Chapter 13
The Complete Income Statement
Multiple Choice Questions
1. Which one of the following events is an operating transaction?
a. Purchase of equipment
b. Payment for equipment rental
c. Purchase of land
d. Issuing bonds for cash
Answer: B
2. Which one of the following events is an operating transaction?
a. Payment of office supplies
b. Change in depreciation accounting principle
c. Purchase of another company for stock
d. Disposal of a business segment
Answer: A
3. On the income statement, the result of changing from double-declining-balance to straightline depreciation is found in
a. operating revenues and expenses.
b. other revenues or expenses.
c. extraordinary gains or losses.
d. cumulative effects.
Answer: D
4. Financing transactions include
a. exchanges with shareholders.
b. revenues.
c. expenses.
d. most transactions that impact the income statement.
Answer: A
5. On the income statement, the loss of equipment caused by the eruption of a volcano in the
Northeastern United States is found in
a. operating revenues and expenses.
b. extraordinary gains or losses.
c. disposal of a business segment.
d. other revenues or expenses.
Answer: B
6. Which one of the following events is not an operating transaction related to a company’s
primary activity?
a. Disposal of a business segment
b. Purchase of equipment
c. Payment for equipment maintenance
d. Purchase of inventory
Answer: A
7. All of the following are termed considered to be operating revenues or expenses that are
usual and frequent except
a. the sale of furniture by a furniture company.
b. interest expense related to financing with bonds.
c. depreciation expense on machinery.
d. delivery cost of goods .
Answer: B
8. Which one of the following is a nonoperating event that must be reported on the income
statement?
a. Acquisition of a plant asset to be used in operations
b. Extraordinary items
c. Recognition of inventory expense
d. Consumption of office supplies
Answer: B
9. Non-operating items are found in the
a. asset section of the balance sheet.
b. liability section of the balance sheet.
c. cash flows from operations section of the cash flow statement.
d. income statement.
Answer: D
10. A summary of operating events is found
a. only in the asset section of the balance sheet.
b. only in the investment and financing sections of the cash flow statement.
c. only in the cash flows from operations section of the cash flow statement.
d. only in the income statement.
e. in the cash flows from operations section of the cash flow statement, and in the income
statement.
Answer: E
11. Operating events include
a. the payment of dividends and accounting principle changes.
b. inflows and outflows of assets due to the generation of revenues.
c. purchases, sales, and exchanges of long-term assets.
d. expenses and costs of acquiring plant assets .
Answer: B
12. On the income statement, interest revenue is found in
a. operating revenues and expenses.
b. other revenues or expenses.
c. the disposal of a business segment section.
d. the extraordinary gains or losses section.
e. the cumulative effects section.
Answer: B
13. On the income statement, marketing expenses are reported as
a. operating revenues and expenses.
b. other revenues or expenses.
c. the disposal of a business segment.
d. an extraordinary gain or loss.
e. a cumulative effect.
Answer: A
14. On the income statement, a gain from the sale of stock is reported as
a. operating revenues and expenses.
b. other revenues or expenses.
c. a disposal of a business segment.
d. an extraordinary gain or loss.
e. a cumulative effect of a change in accounting principle.
Answer: B
15. On the income statement, the loss from selling an independent business component of the
company is reported as a(n)
a. operating revenue or expense.
b. other revenue or expense.
c. disposal of a business segment.
d. extraordinary gain or loss.
Answer: C
16. Which of the following statements is false regarding diluted earnings per share?
a. Reporting diluted earnings per share is required by GAAP when potentially significant
dilution of EPS exists.
b. Diluted earnings per share can be used to reflect the extent of potential share dilution.
c. Diluted earnings per share is not reported by some companies.
d. Diluted earnings per share is always the same as basic earnings per share.
Answer: D
17. Recognition of bad debt expense is an event considered to be
a. an operating activity cash flow.
b. both unusual and infrequent.
c. neither unusual nor infrequent.
d. a financing cash flow.
Answer: C
18. On the income statement, the result of selling equipment is reported as a(n)
a. operating revenue or expense.
b. other revenue or expense.
c. disposal of a business segment.
d. extraordinary gain or loss.
e. cumulative effect of a change in accounting principle.
Answer: B
19. On the income statement, interest expense is reported as a(n)
a. operating revenue or expense.
b. other revenue or expense.
c. disposal of a business segment.
d. extraordinary gain or loss.
e. cumulative effect of a change in accounting principle.
Answer: B
20. On the income statement, usual and frequent income events are found in
a. operating revenues and expenses.
b. other revenues or expenses.
c. disposal of a business segment.
d. extraordinary gains or losses.
e. cumulative effects.
Answer: A
21. On the income statement, unusual OR infrequent income events are found in
a. operating revenues and expenses.
b. other revenues or expenses.
c. disposal of a business segment.
d. extraordinary gains or losses.
e. cumulative effects.
Answer: B
22. Which one of the following is True about earnings per share?
a. Must be calculated as earnings per ‘preferred’ share
b. Must be calculated as earnings per ‘common’ share
c. May be increased or decreased because of outstanding stock options or convertible debt
d. Appears with the gross profit percentage on the income statement
Answer: B
23. Below are five categories of transaction. Generally accepted accounting principles
consider which of these as financing transactions?
