income taxes, and unusual income tax items accounting, 21 st edition warren reeve fess powerpoint...

Income Taxes, and Income Taxes, and Unusual Income Tax Unusual Income Tax

ItemsItemsAccounting, 21st Edition

Warren Reeve Fess

PowerPoint Presentation by Douglas CloudProfessor Emeritus of AccountingPepperdine University

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1. Journalize the entries for corporate income taxes, including deferred income taxes.

2. Prepare an income statement reporting the following unusual items: fixed asset impairments, restructuring charges, discontinued operations, extraordinary items, and changes in accounting principles.

3. Prepare an income statement reporting earnings per share data.

ObjectivesObjectivesObjectivesObjectives

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

4. Describe the concept and the reporting of comprehensive income.

ObjectivesObjectivesObjectivesObjectives

5. Describe the accounting for investments in stocks.

6. Describe alternative methods of combining businesses and how consolidated financial statements are prepared.

7. Compute and interpret the price-earnings ratio.

Corporate Income TaxesCorporate Income TaxesCorporate Income TaxesCorporate Income Taxes

A corporation makes four income tax installment payments

throughout the year.

A corporation makes four income tax installment payments

throughout the year.

Assume that a corporation estimates its taxes for the

year to be $84,000.

Assume that a corporation estimates its taxes for the

year to be $84,000.



Apr. 15 Income Tax Expense 21 000 00

To record quarterly payment of

estimated income tax.

Cash 21 000 00

On April 15, the first of four estimated annual tax payments of $21,000 is made.

On April 15, the first of four estimated annual tax payments of $21,000 is made.


Ratio of Reported Income Tax Expense to Earnings Before Taxes for Selected Industries

Automobiles 33%Banking 35Computers 35Food 35Integrated oil 39Pharmaceutical 30Retail 39Telecommunication 17Transportation 38

Allocating Income TaxesAllocating Income TaxesAllocating Income TaxesAllocating Income Taxes

1. Revenues or gains are taxed after they are reported in the income statement.

2. Expenses or losses are deducted in determining taxable income after they are reported in the income statement.

3. Revenues or gains are taxed before they are reported on the income statement.

4. Expenses or losses are deducted in determining taxable income before they are reported in the income statement.

Differences in tax law and GAAP create some temporary differences that reverse in later years.

Temporary differences do not change or reduce the total amount of tax paid, they affect only the timing of when the taxes are paid.

Temporary DifferencesTemporary Differences

Temporary DifferencesTemporary DifferencesTemporary DifferencesTemporary Differences

Year

1 Year

2 Year

3 Year

4

MACRS (tax depreciation)

Straight-line (financial statement depreciation)

Year

5 Years

1-5

Total

Temporary Differences in Reporting RevenuesTemporary Differences in Reporting Revenues

Report NowReport Now Taxable LaterTaxable Later

Report LaterReport Later Taxable NowTaxable Now

EXAMPLE: Income reporting methods.

Point-of-Sale Method

Installment Method

FinancialReporting

TaxReporting

EXAMPLE: Cash collected in advance.

WhenEarned

WhenCollected

RevenueReporting


Temporary Differences in Reporting ExpensesTemporary Differences in Reporting Expenses

Deduct NowDeduct Now Deduct LaterDeduct Later

Deduct SlowerDeduct Slower Deduct FasterDeduct Faster

EXAMPLE: Product warranty expense.

WhenEstimated

WhenPaid

FinancialReporting

TaxReporting

EXAMPLE: Methodsof depreciation.

Straight-LineMethod

MACRSMethod

ExpenseDeductions



At the end of the first year of operations, a corporation reports $300,000 income before income taxes. With a 40% tax rate, the firm faces a tax of $120,000. Using tax planning, the net income is

reduced to $100,000 and the actual income tax due is $40,000. The difference is deferred to future years.


The entry to record income taxes on April 15 reflects the deferred amount of $80,000.

