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Other Nonowner Items that AffectOwners’ Equity

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10Part One: Financial Accounting

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Detailed Condensed Statement (Top) Slide 10-1

BASEL CORPORATIONCondensed Statement of Income and Retained Earnings

Year Ended December 31, 1998(in thousands)

Net sales and other revenue $60,281 Expenses 46,157 Income from continuing operations before

income taxes 14,124 Provision for income taxes 5,650

Income from continuing operations 8,474 Discontinued operations (Note A):

Loss from operations of Division X (less applicable income taxes of $320) $480

Loss on disposal of Division X (less applicableincome taxes of $640 960 (1,440)

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Extraordinary loss (less applicable income taxesof $400)(Note B) (600)

Cumulative effect of changes in accounting principles(less applicable income taxes of $125)(Note C) (400)

Net income $ 6,034 Retained earnings at beginning of year:

As previously reported $41,400 Adjustments (Note D) (1,200)As restated 40,200

Add net income 6,034 Deduct dividends (2,000)Retained earnings at end of year $44,234

Detailed Condensed Statement (Bottom) Slide 10-2

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The event must be unusual; it should be highly abnormal and unrelated to, or only incidentally related to, the ordinary activities of the entity.

The event must occur infrequently; it should be of a type that would not reasonably be expected to recur in the foreseeable future.

Extraordinary Items Slide 10-3

In order to qualify as an extraordinary item, an event must satisfy two criteria:

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Write-down or write-off of accounts receivable, inventory, or intangible assets

Gains or losses from changes in the value of foreign currency

Gains or losses on disposal of a segment of a business

Gains or losses from the disposal of fixed assetsEffects of a strike

Write-down or write-off of accounts receivable, inventory, or intangible assets

Gains or losses from changes in the value of foreign currency

Gains or losses on disposal of a segment of a business

Gains or losses from the disposal of fixed assetsEffects of a strike

Extraordinary Items Slide 10-4

The following gains and losses are specifically not extraordinary:

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• The transaction must involved a whole business

• Discontinuance may occur by abandoning the segment and selling off the assets

• Discontinuance may occur by selling the whole segment as a unit to some other company

Discontinued Operations Slide 10-5

ChairDivision

ABCFurniture

Mfg.Company

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1. The net income or loss attributed to the operations of the segment until it is sold

2. The estimated net gain or loss on disposal after taking account of all aspects of the sale, including the amount received and the write-off of assets that are not sold

1. The net income or loss attributed to the operations of the segment until it is sold

2. The estimated net gain or loss on disposal after taking account of all aspects of the sale, including the amount received and the write-off of assets that are not sold

Discontinued Operations Slide 10-6

Two amounts are reported on the income statement after their income tax effect has

been taken into account:

Two amounts are reported on the income statement after their income tax effect has

been taken into account:

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Change in Accounting Principles Slide 10-7

Sometimes a change is required by a new FASB Statement.

Sometimes a change is required by a new FASB Statement.

The consistency concept requires that a company use the same accounting principle from one year

to the next.

The consistency concept requires that a company use the same accounting principle from one year

to the next.

If a company has a sound If a company has a sound reason for doing so, it reason for doing so, it may occasionally shift may occasionally shift

from one GAAP to from one GAAP to another one.another one.

If a company has a sound If a company has a sound reason for doing so, it reason for doing so, it may occasionally shift may occasionally shift

from one GAAP to from one GAAP to another one.another one.The cumulative effect of the

change is reported as one of the nonrecurring items on the

income statement in the year the changed is made.

The cumulative effect of the change is reported as one of the

nonrecurring items on the income statement in the year

the changed is made.

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Adjustments to Retained Earnings Slide 10-8

Only correction of past periods errors is

allowed as an adjustmentto Retained Earnings.

Only correction of past periods errors is

allowed as an adjustmentto Retained Earnings.

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• Mathematical mistakes• Mistakes in the

application of accounting principles

• An oversight or misuse of facts

• Mathematical mistakes• Mistakes in the

application of accounting principles

• An oversight or misuse of facts

Adjustments to Retained Earnings Slide 10-8

So, what is an error?

So, what is an error?

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• An amount representing the employee’s FICA contribution and medicare coverage

• An amount withheld from gross earnings to apply toward the employee’s personal state and federal income taxes

• Deductions for charitable contributions, savings plans, union dues, and a variety of other items

Personnel Costs Slide 10-9

Deductions from an employee’s paychecks:

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Personnel Costs Slide 10-10

If an employee with three dependents earned $600 for work in a certain week in 1998, $45.90 for FICA and $63.00 for withholding tax would be deducted from this $600. The

employer incurs a matching expense of $45.90 for FICA plus $54 for federal and state unemployment insurance taxes.

If an employee with three dependents earned $600 for work in a certain week in 1998, $45.90 for FICA and $63.00 for withholding tax would be deducted from this $600. The

employer incurs a matching expense of $45.90 for FICA plus $54 for federal and state unemployment insurance taxes.

