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lays would cause R&D expenditures to de- penditures should be expensed in the period incurred. Among the arguments
for expensing R&D costs is the frequent inability to find a definite causal re-
crease? Why or why not?


Expense/Asset Continuum
exhibit 8-5




Office
Research Land
Supplies
and and
Used
Repairs Development Building




Asset
Expense
368 f369
Completing The Operating Cycle Chapter 8
Completing the Operating Cycle


lationship between the expenditures and future revenues. Sometimes very large expendi-
fyi
tures do not generate any future revenue, while relatively small expenditures lead to sig-
The International Accounting nificant discoveries that generate large revenues. The FASB found it difficult to establish
Standards Committee (IASC) criteria that would distinguish between those R&D expenditures that would most likely
has established an R&D ac- benefit future periods and those that would not.
In summary, the FASB concluded that R&D expenditures are undertaken to benefit
counting rule that many think is
future periods, but that it is impractical to identify which R&D expenditures actually do
superior to the FASB rule. The
provide future economic benefit. Accordingly, all R&D costs are to be recorded as ex-
IASC rule requires research
penses in the year they are incurred. This rule leads to a systematic overstatement of R&D
costs to be expensed and de-
expenses and a systematic understatement of R&D assets. The rule was roundly criticized
velopment costs to be capital-
in 1974 as the FASB prepared to release it. The FASB received many comments predict-
ized. Research costs are defined
ing that if firms were required to expense all R&D costs, they would be forced to signif-
as those R&D costs incurred be-
icantly cut back on research expenditures to avoid hurting reported earnings. This, ac-
fore technological feasibility
cording to these comment letters, would cripple the U.S. economy. And the U.S. economy
has been established.
did indeed suffer in the mid-1970s, and R&D expenditures did decrease, but these oc-
currences may have had more to do with skyrocketing oil prices and double-digit infla-
tion than with the R&D accounting rule passed by the FASB.

Advertising
Every year in the two weeks of hype preceding the Super Bowl, we hear about the incredible
number of media people covering the event and about how much money advertisers are paying
for a 30-second spot during the broadcast. We also hear a little bit about the football teams.
With advertising costs running in excess of $2 million for 30 seconds, one has to believe that
the advertisers expect some future economic benefit from the advertising. So, should advertis-
ing costs be capitalized or expensed?
For accounting purposes, the general presumption is that advertising costs should be ex-
pensed because of the uncertainty of the future benefits. However, in selected cases in which the
future benefits are more certain, advertising costs should be capitalized. This type of advertising
involves targeted advertising to customers who have purchased products in the past. Such ad-
vertising is also characterized by the ability to estimate how many customers will respond fa-
vorably. For example, SEARS discloses in the notes to its 1999 financial statements that it ex-
penses newspaper, television, and radio advertising costs but capitalizes the cost of specialty
catalogs and other direct response advertising. As of December 31, 1999, Sears reported an “ad-
vertising asset” of $180 million in its balance sheet. Of course, this is a rather small amount
compared to the $1.63 billion in advertising that Sears expensed during 1999.
As these discussions of R&D and advertising illustrate, capitalize-or-expense decisions can
be quite difficult from a conceptual standpoint. The general rule of thumb is that, when there
is significant uncertainty about whether an expenditure should be capitalized or expensed, ex-
pense it. This approach is in line with the traditional conservatism of accounting, but be aware
that it can result in a significant understatement of the economic assets of a company.




to summarize
Conceptually, a cost should be recorded as an asset whenever it has a proba-
ble future economic benefit. In practice, it is frequently quite difficult to tell
when a cost should be recorded as an asset (capitalized) and when it should
be recorded as an expense. In some areas, such as research and development
(R&D) and advertising, specific accounting rules have been developed to cre-
ate more uniformity about which costs should be expensed and which should
be capitalized.
369
f370 Part 2 Completing The Operating Cycle
Operating Activities



5 SUMMARIZING OPERATIONS ON AN INCOME
STATEMENT
Prepare an income
statement summarizing
operating activities as well
Having now completed our discussion of operating revenues and expenses (in Chapters 6, 7, and
as other revenues and
thus far in 8), you are ready to examine an income statement, such as the one in Exhibit 8-6, and
expenses, extraordinary
items, and earnings per see how operating results are communicated to investors and creditors. The numbers in the income
share.
statement do not relate to any previous examples; they are shown here for illustrative purposes only.
This income statement shows that with net sales revenue of $2,475,000, P & L Com-
fyi pany had net income of $385,000. The income statement classifies and accounts for the
other $2,090,000 ($2,475,000 $385,000). Sales revenue, cost of goods sold, and op-
Another item that is reported in
erating expenses (which are separated into selling expenses and general and administrative
a separate section of the in-
expenses on the income statement) have already been explained. It is important to note
come statement relates to dis-
that operating income of $726,000 shows how much P & L Company earned from car-
continued operations. When a
rying on its major operations. These items constitute the major ongoing components of
company decides to cease the
the income statement. Items shown at the bottom of the income statement are not part
operations of a segment or a di- of the main operations of the business or are unusual and nonrecurring in nature.
vision, it must provide careful
Other Revenues and Expenses
disclosure as to the past prof-
itability of the segment and the
Other revenues and expenses are those items incurred or earned from activities outside of,
expected costs associated with
or peripheral to, the normal operations of a firm. For example, a manufacturing company
closing the segment. that receives dividends from its investments in the stock of another firm would show those
dividend revenues as “Other Revenues and Expenses.” This way, investors can see how much
of a firm™s income is from its major operating activity and how much is from peripheral activities,
other revenues and ex-
such as investing in other companies. The most common items reported in this section are inter-
penses Items incurred or
est and investment revenues and expenses. The other revenues and expenses category also includes
earned from activities that
gains and losses from the sale of assets other than inventory, such as land and buildings.
are outside of, or peripheral
to, the normal operations of
Extraordinary Items
a firm.

The extraordinary items section of an income statement is reserved for reporting special non-
extraordinary items Nonop-
erating gains and losses operating gains and losses. This category is restrictive and includes only those items that are (1)
that are unusual in nature, unusual in nature, (2) infrequent in occurrence, and (3) material in amount. They are separated
infrequent in occurrence,
from other revenues and expenses so that readers can identify them as onetime, or nonrecur-
and material in amount.
ring, events. Extraordinary items are rare but can include losses or gains from floods, fires, earth-
quakes, and so on. For example, in 1980 when
The 1980 eruption of
Mount St. Helens erupted in Washington, mud-
Mount St. Helens caused
slides and flooding adversely affected much of the
WEYERHAEUSER COM-
WEYERHAEUSER COMPANY™s timberlands.
PANY to report an extra-
ordinary loss of $66.7 mil-
Weyerhaeuser reported an extraordinary loss of
lion. However, it™s not
$66.7 million in 1980 to cover standing timber,
likely Weyerhaeuser will
buildings, equipment, and other damaged items.
have to worry about that
extraordinary event hap-
Certain other types of gains and losses are required
pening again anytime
by generally accepted accounting principles to be
soon!
reported as extraordinary items. These involve
technical accounting issues that are discussed in
more advanced texts.
If a firm has an extraordinary loss, its taxes
are lower than they would be on the basis of or-
dinary operations. P & L Company, for example,
actually paid only $165,000 ($195,000 based on
operations less a $30,000 tax benefit from the ex-
traordinary loss) in taxes. On the other hand, if a
firm has an extraordinary gain, its taxes are in-
creased. Therefore, to ensure that the full effect of
the gain or loss is presented, extraordinary items
are always shown together with their tax effects so
370 f371
Completing The Operating Cycle Chapter 8
Completing the Operating Cycle



