Ch4 Reporting Financial Performance Test Questions & Answers - Intermediate Accounting v1 13e | Canada | Test Bank by Donald E. Kieso. DOCX document preview.
CHAPTER 4
REPORTING FINANCIAL PERFORMANCE
CHAPTER STUDY OBJECTIVES
1. Understand how firms create value, manage performance, and communicate useful information to users. A business is based on a basic model of obtaining financing, investing in assets, and using those assets to generate profits. Different industries have different business models. Even within an industry, different businesses may have different strategies for generating revenues. Some businesses and industries are riskier than others. Companies must decide how and whether to manage these risks. Managing risks costs money, which reduces profits. Capital markets demand greater returns for riskier businesses.
Users use information about performance to evaluate past performance and profitability and to provide a basis for predicting future performance. They also use the information to help assess risk and uncertainty regarding future cash flows.
2. Understand the concept of and be able to assess the quality of earnings/information. The concept of quality of earnings is used by analysts and investors to assess how well the reported income reflects the underlying business and future potential. When assessing quality of earnings, users must consider all information about a company. High-quality earnings have various attributes, as noted in Illustration 4.3. Where the information is biased, this degrades the quality.
3. Understand the differing perspectives on how to measure income. There are various ways to measure income, including operating income, net income, and comprehensive income. IFRS recognizes the concept of comprehensive income, but this is not included under ASPE. Other comprehensive income consists of a set list of items identified under IFRS essentially dealing with certain unrealized gains/ losses. Under IFRS, some of these items are recycled (reclassified) to net income and some are not.
4. Measure and report results of discontinued operations. The gain or loss on disposal of a business component involves the sum of: (1) the income or loss from operations to the financial statement date, and (2) the gain or loss on the disposal of the business component. These items are reported net of tax among the irregular items in the income statement. Related assets are identified on the balance sheet where material. Under IFRS, non-current assets are reclassified to current assets.
5. Measure income and prepare the income statement and the statement of comprehensive income using various formats. There are many ways to present the income statement and the statement of comprehensive income. GAAP lays out certain minimum requirements, but beyond that, a company has some leeway to present the information as it wishes. The goal is to ensure that the statements present information about performance in a transparent manner, including presenting items such that the users can see which are ordinary and which are peripheral activities. IFRS allows the statement of comprehensive income to be presented in a combined statement or two separate statements.
By convention, companies use what is known as a single-step method or a multiple-step method (or a variation of the two).
IFRS requires entities to provide information about either the nature or function of expenses. When information is presented using function, additional disclosures should be made regarding the breakdown of the nature of expenses because this has good cash flow predictive value. The entity should choose the method that best reflects the nature of the business and industry.
6. Prepare the statement of retained earnings and the statement of changes in equity. The retained earnings statement should disclose net income (loss), dividends, prior period adjustments, and transfers to and from retained earnings (appropriations). This statement is required under ASPE.
The statement of changes in equity is a required statement under IFRS and takes the place of the statement of changes in retained earnings. It shows all changes in all equity accounts including accumulated other comprehensive income.
7. Understand how disclosures and analytics help users of financial statements assess performance. Disclosures include notes and supplementary information. They provide background and explanatory information needed to understand the business. Investors and analysts use quality of earnings analysis to help determine a company’s value.
8. Identify differences in accounting between IFRS and ASPE and potential changes. The chart in Illustration 4.16 outlines the major differences
9. Explain the differences between the cash basis of accounting and the accrual basis of accounting. Accrual basis accounting provides information about cash inflows and outflows associated with earnings activities as soon as these cash flows can be estimated with an acceptable degree of certainty. That is, accrual basis accounting aids in predicting future cash flows by reporting transactions and events with cash consequences at the time the transactions and events occur, rather than when the cash is received and paid. The cash basis focuses on when cash is received or disbursed, and therefore it is not the best predictor of future cash flows if the company has irregular cash flow patterns.
Multiple Choice QUESTIONS
Answer No. Description
b 1. Business model activities
c 2. Business model activities and the income statement
b 3. Risk/return trade-off
a 4. Representational faithfulness
b 5. Financial risk management
c 6. Value creation
d 7. Usefulness of the income statement
d 8. Usefulness of the income statement
c 9. Segregating income
c 10. Income statement terminology
d 11. Cost structure
b 12. Concept of soft numbers
d 13. Earnings management
b 14. Limitations of the income statement
d 15. Quality of earnings
b 16. High-quality earnings
a 17. Estimates
c 18. Earnings management
b 19. Net income definition
a 20. IFRS view of income
c 21. Other comprehensive income
a 22. All-inclusive income
c 23. Comprehensive income inclusions
a 24. Accumulated other comprehensive income
c 25. Calculation of earnings per share
d 26. Calculation of net income using retained earnings
a 27. Calculation of total purchases
d 28. Calculation of cost of goods sold
c 29. Calculation of accounts payable
b 30. Other comprehensive income
c 31. Calculating other comprehensive income
c 32. Reporting discontinued operations
d 33. Determination of a discontinued operation
b 34. Classification of assets held for sale
c 35. Assets held for sale
a 36. Recognizing assets that have been written down
b 37. Calculation of income from discontinued operations
c 38. IFRS requirement for expense presentation
d 39. Expenses presented by function
a 40. Presentation of discontinued operations on income statement
b 41. Held for sale assets
b 42. Presentation of discontinued operations in the income statement
c 43. EPS disclosures on income statement
Answer No. Description
b 44. Unusual gains and losses
d 45. Separate presentation under IFRS
b 46. Single-step income statement
a 47. Income statement presentation
c 48. IFRS requirement for expense presentation
d 49. Expenses presented by function
b 50. Intraperiod tax allocation
d 51. Intraperiod tax allocation
c 53. Presentation of expenses by function
d 54. Calculation of selling expenses
a 55. Calculation of general and administrative expenses
a 56. Calculation of selling expenses
b 57. Calculation of general and administrative expenses
d 58. Calculation of income from continuing operations
a 59. Calculation of net income
a 60. Determination of infrequent losses
d 61. Calculation of cost of goods sold
b 62. Multiple-step income statement
c 63. Earnings per share
d 64. Calculating EPS
a 65. P/E ratio calculation
c 66. Retained earnings statement
a 67. Losses excluded from income statement
b 68. Change in accounting principle
d 69. Change in accounting principle
a 70. Correction of an error
b 71. Statement of shareholders’ equity
b 72. Adjustments to retained earnings
a 73. Calculate adjusted retained earnings
c 74. Effect of accounting errors
a 75. Effect of accounting errors
d 76. Effect of accounting errors
a 77. Effect of accounting errors
d 78. Effect of accounting errors on current assets
d 79. Events affecting income from continuing operations
b 80. Events affecting retained earnings
c 81. Calculation of retained earnings balance
c 82. Change in accounting principle
c 83. Notes to financial statements
d 84. Assessing quality of earnings
b 85. Assessing quality of earnings
c 86. Earnings multiple
d 87. Differences between ASPE and IFRS
Answer No. Description
c 88. Presentation of expenses under ASPE
a 89. Presentation of held-for-sale assets
d 90. Accounting policy changes
b 91. Retained earnings statement
b *92. Accrual basis of accounting
b *94. Strict cash basis
b *95. Accrual vs. cash basis
a *96. Calculation of cash basis revenue
c *97. Conversion of cash basis to accrual basis
b *98. Calculate service revenue
d *99. Conversion of accrual basis to cash basis
a *100. Conversion of accrual basis to cash basis
*This topic is dealt with in an Appendix to the chapter.
Exercises
Item Description
E4-101 Value creation
E4-102 Representational faithfulness
E4-103 Income statement performance assessment and cash flow
E4-104 Characteristics of high-quality earnings and income statement limitations
E4-105 Earnings management
E4-106 Earnings management
E4-107 Calculation of net income from the change in shareholders’ equity
E4-108 Calculation of net income from the change in shareholders’ equity
E4-109 Comprehensive income
E4-110 An all-inclusive approach
E4-111 Comprehensive income terminology
E4-112 Recycled items
E4-114 Comprehensive income
E4-115 Discontinued operations
E4-116 Discontinued operations
E4-117 Income statement classifications
E4-118 Classification of income statement and retained earnings statement items
E4-119 Nature versus function of expense presentation
E4-120 Understandability/disclosure trade-off
E4-121 Calculation of net income
E4-122 Allocating tax expense
E4-123 Terminology
E4-124 Statement of changes in equity
E4-125 Statement of retained earnings
E4-126 Comprehensive income
E4-127 Changes in accounting policy
E4-128 Non-GAAP measures
E4-129 The OSC and non-GAAP measures
E4-130 Analyzing financial health and quality of earnings and price earnings ratio
*E4-131 Cash basis
*E4-132 Accrual basis
*E4-133 Cash basis
*E4-134 Cash basis to accrual basis
*This topic is dealt with in an Appendix to the chapter.
Item Description
P4-135 Discontinued operations
P4-136 Multiple-step income statement
P4-137 Income statement, including corrections
P4-138 Multiple-step income statement
P4-139 Multiple-step income statement
P4-140 Income statement adjustments
P4-141 Single-step income statement
P4-142 Income statement and retained earnings statement
P4-143 Danger of using non-GAAP earnings
*P4-144 Cash basis versus accrual accounting
*P4-145 Cash to accrual accounting
*This topic is dealt with in an Appendix to the chapter.
MULTIPLE CHOICE QUESTIONS
1. The business model may be broken down into three activities:
a) investing, operating, allocating.
b) investing, operating, financing.
c) financing, operating, and comprehensive income.
d) balance sheet, income statement, cash flow statement.
Difficulty: Easy
Learning Objective: Understand how firms create value, manage performance, and communicate useful information to users.
Section Reference: Business Models and Industries
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
2. The income statement captures an entity’s
a) financing activities.
b) investing activities.
c) operating activities.
d) interrelationship between activities.
Difficulty: Easy
Learning Objective: Understand how firms create value, manage performance, and communicate useful information to users.
Section Reference: Business Models and Industries
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
3. The “risk/return” trade-off means
a) using various techniques to manage risks.
b) the market demands a greater return when there is greater risk.
c) not investing in a risky business.
d) monitoring risks.
Difficulty: Easy
Learning Objective: Understand how firms create value, manage performance, and communicate useful information to users.
Section Reference: Business Models and Industries
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
4. The concept of representational faithfulness requires that the financial statements
a) reflect the economic reality of running a business.
b) reflect everything no matter how small.
c) reflect the biases of management.
d) identify all risks that the entity faces.
Difficulty: Easy
Learning Objective: Understand how firms create value, manage performance, and communicate useful information to users.
Section Reference: Business Models and Industries
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
5. The first step in the financial risk management process is
a) buying insurance.
b) identifying risks.
c) managing risks.
d) monitoring risks.
Difficulty: Easy
Learning Objective: Understand how firms create value, manage performance, and communicate useful information to users.
Section Reference: Business Models and Industries
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
6. Value creation refers to
a) generating the highest profits possible given available resources.
b) choosing the optimal business model for a given industry.
c) finding an optimal balance between managing risks and taking the right opportunities.
d) how a company creates value for its employees.
Difficulty: Easy
Learning Objective: Understand how firms create value, manage performance, and communicate useful information to users.
Section Reference: Business Models and Industries
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
7. Information in the income statement does NOT help users to
a) evaluate the past performance of the enterprise.
b) provide a basis for predicting future performance.
c) help assess the risk of not achieving future cash flows.
d) calculate the exact amount of future dividends.
Difficulty: Easy
Learning Objective: Understand how firms create value, manage performance, and communicate useful information to users.
Section Reference: Business Models and Industries
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
8. A useful statement of income
a) has feedback value.
b) has predictive value.
c) helps stakeholders understand the business.
d) All options are correct.
Difficulty: Easy
Learning Objective: Understand how firms create value, manage performance, and communicate useful information to users.
Section Reference: Business Models and Industries
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
9. Segregating a company’s recurring operating income from nonrecurring income sources is useful because
a) recurring income is constantly changing.
b) nonrecurring income is subject to greater management bias and uncertainty.
c) results from continuing operations have greater significance for predicting future performance.
d) nonrecurring income is irrelevant to stakeholders.
Difficulty: Easy
Learning Objective: Understand how firms create value, manage performance, and communicate useful information to users.
Section Reference: Business Models and Industries
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
10. Which of the following does NOT refer to the income statement?
a) Statement of Financial Performance
b) Statement of Profit and Loss
c) Statement of Financial Position
d) Statement of Comprehensive Income
Difficulty: Easy
Learning Objective: Understand how firms create value, manage performance, and communicate useful information to users.
Section Reference: Business Models and Industries
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
11. Cost structure is often an indicator regarding business type and the industry in which it operates. What industry would a company with a low gross profit margin and high turnover likely be operating in?
a) Technology
b) Natural resources
c) Transportation
d) Retail
Difficulty: Easy
Learning Objective: Understand how firms create value, manage performance, and communicate useful information to users.
Section Reference: Business Models and Industries
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
12. The concept of soft numbers reflects the fact that
a) financial statement numbers may be manipulated.
b) sometimes significant measurement uncertainty exists.
c) sometimes significant errors exist.
d) earnings numbers may not be sustainable.
Difficulty: Easy
Learning Objective: Understand the concept of and be able to assess the quality of earnings/information.
Section Reference: Quality of Earnings/Information
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
13. Earnings management is
a) the process of managing a business.
b) the process of profit maximization.
c) always fraudulent.
d) manipulating income to meet a targeted earnings level.
Difficulty: Easy
Learning Objective: Understand the concept of and be able to assess the quality of earnings/information.
Section Reference: Quality of Earnings/Information
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
14. Which of the following statements regarding the limitations of income statements is NOT correct?
a) When items cannot be measured reliably, those items are not reported.
b) The application of GAAP is optimal.
c) Income measurement involves the use of estimates.
d) Income numbers are affected by the accounting methods used.
