Income Statement

Medium Practice Test

Financial Accounting

Income Statement

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Medium Practice Test

Click the “Check Your Answer” box below each problem to reveal the correct answer and explanation.

1. Which of the following is not a separate category reported on the income statement?

a. selling a major part of the business
b. other use of assets
c. a loss that is unusual
d. gross profit

Check Your Answer

C. A loss that is unusual is reported in the category of other revenues and expenses. Selling a major part of the business is a discontinued operation. Changing an accounting principle is reported separately below discontinued operations. Gross profit is a separate subtotal for companies that sell goods

2. A loss from restructuring is reported as

a. an operating expense
b. a loss from discontinued operations
c. a loss that is unusual
d. an “other” loss below operating income

Check Your Answer

A. A company that has a restructuring loss is incurring expenses to restructure operations, therefore, it is an operating expense. A discontinued operation only occurs when the company gets totally out of the business. (d.) is incorrect because other revenue and expense is below operating income which includes operating expenses.

3. When a company incurs a loss from a flood it will be reported as

a. income from discontinued operations
b. operating expenses
c. other revenues or expenses
d. gross profit

Check Your Answer

C. A flood is not an activity involved in providing to customers and therefore is reported as an unusual loss in the other revenues and expenses category.

4. The loss from a customer not paying the amount it owes the company is reported as

a. income from discontinued operations
b. operating expenses
c. other revenues or expenses
d. gross profit

Check Your Answer

B. A customer not paying occurs often and is a part of day to day business. It is called bad debt expense. Expenses that are incurred that are part of day to day business are operating expenses. A company has discontinued operations only when they are no longer going to be in that particular business. Gross profit occurs from providing goods.

5. A company that changed their method it uses for computing depreciation expense and incurred more expense will report the change as

a. an unusual loss
b. operating expenses
c. other revenues or expenses
d. gross profit

Check Your Answer

B. This change in accounting principle is a change in an estimate that will be reported in the current period as part of depreciation expense. Depreciation expense is an operating expense. Unusual loses are reported under other revenues or expenses (a. & c.). Gross profit is reported above operating expenses.

6. Losses from an earthquake in an area that has never experienced an earthquake before is reported

a. below income tax expense
b. as an operating expenses
c. in other revenues or expenses
d. as a discontinued operations

Check Your Answer

C. This is an unusual loss that is reported in “other revenues or expenses”. The loss is not related to doing direct business with customers (b.). The company will continue in business after the earthquake clean up (d.) Other revenues and expenses are reported above income tax expense (a.).

7. A company sold equipment and realized a loss that will be reported as

a. an increase to depreciation expense
b. operating expenses
c. other revenues or expenses
d. an extraordinary item

Check Your Answer

C. Gains and losses that result from selling assets are always reported under other revenues and expense. A company is not in business to sell their assets; however, this does occur often and is a peripheral activity that is not directly related to doing business with customers (b.).

8. Which of the following violates the matching principle?

a. recording the cost of inventory sold in the period of the sale
b. recording bad debt expense in the period of the sale
c. recording salary expense when paid
d. recording depreciation expense in the period the asset is used

Check Your Answer

C. The matching principle states that revenues must be recorded when earned and all expenses incurred to generate the revenue must be reported in the same period as the revenue. When cash is paid or received is not relevant, so C is not correct. All other choices put the expense in the same period as the revenue.

9. To compute income tax expense a company multiplies the income tax rate by

a. operating income
b. income from continuing operations
c. income before taxes
d. income from discontinuing operations

Check Your Answer

C. Tax expense is reported just under income before taxes and computed by multiplying the tax rate by income before taxes (the amount just above it). Operating income is before other revenues and expenses. Income from continuing operations is reported after tax expense and discontinued operations is reported after income from continuing operations.