Sample Income Statement
exhibit 8-6


P & L Company
Income Statement
For the Year Ended December 31, 2003

Revenues:
Gross sales revenue . . . . . . . . . . . . . . . . . . . . . . . $2,500,000
Less: Sales returns . . . . . . . . . . . . . . . . . . . . . . . . (12,000)
Less: Sales discounts . . . . . . . . . . . . . . . . . . . . . . (13,000)
Net sales revenue . . . . . . . . . . . . . . . . . . . . . . . $2,475,000
Cost of goods sold. . . . . . . . . . . . . . . . . . . . . . . . . . 1,086,000
Gross margin. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,389,000
Operating expenses:
Selling expenses:
Sales salaries expense. . . . . . . . . . . . . . . . . . . . $200,000
Sales commissions expense . . . . . . . . . . . . . . . 60,000
Advertising expense . . . . . . . . . . . . . . . . . . . . . 45,000
Delivery expense . . . . . . . . . . . . . . . . . . . . . . . . 14,000
Total selling expenses . . . . . . . . . . . . . . . . . . $ 319,000
General and administrative expenses:
Administrative salaries expense. . . . . . . . . . . . . $278,000
Rent expense, office equipment. . . . . . . . . . . . . 36,000
Property tax expense. . . . . . . . . . . . . . . . . . . . . 22,000
Miscellaneous expenses . . . . . . . . . . . . . . . . . . 8,000
Total general and administrative expenses . . . 344,000
Total operating expenses . . . . . . . . . . . . . . . . 663,000
Operating income . . . . . . . . . . . . . . . . . . . . . . . . . . $ 726,000
Other revenues and expenses:
Dividend revenue . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,000
Gain on sale of land . . . . . . . . . . . . . . . . . . . . . . . 4,000
Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . (85,000)
Net other revenues and expenses . . . . . . . . . . . (76,000)
Income from operations before income taxes . . . . . $ 650,000
Income taxes on operations (30%) . . . . . . . . . . . . . . 195,000
Income before extraordinary item . . . . . . . . . . . . . . $ 455,000
Extraordinary item:
Flood loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (100,000)
Income tax effect (30%) . . . . . . . . . . . . . . . . . . . . 30,000 (70,000)
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 385,000
Earnings per share (100,000 shares outstanding):
Income before extraordinary item . . . . . . . . . . . . . $4.55
Extraordinary loss. . . . . . . . . . . . . . . . . . . . . . . . . (0.70)
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3.85




that a net-of-tax amount can be seen. Thus, income tax expense may appear in two places on
the income statement: below operating income before income taxes and in the extraordinary
earnings per share (EPS) items section.
The amount of net income
(earnings) related to each
Earnings per Share
share of stock; computed
by dividing net income by
As noted in Chapter 2, a company is required to show earnings per share (EPS) on the in-
the number of shares of
come statement. If extraordinary items are included on the income statement, a firm will report
stock outstanding during
EPS figures on income before extraordinary items, on extraordinary items, and on net income.
the period.
371
f372 Completing The Operating Cycle
Part 2 EOC Operating Activities


Earnings per share is calculated by dividing a firm™s net income by the number of shares
caution of stock outstanding during the period. Exhibit 8-6 assumes that 100,000 shares of stock
are outstanding. Earnings per share amounts are important because they allow potential
Actual EPS computations are
investors to compare the profitability of all firms, whether large or small. Thus, the per-
much more complicated than
formance of a company earning $200 million and having 200,000 shares of stock out-
shown here. Changes in the
standing can be compared with a company earning $60,000 and with 30,000 shares out-
shares outstanding during the
standing.
period must be considered
when calculating EPS. In addi- Differing Income Statement Formats
tion, there is another EPS fig-
The income statement featured in Exhibit 8-6 demonstrates detailed disclosure of a com-
ure, called diluted earnings per
pany™s operations. Most companies do not provide that level of detail. The information
share, that considers the po-
contained in income statements varies from company to company. For example, MI-
tential effect on EPS of things
CROSOFT (see Appendix A) summarizes the results of its operations in 16 lines. IBM,
like the exercising of stock op-
on the other hand, provides detailed revenue and cost figures on the face of its income
tions by shareholders. statements for each of its five operating segments (hardware sales, services, software, main-
tenance, and rentals). FORD MOTOR COMPANY provides detail in its income state-
ments as to the operations of its two very different lines of business”automotive and financial
services. Keep in mind that the format of the income statement will vary across companies but
the information contained in the income statement is the same”revenues and expenses.



to summarize
The results of operating activities are summarized and reported on an income
statement. On an income statement, cost of goods sold is subtracted from net
sales to arrive at gross margin, or the amount a company marks up its inven-
tory. Operating expenses are then subtracted from gross margin to arrive at
operating income. Nonoperating items, such as other revenues and expenses,
extraordinary items, and earnings per share, are reported on the income state-
ment below operating income.




review of learning objectives

Account for the various components of employee for managers to manipulate reported earnings in order to
1 compensation expense. Total employee compensation boost their own bonuses.

can involve some or all of the following: Stock options. The receipt of stock options gives managers
an incentive to take value-enhancing actions that will in-
• Payroll. Companies serve as the agents of federal, state, and
crease their company™s stock price. The intrinsic value
local governments in withholding necessary taxes from em-
method of accounting for stock options assumes that op-
ployees™ wages and salaries. These withholdings are then
tions have potential value only on the day that they are
periodically forwarded to the appropriate government unit.
granted; this method almost always results in no reported
• Compensated absences. The value of vacation and sick days
compensation expense. A more theoretically satisfying ac-
earned this year should be reported as an expense this year
counting method is the fair value method, which results
even though the actual vacation or sick days are not ex-
in reported compensation expense being equal to the es-
pected to be used until a future year.
timated value of the options granted. The FASB encour-
• Bonuses. Employee bonuses, especially those for top man-
ages use of the fair value method, but almost all compa-
agement, are frequently based on reported accounting
nies continue to use the intrinsic value method.
numbers such as net income. This creates some incentive
372 f373
Completing The Operating Cycle EOC Chapter 8
Completing the Operating Cycle



or asset depends on the outcome of uncertain future events.
• Postemployment benefits. When a company makes a deci-
An example is litigation. A company must make an assessment
sion to terminate employees as part of a restructuring, an
as to the likely outcome and then account for the event ac-
expense equal to the expected value of the employee sev-
cordingly. An event that is “probable” will be recognized on
erance benefits is reported in the year in which the ter-
the financial statements. An event for which the outcome is
mination decision is made.
reasonably possible will be disclosed in the notes to the fi-
• Pensions. The difference between the pension obligation
nancial statements, and an event considered remote is not dis-
liability and the market value of the pension fund assets
closed.
is reported as a net asset or liability in the balance sheet.
Environmental liabilities represent another difficulty for
Net pension expense is composed of interest cost and ser-
businesses. These liabilities result when firms damage the en-
vice cost, which are offset by the expected return on the
vironment. The difficulty with these liabilities is determining
pension fund assets.
an amount. Typically, estimates are made along with exten-
• Postretirement benefits other than pensions. Companies are
sive note disclosure.
required to report an annual expense equal to the value
of retiree benefits such as health care and life insurance
Understand when an expenditure should be recorded
that were earned during the year. These benefit plans are
4 as an asset and when it should be recorded as an ex-
not structured as formally as pension plans.
pense. Many expenditures fall into a gray area where it isn™t
certain whether they should be expensed immediately or cap-
Compute income tax expense, including appropriate
2 italized as assets. Specific practices have arisen with respect to
consideration of deferred tax items. Sales taxes col-
many of these difficult-to-classify expenditures. For research
lected are reported as a liability until the funds are forwarded
and development expenditures, all regular R&D costs are ex-
to the appropriate government agency. When property taxes
pensed as incurred. For advertising expenditures, most adver-
are paid in advance, the amount is reported as a prepaid asset
tising costs are expensed immediately. However, the cost of
until the time period covered by the property tax has expired.
targeted advertising for which customer response can be rea-
With respect to income tax, corporations in the United States
sonably estimated is capitalized.
compute two different income numbers”financial income for
reporting to stockholders and taxable income for reporting to
Prepare an income statement summarizing operating
the IRS. For income tax purposes, some income is not taxed
5 activities as well as other revenues and expenses, ex-
until after it has already been reported as financial accounting
traordinary items, and earnings per share. The income state-
income in a previous year. In this case, a deferred income tax
ment is the means of reporting net income. Its major sections
liability is recognized in the year when the income is first re-
are revenues, cost of goods sold, operating expenses, operating
ported in the income statement to reflect that the income will
income, other revenues and expenses, extraordinary items, net
be taxed in a subsequent year. Similarly, some income tax de-
income, and earnings per share.
ductions are not allowed for income tax purposes until after
In addition to cost of goods sold expense, businesses in-
they have been reported as a financial accounting expense in
cur many other operating expenses. With accrual accounting
a prior year. These items represent potentially valuable future
these are reported on the income statement as they are in-
deductions and are recorded as deferred income tax assets.
curred, not when they are paid. Interest and other nonoper-
ating revenues and expenses are classified separately below op-
Distinguish between contingent items that should be
3 erating income. The income statement is not complete until
recognized in the financial statements and those that
all extraordinary items and earnings-per-share amounts have
should be merely disclosed in the financial statement notes.
been included.
A contingent item is one for which the existence of a liability