Difficulty: Easy
Learning Objective: Understand the concept of and be able to assess the quality of earnings/information.
Section Reference: Quality of Earnings/Information
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
15. Which of the following is NOT correct regarding “quality of earnings”?
a) Quality of earnings refers to how solid the earnings numbers are.
b) Analysts use quality of earnings to assess how well the reported income reflects the underlying business and future potential.
c) If earnings quality is high, numbers are accepted as is.
d) If earnings quality is low, numbers are accepted as is.
Difficulty: Easy
Learning Objective: Understand the concept of and be able to assess the quality of earnings/information.
Section Reference: Quality of Earnings/Information
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
16. Which of the following statements regarding high-quality earnings is NOT correct?
a) The shares of companies with high-quality earnings are valued higher in capital markets.
b) High-quality earnings make verifiable promises about future performance.
c) High-quality earnings provide higher-quality information.
d) High-quality earnings have a lower likelihood of potential misstatement.
Difficulty: Easy
Learning Objective: Understand the concept of and be able to assess the quality of earnings/information.
Section Reference: Quality of Earnings/Information
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
17. In order to enhance the quality of the earnings information, a provision for credit losses
a) requires the use of estimates and is referred to as a “soft” number.
b) cannot be reliably measured and should not be included on the income statement.
c) is not optimal, since this is not GAAP compliant.
d) is an example of conscious bias.
Difficulty: Easy
Learning Objective: Understand the concept of and be able to assess the quality of earnings/information.
Section Reference: Quality of Earnings/Information
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
18. The operations manager at GA Electric has asked the controller to decrease the provisions for credit losses and record sales revenues for customers once the materials for upcoming jobs have been shipped. The controller refuses. In doing so, the controller is
a) applying the concept of earnings management.
b) demonstrating unconscious bias.
c) ensuring transparency.
d) contributing to financial misstatement.
Difficulty: Easy
Learning Objective: Understand the concept of and be able to assess the quality of earnings/information.
Section Reference: Quality of Earnings/Information
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
19. Net income represents
a) revenues and gains less expenses and losses from continuing operations only.
b) revenues and gains less expenses and losses from both continuing and discontinued operations.
c) net income plus/minus other comprehensive income.
d) ongoing revenues and expenses before gains, losses, and discontinued operations.
Difficulty: Easy
Learning Objective: Understand the differing perspectives on how to measure income.
Section Reference: Measurement of Income
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
20. The view of income that IFRS generally supports is referred to as the
a) all-inclusive approach.
b) current operating performance approach.
c) other comprehensive income approach.
d) operating income approach.
Difficulty: Easy
Learning Objective: Understand the differing perspectives on how to measure income.
Section Reference: Measurement of Income
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
21. At year end, other comprehensive income is closed out to
a) retained earnings.
b) share capital.
c) accumulated other comprehensive income.
d) net income.
Difficulty: Easy
Learning Objective: Understand the differing perspectives on how to measure income.
Section Reference: Measurement of Income
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
22. All-inclusive income includes all of the following, except for
a) investments by owners.
b) losses on disposal of assets.
c) dividend revenue.
d) gains on the expropriation of property by the government.
Difficulty: Easy
Learning Objective: Understand the differing perspectives on how to measure income.
Section Reference: Measurement of Income
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
23. Comprehensive income includes all changes in equity during a period, except for
a) gains and losses from discontinued operations.
b) unrealized gains and losses on available for sale securities.
c) those resulting from investments by owners and distributions to owners.
d) gains and losses from irregular items.
Difficulty: Easy
Learning Objective: Understand the differing perspectives on how to measure income.
Section Reference: Measurement of Income
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
24. Accumulated other comprehensive income would be reported in
a) shareholders’ equity.
b) retained earnings.
c) net income.
d) net income from continuing operations.
Difficulty: Easy
Learning Objective: Understand the differing perspectives on how to measure income.
Section Reference: Measurement of Income
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
25. The calculation of earnings per share is generally based on which income figure?
a) Other comprehensive income
b) Income from discontinued operations
c) Net income
d) All-inclusive income
Difficulty: Easy
Learning Objective: Understand the differing perspectives on how to measure income.
Section Reference: Measurement of Income
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
26. Papaya Inc. has 100,000 common shares outstanding and has a policy of paying a $1.30 annual dividend for each of these shares. Papaya has an income tax rate of 35%, and its retained earnings statement for 2023 reported a closing balance of $1,452,000. Assuming an opening retained earnings balance of zero, dividend payments according to its usual policy, and no other adjustments, Papaya's 2023 net income was
a) $1,536,500.
b) $2,364,846.
c) $1,452,000.
d) $1,582,000.
Difficulty: Medium
Learning Objective: Understand the differing perspectives on how to measure income.
Section Reference: Measurement of Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $1,452,000 + ($1.30 x 100,000) = $1,582,000
27. The following information is available for Pear Limited for 2023:
Accounts payable, beginning $14,000
Cash payments on account during year 54,000
Purchase discounts taken during year on 2023 purchases 1,200
Accounts payable, ending 7,000
Assuming the company records purchases at gross amounts, the total purchases for 2023 would be
a) $48,200.
b) $61,000.
c) $55,200.
d) $59,800.
Difficulty: Medium
Learning Objective: Understand the differing perspectives on how to measure income.
Section Reference: Measurement of Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $54,000 + $1,200 – $14,000 + $7,000 = $48,200
28. The following information is available for Excelsior Corp. for 2023:
Payment for goods during year $104,000
Accounts Payable, beginning 14,000
Inventory, beginning 28,000
Accounts Payable, ending 12,600
Inventory, ending 16,200
Cost of goods sold for 2023 is
a) $102,600.
b) $132,000.
c) $105,400.
d) $114,400.
Difficulty: Medium
Learning Objective: Understand the differing perspectives on how to measure income.
Section Reference: Measurement of Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $104,000 – $14,000 + $12,600 = $102,600 (purchases)
$28,000 + $102,600 – $16,200 = $114,400
29. The following information is available for Royal Corp. for 2023:
Accounts payable, beginning $14,000
Cash payments on account during year 7,000
Purchase discounts taken during year on 2023 purchases 1,200
Purchases 10,000
Assuming that all purchases are made on account, accounts payable at the end of the year are
a) $17,000.
b) $22,800.
c) $15,800.
d) $24,000.
Difficulty: Medium
Learning Objective: Understand the differing perspectives on how to measure income.
Section Reference: Measurement of Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $14,000 – $7,000 + $10,000 – $1,200 = $15,800
30. Gains and losses that bypass net income but affect shareholders’ equity are referred to as
a) single-step income.
b) other comprehensive income.
c) prior period income.
d) unusual gains and losses.
Difficulty: Easy
Learning Objective: Understand the differing perspectives on how to measure income.
Section Reference: Measurement of Income
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
31. Star Fruit Corp. has the following December 31, 2023 balances in its shareholders’ equity accounts:
Common Shares $275,000
Accumulated OCI 21,500
Retained Earnings 687,500
During 2024 the company earned net income of $33,500, issued $5,000 in common shares, and declared dividends of $17,500 with an ending total balance in shareholders’ equity of $1,012,500. What was Star Fruit’s other comprehensive income or loss in 2023?
a) $33,500
b) $16,000
c) $7,500
d) $0, there was no comprehensive income or loss
Difficulty: Medium
Learning Objective: Understand the differing perspectives on how to measure income.
Section Reference: Measurement of Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: ($275,000 + $5,000) + ($687,500 + $33,500- $17,500) + ($21,500 + X) = $1,012,500, X = ($1,012,500 – $1,005,000), X = $7,500
32. When a company disposes of a discontinued operation (segment), the transaction should be included in the income statement as a gain or loss on disposal, and reported as
a) a prior period adjustment.
b) other comprehensive income.
c) an amount after continuing operations.
d) a bulk sale of plant assets included in income from continuing operations.
Difficulty: Easy
Learning Objective: Measure and report results of discontinued operations.
Section Reference: Discontinued Operations
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
33. For purposes of discontinued operations, the key elements in determining whether a separate segment exists are that the component is
a) a separate business and a separate legal entity.
b) a separate legal entity and generates its own net cash flows.
c) in a separate geographic region and can be sold.
d) a separate business and generates its own cash flow.
Difficulty: Easy
Learning Objective: Measure and report results of discontinued operations.
Section Reference: Discontinued Operations
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Comprehension
AACSB: Analytic
34. If an asset is to be classified as held for sale, which of the following conditions does NOT apply?
a) The sale has been authorized by the company's management.
b) Changes to the sale plan are likely.
c) It is probable that the asset will be sold within one year.
d) There is an active program to find a buyer.
Difficulty: Easy
Learning Objective: Measure and report results of discontinued operations.
Section Reference: Discontinued Operations
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Comprehension
AACSB: Analytic
35. When an asset is held for sale
a) it must relate to a discontinued operation.
b) the entity must continue to record depreciation for the asset.
c) the asset is remeasured to the lower of carrying (book) value and fair value less costs to sell.
d) the asset is remeasured to the lower of fair value and carrying (book) value.
Difficulty: Easy
Learning Objective: Measure and report results of discontinued operations.
Section Reference: Discontinued Operations
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Comprehension
AACSB: Analytic
36. If the value of an asset that has been written down later increases, to what extent may the related gain be recognized?
a) up to the amount of the original loss
b) No remeasurements may be recognized.
c) None of the gain may be recognized.
d) up to the fair market value of the asset
Difficulty: Easy
Learning Objective: Measure and report results of discontinued operations.
Section Reference: Discontinued Operations
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Comprehension
AACSB: Analytic
37. Sesame Corp.'s adjusted trial balance at December 31, 2023 included the following:
Debit Credit
Sales Revenue $170,000
Cost of Goods Sold $ 70,000
Administrative Expenses 28,000
Loss on Disposal of Equipment 11,000
Sales Commission Expense 9,000
Interest Income 6,000
Loss from Flood Damage 15,000
Loss on Discontinued Operations 24,000
Credit Losses 5,000 __________
Totals $162,000 $176,000
Sesame uses the perpetual system, and its income tax rate is 30%. On Sesame’s multiple-step income statement for 2023, income from discontinued operations is
a) $10,500.
b) $16,800.
c) $24,000.
d) $24,500.
Difficulty: Medium
Learning Objective: Measure and report results of discontinued operations.
Section Reference: Discontinued Operations
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $24,000 x (1 – 0.3) = $16,800
38. During 2023, Honeydew Corp. disposed of Blackberry Division, a major segment of its business. Honeydew realized a gain of $1,500,000, net of taxes, on the sale of Blackberry’s assets. During 2023, Blackberry’s operating losses, net of taxes, were $1,800,000. How should these facts be reported in Honeydew’s income statement for 2023?
Total Amount to be included in
Income from Results from
Continuing Operations Discontinued Operations
a) $1,800,000 loss $1,500,000 gain
b) 300,000 loss 0
c) 0 300,000 loss
d) 1,500,000 gain 1,800,000 loss
Difficulty: Medium
Learning Objective: Measure and report results of discontinued operations.
Section Reference: Discontinued Operations
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $1,800,000 – $1,500,000 = $300,000 loss
39. On January 1, 2023, Bellair Ltd. decided to discontinue its plastics making division. The division, considered a reporting segment, was sold on June 1, 2023. Division assets with a carrying value of $812,500 were sold for $625,000. Operating income from January 1 to May 31 for the division was $62,500. Ignoring income taxes, what amount should be reported on Bellair’s income statement for the year ended December 31, 2023, under the caption "discontinued operations"?
a) $250,000 gain
b) $187,500 loss
c) $62,500 gain
d) $125,000 loss
Difficulty: Medium
Learning Objective: Measure and report results of discontinued operations.
Section Reference: Discontinued Operations
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $812,500 – $625,000 – $62,500 = $125,000 loss
40. During 2023, Door Inc. decided to dispose of Bell Division, which is considered a separate reporting segment. Door estimates it can sell Bell at a loss of $30,000, and does so on May 1, 2023. Bell’s operating income from January 1 to April 30 was $23,000. Ignoring income taxes, and assuming statements are prepared under ASPE, the discontinued operations section of Door’s income statement for the year ended December 31, 2023 should report
a) the $23,000 operating income and the $30,000 loss in the discontinued operations section of the income statement.
b) the $23,000 operating income in the body of the income statement and the $30,000 loss in the discontinued operations section of the income statement.
c) the $23,000 operating income and the $30,000 loss in the body of the income statement.
d) only the income from Door’s other divisions. Since it no longer owns Bell at December 31, Door does not need to report anything relating to Bell’s operations during the year.
Difficulty: Medium
Learning Objective: Measure and report results of discontinued operations.
Section Reference: Discontinued Operations
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
41. In the case where a formal plan of disposal is in place, the gain or loss on disposal of assets held for sale related to a component of a business is reflected on the financial statements as
a) an unusual gain or loss.
b) a part of discontinued operations.
c) an extraordinary item.
d) an accounting change.
Difficulty: Easy
Learning Objective: Measure and report results of discontinued operations.
Section Reference: Discontinued Operations
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
42. On March 31, 2023, Foam Pak Ltd. decided to discontinue its plastics division. The division, considered a reporting segment, was sold on September 1, 2023. Division assets with a carrying value of $515,000 were sold for $375,000. Operating income from January 1 to August 31 for the division was $32,750. Assuming an income tax rate of 20%, what amount should be reported on Foam Pak’s income statement for the year ended December 31, 2023, under the caption "discontinued operations"?
a) $128,700 loss
b) $85,500 loss
c) $32,750 gain
d) $107,250 loss
Difficulty: Medium
Learning Objective: Measure and report results of discontinued operations.
