Financial Accounting, 11e (Harrison/Horngren/Thomas)
Chapter 11 Evaluating Performance: Earnings Quality, the Income Statement, &
Statement of Comprehensive Income
1 Learning Objective 11-1
1) The revenue recognition principle requires that sales revenue be recognized when it is earned.
2) Recognizing revenue before it is earned is a major source of financial statement fraud.
3) WorldCom committed financial statement fraud by deliberately overstating expenses.
4) If net sales are $1,200,000; cost of goods sold is $400,000; and operating expenses are $100,000, gross
profit is $700,000.
5) Gross profit percentage is calculated by dividing cost of goods sold by net sales.
6) The purpose of channel stuffing is to ensure that all customer orders are properly filled before the end
of the seller’s fiscal year.
7) The newly adopted revenue recognition standard, issued by the FASB and IASB, has very little impact
on the retail industry because the standards for revenue recognition in that industry were already closely
aligned globally.
8) Roughly half of all financial statement frauds over the past two decades have involved improper
________ recognition.
A) expense
B) revenue
C) asset
D) liability
9) A type of financial statement fraud that is accomplished by shipping more to customers than they
ordered, with the expectation that they may return some or all of the items is called:
A) improper asset recognition.
B) improper expense recognition.
C) channel stuffing.
D) cooking the books.
10) Examples of fraud involving improper revenue recognition include:
A) recording revenue when significant services are still to be performed.
B) channel stuffing.
C) sales to nonexistent customers.
D) all of the above.
11) Steadily decreasing cost of goods sold as a percentage of net sales is a sign of:
A) increasing earnings quality.
B) decreasing earnings quality.
C) financial statement fraud involving expense recognition.
D) financial statement fraud involving revenue recognition.
12) Sales revenue less cost of goods sold is called:
A) gross profit.
B) gross margin percentage.
C) net profit.
D) net operating profit.
13) Ongoing expenses incurred by the entity, other than the direct expenses for merchandise, are called:
A) other expenses.
B) extraordinary items.
C) cost of goods sold.
D) operating expenses.
14) The operating expense section of an income statement would NOT include ________ expense.
A) salaries
B) utilities
C) supplies
D) interest
15) For a retailer, there will be positive income from operations if:
A) revenues are greater than cost of goods sold.
B) revenues are greater than operating expenses.
C) gross profit is greater than operating expenses.
D) cost of goods sold is greater than operating expenses.
16) Components of increasing earnings quality include all of the following EXCEPT:
A) declining or stable operating expenses compared to sales.
B) improving gross margin compared to sales.
C) increasing cost of goods sold to sales ratio.
D) proper revenue and expense recognition.
17) A sign(s) of increasing earnings quality is(are):
A) improving gross margin/sales ratio.
B) declining operating expenses compared to sales.
C) improving operating earnings/sales ratio.
D) all of the above.
18) A sign of decreasing earnings quality is:
A) declining cost of goods sold/sales ratio.
B) declining gross margin/sales ratio.
C) declining operating expenses/sales ratio.
D) increasing operating income/sales ratio.
19) A corporation’s net income receives more attention than any other financial statement item because an
upward trend in net income usually:
A) leads to dividends in the future.
B) leads to higher stock prices in the future.
C) ensures that there is no financial fraud within the corporation.
D) A and B.
20) A company with low earnings quality is more likely to report ________ than a company with high
earnings quality.
A) high earnings in the future
B) low earnings in the future
C) high revenue levels in the future
D) decreasing operating expenses, compared to sales, in the future
21) Financial statement fraud involving expense recognition involves:
A) understating the amount of expenses.
B) failure to record and disclose some expenses.
C) delaying the proper recognition of expenses.
D) all of the above.
22) Maintaining control of costs is usually accomplished through each of the following EXCEPT:
A) development of effective marketing strategies.
B) establishment of a consistent supply chain for inventory purchases.
C) constantly changing vendors in search for the lowest prices.
D) effectively negotiating leases for new and established retail store locations.
