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business
financial reporting and analysis

Questions and Answers of Financial Reporting and Analysis

Describe the effects that reported earnings have on managers’ wealth and, consequently, on their accounting policy decisions. p-635
Describe the differences between revenues and gains. Also distinguish between expenses and losses. Explain why these items are usually disclosed separately on income statements. p-635
Explain why a firm might elect to report its annual income using a fiscal year-end that doesn’t end on December
p-635
In deciding which items to disclose on the income statement, managers are guided by the materiality principle. Explain how this principle would affect a decision about whether to disclose a firm’s
Often the first item on a firm’s income statement is labeled “Net sales” or “Sales revenue.” Discuss the measuring of these terms. Why do you think this is displayed so prominently on the
Why do most companies disclose the cost of goods sold as a separate item on the income statement? How might this item differ for merchandising firms versus manufacturing firms? Why might some firms
Explain why interest expense is not considered to be an operating expense by most firms. Identify several types of businesses where interest expense might be reported as an operating expense? p-635
Distinguish between a single-step and a multiple-step income statement. Why is a multiple-step format usually more informative to the reader? p-635
Identify and discuss several decisions that managers make based on information from the income statement. Include a discussion of the basic purpose and objectives of an income statement. p-635
Identify and discuss the kinds of information that investors in a firm’s debt and equity securities may seek when reading the income statement. What decisions will usually be of interest to such
Explain the two criteria that must be met for a firm to recognize revenue in its income statement. Discuss how these criteria might be applied to revenue recognition by (a) a fast-food restaurant and
Discuss the purpose of the matching principle, and explain the three ways in which this principle is implemented. p-635
Determine how the matching principle would affect recognition of the following items: (a) cost of inventory sold, (b) depreciation expense of production equipment, and (c) expenditures for new
Income statements are often used in order to provide a historical measure of a firm’s performance, and are also used as a basis for predicting future profitability. How are income statements useful
Why are extraordinary items reported separately in the income statement? Identify an event that would be classified by one firm as an ordinary item and by another firm as an extraordinary item?
Discuss the differences between revenues and profits. Where do each appear on the income statement? Why is it important to keep these two separate? p-635
Discuss the differences between profits and profitability. In what context might they be used interchangeably? When must they be kept separate? p-635
Define the accounting principle of conservatism. Why would a manager or owner prefer conservative profits? When would a manager or owner prefer that income or profit not be measured
Explain why GAAP requires that income taxes be allocated to each major section of the income statement. p-635
Under what circumstances might an income statement report a tax benefit? p-635
Discuss the meaning of a “restructuring charge” and explain why you believe that such charges should (or should not) be reported as extraordinary items in the income statement. How does the
Describe the construction of a common-size income statement. Why is the selection of the base (the number selected as the 100% figure) so important? Discuss how common-size statements are used in a
Identify three reasons why a firm’s gross profit (gross margin) percentage might change over time. p-635
Discuss several reasons why a firm’s net income percentage might change over time. Discuss how financial statements help explain the reasons for changes in the net income percentage over time?p-635
Distinguish between vertical analysis and trend analysis of the income statement. Describe two ways of implementing a trend analysis. p-635
Provide two examples of ratios that link the income statement and the balance sheet. In each case, explain why it is useful to relate the items that appear in the numerator and the denominator of the
The ratios discussed in this chapter include return on assets, return on shareholders’equity, and times interest earned. In each case, a different measure of income is used. Identify and discuss
The chapter states that “accounting income does not strictly measure changes in wealth.”Provide two examples of changes in wealth that would not be reported currently in the income statement. In
Describe the nature of a big bath reported in the income statement. How would a big bath affect reported income in later years? What is the likely effect of a big bath on a firm’s stock price in
Conduct a vertical analysis of the income statement for Hahn Automotive Warehouse in Exhibit 4-4. Discuss Hahn’s profitability (or lack thereof). p-635
For each numbered item, indicate (by letter) where in the income statement it belongs.a. Revenuese. Other Income and Expensesb. Cost of Goods Soldf. Separate Line Item, Net of Taxc. Selling Expenses
Commissions expense _____
Gain on sale of land _____
Dividends declared and paid _____
Prepaid rent _____
Depreciation expense for office equipment _____
Interest expense _____
Tornado loss (business located in Kansas)_____
Merchandise inventory _____
Income tax payable _____
Loss on discontinued operations p-635
Woodway Company’s annual report contained the following data (dollars in millions) on its income statement Interest expense $ 2,489 Investment income 11,218 Other income 9,033 Depreciation 1,257
The Woodway Company included the following note in its 2000 annual report:In June 2000, Woodway Company and its principle subsidiaries filed for protection under Chapter 11 of the United States
James Hardie Industries Ltd. is an Australian company specializing in building materials. It also has several plants in the USA specializing in producing fibrecement roofing materials. It reported
Sort the following account titles according to whether they would appear on the income statement or the balance sheet:
Answer each of the following independent questions:a. The return on equity for the Hammond Corporation for the year ended December 31, 1999, is 9%. The owners’ equity balances on December 31, 1998
The following data were provided by Bluebird Company for calendar year 1999:Sales $350,000 Gross margin percentage 45%Net income percentage 8%Income tax percentage 25%
