ACC 317 Module 2 Income Statement Assignment Example

Continuing, Discontinued and Comprehensive: The Income Statement of a Composite Hot Tub Manufacturer for the Year

[Student Name]

Southern New Hampshire University

ACC 317: Intermediate Accounting I

Module Two Assignment

[Instructor Name]

[Date]

The organization, setting and figures below are a composite written as a model document. No real employer, client, colleague or patient is described.

Continuing, Discontinued and Comprehensive: The Income Statement of a Composite Hot Tub Manufacturer for the Year

Introduction

In June, a composite hot tub manufacturer in eastern Tennessee sold its swim spa line, a separate product group with its own plant building and dealer program, to a competitor. The rest of the business continued normally. This assignment prepares the company's income statement and statement of comprehensive income for the year, with particular attention to three classification questions: whether the swim spa line is a discontinued operation, how its results and the related taxes are presented, and which gains and losses belong in other comprehensive income rather than net income. Income taxes are 25 percent of pretax income for all items.

Is the Swim Spa Line a Discontinued Operation?

Under GAAP, the disposal of a component of an entity is reported as a discontinued operation only if it represents a strategic shift that has, or will have, a major effect on the entity's operations and financial results (Kieso et al., 2019). The swim spa line meets the component test because its operations and cash flows could be clearly distinguished: it had its own building, product codes, dealer agreements and cost records. It also meets the strategic shift test. Swim spas made up about 14 percent of revenue in the prior year and required a different dealer network, and the company has said publicly that it will no longer compete in that market. A sale of one model within a continuing product line would not qualify; leaving an entire product market does.

Year-End Data

Continuing operations produced net sales of $64,200,000 and cost of goods sold of $44,940,000. Selling expenses were $7,380,000 and general and administrative expenses $4,720,000. Interest expense was $610,000, and the company sold used equipment at a gain of $85,000. The swim spa line lost $1,240,000 from operations before tax during the five months it was owned and was sold at a loss of $360,000 before tax. The company holds available-for-sale debt securities that rose $120,000 in fair value during the year, and its small Canadian distribution subsidiary produced a foreign currency translation loss of $48,000, which carries no tax effect because the company intends to reinvest the subsidiary's earnings indefinitely. Weighted average common shares outstanding were 2,500,000.

Multi-Step Income Statement

Table 1. Income Statement for the Year Ended December 31

The gain on the equipment sale is part of continuing operations because it arose from ordinary asset replacement, even though it is not part of operating income. The tax benefits on the swim spa line are $310,000 on the operating loss (25 percent of $1,240,000) and $90,000 on the disposal loss (25 percent of $360,000), for $400,000 in total. Showing them next to the losses they relate to is intraperiod tax allocation: income from continuing operations then reflects only the tax on continuing activities.

Earnings Per Share

The company is closely held and is not required to report earnings per share, but the owners and the bank use it and the assignment requires it. EPS is shown for each major component.

Table 2. Earnings per Share

Statement of Comprehensive Income

Other comprehensive income captures certain gains and losses that GAAP excludes from net income until they are realized. The rise in fair value of available-for-sale debt securities is unrealized and is reported net of its $30,000 tax effect. The translation loss arises from converting the Canadian subsidiary's statements into dollars.

Table 3. Statement of Comprehensive Income

What the Statement Tells Users

Separating continuing from discontinued results changes the story the statements tell. Net income of $3.78 million understates the earning power of the business the company kept, which earned nearly $5 million after tax. A lender forecasting next year's cash flows should start from continuing operations, which is why the conceptual framework stresses predictive value (Financial Accounting Standards Board, 2010). At the same time, the $1.2 million loss is real and confirms that the swim spa venture failed, which bears on how much credit users give management's next expansion plan. Research supports paying attention to the components of earnings. Dechow (1994) showed that accruals improve earnings as a measure of performance in most firms but that the advantage shrinks where accruals are large and volatile, as they are in a year with a disposal. Presenting the components separately lets users make that adjustment themselves.

The notes to the statements should complete the picture. GAAP requires disclosure of the major classes of assets and liabilities of the discontinued line, the revenue and pretax results included in the loss, and the cash flows of the component, so that users can see how much of the year's operating and investing cash came from the swim spa business. The company should also disclose any continuing involvement, such as the eighteen-month agreement under which it still supplies replacement pumps to the buyer. Without those notes, a reader could not tell whether the company has truly left the market or simply moved a loss below the line.

Conclusion

The swim spa line meets both the component and strategic shift criteria and is reported as a discontinued operation net of $400,000 in tax benefits. Income from continuing operations is $4,976,250, or $1.99 per share; net income is $3,776,250, or $1.51 per share; and other comprehensive income of $42,000 brings comprehensive income to $3,818,250. Each classification follows the standard and gives users a clearer view of the business that remains.

References

Dechow, P. M. (1994). Accounting earnings and cash flows as measures of firm performance: The role of accounting accruals. Journal of Accounting and Economics, 18(1), 3-42. https://doi.org/10.1016/0165-4101(94)90016-7

Financial Accounting Standards Board. (2010). Conceptual framework for financial reporting (Statement of Financial Accounting Concepts No. 8). Author.

Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2019). Intermediate accounting (17th ed.). Wiley.