Chapter 5—The Income Statement and the Statement of Cash
Flows Key
1. Which of the following best describes the characteristics that relate to the income statement?
2. The income statement is an important financial statement for all of the following reasons, except
3. The comparison of the beginning and ending capital (net assets) after adjusting for any additional investments
or disinvestment during the period, and indicating the difference to be corporate income, is termed the
4. When net assets are recorded at their historical cost and changes in net assets are not recorded unless an
event, transaction, or circumstance occurs, the
5. In an accrual-based transactional approach, net income is typically defined as
6. Which of the following statements best defines the transactional approach?
7. Which statement best defines income concepts?
8. On December 31, 2010, the net assets of Marino Manufacturing amounted to $40,000. Net income calculated
by using the financial capital maintenance concept amounted to $12,000. During the year, additional common
stock was issued for $8,000, and $5,000 of dividends were paid. The net assets at January 1, 2010, amounted to
9. What income measurement approach is identified by the following equation?
Net income = Net assets at the end of the year – Net assets at the beginning of the year – Additional investment
by owners + Distributions to owners
10. Comprehensive income would include which of the following?
Net Income
Distributions to Owners
I.
No
No
II.
No
Yes
III.
Yes
No
IV.
Yes
Yes
11. Garcia Company began 2010 with net assets of $80,000. Net income calculated by using the capital
maintenance concept was $21,000. During 2010 owners contributed $26,000 of new capital. By year-end, the
net assets totaled $78,000. Dividends to the owners during 2010 were
12. Comprehensive income includes the following changes in equity in a company during a period except
13. Financial flexibility is generally defined as
14. Operating capability refers to
15. Which of the following items would be excluded from “core activities” as defined by the AICPA?
16. Characteristics of risk as they relate to the uncertainty or unpredictability of the future results of a company
include
17. In 2007, the CFA Institute Centre for Financial Market Integrity proposed a new financial model to replace
the traditional earnings number. Which of the following characteristics does the proposed statement of changes
in net assets available to stockholders exclude?
18. In general, revenue is recognized as being earned
19. One method of revenue recognition that postpones the recognition until after the time of sale is
20. Which of the following is not an expense recognition approach recognized by the FASB as an expense
recognition principle to properly match expenses against revenues?
21. In distinguishing between revenues and gains, which of the following statements is not true?
22. Realization of revenue occurs when
23. To be recognized as revenue, an item must
24. A revenue recognition method that recognizes revenue before the time of sale is
25. Depreciation is an example of which expense recognition principle?
26. The gross profit of Abel Company for 2010 is $300,000, cost of goods manufactured is $400,000, the
beginning inventories of goods in process and finished goods are $28,000 and $35,000, respectively, and the
ending inventories of goods in process and finished goods are $50,000 and $70,000, respectively. The cost of
goods sold of Abel Company for 2010 must have been
27. The following information is available for the Brown Company for 2010:
Gross profit
$ 30,000
Net sales
500,000
Beginning inventory
220,000
Ending inventory
40,000
What was the amount of net purchases?
28. Which of the following expenses is an example of expense recognition under the immediate recognition
principle?
29. Examples of matching expenses against revenues using the association of cause and effect include all of the
following except
30. In 2010, the Damon Company had sales of $600,000; cost of sales of $430,000; interest expense of $12,000;
a gain on the sale of a component of $12,000; and an extraordinary loss of $20,000. For its income statement,
Damon uses the single-step format and the all-inclusive concept. What was Damon’s reported pretax income
from continuing operations?
31. The major components of the income statement are listed below:
A = extraordinary items
B = income from continuing operations
C = earnings per share
D = results from discontinued operations
In what sequence do they normally appear on the income statement?
32. From the following information, compute cost of goods sold.
Purchase returns
$ 200
Inventory, December 31
1,500
Freight-in
100
Inventory, January 1
1,800
Purchases
5,000
33. All of the information required in the computation of cost of goods sold is presented below, except for
purchases, which must be what amount?
Purchase discounts
$ 200
Inventory, December 31
1,500
Cost of goods sold
9,500
Purchases
?
Inventory, January 1
1,500
Freight-in
500
34. Which of the following is not a limitation of the income statement?
35. Intraperiod tax allocation
36. All of the following are included in the computation of cost of goods sold except
37. Intraperiod tax allocation requires a corporation’s total income tax expense to be allocated to all of the
following except
38. Which of the following is a required disclosure in the income statement when reporting the sale of a
component of the business?
