1. Income Taxes, Unusual Items, Investments in Stocks
By Rachelle Agatha, CPA, MBA
Slides by Rachelle Agatha, CPA,
with excerpts from Warren, Reeve, Duchac

2. Objectives:
Journalize the entries for corporate income taxes, including deferred income taxes.
Describe and illustrate the reporting of unusual items on the income statement.

3. Objectives:
Prepare an income statement reporting earnings per share data.
Describe the concept and the reporting of comprehensive income.
Describe the accounting for investments in stocks.

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

5. Corporate Income Taxes
Most corporations are required to pay estimated federal income taxes in four installments throughout the year. A corporation estimates its income tax expense for the year to be $84,000. The first of four estimated payments is journalized as follows:
Apr. 15 Income Tax Expense
Cash

6. Automobiles 33% Banking 35 Computers 23 Food 35 Integrated oil 39
Ratio of Reported Income Tax Expense to Earnings Before Taxes for Selected Industries
Automobiles 33%
Banking 35
Computers 23
Food 35
Integrated oil 39
Pharmaceuticals 30
Retail 39
Telecommunication 37
Transportation 38

7. Allocating Income Taxes
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 are call temporary differences because they reverse or turn around in later years.

8. Examples of Items That Create Temporary Differences
Revenues or gains are taxed after they are reported in the income statement.
Expenses or losses are deducted in determining taxable income after they are reported in the income statement.

9. Revenues or gains are taxed before they are reported on the income statement.
Expenses or losses are deducted in determining taxable income before they are reported in the income statement.

10. Total depreciation is the same for tax and financial purposes.
Exhibit 1 Temporary Differences
MACRS (tax depreciation)
Straight-line (financial statement depreciation)
Years
1-5
Total
Year 1
Year 2
Year 3
Year 4
Year 5
Total depreciation is the same for tax and financial purposes.

11. At the end of the first year of operations, a corporation reports $300,000 of income before income taxes. With a 40% tax rate, the firm faces a tax of $120,000 ($300,000 x 40%). Using tax planning, the net income is reduced to $100,000 and the actual income tax due is $40,000 ($100,000 x 40%). The difference is deferred to future years.

12. The entry to record income taxes reflects the deferred amount of $80,000.
Income Tax Expense
Income Tax Payable
Deferred Income Tax Payable

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

14. 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 year’s taxes.

15. Income Tax Expense 80,000
Income Tax Payable 52,000
Deferred Income Tax Payable 28,000
Income tax expense based on
$200,000 reported income at 40% $80,000
Income tax payable based on $130,000
taxable income at 40% 52,000
Income tax deferred to future years $28,000

16. Permanent Differences
Differences between taxable income and income before taxes reported on the income statement may be the result of differences that are not “timing” differences. These are permanent differences that never reverse.
Interest income that is exempt on municipal bonds is an example of this type of a permanent difference.

17. Objective 2
Describe and illustrate the reporting of unusual items on the income statement.

18. Fixed asset impairments Restructuring charges
Reporting Unusual Items on the Income Statement
Reporting Unusual Items on the Income Statement
Unusual items subtracted from gross profit in determining income from continuing operations are:
Fixed asset impairments
Restructuring charges

19. Fixed Asset Impairment
A fixed asset impairment occurs when the fair value of a fixed asset falls below its book value and is not expected to recover.

20. Decrease in market price of fixed assets.
Examples of Events That Might Cause an Asset Impairment
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.

21. On March 1, Jones Corporation 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
Equipment
To record impairment of fixed assets due to plant closing.

22. Fixed asset impairments
Reporting of Unusual Items on the Income Statement
Fixed asset impairments

23. Unusual Items in the Income Statement 23

24. Fixed asset impairments Restructuring charges
Reporting Unusual Items on the Income Statement
Unusual items subtracted from gross profit in determining income from continuing operations are:
Fixed asset impairments
Restructuring charges

25. Restructuring Charges
Restructuring charges are costs incurred with actions such as canceling contracts, laying off or relocating employees, and combining operations.

26. The management of Jones Company communicates a plan to terminate 200 employees from the closed manufacturing plant effective March 1. The restructuring plan calls for a termination benefit of $5,000 per employee. The employees have the right to work 60 days beyond March 1, but may elect to leave the firm earlier.