The entry to record income taxes on April 15 reflects the deferred amount of $80,000.

Apr. 15 Income Tax Expense 120 000 00

To record income tax for the

year.

Income Tax Payable 40 000 00

Deferred Income Tax Payable80 000 00


Apr. 15 Deferred Income Tax Payable 48 000 00

To record current liability for

deferred tax.

Income Tax Payable 48 000 00

If $48,000 of the deferred tax reverses and becomes due in the second year, the entry will reflect this fact.

If $48,000 of the deferred tax reverses and becomes due in the second year, the entry will reflect this fact.

Permanent DifferencesPermanent DifferencesPermanent DifferencesPermanent Differences

Differences between taxable income and income before taxes reported on

the income statement may be the result of differences that never reverse.

Differences between taxable income and income before taxes reported on

the income statement may be the result of differences that never reverse.

Permanent DifferencesPermanent DifferencesPermanent DifferencesPermanent Differences

These differences are referred to as permanent differences. Interest on municipal bonds is an example of

this type of timing difference.

These differences are referred to as permanent differences. Interest on municipal bonds is an example of

this type of timing difference.

Unusual Items Affecting the Unusual Items Affecting the Income StatementIncome Statement


Unusual Items Affecting Income from Continuing

Operations

Unusual Items Affecting Income from Continuing

Operations



Fixed Asset ImpairmentsFixed Asset Impairments

Decrease in market price of fixed assets Significant changes in the business or

regulations related to fixed assets Adverse conditions affecting the use of fixed

assets Expected cash flow losses using fixed assets




On March 1, Jones Company consolidates operations by closing a factory. As a

result of the closing, plant and equipment is impaired by $750,000.

On March 1, Jones Company consolidates operations by closing a factory. As a

result of the closing, plant and equipment is impaired by $750,000.




Mar. 1 Loss on Fixed Asset Impairment 750 000 00

To record impairment of fixed

assets due to plant closing.

Fixed Assets—Plant 400 000 00

Fixed Assets—Equipment350 000 00

Jones CorporationPartial Income Statement

For the Year Ended December 31, 2006

Net sales$12,350,000

Cost of merchandise sold 5,800,000

Gross profit$ 6,550,000

Operating expenses $3,490,000Restructuring charge 1,000,000Loss from asset impairment 750,000

5,240,000Income from continuing operations before income tax

$ 1,310,000Income tax expense

620,000Income from continuing operations

$ 690,000



Restructuring charges are costs associated with involuntarily terminating employees,

terminating contracts, consolidating facilities, or relocating employees.

Restructuring charges are costs associated with involuntarily terminating employees,

terminating contracts, consolidating facilities, or relocating employees.




The management of Jones Company communicate 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.

The management of Jones Company communicate 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.



Restructuring ChargesRestructuring Charges

Mar. 1 Restructuring Charge 1000 000 00

To record restructuring charge

due to plant closing.

Employee Termination

Obligation 1000 000 00



Restructuring ChargesRestructuring Charges

Mar. 1 Restructuring Charge 1000 000 00

Employee Termination

Obligation 1000 000 00

Mar. 25 Employee Termination Obligation 125 000 00

Cash 125 000 00

Unusual Items Not Affecting Income Unusual Items Not Affecting Income From Continuing Operations From Continuing Operations

Unusual Items Not Affecting Income Unusual Items Not Affecting Income From Continuing Operations From Continuing Operations

ClosedClosed

Discontinued OperationsDiscontinued OperationsDiscontinued OperationsDiscontinued Operations

A gain or loss from disposing of a business segment is reported as a gain or loss from discontinued operations.

A gain or loss from disposing of a business segment is reported as a gain or loss from discontinued operations.