2 Learning Objective 11-2
1) In a foreign-currency transaction, foreign currencies must be converted to U.S. dollars for financial
reporting purposes.
2) The foreign-currency transaction gain account holds gains and losses on transactions settled in a
foreign currency.
3) The net of foreign-currency transaction gains and losses will appear on the income statement.
4) Foreign-currency transaction losses can be avoided if international transactions are settled in U.S.
dollars instead of the foreign currency.
5) Hedging enables an entity to protect itself from losing money in a foreign transaction by engaging in a
counterbalancing transaction.
6) A company with a payable denominated in a foreign currency wants the dollar to become weaker
because the payment then costs fewer dollars when the transaction is settled.
7) Foreign-currency transaction gains and losses are reported as part of operating income because they
arise from the company’s main business.
8) On June 15, Blonski Computer Company sold twenty-five computers on account to a company located
in Argentina for 2,600,000 pesos. On that date, the peso is worth $0.084. On July 15, when the peso was
worth $0.080, payment was received. Blonski Computer Company uses the perpetual inventory system.
Ignoring Cost of Goods Sold, the journal entry on June 15 by Blonski Computer Company would be:
A) debit Accounts Receivable $218,400 and credit Sales Revenue $218,400
B) debit Accounts Receivable $208,000 and credit Sales Revenue $208,000
C) debit Accounts Receivable $208,000, debit to Foreign-Currency Transaction Loss $10,400 and credit
Sales Revenue $218,400
D) debit Accounts Receivable $218,400, credit Sales $208,000, and credit Foreign Currency Transaction
Gain $10,400
9) On June 15, Copps Stores sold twenty-five computers, on account, to a company located in Argentina
for 2,600,000 pesos. On that date the peso is worth $0.079. On July 15, when the peso was worth $0.070,
payment was received. The journal entry on July 15 by Copps Stores would include a:
A) credit to Cash $205,400.
B) credit to Accounts Receivable $182,000.
C) debit to Foreign-Currency Transaction Loss $23,400.
D) credit to Sales $182,000.
10) On August 1, Deluka Computers, Inc. purchased thirty computer chips, on account, from a company
located in Taiwan for 520,000 Taiwan dollars. On that date the Taiwan dollar is worth $0.038. On
September 1, when the Taiwan dollar was worth $0.04, payment was made. Deluka Computers uses the
perpetual inventory system. The journal entry on August 1 by Deluka Computers, Inc. would be: (Round
your final answer to the nearest dollar.)
A) debit Inventory $20,800 and credit Accounts Payable $20,800.
B) debit Inventory $19,760 and credit Accounts Payable $19,760.
C) debit Inventory $19,760, credit Foreign-Currency Transaction Gain -$1040, and credit Accounts
Payable $20,800.
D) debit Inventory $19,760 and credit Cash $19,760.
11) On August 1, Steffen Computers, Inc. purchased thirty computer chips, on account, from a company
located in Taiwan for 530,000 Taiwan dollars. On that date the Taiwan dollar is worth $0.034. On
September 1, when the Taiwan dollar was worth $0.036, payment was made. The journal entry on
September 1 by Steffen Computers, Inc. would include a: (Round your final answer to the nearest dollar.)
A) debit to Accounts Payable $19,080.
B) debit to Foreign-Currency Transaction Loss –$1060.
C) credit to Foreign-Currency Transaction Gain -$1060.
D) credit to Cash $18,020.
12) Santa Barbara Company, a U.S. company, purchased merchandise on account from a company in
England. The price was 1300 British pounds. At the time of the purchase, the exchange rate for a British
pound was $1.54. At the time Santa Barbara Company paid for the merchandise, the exchange rate for a
British pound was $1.58. What is the amount of the gain or loss recorded by the Santa Barbara Company
upon payment?
A) Foreign currency transaction gain $52
B) Foreign currency transaction loss $52
C) Foreign currency translation gain $2054
D) Foreign currency translation loss $2054
13) A U.S.-based company sells merchandise on account to a company in Mexico. The Mexican company
wants to pay for the merchandise in pesos. If the peso decreases in value relative to the dollar, the seller
will record a ________. The peso ________ relative to the dollar.
