Free CPA Exam Lecture: The Basics of an Income Statement

Wow, it’s August already!

This month’s (recently updated!) video lecture covers a topic you have to know backwards and forwards: Income Statements. It’s a guarantee you’ll be asked to interpret and possible even construct one during the task-based simulations on the CPA Exam.

Working With An Income Statement

This overview lecture–that’s a longer Deeper Dive in the Wiley CPAexcel course–features Prof. Pam Smith of Northern Illinois University. She’s one of our primary instructors covering FAR exam topics and she does a great job breaking down what’s on an income statement and how to understand its organization.

A Few Practice Questions

As has become our custom, we’d like to test your knowledge of some of the income statement concepts covered in this video lecture. Here are a few practice multiple-choice questions from the Wiley CPAexcel course. After you’ve picked your answers, you can scroll down to the bottom of this blog post for the correct answers and rationales.

Good luck.
1) In a multi-step Income Statement:

A. Total expenses are subtracted from total revenues.
B. Gross profit (margin) is shown as a separate item.
C. Cost of sales and operating expense are subtracted from total revenues.
D. Other income is added to revenue from sales.

2) In Yew Co.’s 2004 annual report, Yew described its social awareness expenditures during the year as follows:

“The Company contributed $250,000 in cash to youth and educational programs. The Company also gave $140,000 to health and human service organizations, of which $80,000 was contributed by employees through payroll deductions. In addition, consistent with the Company’s commitment to the environment, the Company spent $100,000 to redesign product packaging.”

What amount of the above should be included in Yew’s Income Statement as charitable contributions expense?

A. $310,000
B. $390,000
C. $410,000
D. $490,000

3) Blythe Corp. is a defendant in a lawsuit. Blythe’s attorneys believe it is reasonably possible that the suit will require Blythe to pay a substantial amount. What is the proper financial statement treatment for this contingency?

A. Accrued and disclosed.
B. Accrued but NOT disclosed.
C. Disclosed but NOT accrued.
D. No disclosure or accrual.

Answers

1) B
In a multi-step Income Statement, gross profit (margin), operating profit (margin), and pretax income from continuing operations are determined. The focus is on the determination of operating profit rather than simply income from continuing operations. Gross profit (margin) is shown as a separate item.

2) A
The charitable contributions are limited to the $250,000 contribution and the portion of the $140,000 contribution paid for by the firm (which amounted to $60,000 or $140,000 – $80,000 paid by the employees). Thus total charitable contributions are $310,000.
The product packaging cost is a promotional cost.

3) C
Contingencies are accrued and recognized as a liability when the occurrence of the liability is probable and the amount can be reasonably estimated. This lawsuit is reasonably possible, but not probable. Reasonably possible is typically a 50/50 chance of occurrence, where probable is a higher likelihood of occurrence. This answer is correct because this lawsuit would be disclosed, but not accrued.