Question

– Problem –

Paige Co. is a niche furniture manufacturer and retailer who operates mainly in the Carolinas. A partial trial balance showing Paige’s equity, revenue and expense balances as of its December 31, 2019 year-end follows:

    Debits              Credits

Dividends                                                                     $   274,520

Retained earnings (1/1/19)                                                                     $   714,830

Unrealized holding gain – CKB bonds (1/1/19)                                              89,145

Interest revenue                                                                                         21,690

Sales revenue                                                                                        8,432,265

Bad debt expense                                                               104,710

Cost of goods sold                                                         5,258,345

Depreciation expense                                                         219,480

Insurance expense                                                                92,305

Interest expense                                                                 113,925

Salaries and wages expense                                           1,906,670

Utilities expense                                                                193,255

In addition, the following information is available for the company for 2019. Unless indicated otherwise, this information has not yet been reflected in the company’s accounts. All of the dollar amounts are stated on a before-tax basis.

1. In February 2019, Paige shifted its business strategy, resulting in the October 2019 sale of a component of the company considered a separate major line of business. The sale produced a gain on disposal of $94,280. The operations of the component, prior to the sale in October, produced a loss of $19,415.

2. In preparing its 2019 financial statements, Paige has determined that it must write off $79,510 of its recorded goodwill.

3. At year-end 2019, Paige decided to change its inventory cost flow method from Average Cost to First-in, First-out (FIFO). The effect of the change on 2019 and prior years is as follows:

     2019            Prior Years

Cost of goods sold – Average Cost                     $5,258,345       $18,421,000

Cost of goods sold – FIFO                                 5,079,620          18,109,000

Note – The cost of goods sold figure in Paige’s partial trial balance above reflects use of the old method (Average Cost) for 2019.

4. Paige restructured its ongoing operations during 2019, resulting in restructuring charges of $32,925.

5. At year-end 2019, Paige is reviewing the percentage it uses to estimate bad debts. With economic conditions improving, the company determines that it must decrease the percentage it uses to estimate bad debts from 6.95% to 5.70%. The effect of this change on 2019 income is as follows:

Bad debt expense based on a 6.95% rate (old rate)                      $104,710

Bad debt expense based on a 5.70% rate (new rate)                       96,530

Note – The bad debt expense figure in the partial trial balance above reflects use of the old rate (6.95%) for 2019.

6. In July 2019, Paige extinguished 7% bonds payable having a book value of $532,590. Paige paid the investors $598,735 to retire these bonds.

7. In 2013, Paige purchased bonds issued by CKB Co., which it continues to hold as an available-for-sale investment. The fair value of Paige’s investment decreased in 2019, from $461,880 to $414,915.

Note – The $89,145 Unrealized holding gain – CKB bonds (1/1/19) in the partial trial balance above relates to this item and, of course, is stated net of income taxes.

8. In 2017, Paige purchased certain equipment and began using it. In the process of preparing the adjusting entries at year-end 2019, Paige discovered that it mistakenly double-counted the equipment’s estimated salvage value in the depreciation calculations for 2017 and 2018. The total amount of understatement of depreciation expense for these two years was $37,615.

Note – The discovery and correction of the 2017 and 2018 errors will not change the depreciation expense for 2019. The $219,480 figure in the partial trial balance above is correct.

Assume the above amounts are material. Also, assume the income tax rate applicable to all years and all income items is 25%. Finally, note that Paige uses the multiple-step format for the reporting of net income items and the one-income statement approach for the display of other comprehensive income items.

– Instructions –

Prepare the financial statements for the year ended December 31, 2019 to show the proper reporting of Paige’s:

1. income and

2. changes in retained earnings.

Answer 1

Ans. a.

Income Statement For The Year Ending On 31/12/2019

Particulars	Amount in $	Particulars	Amount in $
To Cost Of Goods Sold	50,79,620	By Sales Revenue	84,32,265
To Gross Profit	33,52,645
To Bad Debt Expenses	96,530	By Gross Profit	33,52,645
To Insurance Expenses	92,305	By Interest Revenue	21,690
To Depreciation Expenses	2,19,480
To Interest Expense	1,13,925
To Salaries & Wages Expense	19,06,670
To Utilities Expense	1,93,255
To Redemption Premium paid on bond	66,145
To Dividends	2,74,520
To Income Before Tax from continuing operation	4,11,505
Tax expense	1,02,876.25
Net income from continuing income	3,08,628.75
		Net income from continuing income	3,08,628.75
To Net Income		To Income From Discontinued Operations (Note i)	56,148.75

Notes, Assumptions & Working Notes :-

i) Component of business that is considered as a major separate line of companies business is treated as discontinued operation hence to be shown separately in the income statement net of tax.

A discontinued operation is one that management has decided to dispose of, but either has not yet done so, or has disposed of in the current year after operation had generated income or losses. To be accounted for as a discontinued operation, the business - in terms of assets, operations, investing & financing activities - must be physically & operationally distinct form the rest of the firm.

So as per above given we are assuming that major segment is fulfilling the requirements of discontinuing operations so it has to be shown separately in income statement.

Income form discontinued operations (Net Of Tax) = $ 94,280 + $ (19,415) = $ 74,865

Tax On Above Income = $ 74,865 * 25% = $ 18,716.25

Income net of tax effect = $ 56,148.75

ii) Extra amount paid on retirement of bonds is considered as expense for the current year.

iii) Unrealized gain on CK Bonds held as investment available for sale is reduced by the amount by which fair value is reduced, no effect on income statement is required.

Since this gain is net of tax we have to convert it into gain before adjusting tax. In converting this we are assuming that rate of tax is same when this gain is recognized in income under other comprehensive income statement.

So Amount of gain before tax = $ 89,145 / .75 (1-.25) = 1,18,860

Reduction in fair value = $ 4,61,880 - $ 4,14,915 = $ 46,965

So Value of unrealized gain before tax = $ 71,895

Tax effect on above = $ 71,895 * .25 = $ 17,973.75

So balance of unrealized gain account = $ 53,921.25

iv) You should account for a prior period adjustment by restating the prior period financial statements. This is done by adjusting the carrying amounts of any impacted assets or liabilities as of the first accounting period presented, with an offset to the beginning retained earnings balance in that same accounting period. So in our question we will reduce the balance of retained earnings & assets to which depreciation relates.

b.

Statement showing changes in retained earnings

Particulars	Amount in $
Opening Balance	7,14,830
Adjustment for understatement depreciation	(37,615)
Net Income from income statement	3,64,777.5
Closing Balance	10,41,992.5

Note :- Unrealized gain is part of accumulated other comprehensive income which is shown separately from retained earnings.