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CHAPTER 4
Income Statement and Related Information
ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)
Topics
Questions
Brief
Exercises
Exercises
Problems
Concepts
for Analysis
1.
Income measurement
concepts.
1, 2, 3, 4, 5,
6, 7, 8, 9, 10,
11, 32
2, 3, 4, 6
5.
Intraperiod tax
allocation.
21, 22, 24,
26, 27
9, 11, 13,
14, 16
2, 4, 7, 8
6.
Accounting changes;
discontinued
operations; prior
period adjustments;
errors.
16, 17, 18,
19, 24, 25,
27, 28, 29,
30
7, 8, 9
6, 8, 10, 11,
13, 14
4, 6, 7, 8
2, 3, 4, 5, 6
ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Learning Objectives
Brief
Exercises
Exercises
Problems
Concepts
for
Analysis
1. Identify the uses and limitations
of an income statement.
1, 2, 3, 4,
5
4. Explain the reporting of accounting
changes and errors.
8, 9, 12
8, 9, 12, 14
4, 5, 6, 7, 8
5, 6, 7
ASSIGNMENT CHARACTERISTICS TABLE
Item
Description
Level of
Difficulty
Time
(minutes)
E4.1
Compute income measures.
Simple
10–15
E4.2
Computation of net income.
Simple
18–20
E4.3
Income statement items.
Simple
25–35
E4.11
Condensed income statement—periodic inventory
method.
Moderate
20–25
E4.12
Retained earnings statement.
Simple
20–25
E4.13
Earnings per share.
Moderate
15–20
E4.14
Change in accounting principle.
Moderate
15–20
P4.1
Income components.
Simple
5–10
P4.2
Income statement, retained earnings.
Moderate
30–35
P4.3
Income statement, retained earnings, periodic inventory.
Simple
25–30
CA4.1
Identification of income statement deficiencies.
Simple
20–25
CA4.2
Earnings management.
Moderate
20–25
CA4.3
Earnings management
Simple
15–20
ANSWERS TO QUESTIONS
1. The income statement is important because it provides investors and creditors with information
that helps them predict the amount, timing, and uncertainty of future cash flows. It helps investors
and creditors predict future cash flows in a number of different ways. First, investors and creditors can
use the information on the income statement to evaluate the past performance of the enterprise.
2. Information on past transactions can be used to identify important trends that, if continued, provide
information about future performance. If a reasonable correlation exists between past and future
3. Some situations in which changes in value are not recorded in income are:
(a) Unrealized gains or losses on non-trading equity investments,
(b) Changes in the market values of long-term liabilities, such as bonds payable,
4. Some situations in which application of different accounting methods or estimates lead to comparison
problems include:
(a) Inventory methods—weighted average vs. FIFO,
(b) Depreciation methods—straight-line vs. accelerated,
(c) Accounting for long-term contracts—percentage-of-completion vs. completed-contract,
Questions Chapter 4 (Continued)
5. The transaction approach focuses on the activities that have occurred during a given period and
instead of presenting only a net change, a description of the components that comprise the change
is included. In the capital maintenance approach, only the net change (income) is reflected whereas
6. Earnings management is often defined as the planned timing of revenues, expenses, gains and
losses to smooth out bumps in earnings. In most cases, earnings management is used to increase
income in the current year at the expense of income in future years. For example, companies
7. Earnings management has a negative effect on the quality of earnings if it distorts the information
in a way that is less useful for predicting future cash flows. Within the Conceptual Framework,
8. Caution should be exercised because many assumptions and estimates are made in accounting
and the net income figure is a reflection of these assumptions. If for any reason the assumptions are
9. The term “quality of earnings” refers to the credibility of the earnings number reported. Companies
that use aggressive accounting policies report higher income numbers in the short-run. In such
10. Income is increases in economic benefits during the accounting period in the form of inflows or
enhancements of assets or decreases of liabilities that result in increases in equity, other than
those relating to contributions from shareholders.
Questions Chapter 4 (Continued)
11. The definition of income includes both revenues and gains. Gains represent items that meet the
definition of income and may or may not arise in the ordinary activities of a company.
12. (1) Gross profit is the difference between revenue and cost of goods sold and is reported in the
13. Ahold would report the “settlement of securities class action” loss in the other income and expense
section of its income statement.
14. (1) Interest expense is reported on the income statement between income from operations and
15. The “nature of expense” classification uses a natural expense approach (such as direct labor
incurred, advertising expense, depreciation expense) without having to make arbitrary allocations.