1. Purchases, sales, and exchanges of assets
2. Exchanges with shareholders
3. Operating transactions like revenues and expenses
4. Exchanges of liabilities and shareholders’ equity
5. Issues and payments of debt
a. 1 only.
b. 3, 4, and 5.
c. 1,2, and 3.
d. 2,4,and 5.
Answer: D
24. Which one of the following should be NOT reported net of income taxes?
a. Loss from early extinguishment of long-term debt
b. Cumulative adjustments resulting from a change in depreciation methods
c. Bad debt expense associated with a bankrupt customer
d. Gains or loss from discontinuing the operations of a major segment of a business
Answer: C
25. Which one of the following transactions or events is never treated as an extraordinary
item?
a. Losses from the early extinguishment of long-term bonds
b. Losses from flooding in locations where flooding is uncommon and has never occurred
before
c. Operating losses from the discontinued segment of a business
d. Losses from volcanic eruptions in Kansas
Answer: C
26. Mountain Corp. experienced the following events and transactions during 2010:
1 = Dividends declared and paid to Mountain’s shareholders
2 = Cumulative change from FIFO to average cost of inventory
3 = Gain on disposal of a major segment of the business
4 = Depreciation expense
5 = Gain from early debt retirement
Using the numbers of the events and transactions, identify which of the following sequences
is the correct order for presenting the items on the income statement.
a. 5, 1, 3, 2
b. 4, 3, 5, 2
c. 4, 5, 2, 3
d. 1, 4, 3, 5, 2
Answer: B
27. Management of Walker Corporation chose to classify its major losses as extraordinary
items. Managers might be biased toward this approach because
a. investors do not use extraordinary items when predicting future performance.
b. this treatment reduces income taxes.
c. extraordinary losses are considered a good predictor of the company’s future solvency.
d. extraordinary losses bypass net income and are reported directly as part of comprehensive
income.
Answer: A
28. If a loss is unusual in nature but not infrequent in occurrence, the loss should be disclosed
a. as an extraordinary item, net of taxes.
b. in the footnotes.
c. as a separate component of income from continuing operations.
d. as a separate item after the extraordinary items, net of taxes.
Answer: C
29. Carman, Inc. properly reported a change in accounting principle during 2009. This
company must
a. have violated GAAP by not applying accounting principles consistently.
b. have convinced its auditors that the environment in which it operates has changed and
another method is more appropriate.
c. be trying to cover up accounting errors.
d. have initially used the wrong method.
Answer: B
30. Publicly held companies must disclose earnings per share for all of the following except for
a. income from continuing operations.
b. losses from discontinued segments of a business.
c. other revenue and expense items.
d. cumulative effects resulting from changes in accounting principles.
Answer: C
31. Comprehensive income
a. may be reported on a separate statement or on the face of the income statement.
b. can be used as an alternative format of the traditional income statement.
c. includes some revenue and expense items that are part of continuing operations.
d. can be prepared instead of the shareholders’ equity section of the balance sheet.
Answer: A
32. Paulson, Inc. reported net income of $60,000 during 2010. Throughout 2010, 20,000
shares of common stock and 5,000 shares of preferred stock were outstanding. The preferred
stock has no dividend preference. Evans reported earnings only for continuing operations
items. How much is earnings per share for 2010?
a. $3.00
b. $12.00
c. $2.00
d. Not enough information is provided.
Answer: A
33. Intraperiod tax allocation
a. is applied to each income statement item to provide creditors and investors a better
indication of the company’s True revenues and expenses.
b. is a method of allocating income taxes over multiple accounting periods.
c. is applied only to revenues since expenses are not taxed.
d. is applied to net income from continuing operations.
Answer: D
34. Which one of the following items is considered part of comprehensive income but not
reported as part of net income?
a. Accounting principle changes
b. Foreign currency translation adjustments
c. Gain on sale of land
d. Dividend revenue
Answer: B
35. Why is income so important to both investors and stock analysts?
a. It is strongly correlated to the market price of stock and bond prices.
b. It is equal to the amount that shareholders will receive as dividends.
c. Income is tied directly to revenue, i.e., a company that reports a large amount of revenue
will always report a large amount of income.
d. It identifies if the company will be able to pay its current debts when they become due.
Answer: A
36. Which one of the following is True concerning discontinued operations?
a. It relates primarily to product changes in a company.
b. The gain or loss associated with the disposal is shown separately as a component of
continuing operations on the income statement.
c. It is reported with ‘other revenues and losses’ on the company’s income statement.
d. One of two separate disclosures required is income or loss from the segment’s operations
from the beginning of the current accounting period to the date of disposal.
Answer: D
37. An income statement prepared with separate components
a. enables users to distinguish transactions that are due to operations from those that are not
useful as predictors of future performance.
b. is prepared for income items that are frequent and usual.
c. is used primarily by companies involved with complex financing transactions.
d. may replace a statement of cash flows.
.
Answer: A
38. Diluted earnings per share
a. is required for companies that have the potential for liquidation.
b. is a financing and investing activity.
c. shows the effects of possible increases in the number of outstanding common shares.
d. is reported for the ‘other revenues and expenses’ category on the income statement.
