To comply with the matching principle, the cost of labor services of an employee who participates in the manufacturing of a product normally should be charged to the income statement in the period in which the
Answer (D) is correct. The matching principle states that expenses should be recognized in the same period as the revenues that those expenses helped produce. Revenues related to the employee’s labor are not recognized until the goods are sold.
Which one of the following errors will result in the overstatement of net income?
Answer (B) is correct. Cost of goods sold equals beginning finished goods, plus cost of goods manufactured for a manufacturer or purchases for a retailer, minus ending finished goods. Overstated ending inventory therefore results in understated cost of goods sold, overstated net income, and overstated retained earnings in the period of the error.
The following information applies to the income statement of Addison Company:
Gross sales....................... $1,000,000
Net sales............................ 900,000
Ending inventory .................200,000
Gross profit margin 40% Addison’s cost of goods available for sale is
Answer (C) is correct. The gross profit (gross margin) method calculates ending inventory at a given time by subtracting an estimated cost of goods sold from the sum of beginning inventory and purchases (or cost of goods manufactured). The estimated cost of goods sold equals sales minus the gross profit. The gross profit equals sales multiplied by the gross profit percentage, an amount ordinarily determined on a historical basis. Given that the gross margin percentage is 40% of net sales, cost of goods sold must be 60% of net sales, or $540,000 ($900,000 × 60%). Goods available for sale equals cost of goods sold plus ending inventory ($540,000 + $200,000 = $740,000)
Unrealized gains and losses on trading securities should be presented in the
Answer (B) is correct.
Unrealized holding gains and losses on trading securities are included in
earnings and are therefore reported in the income statement.
On July 1, Year 1, Denver Corp. purchased 3,000 shares of Eagle Co.’s 10,000 outstanding
shares of common stock for $20 per share but did not elect the fair value option. On
December 15, Year 1, Eagle paid $40,000 in dividends to its common shareholders. Eagle’s
net income for the year ended December 31, Year 1, was $120,000, earned evenly
throughout the year. In its Year 1 income statement, what amount of income from this
investment should Denver report?
Answer (B) is correct.
Denver Corp.’s purchase of 30% of Eagle presumably allows it to
exercise significant influence. Hence, it should apply the equity method.
The investor’s share of the investee’s income is a function of the
percentage of ownership and the length of time the investment was held.
The income from this investment was therefore $18,000 [$120,000 ×
30% × (6 months ÷ 12 months)].
Net losses on firm purchase commitments to acquire goods for inventory result from a contract price that exceeds the current market price. If a firm expects that losses will occur when the purchase occurs, expected losses, if material,
Answer (A) is correct. A loss is accrued in the income statement on goods subject to a firm purchase commitment if the market price of these goods declines below the commitment price. This loss should be measured in the same manner as inventory losses. Disclosure of the loss is also required