Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Other Nonowner Items that Affect Owners’ Equity © The McGraw-Hill Companies, Inc., Part One: Financial Accounting

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 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 Expenses46,157 Income from continuing operations before income taxes14,124 Provision for income taxes 5,650 Income from continuing operations8,474 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 $640960(1,440)

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 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 restated40,200 Add net income6,034 Deduct dividends (2,000) Retained earnings at end of year$44,234 Detailed Condensed Statement (Bottom) Slide 10-2

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999  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. Extraordinary Items Slide 10-3 In order to qualify as an extraordinary item, an event must satisfy two criteria:

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 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 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 Extraordinary Items Slide 10-4 The following gains and losses are specifically not extraordinary:

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 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 Discontinued Operations Slide 10-5

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 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 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 Discontinued Operations Slide 10-6 Two amounts are reported on the income statement after their income tax effect has been taken into account:

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Change in Accounting Principles Slide 10-7 Sometimes a change is required by a new FASB Statement. The consistency concept requires that a company use the same accounting principle from one year to the next. If a company has a sound reason for doing so, it may occasionally shift from one GAAP to another one. 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.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Adjustments to Retained Earnings Slide 10-8 Only correction of past periods errors is allowed as an adjustment to Retained Earnings. Only correction of past periods errors is allowed as an adjustment to Retained Earnings.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Mathematical mistakes Mistakes in the application of accounting principles An oversight or misuse of facts Mathematical mistakes Mistakes in the application of accounting principles An oversight or misuse of facts Adjustments to Retained Earnings Slide 10-8 So, what is an error? So, what is an error?

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 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 Personnel Costs Slide 10-9 Deductions from an employee’s paychecks:

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Personnel Costs Slide 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 Wages Payable Employment Tax Cost99.90 FICA Taxes Payable45.90 Unemployment Taxes Payable54.00

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Personnel Costs Slide When wages are paid: Wages Payable Cash FICA Taxes Payable45.90 Withholding Taxes Payable63.00 When the government is paid: FICA Taxes Payable91.80 Unemployment Taxes Payable54.00 Withholding Taxes Payable63.00 Cash $ $45.90 $ $45.90

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 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 Pensions Slide A company’s pension cost is the sum of four elements.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Pensions Slide The net pension cost using a defined benefit plan are $500,000 Net Pension Cost500,000 Unfunded Accrued Pension Cost500,000 A liability A subsequent contribution of $450,000 is made to the plan by the employer. Unfunded Accrued Pension Cost450,000 Cash450,000

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Income Taxes Slide 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. In the first year the depreciation charge for tax purposes will be higher than the depreciation for financial reporting purposes. 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. 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.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Deferred Income Taxes Slide 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). Assets = Liabilities + Owners’ Equity - $272,000 Retained Earnings - $340,000 Reflecting actual tax bill paid Reflecting tax expense used to measure book income

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Deferred Income Taxes Slide 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--Current272,000 Income Tax Expense--Deferred68,000 Cash272,000 Deferred Income Taxes Liability68,000

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Deferred Tax Measurement Slide $1,000.0 $ 333.3$ 666.7$ , , , , $5,000.0$1,000.0$4,000.0$1,600.0 Income before Depreciation Taxable Taxes Due Year Depreciation and Taxes Charge Income (at 40 percent rate) Calculation of Taxes Due (thousands of dollars)

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Deferred Tax Measurement Slide $1,000.0 $333.3$333.3$ , , , , , Original Annual Cumulative Year Depreciable Cost Tax Depreciation Tax Depreciation Tax Basis Tax Basis Calculation (thousands of dollars)

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Deferred Tax Measurement Slide $1,000.0 $200.0$200.0$ , , , , , Original Annual Book Cumulative Book Net Book Year Book Cost Depreciation Depreciation Value Net Book Value Calculation (thousands of dollars)

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Deferred Tax Measurement Slide When the taxes are paid: Income Tax Payable266,700 Cash266,700 Combining all three 1998 entries: Income Tax Expense320,000 Cash266,700 Deferred Income Taxes Liability53,300

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Chapter 10 The End