key terms and concepts

bonus 356 employee stock options 356 pension 358
contingency 365 environmental liabilities 366 postemployment benefits 357
defined benefit plan 358 extraordinary items 370 sales tax payable 361
defined contribution plan 358 other revenues and expenses 370 Social Security (FICA) taxes 354
earnings per share (EPS) 371
373
f374 Completing The Operating Cycle
Part 2 EOC Operating Activities




review problem

The Income Statement From the following information prepare an income statement for Southern Corporation for the
year ended December 31, 2003. Assume that there are 200,000 shares of stock outstanding.

Sales Returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 50,000
Sales Discounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70,000
Gross Sales Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,000,000
Flood Loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80,000
Income Taxes on Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500,000
Administrative Salaries Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 360,000
Sales Salaries Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 800,000
Rent Expense (General and Administrative) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32,000
Utilities Expense (General and Administrative). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,000
Supplies Expense (General and Administrative) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,000
Delivery Expense (Selling) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,300
Payroll Tax Expense (Selling). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,000
Automobile Expense (General and Administrative) . . . . . . . . . . . . . . . . . . . . . . . . . . 3,800
Insurance Expense (General and Administrative) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34,000
Advertising Expense (Selling) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 398,000
Interest Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,000
Interest Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92,000
Insurance Expense (Selling) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,000
Entertainment Expense (Selling) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,200
Miscellaneous Selling Expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,000
Miscellaneous General and Administrative Expenses . . . . . . . . . . . . . . . . . . . . . . . . . 10,800
Tax rate applicable to flood loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30%
Cost of Goods Sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,950,000


Solution The first step in preparing an income statement is classifying items, as follows:


Revenue Accounts

Sales Returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 50,000
Sales Discounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70,000
Gross Sales Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,000,000



Cost of Goods Sold Accounts

Cost of Goods Sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $5,950,000



Selling Expense Accounts

Sales Salaries Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $800,000
Delivery Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,300
Payroll Tax Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,000
Advertising Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 398,000
Insurance Expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,000
Entertainment Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,200
Miscellaneous Selling Expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,000
374 f375
Completing The Operating Cycle EOC Chapter 8
Completing the Operating Cycle



General and Administrative Expense Accounts

Administrative Salaries Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $360,000
Rent Expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32,000
Utilities Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,000
Supplies Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,000
Automobile Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,800
Insurance Expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34,000
Miscellaneous General and Administrative Expenses . . . . . . . . . . . . . . . . . . . . . . . . . 10,800



Other Revenue and Expense Accounts

Interest Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 6,000
Interest Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92,000



Miscellaneous Accounts

Income Taxes on Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $500,000



Extraordinary Item Accounts

Flood Loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $80,000
Tax rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30%


Once the accounts are classified, the income statement is prepared by including the accounts
in the following format:
Net Sales Revenue (Gross Sales Revenue Sales Returns Sales Discounts)
Cost of Goods Sold
Gross Margin
Selling Expenses
General and Administrative Expenses
Operating Income
/ Other Revenues and Expenses (add Net Revenues, subtract Net Expenses)
Income before Income Taxes
Income Taxes on Operations
Income before Extraordinary Items
/ Extraordinary Items (add Extraordinary Gains, subtract Extraordinary Losses, net of applica-
ble taxes)
Net Income

After net income has been computed, earnings per share is calculated and added to the bot-
tom of the statement. It is important that the proper heading be included.

Southern Corporation
Income Statement
For the Year Ended December 31, 2003

Revenues:
Gross sales revenue. . . . . . . . . . . . . . . . . . . . . . . . . . $9,000,000
Less: Sales returns. . . . . . . . . . . . . . . . . . . . . . . . . . . (50,000)
Less: Sales discounts . . . . . . . . . . . . . . . . . . . . . . . . . (70,000)
Net sales revenue . . . . . . . . . . . . . . . . . . . . . . . . . . $8,880,000
(continued)
375
f376 Completing The Operating Cycle
Part 2 EOC Operating Activities


Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,950,000
Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,930,000
Operating expenses:
Selling expenses:
Sales salaries expense . . . . . . . . . . . . . . . . . . . . . . $800,000
Delivery expense . . . . . . . . . . . . . . . . . . . . . . . . . . 6,300
Payroll tax expense. . . . . . . . . . . . . . . . . . . . . . . . . 6,000
Advertising expense . . . . . . . . . . . . . . . . . . . . . . . . 398,000
Insurance expense . . . . . . . . . . . . . . . . . . . . . . . . . 7,000
Entertainment expense . . . . . . . . . . . . . . . . . . . . . . 7,200
Miscellaneous expenses . . . . . . . . . . . . . . . . . . . . . 15,000
Total selling expenses . . . . . . . . . . . . . . . . . . . . . $1,239,500
General and administrative expenses:
Administrative salaries expense . . . . . . . . . . . . . . . $360,000
Rent expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32,000
Utilities expense . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,000
Supplies expense . . . . . . . . . . . . . . . . . . . . . . . . . . 16,000
Automobile expense . . . . . . . . . . . . . . . . . . . . . . . . 3,800
Insurance expense . . . . . . . . . . . . . . . . . . . . . . . . . 34,000
Miscellaneous expenses . . . . . . . . . . . . . . . . . . . . . 10,800
Total general and administrative
expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 460,600
Total operating expenses. . . . . . . . . . . . . . . . . . . 1,700,100
Operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,229,900
Other revenues and expenses:
Interest revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 6,000
Interest expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . (92,000)
Net other revenues and expenses . . . . . . . . . . . . . . (86,000)
Income from operations before income taxes . . . . . . . . $1,143,900
Income taxes on operations . . . . . . . . . . . . . . . . . . . . . 500,000
Income before extraordinary item . . . . . . . . . . . . . . . . . $ 643,900
Extraordinary item:
Flood loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (80,000)
Income tax effect (30%) . . . . . . . . . . . . . . . . . . . . . . . 24,000 (56,000)
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 587,900
Earnings per share:
Before extraordinary items. . . . . . . . . . . . . . . . . . . . . $3.22 ($643,900 200,000 shares)
Extraordinary loss . . . . . . . . . . . . . . . . . . . . . . . . . . . (0.28) ($ 56,000 200,000 shares)
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2.94 ($587,900 200,000 shares)




discussion questions

1. Why is the accounting for payroll-related liabilities 5. What is the primary difference between the intrinsic
more complicated than the accounting for other current value method and the fair value method of accounting
liabilities? for stock-based compensation plans? Which method
2. If the period of time covered by a company™s payroll does the FASB recommend?
does not coincide with the last day of the year for fi- 6. What additional disclosure is required of companies
nancial reporting, how is accounting for the payroll af- that use the intrinsic value method?
fected by this situation? 7. Severance benefits resulting from a company restructur-
3. What is a compensated absence? ing are reported as an expense in the period that the re-
4. What danger is there in basing a manager™s bonus on structuring decision is made rather than when the bene-
reported net income? fits are actually paid. Why?
376 f377
Completing The Operating Cycle EOC Chapter 8
Completing the Operating Cycle



