Learning Module: Analyzing Income Statements

1. Under IFRS, income includes increases in economic benefits from:

A. increases in liabilities not related to owners’ contributions.
B. enhancements of assets not related to owners’ contributions.
C. increases in owners’ equity related to owners’ contributions.

2. Fairplay reported the information shown in Exhibit 1 related to the sale of its
products during 2009, which was its first year of business:

Under the accrual basis of accounting, how much net revenue would be reported on
Fairplay’s 2009 income statement?
A. USD200,000
B. USD900,000
C. USD1,000,000

3. Apex Consignment sells items over the internet for individuals on a consignment basis.
Apex receives the items from the owner, lists them for sale on the internet, and
receives a 25 percent commission for any items sold. Apex collects the full amount
from the buyer and pays the net amount after commission to the owner. Unsold items
are returned to the owner after 90 days. During 2009, Apex had the following
information:
■ Total sales price of items sold during 2009 on consignment was EUR2,000,000.
■ Total commissions retained by Apex during 2009 for these items was EUR500,000.
How much revenue should Apex report on its 2009 income statement?
A. EUR500,000
B. EUR2,000,000
C. EUR1,500,000

4. A company previously expensed the incremental costs of obtaining a contract. All else
being equal, adopting the May 2014 IASB and FASB converged accounting standards
on revenue recognition makes the company’s profitability initially appear:
A. lower.
B. unchanged.
C. higher.

5. Under IFRS, a loss from the destruction of property in a fire would most likely be
classified as:
A. continuing operations.
B. discontinued operations.
C. other comprehensive income.
 Analyzing Income Statements

6. A company chooses to change an accounting policy. This change requires that, if

practical, the company restate its financial statements for:
A. all prior periods.
B. current and future periods.
C. prior periods shown in a report.

7. For 2009, Flamingo Products had net income of USD1,000,000. At 1 January 2009,
there were 1,000,000 shares outstanding. On 1 July 2009, the company issued
100,000 new shares for USD20 per share. The company paid USD200,000 in
dividends to common shareholders. What is Flamingo’s basic earnings per share for
2009?
A. USD0.80
B. USD0.91
C. USD0.95

8. A company with no debt or convertible securities issued publicly traded common stock
three times during the current fiscal year. Under both IFRS and US GAAP, the
company’s:
A. basic EPS equals its diluted EPS.
B. capital structure is considered complex at year-end.
C. basic EPS is calculated by using a simple average number of shares outstanding.

9. For its fiscal year-end, Sublyme Corporation reported net income of USD200 million
and a weighted average of 50,000,000 common shares outstanding. There are
2,000,000 convertible preferred shares outstanding that paid an annual dividend of
USD5. Each preferred share is convertible into two shares of the common stock. The
diluted EPS is closest to:
A. USD3.52
B. USD3.65
C. USD3.70

10. For its fiscal year-end, Calvan Water Corporation (CWC) reported net income of
USD12 million and a weighted average of 2,000,000 common shares outstanding. The
company paid USD800,000 in preferred dividends and had 100,000 options
outstanding with an average exercise price of USD20. CWC’s market price over the
year averaged USD25 per share. CWC’s diluted EPS is closest to:
A. USD5.33
B. USD5.54
C. USD5.94

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11. Laurelli Builders (LB) reported the financial data shown in Exhibit 1 for year-end 31
December:

Which statement about the calculation of LB’s EPS is most accurate?

A. LB’s basic EPS is USD1.12.
B. LB’s diluted EPS is equal to or less than its basic EPS.
C. The weighted average number of shares outstanding is 2,210,000.

12. Cell Services Inc. (CSI) had 1,000,000 average shares outstanding during all of 2009.
During 2009, CSI also had 10,000 options outstanding with exercise prices of USD10
each. The average stock price of CSI during 2009 was USD15. For purposes of
computing diluted earnings per share, how many shares would be used in the
denominator?
A. 1,003,333
B. 1,006,667
C. 1,010,000

13. When calculating diluted EPS, which of the following securities in the capital
structure increases the weighted average number of common shares outstanding
without affecting net income available to common shareholders?
A. Stock options
B. Convertible debt that is dilutive
C. Convertible preferred stock that is dilutive

14. Which statement is most accurate? A common size income statement:

A. restates each line item of the income statement as a percentage of net income.
B. allows an analyst to conduct cross-sectional analysis by removing the effect of
company size.
C. standardizes each line item of the income statement but fails to help an analyst
identify differences in companies’ strategies.

