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Chap002 Accrual Accounting and Net income determination
True/False
[QUESTION]
1. Accrual accounting decouples measured earnings from operating cash inflows and
outflows.
2. Cash-basis accounting provides the most useful measure of future operating
performance.
3. Net asset valuation and net income determination are inextricably intertwined.
4. While the earnings process is the result of many separate activities, it is generally
acknowledged that there is usually one critical event or key stage considered to be
absolutely essential to the ultimate increase in net asset value of the firm.
5. The matching principle says that expenses are matched to the revenue recognized
during the period, not that revenue is matched to the period’s expenses.
6. Period costs would include costs like advertising or insurance where the linkage
between these costs and individual sales is difficult to establish.
7. Traditional financial reporting presents forecasted cash flow information.
8. Gains and losses from continuing operations that are not typical recurring costs are
presented as a separate line in the income from continuing operations section of the
income statement.
9. Each set of EPS numbers includes separately reported numbers for income from
continuing operations and the items that appear below it on the income statement.
10. The change in equity of an entity during a period from transactions and other events
from non-owner sources is known as comprehensive income.
11. Selected unrealized gains (or losses) sometimes bypass the income statement and are
reported as direct adjustments to a stockholders’ equity account.
12. The basic accounting equation may be expressed as assets = liabilities – owners’
equity.
13. To get revenue and expense account balances to zero an adjusting entry is made.
14. For each transaction, the dollar total of the debits must equal the dollar total of the
credits.
15. U. S. GAAP permits companies to report components of other comprehensive
income (OCI) as part of the statement of changes in stockholders’ equity.
16. The point within the operating cycle when the company’s net assets have increased is
the point when revenue should be recognized.
Multiple Choice
[QUESTION]
17. Which of the following statements best describes expenses?
a. They are recorded in the accounting period when they are “earned” and become
“measurable.”
b. They consist of amounts paid for consumable items and services rendered to the
organization during the accounting period.
c. They are the expired costs or assets “used up” during the accounting period.
d. They consist of cash payments to employees during the period for services rendered.
18. The expense matching principle states that
a. Expenses are recognized when paid.
b. All expenses are recognized when the corresponding revenue is recorded.
c. Some expenses are recognized when the corresponding revenue is
recognized and some are spread over time.
d. Expenses are recognized when the invoice is received.
REFERENCE: Ref. 02_01
The Canon Corporation sells ten copiers to the Title Company on October 15 for
$40,000. Canon delivers the copiers to Title on October 20 and Title pays $16,000,
agreeing to pay the balance on November 10.
[QUESTION]
REFER TO: Ref. 02_01
19. Under the cash basis, how much revenue should Canon recognize in October?
a. $0
b. $16,000
c. $24,000
d. $40,000
20. Under the accrual basis, how much revenue should Canon recognize in November?
a. $0
b. $16,000
c. $24,000
d. $40,000
21. Using the accrual basis, which one of the following entries would properly record
Canon’s revenue recognition for October?
a.
DR Cash
40,000
CR Copier sales
40,000
b.
DR Cash
16,000
CR Copier sales
16,000
c.
DR Cash
16,000
DR Accounts receivable
24,000
CR Copier sales
40,000
d.
DR Accounts receivable
40,000
CR Copier sales
40,000
REFERENCE: Ref. 02_02
Hickory Furniture Company paid for the following costs during the month of May:
Inventory purchases
$40,000
Advertising costs
8,000
Delivery costs
2,000
Hickory sold $32,000 of the inventory and has agreed to pay warranty expenses for its
customers. These are expected to be $1,600 and occur evenly over the next four months
(i.e., starting in June).
[QUESTION]
REFER TO: Ref. 02_02
22. What is the amount of Hickory’s cash-basis expenses for the month of May?
a. $33,600
b. $42,400
c. $50,000
d. $51,600
23. What is the amount of Hickory’s May expenses when applying the matching
principle?
a. $33,600
b. $42,400
c. $43,600
d. $50,000
24. Which statement below best describes when to record an expense?
a. When the expense is paid.
b. When the resource paid for is consumed.
c. Always taken in one period only.
d. Never is recognized before revenue is recognized.
25. Which of the following causes basic EPS to differ from fully diluted EPS?
a. Convertible preferred stock.
b. Warrants.
c. Management stock options.
d. All of these answer choices are correct.
26. Which of the following is not correct with respect to accrual accounting?
a. Accrual accounting can produce large discrepancies between the firm’s
reported profit performance and the amount of cash generated from
operations.
b. The principles that govern revenue and expense recognition under accrual
accounting are designed to alleviate the mismatching problems that exist
under cash-basis accounting.
c. Reported accrual accounting net income for a period always provides an
accurate picture of underlying economic performance.
d. Accrual accounting does not decouple measured earnings from operating
cash inflows and outflows.
