PROBLEM 11–4 Income statements of Ferro Corporation, along with its note 7 on income taxes and selected information from its Form 10-K, are reproduced below:

CONSOLIDATED STATEMENT OF INCOME Years Ended December 31, Year 6 and Year 5

($ thousands) Year 6 Year 5 Net sales...................................................................... $376,485 $328,005 Cost of sales................................................................ 266,846 237,333 Selling and administrative expenses ........................... 58,216 54,140 Research and development.......................................... 9,972 8,205 Operating expenses ..................................................... 335,034 299,678 Operating income ........................................................ 41,451 28,327 Other income Equity in net earnings of affiliated companies ...... 1,394 504 Royalties ................................................................. 710 854 Interest earned........................................................ 1,346 1,086 Miscellaneous ......................................................... 1,490 1,761 Total other income................................................... 4,940 4,205 Other charges Interest expense ...................................................... 4,055 4,474 Unrealized foreign currency translation loss ........... 4,037 1,851 Miscellaneous ......................................................... 1,480 1,448 Total other charges.................................................. 9,572 7,773 Income before taxes..................................................... 36,819 24,759 U.S. and foreign income taxes (note 7) ........................ 16,765 11,133 Net income................................................................... $ 20,054 $ 13,626 Notes to Financial Statements Income tax expense is comprised of the following components ($ thousands):

Year 6 U.S. Federal Foreign Total Year 5 U.S. Federal Foreign Total Current.............. $5,147 $11,125 $16,272 Current ............ $2,974 $ 8,095 $11,069 Deferred ............ 353 140 493 Deferred............ 180 (116) 64 Total.................. $5,500 $11,265 $16,765 Total.................. $3,154 $ 7,979 $11,133 Deferred income taxes were mainly the result of using accelerated depreciation for income tax purposes and straight-line depreciation in the consolidated financial statements. State and local income taxes totaling approximately $750,000 and $698,000 in Year 6 and Year 5, respectively, are included in other expense categories. A reconciliation between the U.S. federal income tax rate and the effective tax rate for Year 6 and Year 5 follows:

Year 6 Year 5 U.S. federal income tax rate ................................................................... 48.0% 48.0%

Earnings of consolidated subsidiaries taxed at rates less than the U.S. federal income tax rate.......................................................... (5.3) (5.3)

Equity in after-tax earnings of affiliated companies ............................... (1.4) (0.8)

Unrealized foreign exchange translation loss .......................................... 5.3 3.6 Additional U.S. taxes on dividends from subsidiaries and affiliates........ 0.8 1.0 Investment tax credit .............................................................................. (1.5) (0.9)

Miscellaneous ......................................................................................... (0.4) (0.6)

Effective tax rate ..................................................................................... 45.5% 45.0%

The following information from Ferro Corporation’s Form 10-K is available:
Year 6 Year 5 Cost of sales includes ($ thousands)
Repairs and maintenance..................................................................... $15,000 $20,000 Loss on disposal of chemicals division.................................................. — 7,000 Selling and administrative expenses include ($ thousands)
Advertising............................................................................................ $ 6,000 $ 7,000 Employee training program................................................................... 4,000 5,000 Required:

a. Recast Ferro’s income statements for Years 5 and 6. Show computations.

b. Identify factors causing income tax expense to differ from 48% of pretax income. Identify any random or unstable factors.

c. What significant changes can you identify in Ferro’s operating policies for Year 6? (Hint: Limit your analysis to outlays for repairs and maintenance, advertising, and employee training programs.)