Chapter 12—THE INCOME STATEMENT
Accounting Theory: 8th edition Page 1 of 14
TRUE/FALSE
1. The current operating approach has led to the concept of comprehensive income.
2. Comprehensive income is the change in equity of an entity during a period of transactions and
other events and circumstances, from owner and nonowner sources.
3. The income statement is largely a legacy of fifty years of accounting standards based on the
revenue-expense approach.
4. The FASB appears to be continuing to take a revenue-expense approach to financial statements.
5. Although there are exceptions, revenue is generally recognized at the time cash is collected.
6. The majority of exceptions to the general rule regarding revenue recognition have evolved
because new transactions have emerged that do not fit the mold of traditional transactions.
7. The major expense-recognition problem concerns those costs that are clearly not expired in the
period incurred but are clearly not associated with the revenues of a particular period.
8. The distinction between losses and expenses is important under the all-inclusive income concept.
9. The expense recognition model based on historical cost, as well as the model based on current
value, must allocate the costs incurred.
10. Most accountants believe that the method of cost allocation used is nothing more than an
arbitrary decision.
Chapter 12—THE INCOME STATEMENT
Accounting Theory: 8th edition Page 2 of 14
11. Recognition of a past event is sometimes governed by whether a “one-event view” or a “two–
event view” is held.
12. Management intent is an accepted basis for recognition of future events.
13. Predicting changes in future economic conditions should be a major consideration in the
recognition of future events.
14. Predicting future legal changes that have not yet been enacted should be a major consideration in
the recognition of future events.
15. All empirical evidence supports the all-inclusive income concept.
16. Research on the smoothing of year–to-year income suggests that operating income is better
predicted by operating rather than all-inclusive income.
17. According to the “big bath theory,” when firms disclose bad news, there is a positive response by
the market because the firm has recognized in the financial statements that a major problem exists
and is moving to redress the problem.
18. As a result of APB Opinion No. 30, extraordinary items other than gains and losses from early
extinguishment of debt, have practically disappeared.
19. Extraordinary items should be disclosed net of tax.
20. Prior period adjustments are accounting changes that should be accounted for in comprehensive
income on the income statement of the period of change.
21. The main reason underlying SFAS 154 is that it is part of the convergence project with the IASB.
Chapter 12—THE INCOME STATEMENT
22. If a loss is expected on subsequent disposal of a business segment, the estimated loss is
recognized in the financial statements as of the measurement date.
23. Return on investment is the most-used summary indicator to date.
24. The elimination of primary earnings per share by SFAS No. 128 is a case of less information
leading to more usefulness.
25. A troubled debt restructuring occurs when a creditor, for economic or legal reasons related to the
debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise
consider.
26. A major problem with SFAS No. 114 is that it applies only to creditors, while debtors are still
governed by SFAS No. 15.
27. Currently, expense is recognized when an incentive stock option is granted.
28. The measurement date for determining the value of a stock option is usually the exercise date.
29. Backdating stock options appears to be an illegal conversion of assets belonging to shareholders
to members of management.
30. According to McVay, classification shifting within the income statement is a form of earnings
management.
Chapter 12—THE INCOME STATEMENT
MULTIPLE CHOICE
1. Which of the following best describes “comprehensive income”?
a.
Comprehensive income is the amount resulting from the deduction from revenues, or from
operating revenues, of cost of goods sold, other expenses, and losses.
b.
Comprehensive income is the excess (deficit) of revenue over expenses for an accounting
period.
c.
Comprehensive income is the change in equity of an entity during a period of transactions
and other events and circumstances, from nonowner sources.
d.
Comprehensive income is the change in equity of an entity during a period of transactions
and other events and circumstances, from owner and nonowner sources.
2. Comprehensive income as displayed on the income statement represents:
a.
An asset-liability approach.
b.
A revenue-expense approach.
c.
A current operating approach.
d.
None of the above
3. Which of the following is a definition of revenue that clearly represents an asset-liability
approach?
a.
Revenue results from the sale of goods and rendering of services and is measured by the
charge made to customers, clients, or tenants for goods and services furnished to them.
b.
Revenue represents gross increases in assets and gross decreases in liabilities measured in
conformity with generally accepted accounting principles that result from those types of
profit-directed activities.
c.
Revenue should be identified with the period during which the major economic activities
necessary to the creation and disposition of goods and services has been accomplished.
d.
Revenues are the inflow 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.
4. Under the current-operating concept, increases in equity from peripheral or incidental
transactions (transactions other than sales of products, merchandise, or services) are referred to
as:
a.
Gains.
b.
Revenue.
c.
Comprehensive income.
d.
Accruals.
Chapter 12—THE INCOME STATEMENT
Accounting Theory: 8th edition Page 5 of 14
5. Which of the following best describes when revenues are generally recognized?
a.
At the completion of production
b.
At the point of sale when legal title is transferred
c.
When cash is collected
d.
During production
6. Which of the following is the primary criterion for revenue recognition applied in practice?
a.
