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Reading 29: The Lessons We Learn LOS a-Q 1~4

1.Which of the following statements about financial disclosures are correct or incorrect?

Statement #1:

Transitory earnings are usually more important to investors than permanent earnings.

Statement #2:

Pro-forma earnings are usually prepared in accordance with generally accepted accounting principles.

 

 

     Statement #1

     Statement #2

 

A)      Incorrect                                  Correct

B)      Incorrect                                 Incorrect

C)      Correct                                    Incorrect

D)      Correct                                    Correct

2.Galaxy Company recognized a restructuring charge in its year-end income statement. Similar restructuring charges have occurred in the past. In addition, Galaxy recognized an extraordinary loss. Galaxy uses the term “operational earnings” when discussing its financial results. According to Galaxy, “operational earnings” excludes special nonrecurring transactions such as restructuring charges, discontinued operations, and extraordinary items. Should the restructuring charge and extraordinary loss be included or excluded from “operational earnings” for analytical purposes?

 

    Restructuring charge

     Extraordinary loss

 

A)                                        Included       Excluded

B)                                        Included       Included

C)                                        Excluded     Excluded

D)                                        Excluded     Included

3.Duster Corporation’s year-end income statement reported the following:

Operating income

 

$187,000

Results from discontinued operations:

 

 

Loss from segment operations

 

 

(net of $1,440 tax effect)

($2,160)

 

Gain on segment disposal

 

 

(net of $8,640 tax effect)

12,960

10,800

Gain on sale of equipment

 

3,400

Interest expense

 

12,400

Extraordinary loss

 

 

(net of $2,200 tax benefit)

 

3,300

Income tax expense

 

71,200

Calculate Duster’s income from continuing operations for the year.

A)   $106,800.

B)   $274,000.

C)   $114,300.

D)   $103,500.

4.As compared to an operating lease, which of the following best describes the impact of a capital lease on earnings before interest and taxes (EBIT) and operating cash flow (OCF) according to U.S. generally accepted accounting principles?

 

       EBIT

       OCF

 

A        Higher                                  Higher

B)       Higher                                    Lower

C)       Lower                                     Higher

D)       Lower                                     Lower

答案和详解如下:

1.Which of the following statements about financial disclosures are correct or incorrect?

Statement #1:

Transitory earnings are usually more important to investors than permanent earnings.

Statement #2:

Pro-forma earnings are usually prepared in accordance with generally accepted accounting principles.

 

 

     Statement #1

     Statement #2

 

A)      Incorrect                                  Correct

B)      Incorrect                                 Incorrect

C)      Correct                                    Incorrect

D)      Correct                                    Correct

The correct answer was B)

Statement #1 is incorrect. Investors are usually more interested in permanent earnings. Statement #2 is incorrect. Pro-forma earnings are not prepared in accordance with generally accepted accounting principles because they may exclude certain transactions. This is why it is important for an analyst to understand the disclosures.

2.Galaxy Company recognized a restructuring charge in its year-end income statement. Similar restructuring charges have occurred in the past. In addition, Galaxy recognized an extraordinary loss. Galaxy uses the term “operational earnings” when discussing its financial results. According to Galaxy, “operational earnings” excludes special nonrecurring transactions such as restructuring charges, discontinued operations, and extraordinary items. Should the restructuring charge and extraordinary loss be included or excluded from “operational earnings” for analytical purposes?

 

    Restructuring charge

     Extraordinary loss

 

A)                                        Included       Excluded

B)                                        Included       Included

C)                                        Excluded     Excluded

D)                                        Excluded     Included

The correct answer was A)

The restructuring charge does not appear to be nonrecurring; thus, it should be included in “operational earnings.” By definition, an extraordinary loss is unusual in nature and infrequent in occurrence. Therefore, the extraordinary loss should be excluded from “operational earnings.”

3.Duster Corporation’s year-end income statement reported the following:

Operating income

 

$187,000

Results from discontinued operations:

 

 

Loss from segment operations

 

 

(net of $1,440 tax effect)

($2,160)

 

Gain on segment disposal

 

 

(net of $8,640 tax effect)

12,960

10,800

Gain on sale of equipment

 

3,400

Interest expense

 

12,400

Extraordinary loss

 

 

(net of $2,200 tax benefit)

 

3,300

Income tax expense

 

71,200

Calculate Duster’s income from continuing operations for the year.

A)   $106,800.

B)   $274,000.

C)   $114,300.

D)   $103,500.

The correct answer was A)

Income from continuing operations includes all revenues and expenses except discontinued operations and extraordinary items: $187,000 operating income + $3,400 gain on sale of equipment – $12,400 interest expense – $71,200 income tax expense = $106,800.

4.As compared to an operating lease, which of the following best describes the impact of a capital lease on earnings before interest and taxes (EBIT) and operating cash flow (OCF) according to U.S. generally accepted accounting principles?

 

       EBIT

       OCF

 

A        Higher                                  Higher

B)       Higher                                    Lower

C)       Lower                                     Higher

D)       Lower                                     Lower

The correct answer was A)

With an operating lease, rent expense is included in EBIT. In a capital lease, rent expense is replaced by depreciation expense and interest expense. Since EBIT is calculated before interest and taxes, EBIT is higher with a capital lease. In an operating lease, the rent payment is included in operating cash flow. With a capital lease, the rent payment is replaced by principal and interest. Since principal payments are considered financing activities, operating cash flow is higher with a capital lease.

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