Income Taxes, Unusual Items, Investments in Stocks

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. 0 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. 0 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. 0 Objective 1 Journalize the entries for corporate income taxes, including deferred income taxes.

5. 0 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 21 000 00 Cash 21 000 00

6. 0 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. 0 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. Revenues or gains are taxed after they are reported in the income statement. 0 Examples of Items That Create Temporary Differences • Expenses or losses are deducted in determining taxable income after they are reported in the income statement.

9. 0 • Revenues or gains are taxed before they are reported on the income statement. • Expenses or losses are deducted in determining taxable income beforethey are reported in the income statement.

10. Total Years 1-5 Year 1 Year 2 Year 3 Year 4 Year 5 0 Exhibit 1 Temporary Differences MACRS (tax depreciation) Straight-line (financial statement depreciation) Total depreciation is the same for tax and financial purposes.

11. 0 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. 0 The entry to record income taxes reflects the deferred amount of $80,000. Income Tax Expense 120 000 00 Income Tax Payable 40 000 00 Deferred Income Tax Payable 80 000 00

13. 0 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 48 000 00 Income Tax Payable 48 000 00

14. 0 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 0

16. 0 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 arepermanent differencesthat never reverse. • Interest income that is exempt on municipal bonds is an example of this type of a permanent difference.

17. 0 Objective 2 Describe and illustrate the reporting of unusual items on the income statement.

18. 0 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. 0 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. 0 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. 0 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 750 000 00 Equipment 750 000 00 To record impairment of fixed assets due to plant closing.

22. 0 Reporting of Unusual Items on the Income Statement Fixed asset impairments

23. 0 Unusual Items in the Income Statement 23

24. 0 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. 0 Restructuring Charges Restructuring chargesare costs incurred with actions such as canceling contracts, laying off or relocating employees, and combining operations.

26. 0 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. 0 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 1,000 000 00 Employee Termination Obligation 1,000 000 00 To record impairment of fixed assets due to plant closing.

28. 0 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. 0 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 125 000 00 Cash 125 000 00 To record payment to 25 employees as severance compensation.

30. 0 Reporting of Unusual Items on the Income Statement Restructuring charges

31. 0 Unusual Items in the Income Statement

32. 0 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. 0 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. 0 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. 0 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. 0 Reporting of Unusual Items on the Income Statement Discontinued operations

37. 0 14-2 Unusual Items in the Income Statement 37

38. 0 14-2 Reporting Unusual Items on the Income Statement Unusual items that adjust income from continuing operations in determining net income are: Discontinued operations Extraordinary items

39. 0 14-2 Extraordinary Items 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. 0 14-2 14-2 Reporting of Unusual Items on the Income Statement Insert Exhibit 2 here also, p. 13 Extraordinary items 40

41. 0 Unusual Items in the Income Statement

42. 0 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 • changesfrom one generally accepted accounting principle to another generally accepted accounting principle.

43. 0 Reporting of Unusual Items on the Income Statement Unusual items affecting prior period income statements

44. 0 Objective 3 Prepare an income statement reporting earnings per share data.

45. 0 Earnings per Common Share The profitability of companies is often expressed as earnings per share. Earningsper common share (EPS), sometimes called basic earnings per share, is the net income per share of common stock outstanding during a period.

46. Earningsper common share Net Income Number of common shares outstanding = Earningsper common share Net Income – Preferred stock dividends Number of common shares outstanding = 0 If there is no preferred stock: If there is preferred stock:

47. 0 Income Statement with Earnings per Share

48. $250,000 – $18,000* 580,000 $0.40 per share Earnings per share = = 0 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. *2,000 shares x $100 par value x 9% = $18,000

49. 0 Objective 4 Describe the concept and the reporting of comprehensive income.

50. 0 Comprehensive Income Comprehensive income is defined as all changes in stockholders’ equity during a period, except those resulting from dividends and stockholders’ investments.