15. The following information is available about a company for the current year:
Net income of $32 million
Weighted average number of common shares outstanding of 4.5 million
$15 million of 12% convertible bonds, convertible into 50,000 shares
200,000 options with an exercise price of $50 per share

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Average market price of $80 per share during the year

Tax rate of 30%
The company’s diluted EPS is closest to:
A. $6.81.
B. $6.99.
C. $7.19.

16. Unless it is impractical to do so, changes in accounting policies are to be reported:

A. prospectively.
B. retrospectively.
C. at the bottom of the income statement in the year of change.

17. For which of the examples given would common-size income statements generally
provide the most insight?
A. A liquidity analysis of two companies within the same industry
B. A time-series analysis of a rapidly expanding single company
C. A comparison of similarly sized companies from different industries

18. The following information is available on a company for the current year.

The company’s diluted EPS is closest to:

A. $7.57.
B. $7.69.
C. $7.72.

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19. The following data is available on two companies that operate in the same industry:

Which of the following statements is most appropriate? Better margin performance

will be reported by:
A. Company Y at the gross margin level and Company X at the operating margin level.
B. Company Y at both the gross margin and operating margin levels.
C. Company X at the gross margin level and Company Y at the operating margin level.

20. Under general principles of expense recognition, a company should:

A. apply uniform treatment for administrative and depreciation costs.
B. recognize expenses in the period that it consumes the associated economic
benefits.
C. allocate lost economic benefits prospectively over the expected period in which
the benefits would have been earned.

21. After a two-for-one stock split, which of the following will most likely change relative
to its pre-split value?
A. Earnings per share (EPS)
B. Price-to-earnings ratio (P/E
C. Dividend payout ratio

22. The following relates to a company’s common equity over the course of the year:

If the company’s net income for the year is $5,000,000, its diluted EPS is closest to:
A. $2.17.
B. $2.20.
C. $2.22.

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23. Oceanaqua Apparel (OA) is a manufacturer of swimwear. Abbreviated common-size

income statements and relevant industry data are presented below.

Which statement about OA’s three-year financial performance is most accurate?

OA’s:
A. effective tax rate has been holding steady at approximately 2%.
B. revenues per dollar of sales costs are falling over the time period.
C. profit margins indicate performance superior to the industry average.

24. An artists’ cooperative sells its artwork on a consignment basis through a local art
gallery. The cooperative should most likely recognize revenue when the art gallery:
A. sells the artwork.
B. remits payment for the artwork.
C. receives the artwork.

25. A company sells a non-refundable, two-year service contract for €420. Based on
historical patterns, the company expects to incur 25% of service costs in the first
year of the contract and the remainder in the second year. The amount of revenue
the company recognizes in the first year is closest to:
€105.
€210.
€420.

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26. The following financial information is available at the end of the year.

The diluted EPS (earnings per share) is closest to:

A. $2.91.
B. $2.93.
C. $3.08.

27. The following table shows changes to the number of common shares outstanding for
a company during 2012:

To calculate earnings per share for 2012, the company’s weighted average number of
shares outstanding is closest to:
A. 315,000.
B. 215,000.
C. 430,000.

28. Under US GAAP, for reporting periods after 15 December 2015, unusual or
infrequent items are shown on the income statement separately:
A. below continuing operations.
B. below discontinued operations.
C. as part of continuing operations.

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29. Selected year-end financial data for Mega Industries follows:

The net difference between Mega’s reported basic EPS and its diluted EPS is closest
to:
A. $0.74.
B. $0.27.
C. $0.37.

