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Income Statement Weaknesses

WALTERS CORPORATION
INCOME STATEMENT
YEAR ENDED DECEMBER 31, 2010

Revenues
Gross sales, including sales taxes $1,044,300
Less: Returns, allowances, and cash discounts 56,200
Net sales 988,100
Dividends, interest, and purchase discounts 30,250
Recoveries of accounts written off in prior years 13,850
Total revenues 1,032,200
Costs and expenses
Cost of goods sold, including sales taxes 465,900
Salaries and related payroll expenses 60,500
Rent 19,100
Freight-in and freight-out 3,400
Bad debt expense 27,800
Total costs and expenses 576,700
Income before extraordinary items 455,500
Extraordinary items
Loss on discontinued styles (Note 1) 71,500
Loss on sale of marketable securities (Note 2) 39,050
Loss on sale of warehouse (Note 3) 86,350
Total extraordinary items 196,900
Net income $ 258,600
Net income per share of common stock $2.

Note 1: New styles and rapidly changing consumer preferences resulted in a $71,500 loss on the disposal of
discontinued styles and related accessories.
Note 2: The corporation sold an investment in marketable securities at a loss of $39,050. The corporation normally
sells securities of this nature.
Note 3: The corporation sold one of its warehouses at an $86,350 loss.

Instructions

Identify and discuss the weaknesses in classification and disclosure in the single-step income statement
above. You should explain why these treatments are weaknesses and what the proper presentation of the
items would be in accordance with GAAP.

Solution Preview

1. We do not include sales tax collected in sales revenues. Sales tax collected is a current liability. Therefore, we should report gross sales only.

2. Instead of listing "costs and expenses," cost of goods sold is listed between net sales revenues and gross profit; operating expenses are listed beneath gross profits.

3. Cost of goods sold includes sales taxes paid on inventory (if any) only. However, sales tax collected is a current liability, and its payment is the liquidation of that liability. Therefore, cost of goods sold should not include sales taxes paid other than those which are assessed on inventory.

4. Purchase discounts and freight-in and freight-out are listed as part of the cost of goods sold section. These all relate to the acquisition of inventory.

5. The excess of net sales revenues over cost of goods sold is Gross Profit. This element should be identified between cost of goods sold and operating expenses.

6. Operating expenses should be listed alphabetically. In this case, we would list bad debts expense, rent, and then salaries and related payroll expenses.

7. Most businesses have ...

Solution Summary

Given a company's income statement in poor form, this solution illustrates how to identify and discuss the weaknesses in classification and disclosure in the statement, including why these treatments are weaknesses and what the proper presentation of the items would be in accordance with GAAP.

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