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CHAPTER 4INCOME

STATEMENT

MULTIPLE CHOICE
1. Gross profit is the difference between:
a. net income and operating income
b. revenues and expenses
c. sales and cost of goods sold
d. income from continuing operations and discontinued operations
e. gross sales and sales discounts
ANS: C
2. Which of the following would be included in operating income?
a. interest income for a manufacturing firm
b. rent income for a leasing subsidiary
c. gain from sale of marketable securities for a retailer
d. dividend income for a service firm
e. none of the answers are correct
ANS: B
3. The following relate to Data Original in 2010. What is the ending inventory?
Purchases
Beginning Inventory
Purchase Returns
Sales
Cost of Goods Sold
a.
b.
c.
d.
e.

$540,000
80,000
10,000
800,000
490,000

$120,000
$140,000
$210,000
$260,000
none of the answers are correct

ANS: A

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4.
Changes
during 2010 were:

in account balances of Multi-Plus Inc.


Increase

Assets
Liabilities
Capital Stock
Additional Paid-In Capital
Retained Earnings

$420,000
125,000
100,000
140,000
?

Assuming that there were no charges to retained earnings other than dividends of $62,000, the net
income for 2010 was:
a. ($7,000)
b. $55,000
c. $117,000
d. $257,000
e. none of the answers are correct
ANS: C
5. When a company discontinues and disposes of a component segment of its operations, the gain or loss
from disposal should be reported as:
a. an adjustment to retained earnings
b. a sale of fixed assets in "other" expense
c. an extraordinary item
d. an accounting change
e. a special item after continuing operations and before extraordinary items
ANS: E
6. If the disposal of a segment meets the criteria of a disposal of a segment, then:
a. the loss on disposal is an extraordinary item
b. the loss on disposal is categorized as "other expense"
c. the results of operations of the segment will be reported in conjunction with the gain or
loss on disposal
d. the disposal qualifies as a change in entity, and prior years' statements presented on
comparative purposes must be restated
e. the effects of the disposal are shown as part of operations
ANS: C
7. Which of the following would be classified as an extraordinary item on the income statement?
a. loss from a strike
b. correction of an error related to a prior period
c. write-off of obsolete inventory
d. loss on disposal of a segment of business
e. loss from prohibition of a product
ANS: E

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8.
If a firm
consolidates subsidiaries that are not
wholly owned, an income statement item is created that is termed:
a. dividend income
b. minority share of earnings
c. equity income
d. extraordinary
e. gain from sale of subsidiary
ANS: B
9. Which of the following will not affect retained earnings?
a. declaration of a stock dividend
b. payment of a cash dividend previously disclosed
c. adjustment for an error of a prior period
d. net income
e. net loss
ANS: B
10. Anchor Company has 1,000,000 shares of common stock with a par value of $5. Additional paid-in
capital totals $5,000,000 and retained earnings is $8,000,000. The directors declare a 10% stock
dividend when the market value is $15. The reduction of retained earnings as a result of the declaration
will be:
a. $0
b. $500,000
c. $800,000
d. $1,000,000
e. $1,500,000
ANS: E
11. The stockholders' equity of Anamanda Company at September 30, 2010, is presented below:
Common Stock, par value $10, authorized 500,000 shares; 200,000 shares
issued and outstanding
Paid-In Capital in Excess of Par
Retained Earnings

$2,000,000
300,000
1,300,000
$3,600,000

On October 1, 2010, the Board of Directors of Anamanda declared a 10% stock dividend to be
distributed on November 10. The market price of the common stock was $15 on October 1 and $17 on
November 10. What is the amount of the charge to retained earnings as a result of the declaration and
distribution of this stock dividend?
a. $0
b. $200,000
c. $300,000
d. $340,000
e. $750,000
ANS: C

