?
6. An annual report of Ford Motor Company disclosed the sale of its ownership interest
in Visteon Corporation, a major automotive components manufacturer. The estimated
after-tax loss on disposal of these operations was $2.3 billion. Indicate how the loss from
discontinued operations should be reported by Ford on its income statement.
7. How is the change from one acceptable accounting principle to another acceptable accounting principle shown on the income statement?
8. A corporation reports earnings per share of $1.38 for the most recent year and $1.10 for
the preceding year. The $1.38 includes a $0.40-per-share gain from insurance proceeds
related to a fully depreciated asset that was destroyed by fire.
a. Should the composition of the $1.38 be disclosed in the financial reports?
b. On the basis of the limited information presented, would you conclude that operations had improved or declined?
9. a. List some examples of other comprehensive income items.
b. Does the reporting of other comprehensive income affect the determination of net
income and retained earnings?
10. Why might a business invest in another companys stock?
11. How are temporary investments in marketable securities reported on the balance sheet?
12. How are unrealized gains and losses on temporary investments in marketable securities reported on the statement of comprehensive income?
13. a. What method of accounting is used for long-term investments in stock in which there
is significant influence over the investee?
b. Under what caption are long-term investments in stock reported on the balance sheet?
14. Glover Inc. received a $0.20-per-share cash dividend on 50,000 shares of Gestalt Corporation common stock, which Glover Inc. carries as a long-term investment. Assuming
that Glover Inc. uses the equity method of accounting for its investment in Gestalt
Corporation, what account would be credited for the receipt of the $10,000 dividend?
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15. An annual report of The Campbell Soup Company reported on its income statement $2.4
million as equity in earnings of affiliates. Journalize the entry that Campbell would
have made to record this equity in earnings of affiliates.
16. How is an investment as the result of a business combination reported?
Practice Exercises
PE 14-1A
Deferred tax entries
A corporation has $540,000 of income before income taxes, a 35% tax rate, and $480,000 of
taxable income. Provide the journal entry for the current years taxes.
obj. 1
PE 14-1B
Deferred tax entries
Bismark Corp. has $90,000 of income before income taxes, a 40% tax rate, and $76,000 of
taxable income. Provide the journal entry for the current years taxes.
obj. 1
PE 14-2A
Journalize fixed asset
impairment and
restructuring charge
obj. 2
PE 14-2B
Journalize fixed asset
impairment and
restructuring charge
obj. 2
PE 14-3A
Calculate earnings per
share
On December 15 of the current year, Adams Corporation determined that equipment had
been impaired so that the book value of the equipment was reduced by $46,000. In addition, the senior management of the company communicated an employee severance plan
whereby 15 employees could receive a termination benefit of $4,000 per employee. Provide
the journal entry for the asset impairment and the restructuring charge.
On December 23 of the current year, Dallas Corporation determined that land had been
impaired so that the book value of the land was reduced by $320,000. In addition, the
senior management of the company communicated an employee severance plan whereby
45 employees could receive a termination benefit of $9,000 per employee. Provide the
journal entry for the asset impairment and the restructuring charge.
Wyoming Company had net income of $2,430,000 during the year. There were 240,000 common shares and 30,000 shares of $100 par value, 9% preferred stock outstanding during the
year. Determine the basic earnings per share.
obj. 3
PE 14-3B
Calculate earnings per
share
Broad Plain Inc. had net income of $350,000 during the year. There were 420,000 common
shares and 5,000 shares of $100 par value, 7% preferred stock outstanding during the year.
Determine the basic earnings per share.
obj. 3
PE 14-4A
Comprehensive income
obj. 4
PE 14-4B
obj. 4
Zorba Company had a net income of $104,000 and other comprehensive income of $13,400
for 2008. On January 1, 2008, the Retained Earnings balance was $565,000, and the Accumulated Other Comprehensive Income balance was $71,000. Determine the (a) comprehensive
income for 2008, (b) Retained Earnings balance on December 31, 2008, and (c) Accumulated
Other Comprehensive Income balance on December 31, 2008.
Manitoba Company had a net income of $856,000 and other comprehensive income of
$123,500 for 2008. On January 1, 2008, the Retained Earnings balance was $3,460,000, and
the Accumulated Other Comprehensive Income balance was $624,000. Determine the
(a) comprehensive income for 2008, (b) Retained Earnings balance on December 31, 2008,
and (c) Accumulated Other Comprehensive Income balance on December 31, 2008.
633
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PE 14-5A
Temporary investments
obj. 5
PE 14-5B
obj. 5
PE 14-6A
Equity method
obj. 5
PE 14-6B
Equity method
obj. 5
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Page 634
Mansfield Company began operations on January 1, 2008, and purchased temporary investments in marketable securities during the year at a cost of $123,000. The end-of-period
market value for these investments was $137,000. Net income was $151,000 for 2008. Determine (a) the reported amount of marketable securities on the December 31, 2008, balance
sheet and (b) the comprehensive income for 2008. Assume a tax rate of 40%.
Aaron Company began operations on January 1, 2008, and purchased temporary investments in marketable securities during the year at a cost of $56,000. The end-of-period market value for these investments was $49,700. Net income was $97,500 for 2008. Determine
(a) the reported amount of marketable securities on the December 31, 2008, balance sheet
and (b) the comprehensive income for 2008. Assume a tax rate of 35%.
Gilliam Company purchased 35% of the outstanding stock of Forrester Company on January 1, 2008. Forrester reported net income of $675,000 and declared dividends of $155,000
during 2008. How much would Gilliam adjust its investment in Forrester Company under
the equity method?
Miranda Company purchased 25% of the outstanding stock of Orson Company on January 1, 2008. Orson reported a net loss of $300,000 and declared dividends of $40,000 during 2008. How much would Miranda adjust its investment in Orson Company under the
equity method?
Exercises
EX 14-1
Income tax entries
obj. 1
Journalize the entries to record the following selected transactions of Lone Star Leather Co.:
Apr. 15. Paid the first installment of the estimated income tax for the current fiscal year
ending December 31, $90,000. No entry had been made to record the liability.
June 15. Paid the second installment of $90,000.
Sept. 15. Paid the third installment of $90,000.
Dec. 31. Recorded the estimated income tax liability for the year just ended and the
deferred income tax liability, based on the transactions above and the following
data:
Income tax rate
Income before income tax
Taxable income according to tax return
40%
$950,000
$800,000
Jan. 15. Paid the fourth installment of $50,000.
EX 14-2
Deferred income taxes
obj. 1
EX 14-3
Deferred income taxes
obj. 1
Storage Systems Inc. recognized service revenue of $420,000 on its financial statements
in 2007. Assume, however, that the Tax Code requires this amount to be recognized for
tax purposes in 2008. The taxable income for 2007 and 2008 is $2,600,000 and $3,000,000,
respectively. Assume a tax rate of 40%.
Prepare the journal entries to record the tax expense, deferred taxes, and taxes payable
for 2007 and 2008, respectively.
Eason Company began operations on January 1, 2007, and reported net income of $260,000
during the year. Eason had a taxable income of $350,000 for 2007. The difference between
the reported net income and taxable income will reverse in 2008. The reported net income
for 2008 was $405,000. There were no other temporary differences. The tax rate is 35% for
both years. Prepare the journal entries to record the tax expense, deferred taxes, and taxes
payable for 2007 and 2008, respectively.
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EX 14-4
obj. 2
a. $74,000,000
Laser Pulse Communications Inc. spent $90 million expanding its fiber optic communication network between Chicago and Los Angeles during 2006. The fiber optic network was
assumed to have a 10-year life, with a $10 million salvage value, when it was put into service on January 1, 2007. The network is depreciated using the straight-line method. At the
end of 2008, the expected traffic volume on the fiber optic network was only 60% of what
was originally expected. The reduced traffic volume caused the fair market value of the
asset to be estimated at $50 million on December 31, 2008. The loss is not expected to be
recoverable.
a. Determine the book value of the network on December 31, 2008, prior to the impairment
adjustment.
b. Provide the journal entry to record the fixed asset impairment on December 31, 2008.
c. Provide the balance sheet disclosure for fixed assets on December 31, 2008.
EX 14-5
obj. 2
Harmony Resorts Inc. owns and manages resort properties. On January 15, 2008, one of its
properties was found to be adjacent to a toxic chemical disposal site. As a result of the negative publicity, this propertys bookings dropped 40% during 2008. On December 31, 2008,
the accounts of the company showed the following details regarding the impaired property:
Land
Buildings and improvements (net)
Equipment (net)
Total
$ 30,000,000
120,000,000
25,000,000
$175,000,000
Management decides that closing the resort is the only option. As a result, it is estimated that the buildings and improvements will be written off completely. The land can
be sold for other uses for $17 million, while the equipment can be disposed of for $6 million, net of disposal costs.
a. Provide the journal entry to record the asset impairment on December 31, 2008.
b.
Provide the note disclosure for the impairment.
EX 14-6
obj. 2
a. Restructuring charge,
$4,680,000
Morton Companys board of directors approved and communicated an employee severance