A) Foreign Currency Transaction Gain; weakens
B) Foreign Currency Transaction Gain; strengthens
C) Foreign Currency Transaction Loss; weakens
D) Foreign Currency Transaction Loss; strengthens
14) A U.S.-based company purchases merchandise on account from a company in Mexico. The purchase
contract is denominated in pesos. If the peso decreases in value relative to the dollar, the purchaser will
record a ________. The peso ________ relative to the dollar.
A) Foreign Currency Transaction Loss; weakens
B) Foreign Currency Transaction Loss; strengthens
C) Foreign Currency Transaction Gain; weakens
D) Foreign Currency Transaction Gain; strengthens
15) When a U.S.-based company holds a receivable denominated in a foreign currency, the U.S. company
wants the foreign currency to ________ against the U.S. dollar so that the foreign currency can be
converted into ________.
A) weaken; fewer dollars
B) weaken; more dollars
C) strengthen; fewer dollars
D) strengthen; more dollars
16) When a U.S.-based company has a payable denominated in a foreign currency, the U.S. company
wants the foreign currency to ________ and the U.S. dollar to ________.
A) strengthen; strengthen
B) strengthen; weaken
C) weaken; strengthen
D) weaken; weaken
17) A company has a foreign-currency transaction loss of $1400 and a foreign-currency transaction gain of
$9800. How is this information reported on the income statement?
A) Other Losses: Foreign-Currency Transaction Loss $1400 and Other Gains: Foreign-Currency
Transaction Gain $9800
B) Other Gains: Foreign-Currency Transaction Gain, net $8400
C) Other Comprehensive Income: Foreign-Currency Transaction Gain $9800 and Other Comprehensive
Loss: Foreign-Currency Transaction Loss $1400
D) Other Comprehensive Income: Foreign-Currency Transaction Gain, net $8400
18) A company has a foreign-currency transaction gain of $500 and a foreign-currency transaction loss of
$9500. How is this information reported on the income statement?
A) Other Losses: Foreign-Currency Transaction Loss $9500 and Other Gains: Foreign-Currency
Transaction Gain $500
B) Other Losses: Foreign-Currency Transaction Loss, net $9000
C) Other Comprehensive Loss: Foreign-Currency Transaction Loss $9500 and Other Comprehensive
Income: Foreign-Currency Transaction Gain $500
D) Other Comprehensive Loss: Foreign-Currency Transaction Loss, net $9000
19) Hedging foreign currency transactions can be accomplished by:
A) maintaining equal amounts of receivables and payables in foreign currencies.
B) purchasing future contracts.
C) purchase foreign currencies to be received in the future.
D) all of the above.
3 Learning Objective 11-3
1) Income tax expense is a component of income from operations.
2) Income tax payable is the amount of tax to be paid to the government based on the income tax return.
3) Income tax payable is computed by multiplying income before income taxes, from the income
statement, by the income tax rate.
4) Taxable income should always equal pretax accounting income.
5) One reason why taxable income and pretax accounting income may not be equal is due to the
difference in depreciation methods used.
6) Common stock should be purchased if the estimated value of a company exceeds its current market
value.
7) Financial analysts typically include discontinued operations in predictions of future corporate income.
8) When a company discontinues a segment of its business, the income statement should report income
(loss) from continuing operations and income (loss) from discontinued operations.
9) The weighted-average cost of capital is influenced by the risk that a company might not be able to
sustain a certain rate of return into the indefinite future.
10) A prior-period adjustment is made to the ending balance of retained earnings in the current period’s
statement of stockholders’ equity.
11) Income tax expense appears on the:
A) tax return.
B) statement of stockholders’ equity.
C) income statement.
D) balance sheet.
12) Income tax payable appears on the:
A) statement of retained earnings.
B) statement of stockholders’ equity.
C) income statement.
D) balance sheet.
