Reading 18: understanding income statements Flashcards
For a nonfinancial firm, are depreciation expense and interest expense included or excluded from operating expenses in the income statement?
depreciation expense interest expense
included included
included excluded
excluded included
Depreciation is included in the computation of operating expenses. Interest expense is a financing cost. Thus, it is excluded from operating expenses. (Module 18.1, LOS 18.a)
Which of the following expense items is best described as being classified by function rather than classified in nature?
Cost of goods sold.
Depreciation.
Wage expense.
Cost of goods sold includes a number of expenses related to the same function, the production of inventory. Depreciation and wages are examples of expenses classified by nature. (Module 18.1, LOS 18.a)
The first step in the revenue recognition process is to:
determine the price.
identify the contract.
identify the obligations.
The five steps in revenue recognition are:
Identify the contract or contracts with the customer.
Identify the performance obligations in the contract(s).
Determine a transaction price.
Allocate the transaction price to the performance obligations.
Recognize revenue when/as the performance obligations have been satisfied.
(Module 18.2, LOS 18.b)
When accounting for inventory, are the first-in, first-out (FIFO) and last-in, first-out (LIFO) cost flow assumptions permitted under U.S. GAAP?
fifo lifo
yes yes
yes no
no yes
LIFO and FIFO are both permitted under U.S. GAAP. LIFO is prohibited under IFRS. (LOS 18.d)
Which of the following best describes the impact of depreciating equipment with a useful life of 6 years and no salvage value using the declining balance method as compared to the straight-line method?
Total depreciation expense will be higher over the life of the equipment.
Depreciation expense will be higher in the first year.
Scrapping the equipment after five years will result in a larger loss.
Accelerated depreciation will result in higher depreciation in the early years and lower depreciation in the later years compared to the straight-line method. Total depreciation expense will be the same under both methods. The book value would be higher in the later years using straight-line depreciation, so the loss from scrapping the equipment under an accelerated method is less compared to the straight-line method. (LOS 18.d)
At the beginning of the year, Triple W Corporation purchased a new piece of equipment to be used in its manufacturing operation. The cost of the equipment was $25,000. The equipment is expected to be used for 4 years and then sold for $4,000. Depreciation expense to be reported for the second year using the double-declining-balance method is closest to:
$5,250.
$6,250.
$7,000.
Year 1: (2 / 4) × 25,000 = $12,500. Year 2: (2 / 4) × (25,000 – 12,500) = $6,250. (LOS 18.d)
Changing an accounting estimate:
is reported prospectively.
requires restatement of all prior-period statements presented in the current financial statements.
is reported by adjusting the beginning balance of retained earnings for the cumulative effect of the change.
A change in an accounting estimate is reported prospectively. No restatement of prior period statements is necessary. (LOS 18.e)
Which of the following transactions would most likely be reported below income from continuing operations, net of tax?
Gain or loss from the sale of equipment used in a firm’s manufacturing operation.
A change from the accelerated method of depreciation to the straight-line method.
The operating income of a physically and operationally distinct division that is currently for sale, but not yet sold.
A physically and operationally distinct division that is currently for sale is treated as a discontinued operation. The income from the division is reported net of tax below income from continuing operations. Gains and losses on sales of operating assets, as well as depreciation expense, are reported pretax, above income from continuing operations. (LOS 18.e)
Which of the following statements about nonrecurring items is least accurate?
Discontinued operations are reported net of taxes at the bottom of the income statement before net income.
Unusual or infrequent items are reported before taxes above net income from continuing operations.
A change in accounting principle is reported in the income statement net of taxes after extraordinary items and before net income.
A change in accounting principle requires retrospective application; that is, all prior period financial statements currently presented are restated to reflect the change. (LOS 18.e)
Which of the following is least likely considered a nonoperating transaction from the perspective of a manufacturing firm?
Dividends received from available-for-sale securities.
Interest expense on subordinated debentures.
Accruing bad debt expense for goods sold on credit.
Bad debt expense is an operating expense. The other choices are nonoperating items from the perspective of a manufacturing firm. (LOS 18.f)
A vertical common-size income statement expresses each category of the income statement as a percentage of:
assets.
gross profit.
revenue.
Each category of the income statement is expressed as a percentage of revenue (sales). (LOS 18.i)
Which of the following would most likely result in higher gross profit margin, assuming no fixed costs?
A 10% increase in the number of units sold.
A 5% decrease in production cost per unit.
A 7% decrease in administrative expenses.
A 5% decrease in per unit production cost will increase gross profit by reducing cost of goods sold. Assuming no fixed costs, gross profit margin will remain the same if sale quantities increase. Administrative expenses are not included in gross profit margin. (LOS 18.j)
Which of the following transactions affects owners’ equity but does not affect net income?
Foreign currency translation gain.
Repaying the face amount on a bond issued at par.
Dividends received from available-for-sale securities.
A foreign currency translation gain is not included in net income but the gain increases owners’ equity. Dividends received are reported in the income statement. The repayment of principal does not affect owners’ equity. (LOS 18.k, LOS 18.l)
Which of the following is least likely to be included when calculating comprehensive income?
Unrealized loss from cash flow hedging derivatives.
Unrealized gain from available-for-sale securities.
Dividends paid to common shareholders.
Comprehensive income includes all changes in equity except transactions with shareholders. Therefore, dividends paid to common shareholders do not affect current period comprehensive income. (LOS 18.k, 18.l)