plan in response to a decline in demand for the companys products. The plan called for
the elimination of 180 headquarters positions by providing a severance equal to 5% of the
annual salary multiplied by the number of years of service. The average annual salary of
the eliminated positions is $65,000. The average tenure of terminated employees is eight
years. The plan was communicated to employees on November 1, 2008. Actual termination
notices will be distributed over the period between December 1, 2008, and April 1, 2009.
On December 21, 2008, 50 employees received a lay-off notice and were terminated with
severance.
a. Provide the appropriate journal entry for the restructuring charge.
b. Provide the journal entry to record the severance payment on December 21, 2008, assuming that the actual tenure and salary of terminated employees were consistent with
the overall average.
c. Provide the balance sheet and note disclosures on December 31, 2008.
EX 14-7
obj. 2
a. Restructuring charge,
$3,774,000
Kiwi Juice Company has been suffering a downturn in its juice business due to adverse
publicity regarding the caffeine content of its drink products. As a result, the company has
been required to restructure operations. The board of directors approved and communicated a plan on July 1, 2008, calling for the following actions:
1. Close a juice plant on October 15, 2008. Closing, equipment relocation, and employee
relocation costs are expected to be $600,000 during October.
2. Eliminate 300 plant positions. A severance will be paid to the terminated employees equal
to 400% of their estimated monthly earnings payable in four quarterly installments on
October 15, 2008; January 15, 2009; April 15, 2009; and July 15, 2009.
635
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3. Terminate a juice supply contract, activating a $150,000 cancellation penalty, payable