8. What is the difference between a defined contribution 16. What is the difference between a “contingent liability”
pension plan and a defined benefit pension plan? and a “liability”?
9. How is a company™s pension obligation reported in its 17. Escalating environmental liabilities are a major concern
balance sheet? of companies today. How does a company know when
10. List and briefly discuss the three components of pension to record such liabilities?
expense discussed in the chapter. 18. Currently MICROSOFT spends a tremendous amount
11. In what ways do postretirement health-care and life in- of money on research and development costs to contin-
surance benefit plans differ from postretirement pension uously develop new products. How are such R&D costs
plans? accounted for?
12. Why is an end-of-year adjusting entry for property taxes 19. XYZ Corporation pays for advertising costs all the time.
often necessary? Sometimes the company records these payments as as-
13. In your opinion, what is the primary objective of deter- sets, and sometimes it records them as expenses. Why
mining pretax financial accounting income? How does would XYZ use different accounting treatments?
this objective differ from the objectives of determining 20. What types of items would be included on an income
taxable income as defined by the IRS? statement as “other revenues and expenses”?
14. When and how does a company record the amount 21. More than ever before, tremendous attention is being
owed to the government for income taxes for a given paid to a company™s earnings-per-share number. Why
year? do you think investors and creditors pay so much atten-
15. What causes deferred income taxes? tion to earnings per share?




discussion cases


CASE 8-1 RECORDING LIABILITIES AND THE EFFECT ON BONUSES
John Flowers, president of Marquette Company, is paid a salary plus a bonus equal to 10% of
pretax income. The company has just computed its pretax income to be $3.4 million. Based on
this income, Flowers expects to receive a bonus of $340,000. However, the company has just
been told by outside experts that it may have an environmental liability of $2.1 million and that,
based on new actuarial estimates, the recorded amount of postretirement benefits is too low by
$1.2 million. The experts recommend that both of these liabilities be recorded, which would re-
duce income to $100,000 and Flowers™s bonus to $10,000. Flowers believes he does not need
to record the adjustments for the following reasons: the environmental liability is not certain,
the amount of the potential liability can™t be accurately estimated, and “actuarial estimates” are
always changing. Is Flowers violating GAAP if he refuses to allow the company to adjust pretax
income, or is the decision to not record the adjustments acceptable because of the uncertainty
of the liabilities and the amounts?


CASE 8-2 QUESTIONING THE ACCOUNTING FOR PENSIONS, RESEARCH,
AND INCOME TAXES
Tatia Wilks, the president of Lewbacca Company, is concerned about the low earnings that Lew-
bacca is scheduled to report this year. She called the company™s accounting staff into her office
to question them about the accounting treatment of several items. She raised the following points:
a. Why do we have to report an expense this year associated with our pension plan? Our
company is new, and none of our employees is within even 15 years of retirement. Ac-
cordingly, the pension plan won™t cost us anything for at least 15 years.
b. Research to find new products and improve our old products is one of our key competi-
tive advantages. However, you tell me that all of the money we spend on research is re-
ported as an expense this year. This is silly because the results of our research comprise
our biggest economic asset.
377
f378 Completing The Operating Cycle
Part 2 EOC Operating Activities


c. We have an excellent staff of tax planners who work hard to legally minimize the amount
of income taxes we pay each year. However, I see in the notes to the financial statements
that you are requiring our company to report a “deferred income tax expense” for taxes
that we don™t even owe yet! Why?
How would you respond to each of these points?




exercises


EXERCISE 8-1 PAYROLL ACCOUNTING
Stockbridge Stores, Inc., has three employees, Frank Wall, Mary Jones, and Susan Wright.
Summaries of their 2003 salaries and withholdings are as follows:

Federal State FICA
Gross Income Taxes Income Taxes Taxes
Employee Salaries Withheld Withheld Withheld

Frank Wall $54,000 $6,500 $2,500 $4,131
Mary Jones 39,000 4,800 1,900 2,984
Susan Wright 34,000 4,250 1,500 2,601


1. Prepare the summary entry for salaries paid to the employees for the year 2003.
2. Assume that, in addition to FICA taxes, the employer has incurred $192 for federal un-
employment taxes and $720 for state unemployment taxes. Prepare the summary journal
entry to record the payroll tax liability for 2003, assuming no taxes have yet been paid.
3. Interpretive Question: What other types of items are frequently withheld from employ-
ees™ paychecks in addition to income taxes and FICA taxes?

EXERCISE 8-2 BONUS COMPUTATION AND JOURNAL ENTRY
Pete Mehling is the president of Mehling Company, and his cousin, John Mehling, is the vice
president. Their compensation package includes bonuses of 3% for Pete Mehling and 2% for
John Mehling of net income that exceeds $200,000. Net income for the year 2003 has just
been computed to be $990,000.
1. Compute the amount of bonuses to be paid to Pete and John Mehling.
2. Prepare the journal entries to record the accrual and payment of the bonuses. Summarize
all withholding taxes related to the bonuses in an account called Various Taxes Payable.
Taxes payable on the bonuses total $9,200 for Pete and $6,300 for John.

EXERCISE 8-3 STOCK OPTIONS: INTRINSIC AND FAIR VALUE METHODS
On January 1, 2003, the Magily Company established a stock option plan for its senior em-
ployees. A total of 60,000 options were granted that permit employees to purchase 60,000
shares of stock at $48 per share. Each option had a fair value of $11 on the date the options
were granted. The market price for Magily stock on January 1, 2003, was $50. The employ-
ees are required to remain with Magily Company for the entire year of 2003 in order to be
able to exercise these options.
Compute the total amount of compensation expense to be associated with these options
under the:
1. fair value method.
2. intrinsic value method.
378 f379
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Completing the Operating Cycle



EXERCISE 8-4 STOCK OPTIONS: REQUIRED DISCLOSURE
Refer to the information in Exercise 8-3. Magily™s income for 2003, before subtracting any
compensation expense associated with the stock option plan, is $500,000.
Prepare the required supplemental disclosure for 2003 assuming that Magily decides to
use the intrinsic value method.

EXERCISE 8-5 PENSIONS ON THE BALANCE SHEET
Pension plan information for Rabona Company is as follows:
December 31, 2003
Pension obligation liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,000,000
December 31, 2003
Pension fund assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,150,000
During 2003
Total pension expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200,000

How will this information be reported on Rabona™s balance sheet as of December 31, 2003?

EXERCISE 8-6 COMPUTING PENSION EXPENSE
Lorien Company reports the following pension information for 2003:
Pension-related interest cost for the year . . . . . . . . . . $ 80,000
Pension fund assets, end of year . . . . . . . . . . . . . . . . 925,000
Pension obligation liability, end of year . . . . . . . . . . . 870,000
Pension service cost for the year . . . . . . . . . . . . . . . . 75,000
Return on pension fund assets for the year. . . . . . . . . 100,000

1. What pension amount would Lorien report on its balance sheet as of the end of the year?
2. Compute the amount to be reported on the income statement as pension expense for the
year.