Cash collection
b.
Completion of the production process
c.
Completion of the earnings process
d.
When sales price is measurable
7. Which of the following suggested bases of recognizing revenue is not permitted by authoritative
literature?
a.
During production for long-term construction contracts if reliable estimates of the extent
of progress and of the cost to complete can be made and if reasonable assurance of
collectibility exists
b.
At the completion of production if immediate marketability at a quoted price exists for a
product whose units are interchangeable
c.
On an accretion basis where product marketability at known prices exists and it is
desirable to recognize changes in assets, such as growing timber
d.
On a cash basis if no reasonable basis exist for estimating collectibility
8. Which of the following represents the attribute(s) that must be measurable before revenue is
recognized?
a.
Sales price and cash collections
b.
Sales price
c.
Cash collections
d.
Sales price, cash collections, and future costs
9. Which of the following is a definition of expenses that clearly represents an asset-liability
approach?
a.
Expenses are outflows or other using up of assets or incurrence 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 major or central
operations.
b.
Expenses are costs directly associated with the revenue of the period.
c.
Expenses are gross decreases in assets or gross increases in liabilities recognized and
measured in conformity with generally accepted accounting principles that result from
those types of profit-directed activities of an enterprise.
d.
Expenses in the broadest sense include all expired costs which are deductible from
revenues.
Accounting Theory: 8th edition Page 6 of 14
10. Which of the following should be considered first in applying the matching concept?
a.
Costs should be matched against the revenue directly produced.
b.
Costs should be matched to revenue in a rational and systematic manner.
c.
Costs should be recognized as period expenses when incurred.
d.
Costs should be recognized as expenses when cash is paid.
11. Which of the following is a true statement?
a.
When arbitrary allocations are used, income statements have very little information
content.
b.
The calculation aspects of most expense measurements are easily resolved under historical
cost accounting.
c.
When arbitrary allocations are used, income statements still have information content.
d.
Capital market research has shown that the usefulness of accounting numbers is best
resolved using the deductive logic of the allocation problem.
12. Which of the following is the major problem underlying future events and their impact upon
event recognition?
a.
Management intent
b.
The probabilistic nature of future events
c.
The perception of the past event
d.
Future economic conditions
13. Which of the following statements applies to the two-event view of past event recognition?
a.
It would recognize a transaction as occurring when an offer of early retirement is made to
employees.
b.
It would be more reliant upon probabilistic estimates than the one-event view.
c.
It is faster than the one-event view.
d.
It is consistent with the asset and liability views of SFAC No. 6.
14. The current operating school of thought holds that:
a.
All components of comprehensive income should be in the income statement.
b.
The income statement should contain only normal operating components of
comprehensive income.
c.
Retained earnings should reflect only total earnings as reported in the income statement
and dividend distributions, in addition to beginning and ending balances.
d.
Unusual or infrequently occurring gains and losses should be reported on the income
statement.
15. Which of the following is an argument supporting the “current operating” income recognition
school of thought?
a.
Most financial statement users look only to bottom-line net income to assess current
performance and to make predictions regarding subsequent years’ performance.
b.
Under this approach, management makes the decision on whether or not an item is
extraordinary and therefore excluded from the income statement.
c.
The summation of all income displayed on the income statement for a period of years
should reflect the reporting entity’s net income for that period.
d.
Proper classification within the income statement allows both normal recurring items and
unusual, infrequently occurring items to be displayed separately within the same
statement.
16. SFAS No. 130 allows all but which of the following regarding comprehensive income?
a.
Reporting comprehensive income in a combined statement of financial performance
b.
Reporting comprehensive income in a separate statement of comprehensive income which
would begin with net income
c.
Reporting comprehensive income within a statement of changes in equity
d.
Not reporting comprehensive income
17. Which of the following methods of reporting comprehensive income is preferred by the FASB?
a.
Reporting comprehensive income in a combined statement of financial performance
b.
Reporting comprehensive income in a separate statement of comprehensive income which
would begin with net income
c.
Reporting comprehensive income within a statement of changes in equity
d.
Not reporting comprehensive income
18. Which of the following methods of reporting comprehensive income did the FASB members that
dissented from SFAS No. 130 believe most firms would use?
a.
Reporting comprehensive income in a combined statement of financial performance
b.
Reporting comprehensive income in a separate statement of comprehensive income which
would begin with net income
c.
Reporting comprehensive income within a statement of changes in equity
d.
Not reporting comprehensive income
19. Which of the following is not true regarding comprehensive income?
a.
Comprehensive income includes foreign currency translation adjustments.
b.
Comprehensive income includes unrealized holding gains and losses on available-for-sale
securities.
c.
Comprehensive income includes minimum pension liability adjustments previously
classified as intangible assets.
d.
Earnings per share should be calculated for comprehensive income.
Accounting Theory: 8th edition Page 8 of 14
20. The nonoperating section of the income statement includes:
a.
Extraordinary items.
b.
Extraordinary items and discontinued operations.
c.
