Income Statement Task-Based Simulation TBS029006 – FAR

Simulation Context

• Task-based simulation (TBS) from the FAR section of the CPA Exam.

• Objective: complete Pitt Corp.’s year-3 income statement by selecting correct account titles (Column A) and inserting correct dollar amounts (Column B).

• Any number to be subtracted must be entered as a negative (shown in parentheses in the software).

Exhibits Available

• Email from the Accountant
  • Long, narrative; includes fixed-asset change, discontinued-operations data, etc.
  • All dates, events, and dollar amounts relate to year 3 (unless explicitly noted).

• Insurance-Claim Details
  • Gives deductible + subscriber responsibility → ties to earthquake loss.

• Letter from the Public Accounting Firm
  • Mentions unrecorded $10\,000$ unrealized gain on equity securities (fair-value adjustment).

• Other Information
  • Trial-balance extracts (e.g., net sales, cost of sales, selling & admin).
  • Additional bullets (e.g., 30 % effective tax rate; “ongoing policy of retiring long-term debt”).

Income Statement Lines Provided

Top half (Rows 1-9)

• Net Sales

• Cost of Sales

• (To be filled) Gross Profit

• Selling & Administrative Expenses

• Operating Income

Bottom half (Rows 13-21)

• Four selectable lines: Gain/Loss on Extinguishment, Unusual/ Infrequent Loss, Unrealized Gain/Loss on Equity Securities, etc.

• Income Before Income Tax

• Income Tax Expense

• Income from Continuing Operations

• Discontinued Operations (net of tax)

• Net Income (auto-calculated by software)

Top-Half Construction

1. Gross Profit (Row 3)

• Definition refresher
  • $\text{Gross Profit}=\text{Net Sales}-\text{Cost of Sales}$
  • NOT operating profit (operating profit also subtracts selling & admin).
  • Contribution margin (sales – all variable costs) is BEC-centric, not used here.

• Dollar amount (from trial balance)
  • Net Sales: $\$6,250,000$ (given)
  • Cost of Sales: $\left(\$3,750,000\right)$ (given)
  • $6,250,000-\left(3,750,000\right)=2,500,000$ → insert $\$2\,500\,000$.

2. Selling & Administrative Expenses (Row 5)

• Trial-balance starting figure: $\$1\,212,500$.

• Adjustment for depreciation change on the truck purchased 1/1/Y1:
  • Original cost $=\$180,000$, originally 10-yr straight-line, no salvage.
  • Depreciation taken in Y1 & Y2: $2\times\$18,000=\$36,000$.
  • Carrying value at 1/1/Y3: $180,000-36,000=144,000$.
  • New remaining life (revision realized in Y3): total life 5 yrs ⇒ 3 yrs remain (Y3-Y5).
  • Revised annual depreciation $=\frac{144,000}{3}=48,000$ for Y3.
  • Add $48,000$ to selling & admin.

• Final S&A expense:
  • $1,212,500+48,000=1,260,500$
  • Enter as negative: $(1,260,500)$.

3. Operating Income (Row 6)

• Auto-calc in software:
  • $2,500,000-1,260,500=1,239,500$.

Bottom-Half Construction (Other Revenues & Expenses)

4. Gain on Extinguishment of Debt (Row 13)

• Trial-balance credit: $\$130,000$.

• Policy: company routinely retires LT debt early.

• Gain criteria: amount paid < carrying value.

• Record as positive $130,000$.

5. Loss Due to Earthquake Damage (Row 14)

• Trial balance shows $(700,000)$.

• Area is unusual & infrequent → qualifies for separate presentation within continuing operations (NOT extraordinary per current GAAP).

• Matches deductible + 10 % subscriber share (from Insurance Exhibit).

• Record $(700,000)$.

6. Unrealized Gain on Equity Securities (Row 15)

• Letter points out $10,000$ unrealized fair-value gain not booked.

• All changes in fair value for equity securities flow through income (ASC 321).

• Record $10,000$.

