Update Exercises related to Income Statement Reporting of ...



Update Exercises related to Chapter 4 of Intermediate Accounting

(Income Statement Reporting of Accounting Changes)

UE4-1 (Accounting Change) During 2007 Lebron James Company changed from FIFO to weighted average inventory pricing. Pretax income in 2006 and 2005 (James’ first year of operations) under FIFO was $160,000 and $180,000 respectively. Pretax income using weighted average pricing in the prior years would have been $145,000 in 2006 and $170,000 in 2005. In 2007, Lebron James Company reported pretax income (using weighted average pricing) of $190,000. Show comparative income statements for Lebron James Company, beginning with Income before taxes, as presented on the 2007 income statement (the tax rate in all years is 30%).

UE4-2 (Retained Earnings Statement, Accounting Change) Eddie Zambrano Corporation began operations on January 1, 2004. During its first 3 years of operations, Zambrano reported net income and declared dividends as follows.

Net income Dividends declared

2004 $ 40,000 $ -0-

2005 125,000 50,000

2006 160,000 50,000

The following information relates to 2007.

Income before income tax $240,000

Prior period adjustment: understatement of 2005 depreciation expense (before taxes) $ 25,000

Cumulative decrease in income from change in inventory methods (before taxes) $ 35,000

Dividends declared (of this amount, $25,000 will be paid on Jan. 15, 2008) $100,000

Effective tax rate 40%

Instructions

a) Prepare a 2007 retained earnings statement for Eddie Zambrano Corporation.

b) Assume Eddie Zambrano Corp. restricted retained earnings in the amount of $70,000 on December 31, 2007. After this action, what would Zambrano report as total retained earnings in its December 31, 2007, balance sheet?

UE4-3 (Accounting Change) Tim Mattke Company began operations in 2005 and for simplicity reasons, adopted weighted average pricing for inventory. In 2007, in accordance with other companies in its industry, Mattke changed its inventory pricing to FIFO. The pretax income data is reported below.

|Year |Weighted Average |FIFO | |

|2005 |$370,000 |$395,000 | |

|2006 |390,000 |430,000 | |

|2007 |410,000 |450,000 | |

Instructions

a) What is Mattke’s net income in 2007. Assume a 30% tax rate in all years.

b) Compute the cumulative effect of the change in accounting principle from weighted average to FIFO pricing.

c) Show comparative income statements for Tim Mattke Company, beginning with Income before taxes, as presented on the 2007 income statement.

UE4-4 (Irregular Items) Tony Rich Inc. reported income from continuing operations before taxes during 2007 of $790,000. Additional transactions occurring in 2007 but not considered in the $790,000 are as follows.

1. The corporation experienced an uninsured flood loss (extraordinary) in the amount of $80,000 during the year. The tax rate on this item is 46%.

2. At the beginning of 2005, the corporation purchased a machine for $54,000 (salvage value of $9,000) that had a useful life of 6 years. The bookkeeper used straight-line depreciation for 2005, 2006, and 2007 but failed to deduct the salvage value in computing the depreciation base.

3. Sale of securities held as a part of its portfolio resulted in a loss of $57,000 (pretax).

4. When its president died, the corporation realized $110,000 from an insurance policy. The cash surrender value of this policy had been carried on the books as an investment in the amount of $46,000 (the gain is nontaxable).

5. The corporation disposed of its recreational division at a loss of $115,000 before taxes. Assume that this transaction meets the criteria for discontinued operations.

6. The corporation decided to change its method of inventory pricing from average cost to the FIFO method. The effect of this change on prior years is to increase 2005 income by $60,000 and decrease 2006 income by $20,000 before taxes. (The tax rate on these items is 40%.) The FIFO method has been used for 2007.

Instructions

Prepare an income statement for the year 2007 starting with income from continuing operations before taxes. Compute earnings per share as it should be shown on the face of the income statement. Common shares outstanding for the year are 80,000 shares. (Assume a tax rate of 30% on all items, unless indicated otherwise.)

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