39. A company that discontinues and disposes of an operation (component) should include the gain or loss on
sale in the income statement as a(n)
40. The Gordon Company is disposing of a component of its company. The net loss from the sale is estimated to
be $500,000. Included in the $500,000 is termination pay of $100,000, which is directly associated with the
decision to dispose of the component; and net losses from component asset write-downs of $400,000. Ignoring
taxes, Gordon’s income statement should report a loss on sale of a business component of
41. Exhibit 5-1
The following condensed income statement of Rahm Corporation is presented for the two years ended
December 31, 2010 and 2009:
2009
Net sales
$9,000,000
Cost of sales
6,000,000
Gross profit
$3,000,000
Operating expense
2,000,000
Operating income
$1,000,000
Gain on sale of a component
—
$1,000,000
Income tax expense
300,000
Net income
$ 700,000
On January 1, 2010, Rahm entered into an agreement to sell for $2,000,000 one of its separate operating divisions. The sale resulted in a gain on
disposition of $900,000 on November 12, 2010, and qualifies as a discontinued component. This division’s contribution to Rahm‘s reported income
before income taxes for each year was as follows:
2010
$700,000 loss
2009
$400,000 loss
Assume an income tax rate of 30%.
Refer to Exhibit 5-1. In the preparation of a revised comparative income statement, Rahm should report income from continuing operations after
income taxes for 2010 and 2009, respectively, amounting to
42. Exhibit 5-1
The following condensed income statement of Rahm Corporation is presented for the two years ended
December 31, 2010 and 2009:
2009
Net sales
$9,000,000
Cost of sales
6,000,000
Gross profit
$3,000,000
Operating expense
2,000,000
Operating income
$1,000,000
Gain on sale of a component
—
$1,000,000
Income tax expense
300,000
Net income
$ 700,000
On January 1, 2010, Rahm entered into an agreement to sell for $2,000,000 one of its separate operating divisions. The sale resulted in a gain on
disposition of $900,000 on November 12, 2010, and qualifies as a discontinued component. This division’s contribution to Rahm’s reported income
before income taxes for each year was as follows:
2010
$700,000 loss
2009
$400,000 loss
Assume an income tax rate of 30%.
Refer to Exhibit 5-1. In the preparation of a revised comparative income statement, Rahm should report under the caption “Discontinued
Operations” for 2010 and 2009, respectively,
43. The subtotal, gross profit, will be disclosed on
44. When an entity reports on a sale of a component of the business
45. The Nikel Company sold its cattle ranching component on June 30, 2010, for a gain of $1,000,000. From
January through June, the component had sustained operating income of $300,000. The income tax rate is 30%.
How should Nikel report the income and the sale on its income statement?
46. Which is least likely to be classified as a sale of a component?
47. Which of the following statements concerning the sale of a business component is true?
48. Which of the following is not required to be disclosed, pursuant to GAAP?
49. In 2010, the Sykes Company wrote off a $100,000 debt from a major customer, lost $1,250,000 when a
foreign country devalued its currency, gained $2,000,000 when a manufacturing plant was destroyed by a flood,
lost $500,000 on the early retirement of its long-term bonds, and lost $75,000 on the sale of stock from its
investment portfolio. What amount of extraordinary items (before income taxes) will Sykes report in 2010?
50. To be considered an extraordinary item, an event must be
51. Which of the following material gains/losses would be disclosed as an extraordinary item on an entity’s
income statement?
52. The Riverside Company operates a manufacturing plant overlooking the Snake River. In early 2010, a
tornado destroyed the uninsured plant, resulting in $400,000 damage. Such damage had occurred previously
only once in the last 110 years. Riverside’s $400,000 loss should be reported on the income statement
53. Which of the following items would not be reported on a net-of-tax basis in an entity’s financial statements?
54. Earnings per share is an important disclosure because
55. How should the gain or loss that is considered infrequent but not unusual in nature be disclosed?
56. Under which of the following conditions would frost damage be considered an extraordinary item for
income reporting purposes?
57. How should a material, infrequent event not meeting the criteria for an extraordinary item be disclosed in
the income statement?
58. A review of the December 31, 2010, financial statements of Rule Corporation revealed that under the
caption “extraordinary losses,” Rule had reported a total of $300,000. Further analysis revealed that the
$300,000 in losses comprised the following items:
1.
