Chapter 4 - Intermediate Accounting Spiceland 9e

ABC Tax Advisors receives what kind of revenue? What about Best Buy?

Ans: ABC --> service revenue Best Buy --> sales revenue Details:

Cash borrowed or paid to a creditor is an example of a(n) ________ activity

Ans: Financing Details: *Financing activities* relate to the external financing of the company. Cash inflows occur when cash is borrowed from creditors or invested by owners. Cash outflows occur when cash is paid back to creditors or distributed to owners. The payment of interest to a creditor, however, is classified as an operating activity.

Earnings per share is disclosed at the bottom of the _________ __________

Ans: Income statement Details: When the income statement includes discontinued operations, we report per-share amounts for both income (loss) from continuing operations and for net income (loss), as well as for the discontinued operations.

Asset turnover ratio

Details: A broad measure of asset efficiency is the asset turnover ratio. The ratio is computed by dividing a company's net sales by the average total assets available for use during a period. The denominator, average assets, is determined by adding beginning and ending total assets and dividing by two. Activity ratios: AT = NS / avg total assets RTR = NS / Avg Acc. rec (net) IT = COGS / avg inv

Average days in inventory ratio

Details: Similar to the receivables turnover, we can divide the inventory turnover ratio into 365 days to compute the average days in inventory. This measure indicates the number of days it normally takes to sell inventory. ADII = 365 / Inv. Turnover Ratio

An income statement that classifies items and uses subtotals for gross profit, operating income, and income from coninuing operations is called a ______________ - step income statement

Ans: Multiple Details: The multiple-step format reports a series of intermediate subtotals such as gross profit, operating income, and income before taxes. Most of the real-world income statements are in this format.

The DuPont formula

Ans: N/A Details: In addition to monitoring return on equity, investors want to understand how that return can be improved. The *DuPont framework* provides a convenient basis for analysis that breaks return on equity into three key components: 1) *Profitability*, measured by the profit margin (Net income ÷ Sales). As discussed already, a higher profit margin indicates that a company generates more profit from each dollar of sales. 2) *Activity*, measured by asset turnover (Sales ÷ Average total assets). As discussed already, higher asset turnover indicates that a company uses its assets efficiently to generate more sales from each dollar of assets. 3) *Financial Leverage*, measured by the equity multiplier (Average total assets ÷ Average total equity). A high equity multiplier indicates that relatively more of the company's assets have been financed with debt; that is, the company is more leveraged. As discussed in Chapter 3, leverage can provide additional return to the company's equity holders

Inventory turnover

Ans: N/A Details: The ratio is computed by dividing the period's cost of goods sold by the average inventory balance. The denominator, average inventory, is determined by adding beginning and ending inventory and dividing by two IT = COGS / Avg inventory

Receivables turnover ratio info

Ans: N/A Details: The receivables turnover ratio is calculated by *dividing a period's net credit sales by the average net accounts receivable*. Because income statements seldom distinguish between cash sales and credit sales, this ratio usually is computed using total net sales as the numerator. The denominator, average accounts receivable, is determined by adding beginning and ending net accounts receivable (gross accounts receivable less allowance for uncollectible accounts) and dividing by two.

The formula for return on equity is _______ ________ divided by average total SHE

Ans: NI Details: Equity investors typically are concerned about the amount of profit that management can generate from the resources that owners provide. A closely watched measure that captures this concern is return on equity (ROE), calculated by dividing net income by average shareholders' equity

Costs that are planned and controlled by management that materially change the scope of the business undertaken or the manner in which the business is conducted are called _________ costs.

Ans: restructuring Details: It's not unusual for a company to reorganize its operations to attain greater efficiency. When this happens, the company often incurs significant associated restructuring costs (sometimes referred to as reorganization costs or realignment costs). Restructuring costs are associated with management's plans to materially change the scope of business operations or the manner in which they are conducted. For example, facility closings and related employee layoffs translate into costs incurred for severance pay and relocation costs.

The profit margin ratio is defined as ____________ ___________ divided by net sales.