upon notice of termination. The notice will be formally delivered to the supplier on August 15, 2008.
The 300 employees earn an average of $14 per hour. The average employee works 180
hours per month.
a. Determine the total restructuring charge for 2008.
b. Provide the journal entry for the restructuring charge on July 1, 2008. (Note: Use Restructuring Obligation as the liability account, since the charges involve more than just
employee terminations.)
c. Provide the journal entry for the October 15, 2008, employee severance payment.
d. Provide the balance sheet disclosure for December 31, 2008.
e.
Provide a note disclosure for December 31, 2008.
EX 14-8
Restructuring charges
and asset impairments
obj. 2
a. Severance
restructuring charge,
$780,000
TransCo Inc. has suffered losses due to increased competition in its service market from
low-cost independent truckers. As a result, on December 31, 2008, the board of directors
of the company approved and communicated a restructuring plan that calls for selling 50
tractor-trailers out of a fleet of 400. In addition, the plan calls for the elimination of 50
driver positions and 15 staff support positions. The market price for used tractor-trailers
is depressed due to general overcapacity in the transportation industry. As a result, the
market value of tractor-trailers is estimated to be only 60% of the book value of these
assets. It is not believed that the impairment in fixed assets is recoverable. The cost and
accumulated depreciation of the total tractor-trailer fleet on December 31 are $48 million
and $14 million, respectively. The restructuring plan will provide a severance to the drivers
and staff totaling $12,000 per employee, payable on March 14, 2009, which is the expected
employee termination date.
a. Provide the journal entries on December 31, 2008, for the fixed asset impairment and the
employee severance costs.
b.
Provide the balance sheet and note disclosure on December 31, 2008.
c. Provide the journal entry for March 14, 2009.
EX 14-9
Extraordinary item
obj. 2
EX 14-10
Extraordinary item
obj. 2
A company received life insurance proceeds on the death of its president before the end of
its fiscal year. It intends to report the amount in its income statement as an extraordinary
item.
Would this reporting be in conformity with generally accepted accounting principles? Discuss.
For the year ended December 31, 2002, Delta Air Lines, provided the following note to its
financial statements:
On September 22, 2001, the Air Transportation Safety and System Stabilization Act (Stabilization Act) became effective. The Stabilization Act is intended to preserve the viability of the U.S.
air transportation system following the terrorist attacks on September 11, 2001 by, among other
things, (1) providing for payments from the U.S. Government totaling $5 billion to compensate
U.S. air carriers for losses incurred from September 11, 2001, through December 31, 2001, as a
result of the September 11 terrorist attacks and (2) permitting the Secretary of Transportation to
sell insurance to U.S. air carriers.
Our allocated portion of compensation under the Stabilization Act was $668 million. Due to
uncertainties regarding the U.S. governments calculation of compensation, we recognized $634
million of this amount in our 2001 Consolidated Statement of Operations. We recognized the
remaining $34 million of compensation in our 2002 Consolidated Statement of Operations. We
received $112 million and $556 million in cash for the years ended December 31, 2002 and 2001,
respectively, under the Stabilization Act.
Do you believe that the income related to the Stabilization Act should be reported
as an extraordinary item on the income statement of Delta Air Lines?
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EX 14-11
Extraordinary items
637
Below are three separate historical incidents giving rise to losses for three different companies.
obj. 2
a. In 1980, Weyerhaeuser, a major wood products company, lost $36 million in timber, logs,
and building equipment as a result of the volcanic eruption of Mount St. Helens in the
state of Washington.
b. In 2001, Dow Jones & Company, Inc., the publisher of The Wall Street Journal, suffered
$1.7 million in losses due to damage in its headquarters building as a result of the 9/11
terrorist incident.
c. In 2005, Northrop Grumman Corporation, a major defense contractor, reported significant
losses in its shipbuilding yards along the Gulf Coast as a result of Hurricane Katrina.
The losses were sufficient to cut its projected earnings in half for the year.
In each case, identify whether the loss should be reported as extraordinary.
EX 14-12
Assume that the amount of each of the following items is material to the financial statements. Classify each item as either normally recurring (NR) or extraordinary (E).
Identifying extraordinary
items
obj. 2
EX 14-13
Income statement
objs. 2, 3
Net income, $126,600
EX 14-14
Income statement
objs. 2, 3
Correct EPS for net
income, $0.47
a. Restructuring charge related to employee termination benefits.

b. Loss on sale of fixed assets.
c. Uninsured flood loss. (Flood insurance is unavailable because of periodic flooding in the
area.)
d. Interest revenue on notes receivable.
e. Loss on disposal of equipment considered to be obsolete because of development of new
technology.
f. Uninsured loss on building due to hurricane damage. The firm was organized in 1920
and had not previously incurred hurricane damage.
g. Uncollectible accounts expense.
h. Gain on sale of land condemned for public use.
Wind Surfer Inc. produces and distributes equipment for sailboats. On the basis of the following data for the current fiscal year ended June 30, 2008, prepare a multiple-step income
statement for Wind Surfer, including an analysis of earnings per share in the form illustrated in this chapter. There were 20,000 shares of $150 par common stock outstanding
throughout the year.
Gain on condemnation of land (extraordinary item)
Income tax applicable to gain on condemnation of land
Income tax reduction applicable to loss from discontinued operations
Income tax applicable to income from continuing operations
Loss from fixed asset impairment
Sales
Selling expenses
$ 104,000
467,500
58,000
23,200
32,000
93,200
80,000
120,000
50,000
1,100,000
125,500
Audio Affection Inc. sells automotive and home stereo equipment. It has 50,000 shares of
$100 par common stock outstanding and 10,000 shares of $2, $100 par cumulative preferred
stock outstanding as of December 31, 2008. List the errors you find in the following income
statement for the year ended December 31, 2008.
(continued)
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Audio Affection Inc.

Income Statement
Net sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cost of merchandise sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Operating expenses:
Selling expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income from continuing operations before income tax . . . . . . . . . . . . .
Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income from continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fixed asset impairment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income before condemnation of land, restructuring charge,
and discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Extraordinary items:
Gain on condemnation of land, net of applicable
income tax of $20,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Restructuring charge, net of applicable income tax of $8,000 . . . . . .
Loss on discontinued operations (net of applicable
income tax of $15,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$967,000
578,000
$389,000
$127,000
142,000
$ 48,000
30,000
(12,000)
(22,500)
$ 43,500
Earnings per common share:

