FSAV4e TestBank Module 5. Revenue Recognition and Operating Income.

LO1 – Explain revenue recognition criteria and identify transactions of special concern. LO2 – Describe accounting for operating expenses, including research and development, and restructuring. LO3 – Explain ...

LO1 – Explain revenue recognition criteria and identify transactions of special concern. LO2 – Describe accounting for operating expenses, including research and development, and restructuring. LO3 – Explain and analyze accounting for income taxes. LO4 – Explain how foreign currency fluctuations affect the income statement. LO5 – Compute earnings per share and explain the effect of dilutive securities. LO6 – Explain accounting quality and identify areas for analysis. Module 5: Revenue Recognition and Operating Income True/False Topic: Revenue Recognition LO: 1 1. According to GAAP revenue recognition criteria, in order for revenue to be recognized on the income statement, it must be earned and realized (realizable). Answer: True Rationale: According to GAAP revenue recognition criteria, revenue must be both realized (realizable) and earned, to be recognized on the income statement. The issue of when the revenue is earned is subject to professional judgment. Topic: Percentage of Completion LO: 1 2. Companies that engage in long-term sales contracts such as construction projects often use the percentage of completion method to recognize revenue. This means that revenue is recognized in proportion to the project’s completion. Answer: True Rationale: Percentage of completion method recognizes revenue by determining the costs incurred under the contract relative to its total expected costs and not evenly over time. Topic: Sales on Consignment LO: 1 3. Revenue from a consignment sale is recognized when the item is placed on consignment with the middleman, if sales are probable, based on past experience. Answer: False Rationale: When the item is delivered to the middleman (the consignee) no title has passed therefore no revenue has been earned. Revenue is only earned when the third party buys the item. Topic: Revenue Recognition LO: 1 4. Bed Bath and Beyond has a return policy which states that the customer “may return a purchase for a refund, merchandise credit, or exchange to any of our stores nationwide or to our returns processing center”. The company can report revenue on the full amount as soon as the merchandise is sold. Answer: False Rationale: Revenue will be recognized as soon as the merchandise is sold but only for the portion that the company estimates will not be returned. The estimated returns are netted against sales and set up as a liability (reserve). ©Cambridge Business Publishers, 2015 5-2 Financial Statement Analysis and Valuation, 4th EditionTopic: R&D Costs LO: 2 5. R&D expense is treated as an operating expense, not a capital expenditure, unless the R&D assets acquired have an alternative future use. Answer: True Rationale: Although the R&D assets are similar to regular plant assets, under GAAP, R&D costs are expensed unless the R&D assets have alternative future uses. Topic: R&D Costs LO: 2 6. Next year, Chemical Corporation plans to build a laboratory dedicated to a special project. The company will not use the laboratory after the project is finished. Under GAAP, this laboratory should be expensed. Answer: True Rationale: R&D costs must be expensed under GAAP unless they have alternative future uses. If these assets do, indeed, have alternative future uses, they will be capitalized and depreciated. Topic: Discontinued Operations LO: 2 7. Revenues from discontinued operations of a company are reported separately from revenues from continuing operations in the income statement. Answer: True Rationale: Discontinued operations refer to any identifiable business unit that the company intends to sell. The income (loss) of the discounted operation (net of tax), and the after-tax gain (loss) on sale of the unit, are reported in a separate section of the income statement below income from continuing operations. Topic: Restructuring Costs LO: 2 8. Employee severance costs, as part of board-approved restructuring plans, are reported in the income statement even if the actual payment for these costs occurs in subsequent periods. Answer: True Rationale: Employee severance costs are reported in the income statement as accrued costs. Total estimated costs of terminating or relocating a targeted employee group are recorded as an expense in the period in which these costs are estimated. Topic: Extraordinary Items LO: 2 9. For an item to be classified as extraordinary, it needs to be both unusual and infrequent. However, there is an exception for material items – for one-time items that are extremely large, firms have the option of classify these items as extraordinary to provide better information to investors. Answer: False Rationale: Both of the above conditions need to be fulfilled for an item to be categorized extraordinary. There is no materiality exception. ©Cambridge Business Publishers, 2015 Test Bank, Module 5 5-3Topic: Income Taxes LO: 3 10. Income tax expense is not recorded at the amount owing to the tax authorities even if this is the most objectively measured amount. Answer: True Rationale: Income tax expense is based on GAAP numbers. The amount paid is based on tax rules. The difference between the two is recorded as deferred tax expense (benefit). Topic: Deferred Taxes LO: 3 11. When a company reports a deferred tax asset it means that the company will receive a tax benefit in the future. Answer: False Rationale: The deferred tax asset may be recorded if the future benefit is more likely than not. The company does not have to be absolutely certain only relatively certain that future taxes will be lower (a benefit). Topic: Depreciation and Taxes LO: 3 12. For tax reporting purposes, companies typically transfer more of the asset’s cost from the balance sheet to the income statement in the earlier years of the asset’s life. This is called accelerated depreciation and it is a benefit to the company. Thus, companies record deferred tax assets (benefits) for this accelerated depreciation. Answer: False Rationale: Accelerated depreciation reduces taxable income and, consequently, the current tax liability and, thereby, increases cash flows early in the asset’s life. Over the life of the asset, the company must make up these taxes, thus accelerated depreciation creates a deferred tax liability and not an asset. Topic: Foreign Currency Translation LO: 4 13. Revenue from a foreign subsidiary will be smaller in U.S. dollars when the dollar strengthens relative to the foreign currency. Answer: True Rationale: Foreign currency is weaker when the dollar strengthens. Thus, revenue in the foreign currency is worth fewer U.S. dollars. Topic: Earnings per Share LO: 5 14. A company with outstanding in-the money employee stock options will report a diluted EPS that is lower than basic EPS. Answer: True Rationale: Diluted EPS will only be lower than basic EPS if the outstanding employee stock options are dilutive, which means the stock options are at or in the money. ©Cambridge Business Publishers, 2015 5-4 Financial Statement Analysis and Valuation, 4th EditionTopic: Diluted EPS LO: 5 15. Because diluted EPS include dilutive securities such as convertible securities and employee stock options, it must always be less than or equal to basic EPS. Answer: True Rationale: Diluted EPS includes dilutive securities in the denominator of the ratio. Therefore the diluted EPS ratio must always be less than or equal to basic EPS. Topic: Accounting Quality LO: 6 16. The two factors that enhance the quality of accounting information are reliability and relevance. Answer: True Rationale: Two main uses of financial reports are evaluation and valuation of a company and its performance. As a result, high-quality accounting information that is reliable and relevant is required