Rule recorded a gain of $80,000 incurred in the sale of equipment.
2.
In an unusual and infrequent occurrence, a loss of $250,000 was sustained as a result of tornado damage to a manufacturing facility.
3.
During 2010, several factories were shut down during a major strike by employees of Rule’s major customer. Shutdown expenses
totaled $100,000.
4.
Inventory in the amount of $30,000 was written off as obsolete.
Ignoring income taxes, what amount of loss should Rule report as an extraordinary loss on its 2010 income statement?
59. When a change in accounting principle occurs, the balance of the related asset or liability account is
recalculated
60. Which of the following statements regarding limitations of the income statement is not true?
61. A company is justified in changing from one generally accepted accounting principle to another generally
accepted accounting principle only if
62. Normally, a material effect from changing accounting principles should be reported
63. For an event or transaction to be classified as an extraordinary item in the income statement, it should be
64. The information content of a statement of retained earnings would be increased if
65. Which will never result in an adjustment of a prior period’s financial statements?
66. The following information relates to the Smith Company:
2010 cash dividend declared
$ 400
Restated (adjusted) retained earnings, January 1, 2010
?
2010 net income
480
Error in 2009-Understatement of ending inventory;
error found in 2010
150
Restated (adjusted) retained earnings, December 31, 2010
1,550
What is the adjusted January 1, 2010, balance in retained earnings?
67. The following information relates to the Smith Company:
2010 cash dividends declared
$ 400
Unadjusted (reported) retained earnings, January 1, 2010
?
2010 net income
480
Error in 2009-Understatement of ending inventory;
error found in 2010
150
Unadjusted (reported) retained earnings, December 31, 2010
1,400
What is the unadjusted January 1, 2010, balance in retained earnings?
68. Which of the following events would be accounted for as a prior-period adjustment?
69. Reporting “changes in accounting principles” is important because
70. In preparing a statement of retained earnings, a company needs to know its
71. Which of the following is not a source of a prior-period adjustment?
72. Comprehensive income is an important concept in accounting because it represents
73. Comprehensive income consists of
74. Which of the following is not part of other comprehensive income?
75. Other comprehensive income items may be reported at their:
Gross Amounts
Net of Tax Amounts
I.
Yes
Yes
II.
No
No
III.
Yes
No
IV.
No
Yes
76. When is a company not required to report comprehensive income?
77. Which of the following is not an acceptable way of reporting a company’s comprehensive income?
78. A company is required to report earnings per share on
Net Income
Comprehensive Income
I.
Yes
Yes
II.
No
No
III.
Yes
No
IV.
No
Yes
79. The statement of cash flows is least likely to help external users to assess
80. Which of the following sections will not appear in the statement of cash flows?
81. Which of the following statements regarding a statement of cash flows is not true?
82. IFRS content in the income statement is similar to U.S. GAAP in all of the following areas except the
disclosure of
83. IFRS reporting requires all of the following items except
84. Differences that currently exist between IFRS and U.S. GAAP with regard to the presentation of
information on the income statement include all of the following except
85. While some convergence has been achieved, IFRS still differs from U.S. GAAP in earnings per share
measurement in all of the following ways except
86. The following information relates to the Pierce Company (in thousands):
Additional investment by Mr. Pierce
$ 5
Sales revenue
150
Net assets, beginning of year
100
Distribution to Mr. Pierce
10
Cost of goods sold
125
Net assets, end of year
180
Required:
Compute net income, using the financial capital maintenance approach.
87. The following information relates to the Zhang Corporation (in thousands):
Sales revenue
$90
Net assets, end of year
70
Net income, capital maintenance method
25
Additional investment by stockholders
15
Net assets, beginning of year
35
Required:
Compute the amount of dividends paid during the year, using the financial capital maintenance approach.
88. Listed below are the three expense recognition principles followed by a series of expense items.
a.
association of cause and effect
b.
systematic and rational allocation
c.
immediate recognition
____
1.
Amortization
____
2.
Sales commissions
____
3.
Cost of goods sold
____
4.
Administrative salaries
____
5.
Allocation of prepaid insurance
____
6.
Utilities
____
7.
Product warranty costs
____
8.
Depreciation
____
9.
Transportation-out
____
10.
Travel and entertainment
Required:
Match the expense recognition principles to their corresponding expenses by placing the appropriate letter in the space provided.
1.
b
6.
c
3.
a
8.
b
4.
c
9.
a
5.
b
10.
c