Ans: Net Income Details: The profit margin on sales is simply net income divided by net sales. The ratio measures an important dimension of a company's profitability. It indicates the portion of each dollar of revenue that is available after all expenses have been covered. It offers a measure of the company's ability to withstand either higher expenses or lower revenues What is considered to be a desirable profit margin is highly sensitive to the nature of the business activity. For instance, you would expect a specialty shop to have a higher profit margin than, say, Walmart. A low profit margin can be compensated for by a high asset turnover rate, and vice versa, which brings us to considering the trade-offs inherent in generating return on assets.

In looking at earnings quality, analysts try to separate a company's ___________ earnings effects from its ___________ earnings.

Ans: Temporary, permanent Details: One meaning of earnings quality is the ability of reported earnings (income) to predict a company's future earnings. The relevance of any historical-based financial statement hinges on its predictive value. To enhance predictive value, analysts try to separate a company's temporary earnings from its permanent earnings. Temporary earnings effects result from transactions or events that are not likely to occur again in the foreseeable future or that are likely to have a different impact on earnings in the future. In contrast, permanent earnings relate to operations that are expected to generate similar profits in the future. Analysts begin their assessment of permanent earnings with income before discontinued operations, that is, income from continuing operations

When are restructuring costs recognized on the income statement? a. In the period the exit or disposal obligation is incurred b. In the period included in management's budget c. In the period following the disposal of the assets d. In the period the exit or disposal obligation is paid

Ans: a Details: Restructuring costs are recognized in the period the exit or disposal cost obligation actually is incurred. Suppose, as part of a restructuring plan, employees to be terminated are offered various benefits but only if they complete a certain period of work for the company. In that case, a liability for termination benefits, and corresponding expense, should be accrued in the required period(s) of work. On the other hand, if future work by the employee is not required to receive the termination benefits, the liability and corresponding expense for benefits are recognized at the time the company communicates the arrangement to employees. Similarly, costs associated with closing facilities and relocating employees are recognized when goods or services associated with those activities are received.

Inflows and outflows of cash related to the acquisition and disposition of long-lived assets used in operations and investment assets are what type of cash flow? a. Investing b. Operating c. Financing

Ans: a Details: above

The two types of adjustments to net income for the indirect method are adjustments for a. Components of net income that do not affect cash b. Changes in operating assets and liabilities during the period that affected cash and were not in net income c. Changes in liabilities and owners' equity accounts during the period that affected cash d. Changes in owner's equity accounts during the period that affected cash

Ans: a, b Details: By the indirect method, cash flow from operating activities is derived indirectly by starting with reported net income and adding or subtracting items to convert that amount to a cash basis Two types of adjustments to net income are needed. First, components of net income that do not affect cash are reversed. That means that noncash revenues and gains are subtracted, while noncash expenses and losses are added. For example, depreciation expense does not reduce cash, but it is subtracted in the income statement. To reverse this, then, we add back depreciation expense to net income to arrive at the amount that we would have had if depreciation had not been subtracted in the first place. Second, we make adjustments for changes in operating assets and liabilities during the period that indicate that amounts included as components of net income are not the same as cash flows for those components. For instance, suppose accounts receivable increases during the period because cash collected from customers is less than sales revenue. This increase in accounts receivable would then be subtracted from net income to arrive at cash flow from operating activities. In the indirect method, positive adjustments to net income are made for decreases in related assets and increases in related liabilities, while negative adjustments are made for increases in those assets and decreases in those liabilities.

Gains and losses are increases or decreases in equity from which type of transactions? a. Incidental b. Primary c. Peripheral d. Causal

Ans: a, c Details: Gains and losses are increases or decreases in equity from *peripheral or incidental transactions* of an entity. In general, these gains and losses result from changes in equity that do not result directly from operations but nonetheless are related to those activities. For example, the sale of equipment, buildings, or other operating assets for an amount that differs from their recorded amount results in a gain or loss.

