Financial Statements Overview Quiz

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Questions and Answers

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?

Operational earnings

Non-GAAP earnings

Permanent earnings (correct)

Temporary 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 (correct)

Revenue recognition

Income classification

Expense shifting

In what circumstances are restructuring costs recognized?

When there is interest income or interest expense

When there are gains or losses on sale of investments

When revenue issues affect earnings quality

When management plans to change the scope of business operations (correct)

Which of the following is an example of nonoperating income that relates only tangentially to normal operations?

Interest income or interest expense Signup and view all the answers

What must companies provide when reporting non-GAAP earnings, according to the Sarbanes-Oxley Act?

Reconciliation between non-GAAP and GAAP earnings Signup and view all the answers

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. Signup and view all the answers

What is the purpose of the Statement of Cash Flows?

To provide information about cash receipts and cash payments. Signup and view all the answers

Which of the following is not a characteristic of revenues as described in the text?

Revenues are recognized when the related expenses are incurred. Signup and view all the answers

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. Signup and view all the answers

Which of the following statements is true regarding the recognition of expenses?

Expenses can be allocated over several periods or expensed as incurred. Signup and view all the answers

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. Signup and view all the answers

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 Signup and view all the answers

How are voluntary changes in accounting principles accounted for?

They are accounted for retrospectively by revising prior years' financial statements. Signup and view all the answers

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. Signup and view all the answers

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. Signup and view all the answers

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. Signup and view all the answers

In the context of a statement of cash flows, which activity involves the purchase of inventory?

Operating activities Signup and view all the answers

What does the statement of cash flows provide information about?

Cash receipts and disbursements Signup and view all the answers

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 Signup and view all the answers

What do Noncash Investing and Financing Activities involve?

Activities that do not involve any cash flows Signup and view all the answers

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

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Description

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.