Question

1. The four major elements of the income statement are:

2. The income statement reveals net earnings (net income) of a firm for a period of time.

Explain how “net earnings (net income) of a firm for a period of time” is different from each of the following descriptions:

resources and equities of a firm at a point in time

resources and equities of a firm for a period of time

net earnings (net income) of a firm at a point in time

3. Explain how revising the estimated life of equipment from 10 years to 8 years could be an example of managing earnings down?

4. Explain how underestimating warranty claims could be an example of managing earnings up?

5. Changes in estimates are not carried back to adjust prior years. Explain how changes in estimates are accounted for in the current year?

6. A change in accounting principle requires that the cumulative effect of the change for prior periods be shown as an adjustment to beginning retained earnings of the earliest period presented. Explain what this means?

7. A required disclosure in the income statement when reporting the disposal of a component of the business includes reporting earnings per share from continuing operations, discontinued operations, and net income on the face of the income statement. Provide an example of how this required disclosure would be presented (on the face of the income statement).

8. Carrot Corporation made a very large arithmetical error in the preparation of its year-end financial statements by improper placement of a decimal point in the calculation of depreciation. The error caused the net income to be reported at almost double the proper amount. Correction of the error when discovered in the next year should be treated as a prior period adjustment. Explain what Carrot Corporation needs to do (how do they go about reporting a prior period adjustment)

Answer 1

1. The four major elements of income statement are

a. Revenues

b. Expenses

c. Gains

d. Losses.

2. 'Net income' for a period gives the earnings of a firm over an accounting period. normally accounts are maintained, for each accountig period, separately and therefore the income statement cover a period of time(fromt eh beginning of the accounting year to the end of the accounting year).

a. Net earnings of a firm for a period of time, is different from the resources and equities of a firm at a point of time, in the fact that whicle the former (net earnings) will give us how a firm is operating over a period of time, (accounting period), the resources of a firm are generally stated at a paricular point of time (say December 31, or January 15), and they denote how the firm is operating its activity (the assets it owns and the monies it owes).

b.  Net earnings of a firm for a period of time, is different from the resources and equities of a firm for a period of time,in that the former (net earnings) gives the results of the activities of the activites for a given period, the latter gives the resources used in carrying the activities during the period. Usually the resources and equities for a period of time are given by the cash flow statement.

c. Net earnings at a point of time is denoted by the balance of retained earnings at the point of time. The net earnings for the period is added to the retained earnings at the beginning of the accounting period to get the retained earnings at the end of the accounting period.

3.

When the estimated life of equipment is revised from 10 years to 8 years, it will result in the annual depreciation to go up (the same amount is charged over a lesser period) , which will result in a higher expense for the period which will ultimately result in lower earnings. Hence this an example of managing earnings down.

E.g. If the estimated life of an equipment costing $10,000 is revided from 10 years to 8 years , the depreciation charge will increase to $1,250(10,000 / 8) from $1,000 (10,000/10), thereby reducing the net income by $250.

4. When warranty expense is understated, it results in lower reporting lower expenses, thereby increasing the ner earnings for the period.This is n example of managing earnings up.