30. Which of the following items is an example of deferred income?

A. Normal operating expenses that have been paid in advance
B. A payment received for contracted goods and services prior to their delivery
C. An expense recognized on a company’s income statement but not paid for as of
the balance sheet date

31. An analyst gathers the following information (in € millions) about a manufacturing
company:

Based only on this information, applying vertical common-size analysis to the income
statement, selling, general, and administrative expenses are:
A. 12%.
B. 20%.
C. 30%.

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32. An analyst gathers the following information about a company for its fiscal year
ended 31 December:

Basic EPS is closest to:

A. €0.36.
B. €0.47.
C. €0.54.

33. Which of the following may be reported using the modified retrospective method?
A. Corrections of prior period errors
B. Changes in estimated useful life of PP&E
C. Changes in accounting policies based on the new revenue recognition standard

34. An analyst gathers the following information about a company's fiscal year ended 31
December:

If a 2-for-1 stock split took effect on 1 July, basic EPS for the year is:
A. $3.00.
B. $3.50.
C. $4.20.

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35. An analyst gathers the following information about two companies (in ¥ thousands):

Based only on the companies' common-size income statements, it appears that:

A. Company 1 spent more on advertising than Company 2.
B. both companies spent equally on research and development.
C. Company 1 has a higher gross profit margin than Company 2.

36. An analyst gathers the following information about a company for its fiscal year
ended 31 December:

Each convertible preferred share is convertible into two common shares. If there
are no other potentially dilutive securities outstanding, reported diluted EPS is
closest to:
A. €0.51.
B. €0.57.
C. €0.59.

37. According to the converged standards for revenue recognition, a receivable is

recognized on the seller's balance sheet when:
A. a contract is signed.
B. all performance obligations have been met except for payment.
C. consideration is received in advance of transferring goods or services.

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38. The adjustments related to changes in the estimated residual value of a long-lived
asset should be:
A. handled prospectively.
B. shown separately on the income statement.
C. handled retrospectively unless impractical to do so.

39. In calculating basic and diluted EPS, if the numerators are the same but the
denominators are different, the company:
A. split its stock during the year.
B. had stock options outstanding at year end.
C. had convertible debt outstanding at year end.

40. An analyst gathers the following information about a company's given fiscal year
ended 31 December:

If the bonds are convertible into 200,000 common shares and there are no other
potentially dilutive securities outstanding, the company's reported diluted EPS is
closest to:
A. $1.01.
B. $1.03.
C. $1.07.

41. According to the converged standards for revenue recognition, which of the following
might indicate that a seller has transferred control of an asset to a buyer at a point
in time? The seller has:
A. legal title of the asset.
B. a present right to payment for the asset.
C. significant risks and rewards of ownership related to the asset.

42. A company entered into a 5-year construction contract with a total sales price of
£3,000,000. The estimated total costs are £2,000,000 and the company incurred
£500,000 actual costs in the first year. The company has extensive experience with
similar types of contracts. Costs incurred provide an appropriate measure of progress

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toward completing the contract. Assuming it is highly probable that revenue will not
be subsequently reversed, revenue recognized under the contract in Year 1 is most
likely:
A. £500,000.
B. £600,000.
C. £750,000.

43. For a company reporting on a calendar year basis, the receipt of a payment from a
client in Year 1 for the delivery of services in Year 2 most likely increases:
A. net income for Year 1.
B. liabilities as of 31 December of Year 1.
C. cash flow from operating activities for Year 2.

44. According to the converged accounting standards for revenue recognition, which of
the following is the first of five steps in recognizing revenue?
A. Determine the transaction price
B. Identify the contract with the customer
C. Identify the distinct performance obligations in the contract

45. A company establishes a plan to dispose of one of its material lines of business and
will have no further involvement in its operation. The income statement most likely
reports the results of this line of business as:
A. discontinued operations.
B. unusual or infrequent items.
C. continuing operations until the actual sale is performed.

46. An analyst gathers the following information about a company's fiscal year ended 31
December:

One convertible preferred share is convertible into two common shares. If the tax
rate is 40% and there are no other potentially dilutive securities outstanding,
reported diluted EPS is closest to:
A. €0.38.
B. €0.48.
C. €0.63.

