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I have a question about this multiple choice. I think I am just overthinking it, but with regards to the loss from fire (net of $7000 tax effect), I am confused as to why this would not be added back to NI. Under U.S. GAAP, a transaction that is unusual, but not “infrequent” should be reported separately as a component of continuing operations, (gross) but not net of applicable income taxes (literally the very next multiple choice after this one). The problem states the fire was infrequent but not unusual, so why the tax effect? Also thought gains/losses were not shown net of tax. Can someone help me here? Or am I just getting confused by the way they should be presented in FS as a line item vs the final NI amount? The way they word these questions are so confusing. Sometimes I wonder if I even know what a debit or credit is anymore …..
#19 F1 Optional Questions:
Thorpe Co.’s income statement for the year ended December 31 reported net income of $74,100. The auditor raised questions about the following amounts that had been included in net income:
-Unrealized loss on decline in market value of available-for-sale investments in stock $ (5,400)
-Gain on early retirement of bonds payable (net of $11,000 tax effect) 22,000
-Adjustment to profits of prior years for errors in depreciation (net of $3,750 tax effect) (7,500)
-Loss from fire (net of $7,000 tax effect) (14,000)
The loss from the fire was an infrequent but not unusual occurrence in Thorpe’s line of business. Thorpe’s December 31 income statement should report net income of:
a.$81,600
b.$87,000
c.$65,000
d.$66,100
Explanation
Choice “b” is correct. $87,000. Correction of errors of prior periods should be reported as an adjustment to beginning retained earnings, not as an item of net income.
Net income before adjustments $ 74,100
Add: Unrealized loss in market value of available-for-sale investments in stock for which should not have affected net income of $5400
Add: Correction of error of prior period which should not have affected net income 7,500
Net income after adjustments $87,000
Rule: Unrealized losses (or gains) resulting from changes in market value of available-for-sale investments should be reported as a component of other comprehensive income in shareholders’ equity. Unrealized gains and losses on investments held for trading would be included in net income.
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