Other Nonowner Items that Affect Owners’ Equity

1. 10 Other Nonowner Items that Affect Owners’ Equity Part One: Financial Accounting • The McGraw-Hill Companies, Inc., 1999

2. Detailed Condensed Statement (Top) Slide 10-1 BASEL CORPORATION Condensed Statement of Income and Retained Earnings Year Ended December 31, 1998 (in thousands) Net sales and other revenue $60,281 Expenses 46,157 Income from continuing operations before income taxes 14,124 Provision for income taxes 5,650 Income from continuing operations 8,474 Discontinued operations (Note A): Loss from operations of Division X (less applicable income taxes of $320) $480 Loss on disposal of Division X (less applicable income taxes of $640 960 (1,440)

3. Detailed Condensed Statement (Bottom) Slide 10-2 Extraordinary loss (less applicable income taxes of $400)(Note B) (600) Cumulative effect of changes in accounting principles (less applicable income taxes of $125)(Note C) (400) Net income $ 6,034 Retained earnings at beginning of year: As previously reported $41,400 Adjustments (Note D) (1,200) As restated 40,200 Add net income 6,034 Deduct dividends (2,000) Retained earnings at end of year $44,234

4. Extraordinary Items Slide 10-3 In order to qualify as an extraordinary item, an event must satisfy twocriteria: • The event must be unusual; it should be highly abnormal and unrelated to, or only incidentally related to, the ordinary activities of the entity. • The event must occur infrequently; it should be of a type that would not reasonably be expected to recur in the foreseeable future.

5. Extraordinary Items Slide 10-4 The following gains and losses are specifically notextraordinary: • Write-down or write-off of accounts receivable, inventory, or intangible assets • Gains or losses from changes in the value of foreign currency • Gains or losses on disposal of a segment of a business • Gains or losses from the disposal of fixed assets • Effects of a strike

6. Discontinued Operations Slide 10-5 • The transaction must involved a whole business • Discontinuance may occur by abandoning the segment and selling off the assets • Discontinuance may occur by selling the whole segment as a unit to some other company

7. Discontinued Operations Slide 10-6 Two amounts are reported on the income statement after their income tax effect has been taken into account: 1. The net income or loss attributed to the operations of the segment until it is sold 2. The estimated net gain or loss on disposal after taking account of all aspects of the sale, including the amount received and the write-off of assets that are not sold

8. Change in Accounting Principles Slide 10-7 Sometimes a change is required by a new FASB Statement. If a company has a sound reason for doing so, it may occasionally shift from one GAAP to another one. The consistency concept requires that a company use the same accounting principle from one year to the next. The cumulative effect of the change is reported as one of the nonrecurring items on the income statement in the year the changed is made.

9. Adjustments to Retained Earnings Slide 10-8 Only correction of past periods errors is allowed as an adjustment to Retained Earnings.

10. So, what is an error? Adjustments to Retained Earnings Slide 10-8 • Mathematical mistakes • Mistakes in the application of accounting principles • An oversight or misuse of facts

11. Personnel Costs Slide 10-9 Deductions from an employee’s paychecks: • An amount representing the employee’s FICA contribution and medicare coverage • An amount withheld from gross earnings to apply toward the employee’s personal state and federal income taxes • Deductions for charitable contributions, savings plans, union dues, and a variety of other items

12. Personnel Costs Slide 10-10 If an employee with three dependents earned $600 for work in a certain week in 1998, $45.90 for FICA and $63.00 for withholding tax would be deducted from this $600. The employer incurs a matching expense of $45.90 for FICA plus $54 for federal and state unemployment insurance taxes. When wages are earned: Wages Cost 600.00 Wages Payable 600.00 Employment Tax Cost 99.90 FICA Taxes Payable 45.90 Unemployment Taxes Payable 54.00