Answer: C
39. A company should report a cumulative effect of an accounting principle change when
a. consistency has been violated.
b. errors are made and subsequently corrected.
c. FASB mandates a change from one method to another.
d. international reporting standards differ from GAAP methods.
Answer: C
40. One objective of financial reporting is to provide information that is
a. helpful in assessing the amounts, timing, and uncertainty of future cash flows.
b. useful for competitors who need to assess economic activities.
c. a forecast of future operations.
d. unavailable to management.
Answer: A
41. Changes in accounting methods must be disclosed in three prominent places. These are
a. the auditor’s report, financial statement notes, and the balance sheet.
b. financial statement notes, the income statement, and the auditor’s report.
c. the balance sheet, the income statement, and the statement of cash flows.
d. notes to financial statements, the management letter, and the income statement.
Answer: B
43. Makar Corporation reported net income before extraordinary items and taxes of $200,000
for the year 2010. During 2010, the average number of common shares outstanding was
35,000. Basic net earnings per share for 2010 are reported to be only $2.00. Makar’s income
tax rate is 30%. How much was Makar’s extraordinary gain or loss (before tax) from a major
earthquake? The earthquake was the only item that was reported net of tax in the income
statement for 2010.
a. $70,000.
b. $100,000.
c. $130,000.
d. none of the above
Answer: B
44. Anderson Industries has the following transactions reported in the financial statements:
1. Income effect due to changing from the double-declining balance method to the straightline method of depreciation.
2. Collection of accounts receivable.
3. Purchase of an insurance policy on December 31 that provides coverage for the following
year.
4. Accrued wages earned by the employees.
5. Estimated uncollectible accounts receivable using the aging method.
6. Recognized a gain on the sale of plant equipment.
Which of the above transactions would be considered as “usual and frequent” for income
statement purposes?
a. Transactions 1, 2, 3, 4, & 5
b. Transactions 4 & 5
c. Transactions 4, 5 & 6
d. All transactions 1 through 6
Answer: B
45. Anderson Industries has the following transactions reported in the financial statements:
1. Income effect due to changing from the double-declining balance method to the straightline method of depreciation.
2. Collection of accounts receivable.
3. Purchase of an insurance policy on December 31 that provides coverage for the following
year.
4. Accrued wages earned by the employees.
5. Estimated uncollectible accounts receivable using the aging method.
6. Recognized a gain on the sale of plant equipment.
Which of the above transactions would be considered as “unusual or infrequent” for income
statement purposes?
a. Transactions 1, 5, & 6
b. Transactions1, 3, & 6
c. Transaction 6
d. All transactions 1 through 6
Answer: C
46. Damron Inc. has the following transactions reported in the financial statements:
1. Recognized a loss when the government expropriated land to build a bridge.
2. Declared a dividend valued at $100,000.
3. A lender covenant required the company to appropriate a portion of retained earnings.
4. Received dividends on stocks held as short-term investments. The dividends were declared
and paid on the same day.
5. Recognized the cost of inventory sold during the year under the periodic method.
6. The company paid rent for the current year.
Which of the above transactions would be included on the company’s statement of
shareholders’ equity?
a. Transactions 2 & 4
b. Transactions 1, 2, 3, & 4
c. Transactions 2 & 3
d. All transactions 1 through 6
Answer: C
47. Damron Inc. has the following transactions reported in the financial statements:
1. Recognized a loss when the government expropriated land to build a bridge.
2. Declared a dividend valued at $100,000.
3. A lender covenant required the company to appropriate a portion of retained earnings.
4. Received dividends on stocks held as short-term investments. The dividends were declared
and paid on the same day.
5. Recognized the cost of inventory sold during the year under the periodic method.
6. The company paid rent for the current year.
Which of the above transactions would be considered as “usual and frequent” for income
statement purposes?
a. Transactions 2, 4, 5, & 6
b. Transactions 2 through 6
c. Transactions 4, 5, & 6
d. Transactions 5 & 6
Answer: D
48. Damron Inc. has the following transactions reported in the financial statements:
1. Recognized a loss when the government expropriated land to build a bridge.
2. Declared a dividend valued at $100,000.
3. A lender covenant required the company to appropriate a portion of retained earnings.
4. Received dividends on stocks held as short-term investments. The dividends were declared
and paid on the same day.
5. Recognized the cost of inventory sold during the year under the periodic method.
6. The company paid rent for the current year.
Which of the above transactions would be considered as “unusual or infrequent” for income
statement purposes?
a. Transaction 1
b. Transaction 3
c. Transaction 4
d. None of these transactions
Answer: C
49. Damron Inc. has the following transactions reported in the financial statements:
1. Recognized a loss when the government expropriated land to build a bridge.
2. Declared a dividend valued at $100,000.
3. A lender covenant required the company to appropriate a portion of retained earnings.
4. Received dividends on stocks held as short-term investments. The dividends were declared
and paid on the same day.
