Chapter 5, Problem 16P

Comprehensive: Income Statement and Retained Earnings Milwaukee Manufacturing Company presents the following partial list of account balances, after adjustments, as of December 31, 2019:

The following information is also available but is not reflected in the preceding accounts:

1. a. The company sold Division E (a major component of the company) on August 2, 2019. During 2019, Division E had incurred a pretax loss from operations of $16,000. However, because the acquiring company could vertically integrate Division E into its facilities, Milwaukee Manufacturing was able to recognize a $42,000 pretax gain on the sale.
2. b. On January 2, 2019, without warning, a foreign country expropriated a factory of Milwaukee Manufacturing which had been operating in that country. As a result of that expropriation, the company has incurred a pretax loss of $30,000.
3. c. The common stock was outstanding for the entire year. A cash dividend of $1.20 per share was declared and paid in 2019.
4. d. The 2019 income tax expense totals $31,050 and consists of the following:

Required:

1. 1. As supporting documents for Requirement 2, prepare separate supporting schedules for selling expenses and for general and administrative expenses (include depreciation expense where applicable in these schedules).
2. 2. Prepare а 2019 multiple-step income statement for Milwaukee Manufacturing.
3. 3. Prepare a 2019 retained earnings statement.
4. 4. Next Level What was Milwaukee Manufacturing’s return on common equity for 2019 if its average shareholders’ equity during 2019 was $500,000? What is your evaluation of this return on common equity if its “target” for 2019 was 15%?
5. 5. Next Level Discuss how Milwaukee Manufacturing’s income statement in Requirement 2 might be different if it used IFRS.

To determine

Prepare a separate schedule for both selling and general and administrative expenses of Company M for the year ended December 31, 2019.

Explanation of Solution

Expenses: Expenses are costs incurred for the operations of a business. The costs incurred for generating revenues are rent expense, depreciation expense, general and administrative expenses, selling expenses, and utilities expense.

Prepare a separate schedule for both selling and general and administrative expenses of Company M for the year ended December 31, 2019 as follows:

Company M
For Year Ended December 31, 2019
Schedule 1: Selling Expenses
Particulars	Amounts ($)
Sales salaries expense	$27,400
Delivery expenses	11,700
Sales personnel travel expenses	8,300
Depreciation expense: sales equipment	9,000
Advertising expense	15,700
Total selling expenses	$72,100
Schedule 2: General and Administrative Expenses
Depreciation expense: buildings and office equipment	$14,400
Office and administrative salaries	30,000
Property taxes and insurance expense	9,000
Miscellaneous administrative expenses	3,000
Total general and administrative expenses	$56,400

Table (1)

To determine

Prepare a multi-step income statement of Company M for the year ended December 31, 2019.

Explanation of Solution

Multi-step income statement: The income statement represented in multi-steps with several subtotals, to report the income from principal operations, and separate the other expenses and revenues which affect net income, is referred to as multi-step income statement.

Prepare a multi-step income statement of Company M for the year ended December 31, 2019 as follows:

Company M
Income Statement
For Year Ended December 31, 2019
Particulars	Amounts ($)	Amounts ($)
Sales		463,200
Less: Cost of goods sold		(232,200)
Gross profit		231,000
Less: Operating expenses:
Selling expenses (Schedule 1)	72,100
General and administrative expenses (Schedule 2)	56,400
Total operating expenses		(128,500)
Operating income		102,500
Less: Other items:
Interest revenue	3,200
Miscellaneous rent revenue	5,900
Loss from expropriation	(30,000)
Loss on sale of factory equipment	(4,100)	(25,000)
Pretax income from continuing operations		77,500
Less: Income tax expense (1)		(23,250)
Income from continuing operations		54,250
Results from discontinued operations:
Loss from operations of discontinued Division E (2)	(11,200)
Gain on sale of Division E (3)	29,400	18,200
Net income (a)		72,450
Number of common shares (b) $\left(\frac{\text{\$200,000}}{\text{\$10 par}}\right)$		20,000 shares
Earnings per Common Share $\left(\text{a}÷\text{b}\right)$		$3.62

Table (2)