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47. An analyst gathers the following information about a company's fiscal year ended 31
December:

One convertible preferred share is convertible into six common shares. If there are
no other potentially dilutive securities outstanding, reported diluted EPS should be
closest to:
A. €0.95.
B. €1.02.
C. €1.14.

Solutions
1. B is correct. Under IFRS, income includes increases in economic benefits from
increases in assets, enhancement of assets, and decreases in liabilities.

2. B is correct. Net revenue is revenue for goods sold during the period less any returns
and allowances, or USD1,000,000 minus USD100,000 = USD900,000.

3. A is correct. Apex is not the owner of the goods and should only report its net
commission as revenue.

4. C is correct. Under the converged accounting standards, the incremental costs of

obtaining a contract and certain costs incurred to fulfill a contract must be
capitalized. If a company expensed these incremental costs in the years prior to
adopting the converged standards, all else being equal, its profitability will appear
higher under the converged standards.

5. A is correct. A fire may be infrequent, but it would still be part of continuing

operations and reported in the profit and loss statement. Discontinued operations
relate to a decision to dispose of an operating division.

6. C is correct. If a company changes an accounting policy, the financial statements for

all fiscal years shown in a company’s financial report are presented, if practical, as if
the newly adopted accounting policy had been used throughout the entire period; this
retrospective application of the change makes the financial results of any prior years
included in the report comparable. Notes to the financial statements describe the
change and explain the justification for the change.

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7. C is correct. The weighted average number of shares outstanding for 2009 is

1,050,000. Basic earnings per share would be USD1,000,000 divided by 1,050,000, or
USD0.95.

8. A is correct. Basic and diluted EPS are equal for a company with a simple capital
structure. A company that issues only common stock, with no financial instruments
that are potentially convertible into common stock has a simple capital structure.
Basic EPS is calculated using the weighted average number of shares outstanding.

9. C is correct.

Diluted EPS = (Net income)/(Weighted average number of shares outstanding + New

common shares that would have been issued at conversion)
= USD200,000,000/[50,000,000 + (2,000,000 × 2)]
= USD3.70
The diluted EPS assumes that the preferred dividend is not paid and that the shares
are converted at the beginning of the period.

10. B is correct. The formula to calculate diluted EPS is as follows:

Diluted EPS
= (Net income – Preferred dividends)/[Weighted average number of shares
outstanding + (New shares that would have been issued at option exercise – Shares
that could have been purchased with cash received upon exercise) × (Proportion of
year during which the financial instruments were outstanding)].

The underlying assumption is that outstanding options are exercised, and then the
proceeds from the issuance of new shares are used to repurchase shares already
outstanding:

Proceeds from option exercise = 100,000 × USD20 = USD2,000,000

Shares repurchased = USD2,000,000/USD25 = 80,000

The net increase in shares outstanding is thus 100,000 – 80,000 = 20,000. Therefore,
the diluted EPS for CWC = (USD12,000,000 – USD800,000)/2,020,000 = USD5.54.

11. B is correct. LB has warrants in its capital structure; if the exercise price is less than
the weighted average market price during the year, the effect of their conversion is
to increase the weighted average number of common shares outstanding, causing
diluted EPS to be lower than basic EPS. If the exercise price is equal to the weighted
average market price, the number of shares issued equals the number of shares
repurchased. Therefore, the weighted average number of common shares outstanding
is not affected and diluted EPS equals basic EPS. If the exercise price is greater
than the weighted average market price, the effect of their conversion is anti-

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dilutive. As such, they are not included in the calculation of basic EPS. LB’s basic EPS
is USD1.22 [= (USD3,350,000 – USD430,000)/2,400,000].

Stock dividends are treated as having been issued retroactively to the beginning of
the period.