5. Recognized the cost of inventory sold during the year under the periodic method.
6. The company paid rent for the current year.
Which of the above transactions would be considered as “unusual and infrequent” for income
statement purposes?
a. Transactions 1 & 4
b. Transaction 1
c. Transactions 1 & 3
d. None of these transactions
Answer: B
50. Sunrise Designs maintains a credit line with Ohio River 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. The 2010 income statement data for the company is as follows:
What is the maximum amount of dividends Sunrise can pay if the covenant associated with
the credit line is expressed as 20 percent of net income?
a. $55,000
b. $60,000
c. $52,560
d. $53,700
Answer: C
51. Sunrise Designs maintains a credit line with Ohio River 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. The 2010 income statement data for the company is as follows:
What is the maximum amount of dividends Sunrise can pay if the covenant is expressed as 20
percent of income before change in accounting principle?
a. $55,000
b. $60,000
c. $65,700
d. $42,160
Answer: D
Income before change in accounting method
Maximum Dividend = 20% $210,800
= $42,160
52. Sunrise Designs maintains a credit line with Ohio River 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. The 2010 income statement data for the company is as follows:
What is the maximum amount of dividends Sunrise can pay if the covenant is expressed as 20
percent of income before extraordinary items and change in accounting principle?
a. $37,760
b. $60,000
c. $65,700
d. $52,700
Answer: A
Income before extraordinary items
Maximum Dividend = 20% $188,800
= $37,760
53. Sunrise Designs maintains a credit line with Ohio River 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. The 2010 income statement data for the company is as follows:
What is the maximum amount of dividends Sunrise can pay if the covenant is expressed as 20
percent of net operating income?
a. $44,000
b. $60,000
c. $47,200
d. $52,700
Answer: A
54. Gleeson Industries consists of four separate divisions: compressed wood products,
chemicals, stone products, and plastics. On March 15, 2010, Gleeson sold the chemicals
division for $625,000 cash. Financial information related to the chemicals division follows:
The journal entry to record the sale of the chemicals division will include:
a. a debit to Loss on Disposal of Business Segment for $175,000.
b. a debit to Assets for $1,850,000.
c . a debit to Extraordinary Gain for $175,000.
d. a credit to Gain on Disposal of Business Segment for $175,000.
Answer: D
55. Gleeson Industries consists of four separate divisions: compressed wood products,
chemicals, stone products, and plastics. On March 15, 2010, Gleeson sold the chemicals
division for $625,000 cash. Financial information related to the chemicals division follows:
If the income tax rate for the company is 35%, what amount of income tax liability on the
disposal of the business segment will be recognized?
a. $218,750
b. $61,250
c. $5,250
d. $157,500
Answer: B
56. The management of Hammer Enterprises shares in a bonus that is determined and paid at
the end of each year. The amount of the bonus is based on 12% of net income from
continuing operations after tax. The bonus is not used in the calculation of income from
continuing operations. During 2010, Hammer was sued and was ordered to pay $480,000
over and above the amount covered by insurance. The loss is tax deductible and the
company’s tax rate is 35%. The company was last involved in a lawsuit five years ago. Net
income from continuing operations before tax for 2010, excluding the lawsuit loss was
$750,000.
What would management’s 2010 bonus be if the lawsuit is considered unusual by not
infrequent?
a. $175,500
b. $32,400
c. $21,060
d. $20,160
Answer: C
If a lawsuit is considered unusual but not infrequent, then it would be classified under other
expenses and losses. Consequently, the loss from the lawsuit would be used to compute net
income from continuing operations.
57. The management of Hammer Enterprises shares in a bonus that is determined and paid at
the end of each year. The amount of the bonus is based on 12% of net income from
continuing operations. The bonus is not used in the calculation of income from continuing
operations. During 2010, Hammer was sued and was ordered to pay $480,000 over and above
the amount covered by insurance. The loss is tax deductible and the company’s tax rate is
35%. The company was last involved in a lawsuit five years ago. Net income from continuing
operations (before tax for 2010, excluding the lawsuit loss was $750,000.
What would management’s 2010 bonus be if the lawsuit is considered extraordinary?
a. $90,000
b. $57,600
c. $32,400
d. $58,500
Answer: D
If the loss from the lawsuit is considered extraordinary, then the loss would not be used to
compute net income from continuing operations.
58. The following income statement was reported by Snappy Seacraft Company for the year
ending December 31, 2010:
Assume Snappy has an average of 15,000 shares of common stock outstanding during 2010.
Based on this information, what amount of earnings per share would be reported on the
income statement as the disposal of the business segment?
a. $0.33
b. $0.20
c. $1.00
d. $0.73
Answer: A
* The EPS disclosure for the disposal of the business segment includes both the income from
the disposed segment and the gain on the sale of the disposed segment.
59. The following income statement was reported by Snappy Seacraft Company for the year
ending December 31, 2010:
Assume Snappy has an average of 25,000 shares of common stock outstanding during 2010.
Based on this information, what amount of earnings per share would be reported on the
income statement as the disposal of the business segment?
a. $0.12
b. $0.20
c. $0.08
d. $0.60
Answer: B
* The EPS disclosure for the disposal of the business segment includes both the income from
the disposed segment and the gain on the sale of the disposed segment.
Matching Questions
1. Indicate whether each event listed below in 1 through 6 is reported as a discontinued
operation (D), extraordinary item (E), a change in accounting principle (A), or a component
of continuing operations (C), by placing the letter of your choice in the space provided. If an
item does not fall into one of these categories, place an X in the blank.
