Question 1

The assessment of earnings quality is best accomplished through the use of which one of the following?

Accepted Answer

The multi-step income statement provides more detail and separates operating and non-operating expenses, making it easier to assess the quality of earnings. The balance sheet and cash flow statement are also important in the analysis, but the multi-step income statement provides more specific information. Single-step financial statements do not provide enough detail for a thorough assessment.

Question 2

On the income statement, income from discontinued operations is shown

Accepted Answer

Income from discontinued operations is shown net of taxes and after income from continuing operations on the income statement. This presentation helps users of financial statements distinguish between ongoing business activities and those that are being discontinued.

Question 3

Which of the following items is consistent with earnings being informative about current performance and informing the analyst that level of current earnings are not sustainable?

Accepted Answer

A

Question 4

Which of the following does not describe an extraordinary gain or loss?

Accepted Answer

An extraordinary gain or loss is infrequent in occurrence, unusual in nature, and material in amount. However, it is not necessarily peripheral to the company's core business.

Question 5

Which of the following items is consistent with earnings being informative about current performance but not informative about future earnings?

Accepted Answer

The recognition of a fair value gain on a financial asset due to a favorable move in interest rates reflects a current period event that may not necessarily predict future earnings. This gain is contingent on market conditions at a specific point in time, which can fluctuate and do not provide reliable information about the firm's future earnings potential.

Question 6

Which of the following items is consistent with earnings being informative about current performance and informing the analyst that level of current earnings is sustainable?

Accepted Answer

The firm's successful research and development of new products suggests performance improvements that are sustained over time. Recognizing an unexpected gain (A) or a fair value gain on a financial asset as a result of a favorable move in interest rates (B) may simply reflect fluctuations in external market conditions that are less likely to be sustainable. Recognizing additional expenses this period due to pre-opening costs (C) may have a one-time impact on earnings, but is not indicative of sustained performance.

Question 7

Which of the following items is consistent with earnings not being informative about current performance but are informative about future earnings?

Accepted Answer

Pre-opening costs for new stores are an investment in future growth, indicating that while current earnings are reduced due to these expenses, they are informative about the firm's potential for increased earnings in the future as the new stores begin to generate revenue.

Question 8

In a restructuring it is possible that managers may use the opportunity to write down assets that do not even relate directly to the restructuring action. Why might a manager decide to write down an asset that is not included in the restructuring action?

Accepted Answer

Writing down an asset that is not included in the restructuring action can relieve future periods of depreciation expense, which can increase earnings. This may be a tactic used by managers to boost the company's financial performance in the short term.

Question 9

As transitory components become a more important part of a firm's reported earnings, the reported earnings

Accepted Answer

Transitory components refer to one-time or non-recurring items that are not expected to continue in future periods. If these components become a bigger part of a firm's reported earnings, it can make the reported earnings less reliable as an indicator of sustainable cash flows. This is because these components are not expected to continue and therefore do not represent the long-term earning potential of the firm. In other words, the reported earnings may be inflated or deflated in a given period due to the presence of transitory components, which can obscure the true underlying performance of the business.

Question 10

All of the following are true regarding a high quality balance sheet except:

Accepted Answer

A high quality balance sheet should not be "optimistic" in terms of accounting numbers, but rather provide a realistic portrayal of the firm's financial position.

Question 11

When a company makes a change in an estimate that it has used in its financial statements, it should account for the change by

Accepted Answer

When a company makes a change in an estimate used in its financial statements, it should spread the effect of the change over the current and future periods. This is in accordance with the accounting principle of Prospective Treatment of Changes in Accounting Estimates, which states that changes in accounting estimates should be reflected in the financial statements of the period in which the change is made and in future periods. Option A is incorrect because retroactively restating all prior financial statements is not required for changes in estimates. Option B is incorrect because cumulative-effect accounting does not apply to changes in estimates. Option D is incorrect because companies are allowed to make changes to estimates.

Question 12

Which one of the following is an example of sustainable earnings?

Accepted Answer

Sustainable earnings refer to the recurring income streams that a company generates, usually from its core business operations. Earnings from repeat customers are a reliable and stable source of revenue, making option D the correct choice. The other options are not examples of sustainable earnings as they either result from one-time events or involve expenses rather than income.

