LOS a: Distinguish among the various definitions of earnings (e.g., EBITDA, operating earnings, net income, etc.)

Q1. Duster Corporation’s year-end income statement reported the following:

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

A)   $103,500.

B)   $106,800.

C)   $114,300.

Q2. 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?

A)   Both are included.

B)   One one is included.

C)   Both are excluded.

Q3. 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.

A)   Only statement #1 is incorrect.

B)   Only statement #2 is incorrect.

C)   Both are incorrect.

Q4. 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)      Lower      Higher

B)     Higher     Lower

C)     Higher     Higher

LOS a: Distinguish among the various definitions of earnings (e.g., EBITDA, operating earnings, net income, etc.) fficeffice" />

Q1. 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)   $103,500.

B)   $106,800.

C)   $114,300.

Correct answer is B)

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.

Q2. 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?

A)   Both are included.

B)   One one is included.

C)   Both are excluded.

Correct answer is B)

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.”

Q3. 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.

A)   Only statement #1 is incorrect.

B)   Only statement #2 is incorrect.

C)   Both are incorrect.

Correct answer is C)

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.

Q4. 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 ffice:smarttags" />U.S. generally accepted accounting principles?

          EBIT           OCF

A)      Lower      Higher

B)     Higher     Lower

C)     Higher     Higher

Correct answer is C)

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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