Section Reference: Discontinued Operations
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: ($515,000 – $375,000 – $32,750 = $107,250) x (1-20%) = 85,800 loss
43. Which of the following is a required disclosure in the income statement when reporting the disposal of a segment of the business?
a) The gain or loss on disposal should be reported as an unusual item.
b) Results of operations of a discontinued segment should be disclosed in other comprehensive income.
c) Earnings per share from both continuing operations and for the discontinued segment should be disclosed either on the face of the statement or in the notes.
d) The gain or loss on disposal should not be segregated but should be reported together with the results of continuing operations.
Difficulty: Easy
Learning Objective: Measure and report results of discontinued operations.
Section Reference: Discontinued Operations
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Comprehension
AACSB: Analytic
44. Unusual gains and losses are items on the income statement that
a) are typical of everyday activities but do not occur frequently.
b) are not typical of everyday activities or do not occur frequently.
c) include write down of inventories and write off of credit losses.
d) are not usually disclosed separately.
Difficulty: Easy
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
45. Under IFRS, which of the following is NOT required to be presented separately in the statements of income/comprehensive income?
a) revenues
b) discontinued operations
c) income tax expense
d) depreciation/amortization
Difficulty: Easy
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
46. The single-step income statement emphasizes
a) the gross profit figure.
b) total revenues and total expenses.
c) discontinued operations and accounting changes.
d) the various components of income from continuing operations.
Difficulty: Easy
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
47. Which of the following is NOT a generally practiced method of presenting the income statement?
a) including corrections of errors made in a prior period
b) the single-step income statement
c) the multiple-step income statement
d) including gains and losses from discontinued operations
Difficulty: Easy
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
48. IFRS requires that expenses be presented in the income statement
a) by amount or in alphabetical order.
b) by geographical area or by the single-step method.
c) by nature or by function.
d) by current or non-current.
Difficulty: Easy
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
49. When expenses are presented by function in the income statement,
a) they should be presented by type of expense (e.g., depreciation, purchases, salaries).
b) they should be reported as part of other comprehensive income.
c) the cash flow predictive value is increased.
d) more professional judgement is required to allocate expenses between functions.
Difficulty: Easy
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
50. Intraperiod tax allocation
a) allocates tax balances between fiscal years.
b) allocates tax balances within a fiscal period.
c) is used for income from continuing operations but not for income from discontinued operations.
d) is used for other comprehensive income but not for income from discontinued operations.
Difficulty: Easy
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
51. Intraperiod tax allocation
a) arises because certain revenue and expense items appear in the income statement either before or after they are included in the tax return.
b) is required for the cumulative effect of changes in accounting principles but not for discontinued operations.
c) allocates income tax expense evenly over a number of accounting periods.
d) relates income tax expense to the items that affect the amount of tax.
Difficulty: Easy
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
52. Which of the following statements regarding earnings per share (EPS) data is correct?
a) Both public and private corporations are required to report EPS on the face of the income statement.
b) Although public corporations are required to report EPS, private corporations are not.
c) EPS related to comprehensive income is required.
d) Financial analysts do not attach much importance to EPS data.
Difficulty: Easy
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
53. With regard to the presentation of expenses by nature versus function, function refers to
a) the type of expense, such as depreciation, purchases, or employee benefits.
b) whether the expense actively contributed to the generation of income.
c) the business activity to which the expense relates.
d) the name of the cost centre responsible for the expense.
Difficulty: Easy
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
Use the following information for questions 54–55.
Oskar Corp. reports operating expenses in two categories: (1) selling and (2) general and administrative. The adjusted trial balance at December 31, 2023, included the following expense accounts:
Legal Expense $120,000
Advertising Expense 150,000
Freight Out 75,000
Interest Expense 60,000
Loss on Disposal of Investments—FV-NI 30,000
Management Salaries 180,000
Rent Expense 160,000
Sales Commission Expense 110,000
One-half of the rented premises is occupied by the sales department.
54. How much of the expenses listed above should be included in Oskar’s selling expenses for 2023?
a) $260,000
b) $335,000
c) $340,000
d) $415,000
Difficulty: Medium
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $150,000 + $75,000 + $110,000 + ($160,000/2) = $415,000
55. How much of the expenses listed above should be included in Oskar’s general and administrative expenses for 2023?
a) $380,000
b) $410,000
c) $440,000
d) $470,000
Difficulty: Medium
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $120,000 + $180,000 + ($160,000/2) = $380,000
56. Groucho Corp. reports operating expenses in two categories: (1) selling and (2) general and administrative. The adjusted trial balance at December 31, 2023, included the following accounts:
Legal Expense $140,000
Advertising Expense 160,000
Freight Out 80,000
Interest Expense 70,000
Loss on Disposal of Investments—FV-NI 30,000
Management Salaries 225,000
Rent Expense 220,000
Sales Commission Expense 170,000
One-half of the rented premises is occupied by the sales department. Groucho’s total selling expenses for 2023 are
a) $520,000.
b) $440,000.
c) $410,000.
d) $350,000.
Difficulty: Medium
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $160,000 + $80,000 + ($220,000/2) + $170,000 = $520,000
57. The following items were among those reported on Harry’s Ltd.'s income statement for the year ended December 31, 2023:
Legal Expense $200,000
Rent Expense 470,000
Interest Expense 496,000
Loss on Disposal of Equipment 82,000
The office space is used equally by Harry’s sales and accounting departments. What amount should be classified as general and administrative expenses in Harry’s multiple-step income statement for 2023?
a) $235,000
b) $435,000
c) $670,000
d) $931,000
Difficulty: Medium
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $200,000 + ($470,000/2) = $435,000
Use the following information for questions 58–59.
Sesame Corp.'s adjusted trial balance at December 31, 2023, included the following:
Debit Credit
Sales Revenue $170,000
Cost of Goods Sold $ 70,000
Administrative Expenses 28,000
Loss on Disposal of Equipment 11,000
Sales Commission Expense 9,000
Interest Income 6,000
Loss from Flood Damage 15,000
Loss from Discontinued Operations 24,000
Credit Losses 5,000 ___________
Totals $162,000 $176,000
Sesame uses the perpetual system, and their income tax rate is 30%.
58. On Sesame’s multiple-step income statement for 2023, income from continuing operations is
a) $17,500.
b) $52,800.
c) $24,500.
d) $26,600.
Difficulty: Medium
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $170,000 + $6,000 – $70,000 – $28,000 – $11,000 – $9,000 – $15,000 – $5,000 = $38,000; 38,000 x (1 – 0.3) = $26,600
AACSB: Analytic
59. On Sesame’s multiple-step income statement for 2023, net income is
a) $9,800.
b) $15,000.
c) $16,800.
d) $24,000.
Difficulty: Medium
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: ($176,000 – $162,000) x (1 – 0.3) = $9,800
60. Meg Inc. incurred the following infrequent losses during 2023:
A $135,000 write down of equipment leased to others (net of tax)
A $60,000 adjustment of accruals on long-term contracts (net of tax)
A $90,000 write off of obsolete inventory (net of tax)
Of those losses, what amount should be included in Meg’s 2023 income from continuing operations?
a) $285,000
b) $225,000
c) $195,000
d) $150,000
Difficulty: Medium
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $135,000 + $60,000 + $90,000 = $285,000
61. The following information is available for Quiny Inc. for 2023:
Cash payments for purchases $715,000
Increase in Accounts Payable 63,800
Decrease in Inventory 30,800
Cost of goods sold for 2023 was
a) $715,000.
b) $778,800.
c) $770,000.
d) $809,600.
Difficulty: Medium
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $715,000 + $63,800 + $30,800 = $809,600
62. Honeysuckle Inc. reported the following information for 2023:
Sales Revenue $780,000
Cost of Goods Sold 525,000
Operating Expenses 82,500
Gain on Disposal of Equipment 105,000
Dividend Revenue 4,500
For 2023, on a multiple-step income statement, Honeysuckle would report other income of
a) $277,500.
b) $109,500.
c) $105,000.
d) $4,500.
Difficulty: Medium
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: Other income = $105,000 + $4,500 = $109,500
63. Rudolph Corporation reports the following information:
Net income $900,000
Dividends on common shares $252,000
Dividends on preferred shares $90,000
Weighted average common shares outstanding 300,000
Rudolph should report earnings per share of
a) $1.86.
b) $2.16.
c) $2.70.
d) $3.00.
Difficulty: Medium
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: ($900,000 – $90,000) ÷ 300,000 = $2.70
64. Chan Corporation reports the following information on January 1, 2023:
Preferred shares, 21,000 issued, unlimited number authorized, $.50 dividend paid quarterly
Common shares, 150,000 issued, unlimited number authorized
During 2023 the company earns $550,000 in net income and issues an additional 75,000 common shares on September 1. What is Chan’s EPS on December 31, 2023?
a) $3.08
b) $2.87
c) $2.71
d) $2.90
Difficulty: Medium
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $550,000 – (21,000 x $.50 x 4) = $508,000; $508,000 / (150,000 + 75,000 x 4/12) = $2.90
65. Smith Corporation reports the following information on January 1, 2023:
Preferred shares, 25,000 issued, unlimited number authorized, $.50 dividend paid quarterly
Common shares, 150,000 issued, unlimited number authorized
During 2023 the company earns $350,000 in net income. No additional shares have been issued or repurchased. Assuming shares are trading at $65 per share, what is Smith’s price earnings ratio on December 31, 2023?
a) 32.50
b) 31.25
c) 30.00
d) 28.85
Difficulty: Medium
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $350,000 – (25,000 x $.50 x 4) = $300,000; $300,000 / 150,000 = $2.00 / share, P/E Ratio: $65 / $2.00 = 32.50
66. Which of the following items will NOT appear in the retained earnings statement?
a) net loss
b) correction of an error
c) change in accounting estimates
d) stock dividends
Difficulty: Easy
Learning Objective: Prepare the statement of retained earnings and the statement of changes in equity.
Section Reference: The Statement of Retained Earnings and the Statement of Changes in Equity
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
67. Which one of the following types of losses is excluded from the determination of net income in the income statement?
a) material losses resulting from correction of errors related to prior periods
b) material losses resulting from sale of assets not originally acquired for resale
c) material losses resulting from write off of intangibles
d) material losses resulting from sale of investments
Difficulty: Easy
Learning Objective: Prepare the statement of retained earnings and the statement of changes in equity.
Section Reference: The Statement of Retained Earnings and the Statement of Changes in Equity
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
68. Which of the following is a change in accounting principle?
a) a change in the estimated service life of machinery
b) a change from FIFO to weighted average for inventory costing
c) a change in the estimated allowance for credit losses
d) a change in estimated future warranty expense
Difficulty: Easy
Learning Objective: Prepare the statement of retained earnings and the statement of changes in equity.
Section Reference: The Statement of Retained Earnings and the Statement of Changes in Equity
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
69. When reporting a change in accounting principle, required disclosure(s) on the income statement include
a) a per share amount for the cumulative effect of the change.
b) the cumulative effect on prior years, net of tax.
c) the cumulative effect be disclosed immediately after discontinued operations.
d) a change in accounting principle is not reported on the income statement.
Difficulty: Easy
Learning Objective: Prepare the statement of retained earnings and the statement of changes in equity.
Section Reference: The Statement of Retained Earnings and the Statement of Changes in Equity
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
70. Unsure Inc. made a very large mathematical error in the preparation of its year-end financial statements by the incorrect placement of a decimal point in the calculation of depreciation. The error caused the net income to be reported at almost double the correct amount. When Unsure discovered the error in the following year, correction of the error should be treated as a(n)
a) adjustment to beginning retained earnings, net of tax.
b) increase in depreciation expense for the year in which the error is discovered.
c) gain for the year in which the error was made.
d) component of income for the year in which the error is discovered, but separately listed on the income statement and fully explained in a note to the financial statements.
Difficulty: Easy
Learning Objective: Prepare the statement of retained earnings and the statement of changes in equity.
Section Reference: The Statement of Retained Earnings and the Statement of Changes in Equity
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
71. The statement of changes in shareholders’ equity
a) is a required statement under ASPE.
b) is a required statement under IFRS.
c) is a required statement under both IFRS and ASPE.
d) is an optional statement under both IFRS and ASPE.
Difficulty: Easy
Learning Objective: Prepare the statement of retained earnings and the statement of changes in equity.
Section Reference: The Statement of Retained Earnings and the Statement of Changes in Equity
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
72. Which of the following should be reported as an adjustment to retained earnings?
Change in Estimated Lives Change from Unaccepted
of Depreciable Assets Principle to Accepted Principle
a) Yes Yes
b) No Yes
c) Yes No
d) No No
Difficulty: Easy
Learning Objective: Prepare the statement of retained earnings and the statement of changes in equity.
Section Reference: The Statement of Retained Earnings and the Statement of Changes in Equity
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
73. Portland Corporation reports the following information:
Correction of understatement of depreciation expense
in prior years, net of tax $1,376,000
Dividends 1,024,000
Net income 3,200,000
Retained Earnings, January 1, 2023 6,400,000
Portland should report retained earnings at January 1, 2023, as adjusted at
a) $5,024,000.
b) $7,200,000.
c) $8,576,000.
d) $9,952,000.
Difficulty: Medium
Learning Objective: Prepare the statement of retained earnings and the statement of changes in equity.
Section Reference: The Statement of Retained Earnings and the Statement of Changes in Equity
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $6,400,000 – $1,376,000 = $5,024,000
Use the following information for questions 74–75.
The 2022 and 2023 financial statements of Banana Inc. contained the following errors:
___________2022________ 2023
Ending Inventory $10,000 overstated $16,000 understated
Insurance Expense 4,800 understated 2,600 overstated
74. Assuming that none of the errors were detected or corrected, by what amount will 2022 income before taxes be overstated or understated?
a) $5,200 understated
b) $5,200 overstated
c) $14,800 overstated
d) $14,800 understated
Difficulty: Medium
Learning Objective: Prepare the statement of retained earnings and the statement of changes in equity.