EXERCISE 8-7 PENSION COMPUTATIONS
The following pension information is for three different companies. For each company, com-
pute the missing amount or amounts.


Company 1 Company 2 Company 3

Pension fund assets . . . . . . . . . . . . . . . . . $100,000 $75,000 $ (e)
Pension obligation liability . . . . . . . . . . . . (a) 80,000 100,000
Net pension asset (liability). . . . . . . . . . . . 20,000 (c) (25,000)

Pension-related interest cost . . . . . . . . . . . $ 10,000 (d) $ 20,000
Service cost . . . . . . . . . . . . . . . . . . . . . . . 8,000 6,000 23,000
Return on pension plan assets . . . . . . . . . 5,000 8,000 (f)
Pension expense . . . . . . . . . . . . . . . . . . . (b) 10,000 35,000



EXERCISE 8-8 ACCOUNTING FOR PROPERTY TAXES
In July 2003, Reynolds Company received a bill from the county government for property
taxes on its land and buildings for the period July 1, 2002, through June 30, 2003. The
amount of the tax bill is $7,600, and payment is due August 1, 2003. The tax rate will not
change for the period July 1, 2003, to June 30, 2004, and the company does not plan to ac-
quire any additional taxable assets during that period. Reynolds Company uses the calendar
year for financial reporting purposes.
1. Prepare the journal entries to record payment of the property taxes on August 1, 2003.
2. Prepare the adjusting entry for property taxes on December 31, 2003.
379
f380 Completing The Operating Cycle
Part 2 EOC Operating Activities



EXERCISE 8-9 DEFERRED INCOME TAXES
Yosef Company began operating on January 1, 2003. At the end of the first year of operations,
Yosef reported $750,000 income before income taxes on its income statement but only $660,000
taxable income on its tax return. This difference arose because $90,000 in income earned during
2003 was not yet taxable according to the income tax regulations. The tax rate is 35%.
1. Compute the amount of income tax that Yosef legally owes for taxable income generated
during 2003.
2. Compute the amount of income tax expense to be reported on Yosef™s income statement
for 2003.
3. State whether Yosef has a deferred income tax asset or a deferred income tax liability as
of the end of 2003. What is the amount of the asset or liability?

EXERCISE 8-10 DEFERRED INCOME TAXES
Boatogooso Company began operating on January 1, 2003. At the end of the first year of op-
erations, Boatogooso reported $500,000 income before income taxes on its income statement
but taxable income of $600,000 on its tax return. This difference arose because $100,000 in
expenses incurred during 2003 were not yet deductible for income tax purposes according to
the income tax regulations. The tax rate is 40%.
1. Compute the amount of income tax that Boatogooso legally owes for taxable income
generated during 2003.
2. Compute the amount of income tax expense to be reported on Boatogooso™s income
statement for 2003.
3. State whether Boatogooso has a deferred income tax asset or a deferred income tax liabil-
ity as of the end of 2003. What is the amount of the asset or liability?

EXERCISE 8-11 CONTINGENT LIABILITIES
Rayn Company is involved in the following legal matters:
a. A customer is suing Rayn for allegedly selling a faulty and dangerous product. Rayn™s at-
torneys believe that there is a 40% chance of Rayn™s losing the suit.
b. A federal agency has accused Rayn of violating numerous employee safety laws. The com-
pany faces significant fines if found guilty. Rayn™s attorneys feel that the company has
complied with all applicable laws, and they therefore place the probability of incurring
the fines at less than 10%.
c. Rayn has been named in a gender discrimination lawsuit. In the past, Rayn has systemati-
cally promoted its male employees at a faster rate than it has promoted its female employees.
Rayn™s attorneys judge the probability that Rayn will lose this lawsuit at more than 90%.
For each item, determine the appropriate accounting treatment.

EXERCISE 8-12 CLASSIFYING EXPENDITURES AS ASSETS OR EXPENSES
Determining whether an expenditure should be expensed or capitalized is often difficult. Con-
sider each of the following independent situations and indicate whether you would recom-
mend that the cost be expensed or capitalized as an asset. Explain your answer.
1. Splash.com has spent $1.5 million for a 30-second advertisement to be aired during the
Super Bowl. The ad introduces the company™s new Web-based product, and the com-
pany expects the ad to increase sales for at least 18 months.
2. Chromosome.com has spent $8 million on research related to genetic diseases. The com-
pany expects this research to lead to substantial revenues, beginning in the next year.
3. Catalog.com is an online catalog sales company. Catalog.com has just spent $5 million
designing a targeted advertising campaign that will encourage regular customers of the
company™s online catalog service to buy new products.
4. Food.com is an online seller of groceries. The company just spent $4 million building a
new warehouse. The warehouse is expected to be useful for the next 15 years.
380 f381
Completing The Operating Cycle EOC Chapter 8
Completing the Operating Cycle



EXERCISE 8-13 PREPARING AN INCOME STATEMENT
Willow Company is preparing financial statements for the calendar year 2003. The following
totals for each account have been verified as correct:

Office Supplies on Hand . . . . . . . . . . . . . $ 300
Insurance Expense . . . . . . . . . . . . . . . . . . 120
Gross Sales Revenue . . . . . . . . . . . . . . . . 6,000
Cost of Goods Sold . . . . . . . . . . . . . . . . . 3,220
Sales Returns. . . . . . . . . . . . . . . . . . . . . . 200
Interest Expense . . . . . . . . . . . . . . . . . . . 100
Accounts Payable . . . . . . . . . . . . . . . . . . 120
Accounts Receivable . . . . . . . . . . . . . . . . 260
Extraordinary Loss . . . . . . . . . . . . . . . . . . 1,080
Selling Expenses . . . . . . . . . . . . . . . . . . . 360
Office Supplies Used . . . . . . . . . . . . . . . . 80
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300
Revenue from Investments . . . . . . . . . . . 280
Number of Shares of Capital Stock . . . . . 90

Prepare an income statement. Assume a 20% income tax rate on both income from opera-
tions and extraordinary items. Include EPS numbers.


EXERCISE 8-14 UNIFYING CONCEPTS: THE INCOME STATEMENT
Use the following information to prepare an income statement for Fairchild Corporation for
the year ended December 31, 2003. You should show separate classifications for revenues,
cost of goods sold, gross margin, selling expenses, general and administrative expenses, operat-
ing income, other revenues and expenses, income before income taxes, income taxes, and net
income. (HINT: Net income is $27,276.)

Sales Returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,280
Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26,000
Interest Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,400
Office Supplies Expense (General and Administrative) . . . . . . . . . . . . . . . . . . . . . . . . . 400
Utilities Expense (General and Administrative). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,980
Office Salaries Expense (General and Administrative) . . . . . . . . . . . . . . . . . . . . . . . . . 12,064
Miscellaneous Selling Expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 460
Insurance Expense (Selling) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,160
Advertising Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,922
Sales Salaries Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,088
Sales Discounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,644
Interest Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,170
Miscellaneous General and Administrative Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . 620
Insurance Expense (General and Administrative) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 600
Payroll Tax Expense (General and Administrative) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,600
Store Supplies Expense (Selling) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 800
Delivery Expense (Selling) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,198
Inventory, January 1, 2003. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79,400
Sales Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 395,472
Average number of shares of stock outstanding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000
Cost of Goods Sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 262,610
Purchases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 230,560
Purchases Discounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,050
Inventory, December 31, 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44,300
381
f382 Completing The Operating Cycle
Part 2 EOC Operating Activities




problems


PROBLEM 8-1 PAYROLL ACCOUNTING
Orange County Bank has three employees, Albert Myers, Juan Moreno, and Michi Endo. Dur-
ing January 2003, these three employees earned $6,000, $4,200, and $4,000, respectively. The
following table summarizes the required withholding rates on each individual™s income for the
month of January:

Federal Income State Income Tax
Employee Tax Withholdings Withholdings FICA Tax

Albert Myers . . . . . . . . . . . . . . . 33% 3% 7.65%
Juan Moreno . . . . . . . . . . . . . . . 28 4 7.65
Michi Endo . . . . . . . . . . . . . . . . 28 5 7.65


You are also informed that the bank is subject to the following unemployment tax rates on the
salaries earned by the employees during January 2003:
Federal unemployment tax . . . . . 0.8%
State unemployment tax . . . . . . . 3.0%

1. Prepare the journal entry to record salaries payable for the month of January.
Required:
2. Prepare the journal entry to record payment of the January salaries to employees.
3. Prepare the journal entry to record the bank™s payroll taxes for the month of January.

