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Accounting 1020 (Chapter 13)

Sustainable income is equal to net income. True/False
False
Which amount is calculated when net income is adjusted for irregular items?
A. Sustainable income
B. Comprehensive income
C. Quality income
D. Accrual income
A. Sustainable income
Sustainable income differs from net income because of which of the following items?
A. Gains and losses
B. Gains and losses, and regular and irregular revenues
C. Irregular revenues, irregular expenses
D. Gains and losses, and irregular revenues and irregular expenses
A. Gains and losses
A corporation shows income from continuing operations of $175,000. It has an extraordinary gain (pretax) of $50,000 and its tax rate is 30%. How much is the corporation’s net income?
A. $225,000
B. $210,000
C. $140,000
D. $125,000
B. $210,000
Which of the following is not an irregular item on the income statement?
A. Discontinued operations
B. Extraordinary items
C. Other revenues and expenses
D. All of the answer choices are irregular items
C. Other revenues and expenses
How are irregular items reported on the income statement?
A. As part of sustainable income
B. In a separate section below income from sustainable operations
C. As part of other revenues and expenses
D. In a separate section below cost of goods sol
B. In a separate section below income from sustainable operations
Where are extraordinary items reported on the income statement?
A. Immediately below income from continuing operations
B. Immediately before income before income taxes
C. Immediately below income before income taxes
D. Immediately after discontinued operations
D. Immediately after discontinued operations
Which of the following is not considered to be an extraordinary item?
A. Losses attributable to a labor strike
B. Effects of rare major natural casualties
C. Expropriation of property by a foreign government
D. Effects of a newly enacted law or regulation
A. Losses attributable to a labor strike
Sudley Shoppe had severe damage done to its Christmas inventory due to an escaped circus elephant rampaging through the store. The inventory loss was $80,000 before applicable taxes of $20,000. How should Sudley Shoppe report the loss?
A. $80,000 loss in other expenses and losses
B. $80,000 extraordinary loss
C C. $60,000 extraordinary loss
D. $100,000 extraordinary loss
C. $60,000 extraordinary loss
In reporting discontinued operations, which of the following should be shown in a separate section of the income statement?
A. Gains on the disposal of the discontinued business segment
B. Wages expense
C. Depreciation expense
D. Sales revenue
A. Gains on the disposal of the discontinued business segment
Cool Stools Corporation has income before taxes of $400,000 and a pretax extraordinary loss of $100,000. If the income tax rate is 25%, the income statement should show income before irregular items and extraordinary items, respectively, of
A. $325,000 and $100,000
B. $325,000 and $75,000
C. $300,000 and $100,000
D. $300,000 and $75,000
C. $300,000 and $100,000
Which of the following is considered an “Other comprehensive income” item?
A. Gain on disposal of discontinued operations
B. Unrealized loss on available-for-sale securities
C. Extraordinary loss related to flood
D. Income before taxes
B. Unrealized loss on available-for-sale securities
According to the FASB, what is added to or subtracted from net income to determine comprehensive income?
A. Dividends
B. Additional investments by the stockholders
C. All changes in stockholders’ equity except changes resulting from transactions with stockholders
D. All changes in stockholders’ equity
C. All changes in stockholders’ equity except changes resulting from transactions with stockholders
Which of the following is income that includes all changes in stockholders’ equity during a period except those resulting from investments by stockholders and distributions to stockholders?
A. Net income
B. Income from continuing operations
C. Comprehensive income
D. Sustainable income
C. Comprehensive income
A company has net income of $200,000. Its portfolio of available-for-sale securities has a cost of $50,000 and a market value at the end of its accounting period of $54,000. How much is the company’s comprehensive income?
O A. $254,000
O B. $250,000
C C. $204,000
O D. $246,000
C. $204,000
Horizontal analysis is a technique for evaluating and comparing several companies at one time.
O A. True
C B. False
False
Total current liabilities are $10,000 in 2012, $18,000 in 2013, and $22,000 in 2014. What is the percentage increase from 2012 to 2014?
O A. 22%
O B. 80%
C C. 120%
O D. It cannot be computed from the data given
$120%
Assume the following cost of goods sold data for a company:
*2014 1,500,000
*2013 1,200,000
*2012 900,000
If 2012 is the base year, what is the percentage increase in cost of goods sold from 2012 to 2014?
A. 166.7%
B. 66.7%
C. 60.0%
D. 40.0%
66.7%
Assume the following cost of goods sold data for a company:
*2014 1,600,000
*2013 1,500,000
*2012 1,200,000
If 2012 is the base year, what is the percentage increase in cost of goods sold from 2012 to 2014?
A. 44.4%
B. 33.3%
C. 66.7%
D. 133.3%
33.3%
In horizontal analysis of a balance sheet, of what amount is each item expressed as a percentage?
A. Current year net income amount
B. Current year stockholders’ equity amount
C. Current year total assets amount
D. Base-year amount
D. Base-year amount
Adams Corporation reported net sales of $300,000, $330,000, and $360,000 in the years 2012, 2013, and 2014, respectively. If 2012 is the base year, what percentage do 2014 sales represent of the base?
A. 77%
B. 108%
C. 120%
D. 130%
C. 120%
Vertical analysis is a technique for evaluating financial statement data by expressing each item in a financial statement as a percent of a base amount in that statement.
A. True
B. False
true
The following schedule is a display of what type of analysis?