Section Reference: The Statement of Retained Earnings and the Statement of Changes in Equity
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $10,000 + $4,800 = $14,800 overstated
75. Assuming that none of the errors were detected or corrected, by what amount will 2023 income before taxes be overstated or understated?
a) $28,600 understated
b) $23,800 understated
c) $13,400 understated
d) $13,400 overstated
Difficulty: Medium
Learning Objective: Prepare the statement of retained earnings and the statement of changes in equity.
Section Reference: The Statement of Retained Earnings and the Statement of Changes in Equity
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $10,000 + $16,000 + $2,600 = $28,600 understated
Use the following information for questions 76–78. Ignore taxes.
Peach Inc.’s financial statements for the years 2022 and 2023 contained errors as follows:
_______2022________ 2023_________
Ending Inventory $3,000 understated $5,000 overstated
Depreciation Expense 5,500 overstated 3,500 overstated
76. Assuming that the errors made in 2022 were corrected, but that the errors made in 2023 were not detected, by what amount will 2023 income before taxes be overstated or understated?
a) $5,000 overstated
b) $8,500 overstated
c) $1,500 understated
d) $1,500 overstated
Difficulty: Medium
Learning Objective: Prepare the statement of retained earnings and the statement of changes in equity.
Section Reference: The Statement of Retained Earnings and the Statement of Changes in Equity
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $5,000 – $3,500 = $1,500 overstated
77. Assuming that none of the errors were detected or corrected, by what amount will retained earnings at December 31, 2023 be overstated or understated?
a) $4,000 understated
b) $5,000 overstated
c) $8,500 understated
d) $11,500 understated
Difficulty: Medium
Learning Objective: Prepare the statement of retained earnings and the statement of changes in equity.
Section Reference: The Statement of Retained Earnings and the Statement of Changes in Equity
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $5500 + $3,500 – $5,000 = $4,000 understated
78. Assuming that none of the errors were detected or corrected, and that no additional errors were made in 2022, by what amount will current assets at December 31, 2023 be overstated or understated?
a) $2,000 overstated
b) $10,000 understated
c) $10,000 overstated
d) $5,000 overstated
Difficulty: Medium
Learning Objective: Prepare the statement of retained earnings and the statement of changes in equity.
Section Reference: The Statement of Retained Earnings and the Statement of Changes in Equity
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $5,000 overstated
Use the following information for questions 79–80.
For Peach Limited, events and transactions during 2021-2023 included the following. The tax rate for all items is 30%.
1. Depreciation for 2022 was found to be understated by $30,000.
2. A 2023 strike by the employees of a supplier resulted in a loss of $20,000.
3. The inventory at December 31, 2021 was overstated by $40,000.
4. A 2023 flood destroyed a building that had a book value of $400,000. Floods are very uncommon in that area.
79. The effect of these events and transactions on 2023 income from continuing operations net of tax would be
a) $14,000.
b) $35,000.
c) $63,000.
d) $294,000.
Difficulty: Medium
Learning Objective: Prepare the statement of retained earnings and the statement of changes in equity.
Section Reference: The Statement of Retained Earnings and the Statement of Changes in Equity
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: ($20,000 + $400,000) x (1 – 0.3) = $294,000
80. The effect of these events and transactions on the balance of retained earnings at January 1, 2023 would be
a) $14,000.
b) $21,000.
c) $294,000.
d) $343,000.
Difficulty: Medium
Learning Objective: Prepare the statement of retained earnings and the statement of changes in equity.
Section Reference: The Statement of Retained Earnings and the Statement of Changes in Equity
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $30,000 x (1 – 0.3) = $21,000
81. The following information was extracted from the accounts of Tomato Corporation at December 31, 2023:
CR (DR)
Total reported income since incorporation $1,540,000
Total cash dividends paid (550,000)
Cumulative effect of changes in accounting principle (154,000)
Total stock dividends distributed (330,000)
Correction of an error, recorded January 1, 2023 84,700
What should be the balance of retained earnings at December 31, 2023?
a) $465,300
b) $550,000
c) $590,700
d) $506,000
Difficulty: Medium
Learning Objective: Prepare the statement of retained earnings and the statement of changes in equity.
Section Reference: The Statement of Retained Earnings and the Statement of Changes in Equity
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $1,540,000 – $550,000 – $154,000 – $330,000 + $84,700 = $590,700
82. If the change resulted in reliable and more relevant information, a change in the method of inventory costing from average cost to FIFO would be accounted for as
a) a part of discontinued operations.
b) an unusual item.
c) a change in accounting policy
d) a change in an accounting estimate.
Difficulty: Easy
Learning Objective: Prepare the statement of retained earnings and the statement of changes in equity.
Section Reference: The Statement of Retained Earnings and the Statement of Changes in Equity
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
83. Which of the following is(are) NOT recommended to be included in notes to the financial statements?
a) accounting policies
b) information about the capital structure of the company
c) individual salaries of the executive team
d) sources of estimation uncertainty
Difficulty: Easy
Learning Objective: Understand how disclosures and analysis help users of financial statements assess performance.
Section Reference: Disclosure and Analysis
CPA: Financial Reporting
CPA: Strategy & Governance
Bloomcode: Knowledge
AACSB: Analytic
84. To assess the quality of earnings, financial statement users should look at
a) the income statement only.
b) the statement of cash flows.
c) the level of business risk.
d) the whole set of financial statements, including the notes, as well as environmental factors.
Difficulty: Easy
Learning Objective: Understand how disclosures and analysis help users of financial statements assess performance.
Section Reference: Disclosure and Analysis
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
85. When looking to the statement of financial position for an assessment of earnings quality, stakeholders should pay particular attention to
a) a proportionately high cash balance, as this signifies high-quality earnings.
b) how the company is financed and what the revenue-generating assets are.
c) a proportionately low liability balance, as this signifies high-quality earnings.
d) The statement of financial position is not a reflection of earnings quality.
Difficulty: Easy
Learning Objective: Understand how disclosures and analysis help users of financial statements assess performance.
Section Reference: Disclosure and Analysis
CPA: Financial Reporting
CPA: Finance
Bloomcode: Knowledge
AACSB: Analytic
86. An earnings multiple is an indicator of how much an investor is willing to pay for a dollar earned by the company. This is determined by
a) the earnings per share of the company.
b) the net income of the firm.
c) the price earnings ratio.
d) the balance in retained earnings.
Difficulty: Easy
Learning Objective: Understand how disclosures and analysis help users of financial statements assess performance.
Section Reference: Disclosure and Analysis
CPA: Financial Reporting
CPA: Finance
Bloomcode: Knowledge
AACSB: Analytic
87. Which of the following is INCORRECT regarding differences between IFRS and ASPE?
a) Both IFRS and ASPE mandate a list of required items that must be presented.
b) IFRS requires that held-for-sale assets be reclassified as current assets.
c) Comprehensive income is not recognized under ASPE.
d) Both IFRS and ASPE require presentation of both basic and diluted EPS.
Difficulty: Easy
Learning Objective: Identify differences in accounting between IFRS and ASPE and potential changes.
Section Reference: IFRS/ASPE Comparison
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
88. Regarding the classification of expenses by nature versus function, under ASPE, an entity is required to
a) present an analysis of expenses based on their nature.
b) present its expenses according to their nature.
c) present expenses in a manner that is most transparent.
d) present its expenses according to their function.
Difficulty: Easy
Learning Objective: Identify differences in accounting between IFRS and ASPE and potential changes.
Section Reference: IFRS/ASPE Comparison
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
89. Regarding presentation of discontinued operations, under IFRS, on the balance sheet, an entity must classify held-for-sale assets as
a) current assets.
b) current or non-current, depending on their nature.
c) available for sale assets.
d) Assets held for sale do not appear on the balance sheet.
Difficulty: Easy
Learning Objective: Identify differences in accounting between IFRS and ASPE and potential changes.
Section Reference: IFRS/ASPE Comparison
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
90. For all accounting policy changes
a) under IFRS and ASPE, it is at the discretion of management to determine if the policy is reliable.
b) under IFRS and ASPE, all changes must be applied retroactively.
c) under ASPE, companies must follow the same standards as applicable under IFRS.
d) under IFRS, the new policy must be more reliable and more relevant.
Difficulty: Easy
Learning Objective: Identify differences in accounting between IFRS and ASPE and potential changes.
Section Reference: IFRS/ASPE Comparison
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
91. The statement of retained earnings
a) is used under IFRS and ASPE.
b) is a core statement under ASPE.
c) is interchangeable with the statement of changes in equity.
d) has limited usefulness under IFRS.
Difficulty: Easy
Learning Objective: Identify differences in accounting between IFRS and ASPE and potential changes.
Section Reference: IFRS/ASPE Comparison
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
*92. The accrual basis of accounting
a) must be used by all taxpayers.
b) recognizes revenue when earned and expenses when incurred.
c) does not record depreciation.
d) records depreciation but expenses all inventory purchases.
Difficulty: Easy
Learning Objective: Explain the differences between the cash basis of accounting and the accrual basis of accounting.
Section Reference: Application of the Cash and Accrual Bases of Accounting (Appendix 4A)
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
*93. The modified cash basis
a) is frequently used by manufacturing firms.
b) does not usually record inventory.
c) capitalizes and depreciates property, plant, and equipment.
d) is derived from the accrual basis of accounting.
Difficulty: Easy
Learning Objective: Explain the differences between the cash basis of accounting and the accrual basis of accounting.
Section Reference: Application of the Cash and Accrual Bases of Accounting (Appendix 4A)
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Knowledge
AACSB: Analytic
*94. The strict cash basis of accounting
a) records revenue when earned.
b) does not conform with GAAP.
c) records expenses when incurred.
d) adheres to the matching principle.
Difficulty: Easy
Learning Objective: Explain the differences between the cash basis of accounting and the accrual basis of accounting.
Section Reference: Application of the Cash and Accrual Bases of Accounting (Appendix 4A)
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
*95. Compared to the accrual basis of accounting, the cash basis of accounting overstates income by the net increase during the accounting period of the
Accounts Accrued
Receivable Expenses Payable
a) No No
b) No Yes
c) Yes No
d) Yes Yes
Difficulty: Medium
Learning Objective: Explain the differences between the cash basis of accounting and the accrual basis of accounting.
Section Reference: Application of the Cash and Accrual Bases of Accounting (Appendix 4A)
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
*96. For the year ended June 30, 2023, Harry Corp. reported revenue of $900,000 in its accrual basis income statement. Additional information was as follows:
Accounts Receivable June 30, 2022 $200,000
Accounts Receivable June 30, 2023 490,000
Uncollectible accounts written off during the fiscal year 20,000
Under the cash basis, Harry should report revenue of
a) $590,000.
b) $610,000.
c) $630,000.
d) $1,190,000.
Difficulty: Medium
Learning Objective: Explain the differences between the cash basis of accounting and the accrual basis of accounting.
Section Reference: Cash Basis versus Accrual Basis Earnings (Appendix 4A)
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $900,000 + $200,000 – $490,000 – $20,000 = $590,000
*97. Gerald Bone, M.D., keeps his accounting records on the cash basis. During 2023, Dr. Bone collected $150,000 from his patients. At December 31, 2022, Dr. Bone had accounts receivable of $45,000. At December 31, 2023, Dr. Bone had accounts receivable of $35,000 and unearned revenue of $5,000. On the accrual basis, how much was Dr. Bone’s patient service revenue for 2023?
a) $145,000
b) $140,000
c) $135,000
d) $105,000
Difficulty: Medium
Learning Objective: Explain the differences between the cash basis of accounting and the accrual basis of accounting.
Section Reference: Application of the Cash and Accrual Bases of Accounting (Appendix 4A)
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $150,000 – $45,000 + $35,000 – $5,000 = $135,000
*98. In 2023, Junction Corporation has cash receipts from customers of $270,000 and cash payments for operating expenses of $168,000. At January 1, 2023, accounts receivable was $30,000; at December 31, 2023 the receivables were $34,400. Total service revenue is
a) $270,000.
b) $274,400.
c) $106,400.
d) $265,600.
Difficulty: Medium
Learning Objective: Explain the differences between the cash basis of accounting and the accrual basis of accounting.
Section Reference: Application of the Cash and Accrual Bases of Accounting (Appendix 4A)
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $270,000 – $30,000 + $34,400 = $274,400
Use the following information for questions 99–100.
The 2023 statement of income for Carly Corporation showed rent expense of $9,900 and salary expense of $6,350. The related statement of financial position account balances at each year end were as follows:
2023 2022
Prepaid Rent $650 $450
Salaries Payable 325 475
*99. Determine the cash paid for rent in 2023.
b) $9,700
c) $9,900
d) $10,100
Difficulty: Medium
Learning Objective: Explain the differences between the cash basis of accounting and the accrual basis of accounting.
Section Reference: Application of the Cash and Accrual Bases of Accounting (Appendix 4A)
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $9,900 - $450 + $650=$10,100
*100. Determine the cash paid for salaries in 2023.
a) $6,500
b) $6,350
c) $6,200
d) $5,500
Difficulty: Medium
Learning Objective: Explain the differences between the cash basis of accounting and the accrual basis of accounting.
Section Reference: Application of the Cash and Accrual Bases of Accounting (Appendix 4A)
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $6,350 + $475 – $325 =$6,500
EXERCISES
Ex. 4-101 Value creation
Describe the concept of value creation. Does the value creation process look the same for all companies? Explain.
Solution 4-101
Value creation refers to the act of finding an optimal balance between managing risks and taking the right opportunities such that the firm’s net assets and potential are maximized. Well-run companies develop strategies that will allow them to react to the best opportunities to maximize shareholder value and maintain risks at an acceptable level.
This process will look different for every company as it depends on many variables. These might include their industry, the opportunities available to them, the assets they have to realize those opportunities, and their risk tolerance (acceptable level of risks). It also depends on shareholder demands and expectations. Some companies are expected to grow steadily and maintain stability, while others are expected to be more volatile.
Difficulty: Easy
Learning Objective: Understand how firms create value, manage performance, and communicate useful information to users.