PROBLEM 8-2 DETERMINING PAYROLL COSTS
Orson Nutrition pays its salespeople a base salary of $1,000 per month plus a commission. Each
salesperson starts with a commission of 1% of total gross sales for the month. The commission
is increased thereafter according to seniority and productivity, up to a maximum of 5%. Orson
has five salespeople with gross sales for the month of March and commission rates as follows:

Commission Gross
Rate Sales

JD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.5% $100,000
Derrald . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.0 120,000
Cierra . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.5 80,000
Hannah . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.0 50,000
Skyler . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.0 200,000


The FICA tax rate is 7.65%. In addition, state and federal income taxes of 20% are withheld
from each employee.
1. Compute Orson™s total payroll expense (base salary plus commissions) for the month.
Required:
2. Compute the total amount of cash paid to employees for compensation for the month.
3. Interpretive Question: Briefly outline the advantages and disadvantages of having no in-
come taxes withheld, but instead relying on individual taxpayers to pay the entire amount
of their income tax at the end of the year when they file their tax return.

PROBLEM 8-3 STOCK OPTIONS
On January 1, 2003, Tiger Man Company established a stock option plan for its senior em-
ployees. A total of 400,000 options were granted that permit employees to purchase 400,000
382 f383
Completing The Operating Cycle EOC Chapter 8
Completing the Operating Cycle


shares of stock at $20 per share. Each option had a fair value of $5 on the grant date. The mar-
ket price for Tiger Man stock on January 1, 2003, was $20. The employees are required to re-
main with Tiger Man for three years (2003, 2004, and 2005) in order to be able to exercise
these options. Tiger Man™s net income for 2003, before including any consideration of com-
pensation expense, is $675,000.
Required: 1. Compute the compensation expense associated with these options for 2003 under the fair
value method. Note that the period of time that the employees must work to be able to
exercise the options is three years.
2. Repeat (1) using the intrinsic value method.
3. Prepare any supplemental disclosures needed if Tiger Man uses the intrinsic value
method.
4. Interpretive Question: You are a Tiger Man stockholder. What objections might you
have to Tiger Man™s employee stock option plan?

PROBLEM 8-4 ACCOUNTING FOR PENSIONS
The following information is available from Haan Company relating to its defined benefit pen-
sion plan:
Balances as of January 1, 2003:
Pension obligation liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,500
Pension fund assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000

Activity for 2003:
Service cost . . . . . . . . . . . . . . ........................................... $ 400
Contributions to pension fund ........................................... 230
Benefit payments to retirees. . ........................................... 170
Return on plan assets . . . . . . ........................................... 330
Pension-related interest cost . ........................................... 280

Required: 1. Compute the amount of pension expense to be reported on the income statement for
2003.
2. Determine the net pension amount to be reported on the balance sheet at the end of the
year. Note: The benefit payments to retirees are made out of the pension fund assets.
These payments reduce both the amount in the pension fund and the amount of the re-
maining pension obligation.
3. Interpretive Question: You are an employee of Haan Company and have just received
the above information as part of the company™s annual report to the employees on the
status of the pension plan. Does anything in this information cause you concern? Ex-
plain.

PROBLEM 8-5 ACCOUNTING FOR PENSIONS
Kiev Company reported the following information relating to its pension plan for the years 2001
through 2004:

Year-End Year-End Interest Service Return
Obligation Plan Assets Cost Cost on Assets

2001 $522,500 $469,000 ” ” ”
2002 581,250 505,050 $52,250 $61,500 $62,750
2003 643,000 549,700 58,125 65,625 71,650
2004 681,500 615,600 64,300 37,900 68,500


Required: 1. Compute the amount of pension expense to be reported on the income statement for
each of the years 2002 through 2004.
2. Determine the net pension amount to be reported on the balance sheet at the end of each
year 2001 through 2004. Clearly indicate whether the amount is an asset or a liability.
383
f384 Completing The Operating Cycle
Part 2 EOC Operating Activities


3. Each year, the amount of the pension obligation is increased by the interest cost and the
service cost. The pension obligation is reduced by the amount of pension benefits paid.
Compute the amount of pension benefits paid in each of the years 2002 through 2004.
4. Each year, the amount in the pension fund is increased by contributions to the fund and
by the return earned on the fund assets. The pension fund amount is reduced by the
amount of pension benefits paid. Compute the amount of contributions to the pension
fund in each of the years 2002 through 2004.

PROBLEM 8-6 LIFE CYCLE OF A DEFERRED TAX ITEM
Black Kitty Company recorded certain revenues of $10,000 and $20,000 on its books in 2001
and 2002, respectively. However, these revenues were not subject to income taxation until 2003.
Company records reveal pretax financial accounting income and taxable income for the three-
year period as follows:


Financial Income Taxable Income
2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $44,000 $34,000
2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38,000 18,000
2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21,000 51,000


Assume Black Kitty™s tax rate is 40% for all periods.
Required: 1. Determine the amount of income tax that will be paid each year from 2001 through
2003.
2. Determine the amount of income tax expense that will be reported on the income state-
ment each year from 2001 through 2003.
3. Compute the amount of deferred tax liability that would be reported on the balance
sheet at the end of each year.
4. Interpretive Question: Why would the IRS allow Black Kitty to defer payment of taxes
on some of the revenue earned in 2001 and 2002?

PROBLEM 8-7 UNIFYING CONCEPTS: THE INCOME STATEMENT
From the following information, prepare an income statement for Notem, Inc., for the year
ended December 31, 2003. (HINT: Net income is $119,100.) Assume that there are 10,000
shares of capital stock outstanding.
Gross Sales Revenue. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,625,000
Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140,000
Cost of Goods Sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,415,000
Sales Salaries Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 410,000
Rent Expense (Selling) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,000
Payroll Tax Expense (Selling) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,100
Entertainment Expense (Selling) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,000
Miscellaneous Selling Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,800
Miscellaneous General and Administrative Expenses. . . . . . . . . . . . . . . . . . . . . . . . . 5,400
Automobile Expense (Selling) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,500
Insurance Expense (General and Administrative) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,900
Interest Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46,000
Interest Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000
Sales Returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000
Advertising and Promotion Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 199,000
Insurance Expense (Selling). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,000
Delivery Expense (Selling) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,100
Office Supplies Expense (General and Administrative). . . . . . . . . . . . . . . . . . . . . . . . 8,000
Utilities Expense (General and Administrative) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,100
Administrative Salaries Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180,000
Fire Loss (net of tax) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,000
384 f385
Completing The Operating Cycle CEO Chapter 8
Completing the Operating Cycle



PROBLEM 8-8 INCOME STATEMENT ANALYSIS
The following table represents portions of the income statements of Brinkerhoff Company for
the years 2001“2003:

2003 2002 2001

Gross sales revenue . . . . . . . . . . . . . . . . . . . . . . . $42,000 $ (9) $25,800
Sales discounts . . . . . . . . . . . . . . . . . . . . . . . . . . 0 100 100
Sales returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 200 700
Net sales revenue. . . . . . . . . . . . . . . . . . . . . . . . . 42,000 (10) (1)
Beginning inventory . . . . . . . . . . . . . . . . . . . . . . . (15) 8,000 (2)
Purchases. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24,800 (11) 15,000
Purchases discounts . . . . . . . . . . . . . . . . . . . . . . . 700 300 500
Freight-in . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (16) 0 500
Cost of goods available for sale . . . . . . . . . . . . . . 29,000 25,000 (3)
Ending inventory . . . . . . . . . . . . . . . . . . . . . . . . . 3,800 (12) (4)
Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . (17) (13) (5)
Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . (18) 14,000 (6)
Selling expenses . . . . . . . . . . . . . . . . . . . . . . . . . 4,000 (14) (7)
General and administrative
expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (19) 3,200 3,000
Income before income taxes. . . . . . . . . . . . . . . . . 9,000 8,000 4,000
Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,500 4,000 (8)
Net income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (20) 4,000 2,000


Fill in the missing numbers. Assume that gross margin is 40% of net sales revenue.
Required:




competency enhancement opportunities
vvv
vvvv




Analyzing Real Company Information The Debate
International Case Cumulative Spreadsheet Project
Ethics Case Internet Search
Writing Assignment




The following additional assignments provide opportunities for students to de-
velop critical thinking, ethical perspectives, oral and written communication
skills, experience with electronic research, and teamwork through group and
business activities.
v




ANALYZING REAL COMPANY INFORMATION
• Analyzing 8-1 (Microsoft)
The 1999 annual report for MICROSOFT is included in Appendix A. Locate that
annual report and consider the following questions:
1. Find Microsoft™s financial statement note on “Income taxes.”
a. Using the current tax information and the information given on income
before income taxes, compute Microsoft™s 1999 effective tax rate for
385
f386 Completing The Operating Cycle
Part 2 CEO Operating Activities




both U.S. and international income. The effective tax rate is computed
by dividing current taxes by income before income taxes.
b. As of June 30, 1999, Microsoft had $1,709 million in deferred income
tax liabilities. What was the source of most of this deferred tax liabil-
ity?
2. Find Microsoft™s financial statement note concerning “employee stock and
savings plans.”
a. Briefly describe Microsoft™s employee stock purchase plan.
b. Microsoft also has an employee stock option plan whereby certain key
employees are granted incentive stock options that allow them to buy
Microsoft stock at a fixed price in the future. If Microsoft™s stock price
continues to rise, these options could be very valuable. Microsoft is not
required to report any expense associated with the granting of these
options. However, Microsoft is required to estimate the value of these
options and disclose what net income would have been if this value
had been recognized as an expense. How much would Microsoft™s 1999
net income have decreased if the value of the incentive stock options
had been recognized as an expense?

• Analyzing 8-2 (General Motors)
GENERAL MOTORS has the largest set of private pension plans in the world.
The company has many different pension plans covering different groups of
employees. The following information was extracted from the notes to GM™s
1999 financial statements. All numbers are in millions of U.S. dollars. As you
can see, for reporting purposes these plans are separated into U.S. plans and
non-U.S. plans.


U.S. Plans Non-U.S. Plans
Pension Benefits Pension Benefits

1999 1998 1999 1998

Projected benefit obligation
at end of year $73,269 $76,963 $ 9,728 $10,283
Fair value of plan assets at end
of year 80,462 75,007 7,062 5,976
Funded status $ 7,193 $ (1,956) $(2,666) $ (4,307)



1. The projected benefit obligation is the measure of the value of the pension
benefits earned by GM™s employees that has not yet been paid. What is
GM™s total projected benefit obligation?
2. To ensure that employees will be able to collect their pension benefits, GM
is required by law to set aside funds in a pension plan. What is the total
value of assets in all of these pension funds?
3. Why do you think GM is required to separate its disclosure of pension plans
into U.S. and non-U.S. plans?

• Analyzing 8-3 (IBM)
Note P to IBM™s 1999 financial statements describes how taxes affect IBM™s op-
erations. Among the information given is the following (all amounts are in mil-
lions of U.S. dollars):
386 f387
Completing The Operating Cycle CEO Chapter 8
Completing the Operating Cycle




1999 1998 1997

Earnings before income taxes:
U.S. operations $ 5,892 $2,960 $3,193
Non-U.S. operations 5,865 6,080 5,834
Total earnings before income taxes $11,757 $9,040 $9,027
Provision for income taxes:
U.S. operations $ 2,005 $ 991 $ 974
Non-U.S. operations 2,040 1,721 1,960
Total income taxes $ 4,045 $2,712 $2,934
Total other taxes
(Social Security, real estate,
personal property, and other taxes) $ 2,831 $2,859 $2,774



1. a. Compute the effective tax rate (income taxes/earnings before income
taxes) for both U.S. and non-U.S. operations for 1997, 1998, and 1999.
b. For each year 1997“1999, compute the percentage of the total tax bur-
den that was made up of income taxes.
2. A deferred tax asset is a tax deduction that has already occurred and has
been reported as a financial accounting expense but cannot be used to re-
duce income taxes until a future year. As of December 31, 1999, IBM re-
ports that it has a deferred tax asset of $3.737 billion related to employee
benefits. How would such a deferred tax asset arise?
v




INTERNATIONAL CASE
• Hutchison Whampoa
In Hong Kong, Li Ka-shing is known as “Superman.” Li™s personal wealth is
estimated to be in excess of $1 billion, and there is a saying in Hong Kong that
for every dollar spent, five cents goes into Li™s pocket. Li and his family fled
from China in 1940 in order to escape the advancing Japanese army. Li dropped
out of school at age 13 to support his family by selling plastic trinkets on the
streets of Hong Kong. Later, he scraped together enough money to buy a com-
pany that produced plastic flowers. His big success came when he bought the
real estate surrounding his factory and watched the land skyrocket in value.
Today, Li continues his simple lifestyle even though the companies he controls
comprise over 10% of the value of the Hong Kong stock market. When asked
why his sons have much nicer houses and cars than he does, Li responded,
“My sons have a rich father; I did not.”
Li is chairman of HUTCHISON WHAMPOA LIMITED. Hutchison has five ma-
jor business segments: property development, container port operations, re-
tailing, telecommunications, and energy. In 1999, Hutchison Whampoa re-
ported net income of HK$118.735 billion (equivalent to approximately US$15.3
billion).
1. Assume that one of Hutchison Whampoa™s overseas subsidiaries earns in-
come of $1,000. The income tax rate in Hong Kong is 15%. When this in-
come of $1,000 is transferred to the parent company in Hong Kong, it will
be taxed, but no income tax is owed until then. What journal entry should
Hutchison Whampoa make to record the income tax consequences of this
$1,000 in income?
387
f388 Completing The Operating Cycle
Part 2 CEO Operating Activities




2. In 1999, Hutchison Whampoa reported earnings per share of HK$30.28. How
many shares were outstanding during the year? (Note: See the net income
information given above.)
3. Hutchison Whampoa reports that it records as assets the costs it incurs to
sign up new subscribers to its cellular phone service network. These signup
costs are then systematically transferred to expense over the following
three years. What is the theoretical justification for this accounting prac-
tice?
v