16. (a) A loss on discontinued operations is reported net of tax in the income statement between
income from continuing operations and net income.
17. (a) The write-down of plant assets due to impairment should be shown as an other income and
expense item.
(b) The delivery expense on goods sold should be shown as a selling expense in the income
statement. It is an ordinary expense to the company and represents a cost of selling goods.
(c) If the amount is immaterial, it may be combined with the depreciation expense for the year
and included as a part of the depreciation expense appearing in the income statement. If the
amount is material, it should be shown in the retained earnings statement as an adjustment to
the beginning balance of retained earnings.
Questions Chapter 4 (Continued)
18. (a) The remaining book value of the equipment should be depreciated over the remainder of the
five-year period. The additional depreciation (£425,000) is not a correction of an error and is not
shown as an adjustment to retained earnings. The change is considered a change in estimate.
(b) The loss should be shown as an Other income and expense item.
19. (a) Other income and expense section.
(b) Expense section or other income and expense.
(c) Expense section, as a selling expense, but sometimes reflected as an administrative expense.
20. Both formats are acceptable. The amount of detail reported in the income statement is left to the
judgment of the company, whose goal in making this decision should be to present financial
statements which are most useful to decision makers. We want to present a simple, understand-
21. Intraperiod tax allocation should not affect the reporting of an unusual gain. The IASB reserves
22. Intraperiod tax allocation has no effect on reported net income, although it does affect the amounts
reported for various components of income. The effects on these components offset each other so
Questions Chapter 4 (Continued)
23. If Neumann has preference shares outstanding, the numerator in its computation may be incorrect.
A better description of “earnings per share” is “earnings per ordinary share.” The numerator should
include only the earnings available to ordinary shareholders. Therefore, the numerator should be:
24. A loss on the disposal of a component of a business is reported separately from continuing
25. The earnings per share trend is not negative. A loss on discontinued operations is a one-time
occurrence which is not expected to be reported in the future. Therefore, earnings per share on
26. Tax allocation within a period is the practice of allocating the income tax for a period to such items
as income before income tax, discontinued operations, and prior period adjustments.
27. Tax allocation within a period (intraperiod) becomes necessary when a firm encounters such items
as discontinued operations or corrections of errors. Such allocation is necessary to bring about an
appropriate relationship between income tax expense and income from continuing operations,
discontinued operations etc.
Tax allocation within a period is handled by first computing the tax expense attributable to income
28. The assets, cash flows, results of operations, and activities of the plants closed would not appear to
be clearly distinguishable, operationally or for financial reporting purposes, from the assets, results of
29. Companies report corrections of errors as an adjustment (net of tax) to the beginning balance of
Questions Chapter 4 (Continued)
30. A change in accounting principle has no effect on the current year’s net income because it is
31. The major items reported in the retained earnings statement are: (1) adjustments of the beginning
balance for corrections of errors or changes in accounting principle, (2) the net income or loss for
32. IFRS is ordinarily concerned only with a “fair presentation” of business income. In contrast, taxable
income is a statutory concept which defines the base for raising tax revenues by the government,
and any method of accounting which meets the statutory definition will “clearly reflect” taxable
income as defined by relevant tax laws. It should be noted that many tax systems prohibit use of
the cash receipts and disbursements method as a method which will clearly reflect income in
accounting for purchases and sales if inventories are involved.
The cash receipts and disbursements method will not usually fairly present income because:
(1) The completed transaction, not receipt or disbursement of cash, increases or diminishes
33. Other comprehensive income may be displayed (reported) in one of two ways: (1) a single
continuous statement (one statement approach) or (2) consecutive statements of net income and
34.
GRIBBLE AG
Comprehensive Income Statement
For the Year Ended 2019
(in thousands of Euros)
Net income ...................................................................................................... €150
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 4.1
STARR LTD
Income Statement
For the Year 2019
Sales Revenue ................................................................
£540,000
Cost of goods sold ............................................................
330,000
Gross profit ........................................................................
210,000
Selling expenses ...............................................................
£120,000
BRIEF EXERCISE 4.2
BRISKY CORPORATION
Income Statement
For the Year Ended December 31, 2019
Net sales ................................................................
$2,400,000
Cost of goods sold .................................................
1,450,000
Gross profit .......................................................
950,000
Selling expenses ....................................................
$280,000
Administrative expenses .......................................