Section Reference: Business Models and Industries
CPA: Communication
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Comprehension
AACSB: Communication
Ex. 4-102 Representational faithfulness
Consider the concept of representational faithfulness. Explain why an understanding of the business and industry in which the business operates is essential to performing an audit, and how this relates to the fundamental characteristic of representational faithfulness.
Solution 4-102
The financial statement auditor’s responsibility is to determine whether the financial statements present fairly the financial position and performances of the entity. This fair presentation is known as representational faithfulness, which requires financial statements to reflect the economic reality of running a business, including how it creates and sustains value. Knowledge of a business, its strategy, and its industry creates expectations of financial statement figures and ratios. For example, a company following a low-cost strategy will have small sales margins, while one that emphasizes product differentiation will have larger sales margins. The auditor (as well as other financial statement users) could check that figures are consistent with the strategy as an initial, high-level indicator of representational faithfulness.
Difficulty: Easy
Learning Objective: Understand how firms create value, manage performance, and communicate useful information to users.
Section Reference: Business Models and Industries
CPA: Communication
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Comprehension
AACSB: Communication
Ex. 4-103 Income statement performance assessment and cash flow
Explain how the income statement can be used to evaluate an enterprise’s past performance and profitability. What other information might be useful for performance and profitability evaluation? Explain how stakeholders could also use the income statement to help assess a company’s expected cash inflows. Why would a stakeholder be interested in this information?
Solution 4-103
By examining revenues, expenses, gains, and losses, users can see how the company (and management) performed and compare the company’s performance with that of its competitors. Balance sheet information is also useful in assessing profitability, such as by calculating return on assets. Users can also examine information (such as press releases) released by the company, and by analysts and regulators, to form a better assessment of a company’s performance. The relationship among various components of income highlights the relationships among them and can be used to predict future performance, including cash flows. For example, for a company with healthy collections, recurring operating income should be a rough estimation of cash flow from operating activities. These results from continuing operations can be used to predict future performance.
Difficulty: Easy
Learning Objective: Understand how firms create value, manage performance, and communicate useful information to users.
Section Reference: Business Models and Industries
CPA: Communication
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Comprehension
AACSB: Communication
Ex. 4-104 Characteristics of high-quality earnings and income statement limitations
Describe the characteristics of high-quality earnings. Are there any limitations to the income statement that might affect the quality of earnings?
Solution 4-104
Characteristics of high-quality earnings includes the following:
- Information content: unbiased/objectively determined
- Reflects the economic reality
- Sustainable—reflects primary earnings generated from ongoing core business activities
- Closely correlated with cash flows from operations
- Based on a sound business strategy/business model
- Presentation: transparent and understandable
The results disclosed in the income statement are based on the use of estimates and assumptions and may also be affected by the accounting methods used. Furthermore, some important items may, for lack of measurability, not be disclosed at all. Financial recording bias can exist and degrade the quality of the financial statements and subsequently the quality for the earnings information.
Difficulty: Easy
Learning Objective: Understand the concept of and be able to assess the quality of earnings/information.
Section Reference: Quality of Earnings/Information
CPA: Communication
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Communication
Ex. 4-105 Earnings management
Explain the concept of earnings management. Why is it of concern to investors and financial statement users? Do you think this practice should be allowed?
Solution 4-105
Earnings management is the process of targeting certain earnings levels or desired earnings trends and working backwards to ensure these targets are met. This can involve accounting policy selection, use of estimates, and transaction execution, often to increase income in the current year (however, depending on reporting motivations, earnings may also be manipulated downward in the current year). As long as there is full disclosure, the market should be able to see through attempts to mask economic reality. Despite this, investors and financial statement users are concerned that information presented is too promotional and lacks the transparency required to adhere to the principle of representational faithfulness—there is still a great deal of information asymmetry, or information known by management and unavailable to external stakeholders. In short, companies do not always disclose all important information and markets do not always operate efficiently.
Difficulty: Easy
Learning Objective: Understand the concept of and be able to assess the quality of earnings/information.
Section Reference: Quality of Earnings/Information
CPA: Communication
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Comprehension
AACSB: Communication
Ex. 4-106 Earnings management
Consider the practice of earnings management. Produce a scenario where a company might have an incentive to report lower earnings. Describe some earnings management approaches they might take to achieve this objective.
Solution 4-106
A company might decrease current earnings in order to increase future income (“taking a bath”). However, certain companies might more consistently report lower earnings to reduce their tax burden, maintain a level of profitability required to qualify for grants, or funding, or, to minimize pressure from shareholders to pay out dividends or other returns.
Some ways a company could decrease current earnings include:
- establish reserves using aggressive assumptions to estimate items such as sales returns, loan losses, and warranty returns
- delay recognition of large sales to the following fiscal year
- accelerate recognition of larger expense items
- establish aggressive estimates regarding the useful lives of assets to maximize the depreciation expense
Difficulty: Medium
Learning Objective: Understand the concept of and be able to assess the quality of earnings/information.
Section Reference: Quality of Earnings/Information
CPA: Communication
CPA: Financial Reporting
CPA: Strategy and Governance
Bloomcode: Application
AACSB: Communication
Ex. 4-107 Calculation of net income from the change in shareholders' equity
Presented below is selected information pertaining to Pullman Enterprises Ltd. for last year:
Assets, January 1 $240,000
Assets, December 31 320,000
Liabilities, January 1 120,000
Common shares, December 31 60,000
Retained earnings, December 31 20,000
The company also declared dividends of $32,000 and issued $2,000 of common shares.
Instructions
Calculate the net income for last year.
Solution 4-107
January 1 December 31
Assets $240,000 $320,000
Liabilities 120,000 240,000
Shareholders' equity $120,000 $ 80,000 *
Calculation of net income:
Shareholders' equity, Dec 31 $ 80,000
Less shareholders' equity, Jan 1 (120,000)
Decrease (40,000)
Add back dividend declared 32,000
Less common shares issued (2,000)
Net income (loss) $(10,000)
*$60,000 + $20,000
Difficulty: Medium
Learning Objective: Understand the differing perspectives on how to measure income.
Section Reference: Measurement of Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 4-108 Calculation of net income from the change in shareholders' equity
Presented below are changes in all account balances of Heys Inc. during last year, except for retained earnings.
Increase Increase
(Decrease) (Decrease)
Cash $22,000 Accounts Payable $28,000
Accounts Receivable (9,000) Bonds Payable (14,000)
Inventory 48,000 Common Shares 72,000
Equipment 24,000
The only entries in retained earnings were for net income and a dividend declaration of $12,000.
Instructions
Calculate the net income for last year.
Solution 4-108
Calculation of net income:
Change in assets ($94,000 – $9,000) $85,000 Increase
Change in liabilities ($28,000 – $14,000) 14,000 Increase
Change in shareholders' equity 71,000 Increase
Add back dividend declared 12,000
Less common shares (72,000)
Net income $ 8,000
Difficulty: Medium
Learning Objective: Understand the differing perspectives on how to measure income.
Section Reference: Measurement of Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 4-109 Comprehensive income
Tarzana Corporation completed its first year of operations on December 31, 2023. Results and other information for the year included the following:
Sales Revenue $810,000
Cost of Goods Sold 320,000
Operating Expenses 94,000
Unrealized Gain—OCI 31,000
Instructions
Based on the information provided, prepare a combined statement of income and comprehensive income. Ignore income taxes and EPS.
Solution 4-109
TARZANA CORPORATION
Statement of Income and Comprehensive Income
For the Year Ended December 31, 2023
Sales Revenue $810,000
Cost of Goods Sold 320,000
Gross Profit 490,000
Operating Expenses 94,000
Net Income 396,000
Other Comprehensive Income
Unrealized Gain—OCI 31,000
Comprehensive Income $427,000
Difficulty: Medium
Learning Objective: Understand the differing perspectives on how to measure income.
Section Reference: Measurement of Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 4-110 An all-inclusive approach
The notion of comprehensive earnings is sometimes referred to as the “all-inclusive” approach to measuring income. Explain what is meant by “all-inclusive.” How does this differ from the traditional notion of income? Why do you think that emerging standards such as IFRS support this view of income?
Solution 4-110
The “all-inclusive” approach is an income measurement approach that indicates most items, including irregular ones, are reported in net income. In contrast, more traditional views of net income exclude irregular items from net income, under the argument that they are not representative of continuing operations. Emerging standards such as IFRS, however, are strong proponents of fair value reporting as representational faithfulness and thus take preference to inclusion of ALL operations (even irregular or discontinued ones) on the income statement to provide stakeholders with a complete view of business operations. There is still some resistance to this view, as oft-used performance measures such as earnings per share still employ the traditional net income figure.
Difficulty: Easy
Learning Objective: Understand the differing perspectives on how to measure income.
Section Reference: Measurement of Income
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
Ex. 4-111 Comprehensive income terminology
Differentiate between other comprehensive income, comprehensive income, and accumulated other comprehensive income. Provide specific details on how each of these is applied and subsequently presented in the financial statements.
Solution 4-111
Other comprehensive income (OCI) is made up of certain specific gains or losses including unrealized gains and losses on certain securities, certain foreign exchange gains or losses, and other gains and losses as defined by IFRS. Some items are “recycled” or reclassified which means that they are recognized first in OCI and then reclassified later to net income.
Comprehensive income is net income plus/minus other comprehensive income/loss.
Other comprehensive income is closed out to a balance sheet account that is often referred to as
Accumulated Other Comprehensive Income, which acts as a type of retained earnings account. Accumulated Other Comprehensive Income is an equity account on the balance sheet.
Difficulty: Easy
Learning Objective: Understand the differing perspectives on how to measure income.
Section Reference: Measurement of Income
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Communication
Ex. 4-112 Recycled items
Under IFRS, some items included in other comprehensive income are “recycled” or reclassified which means that they are recognized first in OCI and then reclassified later to net income. Identify which of the following items should be recycled/reclassified and which should not by using the letter “Y” for yes and the letter “N” for no.
1. Changes in revaluation surplus under the revaluation method for property, plant, and equipment.
2. Gains and losses on remeasurement of defined benefit pension plans.
3. Gains and losses arising from translating the financial statements of certain foreign operations.
4. Gains and losses for certain hedges.
5. Gains and losses on remeasuring FV-OCI Investments-debt instruments.
6. Gains and losses on remeasuring FV-OCI Investments-equity instruments.
7. Changes in fair value of certain liabilities measured at fair value through profit or loss relating to the liability’s credit risk under IFRS 9.
Solution 4-112
N 1. Changes in revaluation surplus under the revaluation method for property, plant, and equipment.
N 2. Gains and losses on remeasurement of defined benefit pension plans.
Y 3. Gains and losses arising from translating the financial statements of certain foreign operations.
Y 4. Gains and losses for certain hedges.
Y 5. Gains and losses on remeasuring FV-OCI Investments-debt instruments.
N 6. Gains and losses on remeasuring FV-OCI Investments-equity instruments.
N 7. Changes in fair value of certain liabilities measured at fair value through profit or loss relating to the liability’s credit risk under IFRS 9.
Difficulty: Easy
Learning Objective: Understand the differing perspectives on how to measure income.
Section Reference: Measurement of Income
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
Ex. 4-113 Definitions
Provide clear, concise answers for the following:
1. What are revenues?
2. What are expenses?
3. What are gains?
4. What are losses?
5. How should unusual gains and losses be disclosed in the income statement?
6. When does a discontinued segment qualify as discontinued operations?
7. How are earnings per share calculated?
8. State two examples of adjustments to prior years’ retained earnings and indicate how they are reported in the financial statements.
9. The IASB is planning significant changes regarding the presentation of financial statements. What plans does the IASB have?
Solution 4-113
1. Revenues are increases in economic resources either by way of inflows or enhancements of assets of an entity or settlements of liabilities, resulting from an entity’s ordinary revenue-generating activities.
2. Expenses are decreases in economic resources, either by outflows or reductions of assets or incurrence of liabilities, resulting from an entity’s ordinary revenue-generating activities.
3. Gains are increases in equity (net assets) from peripheral or incidental transactions of an entity from all other transactions and other events and circumstances affecting the entity during a period, except those that result from revenues or investment by owners.
4. Losses are decreases in equity (net assets) from peripheral or incidental transactions of an entity from all other transactions and other events and circumstances affecting the entity during a period, except those that result from revenues or investment by owners.
5. If they are material, they are disclosed separately but must be shown above "income (loss) before discontinued operations” and above the income tax provision. If they are immaterial, they are combined with other gains and losses of the period. Either way, they are included in the company's income from continuing operations.
6. In order for a segment to be a discontinued operation it must be a distinguishable component of an entity, the activities of which represent a line of business significant to the entity as a whole and/or that are directed to a significant particular class of customer.
7. The calculation of earnings per share is: net income minus preferred dividends divided by the weighted average number of common shares outstanding.
8. Adjustments to prior years’ retained earnings include correction of an error in the financial statements of a prior period and retroactively applied changes in accounting principles. The adjustments should be charged or credited to the opening balance of retained earnings.
9. The IASB issued an exposure draft called “General Presentation and Disclosures” as part of its Primary Financial Statements Project. The comment period was extended to September 2020. While the Exposure Draft was largely well received, there were items with mixed feedback. The ASB is discussing the feedback and deliberating next steps.
Difficulty: Medium
Learning Objective: Understand the differing perspectives on how to measure income.
Section Reference: Measurement of Income
Learning Objective: Measure and report results of discontinued operations.
Section Reference: Discontinued Operations
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
Learning Objective: Prepare the statement of retained earnings and the statement of changes in equity.
Section Reference: The Statement of Retained Earnings and the Statement of Changes in Equity
Learning Objective: Identify differences in accounting between IFRS and ASPE and potential changes.
