Morton Manufacturing maintains a credit line with first bank that allows the company to borrow up to $1 million. A covenant associated with the loan contract limits the company’s dividends in any one year to 20 percent of net income. The 2012 income statement date of Morton Manufacturing is as follows:

Net sales ……………………………………………… $840,000

Less: cost of goods sold ……………………………….. 570,000

Gross profit …………………………………………… $270,000

Selling and administrative expenses …………………... 120,000

Net operating income ………………………………… $150,000

Gain on sate of securities ……………………………….. 14,000

Interest expense …………………………………………. (4,000)

Net income from continuing operations before tax ….. $160,000

Less: income tax ………………………………………… 51,200

Net income from continuing operations. ……………… $108,800

Extraordinary gain (net of tax) …………………………... 22,000

Net income before change in accounting principle …… $130,800

Income effect due to change in accounting principle …… 52,000

Net income ……………………………………………. $182,000

(a) Compute the maximum amount of dividends Morton can pay if the debt convenient is expressed as 20 percent of each of the following:

(1) Net income

(2) Income before change in accounting principle

(3) Income before extraordinary items (from continuing operations)

(4) Net operating income

(b) Explain why the bank may wish to state the contractual limitation on dividends in terms of income from operations instead of net income.