Answer:
1. C
2. E
3. C
4. A
5. E
6. C
2. Given below are several items (1 through 4) that will be reported on a company’s financial
statements. Select the letter of the proper financial statement reporting section listed as a through
f. You may use each letter more than once or not at all.
_____1. A loss incurred by Maranda Corporation due to a strike by employees of the company
_____2. A large loss of inventory incurred by a meat-packing factory due to a government FDA
inspection which found dangerously high levels of bacteria; no previous situations in the
company’s history
_____3. Manufacturing circuits were determined obsolete and had to be written down to a
nominal scrap value due to an improved manufacturing process
_____4. A loss due to a decline in market value on an available-for-sale investment
_____5. Losses due to a hurricane damage
_____6. Financial impacts of the adoption of a new FASB standard on goodwill.
_____7. The financial effects of outsourcing the company’s industrial product division
Answer:
1. a
2. a
3. a
4. e
5. c
6. d
7. b
3. Given below are several items (1 through 4) that will be reported on a company’s financial
statements. Select the letter of the proper financial statement reporting section listed as a through
f. You may use each letter more than once or not at all.
_____1. A gain due to an early payoff of debt that had a high interest rate
_____2. Another loss of plant assets incurred by a company whose distribution warehouse is
located on an island that has experienced severe flooding three times in the past 5 years
_____3. A $1 billion loss due to a permanent shutdown of the company’s only subsidiary,
Coastal, Inc, triggered by poor product development
_____4. A foreign currency translation gain at yearend
Answer:
1. c
2. a
3. b
4. e
4. Select the financial statement section (a through f) in which each of the items listed in 1
through 6 would be reported by writing the letter of the best answer in the space provided.
1. ____ Government expropriation of plant location in Venezuela
2. ____ Financial effects of the adoption of a new FASB standard regarding post-retirement
benefits
3. ____ Financial effects of dropping a company’s domestic product division
4. ____ Unusual and infrequent gain from a plant explosion
5. ____ Unrealized gain/loss from trading securities
6. ____ Interest revenue
Answer:
1. c
2. d
3. b
4. c
5. a
6. a
5. Select the financial statement section (a through g) in which each of the items listed in 1
through 5 below would properly be reported by writing the letter of the best answer in the
space provided.
1. _____ Declared cash dividends for the first time in the history of the corporation
2. _____ Incurred a gain on the sale of four Preston franchise stores, but held onto the Little
Steps chain
3. _____ Incurred a huge loss from a hurricane that destroyed the company’s Louisiana
packaging plant; no previous hurricanes have occurred at this location
4. _____ Recorded interest income for the year
5. _____ Incurred $14,000 to replace the company’s office products (letterhead, envelopes,
pens, etc.) with a new logo to promote a new product line
Answer:
1. e
2. b
3. c
4. a
5. a
Short Problems
1. Wellman Inc., a computer manufacturer located in Texas, lost an uninsured building due to
the infrequent and unusual occurrence of a hurricane. The building has a balance sheet value
of $20,000 and will cost $165,000 to rebuild. Wellman’s income tax rate is 40%. Calculate
the amount of any extraordinary loss that should be reported on Wellman’s income statement.
Prepare a partial income statement that shows how the item will be presented.
Answer:
2. The following information was taken from the 2010 financial records of Hopewell
Company.
The company’s income tax rate is 35 percent, and the items above are treated identically for
the financial reporting and tax purposes.
REQUIRED:
Prepare an income statement using this information.
Answer:
3. Canter Company operates a boat rental service in North Carolina. The company was
involved in the following transactions and events during 2009:
1. The supplies, gasoline, and other maintenance item costs incurred associated with the
rentals are $420,000.
2. Provided rental boats to customers during 2009 for total revenue of $880,000.
3. Damage by an earthquake to one of Canter’s uninsured rental centers in Georgia, during
2009 was $440,000. Earthquakes have never occurred here before.
4. Sued by a rental customer that got his head caught in the ladder of a rental boat. The
customer will probably win the suit that is estimated at $80,000. Lawsuits are common in the
rental industry.
5. Switched from double-declining-balance to straight-line depreciation. Effect was to
decrease the accumulated depreciation account by $58,000.
6. Declared and paid $25,000 in dividends.
For each transaction, state in which section of the income statement it should be reported and
give the dollar amount that should be reported. State whether each reporting amount is added
or subtracted on the income statement and if the specific line item on the income statement is
reported net of taxes. Canter’s income tax rate is 30%.
Answer: 1. Income from continuing operations—cost of goods sold; $420,000, subtract, not
net of tax
2. Income from continuing operations—sales revenue; $880,000, add, not net of tax
3. Extraordinary item section; $440,000 – $132,000 = $308,000, subtract, net of tax
4. Income from continuing operations—other expenses; $80,000, subtract, not net of tax
5. Cumulative effect of a change in principle section; $58,000 – $17,400 = $40,600, add, net
of tax
6. Not on income statement
4. The following are the revenue and expense accounts for the year ending August 31, 2009,
for Hammer Corporation:
A. Calculate the amount of gross profit for Hammer Corporation for the year ending August
31, 2009.
