 Hello and welcome to the session in which we would look at CPA exam questions that deals with the income statement. The income statement is an important topic on the CPA exam and that's obvious because every and each company will have to prepare an income statement. Now in this session we would look at CPA questions that deals with items that goes on the income statement. You need to know how they are presented, when they are presented and why they are presented in a certain manner. So if you are a CPA candidate or an accounting student or a CMA candidate, I strongly suggest you check out my website farhatlectures.com. No, I don't replace your CPA review course. If you have a course you can keep it. That's not my intent. My intent is to be a useful addition to your CPA review course. I can add 10 to 15 points to your CPA exam score by explaining the material differently. Maybe better, maybe not better, but at least I can show you the material in an alternative fashion, an alternative matter. And it's often time it might click and it might help you understand your CPA review course better, which will help you on the CPA exam. And what I did is I created my courses very similar, mirror image your CPA review course, so it's very easy to follow between my course and your course. Your risk to try me is one month. If you like it, keep it if not cancelled. Your return is potentially passing the exam. And if not for anything, take a look at my website to find out how well your university doing on the CPA exam. As I mentioned, I do have other CPA, other than CPA review courses, I have accounting courses as well. Please connect with me only then if you haven't done so. And you can view only then people that actually used my material to pass the exam, like this recording on YouTube, share it, connect with me on Instagram and Facebook. Let's take a look at the first question. It's better to read the question first. What before tax amount should the company report as a loss on this continued operation in its 2021 income statement? So we are looking for a loss. So that's easy. They're not confusing us between a loss and a gain. And specifically they are asking about this continued operation. So let's see what's happening here. On October 28th, a company committed to plan to sell a division that qualify as a component of an entity according to GAP regarding this continued operation. This continued operation is an important concept that you need to understand very well on the exam and was properly classified as held for sale as of December 31st 2021 at the end of the physical year. So it's a division, discontinued operation and was properly recorded. Okay. The division's loss from operation for 2021 was 2 million. So they're telling us the division loss was 2 million. The division's book value and fair value less cost to sell were 3 million and 2.5 million respectively. So they're asking us how much we need to report as a loss from this discontinued, discontinued operation. Well, obviously it's 2 million. We're going to start with this. And why? Because they operated the business, sorry, they operated the business, they operated the business and they incur 2 million of losses. Therefore, it's 2 million. What else do we have to report? Look what we are told. Let me just highlight this. We are told that the division book value, the division book value was 3 million and the division fair value at the end of the period was 2.5. It seems that the division has an impairment loss because the fair value is less than the book value. Well, based on conservatism, we're going to have to report an additional 500,000 of losses. Why? Because look, their book value and their fair value, their book value is 3 million, the fair value of the division is 2.5. Well, we have to report an impairment loss of half a million. Therefore, all in all, the report the loss from discontinued operation is 2.5 million. So it's very important that you understand how discontinued operation works. And in this example, actually we ignored taxes. So you have to report those figures net of tax. And this is where Farhat Lectures will help you tremendously understanding what does it mean something reported net of tax and specifically something as important as the discontinued operation. A likely method that manager use for classification shifting in its report of operating expenses. So when they're shifting operating expenses, what can they use? Well, can they use revenues? No, it cannot be you're shifting certain expenses. You cannot turn them into revenues. That will be very creative. But that's quite impossible taken an expense and turn it into a revenue. Let's skip the income tax expense. Well, you can shift something into an income tax expense, but that's going to be too obvious. From an auditor's perspective, from a user's perspective, your expenses will be too large. So it's not really shifting to report certain operating expenses. You don't shift them into income tax expense into an asset. You can shift, you can turn an expense into an asset. But for classification shifting, so we're not turning the expense into something else. Something else could be revenue, very difficult to do. But you can turn an expense into an asset. Say it's going to serve me for several years, this expenditure, it's an asset. But here we are shifting classification, not the nature of the expenditure. Therefore, you are likely to report it as non-operating expense. So we have operating expenses and non-operating. Non-operating will be interest, income tax, income tax expense is non-operating. So you might take something that's operating and shift it into non-operating. Now, why would the manager will do that? It's still an expense. So this is an