27. The fair value of this plan would be $1,000,000 (200 x $5,000), which is the aggregate expected cost of terminating the employees. The restructuring charge would be recorded as follows:
Mar. 1 Restructuring Charge 1,
Employee Termination
Obligation 1,
To record impairment of fixed assets due to plant closing.

28. 14-2
Twenty five employees find employment elsewhere and leave the company on March 25. Payment is made to these employees on that date.

29. On March 25, the entry to record a severance payment of $125,000 to 25 of the terminated employees would be as follows:
Mar. 25 Employee Termination Obligation
Cash
To record payment to 25 employees as severance compensation.

30. Restructuring charges
Reporting of Unusual Items on the Income Statement
Restructuring charges

31. Unusual Items in the Income Statement

32. On December 20 of the current year. Torro 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 entries for the asset impairment and the restructuring charge. 32

33. Dec. 20 Loss on Fixed Asset Impairment 180,000
Equipment 180,000
20 Restructuring Charge 560,000*
Employee Termination
Obligation 560,000
*80 employees x $7,000

34. Discontinued operations Extraordinary items
Reporting Unusual Items on the Income Statement
Unusual items that may add or subtract income from continuing operations in determining net income are:
Discontinued operations
Extraordinary items

35. 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.

36. Discontinued operations
Reporting of Unusual Items on the Income Statement
Discontinued operations

37. Unusual Items in the Income Statement
14-2 37

38. Discontinued operations Extraordinary items
Reporting Unusual Items on the Income Statement
14-2
Unusual items that adjust income from continuing operations in determining net income are:
Discontinued operations
Extraordinary items

39. Extraordinary items result from events and transactions that—
Extraordinary Items
14-2
Extraordinary items result from events and transactions that—
are significantly different (unusual) from the typical or the normal operating activities of the business, and
occur infrequently.

40. Insert Exhibit 2 here also, p. 13
Reporting of Unusual Items on the Income Statement
14-2
14-2
Insert Exhibit 2 here also, p. 13
Extraordinary items 40

41. Unusual Items in the Income Statement

42. Retroactive Restatement
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:
errors in the recognition, measurement, presentation, or disclosure of financial statements, and
changes from one generally accepted accounting principle to another generally accepted accounting principle.

43. Unusual items affecting prior period income statements
Reporting of Unusual Items on the Income Statement
Unusual items affecting prior period income statements

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

45. Earnings per Common Share
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.

46. If there is no preferred stock:
If there is no preferred stock:
Earnings per common share =
Net Income
Number of common shares outstanding
If there is preferred stock:
Earnings per common share =
Net Income – Preferred stock dividends
Number of common shares outstanding

47. Income Statement with Earnings per Share

48. *2,000 shares x $100 par value x 9% = $18,000
Manning Company had net income of $250,000 during the year. There were 580,000 common shares outstanding during the year. There were 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*
580,000
$0.40 per share =
*2,000 shares x $100 par value x 9% = $18,000

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

50. Comprehensive Income
Comprehensive income is defined as all changes in stockholders’ equity during a period, except those resulting from dividends and stockholders’ investments.

51. Other comprehensive income items include foreign currency items, pension liability adjustments, and unrealized gains and losses on investments.

52. 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.

53. Statement of Comprehensive Income
Statement of Comprehensive Income
Triple-A Enterprises, Inc. reported comprehensive income on a separate statement as follows:
Net income $
Other comprehensive income, net of tax
Total comprehensive income $
Triple-A Enterprises, Inc.
Statement of Comprehensive Income
For the Year Ended December 31, 2008
Triple-A Enterprises, Inc.
Statement of Comprehensive Income
For the Year Ended December 31, 2008
Net income $
Other comprehensive income, net of tax
Total comprehensive income $

54. Stockholders’ Equity Section of Triple-A Enterprises’ Balance Sheet
Stockholders’ Equity Section of Triple-A Enterprises’ Balance Sheet
Triple-A Enterprises, Inc.
Stockholders’ Equity
For the Year Ended December 31, 2008
Stockholders’ equity:
Common stock $ $
Paid-in capital in excess of par
Retained earnings
Accumulated other
comprehensive income
Total stockholders’ equity $ $

55. Myers Company had a net income of $74,000, and other comprehensive income of $12,500 for 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.

56. $86,500 = $74,000 + $12,500
$499,000 = $425,000 + $74,000
c) $69,500 = $57,000 + $12,500

57. Describe the accounting for investments in stocks.
Objective 5
Describe the accounting for investments in stocks.

58. Accounting for Investments in Stocks
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 on excess cash that it does not need for its normal operations.

