Chapter 3 In Class Practice Problems
On the income statement for the year ending December 31, Y1, the accountant for ABC
calculated operating income of $300,000. The income tax rate for ABC was 40% during all
years. The $300,000 Y1 operating income did not include the effect of any of the following:
1. ABC had interest expense of $12,000.
2. On September 1, Y1, ABC decided to sell the assets and product line of one of its
components. During Y1, the pretax income from the segment was $60,000 spread
evenly throughout the year. None of the income from this segment was included in
Y1 income. The sale of the division will be finalized on February 1, Y2. The book
value of the component was $800,000 and the fair value less cost to sell is $700,000
on December 31, Y1.
3. ABC sold a building that had a book value of $120,000 for $150,000 during Y1.
4. During Y1, ABC discovered that land that the company had bought for speculative
purposes for $15,000 in Y0 had been incorrectly expensed during Y0.
5. ABC decided to change its depreciation method for trucks in the year from straight-
line to double-declining balance. ABC calculated the $300,000 above using straight-
line depreciation expense. The cost of trucks, all which were purchased on 1/1/Y0
was $200,000. ABC estimated at that time the salvage value to be $20,000 and the
useful life of the trucks to be 9 years.
6. There were $25,000 of dividends declared and paid on the common stock during Y1.
Retained earnings had a balance of $1,000,000 on January 1, Y1 and only one year is
presented on the face of the financial statements.
Assuming that these items were not corrected in the income statement. What would the
effect of these errors be on net income in year 1? Then, create a statement of retained
earnings. ABC only presents one year on their financial statements.