Accrual Basis Income Statement

Easy Practice Test

Introduction to Accounting

Easy Practice Test

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

1. Which of the following is not included in other revenues and expenses for a retail store?

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

Answer
D. Other revenues and expenses are earned or incurred from activities other than the company’s primary day to day business. Rent expense for space used is part of the day to day primary 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 to others (unless it is a real estate company).
2. 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

Answer
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 are not related to day to day primary business activities.
3. An extraordinary item is

a. unusual
b. infrequent
c. both unusual and infrequent
d. a result of a future transaction

Answer
C. An extraordinary items must be both unusual and infrequent. It is something that is not expected to occur in the future. Unusual or infrequent items (not both) are reported as part of other revenues and expenses. All items reported must be a result of a past transaction.
4. 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

Answer
D. Sales less cost of goods sold is gross profit. Gross profit is the amount the company earns only from selling goods. Gross profit must be used to cover other operating expenses before net income is determined.
5. 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 a minor product
d. a company changes their operations to become more profitable

Answer
B. Discontinued operations occur when a company sells a major part of the business and will not continue in that business anymore. Changing products and restructuring operations is not a discontinued operation because the company will continue to operate that part of the business.
6. 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

Answer
D. Cost of goods sold is the cost of the inventory that is sold to the customer ONLY. It does not include any other operating expenses. Selling and administrative expenses (a., b., & c.) are all part of operating expenses.
7. 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 when cash is paid and received

Answer
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 to the income statement.
8. The cost of restructuring is reported as

a. an operating expense
b. a loss from discontinued operations
c. a loss that is unusual
d. a loss that is unusual and infrequent

Answer
A. Restructuring costs are incurred to restructure operations; therefore, it is an operating expense. A discontinued operation only occurs when the company gets totally out of the business. Company restructures occur quite often and are not unusual.
9. 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

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.
10. Which of the following will not be reported as an operating expense for a company that operates retail stores?

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

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.
11. Prepare a multi-step income statement using the improperly formatted single step income statement below. Make sure that you show required subtotals.

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

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. Not reported on the Income Statement

______ 1. Cash collected in advance of the service provided to customers
______ 2. Reorganizing the company’s operations
______ 3. Loss from selling a major product line
______ 4. Interest income
______ 5. Provide goods to customers
______ 6. The use of long-term physical assets
______ 7. Loss from a hurricane in Florida
______ 8. Research and development expenses
______ 9. Marketing expenses
______ 10. Executive salaries
______ 11. Pay employees for worked performed in the prior period
______ 12. Rent income
______ 13. The cost of inventory sold to customers
______ 14. Loss on the sale of an investment
______ 15. Loss from a flood

Answer
E        1. Cash collected in advance
no service provided

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

B        6. Using long-term physical assets
depreciation expense

C        7. Loss from a hurricane in Florida
not part of business with customers

B        8. Research and development expenses

B        9. Marketing expenses

B        10. Executive salaries

E        11. Pay for work performed in the prior period
expense in the prior period

C        12. Rent income

A        13. The cost of inventory sold to customers

C        14. Loss on the sale of an investment

C        15. Loss from a flood

13. Prepare an income statement in proper format for “this period” (the current period) using the following information:

 

a. goods provided this period; customer paid cash $12,000
b. goods provided this period; customer pays later $64,000
c. cash collected for goods provided last period $53,000
d. paid to employees for work done last period $22,000
e. paid to employees for work done this period $  4,000
f. total amount employees earned for work this period $28,000
g. utility bill received for this period; pay next period $     200
h. total paid to the utility company for last period $     800
i. amount paid for rent (space used) last period $  1,200
j. the cost to rent the building for this period only $     600
k. the cost of inventory provided to customers this period $43,000
l. the company’s income tax rate is estimated to be 30%  
Answer
Sales $76,000
– Cost of goods sold (  43,000)
=Gross Profit 33,000
– Salary Expense (  28,000)
– Utility Expense (       200)
– Rent Expense (       600)
=Income before tax 4,200
– Income tax expense (    1,260)
= Net Income $2,940

 

Revenues and expenses are not recorded when collected or paid.
Goods provided is reported as revenue in the period it occurs.
Expenses are reported for the amount of service that was provided to the company or asset was used in the period it occurs.
Only activities that occur in the current period are reported on the current period income statement.
When cash is paid or collected does not matter to the income statement.