income and changes in retained earnings lecture # 15
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Chapter 12. INCOME AND CHANGES IN RETAINED EARNINGS Lecture # 15. Normal, recurring revenue and expense transactions. Unusual, nonrecurring events that affect net income. 1. Results of discontinued operations. 2. Impact of extraordinary items. - PowerPoint PPT PresentationTRANSCRIPT
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INCOME AND CHANGES IN RETAINED EARNINGS
Lecture # 15
Chapter
12
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Information about net income can be divided into two major categories
Income from continuing operations.
1. Results of discontinued operations.
2. Impact of extraordinary
items.
3. Effects of changes in accounting principles.
Normal, recurring revenue and expense transactions.
Unusual, nonrecurring events that affect net income.
Reporting the Results of Operations
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Matrix, Inc.Income Statement
For the Year Ended December 31, 2005
Net Sales 8,000,000$ Cost of goods sold 4,500,000 Gross margin 3,500,000$ Operating expenses: Selling expenses 1,500,000$ General & admin. exp. 920,000 Loss on settlement of lawsuit 80,000 Income taxes 300,000 2,800,000 Income from continuing operations 700,000$ Discontinued operations 245,000 Extraordinary items (70,000) Cumulative effect of a change in accounting principle 140,000 Net income 1,015,000$ This tax expense
does not include effects of unusual,
nonrecurring items.
These unusual, nonrecurring items are each reported
net of taxes.
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Income/Loss from operating the segment
prior to disposal.
Income/Loss on disposal of the segment.
When management enters into a formal plan to sell or discontinue a segment of the business, the related gains and losses must be disclosed on the income statement.
Discontinued Operations
Discontinued Operations
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A segment must be a separate line of business activity or an
operation that services a distinct category of customers.
When management enters into a formal plan to sell or discontinue a segment of the business, the related gains and losses must be disclosed on the income statement.
Discontinued Operations
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During 2005, Matrix, Inc. sold an unprofitable segment of the company. The segment had a net loss from operations during the period of
$150,000 and its assets sold at a loss of $100,000. Matrix reported income from
continuing operations of $350,000. All items are taxed at 30%.
How will this appear on the income statement?
Discontinued Operations
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Loss on segment operations (150,000)$ Less: Tax benefits ($150,000 × 30%) 45,000 Net loss (105,000)$
Loss on disposal of assets (100,000)$ Less: Tax benefits ($100,000 × 30%) 30,000 Net loss (70,000)$
Discontinued Operations
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Income from continuing operations 350,000$ Discontinued operations: Loss on operations (net of tax benefit of $45,000) (105,000) Loss on disposal of assets (net of tax benefits of $30,000) (70,000) Earnings before extraordinary item 175,000$
Income Statement Presentation:
Discontinued Operations
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Extraordinary Items
• Material in amount.• Gains or losses that are
both unusual in nature and not expected to recur in the foreseeable future.
• Reported net of related taxes.
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During 2005, Matrix, Inc. experienced a loss of $75,000 due to an earthquake at one of its manufacturing plants in Nashville. This was
considered an extraordinary item. The company reported income before
extraordinary item of $175,000. All gains and losses are subject to a 30% tax rate.How would this item appear on the 2005
income statement?
Extraordinary Items
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Earnings before extraordinary item 175,000$ Extraordinary Loss: Earthquake loss (net of tax benefit of $?) ?Earnings before cumulative effect of a change in accounting principle ?
Earnings before extraordinary item 175,000$ Extraordinary Loss: Earthquake loss (net of tax benefit of $22,500) (52,500) Earnings before cumulative effect of a change in accounting principle 122,500$
Income Statement Presentation:
Extraordinary Loss (75,000)$ Less: Tax Benefits ($75,000 × 30%) 22,500 Net Loss (52,500)$
Extraordinary Items - Example
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Type of Accounting Change Definition
Change in Accounting Principle
Replaces one GAAP with another
Change in Accounting Estimate
Revision of an estimate because of new information or new experience
Accounting Changes
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Change in Accounting Principle
• Occurs when changing from one GAAP method to another GAAP method.
• Make a catch-up adjustment known as the cumulative effect of a change in accounting principle.
• The cumulative effect is reported net of taxes and after extraordinary items.
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Also in 2005, Matrix, Inc. decided to change from the double-declining balance to the
straight-line method for depreciation. The effect of this change is an increase in net
income of $65,000. Matrix reported income before cumulative effect of an accounting
change of $122,500 during the year. All items of income are subject to a 30% tax rate.
How would this item appear on the income statement?
Change in Accounting Principle
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Earnings before cumulative effect of a change in accounting principle 122,500$ Cumulative effect of change in accounting principle: Change in accounting method (net of $ ? tax expense) ?Net Income ?
Earnings before cumulative effect of a change in accounting principle 122,500$ Cumulative effect of change in accounting principle: Change in accounting method (net of $19,500 tax expense) 45,500 Net Income 168,000$
Income Statement Presentation:
Increase in income 65,000$ Less: Tax expense ($65,000 × 30%) (19,500) Net increase in income 45,500$
Computation:Change in Accounting Principle
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Change in Estimates
• Revision of a previous accounting estimate.
• The new estimate should be used in the current and future periods.
• The prior accounting results should not be disturbed.
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On January 1, 2002, we purchased equipment costing $30,000, with a useful
life of 10 years and no salvage value. During 2005, we determine that the
remaining useful is 5 years (8-year total life). We use straight-line depreciation.
Compute the revised depreciation expense for 2005.
Change in Estimates
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Asset cost 30,000$ Accumulated depreciation 12/31/04 - ($3,000 × 3 years) (9,000) Remaining to be depreciated 21,000$ Remaining useful life ÷ 5 yearsRevised annual depreciation 4,200$
Record depreciation expense of $4,200 for2005 and subsequent years.
Change in Estimates