Understanding Income Statements

Question 1

What does the Income Statement show?

Answer 1

An entity’s revenues, expenses, gains and losses during a reporting period.

Question 2

What is the difference between a multi-step and single step income statement?

Answer 2

A multi-step income statement provides a subtotal for gross profit and a single step income statement does not.

Question 3

When is revenue recognized?

Answer 3

When earned.

Question 4

When are expenses recognized?

Answer 4

Expenses are recognized when incurred.

Question 5

What are the two methods for accounting for long-term contracts?

Answer 5

1. Percentage-of-completion
2. Completed-contract

Question 6

What is the percentage of completion method?

Answer 6

1. Method of accounting for long-term contracts.
2. Recognizes revenue in proportion to costs incurred.

Question 7

What is the completed contract method?

Answer 7

1. Method of accounting for long-term contracts.
2. Recognizes revenue only when the contract is complete.

Question 8

What are the three types of revenue recognition methods for installment sales?

Answer 8

1. Normal revenue recognition at time of sale
2. Installment sales method
3. Cost recovery method

Question 9

Installment sales: under what circumstances is normal revenue recognition acceptable?

Answer 9

If collectability is reasonably assured.

Question 10

Installment sales: under what circumstances is installment sales method acceptable?

Answer 10

When collectability cannot be reasonably estimated.

Question 11

Installment sales: under what circumstances is the cost recovery method acceptable?

Answer 11

When collectability is highly uncertain.

Question 12

Revenue from barter transactions can only be recognized if?

Answer 12

Its fair value can be estimated from historical data on similar non-barter transactions.

Question 13

Which is more aggressive: percentage-of-completion or completed-contact method?

Answer 13

Because of the estimates involved, the percentage-of-completion method is more aggressive than the completed-contact method.

Question 14

Which is more aggressive: Installment or the cost recovery method.

Answer 14

The installment method is more aggressive than the cost recovery method.

Question 15

What is straight-line depreciation?

Answer 15

Equal amount of depreciation expense in each year of the asset’s useful life.

Question 16

What is double declining balance depreciation?

Answer 16

Apply a constant rate of depreciation to the declining book value until book value equals residual value.

Question 17

What are the four types of inventory valuation methods?

Answer 17

1. FIFO
2. LIFO
3. Average cost
4. Specific identification

Question 18

What is FIFO?

Answer 18

When inventory reflects cost of most recent purchases, COGS reflects cost of oldest purchases.

Question 19

What is LIFO?

Answer 19

COGS reflects cost of most recent purchases, inventory reflects cost of oldest purchases.

Question 20

What is the average cost method of inventory valuation?

Answer 20

Unit cost equals cost of goods available for sale divided by total units available and is used for both COGS and inventory.

Question 21

Describe the specific identification method for inventory valuation:

Answer 21

• Each item in inventory is identified and its historical cost is used for calculating COGS when the item is sold.
• Ideal for easily identifiable inventory(car dealership)

Question 22

How are results of discontinued operations are reported?

Answer 22

Below income from continuing operations, net of tax, from the date the decision to dispose of the operations is made.

These results are segregated because they likely are non-recurring and do not affect future net income.

Question 23

How are unusual or infrequent items reported?

Answer 23

Before tax and above income from continuing operations.

Question 24

How are extraordinary items (both unusual and infrequent) reported?

Answer 24

Below income from continuing operations, net of tax under U.S. GAAP, but this treatment is not allowed under IFRS.

Question 25

What three changes require a retrospective restatement of all prior-period financial statements?

Answer 25

1. Changes in accounting standards,
2. Changes in accounting methods applied
3. Corrections of accounting errors

Question 26

What change is applied prospectively, with no prior-period restatement?

Answer 26

A change in an accounting estimate.

Question 27

What is the basic EPS equation?

Answer 27

Question 28

What is the equation for diluted EPS?

Answer 28

Question 29

What is a dilutive security?

Answer 29

One that, if converted to its common stock equivalent, would decrease EPS.

Question 30

What is an anti dilutive security?

Answer 30

A security that would not reduce EPS if converted to its common stock equivalent.

Question 31

What is a vertical common size income statement?

Answer 31

• An income statement in which each account is expressed as a percentage of the value of sales

Question 32

What is the equation for gross profit margin?

Answer 32

• Profitability ratio
• gross profit / revenue

Question 33

What is the equation for net profit margin?

Answer 33

• Profitability ratio
• net income / revenue

Question 34

What is comprehensive income?

Answer 34

• The sum of net income and other comprehensive income.
• Measures all changes to equity other than those from transactions with shareholders.

Question 35

Are transactions with shareholders reported on the income statement?

Answer 35

NO!!! Transactions with shareholders, such as dividends paid and shares issued or repurchased, are not reported on the income statement.

Question 36

Does other comprehensive income affect net income?

Answer 36

NO!!! Other comprehensive income includes other transactions that affect equity but do not affect net income.

Question 37

What are four categories of transactions that would be clasified as other comprehensive income?

Answer 37

1. Gains and losses from foreign currency translation.
2. Pension obligation adjustments.
3. Unrealized gains and losses from cash flow hedging derivatives.
4. Unrealized gains and losses on available-for-sale securities.