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Selected information from the December 31 20X4 trial balance of Pitt Corp.

included the following:

Debit Credit
Common stock 1250000
Additional paid-in capital 2187500
Retained earnings 1/1/X4 1650000
Net sales 6250000
Cost of sales 3750000
Selling and administrative expenses 1212500
Interest expense 122500
Gain on extinguishment of debt 130000
Loss on sale of equipment 225000
Loss due to earthquake damage 700000

Other financial data for the year ended December 31 20X4:


· In September 20X4 one of Pitt's operating plants was destroyed by an earthquake. Earthquakes are rare
in the area in which the plant was located. The portion of the resultant loss not covered by insurance was
700000.
· On October 1 20X4 Pitt Corp. committed itself to a formal plan to sell its Kam Division's assets early in
20X5. On that date Pitt estimated that the fair value of the component's assets was 25000 less than the carrying
value. Pitt also estimated that Kam would incur operating losses of 100000 for the year-ended 12/31/20X4 and
50000 for the period January 1 20X5 through February 28 20X5. All estimates proved to be materially correct.
· Pitt Corp. bought a truck in January 20X2 for 180000. The truck was expected to have a ten-year useful
life and no salvage value. During year 20X4 Pitt Corp. realized that the truck would only have a total useful life
of 5 years. The truck is being depreciated using the straight-line method. The depreciation expense (on the
truck) to be included in selling and administrative expenses has not yet been recorded.
· The company has an ongoing policy of retiring long-term debt.
· Pitt Corp. had unrealized gains of 10000 on available-for-sale securities during the current year.
· Pitt Corp's pension plan recorded prior service cost of 6000 during 20X4 due to plan amendments.
· Pitt's effective income tax rate is 30%.

From the following items, select two that should be included in Pitt's statement of comprehensive income as
part of other comprehensive income.

1. False.
Gain on extinguishment of debt is either reported as part of extraordinary items or as part of income from
continuing operations, depending on the criteria included in APB Opinion No. 30 (per SFAS No. 145). In
Pitt's case, this is reported as a component of income from continuing operations on the income statement.

2. False.
In Pitt's case, the damage from the earthquake is reported as part of extraordinary items on the income
statement.

3. False.
The loss on discontinued operations of Kam Division is reported on Pitt's income statement as part of the
discontinued operations section.

4. True.
Unrealized gains on the sale of available-for-sale securities are reported as components of other
comprehensive income on the statement of comprehensive income.
5. True.
Per FAS 158, a change in pension plan funded status due to prior service cost is recognized in other
comprehensive income in the period of the change, until recognized as a component of net periodic
pension cost.

Net sales $6,250,000


Cost of sales (3,750,000)
Gross Profit 2,500,000
Selling and administrative expenses (1,260,500) [A]
Operating income 1,239,500

Other income and (expenses):


Interest expense (122,500)

Other gains and (losses):


Loss on sale of equipment (225,000)
Gain on extinguishment of debt 130,000 [B]
Income before income tax 1,022,000
Income tax expense (306,600) [$1,022,000 x .30%]
Income from continuing operations 715,400
Income (loss) from discontinued operations (87,500) [C]
Extraordinary gain (loss) (490,000) [D]
Not applicable -
Net income $ 137,900

[A] "Revised" selling and administrative expenses $1,260,500


$180,000 Cost 10 year life  $18,000 per year depreciation
2 yrs
36,000 Accum. Depr.
(36,000)
144,000 Book value Remaining life 3 years  $48,000

Selling and administrative expense $ 1,212,500


 Revised Depr. Exp. 48,000
$ 1,260,500

[B] Gain on extinguishment of debt: $130,000


Because the company has an ongoing policy of extinguishing long-term debt prior to its maturity date, these
events cannot be considered "extraordinary" as they are certainly not unusual (and may also be frequent)
with respect to the company's operations. The gain on extinguishment of debt, therefore, would be reported
in income from continuing operations, NOT net of tax.

[C] Income (loss) from discontinued operations: ($87,500)


Impairment loss of component's assets $ (25,000)
Component's 20X4 net losses (100,000)
Total losses on discontinued component (125,000)
Tax savings [30% x 125,000] 37,500
Loss from discontinued operations $ (87,500)

Note: The losses anticipated for future periods are not recognized until they occur.

[D] Extraordinary gain (loss): ($490,000)


As indicated in note [B], the gain on extinguishment of debt is not an extraordinary item; however, the loss
incurred due to the earthquake (which is a rare occurrence in the location of the plant) is considered an
extraordinary item and is reported net of tax.
Loss from earthquake $ (700,000)
Tax savings [30% x 700,000] 210,000
Extraordinary loss (490,000)

1. Accounting principle change (retrospective application effect on retained earnings)


The cumulative effect of a change in accounting principle is shown on the statement of retained earnings
as an adjustment of the beginning balance of the earliest year presented.