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12.
Andromeda Industries had 300,000
shares of common stock with a $3 par value and retained earnings of $180,000. In 2010, earnings per
share were $1.80. In 2009, the stock was split 3 for 1. Which of the following would not result from
the stock split?
a. The new shares would total 900,000.
b. The total amount in the capital stock account would remain the same.
c. The par value would become $1.
d. Retained earnings would be reduced.
e. The earnings per share for 2006 would be restated at $0.60.
ANS: D
13. Which of the following is not true about a stock dividend?
a. With a stock dividend, the firm issues a percentage of outstanding stock as new shares to
existing shareholders.
b. The overall effect of a stock dividend is to leave total stockholders' equity and each
owner's share of stockholders' equity unchanged.
c. In theory, with a stock dividend, total market value considering all outstanding shares
should not change.
d. Since the number of shares changes under a stock dividend, any ratio based on the number
of shares must be restated.
e. The accounting for a stock dividend, assuming the distribution is relatively small, requires
that the par value of the stock be removed from retained earnings.
ANS: E
14. Which of the following is not a category within accumulated other comprehensive income?
a. post retirement commitments on health plans
b. foreign currency translation adjustments
c. unrealized holding gains and losses on available-for-sale marketable securities
d. changes to stockholders equity resulting from additional minimum pension liability
adjustments
e. unrealized gains and losses from derivative instruments
ANS: A
15. Which of the following is a recurring item?
a. equity in earnings of nonconsolidated subsidiaries
b. error of a prior period
c. discontinued operations
d. extraordinary gain
e. cumulative effect of change in accounting principle
ANS: A
16. If Investor Company owns 20% of the stock of Investee Company and Investee Company reports
profits of $100,000, then Investor Company reports equity income of:
a. $80,000
b. $20,000
c. $40,000
d. $60,000
e. none of the answers are correct
ANS: B

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17.
Which of
the following items on the income
statement is not disclosed net of tax?
a. unusual or infrequent item disclosed separately
b. discontinued operations
c. extraordinary loss
d. cumulative effect of change in accounting principle
e. unusual or infrequent item disclosed separately and discontinued operations are both not
disclosed net of tax
ANS: A
18. Which of the following will be disclosed in the reconciliation of retained earnings?
a. adjustment for an error of a prior period
b. net income
c. net loss
d. dividends
e. all of the answers are correct
ANS: E
19. Fisher Company has 1,000,000 share of common stock with a par value of $10. Additional paid-in
capital totals $10,000,000 and retained earnings is $12,000,000. The directors declare a 6% stock
dividend when the market value is $5. The reduction of retained earnings as a result of the declaration
will be:
a. $0
b. $300,000
c. $600,000
d. $500,000
e. none of the answers are correct
ANS: B
20. Which of the following would be classified as an extraordinary item on the income statement?
a. loss on disposal of a segment of business
b. cumulative effect of a change in accounting principle
c. a sale of land
d. an error correction that relates to a prior year
e. a loss from a flood in a location that would not be expected to flood
ANS: E
TRUE/FALSE
1. In practice, the income statement is frequently considered to be the least important financial statement.
ANS: F
2. Gross profit will be a prominent figure on a single-step income statement.
ANS: F
3. An income statement is a summary of revenues and expenses and gains and losses, ending with net
income for a particular period of time.

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ANS: T
4. Advertising expense would be an administrative expense.
ANS: F
5. Other income and other expense are categories under which secondary activities of the firm not
directly related to the operations are classified.
ANS: T
6. The term primary analysis is used to describe consistent and conservative analysis.
ANS: T
7. Equity earnings can distort the reported results of a businesss operations.
ANS: T
8. Ideally, income from continuing operations would be the better income figure to use to project the
future from the analysis of historical statements.
ANS: T
9. In analysis of income, for purposes of determining a trend, extraordinary items should be included.
ANS: F
10. Extraordinary items are always presented gross of applicable income taxes.
ANS: F
11. Retained earnings, an account on the balance sheet, represents the undistributed earnings of the
corporation.
ANS: T
12. Earnings per share is the earnings per share of outstanding common stock.
ANS: T
13. Presenting an item after tax, with the related tax deducted, is called net-of-tax presentation.
ANS: T
14. Equity earnings (losses) are the proportionate share of the earnings (losses) of the investee.
ANS: T
15. It is the date of the declaration of dividends, not the date of dividend payment, that affects retained
earnings and creates the liability.
ANS: T

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16. With a stock dividend, total market value considering all outstanding shares should decline.
ANS: F
17. A stock split merely increases the number of shares of stock; it usually does not change retained
earnings or paid-in capital.
ANS: T
18. The legality of distributions to stockholders is governed by federal law.
ANS: F
19. Accountants have not accepted the role of disclosing the firms capacity to make distributions to
stockholders.
ANS: T
20. Comprehensive income is net income plus the periods change in accumulated other comprehensive
income.
ANS: T
21. The accounting standard provides considerable flexibility in reporting comprehensive income.
ANS: T
22. Since the number of shares changes under both a stock dividend and a stock split, any ratio based on
the number of shares must be restated.
ANS: T

