Chapter 3

Question 1

What is the income statement?

Answer 1

The report that measures the success of company operations for a given period of time.

Question 2

How do the business and investment community use the income statement?

Answer 2

The business and investment community uses the income statement to determine profitability, investment value, and creditworthiness.

Question 3

What information does the income statement provide investors and creditors with?

Answer 3

The income statement provides investors and creditors with information that helps them predict the amounts, timing, and uncertainty of future cash flows.

Question 4

Because net income is based on estimates, a number of assumptions, as well as actual performance, income statement users need to be aware of certain limitations associated with its information. Some of these limitations include:

Answer 4

1. Companies omit items from the income statement that they cannot measure reliably.
2. Income numbers are affected by the accounting methods employed.
3. Income measurement involves judgment.

Question 5

What are revenues?

Answer 5

Inflows or other enhancements of assets of an entity or settlements of its liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations.

Question 6

What are expenses?

Answer 6

Outflows or other using-up of assets or incurrences of liabilities during a period from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity’s ongoing major or central operations.

Question 7

What are gains?

Answer 7

Increases in equity (net assets) from peripheral or incidental transactions of an entity except those that result from revenues or investments by owners.

Question 8

What are losses?

Answer 8

Decreases in equity (net assets) from peripheral or incidental transactions of an entity except those that result from expenses or distributions to owners.

Question 9

This method of income measurement focuses on the income-related activities that have occurred during the period. What method it is?

Answer 9

Transaction Approach

Question 10

How is the Multiple-step income statement organized?

Answer 10

Sales:
Sales revenue (right)
Less: Sales discounts (left)
Sales return and allowances (left)
Net Sales (right)
Cost of goods sold (right)
Gross Profit (right)
Operating expenses (left)
Selling expenses (left)
General and administrative expenses (left)
Income from Operations (right)
Other revenues and gains
Dividend revenue (left)
Gain on sale of equipment (left)
Other expenses and losses
Interest on bond and notes (left)
Loss on flood (left)
Income before Income Tax (right)
Income tax (right)
Net income (right)
Earnings per common share (right)

Question 11

What two types of expenses combine together to make Total Operating expense?

Answer 11

Selling expenses & General and Administrative expenses.

Question 12

How do you find earnings per share (EPS)?

Answer 12

EPS= [(Net Income- Preferred Dividends)/ Weighted-Average Number of Common Shares Outstanding]

Question 13

What does earning per share (EPS) measure?

Answer 13

earnings per share (EPS) measures the number of dollars earned by each share of common stock. It does not represent the dollar amount paid to stockholders in the form of dividends.

Question 14

Single-step income statement format?

Answer 14

Revenues:
Net Sales
Dividend revenue
Gain on sale of equipment
Total revenues
Expenses:
Cost of goods sold
Selling expenses
Administrative expenses
Interest expense on bonds and notes
Loss on flood
Income tax
Total expenses
Net income
Earning per common share

Question 15

How does discontinued operations happen?

Answer 15

1. A company eliminates the results of operations of a component of the business. A component comprises operations and cash flows that can be clearly distinguished, both operationally and for financial reporting purposes.
2. The elimination of a component that represents a strategic shift, having a major effect on the company’s operations and financial results. A strategic shift generally includes the disposal of (1) a major line of business, (2) a major geographical area, or (3) a major equity method investment. [3]

Question 16

When is the phrase “Income from continuing operations”

Answer 16

That phrase is used only when gains or losses on discontinued operations occur.

Question 17

The allocation of tax to this item is called

Answer 17

intraperiod tax allocation, that is, allocation within the income statement of a period.

Question 18

What does the Comprehensive income include?

Answer 18

Comprehensive income includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. Comprehensive income, therefore, includes everything that is included on the income statement plus all gains and losses that bypass net income but affect stockholders’ equity.

Question 19

What are other comprehensive income?

Answer 19

The gains and losses that bypass the income statement

Question 20

Companies must display the components of other comprehensive income in two ways which are these two ways?

Answer 20

One statement approach. A single continuous statement. This approach is often referred to as the statement of comprehensive income.
Two statement approach. Two separate, but consecutive, statements of net income and other comprehensive income. This approach uses the traditional term “income statement” for the first statement and “comprehensive income statement” for the second statement.

Question 21

In some cases, companies transfer the amount of retained earnings restricted to an account titled _____________

Answer 21

Appropriated Retained Earnings.

Question 22

The retained earnings section may therefore report two separate amounts ____________ & _____________

Answer 22

(1) retained earnings free (unrestricted) and (2) retained earnings appropriated (restricted). The total of these two amounts equals the total retained earnings.

Question 23

In addition to a balance sheet, statement of cash flows, and a comprehensive income statement, companies also report a __________________

Answer 23

statement of stockholders’ equity (often referred to as statement of changes in shareholders’ equity).

Question 24

In what format is the statement of stockholders’ equity and why?

Answer 24

Companies often prepare this statement in columnar form. In this format, they use columns for each account and for total stockholders’ equity. Stockholders’ equity is generally comprised of contributed capital (common and preferred stock and additional paid-in capital), retained earnings, and the accumulated balances in other comprehensive income.

Question 25

The objective of the revenue recognition standard is?

Answer 25

to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that the company receives, or expects to receive, in exchange for those goods or services.