27. What type of cost is the advertising expense?
a. Product cost
b. Traceable cost
c. Inventory cost
d. Period cost
28. Revenue is recognized when
a. a contract is signed by both parties.
b. the seller completes performance required by an agreement.
c. the buyer completes payment required under an agreement.
d. the buyer accepts delivery and completes required payments.
29. Net income recognition always increases
a. assets.
b. net assets.
c. liabilities.
d. net liabilities.
30. The real accounting issue in net income recognition is the
a. quantity of income recognized.
b. type of income recognized.
c. timing of the recognition.
d. basis of net income recognition.
31. Which of the following is not a change in reporting entity?
a. When combined statements replace statements of individual entities.
b. When there is a change in the subsidiaries to be consolidated or combined.
c. When a business combination is accounted for under the acquisition method.
d. All of these answer choices are correct.
32. Which of the following does not properly state the reporting requirements when a
change in reporting entity occurs?
a. Comparative financial statements for prior years must be restated to reflect the new
reporting entity as if it had been inexistence during all the years presented.
b. Comparative financial statements for the prior year only must be restated to reflect
the new reporting entity.
c. The effect of the change on income before extraordinary items, net income and other
comprehensive income must be restated.
d. Per share amounts must be disclosed for all periods presented.
33.
Accounting errors or irregularities can occur for which reasons?
a. simple oversight.
b. misapplication of GAAP.
c. management exploitation of the flexibility in GAAP.
d. all of these answer choices are correct.
34.
Which of the following parties are responsible for the detection of errors and accounting
irregularities in a company’s financial statements?
a. external auditors.
b. the SEC staff during their review process.
c. internal audit staff and audit committee of the board of directors.
d. all of these answer choices are correct.
35. Restatements occur for a number of reasons. Which of the following is the most
common type of restatement?
a. those related to revenue recognition.
b. items related to core expense issues.
c. items related to non-core expense issues.
d. reclassification and disclosure issues.
36. Misstatements of tax expense, improper restructuring charges, asset impairment
charges and gains/losses related to acquisitions are which type of restatement?
a. those related to revenue recognition
b. items related to core expense issues
c. items related to non-core expense issues
d. reclassification and disclosure issues
37. The matching principle requires that expenses be recognized
a. in the same period in which all the assets are used up.
b. in the same period in which the revenue generated by these expenses is recognized.
c. when the costs are paid by the entity.
d. in the same period in which the revenue generated by these expenses is received.
38. Traceable costs are also called
a. period costs.
b. expired costs.
c. product costs.
d. administrative costs.
39. The statement, “linkage between these costs and individual sales is difficult to
establish,” refers to
a. period costs.
b. expired costs.
c. product costs.
d. traceable costs.
40. Income statements are classified into sections to
a. separate revenue recognized from deferred revenue.
b. distinguish between sustainable and transitory income.
c. separate real income from book income.
d. distinguish between book income and taxable income.
41. Which item is not correct with respect to the treatment of sustainable and
transitory items and a company's income statement?
a. Financial reporting assists statement users in forecasting future cash
flows by providing an income statement format that segregates components
of net income.
b. Income statements prepared in accordance with GAAP differentiate
between income components that are believed to be sustainable and those
that are transitory.
c. The income statement isolates a key figure called “income from
sustainable operations.”
d. Transitory items are disclosed separately on the income statement so that
statement users can place less weight on these earnings components when
forecasting future profitability.
42. The rationale behind the rules for multiple-step income statements is to subdivide the
income in a manner that facilitates
a. cash flows.
b. forecasting.
c. tax return preparation.
d. audits.
43. The best measure of a firm’s sustainable income is
a. income from continuing operations.
b. income before income tax.
c. income before unusual items and change in accounting principle.
d. net income.
44. On the income statement, income from discontinued operations is shown
a. as a separate section of income from continuing operations.
b. as an accounting principle change.
c. without any income tax effect.
d. net of taxes after income from continuing operations.
45. When transitory earnings are present, which of the following correctly depicts the
order used on the income statement?
a. Income from continuing operations, unusual items, income tax expense, discontinued
operations, net income.
b. Income from continuing operations, discontinued operations, income tax expense, net
income.
c. Income from continuing operations, income tax expense, discontinued operations, net
income.
d. Income tax expense, income from continuing operations, unusual items, discontinued
operations, net income.
