CHAPTER 4
UNDERSTANDING INCOME STATEMENTS

SOLUTIONS

  1. C is correct. IAS No. 1 states that expenses may be categorized by either nature or function.
  2. C is correct. Cost of goods sold is a classification by function. The other two expenses represent classifications by nature.
  3. C is correct. Gross margin is revenue minus cost of goods sold. Answer A represents net income and B represents operating income.
  4. B is correct. Under IFRS, income includes increases in economic benefits from increases in assets, enhancement of assets, and decreases in liabilities.
  5. B is correct. Net revenue is revenue for goods sold during the period less any returns and allowances, or $1,000,000 minus $100,000 = $900,000.
  6. C is correct. The preferred method is the percentage-of-completion method. The completed contract method should be used under US GAAP only when the outcome cannot be measured reliably. A method similar to, but not referred to as, the cost recovery method is used under IFRS when the outcome cannot be measured reliably.
  7. A is correct. Under the completed contract method, no revenue would be reported until the project is completed.
  8. A is correct. The installment method apportions the cash receipt between cost recovered and profit using the ratio of profit to sales value (i.e., $3,000,000 ÷ $5,000,000 = 60 percent). Argo will, therefore, recognize $600,000 in profit for 2009 ($1,000,000 cash received × 60 percent).
  9. A is correct. Under the cost recovery method, the company would not recognize any profit until the cash amounts paid by the buyer exceeded Argo's cost of $2,000,000.
  10. C is correct. Revenue for barter transactions should be measured based on the fair value of revenue from similar non-barter transactions with unrelated parties.
  11. A is correct. Apex is not the owner of the goods and should only report its net commission as revenue.
  12. B is correct. Under the first in, first out (FIFO) method, the first 10,000 units sold came from the October purchases at £10, and the next 2,000 units sold came from the November purchases at £11.
  13. C is correct. Under the weighted average cost method:
    October purchases 10,000 units $100,000
    November purchases 5,000 units $55,000
     Total 15,000 units $155,000
    $155,000/15,000 units = $10.3333 × 12,000 units = $124,000.
  14. B is correct. The last in, first out (LIFO) method is not permitted under IFRS. The other two methods are permitted.
  15. A is correct. Straight-line depreciation would be ($600,000 − $50,000)/10, or $55,000.
  16. C is correct. Double-declining balance depreciation would be $600,000 × 20 percent (twice the straight-line rate). The residual value is not subtracted from the initial book value to calculate depreciation. However, the book value (carrying amount) of the asset will not be reduced below the estimated residual value.
  17. C is correct. This would result in the highest amount of depreciation in the first year and hence the lowest amount of net income relative to the other choices.
  18. B is correct. A fire may be infrequent, but it would still be part of continuing operations. IFRS do not permit classification of an item as extraordinary. Discontinued operations relate to a decision to dispose of an operating division.
  19. C is correct. The weighted average number of shares outstanding for 2009 is 1,050,000. Basic earnings per share would be $1,000,000 divided by 1,050,000, or $0.95.
  20. A is correct. With stock options, the treasury stock method must be used. Under that method, the company would receive $100,000 (10,000 × $10) and would repurchase 6,667 shares ($100,000/$15). The shares for the denominator would be:
    Shares outstanding 1,000,000
    Options exercises 10,000
    Treasury shares purchased (6,667)
    Denominator 1,003,333
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