QUESTION
Overview: For Milestone One, which is due in Module Three, you will develop a portion of the workbook, notes to the financial statements, and a brief memo to management explaining the impacts to stockholder equity and the impact of tax structures. You will build on this milestone in subsequent modules to create the workbook and executive summary portions of your final project.
Prompt: First, review the Final Project Scenario document. Using your review of the scenario, begin your workbook and discuss the impacts in your management brief, including impacts on stockholder equity and impacts based on changes to tax structure.
Note: Milestone One is a draft of some of the critical elements of the final project.
Specifically, the following critical elements must be addressed:
I. Workbook
A. Prepare adjusting entries for unrealized loss and tax issues.
II. Management Brief
A. Identify sources of other comprehensive income not included in net income.
B. Explain rationale for the inclusion as comprehensive income (as opposed to net income) of nondisclosure within notes.
C. Evaluate impacts of company goals and finances for their implications on stockholder equity, using financial information to support claims.
D. Evaluate impacts of company goals and finances for their implications on retained earnings per share, using financial information to support
claims.
E. Explain the impact of issuing preferred stock or debt for determining changes to equity structures.
F. Assess the impact of changes to current tax structure for articulating changes relevant to the company
ANSWER
Sources of Comprehensive income not in Net Income
The first source that has not been listed in the net income statement is the marketable securities. The gains and losses on the pension plans which are decided based on the actuaries is also not listed in the net income statement. The cost of patent, changes in bond positions and the lease liabilities are also not a part of the income statement but are available in the comprehensive income statement.
Rationale
The reason for using a comprehensive net income statement in the notes is because that gives a holistic idea about the financial position of the company to the shareholders. It provides much more details about where the income and expenses of the company resides and items like retirement employee benefits are highlighted in the comprehensive statement which are not a part of the net income statement.
Impact on Shareholder’s Equity
The company goal is to keep the shareholders aware of the complete position of the company. For the same reason the company also includes the comprehensive income statement in the notes. If a stock option is chosen to finance the new expansion then the preferred stock portion of shareholder’s equity will be diluted which is currently at 500000. The other method of bonds will not affect the shareholder’s equity.
Impact on retained earnings per share
In case of using a debt option the retained earnings per share will increase. A total of 2010000 shares are outstanding and the increase in net profit will be 600,000. After excluding 8% of bond interest of 80000 the earnings will go up.
In case of choosing the option of preferred stocks the total outstanding shares will be 2020000. This will still increase the retained earnings per share.
Impact of issuing preferred stock or debt
The current debt to equity ratio is 0.67, In case just the stocks are used the ratio will fall to 0.62 whereas it will rise to 0.76 in case of using bonds. There will be a minor rise to 0.69 in case we split the requirements equally between stocks and bonds. Based on the company finances and its ability to pay the current requirements using current assets, the company should choose the option to fund the expansion using bonds instead of stocks ad that will make the debt to equity ratio more healthy and attractive for the shareholders.
Impact of Current tax structure
The company keeps the depreciation separate for balance sheet and taxes and uses permanent difference for reducing the tax. These methods reduce the overall liability that the company has to face. However, this is also an extra overhead and is a temporary gain as a change in the GAAP principles will make the company pay all these liabilities
Notes
(1) Marketable securities listed on the balance sheet at a cost of $5,500,000 sold only at a cost of $5235000
(2) $1,500 in meal and entertainment expenses is a permanent difference of tax. Half of it is tax deductible.
(3) MACRS depreciation used for tax returns. It was $209,301 higher than straight line depreciation in books. Same amount added to deferred tax expense.