13) Which of the following statements is TRUE?
A) Income tax payable is the amount of tax to be paid to the government based on the company’s
financial statements.
B) When income tax payable exceeds income tax expense, the company debits a Deferred Tax Asset.
C) Deferred Tax Liability is usually shown on the balance sheet as a current liability.
D) The income tax return and the income statement are identical.
14) The formula to determine income tax expense is:
A) taxable income (from the income tax return) multiplied by the income tax rate.
B) taxable income(from the income statement) multiplied by the income tax rate.
C) income before income tax expense (from the tax return) multiplied by the income tax rate.
D) income before income tax expense (from the income statement) multiplied by the income tax rate.
15) The formula to determine income tax payable is:
A) taxable income (from the income tax return) multiplied by the income tax rate.
B) taxable income(from the income statement) multiplied by the income tax rate.
C) income before income tax expense (from the tax return) multiplied by the income tax rate.
D) income before income tax expense (from the income statement) multiplied by the income tax rate.
16) Assume it is the first year of operations. When pretax accounting income exceeds taxable income, a:
A) Deferred Tax Asset is debited.
B) Deferred Tax Liability is credited.
C) Deferred Tax Asset is credited.
D) Deferred Tax Liability is debited.
17) Eastwich Corporation has pretax accounting income of $5,900,000 and taxable income of $5,820,000.
The company’s income tax rate is 20%. The journal entry to record the income tax includes a:
A) debit to Deferred Tax Asset $16,000.
B) credit Income Tax Payable $1,180,000.
C) credit to Deferred Tax Liability $16,000.
D) debit Income Tax Expense $1,164,000.
18) Western Corporation has taxable income of $420,000 and pretax accounting income of $200,000. The
company’s income tax rate is 20%. The journal entry to record the income tax includes a:
A) debit to Income Tax Expense $84,000.
B) credit to Deferred Tax Asset $44,000.
C) debit to Deferred Tax Asset $44,000.
D) credit to Income Tax Payable $40,000.
19) The estimated value of a share of a company’s stock is less than the current market price per share.
Based on this information, the investment decision rule is to:
A) buy the company’s stock.
B) hold the company’s stock.
C) sell the company’s stock.
D) sell the company’s stock on the margin.
20) The gain or loss on the disposal of a business segment is shown on the income statement as:
A) part of comprehensive income.
B) part of discontinued operations
C) part of continuing operations.
D) other gains or losses.
21) Which of the following statements is INCORRECT?
A) The balance sheet caption “Discontinued Operations” includes both operating income or loss of the
segment during the divestiture period and gains or losses on the transaction at the point of sale of the
segment.
B) Income from discontinued operations is a component of net income.
C) All gains and losses from discontinued operations are shown “net of tax.”
D) Financial analysts typically do not include discontinued operations in predictions of future corporate
income because the discontinued segments will not continue to generate income for the business.
22) The loss incurred as a result of the impairment of goodwill should be reported as:
A) part of discontinued operations.
B) an operating expense.
C) other expenses and losses.
D) an extraordinary item.
23) Katherine’s Fashions is going to discontinue one of its manufacturing divisions. The division’s assets
with a book value of $1,010,000 are sold for $80,000. The division generated an operating loss of
$1,480,000 after the decision was made to discontinue the segment. Ignoring income taxes, what total
amount should be reported on the income statement as discontinued operations?
A) $550,000 loss
B) $930,000 loss
C) $2,410,000 loss
D) $1,480,000 gain
24) Following U.S. Generally Accepted Accounting Principles, how is a change in accounting estimate
handled?
A) The new estimate must be used in the current and future years only.
B) The new estimate must be used in the prior year financial statements only.
C) The new estimate must be used in the future years only.
D) The new estimate must be used in the prior, current and future years.
25) Assume it is the first year of operations. When taxable income exceeds pretax accounting income,
accountants record a(n):
A) Deferred Tax Asset.
B) Deferred Tax Liability.
C) Income Tax Payable.
D) Prepaid Income Taxes.