Income from continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fixed asset impairment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income before extraordinary item and discontinued operations . . . . . .
Extraordinary items:
Gain on condemnation of land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Restructuring charge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loss on discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
EX 14-15
Earnings per share with
preferred stock
obj. 3
EX 14-16
269,000
$120,000
48,000
$ 72,000
(24,000)
$
$
1.44
(0.48)
0.96
0.60
(0.24)
(0.45)
0.87
FirstLight Lighting Company had earnings for 2008 of $150,600. The company had 90,000
shares of common stock outstanding during the year. In addition, the company issued 2,000
shares of $100 par value preferred stock on January 5, 2008. The preferred stock has a dividend of $6 per share. There were no transactions in either common or preferred stock during 2008.
Determine the basic earnings per share for FirstLight.
The statement of comprehensive income for Lancaster Company was as follows:
obj. 4
a. $1,693,000
Lancaster Company
Net income
Other comprehensive income:
Unrealized loss on temporary investments in marketable
equity securities (net of $25,000 tax benefit)
$460,000
(45,000)
$415,000
The balance sheet dated December 31, 2007, showed a Retained Earnings balance of
$1,483,000 and an Accumulated Other Comprehensive Income balance of $171,000. The company paid $250,000 in dividends during 2008.
a. Determine the December 31, 2008, Retained Earnings balance.
b. Determine the December 31, 2008, Accumulated Other Comprehensive Income (Loss)
balance.
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Chapter 14
EX 14-17
and temporary
investments
objs. 4, 5
c. $84,000
639
The statement of comprehensive income for the years ended December 31, 2008 and 2009,
plus selected items from comparative balance sheets of Johnson Wholesalers Inc. are as
follows:
Johnson Wholesalers Inc.
For the Years Ended December 31, 2008 and 2009
2008
2009
a.
b.
c.
$100,000
4,000
e.
Net income
Other comprehensive income (loss), net of tax
Johnson Wholesalers Inc.
Selected Balance Sheet Items
December 31, 2007, 2008, and 2009
Temporary investments in marketable

securities at fair market value, net
of taxes on unrealized gains or losses
Retained earnings
or (loss)
Dec. 31,
2007
Dec. 31,
2008
Dec. 31,
2009
$ 32,000
175,000
d.
$250,000
f.
g.
1,000
h.
(8,000)
There were no dividends or purchases or sales of temporary investments. Other comprehensive items included only after-tax unrealized gains and losses on investments.
Determine the missing lettered items.
EX 14-18
and temporary
investments
objs. 4, 5
a. Total comprehensive
income, $205,000
During 2008, Mango Corporation held a portfolio of available-for-sale securities having a

cost of $260,000. There were no purchases or sales of investments during the year. The market values after adjusting for the impact of taxes, at the beginning and end of the year, were
$215,000 and $270,000, respectively. The net income for 2008 was $150,000, and no dividends were paid during the year. The Stockholders Equity section of the balance sheet was
as follows on December 31, 2007:
Mango Corporation
Stockholders Equity
December 31, 2007
Common stock
Paid-in capital in excess of par value
Retained earnings
Accumulated other comprehensive loss
Total
$ 35,000
350,000
435,000
(45,000)
$775,000
a. Prepare a statement of comprehensive income for 2008.

b. Prepare the stockholders equity section of the balance sheet for December 31, 2008.
EX 14-19
and other comprehensive
income
objs. 4, 5
a. 2009 unrealized gain,
$54,000
The temporary investments of Catalyst Inc. only include 10,000 shares of Bristol Inc. common
stock purchased on January 10, 2008, for $20 per share. As of the December 31, 2008, balance
sheet date, assume that the share price declined to $16 per share. As of the December 31, 2009,
balance sheet date, assume that the share price rose to $25 per share. The investment was held
through December 31, 2009. Assume a tax rate of 40%.
a. Determine the net after-tax unrealized gain or loss from holding the Bristol common
stock for 2008 and 2009.
b. What is the balance of Accumulated Other Comprehensive Income or Loss for December 31, 2008, and December 31, 2009?
c. Where is Accumulated Other Comprehensive Income or Deficit disclosed on the financial statements?
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EX 14-20
Temporary investments in
marketable securities
FINAL
Page 640
During 2008, its first year of operations, Geo-Metrics Corporation purchased the following
securities as a temporary investment:
obj. 5
Security
M-Labs Inc.
Spectrum Corp.
Shares
Purchased
Cost
Cash
Dividends
Received
1,000
2,500
$19,000
38,000
$ 750
1,400
a. Record the purchase of the temporary investments for cash.

b. Record the receipt of the dividends.
EX 14-21
Financial statement
reporting of temporary
investments
objs. 4, 5
Using the data for Geo-Metrics Corporation in Exercise 14-20, assume that as of December
31, 2008, the M-Labs Inc. stock had a market value of $25 per share and the Spectrum Corp.
stock had a market value of $14 per share. For the year ending December 31, 2008, GeoMetrics Corporation had net income of $100,000. Its tax rate is 40%.
a. Prepare the balance sheet presentation for the temporary investments.
b. Prepare a statement of comprehensive income presentation for the temporary investments.
b. Comprehensive
income, $101,800
EX 14-22
On February 27, Ball Corporation acquired 4,000 shares of the 50,000 outstanding shares of
Entries for investment in

Bat Co. common stock at 40.75 plus commission charges of $200. On July 8, a cash dividend
stock, receipt of dividends, of $1.75 per share and a 2% stock dividend were received. On December 7, 1,000 shares
and sale of shares
were sold at 53, less commission charges of $65. Record the entries to record (a) the pur-
obj. 5
chase of the stock, (b) the receipt of dividends, and (c) the sale of the 1,000 shares.
EX 14-23
At a total cost of $1,960,000, Turner Corporation acquired 70,000 shares of May Corp.
common stock as a long-term investment. Turner Corporation uses the equity method of
accounting for this investment. May Corp. has 280,000 shares of common stock outstanding, including the shares acquired by Turner Corporation. Journalize the entries by Turner
Corporation to record the following information:
Entries using equity