expense and these are expenses. Well, because when you value a company, you are looking at their operating income. Really, when you are looking at a company, what you care about is their operating income. And operating income is computed by taking operating revenues minus operating expenses to get to operating income. So the managers might want to shift some of those expenses to non-operating. So the operating income would look larger, the company will get a higher value, the company would look good, the manager would look good. So this is one potential shifting is going from operating expenses, shifting an expense and say this is a non-operating. Temporary earnings are best characterized as what? So we have temporary earnings and obviously we have permanent earnings. Really, the term is just for there's no strictly accounting terms that says temporary earnings, but temporary earnings are earnings that don't repeat, earnings that don't repeat in the future. Now, why do we want to differentiate between temporary earnings and equal to permanent earnings or earnings likely to occur? Just like expenses, we want to know the nature of the expenses. Whether this expense is operating and usually operating expenses stay with us because it's part of the business, non-operating they have nothing to do with operating the business. For example, interest is financing income taxes has to do with the government. So for revenues, we also have to kind of tell the users on the income statement whether this revenue is temporary or it's going to repeat. Okay. A, an earning that don't have corresponding cash flow. Well, maybe here you're saying a cruel revenue because corresponding cash flow means it wasn't in cash. Well, not really. That doesn't mean anything. You could have earnings. It doesn't have a cash flow yet. So that's not temporary earnings. Earnings from non-operating activities. Not necessary, not necessary earnings from non-operating activities because non-operating, you could have earnings from non-operating activities like interest, interest revenue. Okay. You could have, if you are not a bank, you could have or an investment firm, you could have dividend revenue. Those are non-operating revenue. They are earnings but they're not from your operation. Okay. So that's not the definition of it. Earnings that do not conform to gap. Well, those are fraud, fraud earnings. So that's no. D is by process of elimination is the correct answer. And D says earnings that likely that arise from event that are not likely, notice here, not likely to reoccur in the foreseeable future, not likely to reoccur. So what's the best example I can give you about this? It was at Caterpillar? Was it Caterpillar or John Deere? I'm not sure whether it's Caterpillar or John Deere. In one particular year, this 25% of their sales, I'm not sure what's it, John Deere or Caterpillar please, but I'm going to illustrate the point. 25% of the revenue was a contract with the Brazilian government. It's a one-time deal. So 25% of the revenue was a contract with the Brazilian government. So they have to tell you that this revenue, that's substantial revenue, that's substantial amount of revenue, it's a temporary earning. It means it's not going to reoccur in the foreseeable future. Most likely it's operating revenue. They were selling them, you know, their product, their machinery, their equipment, that's what they sell, but it's a one-time deal. It's not going to reoccur again. So from a user's perspective, you want to tell the user, look, just be careful, this is temporary earnings. That's why our revenue is so large. Don't count on that next year. This is what we mean by temporary earnings, okay? Versus we also have non-operating activities, earnings from non-operating, which is interest and revenue, they do occur again year after year. You might have interest or dividend, but also under non-operating activities, you could have gains and losses. So you might sell an asset, asset you don't use. Those are non-operating, okay? They might occur again, but they're non-operating. So temporary earnings has to do with a specific event, specific event, like a special contract with the government. Let's take a look at this question. A company has decided to discontinue a component of its business and sell the component at the end of the year. Fair enough? The amount that the company would report as income from discontinued operation, ignoring tax is what? Only income from operating for the year. No, you would still report any income or loss from the discontinued operation. Only the income or loss on the disposal of the component. No, not only the disposal, you also want to report the, you also want to report the revenues or revenues and expenses, which is operating loss or operating income, not only the gain or loss on the disposal. Income from operation for the year, and only loss on the disposal of the component. So they're saying report the income for, report the income from the operation and only the loss on the disposal. No, you would report the loss. Or you might have a gain on the disposal. Income from operation for the year, and either a gain or a loss on the disposal. Yes, you would report the income, okay? The income could be again income from operation could be here we can we can say income slash loss but from operation results from operation and either gain or loss on the disposal you have to report both so remember you have to report two things with this continued operation why because okay you classified it you would have one division you know your your car manufacturing you're selling your car money let's be let's assume google is selling youtube which is in a way they would sell alphabet not google alphabet to