Q: A company acquires 25% of Company B's voting common stock for $$600,000. Company B reports 300$$,000 in earnings and pays out 75% as cash dividends. Using the equity method, what amount of equity income should Company A report?

Equity income = $$300,000 \times 25\% = 75$$,000$

Question 1

Which of the following best describes the multiple-step income statement format?

Accepted Answer

It separates operating revenues and expenses from non-operating items, providing subtotals such as gross profit and operating income.

Question 2

Given the following information: Net sales = $$1,509, Cost of goods sold = 750$$, Depreciation expense = $$65, Interest expense = 70$$, Effective tax rate = 20%. What is the gross profit margin?

Accepted Answer

Gross profit margin = $$\frac{Gross\ profit}{Net\ sales} = \frac{1,509 - 750}{1,509} = \frac{759}{1,509} \approx 50.3\%$$

Question 3

A company reports $$30M in nominal sales in 2021 and 34M in $$nominal sales in 2022. The CPI was 271.0 in 2021 and 292.6 in 2022. What is the real sales growth from 2021 to 2022?

Accepted Answer

Real sales growth = $$\frac{Nominal\ sales_{2022}}{CPI_{2022}} \div \frac{Nominal\ sales_{2021}}{CPI_{2021}} - 1 = \frac{34/292.6}{30/271.0} - 1 \approx 5.6\%$$

Question 4

Which of the following is NOT an example of an operating expense on the income statement?

Accepted Answer

Interest expense

Question 5

A company acquires 25% of Company B's voting common stock for $$600,000. Company B reports 300$$,000 in earnings and pays out 75% as cash dividends. Using the equity method, what amount of equity income should Company A report?

Accepted Answer

Equity income = $$300,000 	imes 25\% = 75$$,000$

Question 6

Which of the following would most likely be classified as an unusual and infrequent item on the income statement?

Accepted Answer

A gain from the sale of a major division (discontinued operations)

Question 7

Which method of depreciation is most commonly used by companies and produces a smoother earnings stream?

Accepted Answer

Straight-line depreciation

Question 8

Which of the following is a method firms can use to modify the number of common shares outstanding?

Accepted Answer

Stock splits

Question 9

Which of the following is a sign of potential earnings management related to the allowance for doubtful accounts?

Accepted Answer

A sudden decrease in the allowance for doubtful accounts while sales and accounts receivable increase

Question 10

Which of the following is NOT a category in the statement of cash flows?

Accepted Answer

Earnings per share

Question 11

Which of the following best describes the difference between the direct and indirect methods of calculating net cash from operating activities?

Accepted Answer

The direct method lists cash receipts and payments, while the indirect method adjusts net income for non-cash items and changes in working capital.

Question 12

A company has $$104 in starting cash and 221 in $$ending cash. It purchased $$130 in fixed assets, had 65 in $$depreciation expense, reduced short-term debt by $$73, earned 493 in $$net income, paid $$123 in dividends, increased accounts payable by 34$$, increased accounts receivable by $$233, increased inventory by 2$$, increased common stock by $$40, and increased long-term debt by 46. $$What is the net cash flow from operating activities using the indirect method?

Accepted Answer

Net cash from operating activities = $$493 + 65 - 233 + 34 - 2 = 357$

Question 13

Which of the following is a sign of high earnings quality?

Accepted Answer

Revenue recognition is consistent with ASC 606's five-step framework and supported by auditor's report and MD&A.

Question 14

Which of the following is a potential abuse of reserve accounts?

Accepted Answer

Cookie jar accounting

Question 15

If a company reports a net profit margin of 12%, what does this indicate?

Accepted Answer

Net profit margin = $$\frac{Net\ earnings}{Net\ sales}$$; the company earns 12 cents of profit for every dollar of sales.

Question 16

Which of the following would increase the number of shares outstanding without affecting the total equity value?

Accepted Answer

Stock split

Question 17

Which of the following is a sign of potential problems in revenue recognition?

Accepted Answer

Significant divergence between sales growth and accounts receivable growth

Question 18

Which of the following would be classified as a financing activity in the statement of cash flows?

Accepted Answer

Issuing common stock

Question 19

Which of the following is a key insight from cash flow analysis regarding a company's financial health?

Accepted Answer

A high percentage of inflows from operations indicates strong ability to cover investing and financing outflows.

Income Statement, Statement of Stockholders' Equity, and Statement of Cash Flows: Study Guide

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