Power Notes Chapter 13 Corporations: Income and Taxes, Stockholders’ Equity, Investments in Stocks Learning Objectives C13 1. Corporate Income Taxes 2. Unusual Income Statement Items 3. Earnings Per Common Share 4. Reporting Stockholders’ Equity 5. Comprehensive Income 6. Accounting for Investment in Stocks 7. Business Combinations 8. Financial Analysis and Interpretation

Power Notes Chapter 13 Corporations: Income and Taxes, Stockholders’ Equity, Investments in Stocks Slide # Power Note Topics 3 10 16 22 28 36 38 Corporate Income Taxes Unusual Income Statement Items Earnings Per Common Share Reporting Stockholders’ Equity Long-Term Stock Investments Business Combinations Price-Earnings Ratio Note: To select a topic, type the slide # and press Enter.

Corporate Income Taxes Corporations are taxable entities that must pay income taxes. Because income tax is often a significant amount, it is reported as a special deduction. Taxable income is determined according to tax laws which are often different from income before income tax according to GAAP. 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 Differences in Reporting Revenues Financial Reporting Tax Reporting Revenue Reporting Report Now Taxable Later Report Later Taxable Now Example: Income reporting methods. Point-of-Sale Method Installment Method Example: Cash collected in advance. When Earned When Collected

Temporary Differences in Reporting Expenses Financial Reporting Tax Reporting Expense Deductions Deduct Now Deduct Later Deduct Slower Deduct Faster Example: Product warranty expense. When Estimated When Paid Example: Methods of depreciation. Straight-Line Method MACRS Method

Income Tax Accounting Financial reporting and tax reporting summary: Income before tax $300,000 x 40% rate = $120,000 Taxable income $100,000 x 40% rate = $40,000 Date Description Debit Credit Income Tax Expense 120,000 Income Tax Payable 40,000 Deferred Income Tax Payable 80,000 Deferred Income Tax Payable 48,000 Income Tax Payable 48,000 1st Yr. Income tax allocation due to timing differences. 2nd Yr. Record $48,000 of deferred tax as payable.

Income Tax Accounting Financial reporting and tax reporting summary: Income before tax $300,000 x 40% rate = $120,000 Taxable income $100,000 x 40% rate = $40,000 Date Description Debit Credit Income Tax Expense 120,000 Income Tax Payable 40,000 Deferred Income Tax Payable 80,000 1st Yr. The income tax expense is deducted from the income before tax reported on the income statement.

Income Tax Accounting Financial reporting and tax reporting summary: Income before tax $300,000 x 40% rate = $120,000 Taxable income $100,000 x 40% rate = $40,000 Date Description Debit Credit Income Tax Expense 120,000 Income Tax Payable 40,000 Deferred Income Tax Payable 80,000 1st Yr. The income tax payable is based on the taxable income and is a current liability due and payable.

Income Tax Accounting Financial reporting and tax reporting summary: Income before tax $300,000 x 40% rate = $120,000 Taxable income $100,000 x 40% rate = $40,000 Date Description Debit Credit Income Tax Expense 120,000 Income Tax Payable 40,000 Deferred Income Tax Payable 80,000 1st Yr. The deferred income tax payable is a deferred liability due later as the timing differences reverse and the taxes become due.

Unusual Income Statement Items Three types of unusual items are: 1. Results of discontinued operations. 2. Extraordinary items of gain or loss. 3. A change from one generally accepted accounting principle to another. These items and the related tax effects are reported separately in the income statement.

Jones Corporation Income Statement For the Year Ended December 31, 2003 Net sales $9,600,000 Income from continuing operations before income tax $1,310,000 Income tax 620,000 Income from continuing operations $ 690,000 Loss on discontinued operations (Note A) 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 to different depreciation method (Note B) 92,000 Net income $832,000

Jones Corporation Income Statement For the Year Ended December 31, 2003 Net sales $9,600,000 Income from continuing operations before income tax $1,310,000 Income tax 620,000 Income from continuing operations $ 690,000 Loss on discontinued operations (Note A) 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 to different depreciation method (Note B) 92,000 Net income $832,000