12. A is correct. With stock options, the treasury stock method must be used. Under
that method, the company would receive USD100,000 (10,000 × USD10) and would
repurchase 6,667 shares (USD100,000/USD15). The shares for the denominator
would be:

13. A is correct. When a company has stock options outstanding, diluted EPS is calculated
as if the financial instruments had been exercised and the company had used the
proceeds from the exercise to repurchase as many shares possible at the weighted
average market price of common stock during the period. As a result, the conversion
of stock options increases the number of common shares outstanding but has no
effect on net income available to common shareholders. The conversion of convertible
debt increases the net income available to common shareholders by the after-tax
amount of interest expense saved. The conversion of convertible preferred shares
increases the net income available to common shareholders by the amount of
preferred dividends paid; the numerator becomes the net income.

14. B is correct. Common size income statements facilitate comparison across time
periods (time-series analysis) and across companies (cross-sectional analysis) by
stating each line item of the income statement as a percentage of revenue. The
relative performance of different companies can be more easily assessed because
scaling the numbers removes the effect of size. A common size income statement
states each line item on the income statement as a percentage of revenue. The
standardization of each line item makes a common size income statement useful for
identifying differences in companies’ strategies.

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15.

16. B is correct. Changes in accounting policies are reported through retrospective

application unless it is impractical to do so.

17. B is correct. Common-size income statements facilitate comparison across time

periods (time-series analysis) because the standardization of each line item removes
the effect of size. They would be particularly useful in neutralizing the size effect
for a company experiencing rapid growth. For example, efficiencies gained from
increased volume may be more readily apparent. Common-size income statements

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would be less useful for similarly sized companies from different industries because
the size effect is less important in the comparison.

18. C is correct. Because both the preferred shares and the bonds are dilutive, they
should both be converted to calculate the diluted EPS. Diluted EPS is the lowest
possible value.

19. C is correct. Common size statements offer a convenient way to compare companies
of different magnitudes. Company X reports better (higher) gross margin
performance. Company Y reports better (higher) operating margin performance.

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20. B is correct. In general, a company recognizes expenses in the period that it consumes
(i.e., uses up) the economic benefits associated with the expenditure or loses some
previously recognized economic benefit.

21. A is correct. A two-for-one stock split will double the number of shares, thus
reducing the EPS to half of its pre-split value. P/E will remain unchanged because the
price also reduces by half and exactly cancels out the effect of the reduced EPS.
The dividend payout ratio remains unchanged because the same proportion of earnings
will still be used after the split.

22. C is correct. First, determine the incremental shares issued from stock option
exercise (treasury stock method):

23. B is correct. OA’s cost of sales have been steadily rising, causing the firm’s gross
profit margin to fall below the industry average. A falling gross margin indicates
falling revenue per dollar of sales costs.

24. A is correct. Revenue is recognized by the cooperative when the art gallery sells the
artwork because that is the point at which the risks and rewards transfer from the
cooperative to a third party and the amount of revenue is measurable.

25. A is correct. Service revenues are recognized by reference to the stage of

completion of the service contract. Historical patterns provide evidence that 25% of
the services performed under the contract are incurred during the contract’s first
year. As such, only 25% of the contract revenue would be recognized in the first
year:

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Calculation Total contract value€420 Stage of completion at end of first year25%

Revenue recognized in first year€10525% × €420

26. A is correct. The convertible preferred shares are anti-dilutive, as shown in the
following table. Therefore, the diluted EPS is the same as the basic EPS, $2.91.

27. C is correct. The weighted average number of shares outstanding is time weighted:

28. C is correct. Under US GAAP, material items that are unusual or infrequent and that
are both as of reporting periods beginning after 15 December 2015 are shown as part
of a company’s continuing operations but are presented separately.

29. B is correct. As the calculations below show, the basic and diluted EPS are $3.60 and
$3.33, respectively, and the resulting net difference is $0.27.

30. B is correct because the company would record a liability for unearned revenue, or
deferred revenue, when the cash is initially received, and revenue would be
recognized over time as products and services are delivered. An example would be a

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subscription payment received in advance for cloud-based software delivered over a

year.

31. A is correct because a vertical common-size income statement divides each income
statement item by revenue. Gross profit is the amount of revenue available after
subtracting the costs of delivering goods or services. Accordingly, based only on this
information, under vertical common-size analysis, selling, general, and administrative
expenses can be expressed as = Selling, general, and administrative expenses /
Revenue = Selling, general, and administrative expenses / (Gross profit + Cost of
sales) = 30 / (100 + 150); or = 30 / 250 = 12%.