13. Personnel Costs Slide 10-11 When wages are paid: Wages Payable 600.00 Cash 491.10 FICA Taxes Payable 45.90 Withholding Taxes Payable 63.00 When the government is paid: FICA Taxes Payable 91.80 Unemployment Taxes Payable 54.00 Withholding Taxes Payable 63.00 Cash 208.80 $45.90 + $45.90

14. Pensions Slide 10-12 A company’s pension cost is the sum of four elements. • The year’s service cost element • The year’s interest cost element • The actual return on plan assets element • The amortization of several other pension-related items

15. Pensions Slide 10-13 The net pension cost using a defined benefit plan are $500,000 Net Pension Cost 500,000 Unfunded Accrued Pension Cost 500,000 A liability A subsequent contribution of $450,000 is made to the plan by the employer. Unfunded Accrued Pension Cost 450,000 Cash 450,000

16. Income Taxes Slide 10-14 A company buys personal computers costing over $15,000 each. For tax purposes it elects to use an accelerated depreciation method. For financial reporting purposes it decides to use the straight-line method. If all other items are accounted for in the same way, the company’s taxable income for the year will be lower than its book pre-tax income. In the first year the depreciation charge for tax purposes will be higher than the depreciation for financial reporting purposes. At the end of the year the net carrying amount of the computers on the company’s tax books will be lower than their net carry amount on the company’s financial reporting books.

17. Assets = Liabilities + Owners’ Equity - $272,000 Retained Earnings - $340,000 Deferred Income Taxes Slide 10-15 Because of temporary differences, in 1998 a corporation reported $1 million pre-tax income to its shareholders and $800,000 taxable income to the IRS (resulting in an income tax expense of $340,000 and a tax liability of only $272,000). Reflecting actual tax bill paid Reflecting tax expense used to measure book income

18. Deferred Income Taxes Slide 10-16 Because of temporary differences, in 1998 a corporation reported $1 million pre-tax income to its shareholders and $800,000 taxable income to the IRS (resulting in an income tax expense of $340,000 and a tax liability of only $272,000). Income Tax Expense--Current 272,000 Income Tax Expense--Deferred 68,000 Cash 272,000 Deferred Income Taxes Liability 68,000

19. Deferred Tax Measurement Slide 10-17 Income before Depreciation Taxable Taxes Due Year Depreciation and Taxes Charge Income (at 40 percent rate) 1998 $1,000.0 $ 333.3 $ 666.7 $ 266.7 1999 1,000.0 266.7 733.3 293.3 2000 1,000.0 200.0 800.0 320.0 2001 1,000.0 133.3 866.7 346.7 2002 1,000.0 66.7 933.3 373.3 $5,000.0 $1,000.0 $4,000.0 $1,600.0 Calculation of Taxes Due (thousands of dollars)

20. Deferred Tax Measurement Slide 10-18 Original Annual Cumulative Year Depreciable Cost Tax Depreciation Tax Depreciation Tax Basis 1998 $1,000.0 $333.3 $333.3 $666.7 1999 1,000.0 266.7 600.0 400.0 2000 1,000.0 200.0 800.0 200.0 2001 1,000.0 133.3 933.3 66.7 2002 1,000.0 66.7 1,000.0 -0- Tax Basis Calculation (thousands of dollars)

21. Deferred Tax Measurement Slide 10-19 Original Annual Book Cumulative Book Net Book Year Book Cost Depreciation Depreciation Value 1998 $1,000.0 $200.0 $200.0 $800.0 1999 1,000.0 200.0 400.0 600.0 2000 1,000.0 200.0 600.0 400.0 2001 1,000.0 200.0 800.0 200.0 2002 1,000.0 200.0 1,000.0 -0- Net Book Value Calculation (thousands of dollars)

22. When the taxes are paid: Income Tax Payable 266,700 Cash 266,700 Combining all three 1998 entries: Income Tax Expense 320,000 Cash 266,700 Deferred Income Taxes Liability 53,300 Deferred Tax Measurement Slide 10-20

23. Chapter 10 TheEnd