7. Income Before Income Tax (Row 16)

• Sum of continuing-ops items:

  • Operating Income (Row 6) ……………………………….1,239,500

  • Interest expense (Row 9) …………………………………(122,500)

  • Loss on sale of equipment (Row 12) …………………….(250,000)

  • Gain on extinguishment of debt (Row 13) ………………..130,000

  • Loss due to earthquake damage (Row 14) …………….(700,000)

  • Unrealized gain on equipment securities (Row 15) ……….10,000

• Total: $1,239,500+\left(122,500\right)+\left(225,000\right)+130,000+\left(700,000\right)+10,000=332,000$

8. Income Tax Expense (Row 17)

• Effective tax rate: 30 %.

• $332,000\times30\%=99,600$ .

• Enter as negative $(99,600)$.

9. Income from Continuing Operations (Row 18)

• $332,000-99,600=232,400$.

10. Discontinued Operations, Net of Tax (Row 19)

• Facts (Email):
  • 10/1/Y3: formal plan to sell CAM division early Y4.
  • Impairment loss on commitment date: $25,000$.
  • Y3 operating loss: $100,000$.
  • Y4 projected loss $50,000$ ignored (belongs to Y4 FS).

• Pre-tax loss total: $25,000+100,000=125,000$.

• Tax benefit: $125,000\times30\%=37,500$ .

• Net loss: $125,000-37,500=87,500$.

• Enter $(87,500)$.

11. Net Income (Row 21 – auto-calc)

• $232,400-87,500=144,900$.

Completed Income Statement (Year 3)

• Net Sales ……………………………………… $4,500,000$

• Cost of Sales ……………………………… $(2,000,000)$

• Gross Profit …………………………… $2,500,000$

• Selling & Admin Exp. ………………… $(1,260,500)$

• Operating Income ………………… $1,239,500$

• Gain on Extinguishment …………….. $130,000$

• Loss – Earthquake …………………….. $(700,000)$

• Unrealized Gain – Equity Sec. …… $10,000$

• Income Before Tax ………………… $332,000$

• Income Tax Expense (30 %) ……… $( 99,600)$

• Income from Continuing Ops … $232,400$

• Loss from Discontinued Ops (net) $( 87,500)$

• Net Income …………………………… $144,900$

Key Concepts & Reminders for the Exam

• Gross vs Operating Profit: gross ignores S&A; operating includes them.

• Change in Estimate for Depreciation: prospective only; adjust remaining CV over remaining useful life.

• Unusual & Infrequent Items (ASC 220): reported in continuing ops, separate line, NOT “extraordinary.”

• Extinguishment of Debt: $\text{Gain/Loss}=\text{Reacquisition price}-\text{CV of debt}$.

• Equity Securities (ASC 321): FV changes → P&L.

• Discontinued Operations (ASC 205-20):
  • Requires held-for-sale commitment plus separate major line of business or geographical area.
  • Present below continuing ops and net of tax.
  • Include impairment + current-year operating results; exclude future-year estimates.

• Effective Tax Rate: apply to pre-tax continuing-ops income to derive tax expense; separately calculate tax effect on discontinued ops.

Practical Exam Tips

• Skim every exhibit (~5–10 s each) before crunching numbers; orient yourself to sources.

• Use high-level roadmap: fill top of IS first (revenues, COGS, S&A), then bottom (non-op items, tax, disc ops).

• Double-check signs (negatives) — most common TBS error.

• Keep scratch paper table for totals so you can reconcile to software’s auto-calcs.

• Memorize standard presentation order: Operating → Other Rev/Exp → Pre-tax → Tax → Continuing Ops → Discontinued Ops (net) → Net Income.

Real-World Connections

• Early debt retirement mirrors homeowners paying off mortgages early; the gain here resembles the savings obtained if the payoff amount is below carrying value.

• Earthquake loss illustrates risk-management/insurance deductible concepts; identifies importance of location-specific contingencies.

• Depreciation revision reflects continuous reassessment of useful life — common when usage patterns or technology change.

• Discontinued operations treatment ensures users assess sustainable earnings separately from segments being divested.

Ethical & Professional Implications

• Properly isolating unusual or discontinued items avoids misleading stakeholders about core profitability.

• Accurate FV reporting of equity securities enhances transparency but introduces volatility; management must resist earnings-management temptations (e.g., selective sale near period end).

• Public accountants’ letters highlight auditor’s role in flagging unrecorded adjustments, reinforcing professional skepticism and responsibility to ensure GAAP compliance.