Ch6 Financial Statement I The Income Statement Exam Prep

Chapter 6

Multiple choice

1. The disposal of a significant component of a business is called

a. A change in accounting principle

b. A special item of income from continuing operations item

c. An other expense

d. Discontinued operation

2. If year one sales equal $800,000, year two equal $840,000 and year three equals $896,000 the percentage to be assigned for year two in a sales trend analysis, assuming that year 1 is the base year, is

a. 100%

b. 89%

c. 105%

d. 112%

3. A measure of a company’s profitability is the

a. Current ratio

b. Current cash debt coverage ratio

c. Return on assets ratio

d. Debt to total assets ratio

1. Which of the following is not an economic consequence of financial reporting?
   1. Financial information can affect the distribution of wealth among investors. More informed investors, or investors employing security analysts, may be able to increase their wealth at the expense of less informed investors.
   2. Financial information can affect the level of risk accepted by a firm. Focusing on short-term, less risky projects may have long-term detrimental effects.
   3. Financial information can affect the rate of capital formation in the economy and result in a reallocation of wealth between consumption and investment within the economy.
   4. Financial information can affect the allocation of psychic income among investors.
2. Which of the following is not an income statement element?
   1. Asset
   2. Gain
   3. Revenue
   4. Expense
3. The statement, net income should reflect all items that affected the net increase or decrease in stockholders’ equity during the period is consistent with which of the following concepts of income?
   1. Economic
   2. All inclusive
   3. Current operating performance
   4. Money
4. Which of the following is not an accounting change?
   1. Change in accounting principle
   2. Change in accounting estimate
   3. Change in a reporting entity
   4. Change because of an error
5. Which of the following is not an example of an error?
   1. A change from an accounting practice that is not generally acceptable to a practice that is generally acceptable.
   2. Mathematical mistakes.
   3. A change from LIFO to FIFO inventory costing
   4. The incorrect classification of costs and expense
6. The formula, Operating profit/Sales, is used to calculate
   1. Gross profit percentage
   2. Net profit percentage
   3. Comprehensive income percentage
   4. Operating profit percentage
7. Which of the following is the definition of an expense?
   1. Outflows or other using-up of assets or incurrences of liabilities during a period from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity’s ongoing major or central operations.
   2. Inflows or other enhancements of assets of an entity or settlements of its liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations.
   3. Decreases in equity (net assets) from peripheral or incidental transactions of an entity except those that result from expenses or distributions to owners.
   4. Increases in equity (net assets) from peripheral or incidental transactions of an entity except those that result from revenues or investments by owners.