59. 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.

60. When a business invests in available-for-sale securities, such investments are classified as temporary investments or marketable securities.

61. Marketable securities must meet two conditions:
The securities must be readily marketable, and can be sold for cash at any time.
Management must intend to sell the securities when the business needs cash for operations.

62. 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. The firm paid $180,000 [($89.75 x 2,000 shares) + $500].
June 1 Marketable Securities
Cash
Purchased 2,000 shares of Inis Corporation common stock.

63. On October 1, Inis declared a $0.90 per share dividend payable on November 30.
Nov 30 Cash
Dividend Revenue
Received dividends on Inis Corporation common stock (2,000 shares x $0.90).

64. Unrealized Holdings Gain or Loss
On the balance sheet, temporary investments are reported at their fair market value. Any difference between the fair market value and their cost is an unrealized holding gain or loss.

65. The 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.
Unrealized
Common Stock Cost Market Gain (Loss)
Edwards Inc. $150,000 $190,000 $40,000
SWS Corp. 200, ,000 —
Inis Corporation 180, ,000 30,000
Bass Co , ,000 (10,000)
Total $690,000 $750,000 $60,000

66. Temporary Investments on the Balance Sheet

67. 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 Determine (a) the reported amount of marketable securities on the December 31, 2008 balance sheet, and (b) the comprehensive income for Assume a tax rate of 40%.

68. Initial costs $ 75,000
Unrealized gain ($110,000 – $75,000) $35,000
Less: Tax on unrealized gain ($35,000 x 40%) 14,000
Unrealized gain, net of tax ,000
Reported amount of marketable securities $ 96,000
Net income $180,000
Unrealized gain ($110,000 – $75,000) $35,000
Less: Tax on unrealized gain ($35,000 x 40%) 14,000
Other comprehensive income, net of tax ,000
Net income $201,000

69. Long-Term Investments in Stocks
Long-term investments 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.

70. Accounting for Long-Term Stock Investments
Accounting for Long-Term Stock Investments
Is there a significant influence over the investee? No
Yes
Account for the investment as an available-for-sale security
Account for the investment by using the equity method

71. On January 2, Hally Inc. pays cash of $350,000 for 40% of the common stock and net assets of Brock Corporation.
Jan. 2 Investment in Brock Corp. Stock
Cash
Purchased 40% of Brock Corp. common stock.

72. For the year ending December 31, Brock Corporation reports net income of $105,000.
Dec. 31 Investment in Brock Corp. Stock
Income of Brock Corp
Recorded 40% share of Brock Corp. net income of $105,000.

73. On December 31, Brock Corporation pays $45,000 in dividends.
14-5
On December 31, Brock Corporation pays $45,000 in dividends.
Dec. 31 Cash
Investment in Brock Corp.Stock
Recorded 40% share of Brock Corp. dividends.

74. Investments and Dividends

75. Sale of Investments in Stocks
On March 1, an investment in Drey Inc. stock that had a carrying amount of $15,700 is sold for $17,500.
Mar. 1 Cash
Investment in Drey Inc. Stock
Gain on Sale of Investments

76. Phillips Company purchased 30% of the outstanding stock of Singh Company on January 1, Singh reported net income of $90,000 and declared dividends of $15,000 during How much would Phillips adjust their investment in Singh Company under the equity method?

77. Phillips share of Singh reported net income (30% x $90,000) $27,000
Less: Phillips share of the Singh dividend (30% x $15,000) 4,500
Increase in Investment in Singh Company Stock $22,500

78. Financial Analysis and Interpretation
14-5
14-5
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. This ratio, called the price-earnings ratio, or P/E ratio, is commonly included in stock market quotations.

79. Earnings per Share of Common Stock
Earnings Per Share
Net Income
Common Shares
Earnings per Share of Common Stock =
Price - Earnings Ratio
Market Price Per Share
of Common Stock
Earnings Per Share of
Common Stock
Price-
Earnings
Ratio =

80. 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.

81. An example:
Market price per share $24.60 $16.20
Earnings per share $ $1.35
Price-earnings ratio
The price-earnings ratio indicates that a share of common stock was selling for 12 times the amount of earnings per share at the end of 2007 and 15 times earnings per share at the end of

82. Summary J/E’s for corporate income tax Unusual Items
Income statement for EPS
Comprehensive Income
Accounting for Investments in stock