Jones Corporation Income Statement For the Year Ended December 31, 2003 Net sales $9,600,000 Income from continuing operations before income tax $1,310,000 Income tax 620,000 Income from continuing operations $ 690,000 Loss on discontinued operations (Note A) 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 to different depreciation method (Note B) 92,000 Net income $832,000

Jones Corporation Income Statement For the Year Ended December 31, 2003 Net sales $9,600,000 Income from continuing operations before income tax $1,310,000 Income tax 620,000 Income from continuing operations $ 690,000 Loss on discontinued operations (Note A) 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 to different depreciation method (Note B) 92,000 Net income $832,000

Jones Corporation Income Statement For the Year Ended December 31, 2003 Net sales $9,600,000 Income from continuing operations before income tax $1,310,000 Income tax 620,000 Income from continuing operations $ 690,000 Loss on discontinued operations (Note A) 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 to different depreciation method (Note B) 92,000 Net income $832,000 Differences created by unusual items: discontinued operations, extraordinary items, and change in methods.

Reporting Earnings Per Common Share Earnings per share (EPS) is the net income per share of common stock outstanding. When unusual items exist, EPS should be reported for: 1. Income from continuing operations. 2. Income before extraordinary items and the cumulative effect of a change in accounting principle. 3. Extraordinary items and the cumulative effect of a change in accounting principle. 4. Net income.

Jones Corporation Income Statement For the Year Ended December 31, 2003 Income from continuing operations $690,000 Net income $832,000 Earnings per common share: Income from continuing operations $ 3.45 Loss on discontinued operations .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 .46 Net income $ 4.16

Jones Corporation Income Statement For the Year Ended December 31, 2003 Income from continuing operations $690,000 Net income $832,000 Earnings per common share: Income from continuing operations $ 3.45 Loss on discontinued operations .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 .46 Net income $ 4.16

Jones Corporation Income Statement For the Year Ended December 31, 2003 Income from continuing operations $690,000 Net income $832,000 Earnings per common share: Income from continuing operations $ 3.45 Loss on discontinued operations .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 .46 Net income $ 4.16

Jones Corporation Income Statement For the Year Ended December 31, 2003 Income from continuing operations $690,000 Net income $832,000 Earnings per common share: Income from continuing operations $ 3.45 Loss on discontinued operations .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 .46 Net income $ 4.16

Jones Corporation Income Statement For the Year Ended December 31, 2003 Income from continuing operations $690,000 Net income $832,000 Earnings per common share: Income from continuing operations $ 3.45 Loss on discontinued operations .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 .46 Net income $ 4.16

Stockholders’ Equity Paid-in capital: Preferred $5 stock, cumulative, $50 par (2,000 shares authorized and issued) $100,000 Excess of issue price over par 10,000 $ 110,000 Common stock, $20 par (50,000 shares authorized, 45,000 issued) $900,000 Excess of issue price over par 132,000 1,032,000 From donated land 60,000 Total paid-in capital $1,202,000

Stockholders’ Equity Paid-in capital: Preferred $5 stock, cumulative, $50 par (2,000 shares authorized and issued) $100,000 Excess of issue price over par 10,000 $ 110,000 Common stock, $20 par (50,000 shares authorized, 45,000 issued) $900,000 Excess of issue price over par 132,000 1,032,000 From donated land 60,000 Total paid-in capital $1,202,000 Shareholders’ Equity Contributed capital: Preferred 10% stock, cumulative, $50 par (2,000 shares authorized and issued) $100,000 Common stock, $20 par (50,000 shares authorized, 45,000 issued) $900,000 Additional paid-in capital 202,000 Total contributed capital $1,202,000

Stockholders’ Equity Paid-in capital: Preferred $5 stock, cumulative, $50 par (2,000 shares authorized and issued) $100,000 Excess of issue price over par 10,000 $ 110,000 Common stock, $20 par (50,000 shares authorized, 45,000 issued) $900,000 Excess of issue price over par 132,000 1,032,000 From donated land 60,000 Total paid-in capital $1,202,000 Shareholders’ Equity Contributed capital: Preferred 10% stock, cumulative, $50 par (2,000 shares authorized and issued) $100,000 Common stock, $20 par (50,000 shares authorized, 45,000 issued) $900,000 Additional paid-in capital 202,000 Total contributed capital $1,202,000