11. Which of the following occur from peripheral or incidental transactions?

a. Sales revenue

b. Cost of goods sold

c. Gain on the sale of equipment

d. Operating expenses

1. Which of the following items would be reported net of tax on the face of the income statement?
   • • • 1. Discontinued operations
         2. Unusual gain
         3. Change in collectability of receivables
         4. Prior period adjustment
2. An example of the correction of an error in previously issued financial statements is a change
3. From the completed contract to the percentage-of-completion method of accounting for long-term construction-type contracts.
4. In the depletion rate, based on new engineering studies of recoverable mineral resources.
5. From the sum-of-years-digits to the straight-line method of depreciation for all plant assets.
6. From the installment basis of recording sales to the accrual basis, when collection of the sales price has been and continues to be reasonably assured
7. Which of the following is characteristic of a change in an accounting estimate?
8. It usually need not be disclosed
9. It does not affect the financial statements of prior periods
10. It should be reported through the restatement of the financial statements
11. It makes necessary the reporting of pro forma amounts for prior periods
12. A change in the method of inventory pricing from FIFO to LIFO would be accounted for as a (an):
    1. Part of discontinued operations
    2. Part of gross profit
    3. Change in accounting principle
    4. Change in estimate.
13. A company changed its method of inventory pricing from last-in, first-out to first-in, first-out during the current year. Generally accepting accounting principles require that this change in accounting method be reported by:
14. Accounting for the effects of the change in the current and future periods.
15. Showing the cumulative effect of the change in the current year’s financial statements and pro forma effects on prior year’s financial statements in an appropriate footnote
16. Disclosing the reason for the change in the “significant accounting policies” footnote for the current year but not restating prior year financial statements
17. Applying retroactively the new method in restatements of prior years and appropriate footnote disclosures
18. A transaction that is material in amount, unusual in nature, but not infrequent in occurrence should be presented separately as a (an)
19. Component of income from continuing operations, but not net of applicable income taxes
20. Component of income from continuing operations, net of applicable income taxes
21. Extraordinary item, net of applicable income taxes
22. Prior period adjustment, but not net of applicable income taxes
23. Which of the following is not reported as an accounting error (prior period adjustment)?
    1. Change in the method of inventory pricing form FIFO to average-cost.
    2. Mathematical mistakes.
    3. Mistakes in the application of accounting principles.
    4. Oversight or misuse of facts that existed at the time financial statements were prepared.
24. The correction of an error in the financial statements of a prior period should be reflected, net of applicable income taxes, in the current
25. Income statement after income from continuing operations
26. Income statement before income from continuing operations
27. Retained earnings statement as an adjustment of the opening balance
28. Retained earnings statement after net income but before dividends
29. A prior period adjustment is reported as:
    1. An unusual item in the income statement
    2. An addition to (or deduction from) net income in the income statement
    3. An addition to (or a deduction from) the beginning balance of retained earnings
    4. An addition to (or deduction from) the ending balance of retained earnings
30. A prior period adjustment should be reflected, net of applicable income taxes, in the financial statements of a business entity in the
    1. Retained earnings statement after net income but before dividends
    2. Retained earnings statement as an adjustment of the opening balance
    3. Income statement after income from continuing operations
    4. Income statement as part of income from continuing operations
31. Gains and losses that bypass net income but affect stockholders' equity are referred to as:
    1. Comprehensive income
    2. Other comprehensive income
    3. Prior period income
    4. Unusual gains and losses
32. What is the purpose of reporting comprehensive income?
    1. To provide information for each segment of the business.
    2. To provide a consolidation of the income of the firm's segments.
    3. To summarize all changes in equity from nonowner sources.
    4. To reconcile the difference between net income and cash flows provided from operating activities.
33. Which of the following is not an acceptable way of displaying the components of other comprehensive income?
    1. Combined statement of retained earnings.
    2. One statement approach.
    3. Two statement approach.
    4. One or Two statement approach
34. Earnings per share is computed as net income:
    1. Minus preferred dividends divided by the ending common shares outstanding
    2. Minus preferred dividends divided by the weighted average of common shares outstanding
    3. Divided by the weighted average of common shares outstanding
    4. Divided by the ending common shares outstanding
    5. $3.18
    6. $3.25
    7. $3.30
    8. $2.95.
35. Antidilutive securities would generally be used in the calculation of

Basic Diluted

Earnings per share Earnings per share

1. Yes Yes
2. No Yes
3. No No
4. Yes No
5. A change in accounting principle requires that the cumulative effect of the change for prior periods be shown as an adjustment to:
   1. Beginning retained earnings of the earliest period presented
   2. Comprehensive income for the earliest period presented
   3. Stockholders’ equity of the period in which the change occurred
   4. Net income of the period in which the change occurred
6. Which of the following is true in accounting for changes in estimates?
   1. Changes in estimates are considered as errors.
   2. A company recognizes a change in estimate by making a retrospective adjustment to the financial statements.
   3. A company accounts for changes in estimates only in the period of change, even though it affects the future periods.
   4. Changes in estimates are not carried back to adjust prior years.
7. A change in the salvage value of an asset depreciated on a straight-line basis and arising because additional information has been obtained is
   1. An accounting change that should be reported in the period of change and future periods of change if the change affects both
   2. An accounting change that should be reported by restating the financial statements of all prior periods presented
   3. A correction of an error
   4. Not an accounting change
8. A loss should be reported separately as a net-of-tax component of net income when it is which of the following?