Investing activities involve the acquisition and sale of a. Nonoperating investment assets b. Inventories sold in normal operations c. Long-Lived assets used in business operations

Ans: a, c Details: Investing activities involve the acquisition and sale of (1) long-term assets used in the business (2) nonoperating investment assets. *Cash flows from investing activities* include inflows and outflows of cash related to the acquisition and disposition of long-lived assets used in the operations of the business (such as property, plant, and equipment) and investment assets (except those classified as cash equivalents and trading securities). *The purchase and sale of inventories are not considered investing activities*. Inventories are purchased for the purpose of being sold as part of the company's operations, so their purchase and sale are *included with operating activities* rather than investing activities.

The purpose of the statement of cash flows includes which of the following? a. Provide information about cash receipts during a period b. Provide information about cash disbursements on a specific date c. Provide information about cash disbursements during a period d. Provide information about cash reveipts on a specific date.

Ans: a, c Details: When a balance sheet and an income statement are presented, a statement of cash flows (SCF) is required for each income statement period. The purpose of the SCF is to provide information about the cash receipts and cash disbursements of an enterprise. Similar to the income statement, it is a change statement, summarizing the transactions that affected cash during the period. The term cash in the statement of cash flows refers to the total of cash, cash equivalents, and restricted cash

Which of the following are commonly used to assess a company's profitability? a. Profit margin on sales b. Quick ratio c. Return on shareholder's equity d. Return on assets e. Current Ratio

Ans: a, c, d Details: A fundamental element of an analyst's task is to develop an understanding of a firm's profitability. Profitability ratios attempt to measure a company's ability to earn an adequate return relative to sales or resources devoted to operations. Resources devoted to operations can be defined as total assets or only those assets provided by owners, depending on the evaluation objective. Three common profitability measures are (1) the profit margin on sales PM = NI / NS (2) the return on assets ROA = NI / Avg Total Assets (3) the return on shareholders' equity. ROSHE = NI / Avg SHE

Which of the following are cash outflows from financing activities? a. Repayment of note payable b. Purchase of equipment c. Issuance of common stock d. Payment of income taxes e. Payment of dividends

Ans: a, e Details: Cash inflows include cash received from the following: 1) Owners when shares are sold to them 2) Creditors when cash is borrowed through notes, loans, mortgages, and bonds Cash outflows include cash paid to the following: 1) Owners in the form of dividends or other distributions 2) Owners for the reacquisition of shares previously sold 3) Creditors as repayment of the principal amounts of debt (excluding trade payables that relate to operating activities)

Other comprehensive income is reported in the current reporting period on the income statement or as an addition to the income statement, and _______________ other comprehensive income is reported on the balance sheet.

Ans: accumulated Details: In addition to reporting OCI that occurs in the current reporting period, we must also report these amounts on a cumulative basis in the balance sheet. This is consistent with the way we report net income for the period in the income statement and also report accumulated net income (that hasn't been distributed as dividends) in the balance sheet as retained earnings. Similarly, we report OCI for the period in the statement of comprehensive income and also report *accumulated other comprehensive income (AOCI) in the balance sheet*.

Non - GAAP earnings are a. Historical earnings for the previous 3 years b. Management's estimates and view of earnings c. A good performance measure because they are audited d. Exclusively used for financial statement analysis

Ans: b Details: Companies are required to report earnings based on Generally Accepted Accounting Principles (GAAP). This number includes all revenues and expenses. Most companies, however, also voluntarily provide non-GAAP earnings when they announce annual or quarterly earnings. Non-GAAP earnings exclude certain expenses and sometimes certain revenues. Common expenses excluded are restructuring costs, acquisition costs, write-downs of impaired assets, and stock-based compensation. Supposedly, *non-GAAP earnings are management's view of "permanent earnings,"* in the sense of being a better long-run measure of its company's performance. Nearly all major companies report non-GAAP earnings. For example, Hewlett-Packard Company reported GAAP earnings in 2015 of $4.6 billion or $2.48 per share. At the same time, the company announced that its non-GAAP earnings for the year were $6.6 billion or $3.59 per share (nearly 50% higher than GAAP earnings). The difference in earnings numbers relates primarily to management excluding certain restructuring charges, amortization of intangible assets, and employee separation costs in the calculation of non-GAAP earnings. Non-GAAP earnings are controversial. Non-GAAP earnings are controversial because determining which expenses to exclude is at the discretion of management. By removing certain expenses from reported GAAP earnings, management has the potential to report misleadingly higher profits.