23. Noncontrolling interest reflects income from ownership of noncontrolling shareholders in the equity of
consolidated subsidiaries less than wholly owned.
ANS: T

24. For the income statement under IFRS, there is a required format.
ANS: F

25. Under IFRS, equipment may be revalued.


ANS: T

26. IFRS allows for alternative performance measures to be presented in the income statement that are not
allowed by U.S. GAAP.
ANS: T

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PROBLEMS
1. Required: Indicate the section of a multiple-step income statement in which each of the following
items would usually appear for a manufacturing company.
a.
b.
c.
d.
e.
f.
g.
h.
i.

fire loss, net of tax


depreciation on office equipment
interest income
sales commissions
cost of goods manufactured
dividend income
advertising expense
interest expense
factory workers' salaries

ANS:
a.
b.
c.
d.
e.
f.
g.
h.
i.

extraordinary items
administrative or general expenses
other income
selling expense
cost of goods sold
other income
selling expense
other expense
cost of goods sold

2. Information related to Batavia Furniture Company for the year ended December 31, 2010, follows.
Cost of Goods Sold
Dividends Declared
Flood Loss (pre-tax)
General Expense
Other Income
Other Expense
Retained Earnings, January 1, 2010
Sales
Selling Expense

$ 70,000
5,000
12,000
8,000
9,000
11,000
116,000
131,000
7,000

Required:
Prepare in good form a multiple-step income statement for the year 2010. Assume a 50% tax rate and
that 5,000 shares of common stock were outstanding during the year.

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ANS:
Batavia Furniture Company
Income Statement
For the Year Ended December 31, 2010
Sales
Cost of Goods Sold
Gross Profit
Operating Expenses
Selling Expenses
General Expenses
Operating Income
Other Income
Other Expense
Income Before Tax
Income Tax
Income Before Extraordinary Items
Flood Loss, Net of $6,000 Tax
Net Income

$131,000
70,000
$ 61,000
$7,000
8,000

Per Share of Common Stock:


Income Before Extraordinary Item
Extraordinary Item
Net Income

15,000
$ 46,000
9,000
(11,000)
$ 44,000
22,000
$ 22,000
6,000
$ 16,000

$
$

4.40
(1.20)
3.20

3. The income statement for Lifeline Products in single-step format follows.


Lifeline Products
Income Statement
For the Year Ended December 31, 2010
Revenues:
Sales
Rent Income

$3,000,000
14,000
$3,014,000

Costs and Expenses:


Cost of Sales
Selling and Administrative Expenses
Interest Expense
Loss on the Sale of Plant Assets

2,370,000
322,000
48,000
16,000
$2,756,000
$ 258,000
112,000
$ 146,000
$
7.30

Income Before Taxes


Income Taxes
Net Income
Earnings per Share

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Required:
a.
b.
c.
d.

Convert the statement to multiple-step format.


Recompute net income with the unusual loss removed.
Why may net income with the unusual loss removed be preferable to use for trend analysis?
Speculate on why this loss is not considered extraordinary or as a disposal of a segment.

ANS:
a.
Lifeline Products
Income Statement (Multiple-Step)
For the Year Ended December 31, 2010
Sales
Cost of Sales
Gross Profit
Selling and Administrative Expenses
Operating Income
Other Income:
Rent Income
Other Expenses:
Interest Expense
Loss on Sale of Plant Assets
Income Before Taxes
Income Taxes
Net Income
Earnings per Share

$3,000,000
2,370,000
$ 630,000
322,000
$ 308,000
14,000
$48,000
16,000
$
$
$

(64,000)
258,000
112,000
146,000
7.30

b. Tax rate:
Taxes
f
Income Before Taxes

$112,000
$258,000

Loss on Sale of Plant Assets


Less: Tax Effects (43.4%)
Net Item
Net Income
Net Income with Unusual Item Removed

$
$
$

= 43.4%

16,000
(6,944)
9,056
146,000
155,056

c. The loss from sale of plant assets may not be expected to recur; hence, future operations may
be more closely related to net income with the loss removed.
d. The item is not extraordinary because the sale of parts of plant assets is not unusual. The loss
appears to relate to a few assets, not those of an entire segment. Treatment as a disposal of a
segment is therefore unwarranted.

