Income Statement

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

1.  When total revenues are greater than total expenses, a company has

a. a net loss
b. a net income
c.  a net gain
d.  a decrease in net assets

Check Your Answer
B.  Revenue less expenses is equal to net income when revenues are higher and is equal to net loss when expenses are higher.   Net income normally results in an increase in net assets. Gains and losses occur when assets are sold.
2.  An investor uses the income statement to determine

a.  whether the company has enough cash to pay current liabilities
b.  if the company has invested too much cash in current assets
c.  how much a company has earned for a given period of time
d.  how much a company has earned cumulatively as of a given date

Check Your Answer
C.  The income statement reports how much a company has earned during a period of time.  It is not a cumulative statement. (a.) and (b.) are determined using the balance sheet.
3.  Revenues are technically defined as

a.  amounts earned from providing goods and services
b.  amounts collected from providing goods and services
c.  decreases in net assets
d.  decreases in net assets as a result of day to day activities

Check Your Answer
A.   The technical definition of a revenue is amounts earned from providing goods and services in exchange for an asset.  When the cash is collected does not matter as long as the company believes it will be collected. Revenues result in an increase in assets.
4.  Which of the following is not a true statement?

a.  revenues cause an increase in net assets
b.  expenses cause a decrease in net assets
c.  net income and change in cash are the same thing
d.  net income is not the same thing as retained earnings

Check Your Answer
C.  Net income comes from revenues less expenses.  Revenues and expenses are not recognized when cash is received and paid, therefore income and cash are not the same thing.  Retained earnings is cumulative net income/loss. Net income refers to this period only. Both (a.) and (b.) are true statements.
5.  Which of the following expenses is usually listed towards the bottom of the income statement?

a.  cost of goods sold
b.  rent expense
c.  accrued expenses
d.  tax expense

Check Your Answer
D.  Tax expense is listed after income before tax which normally includes all other revenues and expenses.  Cost of goods sold is normally listed second after sales. Rent expense is an operating expense. Tax expense is not listed with other operating expenses.  Accrued expenses is a liability and is not reported on the income statement.
6.  Which of the following is a condition that must be met for revenue to be recognized on the income statement?

a.  cash must be collected
b.  delivery of goods or services has occurred
c.  a promise to deliver goods or services has been made
d.  all of the above

Check Your Answer
B.  Revenue is recognized when the goods or services have been provided to the customer.  When cash is collected does not matter. Nothing is recorded when a promise occurs because an exchange has not occurred.
7.   Which of the following is a true statement?

a.  Expenses are always recorded when cash is paid
b.  Revenue is recognized when it is earned
c.  Expenses are not matched against revenues in the same period
d.  Cash received after services is provided is called unearned revenue

Check Your Answer
B.  Revenue is recognized when the goods or services have been provided to the customer; when earned.  Expenses are recorded when they are incurred – use an asset or been provided a service. When the cash is paid for an expense does not matter.  Cash received before the service is provided is a liability called unearned revenue.
8.  An accrued expense is

a.  an expense that has been paid for
b.  an expense that has been incurred but not yet paid for
c.  a revenue that has a future expense associated with it
d.  none of the above

Check Your Answer
B.  Accrued expense means incurred and not yet paid for.  It is a liability that is reported on the balance sheet.
9.  The principle that states that all expenses incurred in the revenue process should be recorded in the same period as the revenue generated is

a.  the revenue principle
b.  the expense principle
c.  the matching principle
d.  the historical cost principle

Check Your Answer
C.   This is the matching principle.  The revenue recognition principle states revenues are recorded when earned.  There is no such thing as the expense principle. The historical cost principle states that assets and liabilities are recorded at cost, which has nothing to do with expenses.
10.  Which of the following will be an expense on this period’s income statement?

a.  cash paid for the utility bill
b.  the amount on the utility bill for services provided this period
c.  the estimated amount for advertising for next month
d.  amounts paid in advance for insurance coverage

Check Your Answer
B.   To be an expense this period, the company must have incurred the expense this period.  Incurred means the asset is used or the service has been provided to the company during this period.  When cash is paid does not matter. Amounts paid in advance are assets called prepaid because they provide future benefit.
11.  Which of the following will be recorded as revenue in this period’s income statement?

a.  cash collected from customers for last months services provided
b.  the value of services provided last month
c.  cash collected for services to be provided next month
d.  the value of services provided this month

Check Your Answer
D.  To be recorded as a revenue this period, the goods or services have to be provided this period.  When cash is collected does not matter. Services provided last month are last month’s revenues and services provided next month are next month’s revenues.
12.   Which of the following situations is a violation of the revenue recognition principle?

a.  recording revenues when the goods or service is provided
b.  recording expenses when the cost is incurred
c.  recording revenues when the cash is received and the service is provided
d.  recording revenues when the cash is received and the service has not yet been provided.

Check Your Answer
D.  The revenue recognition principle states that revenues must be recorded in the period the goods or services are provided.  When cash is received does not matter. As long as the service is provided during this period a revenue may be recorded for this period.  Expenses are not covered under the revenue recognition principle.
13.  Dividends paid to shareholders

a. is an expense reported on the income statement
b. is a direct reduction to retained earnings
c. is a revenue reported on the income statement
d. is reported on the balance sheet

Check Your Answer
B.  Dividends paid to shareholders is a return of investment and is a direct reduction to retained earnings.  Dividends paid do not meet the definition of an expense because a service has not been provided to the company.  Dividends paid is not a revenue because no service is provided by the company. Dividends are not reported separately on either the income statement or the balance sheet.  Dividends are netted in the retained earnings balance.
14.   When a company records service revenue

a.  assets will decrease
b.  net income will increase
c.  net income will decrease
d.  liabilities will increase

Check Your Answer
B.  Revenues increase net income since revenues less expenses equal net income.  When a company records service revenue it must also record an increase in cash or accounts receivable.  Cash or accounts receivable is exchanged for the service provided. Assets will increase. Liabilities are not impacted.
15.  The accrual method of accounting requires

a.  revenues to be recorded when the cash is received
b.  expenses to be recorded when the cash is paid
c.  revenues to be recorded when earned
d.  both a. & b.

Check Your Answer
C.  The accrual method of accounting requires revenues to be recorded when earned and expenses to be recorded when incurred.  When cash is received or paid does not matter!
16.  The major difference between revenues and gains is

a.  revenues are from providing goods and services and gains are from selling assets at more than book value
b.  GAAP makes no distinction between the two, they are the same
c.  revenues are from peripheral activities
d.  gains cause a decrease in net assets

Check Your Answer
A.  GAAP distinguishes between the two, as defined in (a.).  Revenues are from the primary business activities of the company; providing goods and services.  Gains occur when you sell an asset for more than was originally paid for the asset and cause an increase in net assets (you get more than you gave up).