2. Income from continuing operations


Settlement of material litigation is to be reported in the income from continuing operations section of the
income statement, as although it is likely an infrequent event, it is not considered unusual in nature.

3. Extraordinary items
A prohibition of a product line by the government would be deemed an extraordinary event in a business,
as it certainly unusual in nature and happens infrequently.

4. Income from continuing operations


While a material gain on the sale of a factory building is a rather infrequent event, it is not considered
unusual in nature for a company to have this type of transaction; therefore, it is reported in the income
from continuing operations section of the income statement.

5. Income from continuing operations


A change from the double-declining balance method of depreciation to the straight-line method of
depreciation is a change in accounting estimate effected by a change in accounting principle. This type of
change is reported prospectively, and all activity is reported through income form continuing operations.
There is no separate or special reporting of the effect of the change. The change in method is simply
implemented, and the depreciation under the straight-line method is reported as expense in income from
continuing operations for the first quarter.

6. Discontinued operations
The results of operations of a component of an entity will be reported in the discontinued operations
section of the income statement if the component is deemed to have met all criteria for the "held for sale"
classification.

7. Income from continuing operations


A loss from a major strike by employees, while infrequent and likely material, is not considered an
extraordinary event, as it is not unusual for a company's employees to go on strike. This loss would be
reported in the income from continuing operations section of the income statement.

8. Income from continuing operations


In order for information to be presented as a component of discontinued operations in the income
statement, it must be information for a qualifying component of the business, which is the lowest level for
which operations and cash flows can be clearly distinguished, both operationally and for financial
reporting purposes, from the rest of the entity. A dress line in women's clothing would not qualify as a
component; therefore, the revenue from the discontinued dress line would be reported in the income from
continuing operations section of the income statement.

9. Income from continuing operations


Material flood damage to a building that is located in a flood plain that floods every two years is not
considered an infrequent or unusual event; therefore, the loss is reported in the income from continuing
operations section of the income statement.

10. Income from continuing operations


A change in the service life of an asset is a change in estimate, which is implemented in the current year
and reported in the income from continuing operations section of the income statement.

11. Income from continuing operations


When the extinguishment of long-term debt is a common management strategy of a company, the
transaction is not deemed to be unusual; therefore, it cannot be reported in the section for extraordinary
items. The gain or loss would be reported in the income from continuing operations section of the income
statement.

12. Extraordinary items


The occurrence of an earthquake in Wisconsin in an unusual and infrequent event (as this state rarely
experiences earthquakes); therefore, the loss from destruction of a warehouse (likely material) is reported
in the extraordinary items section of the income statement.

13. Income from continuing operations


A material write-down of inventory, while likely infrequent, is not considered unusual in nature for a
business; therefore, the loss cannot be reported in the extraordinary items section of the income statement.
The loss would be reported in the income from continuing operations section of the income statement.

14. Discontinued operations


The results of operations of a component of an entity will be reported in the discontinued operations
section of the income statement if the component is a subsidiary that has already been sold.
Pitt Corp. has asked your accounting firm to provide its management committee with answers to their questions
surrounding the plan to sell Kam Division's net assets. Specifically, management would like to know the
following:
How would the results of operations of the division be reported for the year 20X3, should management
choose to present that year?
Why were future expected losses on the sale not reported in the current year, especially since they were
reasonably estimated at year-end?
Will the assets of the division continue to be depreciated or amortized after the decision to sell the
division?
In a brief communication to the management of Pitt Corp., provide the answers to their questions.

Type your communication in the response area below the horizontal line using the word processor provided.

Memorandum
To: Pitt Corp. Management Committee
Subject: Answers to specific Management Committee questions

Thank you for the opportunity to provide assistance by responding to your questions regarding the sale of the
Kam Division. I will address each question separately below.

Question #1:
If management would choose to present the financial statements for the year 20X3 along with the financial
statements for the year 20X4, the results of operations of the Kam Division for 20X3 and 20X4 would be
presented as components of discontinued operations in both years, even though the division was not deemed
“held for sale” in the year 20X3.

Question #2:
Even though the future expected losses up until the sale date were reasonably estimated at year-end
(12/31/X4) to be $50,000 in 20X5, losses that are expected to occur in future periods cannot be recognized
until they occur, according the to the requirements of SFAS No. 144.

Question #3:
The assets within the component of the Kam Division will not be depreciated or amortized after the division is
deemed to be in the “held for sale” classification.

I hope that this brief communication has adequately served your needs. Should you require anything further,
please feel free to call me.