In calculating basic earnings per share, _______ is divided by the weighted average common shares outstanding. a. Net income plus preferred stock dividends b. Net income less any preferred stock dividends c. Ending retained earnings of the period d. Average total assets at the end of the period.

Ans: b Details: U.S. GAAP requires that public companies report two specific calculations of EPS: (1) basic EPS and (2) diluted EPS. Basic EPS equals total net income (less any dividends to preferred shareholders) divided by the weighted-average number of common shares outstanding. Dividends to preferred shareholders are subtracted from net income in the numerator because those dividends are distributions of the company not available to common shareholders. The denominator is the weighted-average number of common shares outstanding, rather than the number of shares outstanding at the beginning or end of the period, because the goal is to relate performance for the period to the shares that were in place throughout that period. The number of common shares may change over the year from additional issuances or company buybacks, so a weighted average better reflects the number of shares outstanding for the period. The resulting EPS provides a measure of net income generated for each share of common stock during the period.

Green Company has net credit sales of $100,000, an asset turnover ratio of 4, and a receivables turnover ratio of 9. What is the average collection period? a. 11.1 days b. 40.6 days c. 36 days d. 25 days

Ans: b Details: A convenient extension to receivables turnover ratio is the *average collection period*. This measure is computed by *dividing 365 days by the receivables turnover ratio*. The result is an approximation of the *number of days the average accounts receivable balance is outstanding*. i.e.) ACP = 365 / RTR RTR = NS / Avg Acc. Rec (net)

Discontinued operations should be reported on the income statement a. Pre-tax before income from continuing operations b. Net of tax below income from continuing operations c. Net of tax in operating income d. Pre-tax with other income and other loss in operating income

Ans: b Details: Sometimes a company decides to discontinue (or sell) part of its business. For example, in 2015 Abbott Laboratories decided to sell its businesses related to developed markets branded generic pharmaceuticals and animal health. Obviously, profits from these discontinued operations will not continue. Because profits from these operations are considered to have a material effect on the income statement, Abbott Laboratories reported them separately to allow statement users to focus on continuing operations. We saw in the introduction of this chapter how Abbott Laboratories reported discontinued operations separately, below income from continuing operations.

Operating and nonoperating items are NOT separately classified in a ________ - step income statement

Ans: single Details: The *single-step* format first lists all the revenues and gains included in income from continuing operations. Then, expenses and losses are grouped, subtotaled, and subtracted—in a single step—from revenues and gains to derive income from continuing operations. In a departure from that, though, companies usually report income tax expense in a separate line in the statement. Operating and nonoperating items are not separately classified.

The purpose of the statement of cash flows include which of the following? a. Provide information about the revenues that occured during the period b. Provide information about cash disbursements that occurred during the period c. Provide information baout the financing activities that occurred during the period d. Provide information about the expenses that occurred during the period e. Provide information about cash receipts that occurred during the period f. Provide infomration about the investing activities that occurred during the period.

Ans: b, c, e, f Details: The statement of cash flows provides information about the cash receipts and cash payments of a company during a particular reporting period. The difference between cash receipts and cash payments represents the change in cash for the period. To help investors and creditors better understand the sources and uses of cash during the period, the statement of cash flows distinguishes among operating, investing, and financing activities

Which items must be removed from continuing operations and reported separately for a discontinued operation? a. liabilities b. tax expense c. expenses d. assets e. Revenues f. gains

Ans: b, c, e, f Details: above

If a component of the business qualifies for discounted operations treatment, which of the following statements are true? a. Revenue from the discontinued operations is listed immediately below revenue in the operating section of the income statement b. The tax expense effect is removed from continuing operations c. Revenues and expenses are reported in continuing operations, but gains and losses are reported as discontinued operations d. All related revenues, expenses, gains, and losses must be removed from continuing operations.

