CHAPTER 2 Flashcards
Financial Statements
Financial Statements
Cost of goods sold equals cost of goods manufactured (or purchases for a retailer) adjusted for the change in finished goods inventory. The loss on sale of equipment is not an inventoriable cost.
Cost of goods sold = (COGM + BI – EI).
The balance sheet/ Statement of Financial Position
Reports an entity’s financial position at a moment in time. not useful for assessing past performance for a period of time.
Help users assess liquidity, financial flexibility, profitability, and risk.
Other comprehensive income (OCI) includes
components of comprehensive income are net income and OCI
(1) unrealized gains and losses on investments in debt securities classified as available-for-sale securities (except those that are hedged items in a fair value hedge)
(2) gains and losses on derivatives designated, qualifying, and effective as cash flow hedges;
(3) certain amounts associated with recognition of the funded status of postretirement defined benefit plans
(4) certain foreign currency items
the following items are subject to the application of intraperiod income tax allocation
Income tax expense or benefit is allocated to (1) continuing operations,
(2) discontinued operations,
(3) other comprehensive income, and
(4) items debited or credited directly to shareholders’ equity.
(Operating income is not one of the categories of income subject to intra-period income tax allocation)
A company had $100,000 in current liabilities at the end of the current year. The company refinanced this liability on a noncurrent basis subsequent to the end of the year but before the financial statements were issued. How should this liability be presented, according to IFRS and U.S. GAAP, in the company’s year-end financial statements?
Under U.S. GAAP, a current liability is classified as noncurrent if the entity
(1) intends to refinance on a noncurrent basis and
(2) demonstrates an ability to complete such refinancing. The ability to refinance may be demonstrated by entering into an agreement to refinance or to reschedule payments on a long-term basis. Such an agreement may be completed after the reporting date but before the financial statements are issued.
Under IFRS, a current liability may be classified as noncurrent only if the agreement to refinance or reschedule payments on a noncurrent basis is completed before the reporting date.
Dixon Company has the following items recorded on its financial records: Available-for-sale debt securities $200,000 Prepaid expenses 400,000 Treasury stock 100,000 The total amount of the above items to be shown as assets on Dixon’s statement of financial position(balance sheet) is A. $400,000 B. $700,000 C. $600,000 D. $500,000
Available-for-sale debt securities (an investment) and prepaid expenses are assets, but treasury stock is an equity item. The total of the assets reported is therefore $600,000 ($200,000 + $400,000).
The effect of a material transaction that is infrequent in occurrence and unusual in nature should be presented separately as a component of income from continuing operations when the transaction results in a
Gain & Loss: A material event or transaction that is unusual in nature, infrequent in occurrence, or both must be reported as a separate component of income from continuing operations. Whether the item is a gain or loss is irrelevant to the presentation.Such items must not be reported on the face of the income statement net of income taxes.
Clark Co.’s advertising expense account had a balance of $146,000 at December 31, Year 1, before any necessary year-end adjustment relating to the following:
Included in the $146,000 is the $15,000 cost of printing catalogs in Year 1 for a sales promotional campaign in January Year 2.
Radio advertisements broadcast during December Year 1 were billed to Clark on January 2, Year 2. Clark paid the $9,000 invoice on January 11, Year 2.
Clark’s policy is to expense advertising costs when incurred. What amount should Clark report as advertising expense in its income statement for the year ended December 31, Year 1?
$131,000
B. $140,000
C. $122,000
D. $155,000
Answer (D) is correct.
Advertising and promotion costs are expensed either (1) as incurred or (2) when advertising first occurs. The accounting policy chosen must be applied consistently to similar advertising activities. Thus, advertising expense must be recognized when incurred in accordance with Clark’s policy. It must include an accrual for the $9,000 for radio advertisements broadcast in Year 1. The $15,000 cost of printing catalogs also must be recognized as an expense in Year 1 because a liability was incurred in Year 1. Consequently, Year 1 advertising expense is $155,000 ($146,000 + $9,000).
Thorpe Co.’s income statement for the year ended December 31, Year 1, reported net income of $74,100. The auditor raised questions about the following amounts that had been included in net income:
Unrealized holding loss on available-for-
sale debt securities
$(5,400)
Gain on early retirement of bonds payable
(net of $11,000 tax effect)
22,000
Adjustment to profits of prior years for errors
in depreciation (net of $3,750 tax effect)
(7,500)
Loss from fire (net of $7,000 tax effect)
(14,000)
The loss from the fire was an infrequent but not unusual occurrence in Thorpe’s line of business. Thorpe’s December 31, Year 1, income statement should report net income of
The unrealized holding loss on available-for-sale debt securities should have been reported in other comprehensive income, not included in the determination of net income. The gain on early retirement of bonds payable is properly included in income from continuing operations. The fire loss is separately stated in income from continuing operations because it is infrequent in occurrence. But the adjustment for depreciation errors should have been charged directly to retained earnings as a prior-period adjustment. Thus, reported net income should have been $87,000 ($74,100 + $5,400 + $7,500).
