karoliukas

The First National Bank is a commercial bank that specializes in consumer financing, particularly automobile loans. The majority of the loans are funded from customer deposits. In addition, the bank purchases various investment securities with available cash. The investments are debt securities and have an average maturity date of less than 30 days. Should First National Bank report the interest received from the consumer loans and the interest received from the investment securities as an operating or as a nonoperating component in its year-end income statement?

Consumer loans

Investment securities

A) Operating Operating

B) Operating Nonoperating

C) Nonoperating Operating

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Interest received from customers and interest received from investments are a part of normal operations of a financial institution. Thus, the First National Bank will report the interest income from both sources as components of operating income.

karoliukas

Red Oak Corporation is a furniture manufacturer located in Canada. Red Oak is financed with a combination of debt and equity. The debt consists of unsecured zero-coupon bonds that mature in 20 years. For income tax purposes, interest on the bonds is deductible when accrued. Red Oak’s equity consists of common stock and preferred stock. No dividends have ever been paid on Red Oak’s common stock; however, dividends are paid quarterly to the preferred shareholders. Should the accrued interest on the zero-coupon bonds and the dividends paid to the preferred shareholders be reported as a nonoperating component of Red Oak’s net income?

Accrued interest

Preferred dividends

A) Yes Yes

B) Yes No

C) No Yes

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Since Red Oak is a nonfinancial firm, the accrued interest is considered a nonoperating activity, related to how the firm is financed. Dividends paid to preferred shareholders do not affect net income.

karoliukas

Pinto Corporation is an automobile manufacturer located in North America. Pinto owns a 5 percent interest in one of its suppliers, Continental Supply Company. Each year, Pinto receives a cash dividend from Continental. Pinto’s engine supplier, National Supply Company, recently increased prices on goods sold to all customers due to higher labor costs. Should Pinto report the dividends received from Continental and the price increase from National as an operating or nonoperating component on its year-end income statement?

A) Both are nonoperating.

B) Only one is operating.

C) Both are operating.

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Since Pinto is a nonfinancial firm, dividends received would be considered a nonoperating component. An increase in cost of goods sold would be considered a part of normal operations.

karoliukas

On January 1, 2007, Sneed Corporation purchased machinery costing $8 million with a salvage value of $1 million. For the year ended 2007, Sneed recognized depreciation expense of $3.2 million from the machinery using the double-declining-balance method. Should the depreciation expense be reported as an operating component in the income statement, and what is the estimated useful life of the machinery?

Operating expense

Useful life

A) No 5 years

B) Yes 4 years

C) Yes 5 years

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Depreciation expense is reported as an operating component in the income statement. Given the first year depreciation expense of $3.2 million, and the original cost of $8 million, the declining balance percentage is 40% ($3.2 million depreciation expense / $8 million cost). The double declining balance percentage is equal to 2 / useful life = 40%. Thus, the useful life is 5 years (2 / 0.40).

karoliukas

Changes in asset lives and salvage value are changes in accounting:

A) principle and specific disclosures are required.

B) estimates and specific disclosures are required.

C) estimates and no specific disclosures are required.

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Changes in asset lives and salvage value are changes in accounting estimates and are not considered changes in accounting principle. No specific disclosures are required.

karoliukas

Retrospective presentation is least likely required for a change from:

A) percentage-of-completion to completed contract revenue recognition.

B) LIFO to average cost inventory valuation.

C) zero salvage value to positive salvage value.

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Changes in accounting principle require retrospective presentation. A change in the salvage value of an asset is a change in accounting estimate, which does not apply retrospectively.

karoliukas

All the following items are reported net of taxes below net income from continuing operations on the income statement EXCEPT:

A) extraordinary items.

B) unusual or infrequent items.

C) expropriations by foreign governments.

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Unusual or infrequent items appear as a component of net income from continuing operations and are reported "above the line." Extraordinary items, such as expropriations, are unusual and infrequent and appear "below the line."

karoliukas

Which of the following is least likely reported net of tax on the income statement under U.S. GAAP?

A) Income from discontinued operations.

B) Extraordinary items.

C) Interest expense.

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Interest expense would be considered an expense that is incurred from continuing operations and, therefore, is listed prior to subtracting the income tax expense on the income statement. Income from discontinued operations and extraordinary items are included on the income statement after the net income from continuing operations is reported and after the income tax expense from continuing operations is reported. Therefore, these latter accounts are reported net of tax.

karoliukas

Which of the following statements regarding the income statement is least accurate?

A) Items that are unusual in nature or infrequent in occurrence appear below income from continuing operations on a pretax basis.

B) Extraordinary items are both unusual in nature and infrequent in occurrence. Extraordinary items are disclosed net of taxes after income from continuing operations in the income statements.

C) The results of discontinued operations are reported below income from continuing operations on the income statement net of taxes.

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The key word here is "or." Unusual or infrequent items are unusual orinfrequent, but NOT both. These items are reported (as a separate line item) as a component of net income from continuing operations.
Examples of unusual or infrequent items include:

• Gains or losses from the disposal of a business segment (employee separation costs, plant shutdown costs, etc.)
• Gains or losses from the sale of assets or investments in subsidiaries
• Provisions for environmental remediation
• Impairments, write-offs, write-downs, and restructuring costs
• Integration expenses associated iwth businesses that have been recently acquired.

karoliukas

Which of the following items regarding the corporate income statement is most accurate?

A) Unusual or infrequent items appear in the income statement of a corporation as a component of net income from continuing operations.

B) Examples of extraordinary items include expropriations of property and equipment by foreign governments, losses from earthquakes and tornados, and gains from the sale of investments in subsidiaries.

C) If a corporation disposes of a business segment that is separable from the company's core business activities, the results of the discontinued segment are reported as a separate line item below income from continuing operations on a pre-tax basis.

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Explanations for incorrect answers are as follows:

• The gain on the sale of a subsidiary is an unusual or infrequent item.
• The results of a discontinued segment are reported below the line, net of tax (after tax).