Ans: b, d Details: By definition, the income or loss stream from a discontinued operation no longer will continue. A financial statement user is more interested in the results of their operations that will continue. It is informative, then, for companies to separate the effects of the discontinued operations from the results of operations that will continue. For this reason, the *revenues, expenses, gains, losses, and income tax related to a discontinued operation must be removed from continuing operations and reported separately for all years presented*

When a component that qualifies as a discontinued operation is held for sale, what are the two elements that may be reported in discontinued operations? a. Edtimated gain from the sale of the component b. Estimated impairment loss expected from the sale of the component c. Revenues and expenses related to the component d. Operating income or loss of the component during the reporting period

Ans: b, d Details: What if a company has decided to discontinue a component but, when the reporting period ends, the component has not yet been sold? If the situation indicates that the component is likely to be sold within a year, the component is considered "held for sale." In that case, the income effects of the discontinued operation still are reported, but the two components of the reported amount are modified as follows: 1) Income or loss from operations (revenues, expenses, gains and losses) of the component from the beginning of the reporting period to the end of the reporting period 2) An impairment loss if the book value (sometimes called carrying value or carrying amount) of the assets of the component is more than fair value minus cost to sell The two income elements can be combined or reported separately, net of their tax effects. In addition, if the amounts are combined and there is an impairment loss, the loss must be disclosed, either parenthetically on the face of the statement or in a disclosure note.

Revenues, expenses, gains, and losses that will likely continue in future periods make up what? a. Income from discontinued operations b. Gross revenue c. Income from continuing operations d. Gross margin

Ans: c Details: Income from continuing operations includes revenues, expenses (including income taxes), gains, and losses arising from operations that are more likely to continue. In contrast, income from discontinued operations will not continue into the future. The three major components of income from continuing operations include: 1) Operating income 2) Nonoperating income 3) Income tax expense

Which of the following terms is also used as a heading for an income statement? a. Statement of Cash Flows b. Statement of Business Activities c. Statement of Operations d. Statement of Performance Indicators

Ans: c Details: Income statement (also called statement of operations or statement of earnings) The income statement reports a company's profit during a particular reporting period. Profit equals revenues and gains minus expenses and losses. A few types of gains and losses are excluded from the income statement but are included in the broader concept of comprehensive income. We refer to these other gains and losses as other comprehensive income (OCI)

The two approaches most commonly used to prepare an income statement are a. Operating and nonoperating b. Current and noncurrent c. Single-step and multiple-step d. Direct and indirect

Ans: c Details: No specific standards dictate how income from continuing operations must be displayed, so companies have considerable latitude in how they present the components of income from continuing operations. This flexibility has resulted in a variety of income statement presentations. However, we can identify two general approaches, the single-step and the multiple-step formats, that might be considered the two extremes, with the income statements of most companies falling somewhere in between.

The statement used to predict future profitability and a company's future cash-generating ability is the.... a. Statement of financial position b. Statement of SHE c. Income statement d. Balance sheet

Ans: c Details: The income statement reports a company's profit during a particular reporting period. Profit equals revenues and gains minus expenses and losses. A few types of gains and losses are excluded from the income statement but are included in the broader concept of comprehensive income. We refer to these other gains and losses as other comprehensive income (OCI)

To qualify as an operation for purposes of determining discontinued operations, which of the following must occur? a. The operation must have completed a separate tax return in the past 2 years. b. The operation must have been in business for more than 3 years c. A component of the entity has been sold, disposed of, or is held for sale d. A strategic shift is represented that will have a major effect on financial results

Ans: c, d Details: Discontinued operations are reported when: 1) A component of an entity or group of components has been sold or disposed of, or is considered held for sale, For the first item, a component of an entity includes activities and cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the company. A component could include an operating segment, a reporting unit, a subsidiary, or an asset group. 2) If the disposal represents a strategic shift that has, or will have, a major effect on a company's operations and financial results For the second item, whether the disposal represents a strategic shift requires the judgment of company management. Examples of possible strategic shifts include the disposal of operations in a major geographical area, a major line of business, a major equity method investment, or other major parts of the company

The operating activities section on the statement of cash flows includes the elements of net income on a(n) ___________ basis rather than a(n) _________ basis.