What is the purpose of reporting comprehensive income?
To summarize all changes in equity from nonowner sources.
Comprehensive income includes all changes in equity of a business during a period except those from investments by and distributions to owners. It includes all components of (1) net income and (2) other comprehensive income (OCI).
A partial listing of a company’s accounts is presented below:
Revenues
$80,000
Operating expenses
50,000
Foreign currency translation adjustment gain, net of tax
4,000
Income tax expense
10,000
What amount should the company report as net income?
The company should report net income of $20,000 ($80,000 – $50,000 – $10,000). Foreign currency translation adjustment gain, net of tax, is an item of other comprehensive income and not net income
Which of the following assets or transactions is an element of comprehensive income? A. Investments by owners. B. Sales revenue. C. Deferred revenue. D. Distributions to owners.
Answer (B) is correct.
Comprehensive income includes all components of net income and other comprehensive income. Sales revenue is a component of net income and thus is considered a component of comprehensive income.
A company has the following liabilities at year end:
Mortgage note payable; $16,000 due within 12 months
$355,000
Short-term debt that the company is refinancing with long-term debt
175,000
Deferred tax liability arising from depreciation
25,000
What amount should the company include in the current liability section of the balance sheet?
A. $0
B. $41,000
C. $16,000
D. $191,000
Answer (C) is correct.
The current portion ($16,000) of a note payable (amount due within the longer of 12 months or the operating cycle) is the only item that should be classified as a current liability. The short-term debt that is being refinanced with long-term debt is noncurrent (assuming that the entity has demonstrated an ability to consummate such financing). A deferred tax liability is classified as noncurrent.
Jordan Co. had the following gains during the current period:
Gain on disposal of a material operating segment
$500,000
Foreign currency translation gain
100,000
What amount of gain from continuing operations should be presented on Jordan’s income statement for the current period?
A. $500,000
B. $600,000
C. $0
D. $100,000
Answer (C) is correct.
A gain on disposal of a material operating segment is reported in discontinued operations. Foreign currency translation gain is recognized as an item of other comprehensive income. Accordingly, no gain should be reported in income from continuing operations.
What should be reported as general and administrative expenses
General and administrative expenses are incurred for the direction of the entity as a whole and are not related entirely to a specific function, e.g., selling or manufacturing. They include accounting, legal, and other fees for professional services; officers’ salaries; insurance; wages of office staff; miscellaneous supplies; utilities costs; and office occupancy costs.
Treasury stock is recorded on the statement of financial position as a(n)
Decrease in shareholders’ equity.
Answer (B) is correct.
Treasury stock is reported on the statement of financial position as a decrease in shareholders’ equity.
The accounting measurement that is not consistent with the going concern concept is
Liquidation value.
Answer (D) is correct.
Financial accounting principles assume that a business entity is a going concern without evidence to the contrary. But an entity must prepare financial statements using the liquidation basis of accounting when liquidation is imminent and the going concern assumption does not apply
United, Inc.’s unadjusted current assets section and equity section of its December 31, Year 1, balance sheet are as follows: Current Assets Cash $ 60,000 Investments in equity securities (including $300,000 of United common stock) 400,000 Trade accounts receivable 340,000 Inventories 148,000 Total $948,000 Equity Common stock $2,224,000 Retained earnings (deficit) (224,000) Total $2,000,000 The investments and inventories are reported at their costs, which approximate fair values. In its Year 1 statement of equity, United’s total amount of equity at December 31, Year 1, is A. $1,924,000 B. $1,700,000 C. $2,224,000 D. $2,000,000
Answer (B) is correct.
The $300,000 of United common stock is treasury stock that should be reported as a contra item in the shareholders’ equity section, not as a current asset. Thus, total equity is $1,700,000 ($2,224,000 common stock – $224,000 deficit in retained earnings – $300,000 treasury stock).
Clear Co.’s trial balance has the following selected accounts: Cash (includes $10,000 in bond-sinking fund for long-term bond payable) $50,000 Accounts receivable 20,000 Allowance for doubtful accounts 5,000 Deposits received from customers 3,000 Merchandise inventory 7,000 Unearned rent 1,000 Investment in trading debt securities 2,000 What amount should Clear report as total current assets in its balance sheet? A. $72,000 B. $74,000 C. $64,000 D. $67,000
Answer (C) is correct.
