Background: You have recently been hired as the new staff accountant at Midwest Mechanical Corporation. Midwest Mechanical Corporation is a $35 million (annual sales) company. The company machines parts for small outboard (boat) motors. The accounting department consists of the controller, staff accountant (you), and a parts manager (responsible for inventory accounting).

Outboard motors consist of three main sections. These include:

1. Top (outboard powerhead)
2. Mid-section
3. Outboard lower unit

Midwest Mechanical Corporation has organized their business into three main divisions aligning with the three main sections of the outboard motor.

At the end of 2020 Midwest Mechanical Corporation leadership team prepared the following business update for each division. Midwest Mechanicals customers consist primarily of independent boat repair shops in the Upper-Midwest.

Powerhead Division The Powerhead Division has experienced a steady decline in sales as well as a drop in gross margin. The complexity involved in machining parts for outboard powerhead far exceeds the level of expertise needed to machine parts in the other areas of an outboard motor. Midwest Mechanical Corporation has one machinist who has the necessary skills for this type of work. Unfortunately, this machinist plans to retire on July 15, 2021. Due to the relatively high cost of machining powerhead parts, the industry has experienced a new trend in customer behavior. Customers that need powerhead repairs involving the machining parts, are simply junking their outboard motor and buying new.

Midsection Division The Midsection Division has seen a slight increase in sales and gross margin. The skills of the machinists at Midwest Mechanical Corporation meet or exceed the required level of expertise to do this work. The cost of repair has proven to be a good economical solution for customers hoping to avoid purchasing a new outboard motor.

Lower Unit Division The Lower Unit Division has seen a solid increase in sales over the past few years. Machinists complete work on lower units quickly and a minimal level of expertise is required. The quick turnaround (fixing lower unit and getting the outboard motor back into the hands of the customer) makes repair the best option for customers. Damage to the lower unit parts is normally associated with less experienced boaters. The boating industry has seen an uptick in sales and expects this trend to continue.

Other Midwest Mechanical Corporation has a side business machining one-off parts for ATVs. Individual ATV owners often have a hard time finding machinists for parts repair. Generally, the level of expertise required for these repairs fits the skill set of Midwest Mechanical Corporations machinist. Midwest Mechanical Corporations leadership team believes that ATV parts repair could be a good fit for the company. Nationally, ATV sales have experienced double-digit growth. ATV customers appear to have more disposable income than boat owners and are happy to pay more for fast turnaround of repairs.

Current Events In February 2021, Midwest Mechanical Corporation announced to their customers that they will no longer service/machine the powerhead portion of outboard motors as of June 30, 2021. In the announcement, Midwest Mechanical was careful to remind customers the work they will continue (detailing to the customers the specific types of machining jobs completed for the midsection and lower unit).

On June 30, 2021, Midwest Mechanical Corporation sold specific equipment only used to machine powerhead parts. Specifically, they sold equipment that had a cost of $2.5 million and accumulated depreciation of $2.2 million. The equipment was sold for $2 million dollars.

For the first six months of 2021, Midwest Mechanical Corporations Powerhead Division had sales of $4.8 million and COGS of $3.7 million.

The Fiscal Year Ending December 31, 2021 income statement is presented below.

Situation: The controller has requested that you prepare a correct version of the income statement. The income statement on page 2 was automatically generated by the companys SAP accounting system. The problem is that the system did not properly account for the Discontinued Operations, which of course is the Powerhead Division.

Required:

1. Prepare the income statement correctly breaking out the impact of discontinued operations. Note: A 35% tax rate is applied to both continuing and discontinued income.
2. Answer the following questions (provide clearly written 2 to 3 sentence answers):
3. 1. Why did Midwest Mechanical Corporation sell the Powerhead Division?
   2. Why would you expect gross margin % to increase in your correctly prepared income statement?
   3. Why is it important that EPS presented in your corrected income statement breaks out income from continuing operations and income from discontinued operations?
   4. How will the customer base differ for the developing ATV business versus the remaining outboard motor business?

$Millions Division Powerhead Division Midsection Division Lower Unit Division Other Total 2020 $Sales %GM $ 11.2 24.1% $ 12.9 29.2% $ 10.1 44.5% $ 0.8 Not Available $ 35.0 2019 $Sales %GM $ 13.5 26.1% $ 12.1 28.8% $ 8.4 42.8% $ 0.7 Not Available $ 34.7 2018 $Sales %GM $ 14.1 29.1% $ 12.2 27.5% $ 6.6 43.6% $ 0.6 Not Available $ 33.5 Midwest Mechancial Corporation Income Statement For the Year Ended December 31, 2021 $ 35,300,000 325,000 610,000 Sales Revenue Sales Discounts Sales Returns and Allowances Net Sales Cost of Goods Sold Gross Profit GP% $34,365,000 20,950,000 $ 13,415,000 3996 Selling & Administrative Selling Expenses Administrative Expenses Income from operations 4,950,000 2,925,000 7,875,000 $ 5,540,000 85,000 1,700,000 1,785,000 Other Revenues & Gains Interest Income Gain on sale of equipment Other Expenses & Losses Loss Due to Storm Damage Interest Expense S 75,000 150,000 u (225,000) Income before income tax Income Tax Expense Net Income $ 7,100,000 $ 2,485,000 $ 4,615,000 0.35 EPS $ 4.62 Midwest Mechancial Corporation Adjusted Trial Balance December 31, 2021 Credit $ Debit 4,665,000 4,800,000 $ 150,000 100,000 100,000 9,500,000 11,500,000 4,400,000 1,500,000 800,000 250,000 1,100,000 1,000,000 500,000 Cash Accounts Receivable Allowance for Doubtful Accounts Prepaid Insurance Short-Term Note Receivable Inventory Equipment Accumulated Deperciation - Equipment Building Accumulated Deperciation - Building Land Long-Term Investments Patent Goodwill Accounts Payable Salaries and Wages Payable Bond Payable - Long Term Mortgage Payable Common Stock Par $ 0.01 APIC Retained Earnings Dividends - Common Sales Revenue Sales Discounts Sales Returns and Allowances Cost of Goods Sold Selling Expenses Administrative Expenses Interest Income Loss Due to Storm Damage Interest Expense Income Tax Expense Gain on Sale of Equipment (Powerhead Division) 4,650,000 150,000 5,000,000 1,100,000 10,000 990,000 13,650,000 $ 500,000 35,300,000 325,000 610,000 $ 20,950,000 $ 4,950,000 $ 2,925,000 85,000 $ $ $ 75,000 150,000 2,485,000 $ $ 1,700,000 67,985,000 $ 67,985,000