Question

Discuss the appropriate treatment in the financial statements of each of the following.

(a) Gain on sale of investment securities.

(b) A profit-sharing bonus to employees computed as a percentage of net income.

(c) Additional depreciation on factory machinery because of an error in computing depreciation for the previous year.

(d) Rent received from subletting a portion of the office space.

(e) A patent infringement suit, brought 2 years ago against the company by another company, was settled this year by a cash payment of $725,000.

(f) A reduction in the Allowance for Doubtful Accounts balance because the account appears to be considerably in excess of the probable loss from uncollectible receivables.

Short answer

The reporting of various financial transactions depends upon the nature of the transaction. For instance, if the information is related to the revenues, then the same must be reported in theincome statement.

Step-by-step solution

Meaning of Financial Statements

Financial statements refer to the annual reports prepared by the business entities to determine their growth, profitability, solvency, and other parameters. It includes an income statement, balance sheet, and cash flow statement.

Treatment of various financial transactions

Serial No.	Treatment	Explanation
(a)	Income statement as an extraordinary gain	Gain on sale of securities is non-operating gain; therefore should be reported as extraordinary gain in the income statement.
(b)	Income statement as operating expense	Bonus to employees as a percentage of net profit is an operational expense; hence should be reported in the income statement.
(c)	Retained earnings statement as an adjustment in the beginning	Additional depreciation will reduce the prior year's net income; hence, it should be adjusted at the beginning of the retained earnings statement.
(d)	Income statement as operating income	Receipt of rent is part of business operations; therefore, it should be reported as operating income.
(e)	Income statement as an extraordinary loss	A pending lawsuit is a nonrecurring loss; therefore should be reported as an extraordinary loss in the income statement.
(f)	Income statement as operating expense	Allowance for doubtful accounts is related to the ordinary course of business; hence it should be shown as an operating expense.