method for stock
investment
obj. 5
a. May Corp. reports net income of $3,000,000 for the current period.
b. A cash dividend of $3.80 per common share is paid by May Corp. during the current
period.
EX 14-24
Equity method for stock
investment
Sweet Companys balance sheet disclosed its long-term investment in Sour Company for
comparative years as follows:
obj. 5
Investment in Sour Company stock (in millions)
Dec. 31, 2008
Dec. 31, 2007
$146
$135
In addition, the 2008 Sweet Company income statement disclosed equity earnings in the
Sour Company investment as $15 million. Sweet Company neither purchased nor sold Sour
Company stock during 2008. The market value of Sour Company stock on December 31,
2008, was $154.
Explain the change in the Investment in Sour Company Stock from December 31,
2007, to December 31, 2008.
EX 14-25
Price-earnings ratio
Goodman Company had a net income of $672,000 for 2008. Goodman Companys balance
sheet disclosed the stockholders equity on December 31, 2008, as follows:
Preferred stock, 8,000 shares of $100 par value, 6% stock
Common stock, 120,000 shares of $1 par value stock issued and outstanding
Paid-in capital in excess of par value
$ 800,000
120,000
2,400,000
$3,320,000
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641
The price of Goodman common stock was $72.80 per share on December 31, 2008. Determine the price-earnings ratio for Goodman Company.
EX 14-26
ExxonMobil Corporation is one of the largest companies in the world. The company ex-
Price-earnings ratio
calculations
plores, develops, refines, and markets petroleum products. The basic earnings per share for
three comparative years were as follows:
Years Ended Dec. 31,
a. 2005: 9.7
Basic earnings per share
2005
2004
2003
$5.76
$3.91
$3.24
The market prices at the end of each year were $56, $51, and $41 for December 31, 2005,
2004, and 2003, respectively.
a. Determine the price-earnings ratio for 2005, 2004, and 2003, using end-of-year prices.
Round to one decimal place.
b.
Interpret your results over the three years.
Problems Series A
PR 14-1A
Income tax allocation
obj. 1
Differences between the accounting methods applied to accounts and financial reports and
those used in determining taxable income yielded the following amounts for the first four
years of a corporations operations:
1. Year-end balance,
3rd year, $12,000
Income before income taxes
Taxable income
First
Year
Second
Year
Third
Year
Fourth
Year
$250,000
200,000
$300,000
280,000
$500,000
540,000
$400,000
430,000
The income tax rate for each of the four years was 40% of taxable income, and each
years taxes were promptly paid.
Instructions
1. Determine for each year the amounts described by the following captions, presenting the
information in the form indicated:
Year
Income Tax
Deducted
on
Income
Statement
Income Tax
Payments
for
the Year
Deferred Income
Tax Payable
Years
Addition
(Deduction)
YearEnd
Balance
2. Total the first three amount columns.
PR 14-2A
Income tax; income
statement
objs. 2, 3, 4
Net income, $34,300
The following data were selected from the records of Xtreme World Inc. for the current fiscal year ended June 30, 2008:
Advertising expense
Depreciation expenseoffice equipment
Depreciation expensestore equipment
Gain on discontinued operations
Income tax:
Applicable to gain on disposal of business segment
Applicable to loss on condemnation of land (reduction)
Insurance expense
Interest expense
Loss from condemnation of land
$ 57,000
345,000
16,000
45,000
38,000
10,500
11,400
7,200
9,000
18,000
24,000
(continued)
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Miscellaneous administrative expense
Miscellaneous selling expense
Office salaries expense
Rent expense
Sales
Sales commissions expense
Unrealized gain on temporary investments
$ 40,000
11,000
14,000
70,000
25,000
50,000
865,000
130,000
35,000
Instructions
Prepare a multiple-step income statement, concluding with a section for earnings per share
in the form illustrated in this chapter. There were 5,000 shares of common stock (no preferred) outstanding throughout the year. Assume that the loss on the condemnation of land
is an extraordinary item.
PR 14-3A
Income statement;
retained earnings
statement; balance sheet
objs. 1, 2, 3, 4
Net income, $67,200
The following data were taken from the records of Amana Bread Corporation for the year
ended October 31, 2008:
Income statement data:
Income tax:
Applicable to loss from discontinued business segment
Interest expense
Interest revenue
Loss from discontinued operations
Sales
Selling expenses
Retained earnings and balance sheet data:
Accounts payable
Accounts receivable
Accumulated depreciation
Accumulated other comprehensive loss
Allowance for doubtful accounts
Cash
Common stock, $1 par (100,000 shares authorized; 82,000 shares issued)
Deferred income taxes payable (current portion, $5,400)
Dividends:
Cash dividends for common stock
Cash dividends for preferred stock
Stock dividends for common stock
Dividends payable
Employee termination obligation (current)
Equipment
Income tax payable
Interest receivable
Merchandise inventory (October 31, 2008), at lower of cost (FIFO) or market
Notes receivable
Paid-in capital from sale of treasury stock
Paid-in capital in excess of parcommon stock
Paid-in capital in excess of parpreferred stock
Patents
Preferred 8% stock, $100 par (10,000 shares authorized; 2,000 shares issued)
Prepaid expenses
Retained earnings, November 1, 2007
Temporary investment in marketable equity securities
Treasury stock (2,000 shares of common stock at cost of $20 per share)
Unrealized loss on temporary equity securities (net of taxes)
80,000
458,000
80,000
36,800
24,000
32,000
5,000
4,000
60,000
35,000
65,000
955,000
224,000
47,800
185,000
465,000
28,000
5,400
165,300
82,000
28,300
35,000
16,000
12,000
12,750
45,000
1,958,000
11,200
2,500
122,000
42,500
16,000
451,000
8,000
14,000
200,000
2,600
1,277,250
122,000
40,000
28,000
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643
Instructions
1. Prepare a multiple-step income statement for the year ended October 31, 2008, concluding with earnings per share. In computing earnings per share, assume that the average
number of common shares outstanding was 80,000 and preferred dividends were $16,000.
Assume that the gain on condemnation of land is an extraordinary item.
2. Prepare a retained earnings statement for the year ended October 31, 2008.
3. Prepare a balance sheet in report form as of October 31, 2008.
PR 14-4A
Entries for investments in
stock
obj. 5
Samson Company is a wholesaler of mens hair products. The following transactions relate
to certain securities acquired by Samson Company, which has a fiscal year ending on December 31:
2006
Jan.
July
Dec.
3. Purchased 4,000 shares of the 100,000 outstanding common shares of Nichols