Working note (1):

Compute the amount of income tax expense:

$\begin{array}{c}\text{Income tax expense}=\left[\begin{array}{l}\text{Tax expense from continuing operations}\\ -\text{Tax credit on loss from expropriation}\end{array}\right]\\ =\$32,250-\$9,000\\ =\$23,250\end{array}$

Working note (2):

Compute the loss from operations of discontinued Division E:

$\begin{array}{c}\begin{array}{l}\text{Loss from operations of}\\ \text{discontinued Division E}\end{array}\}=\left[\begin{array}{l}\text{Pretax loss}-\text{Tax credit on}\\ \text{division E operating loss}\end{array}\right]\\ =\$16,000-\$4,800\\ =\$11,200\end{array}$

Working note (3):

Compute the Gain on sale of Division E:

$\begin{array}{c}\begin{array}{l}\text{Gain on sale }\\ \text{of Division E}\end{array}\}=\left[\begin{array}{l}\text{Pretax Gain}-\text{Tax expenses on}\\ \text{gain from sale of division E}\end{array}\right]\\ =\$42,000-\$12,600\\ =\$29,400\end{array}$

To determine

Prepare a retained earnings statement of Company M for the year ended December 31, 2019.

Explanation of Solution

Retained earnings: Retained earnings are that portion of profits which are earned by a company but not distributed to stockholders in the form of dividends. These earnings are retained for various purposes like expansion activities, or funding any future plans.

Prepare a retained earnings statement of Company M for the year ended December 31, 2019 as follows:

Statement of Retained Earnings
For Year Ended December 31, 2019
Particulars	Amount ($)
Retained earnings as on January 1,2019	$200,800
Add: Net income	72,450
	273,250
Less: Cash dividends (4)	(24,000)
Retained earnings as on December 31, 2019	$249,250

Table (3)

Working note (4):

Compute the amount of cash dividend:

$\begin{array}{c}\text{Cash dividends}=\text{Number of shares}\times \text{Dividend declared per share}\\ =\text{20,000 shares}\times \$1.20\\ =\$24,000\end{array}$

To determine

Ascertain the return on common equity of Company M for 2019 and comment.

Explanation of Solution

Return on equity (ROE): This financial ratio evaluates a company’s efficiency in using stockholders’ equity to generate net income. So, ROE is a tool used to measure the performance of a company.

Ascertain the return on common equity of Company M for 2019 as follows:

$\begin{array}{c}\text{Return on common equity}=\frac{\text{Net income}}{\text{Average shareholder's equity}}\times 100\\ =\frac{\$72,450}{\$425,025\text{ (5)}}\times 100\\ =17\%\end{array}$

Working note (5):

Compute the average shareholder’s equity:

$\begin{array}{c}\begin{array}{l}\text{Average}\\ \text{shareholder’s equity}\end{array}\}=\frac{\left[\begin{array}{l}\text{Common stock}+\text{Opening }\\ \text{retained earnings}\end{array}\right]+\left[\begin{array}{l}\text{Common stock}+\text{Ending}\\ \text{retained earnings}\end{array}\right]}{2}\\ =\frac{\left[\begin{array}{l}\text{\$200,000}+\\ \text{\$200,800}\end{array}\right]+\left[\begin{array}{l}\text{\$200,000}+\\ \text{\$249,250}\end{array}\right]}{2}\\ =\frac{\$850,050}{2}\\ =\$425,025\end{array}$

The return on shareholders’ equity of Company M for the year 2019 is 17.0%, which is above the target of 15%. However, Company M had results from discontinued operations in 2019. The target return falls short to 12.8%$\left(\frac{\text{\$54,250}}{\$425,025}\right)$, if the company used income from continuing operations of $54,250.

To determine

State the manner in which the income statement of Company M given in requirement 2 gets differs, if it uses IFRS.

Explanation of Solution

The presentation and the content of the income statement might differ as follows:

• Either the single-step or multiple-step format could have been used.
• The term “Turnover” could have been used instead of sales.
• The expenses might be classified by their nature rather than their function.
• To adjust the depreciation expense, if it has revalued its property.