QUESTIONS
1. What kinds of questions about future cash flows do investors and creditors attempt to answer with information in the income statement?
2. How can information based on past transactions be used to predict future cash flows?
3. Identify at least two situations in which important changes in value are not reported in the income statement.
4. Identify at least two situations in which application of different accounting methods or accounting estimates results in difficulties in comparing companies.
5. Explain the transaction approach to measuring income.
Why is the transaction approach to income measurement preferable to other ways of measuring income?
6. What is earnings management?
7. How can earnings management affect the quality of earnings?
8. Why should caution be exercised in the use of the net income figure derived in an income statement? What are the objectives of generally accepted accounting principles in their application to the income statement?
9. A Wall Street Journal article noted that Apple reported higher income than its competitors by using a more aggressive policy for recognizing revenue on future upgrades to its products. Some contend that Apple’s quality of earnings is low. What does the term “quality of earnings” mean?
10. What is the major distinction (a) between revenues and gains and (b) between expenses and losses?
11. What are the advantages and disadvantages of the single-step income statement?
12. What is the basis for distinguishing between operating and nonoperating items?
13. Distinguish between the modified all-inclusive income statement and the current operating performance income statement. According to present generally accepted accounting principles, which is recommended? Explain.
14. How should correction of errors be reported in the financial statements?
15. Discuss the appropriate treatment in the financial statements of each of the following.
(a) Gain on sale of investment securities.
(b) A profit-sharing bonus to employees computed as a percentage of net income.
(c) Additional depreciation on factory machinery because of an error in computing depreciation for the previous year.
(d) Rent received from subletting a portion of the office space.
(e) A patent infringement suit, brought 2 years ago against the company by another company, was settled this year by a cash payment of $725,000.
(f) A reduction in the Allowance for Doubtful Accounts balance because the account appears to be considerably in excess of the probable loss from uncollectible receivables.
16. Indicate where the following items would ordinarily appear on the financial statements of Boleyn, Inc. for the year 2017.
(a) The service life of certain equipment was changed from 8 to 5 years. If a 5-year life had been used previously, additional depreciation of $425,000 would have been charged.
(b) In 2017, a flood destroyed a warehouse that had a book value of $1,600,000. Floods are rare in this locality.
(c) In 2017, the company wrote off $1,000,000 of inventory that was considered obsolete.
(d) In 2014, a supply warehouse with an expected useful life of 7 years was erroneously expensed.
(e) Boleyn, Inc. changed from weighted-average to FIFO inventory pricing.
17. Indicate the section of a multiple-step income statement in which each of the following is shown.
(a) Loss on inventory write-down.
(b) Loss from strike.
(c) Bad debt expense.
(d) Loss on disposal of a discontinued operation.
(e) Gain on sale of machinery.
(f) Interest revenue.
(g) Depreciation expense.
(h) Material write-offs of notes receivable.
18. Perlman Land Development, Inc. purchased land for $70,000 and spent $30,000 developing it. It then sold the land for $160,000. Sheehan Manufacturing purchased land for a future plant site for $100,000. Due to a change in plans, Sheehan later sold the land for $160,000. Should these two companies report the land sales, both at gains of $60,000, in a similar manner?
19. You run into Greg Norman at a party and begin discussing financial statements. Greg says, “I prefer the singlestep income statement because the multiple-step format generally overstates income.” How should you respond to Greg?
20. Santo Corporation has eight expense accounts in its general ledger which could be classified as selling expenses.
Should Santo report these eight expenses separately in its income statement or simply report one total amount for selling expenses?
21. Cooper Investments reported an unusual gain from the sale of certain assets in its 2017 income statement. How does intraperiod tax allocation affect the reporting of this unusual gain?
22. Discuss the appropriate treatment in the income statement for the following items:
(a) Loss on discontinued operations.
(b) Noncontrolling interest allocation.
(c) Earnings per share.
(d) Gain on sale of equipment.
23. Lebron Co. owns most but not all of the shares of its subsidiary
Bryant Inc. Lebron reported net income of $124,700. The amount to be attributed to the noncontrolling interest in Bryant is $30,000. Indicate how Lebron will report the noncontrolling interest in its income statement.
24. What effect does intraperiod tax allocation have on reported net income?
25. Neumann Company computed earnings per share as follows.
Neumann has a simple capital structure. What possible errors might the company have made in the computation?
Explain.
26. Qualls Corporation reported 2017 earnings per share of $7.21. In 2018, Qualls reported earnings per share as follows.
On income from continuing operations $6.40
On discontinued operations 1.88
On net income $8.28
Is the increase in earnings per share from $7.21 to $8.28 a favorable trend?
27. What is meant by “tax allocation within a period”? What is the justification for such practice?
28. When does tax allocation within a period become necessary?
How should this allocation be handled?
29. During 2017, Liselotte Company reported income of $1,500,000 before income taxes and realized a gain of $450,000 on the disposal of assets related to a discontinued operation. The criteria for classification as a discontinued operation is appropriate for this sale. The income is subject to income taxation at the rate of 34%. The gain on the sale of the plant is taxed at 30%. Indicate an appropriate presentation of these items in the income statement.
30. On January 30, 2016, a suit was filed against Frazier Corporation under the Environmental Protection Act. On
August 6, 2017, Frazier Corporation agreed to settle the action and pay $920,000 in damages to certain current and former employees. How should this settlement be reported in the 2017 financial statements? Discuss.
31. Linus Paper Company decided to close two small pulp mills in Conway, New Hampshire, and Corvallis, Oregon.
These two closings do not represent a major shift in strategy for the company. Would these closings be reported in a separate section entitled “Discontinued operations after income from continuing operations”?
Discuss.
32. What major types of items are reported in the retained earnings statement?
33. Generally accepted accounting principles usually require the use of accrual accounting to “fairly present” income. If the cash receipts and disbursements method of accounting will “clearly reflect” taxable income, why does this method not usually also “fairly present” income?
34. State some of the more serious problems encountered in seeking to achieve the ideal measurement of periodic net income. Explain what accountants do as a practical alternative.
35. What is meant by the terms elements and items as they relate to the income statement? Why might items have to be disclosed in the income statement?
36. What are the two ways that other comprehensive income may be displayed (reported)?
37. How should the disposal of a component of a business be disclosed in the income statement?