32. B is correct because Basic EPS = (Net income-Preferred dividends) / (Weighted

average number of shares outstanding) = (€80,000 – €10,000) / 150,000 ≈ €0.47.

33. C is correct because at times, standard setters issue new standards that require
companies to change accounting policies. Depending on the standard, companies may
be permitted to adopt the standards prospectively (in the future) or retrospectively
(restate financial statements as though the standard existed in the past) while the
new revenue recognition standard also offered companies the option of using a
“modified retrospective” method of adoption. Under the modified retrospective
approach, companies were not required to revise previously reported financial
statements. Instead, they adjusted opening balances of retained earnings (and other
applicable accounts) for the cumulative impact of the new standard.

34. A is correct because Basic EPS = (Net income – Preferred dividends) / Weighted
average number of shares outstanding = ($210,000 – $0) / [[(50,000 × 3/12) + (50,000
– 20,000) × 9/12)] × 2] = $210,000 / [(12,500 + 22,500) × 2] = $210,000 / 70,000 =
$3.00. If the number of shares of common stock increases as a result of a stock
dividend or a stock split, the EPS calculation reflects the change retroactively to the
beginning of the period.

35. C is correct because common-size analysis of the income statement can be performed
by stating each line item on the income statement as a percentage of revenue.
Accordingly, Company 1's gross profit margin = (7,586,000 –3,413,700) ÷ 7,586,000
= 55%, being higher than Company 2's gross profit margin of (9,445,000 –4,533,600)÷
9,445,000 = 52%.

36. C is correct because Diluted EPS = Net income / (Weighted average number of
common shares + New common shares issued at conversion); and Weighted average
number of common shares during the year = 3,500,000 + 1,000,000 × ¾ = 4,250,000,
which reflects the shares issued on April 1 which are outstanding for 9 of the 12
months of the year. New shares issued at conversion = 400,000 × 2 = 800,000. Diluted
EPS = €3,000,000 / (4,250,000 + 800,000) = €3,000,000 / 5,050,000 = €0.5941 ≈
€0.59. Basic EPS = (Net income – Preferred dividend) / Weighted average common
shares= (€3,000,000 − €400,000)/4,250,000 = €2,600,000 / 4,250,000 = €0.6118.

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The convertible preferred shares are not anti-dilutive, as €0.59 is less than basic
EPS €0.6118. Thus the reported diluted EPS is €0.59.

37. B is correct because it is only at the point when all performance obligations have been
met except for payment that a receivable appears on the seller’s balance sheet.

38. A is correct because in contrast to changes in accounting policies (such as whether

to expense the cost of employee stock options), companies sometimes make changes
in accounting estimates (such as the useful life of a depreciable asset). Changes in
accounting estimates are handled prospectively, with the change affecting the
financial statements for the period of change and future periods. No adjustments
are made to prior statements, and the adjustment is not shown on the face of the
income statement.

39. B is correct because the assumed exercise of the stock options would not change net
income for the year (or preferred dividends). For calculating EPS, therefore, no
change is made to the numerator. However, the denominator would be increased by
the incremental number of shares issued as a result of the stock option being
exercised.

40. B is correct because the basic EPS calculation highlights that the convertible bond is
dilutive; that is, Basic EPS = (Net income - Preferred dividends) / (Weighted average
number of shares outstanding), Where net income is $1,200,000. There are no
preferred dividends.

Weighted average number of shares outstanding is:

1,000,000 x (3 months ÷ 12 months) = 250,000
1,100,000 x (9 months ÷ 12 months) = 825,000

Weighted average number of shares outstanding equals 250,000 + 825,000 =

1,075,000 shares.
Basic EPS = $1,200,000 / 1,075,000 = $1.12.
Diluted EPS is calculated using the following formula:
(Net income + After-tax interest on convertible debt - Preferred dividends) /
(Weighted average number of shares outstanding + Additional common shares that
would have been issued at conversion) After-tax interest on convertible debt equals
$2,000,000 √ó 8% √ó (1 - 30%) = $112,000. Therefore, computed diluted EPS =
($1,200,000 + $112,000) / (1,075,000 + 200,000) = $1,312,000 / 1,275,000 = $1.029
which rounds to $1.03.

