Problem: Sparky, Inc. is preparing its 2016 financial statements. The company\'s
ID: 2424360 • Letter: P
Question
Problem: Sparky, Inc. is preparing its 2016 financial statements. The company's accountant calculated Income from Continuing Operations to be $600,000, but upon further review is not certain this number is accurate. Your job is to examine the following items and determine the appropriate adjustment to Income from Continuing Operations, if any, that is required for each item. All amounts listed are pretax unless otherwise noted. Sparky has a corporate income tax rate of 40%.
Item A: On January 1, 2013, Sparky purchased a machine for $80,000 with a salvage value of $20,000 and useful life of eight years which was depreciated using the straight-line method. During 2016, Sparky decided to change to double-declining-balance method; Depreciation Expense for 2016 using double-declining-balance method is $23,000. However, the $600,000 Income from Continuing Operations was calculated using the straight-line depreciation method.
Determine the ADJUSTMENT to Sparky’s Income from Continuing Operations (ICO) for this item.
If you need to increase ICO, enter your answer as a positive number;
If you need to decrease ICO, enter your answer as a negative number using ( ) parenthesis.
If you determine no change is needed to ICO; enter NE.
[HINT: Remember, ICO is after tax, therefore any adjustments you make to it must also be after tax!]
Determine the adjustment for Depreciation Expense (2016):
Problem continued:
Item B: Sparky had an unrealized translation loss from foreign currency of $12,000 (pretax) that was included in calculating the $600,000 income from continuing operations. Sparky has a corporate income tax rate of 40%.
Determine the ADJUSTMENT to Sparky’s Income from Continuing Operations (ICO) for this item.
If you need to increase ICO, enter your answer as a positive number;
If you need to decrease ICO, enter your answer as a negative number using ( ) parenthesis.
If you determine no change is needed to ICO; enter NE.
[HINT: Remember, ICO is after tax, therefore any adjustments you make to it must also be after tax!]
Determine the adjustment for Translation Loss from Foreign Currency:
Problem continued:
Item C: During 2016, Sparky realized a pre-tax loss of $50,000 on a one month long labor strike. The $50,000 loss was included in determining the $600,000 income from continuing operations. Sparky has a corporate income tax rate of 40%.
Determine the ADJUSTMENT to Sparky’s Income from Continuing Operations (ICO) for this item.
If you need to increase ICO, enter your answer as a positive number;
If you need to decrease ICO, enter your answer as a negative number using ( ) parenthesis.
If you determine no change is needed to ICO; enter NE.
[HINT: Remember, ICO is after tax, therefore any adjustments you make to it must also be after tax!]
Adjustment for Labor Strike Loss: NE
Problem continued:
Item D: Sparky has not accrued $1,500 of interest on a NOTE RECEIVABLE. It was not included in the $600,000 income from Continuing Operations calculation. Sparky has a corporate income tax rate of 40%.
Determine the ADJUSTMENT to Sparky’s Income from Continuing Operations (ICO) for this item.
If you need to increase ICO, enter your answer as a positive number;
If you need to decrease ICO, enter your answer as a negative number using ( ) parenthesis.
If you determine no change is needed to ICO; enter NE.
[HINT: Remember, ICO is after tax, therefore any adjustments you make to it must also be after tax!]
Determine the adjustment for Interest in 2016:
Problem continued:
Item E: On April 1, 2015 Sparky paid $40,000 for four years rent on office space and at the time debited a nominal account, Rent Expense. No adjusting or correcting entries were made for this transaction in 2015 or 2016. Sparky has a corporate income tax rate of 40%.
Determine the ADJUSTMENT to Sparky’s Income from Continuing Operations (ICO) for this item.
If you need to increase ICO, enter your answer as a positive number;
If you need to decrease ICO, enter your answer as a negative number using ( ) parenthesis.
If you determine no change is needed to ICO; enter NE.
(HINT: Remember, ICO is after tax, therefore any adjustments you make to it must also be after tax!)
Determine the adjustment for Rent Expense in 2016:
Problem continued: Using the adjustments you made in items A-E above determine the Sparky’s CORRECTED Income from Continuing Operations.
Explanation / Answer
(A)
Adjustment for Depreciation Expense (2016):-9300
SL Depreciation Expense: (80,000–20,000 Salvage) / 8 = $7,500per year.
New DDB Depreciation Expense for 2016 = $23,000
Need to increase Depreciation expense by 15,500 pretax *.6 = 9300 decrease in ICO
(B)
Adjustment for Translation Loss from Foreign Currency: $7200
Translation Loss on Foreign Currency are part of Other Comprehensive Income and should not be included in NI. We must reverse this loss from ICO, so we need to increase ICO by 12,000 *.6 = $7200
(C)
Adjustment for Labor Strike Loss:NE
Labor strike Loss are considered to be part of the Other expenses and Losses in the NON-Operating section on the Income Statement. So its inclusion in ICO is correct.
(D)
Adjustment for Interest in 2016: $900
Interest Revenue on the NR should be included in the ICO. So we need to add
1,500*.6 = $900 to ICO.
(E)
Adjustment for Rent Expense in 2016: (6000)
ICO is only dealing with the current 2016 year information. For 2016, we should have Rent Expense of 10,000. However, we have not recorded any Rent Expense. So we need to fix ICO by subtracting 10,000*.6 = (6,000) from ICO
FYI: to correct the error . They expensed a full 48 months worth of expense, but shouldhave expensed only 9 months in 2015. So to fix prior years, we would need a positive PPA of 40,000/48 =833*39=$32,500* .6 = $19,500 to fix RE
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