10. The multi-step income statement is presented in the which order?

a. gross profit, income from continuing operations, income from operations
b. income from operations, income from discontinued operations, income before income taxes
c. gross profit, income from operations, income from continuing operations
d. sales, income from operations, gross profit

Check Your Answer

C. The income statement is presented: Sales less cost of goods sold = gross profit – operating expenses = income from operations + – other revenues/expenses = income before tax less tax expense = income from continuing operations. Then discontinued operations is just before net income

11. Prepare a multi-step income statement using the single step income statement below. Make sure that you show subtotal categories.

Revenues and Gains:

Sales
Dividend income
Gain on sale of equipment
Rent income

Expenses and Losses:

Salaries
Loss from fire
Depreciation expense
Cost of goods sold
Income tax expense
Administrative expense
Restructuring expense
Loss from selling major part of the business

Check Your Answer


  Sales 
- Cost of goods sold
= Gross profit
-    Operating expenses:
  	Salaries expense
	Depreciation expense
	Administrative expense
	Restructuring expense
= Income from operations
- + Other revenues and expenses
	Loss from fire
	Rent income
	Dividend income
	Gain on sale of equipment
=Income before tax
- Income tax expense
= income from continuing operations
- Discontinued operation - Loss from selling major part of the business
= Net income

12. Match the following categories with the descriptions provided below:

A. Included in Gross Profit
B. Included in Operating expenses
C. Included in Other Revenues and Expenses
D. Included in Discontinued Operations
E. Is not reported on the Income Statement

______ 1. Rent revenue collected in advance
______ 2. Reorganizing the company’s operations
______ 3. Loss from selling a major product line
______ 4. Interest income
______ 5. Provide goods to customers
______ 6. Loss from a hurricane in Florida
______ 7. Research and development expenses
______ 8. Marketing expenses
______ 9. Executive salaries
______ 10. Depreciation on manufacturing equipment
______ 11. Rent income
______ 12. The cost of inventory sold to customers
______ 13. Loss on the sale of an investment

Check Your Answer

E 1. Rent revenue collected in advance (unearned revenue – liability)
B 2. Reorganizing the company’s operations (restructuring expense)
D 3. Loss from selling a major product line
C 4. Interest income
A 5. Provide goods to customers (sales)
C 6. Loss from a hurricane in Florida
B 7. Research and development expenses
B 8. Marketing expenses
B 9. Executive salaries
A 10. Depreciation on manufacturing equipment (cost of making product)
C 11. Rent income
A 12. The cost of inventory sold to customers (cost of goods sold)
C 13. Loss on the sale of an investment

13. Prepare a multi-step income statement using the following information:

1) The cost of inventory sold to customer	$220,000
2) Advertising expenses	$ 25,000
3) Administrative salary expenses	$ 80,000
4) Issued common stock	$ 75,000
5) Interest income	$ 10,000
6) Insurance expense	$ 4,000
7) Research and development costs	$ 22,000
8) Dividends paid	$ 15,000
9) Tax expense	35%
10) Rent expense	$ 12,000
11) Loss from closing 1 out of 6 shops	$ 8,000
12) Accrued expenses	$ 11,000
13) Sales price of goods provided
to customers	$450,000
14) Loss on the sale of a building	$ 26,000

Check Your Answer

Sales	$450,000
– Cost of goods sold	( 220,000)
= Gross profit	230,000
– Operating expenses:
Advertising expense	25,000
Insurance expense	4,000
Administrative salary expense	80,000
Rent expense	12,000
Research & Development expense	22,000
Restructuring expense	8,000
= Income from operations	79,000
– + Other revenues and expenses
Loss on sale of a building	(26,000)
Interest income	10,000
=Income before tax	63,000
– income tax expense	(22,050)
= Net Income	40,950

Important to Note:

Issuing common stock is an increase in cash and an increase in owner’s equity.
It is not a revenue or an expense and is not reported on the income statement.

Dividends paid is a direct reduction to retained earnings on the balance sheet.
It is not an expense and is not reported on the income statement.

Accrued expense is a liability that is reported only on the balance sheet.

Closing 1 of 6 shops is not selling of a major part of the business. The company continues in this business and is closing one to change operations to make the company more profitable.

Income Statement

Medium Practice Test

Financial Accounting