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TitleanthonyIM_10
TagsDebits And Credits Book Value Deferred Tax Retained Earnings Dividend
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Table of Contents
                            Changes from Eleventh Edition
Approach
Cases
Problems
	Problem 10-1
	Problem 10-2
	Problem 10-4
	Problem 10-5
Cases
	Approach
	Answers to Questions
	Approach
	Comments on Questions
	Approach
	Comments on Questions
                        
Document Text Contents
Page 1

CHAPTER 10
OTHER ITEMS THAT AFFECT

NET INCOME AND OWNER’S EQUITY

Changes from Eleventh Edition

Updated from Eleventh Edition.

Approach

This chapter contains several topics that instructors may wish to emphasize in varying degrees. In
particular, the rather detailed rules on extraordinary items, discontinued operations, change in accounting
principles, and correction of errors may be more than students can readily assimilate; they can always
refer back to the rules if this becomes necessary.

Similarly, some instructors prefer not to get into foreign currency matters at all in an introductory course;
some cover transactions but not translation; and others cover both, perhaps because of the increased
emphasis on covering international issues in the overall core curriculum.

With respect to personnel costs, the important point is the difference between transactions that are costs to
the company and those that result from the company serving as a collection agency for the government. In
my own view, any details of pension accounting can be withheld for an intermediate course, but I want
students to have an overview of the issues and complications of pension accounting.

I spend the most time on deferred taxes, both because virtually every set of financial statements students
are likely to see will contain this item and because it always seems to be a difficult topic for students to
master. The ease of teaching this subject diminished even further when MACRS allowances replaced the
usual tax deprecation illustrations using sum-of-the-years’-digits depreciation. FAS109, in my view,
further complicates matters.

Cases

Norman Corporation (B) raises some new, and reviews some old, issues in expense recognition.

Silver Appliance Company enables students to explore deferred tax accounting in the context of the
installment method of reporting installment sales revenues.

Kansas City Zephyrs Baseball Club, Inc., requires students to apply accrual accounting to cash flows in
order to properly match costs and revenues.

Freedom Technology Company deals with the translation of financial statements. If desired, both the
currently required method and alternative approaches can be compared.

Proxim, Inc. raises issues related to proforma earnings disclosures. This case is new with the Twelfth
Edition.

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Page 7

©2007 McGraw-Hill/Irwin Chapter 10

The transaction must be reported in the year in which the decision to sell is made, in this case, 2006.
It is reported in two parts:

a. Operating income of the parking lot for 2006 is set out separately. In this case, it would be
$19,000, less applicable income taxes, assumed here to be $7,600 (40%), an increase in net
income of $11,400.

b. AP-30, par. 15, requires recognizing a loss on discontinued operations at the measurement date
(here, December 31, 2006); but a gain should not be reported until it is realized. This is consistent
with the conservatism concept. Thus, Norman’s treatment of this item was correct, even though
its rationale was not the relevant one.

8. The fact that the president sold the stock for $25,000 is irrelevant. This was a transaction between two
outside parties, and had no effect on the Norman Corporation itself. The $3,000 gain on the sale of the
treasury stock does not affect income. A corporation cannot make a gain by issuing its own stock. The
$3,000 should have been credited directly to Capital Surplus (which is the term used by Norman, but
which more properly is called Additional Paid-in Capital).

9. The charge to Retained Earnings should have been made when the $50,000 dividend was declared,
not when it was paid. Thus, the 2006 dividend should have been charged to Retained Earnings in
2006 rather than in 2007, so the amount reported as dividends for 2006 was correct. The result of
Norman’s practice is to omit a current liability, Dividends Payable. The balance sheet should
therefore be adjusted by increasing current liabilities by $50,000 and decreasing Retained Earnings by
$50,000. (There is, of course, no impact on income from dividend transactions.)

The effect of these transactions is summarized in Exhibit A.

Question 2

Norman could “clean up” its net nonoperating income and expense account (which should be called
nonoperating revenue and expense, but usually isn’t in practice). These items actually are either operating
items (e.g., interest expense, which should be shown as a separate line), or extraordinary items,
accounting changes, correction of errors, or discontinued operations (all “below the line” items).

EXHIBIT A
NORMAN CORPORATION (B)

Item
Effect on Income of
Required Changes

1 None
2 None (?)
3 (a) $ -19,000
3 (b) -105,648
4 -35,000
5 -14 000 (?)
6 (a) +1,250
6 (b) +19,650
7 (a) None
7 (b) None
8 -3,000
9 None

Net effect..............................................................................................................................................................................................$-155,748
Of which, change in accounting principles...........................................................................................................................................$ - 85,998
Discontinued operations....................................................................................................................................................................... None
Other.................................................................................................................................................................................................... -69,750

$-155,748

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Page 8

Accounting: Text and Cases 12e – Instructor’s Manual Anthony/Hawkins/Merchant

Case 10-2: Silver Appliance Company *

Note: This case is the same version that was in the Eleventh Edition.

Approach

This case enables students to get some “hands-on” experience in dealing with the complex matter of
deferred taxes, and also in applying the installment method that was described in Chapter 5. It also
requires them to think through how these complexities can be explained to a nonaccountant, and to
recognize that a change in accounting method for tax purposes may involve transitional problems relating
to potential double taxation of income.

Many students will have difficulties figuring out the calculations required for Question 1. These
difficulties can be mitigated by including on the assignment sheet a worksheet format like that used in
Exhibit A of this note. Alternatively, we can hand out in class a copy of Exhibit A, or have them copy it
from a transparency. In any event, in class I go through an example for one year using T accounts, as
follows:

“Book” Tax
Sales.....................................................................................................................................................................................................$1,000 $900
Cost of sales @ 70%............................................................................................................................................................................ 700 630
Gross margin........................................................................................................................................................................................ 300 270
Other expenses..................................................................................................................................................................................... 200 200
Pretax income....................................................................................................................................................................................... 100 70
Income tax expense @ 34%................................................................................................................................................................. 34 23.8
Actual taxes as percent of pretax “Book” income................................................................................................................................34% 23.8%

Cash (or Taxes
Payable)

Income Tax
Expense

Deferred
Taxes

23.8 34 10.2

This illustrates both the basic concept of deferred taxes, and also the rationale  taxes as a percent of
pretax income would be understated (23.8% instead of the “true” 34%) if the “book” income tax expense
amount were the amount of actual taxes rather than the actual tax rate applied to “book” pretax income.
This example uses the deferral method--rather than the liability method--to compute deferred taxes.
Students find this deferral method easier to understand.

Comments on Questions

Question 1

The required calculations are displayed in Exhibit A. Line 8 shows how much less Silver’s taxes would
have been in 1989-93 and that taxes would have been higher in 1993 using the installment method. Line 9
shows each year’s year-end balance of Deferred Taxes; again, note that the reversal in 1993 causes the
balance to decrease.

*This teaching note was prepared by James S. Reece. Copyright © James S. Reece.

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