20 Questions
Which type of earnings are not likely to occur again in the foreseeable future and may have a different impact on earnings in the future?
Permanent earnings
What is the term used to describe the process of overestimating expenses in the current year to reduce net income and then reversing those estimates in future years to increase net income?
Earnings smoothing
In what circumstances are restructuring costs recognized?
When management plans to change the scope of business operations
Which of the following is an example of nonoperating income that relates only tangentially to normal operations?
Interest income or interest expense
What must companies provide when reporting non-GAAP earnings, according to the Sarbanes-Oxley Act?
Reconciliation between non-GAAP and GAAP earnings
Which of the following statements accurately describes the relationship between revenues and expenses?
Expenses are recognized in the same period as the related revenue to establish a causal relationship.
What is the purpose of the Statement of Cash Flows?
To provide information about cash receipts and cash payments.
Which of the following is not a characteristic of revenues as described in the text?
Revenues are recognized when the related expenses are incurred.
What is the purpose of the Comprehensive Income (other comprehensive income) section?
To include a few types of gains and losses excluded from the Income Statement.
Which of the following statements is true regarding the recognition of expenses?
Expenses can be allocated over several periods or expensed as incurred.
Which of the following statements regarding discontinued operations is correct?
When a discontinued component is sold before the end of the reporting period, the income effects include income or loss from operations of the component from the beginning of the reporting period to the disposal date, as well as any gain or loss on disposal of the component's assets.
When a company changes from one acceptable accounting method to another, which of the following approaches is used for implementing the change?
All of the above
How are voluntary changes in accounting principles accounted for?
They are accounted for retrospectively by revising prior years' financial statements.
Which of the following statements regarding changes in accounting estimates is correct?
Changes in accounting estimates are accounted for prospectively, and if the effect of the change is material, a disclosure note is required.
In the calculation of diluted earnings per share (EPS), which of the following statements is true?
Diluted EPS incorporates the dilutive effect of all potential common shares, resulting in a lower EPS compared to basic EPS.
Which of the following is a key difference between GAAP and IFRS in reporting comprehensive income?
GAAP prohibits changes in revaluation surplus, while IFRS allows revaluation.
In the context of a statement of cash flows, which activity involves the purchase of inventory?
Operating activities
What does the statement of cash flows provide information about?
Cash receipts and disbursements
Under the Direct Method of reporting on the statement of cash flows, how are operating activities presented?
Cash effect of each activity is reported directly
What do Noncash Investing and Financing Activities involve?
Activities that do not involve any cash flows
Study Notes
Income Statement Presentation
- GAAP requires expenses to be classified by function
- SEC regulations require certain minimum information to be reported on the face of the income statement
- IFRS allows expenses to be classified either by function or by natural description
- The "bottom line" of the income statement is usually called net income or net loss in GAAP, and profit or loss in IFRS
Earnings Quality
- Ability of reported earnings to predict a company's future earnings
- Earnings quality refers to the degree to which earnings are likely to recur in the future
- Permanent earnings are not likely to occur again in the foreseeable future and are likely to have a different impact on earnings in the future
- Temporary earnings result from transactions that are likely to generate similar profits in the future
Operating Income and Earnings Quality
- Income smoothing: creating a smoother pattern in earnings over time by altering assumptions and estimates
- Classification shifting: shifting operating expenses to a nonoperating expense classification to report fewer operating expenses and higher operating income
- Restructuring costs: costs associated with management's plans to materially change the scope of business operations
- Recognized in the period the exit or disposal cost obligation actually is incurred
Operating Income and Earnings Quality—Other Unusual Items
- Long-lived asset impairments: tangible or intangible asset balance reduced if there has been a significant impairment of value
- Revenue issues affecting earnings quality: misstatement of revenue, premature revenue recognition, and loss of a major customer
Non-GAAP Earnings
- Companies are required to report earnings based on GAAP, including all revenues and expenses
- Non-GAAP earnings exclude certain revenues and expenses, such as restructuring costs, acquisition costs, write-downs of impaired assets, and stock-based compensation
- Non-GAAP earnings are controversial since the expenses to exclude are at the discretion of management
Discontinued Operations
- If a company decides to sell or dispose of a component of their business, profits from these discontinued operations will not continue
- Discontinued operations are reported when a component of an entity or group of components has been sold, disposed of, or is considered held for sale
Comprehensive Income
- Includes a few types of gains and losses excluded from the income statement
- Reports the revenues, expenses, gains, and losses that have occurred during the reporting period
Statement of Cash Flows
- Provides information about cash receipts and cash payments
- Reports the revenues, expenses, gains, and losses that have occurred during the reporting period
- Categories of transactions affecting cash: operating activities, investing activities, and financing activities
Test your knowledge on key financial statements such as the Income Statement, Comprehensive Income, and Statement of Cash Flows. Learn about the reporting of revenues, expenses, gains, and losses in a specific period.
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