B. How much should be reported as ‘Other Revenues’?
Answer: A. Gross profit = $70,000 – $45,000 = $25,000
B. Other Revenues = $3,000 + $8,000 = $11,000
5. Badger, Inc. is planning a major stock issuance in early 2010. During 2009, the company
reported net income from operations of $530,000 before taxes. The items below describe
major events that occurred during 2009.
1. A $52,000 gain was recognized on the sale of a subsidiary
2. Inventory was written down by $21,000 due to obsolescence
3. A forced government takeover of a company plant in India that had a book value of
$320,000
4. A $31,000 gain was recognized due to the adoption of a new FASB statement
The company's tax rate is 30 percent.
A. Which items should not be reported as a component of income from continuing
operations?
B. Suppose management decided to exclude all of the above items from income from
continuing operations. What effect might this have on investor and creditor decisions?
Answer: A. Exclude items 1, 3, and 4.
B. Income from continuing operations is used as a predictor in determining future
performance. Items that are excluded may appear to investors and creditors as one-shot
occurrences. It is quite common for inventory to be written down as the result of
obsolescence. Classifying it as a non-ongoing item will cause investors to disregard it in
predicting future profits and losses.
6. Hamilton Corp. had the following infrequent income statement items during 2009:
$45,000 of dividends received from a stock investment
$20,000 gain on the sale of a plant asset which became outdated because of new technology
$19,000 loss due to the sale of treasury stock at a price less than its original cost
$34,000 fair value adjustment increase to market for available-for-sale investments
$50,000 interest expense for the year of which only $42,000 was actually paid
How much should Hamilton report as a component of ‘income from continuing operations’?
Answer: $45,000 + $20,000 – $50,000 = $15,000
7. On January 1, total assets and liabilities were $30,000 and $12,000, respectively. On
December 31, total assets and liabilities were $28,000 and $20,000, respectively. During the
year, $7,000 of dividends were declared and paid and no stock was purchased or issued.
Calculate the amount of net income or loss for the year.
Answer:
8. Nigel Corporation reported income from continuing operations before taxes and before
adjustment of the transactions below in the amount of $1,000,000. A review of the 2009 income
statement revealed several items that appeared to be incorrectly categorized. The following
items were flagged:
a. Recorded a loss of $29,000 due to a vandalism attack by a gang on one of the company
warehouses; vandalism attacks have occurred at least once per year since the company began
operations
b. Incurred an unusual and infrequent hurricane loss of $41,000 to a company warehouse
c. Closed all five of the company’s supermarkets in Manhattan after bag boys went on strike for
an extended period of time; shutdown expenses totaled $38,000
d. Floods from overflowing toilets on the upper floors of a downtown office building in
Denver caused more than $8 million in repairs. Flooding toilets are rare in this area and have
never occurred in office buildings in Denver before. Insurance coverage paid $8.6 million to
replace the damaged portions of the building.
Nigel has a 30% tax rate. Calculate income from continuing operations. For any item that is
NOT a component of continuing operations, state how it would be reported.
Answer:
Other items:
Hurricane loss = extraordinary loss because it is both unusual and infrequent
Gain from plumbing damage = extraordinary gain because it is both unusual and infrequent
9. On January 1, total assets and liabilities were $21,000 and $8,000, respectively. On
December 31, total assets and liabilities were $30,000 and $7,000, respectively. During the
year, $9,000 of dividends were declared and paid and $3,000 of stock was issued. Calculate
net income for the year.
Answer:
10. On January 1 and December 31, 2010, retained earnings were $23,000 and $42,000,
respectively. During the year, the only dividends were an ordinary stock dividend recorded at
$11,000. Calculate net income for 2010.
Answer:
11. Cabell Inc. reported ‘income from operations before taxes’ in the amount of $402,000
before including the following items for the year ending December 31, 2009:
On December 31, 2009, borrowed long-term debt of $50,000 that limits dividends to 10
percent of net income from continuing operations
$21,000 unrealized gain from fair value adjustment related to available-for-sale
investments
$30,000 loss recognized on the sale of a trading security
$58,000 loss recognized on a lawsuit relating to patent violations
$11,000 government fine for environmental violation
$63,000 write-down of obsolete inventory
$25,000 loss on the early retirement of debt.
The company's income tax rate is 30 percent. No taxes have been considered in any
information provided. Prepare a calculation of income from operations starting with income
from operations before taxes, as tentatively reported. Omit the heading. Be sure to label
correctly.
Answer:
12. Hubbell Service showed the following information for 2010: Net sales revenue,
$410,000; interest revenue, $11,000; cost of goods sold, $220,000; operating expense,
$15,000, extraordinary gain on retirement of debt, $30,000; and dividends declared, $14,000.
Calculate operating income for 2010.
Answer: $410,000 – $220,000 – $15,000 = $175,000
13. The following are some accounts for Marvell Corp. for 2009:
All amounts are before income taxes. Marvell has a 30% tax rate. Determine the amount of
Marvell’ ‘other revenue’ and ‘other expenses’ for 2009. List all non-income statement items
and indicate on which financial statement they are reported.