Question 13

Users of financial statements should consider which of the following when evaluating the quality of accounting information?

Accepted Answer

All of these should be considered when evaluating the quality of accounting information. Economic faithfulness ensures that the measurements and classifications accurately reflect the economic substance of the transactions. Reliability ensures that the information is free from material errors or biases. Reasonableness of estimates ensures that management has exercised appropriate judgment and made informed decisions when applying accounting policies.

Question 14

Under new accounting standards passed in 2006 firms must report changes in accounting principle in the current and prior years as if the new accounting principle had been applied all along. The rationale for this change was

Accepted Answer

The rationale for the change in accounting standards was to enhance the information content of reported earnings in forecasting future earnings by using the same accounting principle in current and prior periods. This makes financial statements more comparable and useful for investors and analysts. This approach also ensures consistency and accuracy in financial reporting, which reduces the potential for misleading information.

Question 15

Examples of poor earnings quality that hinder the forecasting of expected future earnings include all of the following except:

Accepted Answer

The other choices all involve one-time events or non-recurring expenses that can distort the true earnings potential of the company. In contrast, adding equipment to improve environmental compliance and production efficiency is a positive investment that is likely to have long-term benefits for the company's earnings. Therefore, it would not be an example of poor earnings quality that hinders forecasting of expected future earnings.

Question 16

The best measure of a firm's sustainable income is

Accepted Answer

Income from continuing operations is the best measure of a firm's sustainable income because it excludes irregular and non-recurring items, providing a clearer view of the company's ongoing profitability.

Question 17

During July 2012 Ralston Company decides to dispose of one of its subsidiaries which qualifies for accounting as a discontinued operation. At the July 2012 measurement date Ralston Company estimates that it will report net income of $200,000 dollars from the measurement date until the disposal date which is expected to be in April 2013. In addition, Ralston estimates that it will lose $300,000 on the sale of the segment. How much gain or loss on discontinued operations will Ralston report in its 2012 income statement (net of income taxes)?

Accepted Answer

To determine the gain or loss on discontinued operations, we need to calculate the income or loss from operations from July 2012 until the disposal in April 2013, and compare it to the loss on the sale of the segment. 
Income from operations = $200,000 
Loss on sale of segment = $300,000 
Therefore, the total loss on discontinued operations is $100,000. This amount is reported net of income taxes, so the exact amount will depend on the tax rate applied. Option C is the only answer choice that reflects this calculation.

Question 18

Income or loss from discontinued operations would best be regarded by an analyst as:

Accepted Answer

Income or loss from discontinued operations is not expected to continue in the future and is therefore considered transitory earnings.

Question 19

Firms' choices and estimates within U.S. GAAP or IFRS should be determined by all of the following except:

Accepted Answer

Firms' choices and estimates within U.S. GAAP or IFRS should be determined by firms' underlying economic circumstances, conditions in the company's industry, and the company's competitive strategy. Accelerated management efforts to meet earnings projections should not be a factor in determining accounting choices and estimates, as this may lead to manipulation of financial statements and misrepresentation of the company's financial situation.

Question 20

During July 2012 Ralston Company decides to dispose of one of its subsidiaries which qualifies for accounting as a discontinued operation. At the July 2012 measurement date Ralston Company estimates that it will report net losses of $1,500,000 dollars from the measurement date until the disposal date which is expected to be in April 2013. In addition, Ralston estimates that it will lose $300,000 on the sale of the segment. How much gain or loss on discontinued operations will Ralston report in its 2012 income statement (net of income taxes)?

Accepted Answer

The gain or loss on discontinued operations is calculated as the difference between the carrying amount of the discontinued operation and the amount of consideration received. In this case, Ralston Company estimates a net loss of $1,500,000 from the measurement date until the disposal date and an additional loss of $300,000 on the sale of the segment. Therefore, the total estimated loss is $1,800,000. This loss is reported as a separate line item on the income statement, net of income taxes. Therefore, the correct answer is (C) $1,800,000 loss.

Quiz 9: Accounting Quality