Amount/Percent/Current assets
$200,000/25%

Property, plant, and equipment
600,000/75%

Total assets
$800,000/100%

A. Horizontal analysis
B. Trend analysis
C. Vertical analysis
D. Ratio analysis

C. Vertical analysis
In vertical analysis, what is the base amount for depreciation expense?
A. Net sales
B. Depreciation expense in a previous year
C. Gross profit
D. Fixed assets
A. Net sales
Ceradyne, Inc. presented the following data for a company:
Current liabilities $360
Long-term debt 480
Common stock 640
Retained earnings 520
Total liabilities & stockholders’ equity $2,000

How would common stock appear on a common size balance sheet using vertical analysis?
A. 75.0%
B. 55.1%
C. 32.0%
D. Cannot be determined from the data given

C 32.0%
Solvency ratios measure a company’s ability to pay its currently maturing obligations.
A. True
B. False
B. False
Profitability ratios provide information about a firm’s success in generating income from operations.
A. True
B. False
A. True
Who is most interested in a company’s solvency?
A. Short-term creditors
B. Stockholders
C. Competitors
D. Long-term creditors
D. Long-term creditors
Who is most interested in a company’s current ratio?
A. Short-term creditors
B. Stockholders
C. Competitors
D. Long-term creditors
A. Short-term creditors
Which measure(s) is (are) useful in evaluating the efficiency in managing inventories?
A. Inventory turnover
B. Days in inventory
C. Both inventory turnover and days in inventory
D. None of the answer choices are correct.
C. Both inventory turnover and days in inventory
Which of the following is not a liquidity ratio?
A.Current ratio
B. Asset turnover
C. Inventory turnover
D. Accounts receivables turnover
B. Asset turnover
Plano Corporation reported net income $24,000; net sales $400,000; and average assets of $600,000 for 2014. What is the 2014 profit margin?
A. 6%
B. 12%
C. 40%
D. 200%
A. 6%
The price-earnings ratio allows investors to make a meaningful evaluation of market values and earnings across firms.
A. True
B. False
A. True
Pro forma income includes unusual and nonrecurring items.
A. True
B. False
B. False
Which situation below might indicate a company has a low quality of earnings?
A. The same accounting principles are used each year.
B. Revenue is recognized when earned.
C. Maintenance costs are capitalized and then depreciated.
D. The company’s P-E ratio is high relative to competitors.
C. Maintenance costs are capitalized and then depreciated.
Which of the following will differ under IFRS compared to statements prepared under GAAP?
A. Vertical analysis
B. Horizontal analysis
C. Ratio analysis
D. None of the above
D. None of the above
Which of the following is true for reporting extraordinary items under IFRS?
A. They are reported immediately after income from continuing operations on the income statement.
B. They are considered to be ordinary.
C. They are reported as part of comprehensive income.
D. They are reported on the balance sheet.
B. They are considered to be ordinary.
What is the income statement referred to under IFRS?
A. Statement of profit
B. Statement of earnings
C. Statement of comprehensive income
D. Operations statement
C. Statement of comprehensive income
What is the format of the one-statement income statement approach under IFRS?
A. All income items are netted together with no distinction of which items relate to comprehensive income.
B. All components of revenue and expense are reported in a combined statement which computes net income or loss followed by components of comprehensive income or loss to arrive at comprehensive income.
C. A combined statement computes comprehensive income or loss followed by deductions of the components of comprehensive income or loss to arrive at net income.
D. Items considered part of comprehensive income are listed amongst the revenues and expenses.
B.
All components of revenue and expense are reported in a combined statement which computes net income or loss followed by components of comprehensive income or loss to arrive at comprehensive income.
Sustainable Income
Net income adjusted for irregular items.
Irregular items are separately identified on the income statement. Two types are:
*Discontinued operations.
*Extraordinary items.
Discontinued Operations
*Disposal of a significant component of a business.