Answer: Other revenue = $4,000 + $5,000 + $1,000 = $10,000
Other expenses = $3,000 + $6,000 = $9,000
Non-income statement items = Stock dividends declared of $9,000 must be reported on the
statement of shareholders’ equity.
14. Hilton Corporation’s income statement for the year ending December 31, 2009, appears
below.
Compute the maximum amount of dividends Hilton can pay if it has a debt covenant
expressed as 20 percent of net income, and as 20 percent of net operating income. Which
amount would a creditor more likely use as the restriction on dividends? Explain.
Answer: Net income: 20% x $168,100 = $33,620
Net operating income: 20% x $110,000 = $22,000
A creditor would probably select net operating income, not because it is more conservative, but
because it is a better indicator of amounts that are likely to continue into the future.
15. Jarvis Company provided the following information for the year ending December 31,
2009:
Prepare an income statement in good form. You may omit the heading. Include all earnings
per share amounts required for the year ending December 31, 2009.
Answer:
Use the information that follows concerning Palomar Corp. to answer questions 16 through
19.
Nichol Corp. has 20,000 shares of common stock outstanding. For the year ending December
31, 2009, the company tentatively reported income from continuing operations before taxes
of $320,000. Nichol Corp. has a 30 percent tax rate. The additional information given below
has not been recorded in the accounts unless specifically stated.
a. The company is located in Cheyenne, Wyoming . During the year, an earthquake destroyed
some of Nichol’s assets amounting to a loss of $120,000. Earthquakes are considered
infrequent in this area and are very unusual.
b. The company’s employees went on strike for six weeks in March of 2009. Revenues would
have been about $23,000 more had the strike not occurred. No adjustment was recorded.
c. During 2009, the company changed its method of accounting for inventories from FIFO to
weighted average. Cost of goods sold related to prior years would have been $39,000 greater.
d. The company’s accounts include $47,000 as Unrealized Holding Gain from Trading
Investments at December 31, 2009.
16. How much should be reported on the income statement for the year ended December 31,
2009 as ‘Extraordinary Gains or Losses’?
Answer:
17. Calculate how much should be reported on Nichol’s income statement as ‘Income from
Continuing Operations’ for the period ended December 31, 2009.
Answer:
18. How much should be reported on the income statement for the year ended December 31,
2009, as ‘Cumulative Effect of a Change in Accounting Principle’?
Answer:
19. Name the specific items for which Nichol Corp. must apply intraperiod tax allocation in
its financial statements.
Answer: Income from continuing operations, extraordinary loss due to earthquake, the
cumulative effect of an accounting principle change, and net income.
20. On January 1 and December 31, retained earnings were $40,000 and $53,000,
respectively. During the year, $21,000 of dividends were declared. Calculate net income
during the year.
Answer: $40,000 – $21,000 – $53,000 = $34,000
21. The following information was taken from the accounting records of ABCO Corporation
for the year ending December 31, 2009.
A. In good form, prepare the section of the income statement that begins immediately under
‘income from continuing operations’. Do not be concerned with calculating the amount
reported as ‘income from continuing operations.’
B. List all the items that would appear in the ‘Other Revenue/Other Expenses’ section of the
income statement.
C. How is the number of shares of common stock outstanding used on the income statement?
Answer:
22. The following are the revenue and expense accounts of the current year for ABCO
Corporation:
All items are before income taxes. The income tax rate is 20%. Calculate any extraordinary
gain or loss that should be disclosed on the income statement.
Answer: Extraordinary gain, net of taxes = $45,000 – (.20 x $45,000) = $36,000
23. Balance sheet information of Digital Solutions, Inc. at December 31, 2008, is provided
below.
During 2009, the company entered into the following transactions:
1. Common stock was issued for $12,000 cash.
2. Services were performed for $45,000 cash.
3. Cash expenses of $31,000 were incurred.
4. Long-term liabilities of $18,000 were paid.
5. The market value of an available-for-sale investment owned at yearend exceeded its cost
by $6,000.
6. Dividends of $9,000 were declared and paid.
A. Which transactions are operating?
B. Compute net income for the year ending December 31, 2009.
C. Compute comprehensive income for the year ending December 31, 2009.
Answer:
A. Transactions 2 and 3 are operating.
B. $45,000 – $31,000 = $14,000
C. $14,000 + $6,000 = $20,000
Short Essay Questions
1. Identify types of transactions that are considered exchanges of liabilities and shareholders'
equity. Why are these transactions considered ‘financing’?
Answer: Exchanges involving liabilities can be exchanged for other liabilities or converted
into shareholders' equity. Two examples of these include debt refinancing arrangements and
the conversion of convertible bonds and preferred stock to common stock. They are
considered financing transactions because they impact a company's capital structure. They do
not affect the income statement.
2. How do items at the top of the income statement differ from items at the bottom of the
income statement?
Answer: As one moves from the top to the bottom of the income statement, the events
become increasingly less important to the operations of the business. The first of the five
major components is 'net operating income' which reflects financial performance resulting
from transactions that are both fundamental to a company's normal activities and recur
frequently. Other revenues and expenses and disposals of business segments reflect the
financial effects of events that are either not part of a company's normal operations or do not
occur frequently. Extraordinary gains and losses result from events that are both highly
unusual and infrequent, and gains and losses due to changes in accounting principles result
simply from accounting entries.