Jones CorporationIncome Statement


Net sales $12,350,000

Income from continuing operationsbefore income tax $ 1,310,000

Income tax 620,000

Income from continuing operations $ 690,000

Loss on discontinued operations (Note B) 100,000

Income before extraordinary items and cumulative effect of a change in accounting principle $ 590,000

Extraordinary item:Gain on condemnation of land, net of applicable income tax of $65,000 150,000

Cumulative effect on prior years of changing todifferent depreciation method (Note C) 92,000

Net income $ 832,000

Extraordinary items result from events and transactions that (1) are significantly

different from the typical or the normal operating activities of the business AND

(2) occur infrequently.

Extraordinary items result from events and transactions that (1) are significantly

different from the typical or the normal operating activities of the business AND

(2) occur infrequently.

Extraordinary ItemsExtraordinary ItemsExtraordinary ItemsExtraordinary Items



Net sales $12,350,000


Income tax 620,000


Loss on discontinued operations (Note B) 100,000





Accounting changes occur when a business voluntarily change from one

generally accepted accounting principle to another.

Accounting changes occur when a business voluntarily change from one

generally accepted accounting principle to another.

Accounting ChangesAccounting ChangesAccounting ChangesAccounting Changes

Another type of accounting change occurs when businesses are required to change the way they treat an accounting situation when the FASB issues a new accounting standard.

Another type of accounting change occurs when businesses are required to change the way they treat an accounting situation when the FASB issues a new accounting standard.

Accounting ChangesAccounting ChangesAccounting ChangesAccounting Changes



Net sales $12,350,000


Income tax 620,000


Loss on discontinued operations (Note BA) 100,000





Income from continuing operations Income before extraordinary items and the

cumulative effect of a change in accounting principle

Extraordinary items and the cumulative effect of a change in accounting principle

Net income

Earnings per share (EPS) is the net income per share of common stock outstanding. When unusual items exist, EPS should be reported for:

Earnings per Common ShareEarnings per Common ShareEarnings per Common ShareEarnings per Common Share

Earnings per Common ShareEarnings per Common ShareEarnings per Common ShareEarnings per Common Share

Earnings per common share

=Net Income

Number of common shares outstanding

If there is no preferred stock:

If there is preferred stock:

Earnings per common share

=Net Income – Preferred stock dividends

Number of common shares outstanding



Income from continuing operations $690,000

Net income $832,000

Earnings per common share:Earnings per common share:

Income from continuing operations $ 3.45

Loss on discontinued operations (Note B) .50

Income before extraordinary item and cumulative effect of a change in accounting principle $2.95

Extraordinary item .75

Cumulative effect on prior years of changing to a different depreciation method .46Net income $ 4.16




Net income $832,000



Loss on discontinued operations (Note B) . 50







Net income $832,000



Loss on discontinued operations (Note B) .50




Comprehensive IncomeComprehensive IncomeComprehensive IncomeComprehensive Income

Companies may report comprehensive income on the income statement, in a separate statement, or in the statement

of stockholders’ equity.

Companies may report comprehensive income on the income statement, in a separate statement, or in the statement

of stockholders’ equity.

Comprehensive IncomeComprehensive IncomeComprehensive IncomeComprehensive Income

Comprehensive income is defined as all changes in stockholders’

equity during a period.

Comprehensive income is defined as all changes in stockholders’

equity during a period.

However, comprehensive income does not include changes caused by

issuing dividends or from stockholders’ investments.

However, comprehensive income does not include changes caused by

issuing dividends or from stockholders’ investments.

Stockholders’ equity: Common stock $ 20,000 $ 20,000Paid-in capital in excess of par 36,000 36,000Retained earnings 165,500 157,000Accumulated other

comprehensive income 1,290 1,200Total stockholders’ equity $222,790 $214,200

Stockholders’ Equity SectionStockholders’ Equity SectionStockholders’ Equity SectionStockholders’ Equity Section

2006 2005

Accounting for Investments in Accounting for Investments in StocksStocks

Trading securities are securities that management intends to actively trade for profit.

Available-for-sale securities are securities that management expects to sell in the future, but which are not actively traded for profit.