*Income statement should report a gain (or loss) from *discontinued operations, net of tax.
Extraordinary items are events and transactions that meet two conditions:
*Both
*Unusual in nature and
*Infrequent in occurrence
Are these considered Extraordinary Items?
Effects of major natural casualties, if rare in the area. (yes/no)
yes
Are these considered Extraordinary Items?
Effects of major natural casualties, not uncommon in the area. (yes/no)
no
Are these considered Extraordinary Items?
Write-down of inventories or write-off of receivables. (yes/no)
no
Are these considered Extraordinary Items?
Expropriation (takeover) of property by a foreign government. (yes/no)
yes
Are these considered Extraordinary Items?
Losses attributable to labor strikes. (yes/no)
no
Are these considered Extraordinary Items?
Effects of a newly enacted law or regulation, such as a condemnation action. (yes/no)
yes
Are these considered Extraordinary Items?
Gains or losses from sales of property, plant, or equipment. (yes/no)
no
sustainable income: Changes in Accounting Principle
*Principle used in the current year is different from one used in the preceding year.
*Example – change from FIFO to average cost.
*Permissible when management can show new principle is preferable.
*Most changes are reported retroactively
Comprehensive Income; All changes in stockholders’ equity except those resulting from
investments by stockholders and
distributions to stockholders.
Certain gains and losses bypass net income and instead are
reported as direct adjustments to stockholders’ equity.
Analyzing financial statements involves:
*comparison basis
*Basic tools
comparison basis
*Intracompany
*Intercompany
*Industry averages
basic tools
*Horizontal analysis
*Vertical analysis
*Ratio Analysis
Horizontal Analysis
Also called trend analysis, is a technique for evaluating a series of financial statement data over a period of time.
purpose of horizontal analysis
to determine increase or decrease that has taken place.
Hortizontal analysis is Commonly applied to the
balance sheet and income statement.
Vertical Analysis
Also called common-size analysis, is a technique that expresses each financial statement item as a percent of a base amount.
Vertical analysis is commonly applied to the
balance sheet and the income statement.
Financial Ratio Classifications
liquidity, solvency, profitability
liquidity
Measures short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash.
solvency
Measures the ability of the company to survive over a long period of time.
profitability
Measures the income or operating success of a company for a given period of time.
Which of the following is considered a disposal of a significant component of a business?
A. Shifting production activities from one location to another
B. Elimination of a major class of customers
C. Phasing out of a model
D. Disposal of part of a line of business
B. Elimination of a major class of customers
A company that has a ____ provides full and transparent information that will not confuse or mislead users of the financial statements
high quality of earnings
Pro Forma Income
*Usually excludes items that are unusual or nonrecurring.
*Some companies have abused the flexibility that pro forma numbers allow to put their companies in a more favorable light.
Alternative Accounting Methods
*Improper recognition of revenue (channel stuffing).
*Improper capitalization of operating expenses (WorldCom).
*Failure to report all liabilities (Enron).
Price-Earnings Ratio
Reflects investors’ assessment of a company’s future earnings
P-E ratio will be __ if investors think that earnings will increase substantially in the future.
higher
P-E ratio will be __ when there is the belief that a company has poor-quality earnings
lower
Analyzing financial statements involves:
*Characteristics
*Comparison
*Bases
Characteristics
*Liquidity
*Profitability
*Solvency
Comparison
Bases
*Intracompany
*Industry averages
*Intercompany
Liquidity Ratios
Measure the short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash.
Short-term creditors such as bankers and suppliers are particularly interested in ___
assessing liquidity.
Ratios include the
*current ratio
*the current cash debt coverage,
*accounts receivables turnover,
*average collection period,
*inventory turnover
*days in inventory.