212,000
492,000
BRIEF EXERCISE 4.3
(a) Other income and expense = €800,000 – €500,000 – €220,000 = €80,000
BRIEF EXERCISE 4.4
1. Income from operations = HK$100,000 – HK$55,000 – HK$10,000 +
HK$30,000 = HK$65,000
BRIEF EXERCISE 4.5
BRIEF EXERCISE 4.6
1. Income from operations
2. Income before income tax
BRIEF EXERCISE 4.7
Income from continuing operations ..........................
£10,600,000
Discontinued operations
Loss from operation of discontinued
BRIEF EXERCISE 4.8
2019
2018
2017
Income before income tax
$180,000
$145,000
$170,000
BRIEF EXERCISE 4.9
Vandross would not report any cumulative effect because a change in estimate
BRIEF EXERCISE 4.10
BRIEF EXERCISE 4.11
TSUI LTD
Retained Earnings Statement
For the Year Ended December 31, 2019
Retained earnings, January 1 ...........................................
NT$ 675,000
Add: Net income ..............................................................
1,400,000
2,075,000
BRIEF EXERCISE 4.12
TSUI LTD
Retained Earnings Statement
For the Year Ended December 31, 2019
Retained earnings, January 1, as reported .........................
NT$ 675,000
Correction for overstatement of expenses in
BRIEF EXERCISE 4.13
(a) Net income (Dividend revenue) .............................
¥3,000,000
(c) Unrealized holding gain
(Other comprehensive income) .............................
¥4,000,000
(d) Accumulated other comprehensive income,
January 1, 2019 ...................................................
¥ 0
SOLUTIONS TO EXERCISES
EXERCISE 4.1 (10–15 minutes)
Sales revenue .......................................................................... €310,000
Cost of goods sold .................................................................. 140,000
Gross profit .............................................................................. 170,000
Selling and administrative expenses ..................................... 50,000
Other income and expense
Net income ............................................................................... €132,000
Unrealized gain on non-trading equity securities ................. 10,000
Comprehensive income .......................................................... €142,000(d)
EXERCISE 4.2 (15–20 minutes)
Computation of net income
EXERCISE 4.2 (Continued)
Change in equity accounted
for as follows:
Net increase ..........................................................
£163,000
Increase in shares .......................................
£138,000
EXERCISE 4.3 (25–35 minutes)
(a)
Total net revenue:
Sales revenue ...............................
$400,000
Less: Sales discounts ................
$ 7,800
(b)
Net income:
Total net revenue (from a) ...........
$457,300
Expenses:
Cost of goods sold ................
$184,400
Selling expenses ...................
99,400
EXERCISE 4.3 (Continued)
(c)
Dividends declared:
Ending retained earnings ............
$134,000
Beginning retained earnings .......
(114,400)
ALTERNATE SOLUTION (for (c))
Beginning retained earnings ...............................
$114,400
Add: Net income .................................................
51,700
166,100
EXERCISE 4.4 (20–25 minutes)
DUNBAR INC.
Income Statement
For Year Ended December 31, 2019
Net sales ($1,125,000(b) – $17,000) ................................
$1,108,000
Cost of goods sold ...........................................................
500,000
Gross profit .......................................................................
608,000
EXERCISE 4.4 (Continued)
Determination of amounts
(a) Administrative expenses
=
18% of cost of goods sold
=
18% of $500,000
=
$90,000
(c) Selling expenses
=
four times administrative expenses.
(since selling expenses are 4/5
of selling and administrative
EXERCISE 4.5 (20–25 minutes)
WEBSTER PLC
Income Statement
For the Year Ended December 31, 2019
(In thousands, except earnings per share)
Sales revenue .....................................................
£96,500
Cost of goods sold .............................................
63,570
Gross profit .........................................................
32,930
Other income and expense
Rent revenue .............................................
17,230
Income from operations.....................................
24,150
Interest expense ...........................................
1,860
EXERCISE 4.6 (30–35 minutes)
PARNEVIK ASA
Income Statement
For the Year Ended December 31, 2019
Revenue
Sales revenue ...........................................................
€1,280,000
Less: Sales returns and allowances ......................
€150,000
Selling expenses ...................................................
194,000
Admin. and general expenses ..............................
97,000
291,000
Other Income and Expense
Loss from impairment of plant assets .....................
(120,000)
Interest revenue .......................................................
86,000
(34,000)
Income from operations ..................................................
139,000