Section Reference: IFRS/ASPE Comparison
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 4-114 Comprehensive income
Oiseau Inc. reported the following for 2023:
Sales Revenue $1,470,000
Cost of Goods Sold 850,000
Selling and Administrative Expenses 210,000
Loss on Disposal of Equipment (12,000)
Unrealized Gain—OCI 14,000
Instructions
Prepare a statement of comprehensive income. Ignore income tax and EPS. Assume Oiseau follows IFRS.
Solution 4-114
OISEAU INC.
Statement of Comprehensive Income
For the Year Ended December 31, 2023
Sales revenue $1,470,000
Cost of goods sold 850,000
Gross profit 620,000
Operating expenses
Selling and administrative expenses 210,000
Loss on disposal of equipment 12,000
Net income 398,000
Other comprehensive income
Items that may be reclassified subsequently to net income or loss:
Unrealized gain 14,000
Comprehensive income $ 412,000
Difficulty: Medium
Learning Objective: Understand the differing perspectives on how to measure income.
Section Reference: Measurement of Income
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 4-115 Discontinued operations
Hibou Ltd., a private company based in Vancouver, decided to sell its Industrial Design Division. After two years of losses and heavy competition, a plan to dispose of the division was put in place. At the end of 2023, the plan was finalized and approved by the board of directors. The sale is anticipated to be completed by June 30, 2024.
Other information:
1. Hibou's 2023 after-tax net income (excluding the results from the Industrial Design Division) was $450,000.
2. During the year, the division reported an after-tax loss of $120,000 (revenues: $30,000, expenses: $150,000).
3. Management estimates that after-tax legal fees of $32,000 as well as after-tax severance payments of $66,000 will be required to finalize the disposal plan. A portion of these costs is expected to be offset by the after-tax proceeds of $61,000 from the sale of the division's assets.
Instructions
Assuming the Industrial Design Division qualifies for treatment as a discontinued operation, prepare a partial income statement for Hibou for 2023. The statement should begin with income from continuing operations and include an appropriate footnote pertaining to the disposal of the Industrial Design Division.
Solution 4-115
Partial income statement:
HIBOU LTD.
Partial Income Statement
For the Year Ended December 31, 2023
Income from continuing operations $450,000
Discontinued operations*
Loss on discontinued operations (net of tax) $120,000
Loss on disposal of discontinued operations (net of tax) 37,000 157,000
Net Income $293,000
* Footnote:
On December 31, due to continued losses, the board of directors unanimously approved management's plan to dispose of the Industrial Design Division. The sale is anticipated to be completed by June 30, 2024.
The after-tax operating results for the current year are as follows:
Revenue $ 30,000
Expenses 150,000
Net loss $(120,000)
The estimated after-tax loss relating to the disposal of the division is comprised of the following items:
Proceeds from sale of assets $61,000
Less: legal expense 32,000
Less: severance 66,000
$37,000
Difficulty: Medium
Learning Objective: Measure and report results of discontinued operations.
Section Reference: Discontinued Operations
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
Ex. 4-116 Discontinued operations
Motivated Inc.’s manufacturing division lost $140,000 (net of tax) for the year ended December 31, 2023. Motivated estimates that it can sell the division at a loss of $190,000 (net of tax). The division qualifies for treatment as a discontinued operation.
Instructions
a) Explain how the discontinued operation would be measured and presented on the income statement and balance sheet under ASPE.
b) Explain how your answer to part (a) would be different if Motivated prepared financial statements in accordance with IFRS.
Solution 4-116
a) The $140,000 (net of tax) loss from operation of the discontinued division, and the $190,000 (net of tax) loss on impairment of net assets of the discontinued division should be shown in the discontinued operations section of the income statement for the year ended December 31, 2023. The discontinued operations section follows income from continuing operations. Under ASPE, the assets and liabilities related to the discontinued manufacturing division should be segregated on the balance sheet according to their nature (e.g., current assets related to the discontinued manufacturing division should be presented as current assets held for sale/related to discontinued operations, and non-current assets related to the discontinued manufacturing division should be presented as non-current assets held for sale/related to discontinued operations).
b) Under IFRS, the $140,000 (net of tax) loss from operation of the discontinued division, and the $190,000 (net of tax) loss on impairment of net assets of the discontinued division should also be shown in the discontinued operations section of the income statement for the year ended December 31, 2023. However, on the balance sheet, all assets and liabilities related to the discontinued manufacturing division should be presented as held for sale, and classified as current assets and current liabilities, respectively.
Difficulty: Medium
Learning Objective: Measure and report results of discontinued operations.
Section Reference: Discontinued Operations
CPA: Communication
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 4-117 Income statement classifications
Indicate the major section or subsection of a multiple-step income statement in which each of the following items would normally appear:
a) Advertising
b) Depreciation of head office building
c) Dividend revenue
d) Freight-in
e) Loss on disposal of a segment of the business, net of tax
f) Income taxes on income
g) Major fire loss
h) Purchase discounts
i) Sales discounts
j) Officers' salaries
k) Freight-out
l) Sinking fund income
Solution 4-117
a) Selling expense
b) General and administrative expense
c) Other revenue
d) Cost of goods sold, as an addition to purchases
e) Disclosed separately as a loss from discontinued operations
f) Income taxes subtracted from income before income taxes in arriving at net income
g) Disclosed separately, but must be shown above "income (loss) before discontinued operations” and above the income tax provision, i.e., part of income from continuing operations
h) Cost of goods sold, as a subtraction from purchases
i) Subtracted from gross revenues
j) General and administrative expense
k) Selling expense
l) Other revenue
Difficulty: Medium
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 4-118 Classification of income statement and retained earnings statement items
For each of the items listed below, indicate how it should be treated in the financial statements. Use the following letter code for your selections:
a) Ordinary item on the income statement
b) Discontinued operations
c) Unusual item on the income statement
d) Adjustment to prior years’ retained earnings
1. The rate for credit losses was increased from 1% to 2% of sales, thus increasing credit losses.
2. Obsolete inventory was written off. This was a material amount, and the first loss of this type in the company's history.
3. An uninsured earthquake loss was incurred. This was the first loss of this type in the company's history.
4. Recognition of revenue earned last year, inadvertently omitted from last year's income statement.
5. The company sold one of its warehouses at a loss.
6. Settlement of a court case involving the federal government, related to income taxes of three years ago. The company is continually involved in various adjustments with the federal government related to its taxes.
7. A loss incurred from expropriation – the company owned resources in South America that were taken over by a dictator unsympathetic to Canadian business interests.
8. The company failed to record depreciation in the previous year.
9. Discontinuance of all production in Canada. The manufacturing operations were relocated to Honduras.
10. Loss on sale of investments. The company last sold some of its investments two years ago.
11. Loss on the disposal of a segment of the business.
Solution 4-118
1. a
2. a
3. c
4. d
5. a
6. a
7. c
8. d
9. a
10. a
11. b
Difficulty: Medium
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 4-119 Nature versus function of expense presentation
IFRS requires a business to present an analysis of expenses based on either “nature” or “function.” Explain what this means.
Solution 4-119
Nature refers to the type of expense, such as purchases, depreciation, employee benefits, or distribution costs.
Function refers to the business function or activity, such as production or cost of sales, or selling and administrative (head office). Thus, expenses would be grouped by these activities.
Presenting expenses by nature is usually quite straightforward as no allocation of costs is required between functions. On the other hand, presenting expenses by function requires more judgement, as many costs would be allocated between functions, such as payroll, depreciation, and occupancy costs. However, it does give more insight into the various phases of the business.
Difficulty: Easy
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Communication
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
Ex. 4-120 Understandability/disclosure trade-off
Explain briefly the trade-off between understandability and full disclosure. Would statements provided to external users have more or less detail than internal management reports? Why?
Solution 4-120
Usually, financial statements provided to external users have less detail than internal management reports. For external users, expenses might be grouped by nature instead of function, and could be presented in a condensed income statement format with supplementary schedules to support the totals. This helps reduce the statement to one of convenient size, reducing information overload, while availing more detailed information to readers who want to study all reported data on operations. Even then, the data available to readers is not as robust as that available to management because it serves different decision purposes. Further, the cost of presenting accurate granular detail to external users may exceed its usefulness. A company should try to publish information that optimizes this cost-benefit relationship while preserving the underlying principle of representational faithfulness.
Difficulty: Easy
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
Ex. 4-121 Calculation of net income
Heron Ltd. had the following information for 2023:
Assets, January 1 $250,000
Assets, December 31 230,000
Liabilities, January 1 150,000
Common shares, December 31 80,000
Retained earnings, December 31 41,000
The company also declared $13,000 in dividends and issued $10,000 in common shares during the year. Compute the net income for the year.
Jan 1 Dec 31
Assets $250,000
Liabilities 150,000
Shareholders’ Equity $100,000 $121,000*
Computation of net income:
Shareholders’ Equity December 31 $121,000
Shareholders’ Equity January 1 100,000
Increase 21,000
Add: Dividends 13,000
Less: Common Shares (10,000)
Net Income $ 24,000
*$80,000 + $41,000
Difficulty: Medium
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 4-122 Allocating tax expense
Tech Trends Inc. has a December 31, 2023 net income of $330,000 and income taxes of $220,000. This net income information was prepared by the company’s junior accountant and does not reflect a $75,000 gain before taxes incurred by the sale of discontinued operations.
Instructions
Assuming that Tech Trends qualifies for treatment as a discontinued operation, prepare a partial statement of income showing the correct net income for the period. Begin your statement with income before income tax and discontinued operations.
Solution 4-122
Partial income statement:
Tech Trend Inc.
Partial Income Statement
For the Year Ended December 31, 2023
Income from Continuing Operations, Before Tax $550,000
Income Tax Expense……………………………………………………………. 220,000
Income before Discontinued Operations……………………………………… 330,000
Gain on Discontinued Operations, Net of Tax ($75,000 x (1-40%))………… 45,000
Net income $375,000
Difficulty: Medium
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 4-123 Terminology
In the space provided, write the word or phrase that is defined or indicated.
1. Net income minus preferred dividends ________________________________
divided by the weighted average of common
shares outstanding.
2. A correction of an error is reported as a(n) ________________________________
3. An income statement that includes only ________________________________
two groupings (revenues and expenses)
4. The income statement category for a ________________________________
disposal of a segment of a business.
5. Relating tax expense to specific items ________________________________
on the income statement.
Solution 4-123
1. Earnings per share
2. Adjustment to beginning retained earnings
3. Single-step method
4. Discontinued operations
5. Intraperiod tax allocation
Difficulty: Easy
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
Learning Objective: Prepare the statement of retained earnings and the statement of changes in equity.
Section Reference: The Statement of Retained Earnings and the Statement of Changes in Equity
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
Ex. 4-124 Statement of changes in equity
Tote Ltd. reported the following balances at January 1, 2023:
Common shares $370,000
Retained earnings 70,000
Accumulated other comprehensive income 71,000
During the year Tote earned net income of $310,000 and generated other comprehensive income of $64,000.
Instructions
Prepare a statement of shareholders’ equity for the year ended December 31, 2023.
Solution 4-124
TOTE LTD.
Statement of Shareholders’ Equity
For the Year Ended December 31, 2023
Accumulated
Other
Common Comprehensive Retained Comprehensive
Total Shares Income Earnings Income
Beginning balance $511,000 $370,000 $ 70,000 $71,000
Net income 310,000 $310,000 310,000
Other comprehensive income 64,000 64,000 64,000
Comprehensive income $374,000
Ending balance $885,000 $370,000 $380,000 $135,000
Difficulty: Medium
Learning Objective: Prepare the statement of retained earnings and the statement of changes in equity.
Section Reference: The Statement of Retained Earnings and the Statement of Changes in Equity
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 4-125 Statement of retained earnings
Mondial Corporation prepares financial statements in accordance with ASPE. At January 1, 2023, the company had retained earnings of $420,000. In 2023, net income was $1,737,000, and cash dividends of $360,000 were declared and paid.
Instructions
Prepare a 2023 statement of retained earnings for Mondial Corporation.
Solution 4-125
MONDIAL CORPORATION
Statement of Retained Earnings
For the Year Ended December 31, 2023
Balance, January 1 $ 420,000
Add: Net income 1,737,000
2,157,000
Less: Dividends 360,000
Balance, December 31 $1,797,000
Difficulty: Medium
Learning Objective: Prepare the statement of retained earnings and the statement of changes in equity.
Section Reference: The Statement of Retained Earnings and the Statement of Changes in Equity
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 4-126 Comprehensive income
Sunshine Corporation had the following balances at December 31, 2023 (in thousands): preferred shares $3,012; common shares $4,718; contributed surplus $1,750; retained earnings $16,791; and accumulated other comprehensive income $514.
During the year ended December 31, 2023, the company earned net income of $3,613,000, sold common shares of $30,000, and paid out dividends of $14,000 and $5,000 to preferred and common shareholders, respectively.
Instructions
Prepare a statement of changes in equity for the year ended December 31, 2023, as well as the shareholders’ equity section of the Sunshine Corporation balance sheet as at December 31, 2023.
Solution 4-126
SUNSHINE CORPORATION
Statement of Changes in Equity
For the Year Ended December 31, 2023 (all amounts in thousands)
Comp. Preferred Common Contr. Retained Acc. Other
Total Income Shares Shares Surplus Earnings Comp. Inc.
Beginning Balance $26,785 $3,012 $4,718 $1,750 $16,791 $514
Comprehensive Income:
Net income 3,613 $3,613 3,613
Dividends to shareholders:
Preferred (14) (14)
Common (5) (5)
Issue of common shares 30 ________ 30 ________ _________ ______
Ending Balance $30,409 $3,012 $4,748 $1,750 $20,385 $514
SUNSHINE CORPORATION
Balance Sheet (Partial)
December 31, 2023 (all amounts in thousands)
Share capital:
Preferred shares $ 3,012
Common shares 4,748
Total share capital 7,760
Contributed surplus 1,750
Total paid-in capital 9,510
Retained earnings 20,385
Accumulated other comprehensive income 514
Total shareholders’ equity $30,409
Difficulty: Medium
Learning Objective: Prepare the statement of retained earnings and the statement of changes in equity.
