Income Statement

Easy Test

Easy Test

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

1.  Which of the following is a question that is typically answered with the income statement?

a.  What is the company’s financial position?
b.  What is the company’s earnings from operations?
c.  What is the value of the company’s assets?
d.  How has the company financed its operations?

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B.  The income statement reports revenues less expenses which indicates earnings for the period.  All other choices can be answered using the balance sheet.
2.  Which of the following is not included in other revenues and expenses?

a.  rent income
b.  interest income
c.  interest expense
d.  rent expense

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D.  Other revenues and expenses are earned or incurred from activities other than the company’s primary day to day business.  Rent expense must be incurred in support of the day to day business. A company is not in business to borrow or loan money (unless it is a bank or finance company) or rent their excess space (unless it is a real estate company). 
3.  Income tax expense is reported 

a.  as a part of operating expenses
b.  as a part of other revenues and expenses
c.  as a part of discontinued operations
d.  after income before taxes

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D.  Income tax expense is reported separately after income before taxes.  It is often a major expense of the company and not an expense management can control.  Operating expenses are incurred to support day to day business. Discontinued operations are not expected to occur in the future.  Other revenues and expenses do not occur from activities of day to day business.
4.  The company will earn net income if

a.  revenues = expenses
b.  revenues + gains = expenses – losses
c.  revenues + gains > expenses
d.  revenues + gains > expenses + losses

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D.  Revenues higher than expenses will give net income.  Gains and losses are also reported on the income statement. Gains increase income and losses decrease income.
5.  The format of the income statement is designed to report

a.  the change in cash for the period
b.  how the company generates revenues and incurs expense 
c.  in a way to easily compute income tax expense
d.  only transaction expected to continue in the future

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B.  The format of the income statement makes it easy for a user to determine the amount earned from selling goods only, the amount earned from doing business with customers and the earnings from activities unrelated to customers.  The income statement does not report changes in cash (a.). The value of income tax expense is dependent on IRS rules and not on the format of the statement (c.). The income statement reports both transactions expected to continue and those not expected to continue. 
6.  Gross profit is computed from

a.  contribution margin less operating expenses
b.  sales less operating expenses
c.  sales less operating expenses less other revenues and expenses
d.  sales less cost of goods sold

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D.  Sales less cost of goods sold is gross profit.  Gross profit is the amount the company earns only from selling the goods.  Gross profit must be used to cover other operating expenses before profit is determined.
7.  A gain from a discontinued operation occurs when

a.  a company changes the products in a product line
b.  a company sells a major part of its business or an entire product line
c.  a company decides not to sell one product
d.  a company changes operations to become more profitable

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B.   A discontinued operation occurs when a company sells a major part of their business and will not continue in that business anymore.   Changing products or operations is not a discontinued operation because they will continue in that business.
8.  Cost of goods sold is

a.  all costs of selling inventory to the customer
b.  all costs of administration of the company
c.  the cost of collecting from the customer
d.  the cost of the inventory sold to the customer

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D.  Cost of goods sold is the cost of the inventory that is sold to the customer ONLY.  It does not include any other expenses.  Selling and administrative expenses (are all of the other choices) are operating expenses. 
9.  Accrual accounting requires

a.  revenues to be recorded when received
b.  revenues to be recorded when earned
c.  expenses to be recorded when paid
d.  revenues and expenses to be recorded as cash is paid and received

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B.  The accrual method of accounting requires revenues to be recorded when earned and expenses to be recorded when incurred.  When an amount is paid or collected does not matter.  
10.  Which of the following business would use a single step income statement?

a.  a restaurant
b.  a computer manufacturer
c.  a car dealership
d.  an accounting firm

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D.  A business would use a single step income statement when it only provides a service and does not provide goods to the customer.   When goods are provided, cost of goods sold and gross profit is recorded on a multi-step income statement. A restaurant, manufacturer and dealership provide goods to a customer.  An accounting firm provides a service.
11.  A multi-step income statement is useful for

a.  determining income from day to day business
b.  a service organization
c.  determining total company expenses
d.  projecting discontinued operations

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A.  The multi-step income statement sorts expenses according to goods provided, day to day business, and peripheral activities.  It reports the line item “income from operations” which is income from day to day business. The single step statement shows all expenses together and totals all expenses.  The income statement does not report projected items.
12.  Which of the following will not be reported as an operating expense?

a.  restructuring expense
b.  marketing expenses
c.  salary expenses
d.  interest expense

Check Your Answer
D.   Interest expense is not part of the primary day to day business of the company (unless it is a bank) and is not reported as an operating expense.  All other expenses listed are part of day to day business. A company restructures day to day operations, therefore, restructuring is reported as part of operating expenses.
13.  Indicate which section of the classified income statement the account will be reported under:


S-  Sales
CGS-  Cost of Goods Sold
OE-  Operating Expense
ORE-  Other Revenue and Expense
N-  Not reported on the income statement

_____a.  rent expense
_____b.  depreciation expense on administrative furniture
_____c.  insurance expense
_____d.  selling investments at a loss
_____e.  collections from customers
_____f.   restructuring expense
_____g.  loss from a fire
_____h.  the cost of inventory provided to customers
_____ i.  executive salaries
_____ j.  advertising expense
_____k.  owe for employee bonuses
_____l.  supplies on hand

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OE    a.  rent expense

OE b.  depreciation expense on administrative furniture

OE c.  insurance expense

ORE d.  selling investments at a loss

N e.  collections from customers (cash up and A/R down)

OE f.   restructuring expense

ORE g.  loss from a fire

CGS h.  the cost of inventory provided to customers

OE i.  executive salaries

OE j.  advertising expense

N k.  owe for employee bonuses – this is a liability

N l.  supplies on hand – this is an asset

14.  A company has the following accounts at the end of the year.  Prepare a multi-step income statement for the period ended December 31st.

Insurance expense
Loss from a flood
Salesman salary expense
Rent income
Sales revenue
Accumulated depreciation
Loss from selling part of the business
Interest expense
Cost of goods sold
Dividends paid
Rent expense

Check Your Answer
Sales revenue
– Cost of goods sold
= Gross profit
–   Operating expenses:
Insurance expense
Salesman salary expense
Rent expense
= Income from operations
– + Other revenues and expenses
Loss from a flood
Rent income
Interest expense
=Income before tax
– income tax expense
= income from continuing operations
– Discontinued operation (loss from selling part of the business)
= Net income
15.  A company had the following transactions during the first month of the year.  Prepare a multi-step income statement for the month ended January 31st.

a.  paid $16,000 in salaries and wages incurred during the month
b.  sold $100,000 of goods that cost $48,000
c.  collected $69,000 from customers 
d.  paid $900 for rent for this month and the next two months
e.  received $100 for interest earned last month
f.   recorded depreciation expense of $500 for this month
g.  received a bill for utilities for this month for $1,100
h.  paid the utility bill for last month for $950.
i.   the company’s tax rate is 30%

Check Your Answer

c.  Collecting cash from customers is not the revenue, providing the goods is the revenue earned

d.  The amount paid for the next two months rent is recorded on the balance sheet        as $600 prepaid rent

e.  Interest earned last month is recorded last month, not this month.  When the cash is collected does not matter.

h.  Utilities for last month is last month’s expense.  An expense is not recorded when cash is paid, it is recorded when a service is provided to the company.