CMA Overview of the Financial Statements and the Income Statement

When a company discontinues an operation and disposes of the discontinued operation (component), the transaction should be included in the earnings statement as a gain or loss on disposal reported as:

Answer: A separate amount, net of tax, after continuing operations. Rationale: Both the gain or loss from discontinued operations and the gain or loss on sale of the segment should be shown after income from continuing operations.

Big Rock Company (BRC) is a jewelry manufacturer. Below is BRC's activity during year 20X1. Sales Revenue $11,000,000 Dividend Revenue 50,000 Gain on Sale of Equipment 7,000 Cost of Goods Sold 6,600,000 Selling Expenses 1,230,000 Administrative Expenses 920,000 Interest Expense 99,000 Income Tax Expense 456,960 Loss on Sale of Securities 32,000 What is gross profit and operating income, respectively?

Answer: $4,400,000 gross profit, $2,250,000 operating income Rationale:

When using the indirect method, which statement provides the most accurate description of the relationship between accounts receivable and the operating activities section on the statement of cash flows?

Answer: An increase in accounts receivable results in a decrease in the operating activities section on the statement of cash flows. Rationale: An increase in accounts receivable means that sales made on credit exceeded collections from customers. Since net income (the starting point of the operating activities section) uses cash sales and not cash collections, the increase in accounts receivable must be subtracted when calculating cash flow from operating activities.

According to the FASB's conceptual framework, which of the following is/are included in comprehensive income?

Answer: Gross margin and operating income Rationale: Comprehensive income includes all changes in equity during a period except changes from investments by owners and distributions to owners. Net income is the starting point for calculating it. Since operating income and gross margin are both components of net income, they are also components of comprehensive income.

The management of Arthur Energy recognized a contingent liability of $50,000 in the current year. However, before the annual report was issued, the company resolved the issue, making a lump-sum payment of $42,000. The board of directors has decided to incorporate the transaction in the subsequent year's financial statements rather than to adjust the statements about to be issued. Which of the following provisions of U.S. GAAP, if applicable, is likely to suggest that management's decision is wrong?

Answer: If an event provides additional evidence about conditions that existed as of the balance sheet date before statements are issued, and the event clarifies the estimates used, then the financial statements should be adjusted. Rationale: In this case, the amount of contingent liability needs to be revised, as the estimate of the amount of liability has changed. The subsequent event provides evidence regarding conditions present on the balance sheet date. Therefore, the financial statements need to be adjusted.

The financial statements included in the annual report to the shareholders are least useful to which one of the following? -competing businesses -stockbrokers -managers in charge of operating activities -bankers preparing to lend money

Answer: Managers in charge of operating activities Rationale: Generally, the financial statements included in the annual report to the shareholders are most useful to external stakeholders such as stockbrokers, bankers preparing to lend money, and competing businesses. Therefore, these reports are least useful to managers in charge of operating activities.

Which section of the statement of cash flows includes interest payments?

Answer: Operating Rationale: Operating cash flows are cash flows that involve the calculation of net income. Interest expense is subtracted when calculating net income. Consequently, cash used to pay interest is included in cash flows from operating activities.

The calculation of comprehensive income includes which of the following?

Answer: Operating income Rationale: Comprehensive income includes all changes in equity during a period except changes from investments by owners and distributions to owners. Net income is the starting point for calculating it. Since operating income is a component of net income, it is also a component of comprehensive income.

What is the difference between a revenue and a gain?

Answer: Revenues result from transactions related to central operations, whereas gains result from transactions related to peripheral operations. Rationale: Both revenues and gains increase net income. Revenues are the result of activities central to the organization, while gains are the result of peripheral activities.

To get the best possible idea of a firm's ability to pay cash dividends to its stockholders, potential investors should focus on the firm's:

Answer: Statement of Cash Flows Rationale: In order for a firm to be able to pay cash dividends to its shareholders, it needs to generate cash on a consistent basis. The statement of cash flows provides the best source of information concerning a firm's ability to generate cash and to sustain cash generation.

A justification for the periodic recording of depreciation expense can be demonstrated by which of the following?

Answer: Systematic and rational allocation of cost over the periods benefited Rationale: Fixed assets are subject to depreciation expense. It is necessary to record depreciation expense because fixed assets provide benefits over multiple periods. Because it is not always possible to match accomplishments (revenue) with efforts (expense) concerning fixed assets, depreciation expense must be calculated in a systematic and rational manner.

Emerson Industries sold a new issue of common stock to investors. How would this be recorded differently in the statement of cash flows than if they used the stock to purchase equipment?

Answer: The sale of stock to investors should be included in cash flows from financing activities, whereas exchange of stock for equipment should be disclosed in a separate schedule. Rationale: Issuing stock to investors is classified as a cash inflow from financing activities. Any cash-related transaction involving equity (new stock issuances, stock repurchases, and dividend payments) are considered financing activities. When stock is exchanged for equipment, it is classified as a significant non-cash activity. Significant non-cash activities are disclosed on a supplementary schedule to the statement of cash flows.

What is the difference in accounting between a research cost and a development cost?

Answer: There are no differences in accounting between research costs and development costs. Rationale: Under U.S. GAAP, research costs and development costs are treated as period costs, meaning they are expensed in the period incurred. The reason is that although the costs are incurred in order to provide future economic benefit to the company, the chances of achieving success with research and development are too difficult to gauge. To be conservative, the costs are expensed as incurred and no asset is created. The result is that there is no difference in accounting for these costs under U.S. GAAP.

The statement of shareholders' equity shows a:

Answer: reconciliation of the beginning and ending balances in shareholders' equity accounts. Rationale: The purpose of the statement of shareholders' equity is to reconcile the beginning and ending balances in shareholders' equity accounts.

All of the following are elements of an income statement except: -gains and losses -shareholders' equity -expenses -revenue

Answer: shareholders' equity Rationale: Shareholders' equity does not appear on an income statement. It appears on the balance sheet. Revenue, expenses, gains and losses all appear on an income statement.