Section Reference: The Statement of Retained Earnings and the Statement of Changes in Equity
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 4-127 Changes in accounting policy
Describe how changes in accounting policy are applied and affect the financial statements.
Solution 4-127
Changes in accounting policy are generally recognized through retrospective restatement, which involves determining the effect of the policy change on the income of prior periods that are affected. The financial statements for all prior periods that are presented for comparative purposes should be restated except when the effect cannot be determined reasonably. If all comparative years are not disclosed, a cumulative amount would instead be calculated and adjusted through the opening retained earnings amount.
Difficulty: Easy
Learning Objective: Prepare the statement of retained earnings and the statement of changes in equity.
Section Reference: The Statement of Retained Earnings and the Statement of Changes in Equity.
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Communication
Ex. 4-128 Non-GAAP measures
Companies often try to help users assess the results of operations and their financial position by providing modified GAAP information such as non-GAAP earnings. Describe what is meant by non-GAAP earnings and explain the danger in providing these numbers.
Solution 4-128
Non-GAAP earnings start with GAAP net income and add back or deduct nonrecurring or non-operating items to arrive at an adjusted net income number. When clearly disclosed and explained, it can add value to the decision-making process. The danger is that, in the absence of standards to ensure the calculation is consistently prepared and comparable between companies, stakeholders may be misguided in their assessment of company performance.
Difficulty: Easy
Learning Objective: Understand how disclosures and analysis help users of financial statements assess performance.
Section Reference: Disclosure and Analysis
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
Ex. 4-129 The OSC and non-GAAP measures
In an effort to curb to potential confusion created by non-GAAP earnings the OSC has issued a staff notice on these disclosures. Briefly explain what this notice states issuers should do. Why do you think the OSC is particularly interested in streamlining these disclosures?
Solution 4-129
The OSC’s staff notice on non-GAAP financial measures states that an issuer should do the following:
- State explicitly the non-GAAP measure does not have standardized meaning and is thus unlikely to be comparable.
- Present with equal or greater prominence the corresponding GAAP measure.
- Explain why the non-GAAP measure provides useful information to investors, and any purposes for which management uses these measures.
- Provide a clear quantitative reconciliation from the non-GAAP measure to the GAAP measure. Reference this reconciliation if the non-GAAP measure appears in the document first.
5. Explain any changes in composition of the non-GAAP measure when compared with previously disclosed measures.
The OSC polices a wide variety of securities and financial instruments issued by various corporations and has an oversight role to play in ensuring that the information provided to investors is transparent and consistent with the principle of representational faithfulness. As such, they have a vested interest in comparability and understandability of information for all stakeholders. In response to potential sources of ambiguity such as non-GAAP disclosures, the OSC thus chooses to provide guidelines that will streamline these disclosures as much as possible.
Where securities are not publicly listed, but a company still follows GAAP, non-GAAP disclosures would be less of a concern, since stakeholders would likely have access to additional information about the company.
Difficulty: Easy
Learning Objective: Understand how disclosures and analysis help users of financial statements assess performance.
Section Reference: Disclosure and Analysis
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
Ex. 4-130 Analyzing financial health and quality of earnings and price earnings ratio
Umbrella Corporation’s shares are currently trading for $42 / share. Total net income available to common shareholders is $225,000 and the weighted average number of outstanding shares is 75,000. Calculate the company’s price earnings ratio. What does the P/E ratio measure? What factors should a stakeholder take into consideration with assessing the health and quality of earnings of a company.
Solution 4-130
Price Earnings Ratio = Market Price per share / EPS
EPS = Net income available to common shareholders / weight average number of outstanding shares
EPS: $225,000 / 75,000 shares = $3 / share
P/E Ratio: $42 / $3 = 14.
This indicates that shareholders are willing to pay $14 for every dollar of earnings, this is also referred to as an earnings multiple.
When assessing the health and quality of the earnings of a company, shareholders should also take into account the following factors:
1. Accounting policies
2. Notes to financial statements
3. Measurement uncertainty
4. Financial statements as a whole
5. Income statement: percentage of net income from continuing operations
6. Statement of financial position (balance sheet): how is the company financed? What are the revenue-generating assets?
7. Cash flow statement: compare cash from operations to net income
8. Environmental factors (industry, economy), and competition
Difficulty: Easy
Learning Objective: Understand how disclosures and analysis help users of financial statements assess performance.
Section Reference: Disclosure and Analysis
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
*Ex. 4-131 Cash basis
Argent Inc. reported the following information for their 2023 fiscal year:
Sales Revenue $114,000
Accounts Receivable, Jan 1 3,200
Accounts Receivable, Dec 31 6,120
Unearned Revenue, Jan 1 1,200
Unearned Revenue, Dec 31 1,840
Instructions
Calculate the revenue for the year on a cash basis.
*Solution 4-131
$114,000 + $3,200 – $6,120 – $1,200 + $1,840 = $111,720.
Difficulty: Medium
Learning Objective: Explain the differences between the cash basis of accounting and the accrual basis of accounting.
Section Reference: Application of the Cash and Accrual Bases of Accounting (Appendix 4A)
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
*Ex. 4-132 Accrual basis
Discover Inc. reported the following information for their 2023 fiscal year:
Cash Receipts from Sales $114,000
Accounts Receivable, Jan 1 4,500
Accounts Receivable, Dec 31 7,400
Unearned Revenue, Jan 1 1,500
Unearned Revenue, Dec 31 1,200
Instructions
Calculate the revenue for the year on an accrual basis.
*Solution 4-132
$114,000 – $4,500 + $7,400 + $1,500 – $1,200 = $117,200
Difficulty: Medium
Learning Objective: Explain the differences between the cash basis of accounting and the accrual basis of accounting.
Section Reference: Application of the Cash and Accrual Bases of Accounting (Appendix 4A)
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
*Ex. 4-133 Cash Basis
Explain the theoretical weaknesses of the cash basis approach. Isn’t cash management the most important part of a business?
*Solution 4-133
Today’s economy is based more on credit than cash. The accrual basis recognizes all aspects of credit. Accrual basis accounting provides the cash information that investors, creditors, and other decision makers seek about an enterprises future cash flows by reporting this information as soon as those cash flows can be reasonable estimated to an acceptable degree of certainty. Accrual-based accounting aids in predicting future cash flows by reporting transactions and other events with cash consequences at the time the transactions and events occur, rather than when cash is received and paid.
Difficulty: Easy
Learning Objective: Explain the differences between the cash basis of accounting and the accrual basis of accounting.
Section Reference: Application of the Cash and Accrual Bases of Accounting (Appendix 4A)
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
*Ex. 4-134 Cash Basis to Accrual Basis
Off the Hook Technologies Inc. has the following balances in 2023 and 2022:
2023 2022
Accounts Receivable $10,800 $8,200
Prepaid Rent 4,000 3,600
Supplies 900 400
Accounts Payable 3,350 4,225
Unearned Revenue 2,000 1,800
In addition, the company collected $62,500 cash from customers and paid $44,800 cash for operating costs during 2023.
Instructions
Determine Off the Hook’s net income on an accrual basis for 2023.
*Solution 4-134
Cash Collected – Cash Paid = $62,500 – $44,800 = $17,700
Net Income (accrual basis) X
Change in current assets and current liabilities year over year:
Accounts Receivable +$10,800
(8,200) $(2,600)
Prepaid Rent +4,000
(3,600) (400)
Supplies +900
(400) (500)
Accounts Payable (3,350)
4,225 (875)
Unearned Revenue (2,000)
1,800 200
Adjustment to Net Income $(4,175)
Cash from operations $ 17,700
X - $4,175 = $17,700
X = $17,700 + $4,175 = $21,875
Net Income: $17,700 + $4,175 = $21,875
Difficulty: Hard
Learning Objective: Explain the differences between the cash basis of accounting and the accrual basis of accounting.
Section Reference: Application of the Cash and Accrual Bases of Accounting (Appendix 4A)
CPA: Financial Reporting
Bloomcode: Synthesis
AACSB: Analytic
PROBLEMS
Pr. 4-135 Discontinued operations
Bagel Corporation operates several stores in British Columbia (Vancouver, Victoria, Kamloops, Penticton, and Prince George). The restructuring of its organization on November 20, 2023, has led to the decision to sell its Prince George store. In preparing financial statements at December 31, 2023, the following information was made available:
1. The Prince George operation incurred a pre-tax loss of $283,500 for the 2023 calendar year, including $225,000 for the period January 1 to November 20, 2023.
2. Estimated costs to sell are $300,000.
3. At December 31, 2023, the fair value of the Prince George assets is estimated at $7 million and the carrying amount is $7.3 million.
4. The combined provincial and federal income tax rate is 30%.
5. It is estimated that the operation will lose an additional $250,000 before it is sold.
Instructions
a) The Prince George operation qualifies for reporting as a discontinued operation. What amount should be reported in the discontinued operations section of Bagel’s 2023 income statement?
b) In early 2024, the Prince George operation is sold for $8.5 million, with actual costs to sell of $400,000. Additional disposal costs related to the sale are $500,000. The operation lost an additional $150,000 before it was sold. What amount should be reported in the discontinued operations section of Bagel’s 2024 income statement?
Solution 4-135
a)
Loss on discontinued operations $(283,500)
Reduction in carrying amount of assets estimated to be
fair value less costs to sell
($7,300,000 – [$7,000,000 – $300,000]) (600,000)
Estimated loss (883,500)
Recovery of income tax (30% tax on above amount) (265,050)
Loss on discontinued operations $(618,450)
b)
Sale price $8,500,000
Minus assets sold at fair value ($7,000,000 – $300,000) (6,700,000)
Additional costs to sell ($400,000 – $300,000) (100,000)
Less additional loss from operations (150,000)
Additional disposal costs (500,000)
Estimated pre-tax amount 1,050,000
Applicable income tax at 30% (315,000)
Gain on discontinued operations $ 735,000
Difficulty: Medium
Learning Objective: Measure and report results of discontinued operations.
Section Reference: Discontinued Operations
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 4-136 Multiple-step income statement
Presented below is information that relates to Muffin Limited for 2023:
Collections of Accounts Receivable $1,100,000
Retained Earnings, January 1, 2023 800,000
Sales Revenue 1,900,000
Selling and Administrative Expenses 290,000
Loss from Flood Damage 350,000
Dividends 34,000
Cost of Goods Sold 1,100,000
Loss resulting from calculation error on depreciation charge in 2021 (pre-tax) 460,000
Interest Revenue 180,000
Interest Expense 120,000
Loss on Loan Settlement (Loss from early repayment, net of tax) 340,000
Gain on Foreign Currency (pre-tax) 220,000
Additional information:
1. Early in 2023, Muffin changed depreciation methods for its plant assets from the double- declining-balance to the straight-line method. The affected assets were purchased at the beginning of 2018 for $200,000, had no residual value, and had useful lives of 10 years. Depreciation expense of $20,000 is included in the selling and administrative expenses of $290,000.
2. On September 1, 2023, Muffin sold one of its segments (product line) to Best Industries for a gain (pre-tax) of $550,000. During the period January 1 to August 31, the discontinued segment incurred an operating loss (pre-tax) of $480,000. This loss is not included in any of the numbers shown above.
3. Included in selling and administrative expenses are credit losses of $19,000. Muffin bases its credit losses upon a percentage of sales. In 2021 and 2022, the percentage was 0.5 %. In 2023, the percentage was changed to 1%.
Instructions
In good form, prepare a multiple-step income statement for 2023. Assume a 20% income tax rate and that 20,000 common shares were outstanding during the year.
Solution 4-136
MUFFIN LIMITED
Income Statement
For the Year Ended December 31, 2023
Sales revenue $1,900,000
Cost of goods sold 1,100,000
Gross profit 800,000
Selling and administrative expenses 290,000
Operating income 510,000
Other revenues
Interest revenue $180,000
Gain on foreign currency 220,000 400,000
910,000
Other expenses
Interest expense 120,000
Loss on loan settlement 340,000
Loss from flood damage 350,000 810,000
Income from continuing operations before tax 100,000
Income tax expense 20,000
Income from continuing operations 80,000
Discontinued operations:
Loss on discontinued operations, net of tax (384,000)
Gain on disposal of discontinued operations, net of tax 440,000 56,000
Net income $136,000
Earnings per share:
Income from continuing operations $4.00
Discontinued operations 2.80
Net income $6.80
Difficulty: Medium
Learning Objective: Measure and report results of discontinued operations.
Section Reference: Discontinued Operations
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 4-137 Income statement, including corrections
During calendar 2023, Scone Corporation reported income from continuing operations of $800,000 (after taxes). In addition, the following information, which has not yet been considered or included in the above figure, has been revealed:
1. On December 31, 2023, Scone adopted the average cost method of inventory valuation. The company had previously used the FIFO method. The change decreases income for 2023 by $50,000 (pre-tax) and the cumulative effect of the change on prior years' income was a $60,000 (pre-tax) decrease.
2. A machine was sold for $140,000 cash during the year at a time when its carrying amount was $100,000. (Depreciation has been correctly recorded.)
3. Scone decided to discontinue its stereo division in 2023. During the current year, the loss from this segment was $150,000 (before applicable taxes).
Instructions
Present in good form the income statement of Scone Corporation for 2023 starting with "income from continuing operations." Assume that Scone’s tax rate is 20% and that 100,000 common shares were outstanding during the year.
Solution 4-137
SCONE CORPORATION
Partial Income Statement
For the Year Ended December 31, 2023
Income from continuing operations $792,000*
Discontinued operations
Loss on discontinued operations, net of tax of $30,000 (120,000)
Net income $672,000
Earnings per share
Income from continuing operations $7.92
Discontinued operations (1.20)
Net income $6.72
*Income from continuing operations (unadjusted) $800,000
Gain on disposal of machinery (after tax) 32,000
Current effect of change in accounting principle (after tax) (40,000)
Adjusted income from continuing operations $792,000
Difficulty: Medium
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 4-138 Multiple-step income statement
Presented below is information related to Pastry Inc.