be more technical let's assume they decided to sell youtube which is they will never do that it's a growing it's a growing division but the point is if they decided to do that they would have to report two things about youtube when they operate youtube for that particular year they're going to have operating loss or gain which is net income or net loss from operation this is what we meant here and when they sell it they might have a gain slash loss so you report two things for discontinued operation because you are still running the operation you'd have to report the gain and loss for the sale and profit or loss for operating the business two items and both of these items have to reported net net of tax once again if you are studying for the CPA exam this topic is extremely important this is what this is what i do on my website explain this topic in detail discontinued operation the principal benefit of separately reporting discontinued operation is to enhance what so simply put why do we report this continued operation separately why well a predictive ability of future profitability and the answer is yes this is the answer because you want to tell the users look i used to have youtube let's assume we're talking about alphabet google i used to have youtube okay but don't count on any youtube profit in the future or don't factor any youtube losses and my companies in the future because i'm listing this separately now i'm getting rude of it and that's why we that we do things certain way that's why we discontinued the operation we take it out we take it out of the operating section and list it separately so it tells the users look in future years take this this company out and base your decision on what we have on operating income so it helps to enhance predictive ability of future profit profitability so you're taking it out reported it separately although it's on the income statement but it's reported separately consistency and reporting now doesn't the here the predictive ability is better than consistency consistency means using the same method which you should but once you have a discontinued operation you have to show it separately intra period continuity not really comprehensive reporting i'm not sure if you know there's comprehensive income you know you would be comprehensive reporting not really a technical term here let's take a look at this question under normal circumstances again ignoring taxes permanent earnings would be computed as what okay here they're giving us a bunch of earnings and they want us to compute permanent earn remember we have permanent earning and transitory earnings earnings that uh they are not permanent they may not stay with us from year to year what could be permanent earnings earnings that should stay with us from year to year okay with sales revenue stay stay with us from year to year yes with selling expenses we would like to get rid of that but that's not going to happen so we're going to take out selling expenses gain on sale of investment would you consider gain on sale of investment as permanent something that you do every year or it happened once in a while i would say it will happen once in a while although well we'll explain this in a moment gain on sale of the investment it's not considered really permanent permanent interest expense interest expense would be considered permanent from a business perspective you would always have a business interest expense and it's normal to have an interest expense okay gain on sale of the investment it's not it's not permanent both of these by the way both of these are non-operating both of these are non-operating the interest expense is an is a non-operating expense gain on sale of investment non-operating revenue but they're both non-operating but the interest expense is considered permanent under normal circumstances because companies incur expense interest expense as part of financing their business but gain on the sale of the investment not necessarily considered permanent okay cost of good sold yeah that's a big one we would like to get rid of that but we can't so if if we're looking at the permanent earnings of this company we're going to take 860 and deduct from it 250 minus 10 minus 520 the permanent earnings if we're looking at permanent earnings will be 80 000 okay permanent earnings is 80 000 again just want to clarify one more time both of these items this item here gain on sale in interest will be non-operating but that's not what they're asking about here if they were asking about operating income let's assume they were asking about operating income it will be 860 minus 520 which is cost of goods sold minus the selling minus 250 this will give us operating income and this is the most important operating income the company is operating their business are they making a profit how much is that profit this is what operating income is all about the questions what was about permanent earnings we do assume that interest expense is part of doing business gain on sale of investments not necessary okay again unless I mean no let's let's be clear unless on regular basis you sell you buy investments and you sell them and that's fine that's the business that you are in but if you are not in that business it doesn't work that way okay basically at the end of this recording I'm going to invite you again to visit farhatlectures.com again I don't replace your CPA review course I don't intend to do so I intend to help you I intend to be a backup an alternative explanation to your CPA review course give me a chance try me for a month that's your risk it might help you pass the exam an investment that's that's that's going to live with you for 30 years good luck study hard and of course stay safe