Reporting Retained Earnings Adang Corporation Retained Earnings Statement For the Year Ended June 30, 2003 Retained earnings, July 1, 2002 $350,000 Net income $280,000 Less dividends declared 75,000 Increase in retained earnings 205,000 Retained earnings, June 30, 2003 $555,000

Reporting Retained Earnings Adang Corporation Retained Earnings Statement For the Year Ended June 30, 2003 Retained earnings, July 1, 2002 $350,000 Net income $280,000 Less dividends declared 75,000 Increase in retained earnings 205,000 Retained earnings, June 30, 2003 $555,000

Reporting Retained Earnings Adang Corporation Retained Earnings Statement For the Year Ended June 30, 2003 Retained earnings, July 1, 2002 $350,000 Net income $280,000 Less dividends declared 75,000 Increase in retained earnings 205,000 Retained earnings, June 30, 2003 $555,000

Long-Term Stock Investments Ownership % 100% Controlling Interest Equity Method 50% Significant influence 20% Cost Method Not significant influence 0%

Long-Term Stock Investments Ownership % 100% Controlling Interest With less than 20% ownership the buyer does not usually have significant influence. The buyer uses the cost method to account for the investment. Equity Method 50% Significant influence 20% Cost Method Not significant influence 0%

Long-Term Stock Investments Ownership % 100% Ownership over 20% usually indicates significant influence. The buyer uses the equity method to account for the investment. Controlling Interest Equity Method 50% Significant influence 20% Cost Method Not significant influence 0%

Long-Term Stock Investments Ownership % 100% Controlling Interest Equity Method 50% 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 combinine the operating results of the two entities. Significant influence 20% Cost Method Not significant influence 0%

Long-Term Stock Investments Ownership % 100% Controlling Interest Equity Method 50% Significant influence 20% Cost Method Not significant influence 0%

Cost Method The cost method is used when the buyer does not have significant influence over the operating and financing activities of the investee. Date Description Debit Credit Investment in Stock 5,940 Cash 5,940 Cash 200 Dividend Revenue 200 Mar. 1 Purchased 100 shares of Compton Corp. stock at 59 plus brokerage fee of $40. Dec. 31 Received $2 cash dividend from Compton Corp.

Equity Method Investment in Brock Corp. Stock 350,000 Cash 350,000 Date Description Debit Credit Investment in Brock Corp. Stock 350,000 Cash 350,000 Investment in Brock Corp. Stock 42,000 Income of Brock Corp. 42,000 Cash 18,000 Investment in Brock Corp. Stock 18,000 Jan. 2 Purchased 40% of Brock Corporation for $350,000. Dec. 31 Brock Corporation reports net income of $105,000. Dec. 31 Brock Corporation reports total dividends of $45,000.

Sale of Long-Term Stock Investment When shares of stock are sold, the investment account is credited for the carrying value (book value) of the shares sold. Date Description Debit Credit Cash 17,500 Investment in Stock 15,700 Gain on Sale of Investments 1,800 Mar. 1 Sold stock of Drey Inc. for $17,500. Stock has a carrying value of $15,700.

Business Combinations Many businesses combine in order to produce more efficiently or to diversify product lines. A merger combines two corporations by one acquiring the properties of another that is then dissolved. A consolidation is the creation of a new corporation, to which the combined assets and liabilities of the old corporations are transferred.

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

Analyzing Stock Investments Accounting: Earnings Per Share Net Income Common Shares Earnings Per Share = Investing: Price - Earnings Ratio Market Price Per Share Earnings Per Share Price- Earnings Ratio =

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. An example: 2000 1999 Market price per share $20.50 $13.50 Earnings per share $1.64 $1.35 Price-earnings ratio 12.5 10.0 The price-earnings ratio indicates that a share of common stock was selling for 10 times earnings for 1999 and 12.5 times for 2000.

Power Notes This is the last slide in Chapter 13. Chapter 13 Corporations: Income and Taxes, Stockholders’ Equity, Investments in Stocks This is the last slide in Chapter 13. Note: To see the topic slide, type 2 and press Enter.