Question 26

What are the 5 steps of revenue recognition?

Answer 26

1. Identify the contracts
2. Identify Performance Obligations
3. Determined the transaction price
4. Allocate the transaction price
5. Recognize the revenue

Question 27

What are the two types of contract?

Answer 27

Implied contracts and written contracts

Question 28

What is distinct performance obligations?

Answer 28

It is determining whether products or services should be accounted for separated versus together may required significant judgement.

Question 29

When is revenue is recognized with contracts?

Answer 29

Only when a valid contract exits.

Question 30

What does selling expenses include?

Answer 30

Selling expense that are used to get your goods sold that are not considered part of Cost of Goods sold (COGS).

Question 31

What does General and administrative expenses include?

Answer 31

The expenses that do not belong into selling expense and Cost of Goods sold (COGS).

Question 32

The FASB’s guidance is that goods or services are distinct and accounted for as separate performance obligations if BOTH of the following criteria exist. What are they?

Answer 32

1. The customer can benefit from the good or service on its own.
2. The good or service is separately identifiable from other promises in the contract.

Question 33

What are the factors that may have to be considered in determining the transaction price?

Answer 33

These factors include possible variable consideration, noncash considerations, significant financing costs, or amounts payable to customers.

Question 34

When do companies include variable consideration?

Answer 34

A company only includes variable consideration if it is reasonably assured that it will be entitled to that amount.

Question 35

Companies may only recognize variable consideration if ________ & _________

Answer 35

1. they have experience with similar contracts and are able to estimate the cumulative amount of revenue.
2. Based on experience, it is highly probable that there will not be a significant reversal of revenue previously recognized.

Question 36

What is Earnings Management?

Answer 36

The planned timing of revenues, expenses, gains, and losses to smooth out the bumps in earnings.

Question 37

What is intra period tax allocations used for?

Answer 37

1. Income from continuing operations
2. discontinued operations.

Question 38

Where does accumulated other comprehensive income goes on the balance sheet?

Answer 38

It will go under stockholder equity section.

Question 39

Where does unrealized gains go in a two step approach of comprehensive income?

Answer 39

Goes on after the Net income is found, then you add it to net income to get comprehensive income.

Question 40

Other comprehensive income is usually?

Answer 40

Unrealized gains or losses.

Question 41

What is change in control?

Answer 41

The deciding factor in determining when a performance obligation is satisfied.

Question 42

For a contract to be valid it must meet 3 criteria. What are they

Answer 42

1. Approval and commitment of parties.
2. Identification of rights and payment terms and commercial substance (the contract represents a valid transaction).
   3.Collection is probable

Question 43

To find the transaction price companies will use the _______, which is the __________.

Answer 43

Expected value; probability-weight amount.

Question 44

Retrospectively means

Answer 44

restated.

Question 45

What is generally prepared in columnar form?

Answer 45

statements of stockholders’ equity

Question 46

On the income statement, how should the transaction be reported when a company discontinues an operation and disposes of the discontinued operation (component)?

Answer 46

As a disclosure on the face of the income statement showing earnings per share from continuing operations, discontinued operations, and net income

Question 47

Holland Windmills recently received $90,000 for the sale of a windmill. On their income statement, this would be classified as

Answer 47

Revenue

Question 48

Which of the following is the first step in the process for revenue recognition?

Answer 48

identify the contract with customers

Question 49

What is NOT an example of earnings management?

Changing the company policy on employee benefit plans and how much the company will contribute toward those plans. This will result in either lowering or increasing their expenses.

Changing a company policy regarding the methodology for determining allowance for doubtful accounts. This can result in underestimating their bad debt expense compared to historical figures.

Changing the company policy regarding which items are capitalized vs. expensed. This reduces the income immediately and will decrease with the deprecation expenses over time.

Changing the accounting policy from LIFO to FIFO. This will reduce the cost of goods sold on products that continually increase over time by selling the less expensive products (first in) at the newest, higher price.

Answer 49

Changing the company policy on employee benefit plans and how much the company will contribute toward those plans. This will result in either lowering or increasing their expenses.

Question 50

Ashton is an investor looking at the income statements of two different companies. The first company has a very detailed income statement, and the second company has a very condensed income statement. Which company is Ashton more likely to invest in? Why?

Company 2, because the condensed income statement gives him the bigger picture related to the company’s overall income.

Company 1, because the detail in the income statement allows him to more accurately predict future cash flows.

Company 2, because the condensed income statement allows him to more easily compare income to the company’s competitors.

Company 1, because the detail in the income statement allows him to differentiate between revenues and gains as well as between expenses and losses.

Answer 50

Company 1, because the detail in the income statement allows him to more accurately predict future cash flows.

Question 51

The statement of income or statement of earnings is most commonly referred to as the ___________

Answer 51

income statement

Question 52

What is the difference between a revenue and a gain?

Answer 52

Revenues result from transactions related to central operations, whereas gains result from transactions related to peripheral operations.

Question 53

Which of the following reports the results of the company’s principal operations in terms of revenues and expenses?

Answer 53

operating section

Question 54

If one company uses an accelerated depreciation method while another company uses a straight-line depreciation method, which limitation of an income statement has occurred?

Answer 54

Income numbers are affected by the accounting methods employed.