Spinner Sewing Corporation was incorporated on January 1, 2000. Three investors each invested $150,000 in exchange for $150,000 of common stock of the corporation. The following transactions took
Purchased merchandise inventory on account, $200,000.
Rent paid on January 2 for a two-year period, $48,000.
Borrowed $100,000 on March 31 at a 10% annual interest rate for one year.
Sold goods at retail, $300,000; half for cash, half on account. The cost of goods sold was $135,000.
Paid $120,000 on outstanding bills owed to inventory suppliers.
Received $80,000 from receivables customers.
Incurred operating expenses of $36,000, of which $14,000 was paid in cash and the balance on account.Requireda. Record the above transactions, including the initial investment, in the accounting
Expired portion of prepaid rent
Accrued interest expense
Accrued income tax. Assume 20% tax rate.c. Prepare a multiple-step income statement for the year ended December 31, 2000.d. Calculate:
Gross profit percentage
Operating income percentage
Net income percentagee. Calculate:
Return on assets
Return on equityf. Evaluate the performance of the corporation. What other transactions would you typically expect to see?g. What if the corporation discontinued part of its operations during the
Boomingdales, Inc., reported the following transactions:
Purchased $150 of equipment on account. The corporation has over $1 million in assets.
Sold merchandise at retail of $150,000 during the year on account. Customers returned $10,000 of merchandise at retail for credit on their accounts. (Ignore cost of goods sold.)
Received $40,000 in advance from customers.
Recorded annual depreciation of $280,000.Requireda. Record the above transactions in the accounting equation. Set up separate account columns as needed.b. Discuss the generally accepted accounting
Use the following comparative income statements to evaluate Clarkson Brewery’s performance for the year ended December 31, 1999 and 1998.1999 1998 Net sales $405,000 $378,000 Operating
Amherst Trucking Co. had the following pre-tax amounts of revenues, expenses, gains, and losses during 2000. All items are subject to an income tax rate of 40%.Revenues $1,500,000 Operating expenses
Equity Cushion Co. reports the following items in its financial statements:1998 1999 Net income $16,000,000 $24,000,000 Common shares outstanding 1,000,000 shares 1,200,000 shares Requireda.
P-Town O’Malley’s 2000 income statement reported net income of $6 million. A vertical analysis of the income statement shows the following:Net sales percentage ?%Cost of products sold percentage
The Miami Rockies, a recently transplanted baseball franchise, reported the following income statement and horizontal percentages:1999 Amount Percentage Changes(Hundreds of $) During 2000 Revenues $
Ben-Shien’s Wonton Works produces two grades of dumpling wrappers, standard and deluxe. Sales and cost of sales for both products for 1999 and 2000 were:1999 2000(Dollars in thousands)Standard
The following transactions are given:1, Rent for two months of $1,200 was paid in advance.2, A customer’s order was received for a bridal veil that will be billed at delivery for $120.3, Supplies,
Consider the following transactions for the publishers of Mobile Home Improvement. This magazine is produced monthly and sold on newsstands and to annual subscribers.1, Mobile Home Improvement
McGucken’s Software sold $1,354,000 of merchandise for cash and had credit sales totaling $2,658,000. It collected cash from customers in the amount of$3,396,000. McGucken’s received merchandise
Denny’s CPA School provided the following vertical analysis of its income statements for 1999 and 2000:Percentage of Revenues 1999 2000 Revenues 100% 100%Salaries expense 40 45 Rentals expense 20
Prepare Neville Company’s disclosure related to the accounting change; limit disclosure of financial statement line items affected by the change in accounting principle to those appearing on the
Prepare Neville Company’s 2011 and 2010 income statements reflecting the retrospective application of the accounting change from the LIFO method to the FIFO method. LO.1
McDonald’s believes that locally owned and operated restaurants help the Company maximize brand performance and are at the core of its competitive advantage, making McDonald’s not just a global
McDonald’s uses different critical events to recognize revenue for its different business activities. Identify the critical events and rank them from the most to the least conservative policy based
Is there any reason for management to prefer discontinued operations treatment for these noncore business units? LO.1
Assume that in February 2011 a potential buyer of another of the domestic noncore business units insisted on a site assessment prior to signing a purchase commitment. The assessment’s purpose was
Suppose that in March 2011 a buyer signed a purchase commitment for Corrpro’s Rohrback Cosasco Systems division. This sale requires regulatory approval that is expected to take at least 18 months
What criteria must be met to warrant reclassifying the noncore business units as discontinued operations effective with the quarter ending September 30, 2010? LO.1
Identify the key differences between Stanley’s current presentation and the format under the FASB/IASB proposal. LO.1
Prepare Stanley’s Statement of Comprehensive Income for 2009 using the sections and categories recommended in the joint FASB/IASB proposed exposure draft on financial statement presentation. LO.1
Draft the disclosures required by current GAAP related to this restatement. LO.1
Restate the 2010 financial statements as they should appear for comparative purposes in the 2011 annual report. LO.1
Prepare whatever disclosure is required under current GAAP as a result of this change. LO.1
How should Barden’s 2011 comparative financial statements reflect this change in accounting principle? LO.1
Smithfield has been in business for 65 years. The company occasionally issues term bonds, but has not previously retired bonds prior to normal maturity. LO.1
Such early debt retirements are part of Smithfield’s risk management strategy. LO.1
The firm experienced an (extraordinary) uninsured tornado pre-tax loss in the amount of $83,500. LO.1
Jordan Wing suffered a $23,000 impairment loss in 2010, which it failed to record. LO.1
The firm changed its method of depreciating fixed assets from the straight-line method to the declining balance method, which was used to determine income in 2011. LO.1
Sale of 10,000 shares of Xerox stock held as a short-term investment resulted in a gain of$23,450. LO.1
The corporation disposed of its catalog sales component at a pre-tax loss of $345,000. This transaction meets the criteria for discontinued operations. LO.1

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