Unusual Infrequent

In Nature in Occurrence

1. No Yes
2. No No
3. Yes No
4. Yes Yes
5. When a component of a business has been discontinued during the year, this component’s operating losses of the current period up to the measurement date should be included in the
   1. Income statement as part of the income (loss) from operations of the discontinued component
   2. Income statement as part of the loss on disposal of the discontinued component
   3. Income statement as part of the income (loss) from continuing operations
   4. Retained earnings statement as a direct decrease in retained earnings

Essay

1. Discuss the economic consequences of financial reporting.

• Financial information can affect the distribution of wealth among investors. More informed investors, or investors employing security analysts, may be able to increase their wealth at the expense of less informed investors.
• Financial information can affect the level of risk accepted by a firm. As discussed in Chapter 4, focusing on short-term, less risky projects may have long-term detrimental effects.
• Financial information can affect the rate of capital formation in the economy and result in a reallocation of wealth between consumption and investment within the economy.
• Financial information can affect how investment is allocated among firms.

1. Discuss the four income statements elements defined by SFAC No. 6.

• Revenues. Inflows or other enhancements of assets of an entity or settlement of its liabilities (or a combination of both) during a period from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations.
• Gains. Increases in net assets from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity during a period except those that result from revenues or investments by owners.
• Expenses. Outflows or other using-up of assets or incurrences of liabilities (or a combination of both) during a period from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity’s ongoing major or central operations.
• Losses. Decreases in net assets from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity during a period except from expenses or distributions to owners.

1. Discuss the all-inclusive vs. current operating performance views of income.
2. Define and discuss the accounting treatment for discontinued operations.
3. Discuss the evolution of the accounting treatment of extraordinary items.

• Unusual nature. —the event or transaction should possess a high degree of abnormality and be unrelated or only incidentally related to ordinary activities.
• Infrequency of occurrence. —the event or transaction would not reasonably be expected to recur in the foreseeable future. Question: given the ASC, should we remove footnotes to original sources?

1. What are accounting changes and why is it an issue. List and define the three types of accounting changes.
2. Change in an accounting principle. This type of change occurs when an entity adopts a GAAP that differs from one previously used for reporting purposes. Examples of such changes are a change from LIFO to FIFO inventory pricing or a change in depreciation methods.
3. Change in an accounting estimate. These changes result from the necessary consequences of periodic presentation. That is, financial statement presentation requires estimation of future events, and such estimates are subject to periodic review. Examples of such changes are the life of depreciable assets and the estimated collectability of receivables.
4. Change in a reporting entity. Changes of this type are caused by changes in reporting units, which may be the result of consolidations, changes in specific subsidiaries, or a change in the number of companies consolidated.
5. Discuss the concept of simple vs. complex capital structures and how it relates to the reporting of earnings per share.
6. Define and discuss the accounting treatment for prior period adjustments.
7. Correction of an error in the financial statements of a prior period.
8. Adjustments that result from the realization of income tax benefits of preacquisition operating loss carry-forwards of purchased subsidiaries.
9. What is the major distinction between revenues and gains and between expenses and losses?
10. Define comprehensive income. What is the purpose of reporting comprehensive income?
11. What are the two ways that other comprehensive income may be reported on corporate financial statements?
12. Obtain a company’s income statement and ask the students to compute the following:
    • • • 1. Gross profit percentage
          2. Net profit percentage
          3. Operating profit percentage
          4. Price earnings ratio
13. Discuss the sources of guidance for recording accounting transactions outlined by IAS No. 8, Accounting Policies, Changes in Accounting Estimates and Errors.

• the requirements and guidance in IASB standards and interpretations dealing with similar and related issues; and
• the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework for the Presentation of Financial Statements.
• the most recent pronouncements of other standard-setting bodies that use a similar conceptual framework to develop accounting standards.
• other accounting literature and accepted industry practices, to the extent that these do not conflict with the sources in paragraph.