Corporation at 55 plus commission and other costs of $480.
2. Received the regular cash dividend of $1.25 a share on Nichols Corporation
stock.
5. Received the regular cash dividend of $1.25 a share plus an extra dividend of
$0.10 a share on Nichols Corporation stock.
(Assume that all intervening transactions have been recorded properly and that
the number of shares of stock owned have not changed from December 31,
2006, to December 31, 2008.)
2009
Jan.
2. Purchased controlling interest in Telico Inc. for $540,000 by purchasing 32,000

shares directly from the estate of the founder of Telico. There are 128,000 shares
of Telico Inc. stock outstanding.
July 6. Received the regular cash dividend of $1.25 a share and a 4% stock dividend on
the Nichols Corporation stock.
Oct. 23. Sold 800 shares of Nichols Corporation stock at 68. The broker deducted commission and other costs of $140, remitting the balance.
Dec. 10. Received a cash dividend at the new rate of $1.50 a share on the Nichols Corporation stock.
31. Received $38,000 of cash dividends on Telico Inc. stock. Telico Inc. reported net
income of $260,000 in 2009. Samson uses the equity method of accounting for
its investment in Telico Inc.
Instructions
Record the entries for the preceding transactions.
Problems Series B
PR 14-1B
Income tax allocation
obj. 1
Differences between the accounting methods applied to accounts and financial reports and
those used in determining taxable income yielded the following amounts for the first four
years of a corporations operations:
1. Year-end balance,
3rd year, $4,200
Income before income taxes
Taxable income
First
Year
Second
Year
Third
Year
Fourth
Year
$50,000
35,000
$65,000
60,000
$90,000
98,000
$100,000
112,000
The income tax rate for each of the four years was 35% of taxable income, and each
years taxes were promptly paid.
Instructions
1. Determine for each year the amounts described by the following captions, presenting the
information in the form indicated:
(continued)
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Year
Income Tax
Deducted
on
Income
Statement
Income Tax
Payments
for
the Year
Deferred Income
Tax Payable
Years
Addition
(Deduction)
YearEnd
Balance
2. Total the first three amount columns.
PR 14-2B
Income tax; income
statement
objs. 2, 3, 4
ATV Inc. sells off-road motorcycles and vehicles. The following data were selected from the
records of ATV Inc. for the current fiscal year ended March 31, 2008:
Advertising expense
Depreciation expenseoffice equipment
Depreciation expensestore equipment
Income tax:
Applicable to loss from discontinued operations (reduction)
Interest revenue
Loss from disposal of business segment
Miscellaneous administrative expense
Miscellaneous selling expense
Office salaries expense
Rent expense
Sales
Sales salaries expense
Unrealized loss on temporary investments
36,000
1,640,000
32,000
145,000
54,000
94,200
23,400
16,200
25,000
78,000
32,000
41,000
25,000
230,000
100,000
70,000
2,800,000
160,000
40,000
Instructions
Prepare a multiple-step income statement, concluding with a section for earnings per share
in the form illustrated in this chapter. There were 20,000 shares of common stock (no preferred) outstanding throughout the year. Assume that the gain on the condemnation of land
is an extraordinary item.
PR 14-3B
Income statement;
retained earnings
statement; balance sheet
objs. 1, 2, 3, 4
The following data were taken from the records of Disk N Dat Corporation for the year
ended August 31, 2008.
Income statement data:
Income tax:
Applicable to loss from discontinued operation
Interest expense
Interest revenue
Loss from disposal of discontinued operation
Sales
Selling expenses
Retained earnings and balance sheet data:
Accounts payable
Accounts receivable
Accumulated depreciation
$ 23,000
232,000
75,000
70,200
14,400
30,000
3,000
2,500
36,000
14,000
45,000
550,000
60,000
$ 12,000
28,000
145,000
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645

Allowance for doubtful accounts
Cash
Common stock, $1 par (100,000 shares authorized; 46,000 shares issued)
Deferred income taxes payable (current portion, $4,700)
Dividends:
Cash dividends for common stock
Cash dividends for preferred stock
Stock dividends for common stock
Dividends payable
Employee termination obligation (current)
Equipment
Income tax payable
Interest receivable
Merchandise inventory (August 31, 2008), at lower of cost (FIFO) or market
Paid-in capital from sale of treasury stock
Paid-in capital in excess of parcommon stock
Paid-in capital in excess of parpreferred stock
Patents
Preferred 6% stock, $100 par (30,000 shares authorized; 1,500 shares issued)
Prepaid expenses
Retained earnings, September 1, 2007
Temporary investments in marketable equity securities (at cost)
Treasury stock (1,000 shares of common stock at cost of $30 per share)
Unrealized gain on marketable equity securities
9,000
2,500
87,500
46,000
12,800
21,000
9,000
5,000
7,500
30,000
1,350,000
21,450
500
87,000
5,000
820,000
20,000
40,000
150,000
15,900
397,950
125,000
30,000
9,000
Instructions
1. Prepare a multiple-step income statement for the year ended August 31, 2008, concluding with earnings per share. In computing earnings per share, assume that the average
number of common shares outstanding was 45,000 and preferred dividends were $9,000.
Assume that the gain on the condemnation of land is an extraordinary item.
2. Prepare a retained earnings statement for the year ended August 31, 2008.
3. Prepare a balance sheet in report form as of August 31, 2008.
PR 14-4B
Entries for investments in
stock
obj. 5
Encore Design Inc. produces and sells theater set designs and costumes. The following transactions relate to certain securities acquired by Encore Design Inc., which has a fiscal year
ending on December 31:
2006
Feb. 10. Purchased 8,000 shares of the 150,000 outstanding common shares of Mode
Corporation at 36 plus commission and other costs of $864.
July 15. Received the regular cash dividend of $1.10 a share on Mode Corporation stock.
Dec. 15. Received the regular cash dividend of $1.10 a share plus an extra dividend of
$0.05 a share on Mode Corporation stock.
(Assume that all intervening transactions have been recorded properly and that
the number of shares of stock owned have not changed from December 31,
2006, to December 31, 2008.)
2009
Jan.
3. Purchased controlling interest in Applause Inc. for $675,000 by purchasing