46. Black & Decker decides to discontinue producing toasters in lieu of more versatile
toaster ovens. In the process of discontinuing this line, the company disposes of the old
production equipment and buys new equipment. The disposal of the old equipment
would be reported in the income statement as
a. gain or loss on the sale of equipment as part of continuing operations.
b. gain or loss on the sale of production equipment as part of cost of goods manufactured
and sold.
c. gain or loss on the disposal of discontinued business component.
d. income from operation of a discontinued business component.
47. When reporting unusual or infrequent items in the income statement which
of the following is not correct?
a. If a material event is either unusual in nature or an infrequent occurrence
it is classified on the income statement as a special or unusual item in
continuing operations.
b. If a material event is either unusual in nature or an infrequent
occurrence—such as a one-time charge resulting from a major
restructuring—it may be classified on the income statement as a special or
unusual item in continuing operations or treated as an extraordinary item if it
has been a number of years since the company’s last major restructuring
c. Firms that use early debt retirement on a recurring basis as part of their
ongoing risk management practices will report the associated gains and
losses as part of income from continuing operations with separate line-item
disclosure.
d. The write-off of obsolete inventory would be reported on the income
statement as a special item in continuing operations.
48. A component of an entity may be a/an
a. reportable or operating segment.
b. subsidiary.
c. asset group.
d. reportable or operating segment, subsidiary, or asset group.
49. Which of the following best describes the reporting for discontinued
operations?
a. Discontinued operations will not generate future cash flows and thus the
results of transactions related to operations the firm intends to discontinue,
or has already discontinued, must be reported separately from other income
items on the income statement.
b. Discontinued operations presentation is used only when a component of
an entity has been sold.
c. There are 4 criteria that must be met to classify a disposal group as held
for sale.
d. Discontinued operations may generate future cash flows and thus there
will be results of transactions related to operations the firm intends to
discontinue. If the firm does generate future transactions before disposing of
the disposal group, it will report that revenue in continuing operations
revenue.
50. The discontinued operations section of the income statement is comprised of which
one of the following?
a. Income from the operation of a discontinued business component and gain or loss
from the disposal of the discontinued component.
b. Income from the operation of a discontinued business component, net of tax, and gain
or loss from the disposal of the discontinued component, net of tax.
c. Income from the operation of a discontinued business component, net of tax, and gain
or loss from the disposal of the discontinued component.
d. Gain or loss from the disposal of the discontinued component, net of tax.
51. Which of the following is not considered an unusual or infrequently occurring item
on an income statement?
a. Corporate restructuring charges.
b. Gains and losses from sales of investments.
c. Operating income or loss from discontinued operations.
d. Foreign currency transaction gains and losses.
52. For a disposal group to be considered held for sale, which of the following conditions
are required to be met?
a. Management has committed to a plan to see the component.
b. The sale is probable and is expected to be completed within one year.
c. The component is available for immediate sale in its present condition subject only to
usual and customary terms for such sales.
d. All of these conditions must be met.
53. Which one of the following events would be considered an unusual or infrequent
event?
a. a tornado in Kansas.
b. an earthquake in New York.
c. a flood in St. Louis near the Mississippi River.
d. an earthquake in southern California.
54. A special one-time charge resulting from corporate restructurings would be reported
on the income statement as a/an
a. operating item before gross profit.
b. special item in continuing operations.
c. special item in continuing operations, shown net of tax.
d. special item in discontinued operations, shown net of tax.
55. When reporting a change in an accounting principle, the general rule requires that the
current year’s income from continuing operations reflect
a. use of the newly adopted principle for the current year recognition.
b. use of the old principle for the current year recognition.
c. management’s choice of either the old or newly adopted principle for the current year
recognition.
d. FASB’s designation of either the old or newly-adopted principle based on the item
being changed.
56. Accounting treatment for changes in accounting principle are best
described as:
a. Changes in accounting principle that are only permitted when FASB
issues a standard that revises GAAP.
b. Changes in accounting principle that are always accounted for using the
retrospective approach which requires only a restatement of prior years’
presented financial information.
c. Changes in accounting principle that may require both a restatement of
prior years’ financial information and the recording of a cumulative
adjustment to retained earnings.
d. Tax effects are ignored when reporting changes in accounting principles.
57. A cumulative effect of a change in an accounting principle is measured as
a. the difference between prior periods’ net income under the old method and what
would have been reported if the new method had been used in the prior years.
b. the after-tax difference between prior periods’ net income under the old method and
what would have been reported if the new method had been used in the prior years.
c. the difference between prior periods’ net income and current net income under the old
method and what would have been reported if the new method had been used in the prior
years and the current year.
d. the after-tax difference between prior periods’ net income and current net income
under the old method and what would have been reported if the new method had been
used in the prior years and the current year.
