Answered step by step
Verified Expert Solution
Question
1 Approved Answer
A few years ago, a Coleman Air Lines 727 crashed in Dallas. The crash resulted in a gain of $0.16 per share for Coleman. How
A few years ago, a Coleman Air Lines 727 crashed in Dallas. The crash resulted in a gain of $0.16 per share for Coleman. How could this happen? Consider the accounting for airplanes. Airlines insure their craft at market value, $7.0 million for Coleman's 727. However, the planes' book values are often much less because of large accumulated depreciation amounts. The book value of Coleman's 727 was only $1,050,000. Read the requirements. Requirement 1. Suppose Coleman received the insurance payment and immediately purchased another 727 for $7.0 million. Compute the effect of the insurance payment on pretax income. Also compute the effect on Coleman's total assets. Start with the effect of the insurance payment on pretax income, and then compute the effect on Coleman's total assets. Less: Total assets would The of the 727 would $ Requirement 2. Do you think a casualty should generate a reported gain? Why? O A. A casualty should always be reported as a return of capital in the year of the casualty since theorists and practitioners define the income of a going concern to be a function of whether the proceeds will be reinvested in the same types of assets. These individuals maintain that no gain is realized on the airplane crash, because the $7.0 million is really a return of capital (where capital is thought of in physical terms as airplanes, inventories, etc.). Thus, the "gain" would not be shown in the income statement. Instead, it would appear as a special balance sheet item called Revaluation Equity, or a similar title. OB. A casualty should always be reported as a gain in the year of the casualty since the historical-cost model (using nominal dollars) ignores changes in general purchasing power and intervening changes in specific prices while an asset is held. When an asset is disposed of, the gain or loss is measured in nominal dollars (almost always without regard to the intended use of the proceeds). O C. Accounting for casualties is very controversial. It gets to the heart of the question of what is income and what is capital. Does the $7.0 million insurance payment represent a return of capital a payment of both capital and income? Due to the controversial nature of casualties, there is no straight answer to this question. D. According to the U.S. GAAP cost method, the company must write down the original cost of the asset by the fair market value of the casualty. Any insurance proceeds will increase the basis of the asset
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started