Income Statement

Hard Test

Hard Test

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

1.  The income statement separates recurring and non-recurring items in order to increase the 

a.  complexity
b.  reliability
c.  ability to analyze revenues
d.  predictability

Check Your Answer
D.  Predictability refers to being able to predict the results of future operations.  In order to do this the items that are not expected to occur in the future must be separated from those that are expected to occur in the future.  Future income is estimated using items that are expected to happen in the future.
2.  How much of each sales dollar is available to cover operating expenses is given by

a.  cost of goods sold
b.  other revenues and expenses
c.  gross profit
d.  operating income

Check Your Answer
C.  Gross profit gives the amount earned just from providing the goods to the customer.  This amount must cover operating expenses to get income from operations. Other revenues and expenses are peripheral activities not part of day to day business operations.
3.  The cost of making or purchasing inventory that is sold to customers is

a.  cost of goods sold
b.  inventory expenses
c.  gross profit
d.  operating income

Check Your Answer
A.  Cost of goods sold is ONLY the cost of making or purchasing inventory that is sold to customers.  The term inventory expense is not used. Gross profit is sales less cost of goods sold. Operating income is gross profit less operating expenses.
4.  What amount of earnings is directly related to day to day primary business operations?

a.  cost of goods sold
b.  other revenues and expenses
c.  gross profit
d.  operating income

Check Your Answer
D. Operating income is directly related to the results of day to day operations of providing goods or services to customers.  It includes gross profit and cost of goods sold. It does not include other revenues and expenses which are peripheral activities.
5.  When a company increases the sales price and no other factors change,

a.  income will decrease
b.  unusual losses will decrease
c.  income from operations will increase
d.  cost of goods sold will decrease

Check Your Answer
C.  An increase in the sales price with all other expenses remaining the same will increase gross profit which in turn will increase operating income and increase net income.  This will not affect unusual losses or cost of goods sold.
6.  Under the revenue recognition principle, revenue is recognized when

a.  the earnings process is complete and the obligation is met
b.  the expenses associated are not identified
c.  the customer has paid
d.  the customer promises to pay

Check Your Answer
A.  Revenues are recognized when the goods or service is provided to the customer, which means the earnings process is complete and the company does not owe anything else to the customer.  When the customer pays does not affect when the revenue is recognized. Revenues are recognized when earned.
7.  Operating and non-operating income can be distinguished by

a.  the principle activity of the business
b.  consistency of revenue streams
c.  how reliable the income is reported
d.  how relevant the revenue is

Check Your Answer
A.  Operating income includes activities associated with providing goods and services to the customer, which is the principle activity of the businesses.   Non operating income is from peripheral activities. Reliability and relevance do not determine where an item is reported on the income statement.
8.   The difference in a single step income statement and a multi-step income statement is primarily

a.  net income is different
b.  total revenue is different
c.  the format is different
d.  the earned gross profit is different

Check Your Answer
C.  The only difference is in the format.  The company will report the same items and the same amounts.  The items give the same total for both statements.

Reporting the same items will result in the same gross profit and net income.

9.  When a company incurs a loss that is unusual it should be reported as

a.  a change in accounting principles
b.  operating expenses
c.  other revenues or expenses
d.  an extraordinary item

Check Your Answer
C.  A loss that is only unusual should be reported as under other revenues and expenses.
10.   At which point in the business process is revenue typically recognized?

a.  at the end of production
b.  at the point goods are services are rendered
c.  at the point cash is collected
d.  when the product is available for sale

Check Your Answer
B.  Revenues are recognized when the goods or services are provided to the customer, which is typically the same point as rendering the services.  When cash is received does not matter! Products available for sale that have been produced (a. & d.) are reported as inventory on the balance sheet. 
11.  The following accounts are for XYZ Company on December 31st.  The income tax rate is 30%.  Prepare a multi-step income statement for the year ended December 31st.

Check Your Answer
12.  The following income statement was prepared by the marketing manager using the company’s cash records and inventory records:

After examining transactions, you discovered the following:

Included in other expenses

1)  Tax expense was at 36% of income before taxes

2)  The company incurred a loss of $2,800 from selling equipment

3)  Rent expense of $12,000

 Included in other revenues:

1)  Interest income of $13,000

2)  Rent income $6,000

Included in selling expenses:

1)  Loss from selling a major part of the business $17,000

2)  Depreciation expense on manufacturing equipment $22,000

Prepare a corrected multi-step income statement for the Company

Check Your Answer

Cost of Goods Sold = 234,000 + 22,000 depreciation on manufacturing equipment which is a cost to make the product.

Administrative Expense = 144,000 + rent expense 12,000

Selling Expenses = 102,000 -17,000 moved to discontinued loss – 22,000 depreciation moved to cost of goods sold

Other expenses was all moved to other categories:  71,352 tax expense, 2,800 loss, 12,000 rent expense