ETHICS CASE
• Twisting the Contingency Rules to Save the Environment
You are a member of an environmental group that is working to clean up Val-
ley River, which runs through your town. Right now, the group is focusing on
forcing Allied Industrial, a manufacturer with a large plant located on the river,
to conduct its operations in a more environmentally friendly way.
The leader of your group, Frank Bowers, is a political science major at the
local university. Frank discovers that Allied Industrial is involved in ongoing lit-
igation with respect to toxic waste cleanup at 13 factory sites in other states.
Frank is shocked to learn that Allied itself estimates that the total cost to clean
up the toxic waste at these 13 sites could be as much as $140 million yet has
not reported any liability on its balance sheet. Frank found this information
buried in the notes to Allied Industrial™s financial statements.
Frank is convinced that he has found a public relations tool that can be
used to force Allied Industrial to clean up Valley River. He has called a press
conference and plans to accuse Allied of covering up its $140 million obliga-
tion to clean up the toxic waste at the 13 sites. His primary piece of evidence
is the fact that the $140 million obligation is not mentioned anywhere in Al-
lied™s primary financial statements.
You have taken a class in accounting and are somewhat troubled by Frank™s
interpretation of Allied™s financial statement disclosures. You look at Allied™s an-
nual report and see that it does give complete disclosure about the possible
obligation although it does not report the $140 million as a liability. The report
also states that, in the opinion of its legal counsel, it is possible but not proba-
ble that Allied will be found liable for the $140 million toxic waste cleanup cost.
The press conference is scheduled for 3 P.M. What should you do?
v




WRITING ASSIGNMENT
• Computing the Total Compensation for a Professor
Eunice Burns is a new assistant professor of phrenology at the University of
Winnemucca. Her academic year salary is $30,000. In addition, she receives a
summer salary equal to two-ninths (approximately 22%) of her academic year
salary. The university agrees to contribute an amount equal to 7% of Eunice™s
academic year salary to a pension fund. Eunice acquires legal title to these pen-
sion contributions only if she stays at the university for five years or more. His-
torically, approximately 60% of new assistant professors have remained with
the university at least five years. The university withholds $840 per year from
Eunice™s salary as her contribution to medical coverage. It costs the university
$3,000 per year per employee for medical coverage. Eunice has a term-life in-
surance policy through the university because of the favorable group rate she
can get. The $300 annual cost is withheld from her salary. If she were to get
the same insurance on her own, it would cost $450. The FICA tax rate is 7.65%.
388 f389
Completing The Operating Cycle CEO Chapter 8
Completing the Operating Cycle




This amount is withheld from Eunice™s pay, and in addition, the university must
match this amount and pay it to the federal government. Federal income taxes
totaling 15% of income are withheld from Eunice™s pay. Both the FICA tax and
the federal income tax withholding are applied only to Eunice™s academic year
salary; no amounts are withheld from her summer salary.
You have just been hired as an assistant to the chief financial officer of the
university. You have been asked to compute the total cost to the university of
having Eunice Burns on the faculty. Write a one-page memo to the chief fi-
nancial officer of the university outlining your calculations. Be sure to explain
any assumptions that you make.
v




THE DEBATE
• Is Research and Development an Asset or an Expense?
According to U.S. accounting rules (FASB Statement No. 2), all research and
development expenditures should be recognized as expenses in the period in
which they are incurred. This accounting treatment basically assumes that any
expected benefit from the R&D is so uncertain or unpredictable that the R&D
benefit should not be recorded as an asset. In contrast, international account-
ing rules (IAS No. 9) provide for R&D expenditures to be recorded as an asset
if the technological feasibility of the research project has been established.
Divide your group into two teams.

• The first team represents the “Expense All R&D!” group. Prepare a two-
minute oral presentation supporting the notion that the benefit of R&D ac-
tivity is so uncertain that no assets should be recorded in conjunction with
R&D.
• The second team represents the “R&D is an Asset!” group. Prepare a two-
minute oral presentation arguing that the whole point of R&D is to gener-
ate future economic benefit. Accordingly, R&D should be recorded as an
asset.
v




CUMULATIVE SPREADSHEET PROJECT
This spreadsheet assignment is a continuation of the spreadsheet assignments
given in earlier chapters. If you completed those spreadsheets, you have a head
start on this one.
This assignment is based on the spreadsheet prepared in part (1) of the
spreadsheet assignment for Chapter 7. Review that assignment for a summary
of the assumptions made in preparing a forecasted balance sheet and income
statement for 2004 for Handyman Company. Using those financial statements,
complete the following two independent sensitivity exercises.
1. Handyman is involved in a class-action lawsuit in which a number of cus-
tomers allege that they injured their thumbs while using hammers pur-
chased at Handyman. These customers are seeking $50 million in com-
pensatory and punitive damages. [Note: All of the numbers in Handyman™s
financial statements are in millions.] In making the financial statement pro-
jections for Handyman for 2004, it has been assumed that losing this law-
suit is possible, but not probable. Compute how each of the following quan-
tities would be affected if a loss in this lawsuit becomes probable during
2004:
a. Debt ratio (total liabilities/total assets) as of the end of 2004.
b. Return on equity (net income/ending stockholders™ equity) for 2004.
389
f390 Completing The Operating Cycle
Part 2 CEO Operating Activities




2. Ignore the lawsuit described in (1). It is expected that Handyman™s total
“other operating expenses” will be $217 million in 2004. Of this amount,
$20 million is for expected development costs that would be capitalized if
Handyman were allowed to use International Accounting Standards. Com-
pute how the capitalization of these development costs in 2004 would af-
fect the following quantities. (Note: This is a hypothetical exercise because,
as a U.S. company, Handyman is not currently allowed to use International
Accounting Standards in preparing its financial statements.)
a. Debt ratio (total liabilities/total assets) as of the end of 2004.
b. Return on equity (net income/ending stockholders™ equity) for 2004.
v




INTERNET SEARCH
• ExxonMobil
Access EXXONMOBIL™s Web site at http://www.exxonmobil.com. Sometimes
Web addresses change, so if this ExxonMobil address doesn™t work, access the
Web site for this textbook (http://albrecht.swcollege.com) for an updated link
to ExxonMobil. Once you™ve gained access to ExxonMobil™s Web site, answer
the following questions:
1. Using ExxonMobil™s “history” site, determine the original names of the two
companies that later became Exxon and Mobil.
2. Review ExxonMobil™s note disclosure relating to litigation and other con-
tingencies. What significant legal actions are being taken against the com-
pany, and what is their status?
3. Locate ExxonMobil™s note relating to income taxes. What is the company™s
effective tax rate (income tax expense/income before taxes)? How does it
compare to the U.S. statutory rate (as of 1999) of 35%?
4. Review ExxonMobil™s disclosure relating to its pension plans. Does the
amount of funding the company has set aside to satisfy its pension oblig-
ation exceed the company™s pension obligation?
comprehensive problem 6-8
Zepplin Enterprises is a small business that purchases electronic personal information managers
(PIM) from manufacturers and sells them to consumers. These PIMs keep track of appoint-
ments, phone numbers, to-do lists, and the like. Zepplin conducts business via the Internet and,
at this point, carries only one model of PIM, the YO-660. Zepplin provides the following trial
balance as of January 1, 2003.

Zepplin Enterprises
Trial Balance
January 1, 2003

Debits Credits

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 8,500
Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,400
Allowance for Bad Debts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 568
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34,855
Prepaid Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,500
Office Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000
Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19,700
Wages Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,200
Taxes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,500
Common Stock (10,000 shares) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25,000
Retained Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21,287
Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $74,255 $74,255



Zepplin uses the periodic FIFO inventory method in accounting for its inventory. The inven-
tory of YO-660 consists of the following inventory layers:

Layer Units Price per Unit Total Price
1
(oldest purchase) 60 $150 $ 9,000
2 70 155 10,850
3 65 157 10,205
4
(most recent purchase) 30 160 4,800
Total 225 $34,855



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