Short-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in StocksShort-Term Investments in Stocks

Temporary investments are recorded in the current

asset account, Marketable Securities, at their cost.

Temporary investments are recorded in the current

asset account, Marketable Securities, at their cost.


On June 1, Crabtree Company purchased 2,000 shares of Inis Corporation common stock at

$89.75 per share plus a brokerage fee of $500.

On June 1, Crabtree Company purchased 2,000 shares of Inis Corporation common stock at

$89.75 per share plus a brokerage fee of $500.

June 1 Marketable Securities 180 000 00

Purchased 2,000 shares of Inis

Corporation common stock.

Cash 180 000 00

$89.75 x 2,000 shares + $500$89.75 x 2,000 shares + $500


On October 1, Inis declared a $0.90 per share dividend payable on November 30.

On October 1, Inis declared a $0.90 per share dividend payable on November 30.

Nov.30 Cash 1 800 00

Received dividend on Inis

Corporation common stock.

Dividend Revenue 1 800 00

2,000 shares x $0.902,000 shares x $0.90


On the balance sheet, temporary investments are reported at their fair market

value. Any difference between the fair market value and the cost is an unrealized

holding gain or loss.

On the balance sheet, temporary investments are reported at their fair market

value. Any difference between the fair market value and the cost is an unrealized

holding gain or loss.


At year-end, the total cost of Crabtree Co.’s four temporary investments is

$690,000. The current market for these four items totaled $750,000 at year-end.

Thus, Crabtree Co. had a before tax unrealized gain of $60,000.

At year-end, the total cost of Crabtree Co.’s four temporary investments is

$690,000. The current market for these four items totaled $750,000 at year-end.

Thus, Crabtree Co. had a before tax unrealized gain of $60,000.


Crabtree Co.Balance Sheet

December 31, 2006

Crabtree Co.Balance Sheet

December 31, 2006Current assets:

Cash$119,500Temporary investments in

marketable securities at cost $690,000Plus unrealized gain (net of applicable income tax of $18,000) 42,000

732,000

Current assets:Cash$119,500Temporary investments in

marketable securities at cost $690,000Plus unrealized gain (net of applicable income tax of $18,000) 42,000

732,000Stockholders’ Equity

Accumulated other comprehensive income 42,000

Stockholders’ EquityAccumulated other comprehensive income 42,000


Crabtree Co.Statement of Comprehensive Income


Crabtree Co.Statement of Comprehensive Income


Net income$720,000

Other comprehensive income:Unrealized gain on temporary investments

in marketable securities (net ofapplicable tax of $18,000)

42,000Comprehensive income

$762,000

Net income$720,000

Other comprehensive income:Unrealized gain on temporary investments

in marketable securities (net ofapplicable tax of $18,000)

42,000Comprehensive income

$762,000

Long-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in StocksLong-Term Investments in Stocks

Long-term investments are those investments made by a firm that are not intended as a source of cash in the normal operations of the business.

Long-term investments are those investments made by a firm that are not intended as a source of cash in the normal operations of the business.

EquityMethod

CostMethod

Not significantinfluence

Significantinfluence

Ownership %

Controlling Interest

100%100%

CostMethod

Not significantinfluence

0%0%

20%20%

50%50%With less than 20% ownership the buyer

does not usually have significant influence. The buyer uses the cost method

to account for the investment.

With less than 20% ownership the buyer does not usually have significant

influence. The buyer uses the cost method to account for the investment.


EquityMethod

CostMethod

No significantinfluence


Ownership %


0%0%

EquityMethod 50%50%

Ownership over 20% usually indicates significant influence. The buyer uses

the equity method to account for the investment.

Ownership over 20% usually indicates significant influence. The buyer uses

the equity method to account for the investment.

100%100%

20%20%


Jan. 2 Investment in Brock Corp. Stock 350 000 00

Purchased 40% of Brock Corp.

common stock.