An asset is classified as current on the statement of financial position if it is expected to be realized within the entity’s operating cycle or 1 year, whichever is longer. Current assets include (1) cash and cash equivalents; (2) certain individual trading, available-for-sale, and held-to-maturity debt securities; (3) receivables; (4) inventories; (5) prepaid expenses; and (6) certain individual investments in equity securities. Funds restricted as to withdrawal or use for other than current operations are classified as noncurrent assets. Thus, the $10,000 in a sinking fund for a long-term bond payable is classified as a noncurrent asset. Current receivables are measured at net realizable value (i.e., net of allowance for uncollectible accounts). Trading debt securities are classified as current assets because they are bought and held primarily for sale in the near term. Accordingly, the total of current assets is $64,000 ($40,000 unrestricted cash + $15,000 current receivables at NRV + $7,000 merchandise inventory + $2,000 investment in trading debt securities).
The statement of shareholders’ equity shows a
The statement of shareholders’ equity (changes in equity) presents a reconciliation in columnar format of the beginning and ending balances in the various shareholders’ equity accounts. A statement of changes in equity may include, for example, columns for (1) totals, (2) comprehensive income, (3) retained earnings, (4) accumulated OCI (but the components of OCI are presented in another statement), (5) common stock, and (6) additional paid-in capital.
Which of the following statements is correct regarding reporting comprehensive income?
ccumulated other comprehensive income is reported in the equity section of the balance sheet.
Answer (D) is correct.
Total other comprehensive income is transferred to a component of equity separate from retained earnings and additional paid-in capital.
rock Corp. reports operating expenses in two categories: (1) selling and (2) general and administrative. The adjusted trial balance at December 31 included the following expenses and losses: Accounting and legal fees $120,000 Advertising 150,000 Freight-out 80,000 Interest 70,000 Loss on sale of long-term investment 30,000 Officers’ salaries 225,000 Rent for office space 220,000 Sales salaries and commissions 140,000 One-half of the rented premises is occupied by the sales department. Brock’s total selling expenses are A. $340,000 B. $480,000 C. $370,000 D. $400,000
Answer (B) is correct.
Within the categories of expenses presented, the $150,000 of advertising, the $80,000 of freight-out, 50% of the $220,000 rent for office space, and the $140,000 of sales salaries and commissions should be classified as selling expenses. Total selling expenses are therefore $480,000.
The trial balance of Mint Corp. at December 31, Year 6, is presented below and has been adjusted except for income tax expense. Other financial data for the year ended December 31, Year 6, are as follows: During Year 6, estimated tax payments of $450,000 were charged to prepaid taxes. Mint has not recorded income tax expense. There were no temporary or permanent differences, and Mint’s tax rate is 30%. Dr. Cr. Cash $ 600,000 Accounts receivable, net 3,500,000 Contract asset 1,600,000 Contract liability $ 700,000 Prepaid taxes 450,000 Fixed assets, net 1,480,000 Note payable -- noncurrent 1,620,000 Common stock 750,000 Additional paid-in capital 2,000,000 Retained earnings -- unappropriated 900,000 Retained earnings -- restricted for note payable 160,000 Earnings from long-term contracts 6,680,000 Costs and expenses 5,180,000 $12,810,000 $12,810,000
In Mint’s December 31, Year 6, balance sheet, what amount should be reported as total retained earnings? A. $1,950,000 B. $2,560,000 C. $2,400,000 D. $2,110,000
Answer (D) is correct.
Earnings before taxes equals $1,500,000 ($6,680,000 revenues – $5,180,000 expenses). Income tax expense is thus $450,000 ($1,500,000 × 30%) and net income $1,050,000 ($1,500,000 – $450,000). Year-end retained earnings is therefore $2,110,000 ($900,000 unappropriated RE + $160,000 restricted RE + $1,050,000 net income).
how comprehensive income is reported under U.S. GAAP?
Two reporting formats for comprehensive income are allowed: (1) two separate but consecutive statements and (2) one continuous statement. One continuous statement must have two sections: net income and other comprehensive income (OCI). It must include (1) a total of net income with its components, (2) a total of OCI with its components, and (3) a total of comprehensive income. If separate but consecutive statements are presented, the first statement (the income statement) presents the components of net income and total net income. The second statement (the statement of OCI) is presented immediately after the first. It presents (1) the components of OCI, (2) the total of OCI, and (3) a total for comprehensive income. The entity may begin the second statement with net income.