30,000 shares directly from the estate of the founder of Applause. There are
100,000 shares of Applause Inc. stock outstanding.
Apr. 14. Received the regular cash dividend of $1.10 a share and a 2% stock dividend
on the Mode Corporation stock.
July 26. Sold 1,000 shares of Mode Corporation stock at 32. The broker deducted commission and other costs of $125, remitting the balance.
Dec. 15. Received a cash dividend at the new rate of $1.20 a share on the Mode Corporation stock.
31. Received $12,500 of cash dividends on Applause Inc. stock. Applause Inc.
reported net income of $325,000 in 2009. Encore Design uses the equity method
of accounting for its investment in Applause Inc.
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Instructions
Journalize the entries for the preceding transactions.
Special Activities
SA 14-1
Equity method disclosure
The following note to the consolidated financial statements for Goodyear Tire & Rubber
Company relates to the principles of consolidation used in preparing the financial statements:
The Companys investments in 20% to 50% owned companies in which it has the ability to exercise significant influence over operating and financial policies are accounted for by the equity
method. Accordingly, the Companys share of the earnings of these companies is included in consolidated net income.
Is it a requirement that Goodyear use the equity method in this situation? Explain.
SA 14-2
Special charges analysis
The two-year comparative income statements and a note disclosure for Mercury Shoes Inc.
were as follows:
Income Statement
Mercury Shoes Inc.
For the Years Ended December 31, 2008 and 2007
Sales
Gross profit
Selling and administrative expenses
Loss on fixed asset impairment
Income from operations
Income tax expense
Net income
2008
2007
$510,000
224,400
$285,600
122,400
127,500
$ 35,700
14,280
$ 21,420
$430,000
193,500
$236,500
107,500
$129,000
51,600
$ 77,400
Note: A fixed asset impairment of $127,500 was recognized in 2008 as

the result of abandoning an order management software system. The
system project was started in early 2007 and ran into significant delays
and performance problems throughout 2008. It was determined that
there was no incremental benefit from completing the system. Thus,
the accumulated costs associated with the system were written off.
1. Divide each amount in the 2008 and 2007 income statements by total sales for the
given year.
2.
Interpret the performance of the company in 2008.
SA 14-3
The Stockholders Equity section of Yum! Brands, Inc., the operator of Pizza Hut, KFC, and
Taco Bell restaurants, for two recent comparative dates was as follows:
Yum! Brands, Inc.
Stockholders Equity (selected items)
December 31, 2005 and December 31, 2004
(in millions)
Dec. 31, 2005
Common stock, no par value
Retained earnings
Accumulated other comprehensive income (loss)
$
0
1,619
(170)
$1,449
Dec. 31, 2004

$ 659
1,067
(131)
$1,595
1. What is the other comprehensive income or loss for the year ended December 31, 2005?
2.
Explain the concept of other comprehensive income.
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SA 14-4
Ethics and professional
conduct in business
SA 14-5
Reporting extraordinary
item
FINAL
Page 647
Dillon Osborn is the president and chief operating officer of Dollars N Sense Corporation,
a developer of personal financial planning software. During the past year, Dollars N Sense
Corporation was forced to sell 10 acres of land to the city of Houston for expansion of a
freeway exit. The corporation fought the sale; but after condemnation hearings, a judge
ordered it to sell the land. Because of the lands location and the fact that Dollars N Sense
Corporation had purchased the land over 15 years ago, the corporation recorded a $0.20per-share gain on the sale. Always looking to turn a negative into a positive, Dillon has
decided to announce the corporations earnings per share of $1.05, without identifying the
$0.20 impact of selling the land. Although he will retain majority ownership, Dillon plans
on selling 20,000 of his shares in the corporation sometime within the next month.
Are Dillons plans to announce earnings per share of $1.05 without mentioning the
$0.20 impact of selling the land ethical and professional?
Sunshine Fruit Co. is in the process of preparing its annual financial statements. Sunshine
Fruit is a large citrus grower located in central Florida. The following is a discussion between Curtis Kirk, the controller, and Liz Gwinn, the chief executive officer and president
of Sunshine Fruit Co.
Liz: Curtis, Ive got a question about your rough draft of this years income statement.
Curtis: Sure, Liz. Whats your question?
Liz: Well, your draft shows a net loss of $750,000.
Curtis: Thats right. Wed have had a profit, except for this years frost damage. I figured
that the frost destroyed over 30% of our crop. We had a good year otherwise.
Liz: Thats my concern. I estimated that if we eliminate the frost damage, wed show a profit
of . . . lets see . . . about $250,000.
Curtis: That sounds about right.
Liz: This income statement seems misleading. Why cant we show the loss on the frost damage separately? That way the bank and our outside investors will be able to see that this
years loss is just temporary. Id hate to get them upset over nothing.
Curtis: Maybe we can do something. I recall from my accounting courses something about
showing unusual items separately. Lets see . . . yes, I remember. Theyre called extraordinary items.
Liz: Well, we havent had any frost damage in over five years. This years damage is certainly extraordinary. Lets do it!
Discuss the appropriateness of revising Sunshine Fruits income statement to report the frost damage separately as an extraordinary item.
SA 14-6
Extraordinary items and
discontinued operations
Group Project
Internet Project
In groups of three or four, search company annual reports, news releases, or the Internet
for extraordinary items and announcements of discontinued operations. Identify the most
unusual extraordinary item in your group. Also, select a discontinued operation of a wellknown company that might be familiar to other students or might interest them.
Prepare a brief analysis of the earnings per share impact of both the extraordinary item
and the discontinued operation. Estimate the potential impact on the companys market price
by multiplying the current price-earnings ratio by the earnings per share amount of each
item.
One Internet site that has annual reports is EDGAR (Electronic Data Gathering, Analysis,
and Retrieval), the electronic archives of financial statements filed with the Securities and
Exchange Commission. SEC documents can be retrieved using the EdgarScan service from
PricewaterhouseCoopers at http://edgarscan.pwcglobal.com.
To obtain annual report information, type in a company name in the appropriate space.
EdgarScan will list the reports available to you for the company youve selected. Select the
most recent annual report filing, identified as a 10-K or 10-K405. EdgarScan provides an
outline of the report, including the separate financial statements. You can double click the
income statement and balance sheet for the selected company into an Excel spreadsheet
for further analysis.
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Chapter 14
FINAL
Page 648
Answers to Self-Examination Questions