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4.
Forta
Company presents you with the
following account balances taken from the December 31, 2010, trial balance.
Required: Prepare a single-step income statement in proper form.
Sales
Cost of Goods Sold
Cash
Selling Expenses
General and Administrative Expenses
Interest Income
Interest Expense
Accounts Receivable
Retained Earnings
Gain on Sale of Property
Accounts Payable

$200,000
80,000
10,000
20,000
15,000
3,000
2,000
15,000
60,000
2,000
15,000

Additional data:
1. 10,000 shares of common stock were outstanding the entire year.
2. The income tax rate is 35%.
ANS:
Forta Company
Income Statement
For the Year Ended December 31, 2010
Sales
Interest Income
Gain on Sale of Property
Total Revenue

$200,000
3,000
2,000
$205,000

Costs and Expenses


Cost of Goods Sold
Selling Expenses
General and Administrative Expenses
Interest Expense
Total Expense
Income Before Income Taxes
Taxes on Income
Net Income
Net Income per Common Share

80,000
20,000
15,000
2,000
$117,000
88,000
30,800
$ 57,200
$5.72

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5.
Patricia
Company owns 25% of Sandra
Company and accounts for the investment on the equity basis and does not consolidate. At the
beginning of 2010, the investment in Sandra Company was $180,000. In 2010, Sandra Company
earned $70,000 and paid dividends of $10,000.
Required:
a. How much will Patricia Company report as equity in earnings of Sandra Company in 2010?
b. How much cash flow will Patricia Company receive from Sandra Company in 2010?
c. Why does recognition of equity earnings cause problems in analysis?
ANS:
a. $70,000 25% = $17,500
b. $10,000 25% = $2,500
c. Equity earnings cause a problem in analysis because the amount of earnings are usually
different than the cash generated, as was illustrated in (a) and (b). Equity earnings also relate
to profits of another company.
6. Oregm Imports engages in the retail sale of household products and clothing. During 2010, the
company disposed of the clothing segment. Oregm Imports had 150,000 shares of stock outstanding all
year. The results of operations for 2010 follow.
Household
Products
Net sales
Cost of goods sold
Operating expenses
Loss on disposal of clothing business
(before income tax effect)
Interest expense
Extraordinary loss from expropriation of
operations in foreign country (before
income tax effect)

$15,000,000
11,400,000
1,400,000

Clothing
$3,900,000
3,500,000
300,000
680,000

40,000

80,000

Income taxes of 40% apply to all items.


Required:
Prepare a multiple-step income statement for the year ended December 31, 2010, in good format.

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ANS:
Oregm Imports
Income Statement
For the Year Ended December 31, 2010
Net sales
Cost of goods sold
Gross profit
Operating expenses
Operating income
Interest expense
Income
Income tax (40%)
Income from continuing operations
Discontinued operations:
Income during year
Less: taxes
Loss from disposal
Less: taxes
Income before extraordinary loss
Extraordinary item:
Loss from expropriation
Less: taxes
Net income

$15,000,000
11,400,000
$ 3,600,000
1,400,000
$ 2,200,000
40,000
$ 2,160,000
864,000
$ 1,296,000

$100,000
(40,000)
$680,000
272,000

$ 60,000
(408,000)
$

(348,000)
948,000

(48,000)
900,000

$ 80,000
(32,000)

Per common share:


Income from continuing operations
Discontinued operations
Income before extraordinary loss
Extraordinary item
Net income

$8.64
(2.32)
$6.32
(0.32)
$6.00

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7.
Canco
Inc. owns 70% of Supersonics and
consolidates this subsidiary. In 2010, Supersonics earned $100,000 after tax and Canco earned
$1,000,000. Without consideration of minority interests, the stockholders' equity of Supersonics at the
end of 2010 was $1,200,000.
Required:
a. Determine the minority share of earnings in 2010.
b. Determine the consolidated net income.
c. Determine the minority interest at the end of 2010 on the balance sheet.
d. How should minority interest be classified on the balance sheet for analysis?
ANS:
a. Minority share: 30% $100,000 = $30,000
b. Consolidated net income:

$1,000,000 Canco
+ 100,000 Supersonics

Noncontrolling
30,000Interest
$1,070,000

c. Noncontrolling interest: 30% $1,200,000 = $360,000.


d. Noncontrolling interest is best classified as a liability
for analysis.
8. Information for Scandinavian Products at the end of Year 4 follows.
Current Assets
Current Liabilities
Fixed Assets, Net
Investments
Long-Term Debt
Dividends Declared on Common Stock during the Year
Income Summary (income)
Retained Earnings, January 1, Year 4
Common Stock
Premium on Common Stock

$900,000
400,000
600,000
100,000
500,000
50,000
225,000
?
150,000
250,000

Required:
a. Find the ending balance in Retained Earnings as of December 31, Year 4.
b. Find the beginning balance in Retained Earnings as of January 1, Year 4.

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ANS:
a.

Ending Balance
Assets

Liabilities + Equity

900,000
600,000
100,000
__________
$1,600,000

400,000
500,000
150,000
250,000
$1,300,000
300,000
$1,600,000

Retained Earnings, Dec. 31


b. Retained Earnings, Dec. 31 =
+ Dividends

$
$

- Net Income (income summary)


Retained Earnings, Jan. 1

300,000
50,000
350,000
225,000
125,000

9. Assume that Algary, Inc. uses the following financial statements for the year ended December 31,
2010.
BS-Balance Sheet

IS-Income Statement

RE-Retained Earnings

Categories on these statements follow:


A.
B.
C.
D.
E.
F.
G.
H.
I.
J.
K.
L.
M.
N.

Current Assets
Investments
Fixed Assets
Intangible Assets
Current Liabilities
Long-Term Liabilities
Stockholders' Equity
Sales and Other Operating Revenue
Cost of Goods Sold
Operating Expenses
Other Income
Other Expense
Additions to Retained Earnings
Deductions from Retained Earnings

Required: Indicate by the statement abbreviation and category number how each of the following is
best classified or where it is included in the computation. If an item is not reported anywhere, use the
letter "X" to indicate this. Only the best answer should be selected.
For balance sheet accounts only, if the account balance is normally opposite that of a typical account
(contra), set off the answer in parentheses.
Samples.

IS H
(BS C)

Sales
Accumulated Depreciation

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a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.
m.
n.
o.
p.
q.
r.
s.
t.
u.
v.
w.

Capital Lease Obligations (due 2016 and beyond)


Federal Income Taxes Withheld
Accounts Payable
Equipment
Unearned Management Fee Revenue
Unamortized Bond Discount (due 2010)
Interest Expense
Dividends Declared for the Period
Work In Process Inventory
Purchase Returns and Allowances
Unexpired Office Insurance Expense
Rent Income (leasing company)
Treasury Stock
Office Salaries Expense
Loss on Sale of Equipment
Bank Overdrafts
Unused Sales Supplies
Bad Debt Expense
Petty Cash
Oil Wells (drilling company)
Trade Name
Stock Dividends Declared
Gain from Winning Lawsuit (suit was filed in 2006)

ANS:
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.
m.
n.
o.
p.
q.
r.
s.
t.
u.
v.
w.

BS F
BS E
BS E
BS C
BS E
(BS F)
IS L
RE N
BS A
IS I
BS A
IS H
(BS G)
IS J
IS L
BS E
BS A
IS J
BS A
BS C
BS D
RE N
IS K

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10. The income statement of


December 31, 2010, shows:

Jones Company for the year ended

Sales
Cost of goods sold
Gross profit
Operating expenses
Equity earnings of nonconsolidated subsidiaries
Operating income before income taxes
Taxes related to operations
Net income from operations before cumulative effect of change in accounting
principle
Cumulative effect of change in accounting principle (less applicable income
taxes of $30,000)
Net income

$1,800,000
1,200,000
$ 600,000
(200,000)
30,000
$ 430,000
(130,000)
$

300,000

60,000
360,000

Required:
a. Compute the net earnings after removing nonrecurring items.
b. Determine the earnings from the nonconsolidated subsidiary.
c. Determine the total tax amount.
ANS:
a.

$360,000
60,000
$300,000

b.

$ 30,000

c.

$130,000
30,000
$160,000

4-19
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