Retained Earnings, December 31, 2022 $ 650,000
Sales Revenue 1,400,000
Selling and Administrative Expenses 240,000
Loss from Tornado 250,000
Dividends 33,600
Cost of Goods Sold 820,000
Gain resulting from calculation error on depreciation
charge in 2022 (pre-tax) 520,000
Interest Revenue 60,000
Interest Expense 50,000
Instructions
In good form, prepare a multiple-step income statement for the year 2023. Assume a 20% tax rate and that 50,000 common shares were outstanding during the year. Pastry is a private corporation following ASPE.
Solution 4-138
PASTRY INC.
Income Statement
For the Year Ended December 31, 2023
Sales revenue $1,400,000
Cost of goods sold 820,000
Gross profit 580,000
Selling and administrative expenses 240,000
Income from operations 340,000
Interest revenue 60,000
Interest expense (50,000)
Loss from tornado (250,000)
Income before taxes 100,000
Income tax expense (20,000)
Net income $ 80,000
Difficulty: Medium
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 4-139 Multiple-step income statement
Shown below is an income statement for 2023 that was prepared by a junior accountant at Fritter Corporation.
FRITTER CORPORATION
Income Statement
December 31, 2023
Sales Revenue $975,000
Investment Income 19,500
Cost of Goods Sold (408,500)
Selling Expenses (155,000)
Administrative Expenses (215,000)
Interest Expense (13,000)
Income before Special Items 203,000
Special Items
Loss on Discontinued Operations (30,000)
Loss from Fire (80,000)
Net income Tax Payable (27,900)
Net Income $ 65,100
Instructions
In good form, prepare a multiple-step income statement for 2023 for Fritter Corporation that is presented in accordance with generally accepted accounting principles (including format and terminology). Fritter Corporation has 50,000 common shares outstanding and has a 20% income tax rate on all tax-related items. As a private corporation, Fritter does not disclose earnings per share information.
Solution 4-139
FRITTER CORPORATION
Income Statement
For the Year Ended December 31, 2023
Sales Revenue $975,000
Cost of Goods Sold 408,500
Gross Profit 566,500
Selling Expenses $155,000
Administrative Expenses 215,000 370,000
Income from Operations 196,500
Other Revenue
– Investment Income 19,500
216,000
Other expenses
Interest Expense 13,000
Loss from fire 80,000
Income from Continuing Operations before Taxes 123,000
Income Tax Expense 24,600
Income from Continuing Operations 98,400
Discontinued Operations:
Loss from Discontinued Operations, Net of Tax 24,000
Net Income $ 74,400
Difficulty: Medium
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 4-140 Income statement adjustments
You have been hired by the CFO of Turnover Corporation, a public company. As the new senior accountant, you have been asked to help with the preparation of the 2023 income statement.
For 2023, Turnover reported pre-tax income from continuing operations of $3,150,000. However, you have been advised that the following transactions have not yet been considered.
1. A review of the company's depreciation policies for its computer equipment revealed that depreciation expense relating to 2023 was overstated by $19,000.
2. During the year, the company wrote off $62,500 in accounts receivable for which no expected credit losses had been set up.
3. In 2023, the company sold old equipment for $160,000. The equipment had a net book value of $120,000.
4. During the year, Turnover disposed of one its subsidiaries. The CFO tells you that the transaction meets the criteria for discontinued operations. The after-tax losses on the subsidiary’s operations and from disposal were $120,000 and $290,000, respectively.
5. The company made a payment of $400,000 to settle a lawsuit. The lawsuit related to a 2015 event that the company lawyers had been working on since that time. Based on the lawyers’ advice, no contingent liability had been set up.
Instructions
In good form, prepare a partial 2023 income statement for Turnover, taking into account the effects (if any) of the above items. The statement should start with income from continuing operations before income taxes. Unless otherwise indicated, you may assume an income tax rate of 40% for all items. Earnings per share calculations are not required.
Solution 4-140
TURNOVER CORPORATION
Partial Income Statement
For the Year Ended December 31, 2023
Income from Continuing Operations* $2,746,500
Income Tax Expense (1,091,000)
Income before Discontinued Operations 1,655,500
Discontinued Operations
Loss on Discontinued Operations, Net of Tax ($120,000)
Loss on disposal of Discontinued Operations, Net of Tax (290,000) (410,000)
Net Income $1,245,500
*Calculations
Income from Continuing Operations (before adjustments) $3,150,000
1. Depreciation Expense corrected 19,000
2. Credit losses (62,500)
3. Gain on Disposal of Equipment ($160,000 – $120,000) 40,000
4. To be shown in discontinued operations section 0
5. Loss on Lawsuit _(400,000)
Adjusted Income from Continuing Operations $2,746,500
Difficulty: Medium
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 4-141 Single-step income statement
The information below relates to the operations of Konun Corporation for the year ended December 31, 2023:
Cost of Goods Sold $84,500
Interest Expense 585
Sales Returns and Allowances 2,240
Accounts Payable 30,032
Sales Discounts 960
Depreciation Expense 71,148
Sales Revenue 45,586
Salaries and Wages Expense 40,895
Prepaid Expenses 875
Rent Expense 9,500
Loss from Fire 2,092
Rent Revenue 6,000
Additional information:
- The effective tax rate is 30%.
- Depreciation expense: 60% administrative expense and 40% selling expense
- Salaries and wages: 35% administrative expense and 65% selling expense
- Rent expense: 75% administrative expense and 25% selling expense
Instructions
Prepare a single-step income statement in good form by nature (round to the nearest dollar).
Solution 4-141
Konun Corporation
Income Statement
For the Year Ended December 31, 2023
Revenues
Revenue $245,586
Sales Returns and Allowances 2,240
Sales Discounts 960
Net Revenue 242,386
Rent Revenue 6,000
Total Revenues 248,386
Expenses
Cost of Goods Sold 84,500
Depreciation Expense 71,148
Salaries and Wages Expense 40,895
Rent Expense 9,500
Loss from Fire 2,092
Interest Expense 585
Total Expenses 208,720
Net income before tax 39,666
Income Tax Expense 11,900
Net income $27,766
Difficulty: Medium
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 4-142 Income statement and retained earnings statement
Macaroon Corporation's capital structure consists of 20,000 common shares. At December 31, 2023, an analysis of the accounts and discussions with company officials revealed the following information:
Sales Revenue $1,200,000
Purchase Discounts 18,000
Purchases 720,000
Loss on Flood Damage (net of $18,000 tax) 42,000
Selling and Administrative Expenses 288,000
Cash 60,000
Accounts Receivable 90,000
Common Shares 200,000
Accumulated Depreciation 180,000
Dividend Revenue 18,000
Inventory, January 1, 2023 152,000
Inventory, December 31, 2023 125,000
Unearned Revenue 4,400
Interest Payable 1,000
Land 370,000
Patents 100,000
Retained Earnings, January 1, 2023 270,000
Interest Expense 17,000
Cumulative effect of change from straight-line to accelerated
depreciation (net of $15,000 tax) 35,000
Dividends 29,000
Prepaid Insurance 5,000
Notes Payable (maturity July 1, 2026) 200,000
Machinery 450,000
Supplies 40,000
Accounts Payable 60,000
Unless indicated otherwise, you may assume a 30% income tax rate.
Instructions
a) Prepare, in good form, a multiple-step income statement, including earnings per share.
b) Prepare, in good form, a retained earnings statement.
Solution 4-142
MACAROON CORPORATION
Income Statement
For the Year Ended December 31, 2023
Sales revenue $1,200,000
Cost of goods sold
Inventory, Jan 1 $152,000
Purchases $720,000
Less purchase discounts 18,000
Net purchases 702,000
Goods available for sale 854,000
Less: Inventory, Dec 31 125,000
Cost of goods sold 729,000
Gross profit 471,000
Operating expenses
Selling and administrative expenses 288,000
Total operating expenses 288,000
Operating Income 183,000
Other revenues
Dividend Revenue 18,000
Other expenses
Interest expense (17,000)
Loss from flood damage (60,000) (77,000)
Income before taxes 124,000
Income tax expense 37,200
Net income $ 86,800
Earnings per share $4.34
MACAROON CORPORATION
Retained Earnings Statement
For the Year Ended December 31, 2023
Retained earnings, January 1, 2023 as reported $270,000
Cumulative effect of change in depreciation method,
net of applicable taxes of $15,000 (35,000)
Retained earnings, adjusted 235,000
Add: Net income $86,800
Deduct: Dividends 29,000 57,800
Retained earnings, December 31, 2023 $292,800
Difficulty: Medium
Learning Objective: Measure income and prepare the income statement and the statement of comprehensive income using various formats.
Section Reference: The Statement of Income and the Statement of Comprehensive Income
Learning Objective: Prepare the statement of retained earnings and the statement of changes in equity.
Section Reference: The Statement of Retained Earnings and the Statement of Changes in Equity
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 4-143 Danger of using non-GAAP earnings
Explain non-GAAP earnings and the danger of using these earnings to assess the results of operations and the financial position of a company.
Solution 4-143
Companies often try to help users assess the results of operations and their financial position by providing modified GAAP information such as non-GAAP earnings. Non-GAAP earnings start with GAAP net income and add back or deduct nonrecurring or non-operating items to arrive at an adjusted net income number. If the calculation of the non-GAAP earnings is clearly disclosed and explained, and is also reconciled to net income, it hopefully adds value to the decision-making process. The danger with these numbers is that there are no standards to ensure that the calculation is consistently prepared and comparable between companies.
Difficulty: Easy
Learning Objective: Understand how disclosures and analysis help users of financial statements assess performance.
Section Reference: Disclosure and Analysis
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Communication
*Pr. 4-144 Cash basis versus accrual accounting
Off the Hook Inc. prepared the following condensed income statement using the cash basis of accounting:
OFF THE HOOK INC.
Income Statement, Cash Basis
Year Ended December 31, 2023
Sales revenue $820,000
Expenses 640,000
Net income $180,000
Additional data:
1. Depreciation on the company automobile is $9,000.
2. On January 1, 2023, paid for a two-year insurance policy on the automobile amounting to $1,800.
3. Sales revenue does not include $50,000 of goods sold on account in 2023. It does include $20,000 collected in 2023 for 2022 accounts receivable.
4. $50,000 of expenses were incurred in 2023 but won’t be paid until 2024.
Instructions
a) Restate the above statement of income on an accrual basis in conformity with generally accepted accounting principles. Show calculations and explain each change.
b) Explain which basis (cash or accrual) provides a better measure of net income.
*Solution 4-144
a) OFF THE HOOK INC.
Income Statement – Restated
Year Ended December 31, 2023
——————————————————————————————————————————
Sales revenue ($820,000 +$50,000 – $20,000) $850,000
Expenses ($640,000 + $9,000 – $900 + $50,000) 698,100
Net income $151,900
Sales revenue should include the $50,000 for goods sold on account, but not the $20,000 collected in 2023 for goods sold in 2022.
Expenses should include the $50,000 for expenses incurred but not yet paid, and half of the $1,800 insurance premium as only one-half of the two-year policy has been used for 2023. The $9,000 of depreciation for the automobile must be included as an expense in 2023 as it would have been added back to net income on a cash basis.
(b) The accrual basis of accounting provides a better measure of net income than the cash basis. The accrual basis is required under generally accepted accounting principles and recognizes revenues when earned and expenses when incurred. Revenues and expenses recognized under the accrual basis are related to the economic environment in which they occur and thus allow trends to be more meaningfully interpreted.
The cash basis often fails to recognize revenue in the period when earned and expenses when incurred. As well, expenses are not matched with revenues when earned; therefore, expense recognition is not achieved.
Difficulty: Medium
Learning Objective: Explain the differences between the cash basis of accounting and the accrual basis of accounting.
Section Reference: Application of the Cash and Accrual Bases of Accounting (Appendix 4A)
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
*Pr. 4-145 Cash to accrual accounting
Cupcake Corporation maintains its records on the cash basis. You have been engaged to convert its cash-basis income statement to the accrual basis. The cash-basis income statement, along with additional information, follows:
CUPCAKE CORPORATION
Income Statement (Cash Basis)
For the Year Ended December 31, 2023
Cash Receipts from Customers $380,000
Cash Payments:
Salaries and Wages Expense $150,000
Income Tax Expense 65,000
Insurance Expense 40,000
Interest Expense 25,000 280,000
Net income $100,000
Additional information:
_Balances at Dec. 31
2023 2022
Accounts Receivable $50,000 $30,000
Salaries and Wages Payable 15,000 25,000
Income Tax Payable 14,000 19,000
Prepaid Expenses 8,000 4,000
Accumulated Depreciation 95,000 80,000
Interest Payable 3,000 9,000
No assets were sold during 2023.
*Solution 4-145
CUPCAKE CORPORATION
Income Statement (Accrual Basis)
For the Year Ended December 31, 2023
Revenue ($380,000 + $50,000 – $30,000) $400,000
Expenses
Salaries and Wages Expense ($150,000 + $15,000 – $25,000) $140,000
Income Tax Expense ($65,000 + $14,000 – $19,000) 60,000
Insurance Expense ($40,000 + $4,000 – $8,000) 36,000
Depreciation Expense ($95,000 – $80,000) 15,000
Interest Expense ($25,000 + $3,000 – $9,000) 19,000
Total Expenses 270,000
Net Income $130,000
Difficulty: Medium
Learning Objective: Explain the differences between the cash basis of accounting and the accrual basis of accounting.
Section Reference: Application of the Cash and Accrual Bases of Accounting (Appendix 4A)
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
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Intermediate Accounting v1 13e | Canada | Test Bank
By Donald E. Kieso