41. B is correct because the entity [the seller] will recognize revenue when it is able to
satisfy the performance obligation by transferring control to the customer. Factor
to consider when assessing whether the customer has obtained control of an asset at
a point in time: Entity has a present right to payment.

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42. C is correct because the standard states that for performance obligations satisfied
over time (e.g., where there is a long-term contract), revenue is recognized over time
by measuring progress toward satisfying the obligation. The standard refers to
performance obligations satisfied over time and requires that progress toward
complete satisfaction of the performance obligation be measured based on input
method such as the one illustrated here (recognizing revenue based on the proportion
of total costs that have been incurred in the period) or an output method (recognizing
revenue based on units produced or milestones achieved). Accordingly, the company
has incurred 25% of the total expected costs (£0.5m / £2.0m); and will thus
recognize £0.75m (25% × £3.0m) in revenue in Year 1.

43. B is correct because there are situations when a company receives cash in advance
and actually delivers the product or service later, perhaps over a period of time. In
this case, the company would record a liability for unearned revenue when the cash is
initially received, and revenue would be recognized as being earned over time as
products and services are delivered.

44. B is correct because this is the first of five steps in recognizing revenue according
to the converged accounting standard for revenue recognition. The [converged
accounting] standard [for revenue recognition] describes the application of five steps
in recognizing revenue:
1) Identify the contract(s) with a customer
2) Identify the separate or distinct performance obligations in the contract
3) Determine the transaction price
4) Allocate the transaction price to the performance obligations in the contract
5) Recognize revenue when (or as) the entity satisfies a performance obligation.

45. A is correct because when a company disposes of or establishes a plan to dispose of

one of its component operations and will have no further involvement in the operation,
the income statement reports separately the effect of this disposal as a
“discontinued” operation under both IFRS and US GAAP. Financial standards provide
various criteria for reporting the effect separately, which are generally that the
discontinued component must be separable both physically and operationally.

46. C is correct because when a company has convertible preferred stock outstanding,
diluted EPS is calculated using the if-converted method. The formula to calculate
diluted EPS using the if-converted method for preferred stock is: Diluted EPS = Net
income ÷ (Weighted average number of shares outstanding + New common shares that
would have been issued at conversion). Therefore, Diluted EPS = €2,500,000 ÷
(2,000,000 + 2 × 1,000,000) = €2,500,000 ÷ 4,000,000 = €0.625 ≈ €0.63. However,
diluted EPS, by definition, is always equal to or less than basic EPS. Basic EPS = (Net
income - Preferred dividends) ÷ (Weighted average number of shares outstanding) =
(€2,500,000 – 1,000,000 × €1) ÷ 2,000,000 = €1,500,000 ÷ 2,000,000 = €0.75.
Therefore the convertible preferred stocks are dilutive and diluted EPS = €0.63.

Faculty: Vikas Vohra Page 22 of 23

 Analyzing Income Statements

47. C is correct because when a company has convertible preferred stock outstanding,
diluted EPS is calculated using the if-converted method. The formula to calculate
diluted EPS using the if-converted method for preferred stock is: Diluted EPS = Net
income ÷ (Weighted average number of shares outstanding + New common shares that
would have been issued at conversion). Therefore, Diluted EPS = 5,000,000 ÷
(2,000,000 + 6 X 400,000) = 5,000,000 ÷ 4,400,000 = 1.14 . Checking that diluted
EPS, by definition, is always equal to or less than basic EPS. Basic EPS = (Net income
- Preferred dividends) ÷ (Weighted average number of shares outstanding) =
(5,000,000 - 400,000 x 2) ÷ 2,000,000 = 4,200,000 ÷ 2,000,000 = 2.1. Therefore,
the convertible preferred stocks are dilutive and diluted EPS = 1.14.

Faculty: Vikas Vohra Page 23 of 23