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Chapter 4: Question 8 (page 179)

Why should caution be exercised in the use of the net income figure derived in an income statement? What are the objectives of generally accepted accounting principles in their application to the income statement?

Short Answer

Expert verified

There are many assumptions and estimations made in the accounting, and income is reported according to these assumptions. The objectives of generally accepted accounting principles are to report the results of operations.

Step by step solution

01

Generally Accepted Accounting Principles

Generally Accepted Accounting Principles are the set of basic guidelines and rules issued by the Financial Accounting Standards Board to improve the quality of financial statements.

02

Importance of exercising caution

Exercising caution is required because various assumptions are followed in the accounting process,and outcomes such as net income represent those considerations.

If suchassumptionsare not appropriately applied, it may provide inaccurate results.

03

Objectives of GAAP

The objectives of GAAP linked with the income statement are as follows:

  • The primary objective of the GAAP is to ensure that thetransactions belonging to a specific period should be reported in the same period.
  • The application of GAAP also ensures that no artificial information should be recorded in the books.

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Most popular questions from this chapter

Vandross Company has recorded bad debt expense in the past at a rate of 1陆% of accounts receivable, based on an aging analysis. In 2017, Vandross decided to increase its estimate to 2%. If the new rate had been used in prior years, cumulative bad debt expense would have been \(380,000 instead of \)285,000. In 2017, bad debt expense will be \(120,000 instead of \)90,000. If Vandross鈥檚 tax rate is 30%, what amount should it report as the cumulative effect of changing the estimated bad debt rate?

Question: Presented below is a combined single-step income and retained earnings statement for Nerwin Company for 2017.

(000 omitted)

Net sales revenue \(640,000

Costs and expenses

Cost of goods sold \)500,000

Selling, general, and administrative expenses 66,000

Other, net 17,000

583,000

Income before income tax 57,000

Income tax 19,400

Net income 37,600

Retained earnings at beginning of period, as previously reported 141,000

Adjustment required for correction of error (7,000)

Retained earnings at beginning of period, as restated 134,000

Dividends on common stock (12,200)

Retained earnings at end of period \(159,400

Additional facts are as follows.

1. 鈥淪elling, general, and administrative expenses鈥� for 2017 included a charge of \)8,500,000 that was usual but infrequently occurring.

2. 鈥淥ther, net鈥� for 2017 included a loss on sale of equipment of $6,000,000.

3. 鈥淎djustment required for correction of an error鈥� was a result of a change in estimate (useful life of certain assets reduced to 8 years and a catch-up adjustment made).

4. Nerwin Company disclosed earnings per common share for net income in the notes to the financial statements.

Instructions

Determine from these additional facts whether the presentation of the facts in the Nerwin Company income and retained earnings statement is appropriate. If the presentation is not appropriate, describe the appropriate presentation and discuss its theoretical rationale. (Do not prepare a revised statement.)

Wade Corp. has 150,000 shares of common stock outstanding. In 2017, the company reports income from continuing operations before income tax of \(1,210,000. Additional transactions not considered in the \)1,210,000 are as follows.

1. In 2017, Wade Corp. sold equipment for \(40,000. The machine had originally cost \)80,000 and had accumulated depreciation of \(30,000. The gain or loss is considered non-recurring.

2. The company discontinued operations of one of its subsidiaries during the current year at a loss of \)190,000 before taxes. Assume that this transaction meets the criteria for discontinued operations. The loss from operations of the discontinued subsidiary was \(90,000 before taxes; the loss from disposal of the subsidiary was \)100,000 before taxes.

3. An internal audit discovered that amortization of intangible assets was understated by \(35,000 (net of tax) in a prior period. The amount was charged against retained earnings.

4. The company recorded a non-recurring gain of \)125,000 on the condemnation of some of its property (included in the $1,210,000).

Instructions

Analyze the above information and prepare an income statement for the year 2017, starting with income from continuing operations before income tax. Compute earnings per share as it should be shown on the face of the income statement. (Assume a total effective tax rate of 38% on all items, unless otherwise indicated.)

Indicate the section of a multiple-step income statement in which each of the following is shown.

(a) Loss on inventory write-down.

(b) Loss from strike.

(c) Bad debt expense.

(d) Loss on disposal of a discontinued operation.

(e) Gain on sale of machinery.

(f) Interest revenue.

(g) Depreciation expense.

(h) Material write-offs of notes receivable.

You run into Greg Norman at a party and begin discussing financial statements. Greg says, 鈥淚 prefer the single step income statement because the multiple-step format generally overstates income.鈥� How should you respond to Greg?
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