1. A The amount of income tax deferred to future years
is $16,000 (answer A), determined as follows:
Depreciation expense, MACRS
Depreciation expense, straight-line method
Excess expense in determining taxable income
Income tax rate
Income tax deferred to future years
$100,000
60,000
$ 40,000
40%
$ 16,000
2. A Events and transactions that are distinguished by

their unusual nature and by the infrequency of their
occurrence, such as a gain on condemning land for
public use, are reported in the income statement as extraordinary items (answer A). A restructuring charge
(answer C) and fixed asset impairment (answer D) are
unusual items that are related to different accounting
events than land condemnation.
3. B The difference between the cost of temporary investments held as available-for-sale securities and
their market value is reported as an unrealized gain,
net of applicable income taxes, as shown below.
Market value of investments
Cost of investments
Applicable taxes (40%)
Unrealized gain, net of taxes
$120,000
100,000
$ 20,000
8,000
$ 12,000
The unrealized gain of $12,000 (answer B) is reported

on the balance sheet as an addition to the cost of the
investments and as part of other comprehensive income.
4. C Under the equity method of accounting for investments in stocks, Cisneros Corporation records its
share of both net income and dividends of Harrell
Inc. in Investment in Harrell Inc. Stock. Thus, Investment in Harrell Inc. Stock would increase by $82,500
[($150,000 75%) ($40,000 75%)] for the current
year. $30,000 (answer B) is only Cisneros Corporations
share of Harrells dividends for the current year.
$112,500 (answer D) is only Cisneros Corporations
share of Harrells net income for the year.
5. C Price-Earnings Ratio
Market Price per Common Share
Earnings per Share
, or
$60
($800,000 $50,000)/200,000
16

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CH14_Warren22e.

NEIL BRAKE/ASSOCIATED PRESS

Journalize the entries for corporate income

Describe the concept and the reporting of

Describe and illustrate the reporting of unusual

Describe the accounting for investments in

Prepare an income statement reporting

Gaylord Entertainment Co.

f you apply for a bank loan, you will be required

Gaylord Entertainment Co. is an

Corporate Income Taxes

PAYMENT OF INCOME TAXES

Individuals pay quarterly estimated taxes if the amount of

15 Income Tax Expense

Income Taxes, Unusual Income Items, and Investments in Stocks

Year Ended June 30, 2005

Income from Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Earnings Before Income Taxes

ALLOCATING INCOME TAXES

Income Taxes, Unusual Income Items, and Investments in Stocks

Income Taxes, Unusual Income Items, and Investments in Stocks

Income Tax Expense

Deferred Income Tax Payable

REPORTING AND ANALYZING TAXES

Interest from investments in

Income Taxes, Unusual Income Items, and Investments in Stocks

Example Exercise 14-1

Follow My Example 14-1

Income tax expense based on $200,000 reported income at 40% . . . . . . . . . . . . . . . . . . . . . . . . . .

For Practice: PE 14-1A, PE 14-1B

Reporting Unusual Items on the

UNUSUAL ITEMS AFFECTING THE CURRENT PERIODS

Income Taxes, Unusual Income Items, and Investments in Stocks

Reporting of Unusual Items on the Income Statement

1. Unusual items subtracted from

2. Unusual items that adjust income

3. Unusual items affecting prior period income statements.

Loss on Fixed Asset Impairment

Income Taxes, Unusual Income Items, and Investments in Stocks

Unusual Items in the

Integrity, Objectivity, and Ethics in Business

occur, not when it is most convenient. For example, the

Income Taxes, Unusual Income Items, and Investments in Stocks

Mar. 25 Employee Termination Obligation

Example Exercise 14-2

Follow My Example 14-2

Loss on Fixed Asset Impairment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

*80 employees $7,000

For Practice: PE 14-2A, PE 14-2B

Income Taxes, Unusual Income Items, and Investments in Stocks

UNUSUAL ITEMS AFFECTING THE PRIOR PERIODS

Income Taxes, Unusual Income Items, and Investments in Stocks

Earnings per Common Share

Income Taxes, Unusual Income Items, and Investments in Stocks

Earnings per common share:

Example Exercise 14-3

Follow My Example 14-3

*2,000 shares $100 par value 9% $18,000

For Practice: PE 14-3A, PE 14-3B

$86,500 $74,000 $12,500