Income Statement Other Items

Hard Test

Hard Test

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

1. Reporting discontinued operations separately benefits the user of financial statements by increasing

a. the ability to predict future income
b. consistency
c. full disclosure
d. representational faithfulness

Answer
A. Discontinued operations is not expected to occur in the future. Reporting the results from discontinued operations separately allows the user to project profits and losses that may occur in the future.
2. Which of the following is not considered a component of a business?

a. reportable segment
b. operating segment
c. reporting unit
d. equity investments

Answer
D. An equity investment is an investment in an entity for less than 100% ownership. A component of the business must be 100% owned by the company. All of the others are names used to describe a component that when sold is a discontinued operation.
3. Realized gains and losses from sale of short-term investments are reported as an

a. extraordinary item
b. other revenue or expense
c. operating gain or loss
d. other comprehensive income

Answer
B. Investing activities are not related to day to day business with customers and therefore, are not part of operating revenues or expenses. Investment activity is reported as other revenue and expenses. Long-term (not short-term) unrealized gains or losses on investing activity may be reported as other comprehensive income. Extraordinary items is not a category reported on the income statement.
4. An impairment loss on assets held for sale is reported separately when

a. the assets were sold in the current year at a loss
b. the assets have a book value less than the fair market value
c. the assets are considered part of an operating component that is held for sale and book value is greater than fair market value
d. impairment losses are never reported for discontinued operations

Answer
C. An impairment loss occurs when book value is greater than fair market value. This is reported separately as part of discontinued operations when the assets are part of a component that is held for sale.
5. Which item is not included in comprehensive income

a. foreign currency gains and losses
b. gains and losses related to employee pensions
c. gains and losses related to derivatives
d. gains and losses from the sale of operating assets

Answer
D. Comprehensive income does not include gains and losses from the sale of operating assets. This gain or loss is reported as part of other revenue and expense. All other transactions are reported in other comprehensive income.
6. “Earnings quality” is a term used to describe

a. how well management achieved the expected earnings
b. the change in earnings from one year to the next
c. budget compared to actual earnings
d. how well earnings represent the true economic results of operations during the period

Answer
D. Earnings quality is a term that describes how well earnings represent the true economic results of the operations of the company. The quality of earnings is often impacted by management estimates that are different than actual results.
7. Which of the following situations will be reported as discontinued operations?

a. management continues to manage the operating unit for the new owners
b. the operating unit is not material to the operations of the company
c. the operating unit is material and has separately generated cash flows
d. closing a manufacturing plant and combining the operations with another plant

Answer
C. The criteria for a component to be reported as a discontinued operation is that the component has separately distinguishable cash flows and management of the company cannot be involved in the operations in the future. To be reported separately it must be material to the total operations of the company. Closing a manufacturing plant and combining operations with another plant is an example of restructuring.
8. Gains and losses from natural disasters are reported as

a. extraordinary items
b. other revenue or expense
c. operating income or expense
d. reimbursable costs

Answer
D. Gains and losses related to natural disasters are unusual items that are not related to day to day business with customers. Therefore, they are reported below operating income as part of other revenue and expenses. Extraordinary items and reimbursable costs are not reported on a separate line on the income statement.
9. A correction of an error requires restatement to affected accounts in order to follow the principle of

a. full disclosure
b. comparability
c. entity
d. reliability

Answer
B. Restating prior period financial statements allows for comparability among prior years.
10. Discontinued operations is reported differently if management implemented a plan to sell last period and sold the component during the current period with respect to

a. income from discontinued operations
b. impairment losses
c. net of tax presentation
d. the value reported

Answer
B. An impairment loss is reported in the year the plan to sell is implemented if the assets held for sale are impaired. Income from the discontinued operations is reported whether or not the operation is sold during the period as long as a plan to sell is in place. All items below income from continuing operations are reported net of tax.
11. A company prepared the following income statement for the current year:

Sales							    $1,000,000
- Cost of Goods Sold                                      $   300,000
Gross Profit						    $   700,000
- Selling Expense					    $   120,000
- Administrative Expense                                $   180,000
Income from Operations				    $   400,000
Other Revenues and Expenses:
Research and Development			    $   100,000
Income from Discontinued Operations	    $   115,000
Loss on Impairment of Assets 		    $     20,000
Gain on sale of Discontinued Operations   $   145,000
Income Before Tax					    $   540,000
Tax Expense                        $   162,000
Net Income						    $   378,000

Earnings Per Share					    $3.78

Prepare an income statement in proper format.

Answer
1st go through the items and determine how they should be reported:

Sales							  $1,000,000    OK
- Cost of Goods Sold                                   $   300,000    OK
Gross Profit						    $   700,000    OK
- Selling Expense					    $   120,000    OK
- Administrative Expense                            $   180,000    OK
Income from Operations				    $   400,000    OK
Other Revenues and Expenses:
Research and Development			    $   100,000   Operating expense
Income from Discontinued Operations	    $   115,000    After ICO, net of tax
Loss on Impairment of Assets			    $     20,000    Operating expense
Gain on sale of Discontinued Operations   $   145,000    After ICO, net of tax
Income Before Tax					    $   540,000
Tax Expense                                               $   162,000    computes to 30%
Net Income						    $   378,000    

Earnings Per Share					    $3.78        report for CO and DO 

2nd Reorder the income statement:

Sales										        $1,000,000
- Cost of Goods Sold                                                                      $  (300,000)  
Gross Profit									        $   700,000
- Selling Expense								        $  (120,000)   
- Administrative Expense						        $  (180,000)
- Research and Development						        $  (100,000)
- Loss on Impairment of Assets                                                      $   (20,000)
Income from Operations							        $   280,000
Tax Expense                                                                                  $   (84,000)
Income from Continuing Operations					       $   196,000
Discontinued Operations:
   Income from Discontinued Operations, net of tax $34,500         $     80,500
   Gain on sale of Discontinued Operations, net of tax $43,500     $   101,500
                Total Discontinued Operations			        $   182,000
	Net Income								        $   378,000


Earnings Per Share:
					
Continuing Operations		$1.96
Discontinued Operations         $1.82
Net Income				$3.78


12. The company prepared the following income statement:

Sales					1,000,000
- Cost of Goods Sold                 200,000
Gross Profit				   800,000
- Operating Expenses, net         400,000
Operating Income			   400,000
Tax Expense                                80,000
Net Income				   320,000	

The auditors who reviewed the Company’s transactions noticed the following items that were not included in net income:

a. A separately managed division of the company is held for sale.
After tax loss from operations for this division is $120,000. Impairment of assets
related to the sale is $50,000 net of tax.

b. A loss from a warehouse located next to the Mississippi river that flooded was $100,000 after tax.

c. The Company had an average of 50,000 common shares outstanding during the year. $25,000 preferred dividends were declared and paid.

Use the above information to restate the income statement in proper format.

Answer
1st: Determine where to report each situation:

The tax rate is 20%
40,000 tax / 200,000 income before tax is 20%

a. A division of the company that manages cash flows separately is held for sale.
After tax loss from operations for this division is $120,000. Impairment of assets
related to the sale is $50,000 net of tax.

This qualifies as a component that is separately reportable since cash flows are monitored separately. Both items must be reported separately as part of discontinued operations, net of tax.

The before tax amount would be: $150,000 and $62,500
$150,000 – 30,000 tax at 20% = 120,000
$ 62,500 – 12,500 tax at 20% = 50,000

c. A loss from a hurricane in a Florida warehouse was $100,000 after tax.

The before tax amount would be: $125,000
$125,000 – 25,000 tax at 20% = 100,000

Restate the income statement as follows:



Sales					     1,000,000
- Cost of Goods Sold                           200,000   
Gross Profit				       800,000
- Operating Expenses, net                 400,000   
Operating Income			       400,000
Other Revenues/(Expenses)             (125,000)
Income Before Tax			       275,000
Tax Expense                                      (55,000)
Income from Continuing Op.             220,000
Discontinued Operations:
  Loss from oper, net of 30,000        (120,000) 
  Impairment loss, net of 12,500         (50,000)
Net Income (Loss)		                 50,000


Earnings Per Share:
					
Continuing Operations		 $3.90
Discontinued Operations	          ($3.40)
Net Income			          $ 0.50  

Net Income – Preferred dividends
$220,000 – $25,000 = $195,000 / 50,000 shares = $3.90

$(170,000) / 50,000 = ($3.40)
$25,000 / 50,000 = $0.50

13. A company reported income before tax of $2,100,000 before considering the following items:

a. Administrative employees were down sized and severance in the amount of $39,000 net of tax was paid during this year. An additional $60,000 net of tax is expected to be paid next year to employees laid off during the current year.

b. Two manufacturing facilities are held for sale. They are part of an operating division that produces one product line in 4 manufacturing facilities. Income from operations for the facilities held for sale was $150,000 in the current year. An impairment loss on the assets held for sale was determined to be $60,000. Severance costs after the sale of
the facilities is expected to be $29,000. All amounts are before tax.

c. Bad debt expense was increased by $100,000 related to sales that occurred two years ago.

d. The income tax rate is 30%. The Company has 200,000 shares of common stock
outstanding.

Prepare the income statement in proper form beginning with Income before tax.

Answer
1st Look at each item and determine how it will be reported:

a. Administrative employees were down sized and severance in the amount of $39,000 net of tax was paid during this year. An additional $60,000 net of tax is expected to be paid next year to employees laid off during the current year.

This is a restructuring expense reported as other revenue/expense before income from continuing operations

Only amounts incurred in the current period is reported in the current period. Both payments were incurred this period as the layoff occurred this year.

Report before tax: 99,000 / .7 = 141,429 before tax

b. Two manufacturing facilities are held for sale. They are part of an operating division that produces one product line in 4 manufacturing facilities. Income from operations for the facilities held for sale was $150,000 in the current year. An impairment loss on the assets held for sale was determined to be $60,000. Severance costs after the sale of
the facilities is expected to be $29,000. All amounts are before tax.

This does not qualify to be separately reported as a discontinued operation since the company will remain in this line of business. The impairment loss should be reported under other revenues and expenses.

Report before tax:
60,000 loss on impairment
29,000 restructuring expense

c. Bad debt expense was increased by $100,000 related to sales that occurred two years ago.

This is a change in estimate which is reported in the current year as an additional operating expense.

Adjustment to income before tax:

Previous amount:          2,100,000
Restructuring (a.)			(141,429)
Restructuring (b.)               (29,000)
Impairment loss (a.)                  (60,000)
Bad debt expense (c.)		(100,000)
Adjusted Income before Tax:	1,769,571

Report on Income Statement:

		Income Before Tax			1,769,571

		  Tax Expense			       530,871

		Net Income				1,238,700

		Earnings per share			     $6.19