Further managers have greaterabilitytomanipulate

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Unformatted text preview: tions on dividends decrease the amount that Morton Manufacturing can potentially pay out as dividends, thereby increasing the probability that the company will have sufficient cash to meet its obligations to the bank. In this particular case, basing the dividend restriction on net operating income provides the most stringent dividend restriction. Further, managers have greater ability to manipulate items disclosed after net operating income than those items disclosed before it. For example, the decision to sell assets and realize gains is completely at a manager's discretion, as is a change in accounting principle resulting in an increase in net income. Therefore, basing the dividend restriction on net operating income limits management's ability to manipulate the restriction. E13–5 a. Losses from equity investments: AT&T invested excess cash in the equity of other companies; the value of these investments dropped during the course of the year; Loss from discontinued operations: AT&T closed down or sold off business units during the year; the business units had generated losses (expenses exceeded revenues), but those units are no longer operating as part of the company; Gain on disposition of discontinued operations: price that exceeded the book value of the units; The discontinued business units were sold for a Gain/Loss from accounting changes: AT&T made a one­time change to its accounting treatment of particular transactions and the change resulted in either a gain or loss. b. Year 1 Year 2 Reported net income Year 3 ($ in billions) Loss on equity investments Loss from discontinued operations Gain from sale of discontinued operations Gain from accounting changes (.02) $7.7 ($ 1 3 ) $1.9 7.5 0.4 4.0 14.5 0.01 0.01 (1.3) (1.3) (0.9) Loss from accounting changes 0.9 Operating income $1.5 $1.9 $17 .0 Each of these special items are not part of operating income, which represents the recurring activities of the business. These special charges are one time gains or losses and so can mislead the users of financial statements as to the future prospects of the company. The schedule above shows that the operating income of AT&T dropped significantly from Year 1 levels, but that the performance between Year 2 and Year 3 is more consistent than shown by the net income figures. Adjusting net income for the nonrecurring items gives a clearer picture of the company’s performance; business has changed significantly from Year 1 levels, but performance in the last two years has been more consistent. E13–6 a. Cash (+A) Liabilities (–L) Business Segment (Ga, +SE) Sold business segment. 625,000 1,400,000 Assets (–A) 1,850,000 Gain on Disposal of 175,000 E13–6 Concluded Gain on Disposal of Business Segment (–Ga, –SE) Income Tax Liability (+L) 61,250 Recognized income tax liability on disposal of business segment. 61,250* $61,250 = Gain on disposal of $175,000 Tax rate of 35% R e ve n u e Operations of Discontinued Segment (Ga, +SE) Income From Operations of Discontinued Segment (–Ga, –SE) Income Tax Liability (+L) Recognized income tax benefit on net loss of discontinued segment. * b. 175,000 Operating Expenses 160,000 Income From 15,000 5,250* 5,250 $5,250 = Net income of $15,000 Tax rate of 35% Discontinued operations: Income from operations of discontinued segment (net of tax expense of $5,250) Gain on disposal of business segment (net of $61,250 in taxes) Discontinued operations $ 9...
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