Reading 32: Understanding the Income Statement LOS E习题精选 automobile, 2010, commercial, investment, available

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LOS e: Distinguish between the operating and nonoperating components of the income statement.

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 Nonoperating

B) Operating Operating

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.

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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.

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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) Both are operating.

C) Only one is 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.

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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 5 years

C) Yes 4 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).