3. How are operating transactions that are not based primarily on the normal operations of a
company reported on the financial statements?
Answer: Some revenues and expenses from activities not germane to a company's primary
activities may occur infrequently. These consist of extraordinary items, disposals of
segments, gains and losses due to changes in accounting principle, and other revenues and
expenses. These items are reported separate from operating income on the income statement.
The separation of these items allows investors and creditors to make better-informed
decisions. Income from continuing operations, which represents the company's primary
activities, is expected to recur in future accounting periods. The separation of the special
items allows users to clearly see the impact on total income, while at the same time allowing
them to omit or separate infrequent items that may distort forecasts.
4. One of the three objectives of financial reporting directly relates to the income statement
and measure of income. Indicate the context of this objective, and explain how it relates to
the earnings process.
Answer: This objective of financial reporting that directly relates to earnings states that the
objective is to provide information to users to make decisions about economic resources, the
claims to those resources, and changes in them. The changes in the resources appear as
increases or decreases in shareholders' equity that corresponds to the ‘changes in them’
portion of the objective.
5. Identify the GAAP requirements of comprehensive income.
Answer: SFAS No. 130 mandates comprehensive income reporting. It establishes the
standards for reporting a display of comprehensive income and its components. It includes
items not included in the computation of net income such as foreign currency translation
adjustments and unrealized gains and losses on available-for-sale securities.
6. What is the definition of a business segment and what special reporting is required for
discontinued segments?
Answer: A business segment is defined as a separate line of business, product line, or class of
customers involving operations that are independent from a company's other operations. In
addition to reporting any gain or loss related to the disposal of the segment itself, the income
or loss attributed to the segment's operations up to the time of the disposal must also be
included under the caption ‘disposal of business segments.’
7. Is consistency violated when a company changes accounting principles?
Answer: The concept of consistency generally means that once a company chooses an
acceptable principle, it must continue to use that method consistently from one year to the
next. Consistency helps to maintain the credibility of accounting reports, enabling investors,
creditors, and other interested parties to make more meaningful comparisons and to identify
more easily the trends in a company's performance across time. A company that changes an
accounting principle, and properly discloses the nature of the change in the financial
statements, does not violate consistency.
8. Why are losses resulting from employee layoffs and write-downs such as inventory and
receivables reported as 'other expenses and losses'?
Answer: These items are considered to arise from normal operating business risks. As they
can be expected to routinely occur in the business environment, they are included as part of
income from continuing operations.
9. Discuss the reasons for and the financial statement effects of intraperiod tax allocation.
Answer: Intraperiod tax allocation is a concept that includes the income tax effect of a
particular transaction with the transaction itself. Four items are reported 'net of tax' on the
income statement. The first follows 'net income from continuing operations before taxes'. It
represents the tax expense resulting from all taxable revenues and deductible expenses except
for those listed below it on the income statement. The dollar amounts associated with the
disposal of business segments, extraordinary items, and changes in accounting principle are
all disclosed net of tax. Intraperiod tax allocation enables users to assess the total financial
impact of the special transactions as well as the tax benefit or cost associated with them.
10. What is ‘pro forma’ as it relates to the income statement?
Answer: Pro forma is also called ‘as if.’ Changes in an accounting principle can make it more
difficult to compare a company's financial performance across time. In order to provide
enough information so the user can compare the method used in the current period with the
old method, disclosure of the pro forma effects is required. The disclosure provides
information ‘as if’ the alternate method had been used to calculate net income. It enables
users to make more meaningful comparisons, at least across the periods presented on the face
of the income statement.
11. How does diluted earnings per share differ from the traditional basic earnings per share?
Answer: Diluted earnings per share is calculated for companies that have a potential for
significant dilution. Dilution is a reduction of the original earnings per share calculation that
results from potential issuances of additional shares of common stock. Instruments that may
cause dilution include preferred stock and bonds that can be converted to common stock,
stock options and warrants, and other possible conversions by investors.
12. What is earnings persistence?
Answer: Earnings persistence reflects the extent to which particular dollar amounts of
earnings can be expected to continue in the future and generate future cash flows. Earnings
amounts with high levels of persistence are expected to continue in the future, while those
with low levels of persistence are not. Income statement classifications are useful because for
the most part, they are defined in terms of their persistence.
13. How has the movement toward internationalization of many businesses increased
reporting of the number of special gains and losses on the income statement?
Answer: International operations are subject to certain risks and opportunities, including
currency fluctuations, government actions, and investment earnings which are created by
accounting for subsidiaries under the equity method. These aspects cause the number of
special gains and losses to increase because without the international operations, many of
them would not exist. Companies must closely monitor their methods of operating in each
country.
IFRS questions
1. Which of the following statements is True?
a. IFRS relies less heavily on fair market value accounting than does US GAAP
b. IFRS relies more heavily on fair market value accounting than does US GAAP
c. Neither IFRS nor US GAAP will use fair market value accounting in the near future
d. Only US GAAP uses fair value market accounting.
Answer: B
Test Bank for Financial Accounting: In an Economic Context
Jamie Pratt
9780470635292, 9781119537571, 9781119444367