Current Ratio
Expresses the relationship of current assets to current liabilities.
Current Cash Debt Coverage
Because it uses cash provided by operating activities, it may provide a better representation of liquidity.
Accounts Receivables Turnover
Measures the number of times, on average, a company collects receivables during the period.
Average Collection Period
Converts the receivable turnover ratio into days.
Inventory Turnover
Measures the number of times average inventory was sold during the period.
Days in Inventory
Measures the average number of days inventory is held.
Solvency Ratios
measure the ability of a company to survive over a long period of time.
Debt-Paying Ability
*Debt to total assets ratio
*Times interest earned
*Cash debt coverage
Free cash flow provides information about
solvency and ability to pay additional dividends or investments
Debt to Assets Ratio
Indicates the degree of financial leveraging. Provides some indication of the company’s ability to withstand losses.
Times Interest Earned
(also called interest coverage) indicates the company’s ability to meet interest payments as they come due.
Cash Debt Coverage
Indicates a company’s ability to repay its liabilities from cash generated from operating activities without having to liquidate the assets used in its operations.
Free Cash Flow
Ability to pay dividends or expand operations.
Profitability Ratios
Measure the income or operating success of a company for a given period of time.
Return on Common Stockholders’ Equity (ROE)
Shows how many dollars of net income the company earned for each dollar invested by the owners.
Return on Assets
Measures the overall profitability of assets in terms of the income earned on each dollar invested in assets.
Profit Margin –
(rate of return on sales) is a measure of the percentage of each dollar of sales that results in net income.
High-volume (high inventory turnover) businesses such as grocery stores and pharmacy chains generally have __ profit margins
low
Asset Turnover
– Measures how efficiently a company uses its assets to generate sales.
Gross Profit Rate
– Indicates a company’s ability to maintain an adequate selling price above its cost of goods sold.
Earnings Per Share
A measure of the net income earned on each share of common stock.
Price-Earnings (P-E) Ratio
Reflects investors’ assessments of a company’s future earnings
A __ P-E ratio suggests that the market is more optimistic. It might also signal that its stock is ____.
high; overpriced
Payout Ratio
Measures the percentage of earnings distributed in the form of cash dividends.
current ratio: formula
current assets/current liabilities
inventory turnover ratio: formula
COGS/average inventory
days in inventory ratio: formula
365 days/inventory turnover ratio
receivables turnover ratio: formula
net credit sales/average net receivables
average collection period ratio: formula
365 days/receivables turnover ratio
debt to total assets ratio: formula
total assets/total liabilities
gross profit rate [ratio]: formula
gross profit/net sales
profit margin ratio: formula
net income/net sales
return on assets ratio: formula
net income/average total assets
defination (purpose of): inventory turnover ratio
measure of the lqiuidity in inventory
defination (purpose of): days in inventory ratio
measure of the average # of days the inventoryo is held
defination (purpose of): receivables turnover ratio
measure of the liquidity of receivables
defination (purpose of): average collection period ratio
average # of days the receivables are outstanding
defination (purpose of): debt to total assets ratio
measure of hte % of total financing provided by creditors
defination (purpose of): gross profit rate
gross profit exprssed as a % of sales
defination (purpose of): profit margin ratio:
measure of the net income generated by each $1 of sales
defination (purpose of): return on assets ratio
profitability measure that indactes the amount of net income generated by each dollar of assets
liquidity ratios
measure the short-term liability of the company to pay its maturing obligations
solvency ratios
measure the ability of the company to survive over a long period of time
profitability ratios
measure the income or operating success of a company

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