Cash 350 000 00

On January 2, Hally Inc. pays cash of $350,000 for 40% of Brock Corporation’s common stock.

On January 2, Hally Inc. pays cash of $350,000 for 40% of Brock Corporation’s common stock.


Dec. 31 Investment in Brock Corp. Stock 42 000 00

Recorded share (40%) of Brock

Corp. net income of $105,000.

Income of Brock Corp. 42 000 00

For the year ending December 31, Brock Corporation reports net income of $105,000.

For the year ending December 31, Brock Corporation reports net income of $105,000.


Dec. 31 Cash 18 000 00

Recorded share (40%) of

dividends of $45,000 paid by

Brock Corp.

Investment in Brock Crop. Stock 18 000 00

On December 31, Brock Corporation declared a $45,000 dividend, payable on December 31.

On December 31, Brock Corporation declared a $45,000 dividend, payable on December 31.


Mar. 1 Cash 17 500 00

Sold investment in Drey Inc.

stock.

Investment in Drey Inc. Stock 15 700 00

Gain on Sale of Investments1 800 00

On March 1, an investment in Drey Inc. stock that had a carrying amount of

$15,700 is sold for $17,500.

On March 1, an investment in Drey Inc. stock that had a carrying amount of

$15,700 is sold for $17,500.


EquityMethod

CostMethod

No significantinfluence


Ownership %

0%0%

20%20%




100%100%

50%50%

Business CombinationsBusiness CombinationsBusiness CombinationsBusiness Combinations

The corporation owning all or a majority of the voting stock is called the parent company. The controlled

corporation is the subsidiary company. Consolidated financial statements are prepared which combines the

operating results of the two entities.

The corporation owning all or a majority of the voting stock is called the parent company. The controlled

corporation is the subsidiary company. Consolidated financial statements are prepared which combines the

operating results of the two entities.

Business CombinationsBusiness CombinationsBusiness CombinationsBusiness CombinationsA merger combines two corporations by one

acquiring the properties of another that is then dissolved.

Many businesses combine in order to produce more efficiently or to diversify product lines.

A consolidation is the creation of a new corporation, to which the combined assets and liabilities of the old corporations are transferred to the new corporation.

Business CombinationsBusiness CombinationsBusiness CombinationsBusiness Combinations

Mergers: Company A acquires company B. The assets and liabilities of B are transferred to A and B is then dissolved.

Mergers

A

B

Consolidations: Company A acquires company B. The assets and liabilities of both A and B are transferred to a new company C and A and B are then dissolved.

Consolidations

CA

B

FINANCIAL ANALYSIS AND

INTERPRETATION

A firm’s growth potential and future earnings prospects are indicated by how

much the market is willing to pay per dollar of a company’s earnings.

A firm’s growth potential and future earnings prospects are indicated by how

much the market is willing to pay per dollar of a company’s earnings.

Accounting: Earnings Per ShareAccounting: Earnings Per Share

Net Income

Common Shares

Earnings per Share of Common

Stock=

Investing: Price - Earnings RatioInvesting: Price - Earnings Ratio

Market Price Per Share

of Common StockEarnings Per Share of

Common Stock

Price-Earnings

Ratio=

The price-earnings ratio represents how much the market is willing to pay per dollar of a company’s earnings. This indicates the market’s assessment of a firm’s growth potential and future earnings prospects.

The price-earnings ratio indicates that a share of common stock was selling for 10 times earnings for 2005 and 12.5 times for 2006.

An example: 2006 2005

Market price per share $20.50 $13.50

Earnings per share $1.64 $1.35

Price-earnings ratioPrice-earnings ratio 12.5 12.5 10.0 10.0

The EndThe End

Chapter 14Chapter 14

income taxes, and unusual income tax items accounting, 21 st edition warren reeve fess powerpoint...

Documents

income statement

taxable income

net income

income tax expense21

income reporting methods

deferred income taxes

tax paid

tax law