When wages are earned:

Wages Cost 600.00Wages Payable 600.00

Employment Tax Cost 99.90FICA Taxes Payable 45.90Unemployment Taxes Payable 54.00

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Personnel Costs Slide 10-11

When wages are paid:

Wages Payable 600.00Cash 491.10FICA Taxes Payable 45.90Withholding Taxes Payable 63.00

When the government is paid:

FICA Taxes Payable 91.80Unemployment Taxes Payable 54.00Withholding Taxes Payable 63.00

Cash 208.80

$45.90 + $45.90

$45.90 + $45.90

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• The year’s service cost element• The year’s interest cost element• The actual return on plan assets element• The amortization of several other pension-related

items

Pensions Slide 10-12

A company’s pension cost is the sum of four elements.

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Pensions Slide 10-13

The net pension cost using a defined benefit plan are $500,000

The net pension cost using a defined benefit plan are $500,000

Net Pension Cost 500,000Unfunded Accrued Pension Cost 500,000

A liabilityA liabilityA subsequent contribution of

$450,000 is made to the plan by the employer.

A subsequent contribution of $450,000 is made to the plan by the

employer.

Unfunded Accrued Pension Cost 450,000Cash 450,000

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Income Taxes Slide 10-14

A company buys personal computers costing over $15,000 each. For tax purposes it elects to use an

accelerated depreciation method. For financial reporting purposes it decides to use the straight-

line method.

A company buys personal computers costing over $15,000 each. For tax purposes it elects to use an

accelerated depreciation method. For financial reporting purposes it decides to use the straight-

line method.In the first year the depreciation charge for

tax purposes will be higher than the depreciation for

financial reporting purposes.

In the first year the depreciation charge for

tax purposes will be higher than the depreciation for

financial reporting purposes.

If all other items are accounted for in the

same way, the company’s taxable

income for the year will be lower than its book

pre-tax income.

If all other items are accounted for in the

same way, the company’s taxable

income for the year will be lower than its book

pre-tax income.At the end of the year the net carrying amount of the computers on the company’s tax books will be lower than their net carry

amount on the company’s financial reporting books.

At the end of the year the net carrying amount of the computers on the company’s tax books will be lower than their net carry

amount on the company’s financial reporting books.

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Deferred Income Taxes Slide 10-15

Because of temporary differences, in 1998 a corporation reported $1 million pre-tax income to its shareholders and $800,000 taxable income to the IRS (resulting in an income tax expense of $340,000 and a tax liability of only $272,000).

Because of temporary differences, in 1998 a corporation reported $1 million pre-tax income to its shareholders and $800,000 taxable income to the IRS (resulting in an income tax expense of $340,000 and a tax liability of only $272,000).

Assets = Liabilities + Owners’ Equity

- $272,000 Retained Earnings - $340,000

Reflecting actual tax bill

paid

Reflecting tax expense used to measure book

income

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Deferred Income Taxes Slide 10-16

Because of temporary differences, in 1998 a corporation reported $1 million pre-tax income to its shareholders and $800,000 taxable income to the IRS (resulting in an income tax expense of $340,000 and a tax liability of only $272,000).

Because of temporary differences, in 1998 a corporation reported $1 million pre-tax income to its shareholders and $800,000 taxable income to the IRS (resulting in an income tax expense of $340,000 and a tax liability of only $272,000).

Income Tax Expense--Current 272,000Income Tax Expense--Deferred 68,000

Cash 272,000Deferred Income Taxes Liability 68,000

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Deferred Tax Measurement Slide 10-17

1998 $1,000.0 $ 333.3 $ 666.7 $ 266.7

1999 1,000.0 266.7 733.3 293.3

2000 1,000.0 200.0 800.0 320.0

2001 1,000.0 133.3 866.7 346.7

2002 1,000.0 66.7 933.3 373.3

$5,000.0 $1,000.0 $4,000.0 $1,600.0

Income before Depreciation Taxable Taxes Due Year Depreciation and Taxes Charge Income (at 40 percent rate)

Calculation of Taxes Due (thousands of dollars)

Calculation of Taxes Due (thousands of dollars)

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Deferred Tax Measurement Slide 10-18

1998 $1,000.0 $333.3 $333.3 $666.7

1999 1,000.0 266.7 600.0 400.0

2000 1,000.0 200.0 800.0 200.0

2001 1,000.0 133.3 933.3 66.7

2002 1,000.0 66.7 1,000.0 -0-

Original Annual Cumulative Year Depreciable Cost Tax Depreciation Tax Depreciation Tax Basis

Tax Basis Calculation (thousands of dollars)

Tax Basis Calculation (thousands of dollars)

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Deferred Tax Measurement Slide 10-19

1998 $1,000.0 $200.0 $200.0 $800.0

1999 1,000.0 200.0 400.0 600.0

2000 1,000.0 200.0 600.0 400.0

2001 1,000.0 200.0 800.0 200.0

2002 1,000.0 200.0 1,000.0 -0-

Original Annual Book Cumulative Book Net Book Year Book Cost Depreciation Depreciation Value

Net Book Value Calculation (thousands of dollars)

Net Book Value Calculation (thousands of dollars)

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Deferred Tax Measurement Slide 10-20

When the taxes are paid:Income Tax Payable 266,700

Cash 266,700

Combining all three 1998 entries:Income Tax Expense 320,000

Cash 266,700Deferred Income Taxes Liability 53,300

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Chapter 10

The End