Ans: cash, accrual Details: The difference between the inflows and outflows is called net cash flows from operating activities. This is equivalent to net income if the income statement had been prepared on a cash basis rather than an accrual basis.

A component is qualified as a discontinued operation. What are the two elements that may be reported in discontinued operations on the income statement if the component is not sold by the end of the reporting period? a. Operating income or loss from the component and an impairment loss both reported without consideration of the tax effects b. Revenues and gains of the components for the period c. Estimated gain on sale of the component and the related tax effects d. Operating income or loss from the component and an impairment loss both reported on a net of tax basis.

Ans: d Details: above

The two acceptable methods under GAAP for preparing the statement of cash flows are the _______ method and the ________ method.

Ans: direct, indirect Details: Two generally accepted formats can be used to report operating activities, the direct method and the indirect method. Under the direct method, the cash effect of each operating activity is reported directly in the statement. For example, cash received from customers is reported as the cash effect of sales activities. Income statement transactions that have no cash flow effect, such as depreciation, are simply not reported. By the direct method, the cash effect of each operating activity is reported directly in the SCF.

The outflows of resources incurred while generating revenue are referred to as __________

Ans: expenses Details: *Expenses* are outflows of resources incurred while generating revenue. They represent the costs of providing goods and services. When recognizing expenses, we attempt to establish a causal relationship between revenues and expenses. If causality can be determined, expenses are reported in the same period that the related revenue is recognized. If a causal relationship cannot be established, we relate the expense to a particular period, allocate it over several periods, or expense it as incurred.

When a discontinued operation is sold before the end of the reporting period, the income or loss from operations and the _______________ or _______________ on the disposal of assets is included in the reported income

Ans: gain, loss Details: When the discontinued component is sold before the end of the reporting period, the reported income effects of a discontinued operation will include two elements. 1) Income or loss from operations (revenues, expenses, gains, and losses) of the component from the beginning of the reporting period to the disposal date 2) Gain or loss on disposal of the component's assets The first element would consist primarily of income from daily operations of this discontinued component of the company. This would include typical revenues from sales to customers and ordinary expenses such as cost of goods sold, salaries, rent, and insurance. The second element includes gains and losses on the sale of assets, such as selling a building or office equipment of this discontinued component.

Which of these are cash inflows and which are cash outflows? a. Sale of services for cash b. Payment of salaries c. Collection on account d. Payment on account

Ans: in = a, c out = b, d Details: Cash inflows include cash received from the following: 1) Customers from the sale of goods or services 2) Interest and dividends from investments These amounts may differ from sales and investment income reported in the income statement. For example, sales revenue measured on the accrual basis reflects revenue recognized during the period, not necessarily the cash actually collected. Revenue will not equal cash collected from customers if receivables from customers or deferred revenue changed during the period. Cash outflows include cash paid for the following: 1) The purchase of inventory 2) Salaries, wages, and other operating expenses 3) Interest on debt 4) Income taxes Likewise, these amounts may differ from the corresponding accrual expenses reported in the income statement. Expenses are reported when incurred, not necessarily when cash is actually paid for those expenses. Also, some revenues and expenses, like depreciation expense, don't affect cash at all and aren't included as cash outflows from operating activities.

The calculation of __________ income omits certain gains and losses that are instead included in the broader perspective of ___________ income.

Ans: net, comprehensive Details: The calculation of* net income* omits certain types of gains, losses, and other adjustments that are instead included in other comprehensive income (OCI). As one example, in Chapter 12 you will learn that certain investments are reported in the balance sheet at their fair values, but that the gains and losses resulting from adjusting those investments to fair value might not be included in net income. Instead, they are reported as other comprehensive income (loss). Companies must report both net income and comprehensive income and reconcile the difference between the two. Be sure to remember that net income actually is a part of comprehensive income. The reconciliation simply extends net income to include other comprehensive income items, reported net of tax,

The classifications on the statement of cash flows are cash flows form....

Ans: read details Details: A list of cash flows is more meaningful to investors and creditors if they can determine the type of transaction that gave rise to each cash flow. Toward this end, the statement of cash flows classifies all transactions affecting cash into one of three categories: (1) operating activities (2) investing activities (3) financing activities.