different treatments of financial statements; what is best here?

Given background financial data for Magnolia, Inc., I have to build an income statement, a balance sheet and a cash flow statement.  I need someone to check what I have done and help make any changes if needed.

For each statement, there are variations depending on how we handle 1) inventory (LIFO/FIFO), 2) depreciation (straight line or accelerated), the expensing of store-opening costs (immediate expensing vs. amortized), and treatment of the investment tax credit (flow through or deferral/amortization).  There is one variation per option.  That is to say, the first column in the financial sheets represents the baseline handling of the statements. In column #1 (option #1), Magnolia reports inventory using LIFO, accelerated depreciation (assumed equal to ACRS depreciation), immediate expensing of store-opening costs, and amortization of the investment credit. Each subsequent column changes the handling of ONE (and only one) reporting method. The last column changes the handling of all 4 reporting methods (inventory, appreciation, expensing of store opening costs, and the handling of the tax credit).

Then we have to decide which option would I recommend using (select one only)? Why (relative advantages)?
My instructions are to comment on whatever I think is suitable.

Among others, we can address the implications of the substantially different net incomes produced; the value of the cash flow statement; the usefulness of financial ratios (ROI, ROA, price/earnings, Return on equity, gross margin %, current ratio, acid-test, etc); the measurement of performance; recommendations for management or others.

***I have done the statements, but I am not comfortable with the investment tax credit (ITC) or the analysis of options (offhand, I believe its option #3, because it just looks the best with the tax liability, net income, and such...but I am not sure....can you help?)  My work is in attachment #2.

I WOULD LIKE SOMEONE TO CHECK MY WORK, and give any insight as to which option is best.

Here is the nitty-gritty:

"Magnolia Inc. is a profitable new company that has good prospects for growth. It is nearing the end of its first year in business and the president Mr. James must make some decisions regarding accounting policies for financial reporting to stockholders. Magnolia's controller and certified public accountant have gathered the following information (see attachment #1, background).

NOTE: ACRS accelerated depreciation and flow-through of the investment credit will be used for TAX CALCULATION and payment purposes REGARDLESS of the method chosen for reporting to stockholders. For all other items, assume that the SAME method used for financial accounting is used for tax purpose".***

***THAT'S PART OF THE CONFUSION FOR ME.  DOING THE I.T.C. AND DEPRECIATION ONE WAY JUST TO CALCULATE TAXES, AND THEN ANOTHER WAY FOR THE ACTUAL FIN. REPORT!!!!!


"1) Prepare a columnar income statement. In column 1, show the results using LIFO, accelerated depreciation (assumed equal to ACRS depreciation), immediate expensing of store-opening costs, and amortization of the investment credit. Show earnings per share as well as net income.


In successive columns, show the income statement and earnings per share of substituting the alternative methods: column 2, FIFO inventory; column 3, straight-line depreciation; column 4, amortization of store-opening costs; column 5, flow-through of investment credit. In column 6, show the total results of choosing all the alternative methods (columns 2 through 5). Note that in columns 2 through 5, ONLY SINGLE CHANGES from column 1 should be shown; that is column 3 does not show the effects of columns 2 and 3 together, nor does column 4 show the effects of columns 2, 3, and 4 together.


2.Prepare an end-of-period columnar balance sheet consistent with requirements of #1 above.


3.Prepare a columnar statement of cash flows consistent with requirements of #1 above.


4.Express all numerical data in thousands (omit 000), and comment on the results.


5.Which option would you recommend (select one only)? Why (relative advantages)? "


Again, I feel fairly confident with what I have done, but I do not know how to interpret what I see (assuming its even correct!!)  And I'm not sure my statements even reflect all they should show.  Does the ITC have to show up as an income item and/or should it show up as deferred investment tax credit on the balance sheet?


As we learned it in class, the flow-thru method for the ITC reduces reported income tax expense by the entire amount of the credit IN THAT YEAR the credit is taken. I believe that's what I have shown. The tax liability decreases and reported income tax expense decreases by the same amount. And the deferral method spreads the tax credit over the assets useful life by REDUCING REPORTED TAX EXPENSE in each of the years. The ITC is initially recorded as a deferred tax credit (a liability), analogous to unearned revenue…...then the income tax expense would decrease each year .  I don't know if I am showing this right on my balance sheet.

Attached file(s):

magnolia_fin_version4BM.xls  View File

magnolia_homework.doc  View File