Extraordinary items, accounting principle changes, and discontinued operations.
d.
Extraordinary items, accounting principle changes, discontinued operations, and prior
period adjustments.
21. Which of the following is not considered one of the three broad categories of accounting
changes?
a.
Change in Accounting Principle
b.
Change in Accounting Estimate
c.
Change in Reporting Entity
d.
Change in Accounting Application
22. Which of the following is the date that management commits itself to a formal plan to dispose of
a business segment?
a.
The measurement date
b.
The disposal date
c.
The assessment date
d.
The transfer date
22. Which of the following is the date that management commits itself to a formal plan to dispose of
a business segment?
a.
The measurement date
b.
The disposal date
c.
The assessment date
d.
The transfer date
23. Which of the following is true regarding discontinued operations?
a.
If a loss is expected on disposal, the estimated loss is recognized in the financial
statements as of the measurement date.
b.
If a loss is expected on disposal, the estimated loss is recognized in the financial
statements as of the disposal date.
c.
If a loss is expected on disposal, recognition is deferred until realization.
d.
If a gain is expected on disposal, the estimated gain is recognized in the financial
statements as of the measurement date.
Accounting Theory: 8th edition Page 9 of 14
24. Which one of the following summary indicators is the most used?
a.
Return on investment
b.
Earnings per share
c.
Debt-to-equity ratio
d.
Current ratio
25. Which of the following is not true regarding SFAS No. 128?
a.
Users can now comprehend the effect upon EPS of the full amount of dilution without the
presence of the artificial and confusing primary earnings per share calculation.
b.
It brought the United States into alignment with virtually all other nations in terms of EPS
requirements.
c.
The elimination of primary earnings per share is a case of more information leading to
more usefulness.
d.
The FASB and the International Accounting Standards Committee cooperated on the
project together.
26. Which of the following is not a true statement regarding accounting for development stage
enterprises?
a.
SFAS No. 7 requires complete disclosure by the development stage enterprise to avoid
misleading financial statement users by heavy initial losses.
b.
SFAS No. 7 achieved uniformity on the basis of the nature of the enterprise rather than on
the basis of the nature of the transaction.
c.
The FASB opted for rigid uniformity in selecting a solution as opposed to finite
uniformity, where a relevant circumstance might be viewed as the development stage of
the enterprise.
d.
SFAS No. 7 requires that costs of a similar nature be accounted for similarly, regardless of
the stage of development of the entity incurring the cost.
27. Which of the following statements is true regarding stock options?
a.
When exercised, an incentive stock option has an option price exceeding the market price.
b.
When granted, a nonqualified stock option has an option price exceeding the market price.
c.
The fair value of an incentive stock option equals the current market price of the stock
minus the present value of the exercise price discounted at the risk free interest rate over
the number of years of life of the option.
d.
The value of an incentive stock option can not be determined at the grant date,
28. Which of the following is not a component of the single income statement proposed by the G4+1
report?
a.
Pro forma earnings
b.
Results of operating or trading activities
c.
Results pertaining to financing and other treasury activities
d.
Other Gains and Losses
Chapter 12—THE INCOME STATEMENT
ESSAY
1. Respond to the following:
a.
When is revenue generally recognized, and what are three other alternative points in
time for recognizing revenue?
b.
When is each alternative revenue recognition method appropriate and why have
these methods evolved?
c.
What is the primary criterion for revenue recognition applied in practice, and what
attributes must be measurable before revenue is recognized.
is transferred. Three alternative points in time for recognizing revenue are: (1) during
production; (2) at the completion of production; and (3) when cash is collected.
the point of sale have evolved because new transactions have emerged that do not fit
the mold of traditional transactions.
accuracy when the earning process is complete, recognition must be delayed until
reasonable measurements can be made.
2. What are the three categories of expenses identified in APB Statement 4, and what is the related
hierarchy of expense recognition?
3. Discuss the effect, if any, each of the following should have on the recognition of future events:
a.
The probabilistic nature of future events
b.
Management intent
c.
Conservatism
d.
Future economic conditions
e.
Future legal requirements
clear what probability percentage should be attached to the concept of “probable.”
considerations. Considering management intent could result in lower comparability.
adding a balance to the totality of financial information flowing to users.
current tax rates.
enacted.
4. Contrast the current operating and the all-inclusive concepts of income and identify arguments
used in supporting each.
5. What is “comprehensive income,” and how does SFAS No. 120 allow it to be reported?
6. Describe how the reporting of extraordinary items is a good example of the shift away from finite
uniformity to rigid uniformity in accounting standards.
7. What is the pro forma earnings approach, and what problem does it present. Also, explain how
pro forma earnings differs form the G4+1 income statement proposal.
8. What are nonqualified stock options and incentive stock options, and how does expense
recognition differ for these two types of stock options?
9. How does the matrix approach proposed by Barker differ from the one proposed by Glover, Ijiri,
Levine, and Lian (GILL)? What are the advantages and disadvantages of each?