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Fundamentals of Financial Accounting Fred Phillips 6th Edition-Test Bank
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Chapter 2 The Balance Sheet
1) A transaction is an exchange or event that directly affects the assets, liabilities, or stockholders’ equity of a company.
Answer: TRUE
Explanation: A transaction is an event or activity that has a direct and measurable financial effect on the assets, liabilities, or stockholders’ equity of a business.
Difficulty: 1 Easy
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
2) General Motors (GM) signs a new labor agreement that its workers will receive a 5% wage increase next year. This transaction affects GM’s financial statements in the current year.
Answer: FALSE
Explanation: A promise to pay has been exchanged for a promise to work next year. This activity is not a transaction because no assets or services were exchanged at the time the new labor agreement is signed. This event does not affect GM’s financial statements in the current year.
Difficulty: 2 Medium
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
3) If total assets decrease, then either total liabilities or total stockholders’ equity must also decrease.
Answer: TRUE
Explanation: The accounting equation (Assets = Liabilities + Stockholders’ Equity) must balance. If one side of the equation decreases, the other side must decrease.
Difficulty: 1 Easy
Topic: Analyzing Transactions
Learning Objective: 02-02 Apply transaction analysis to accounting transactions.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
4) Goodrich, Inc. signed an agreement to rent a warehouse from Ellie Co. This is an example of a transaction that should not be recorded.
Answer: TRUE
Explanation: This activity is not a transaction because no assets or services were exchanged at the time the agreement was signed.
Difficulty: 1 Easy
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
5) A business is obliged to repay both debt and equity financing.
Answer: FALSE
Explanation: There is no requirement to pay back equity contributions to stockholders. There is a legal requirement to pay back debt financing to creditors.
Difficulty: 2 Medium
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
6) You are pleasantly surprised to discover that a popular actress appears on TheTonightShow wearing your company’s jeans. Later, your company’s sales increase by $500,000 as a result. When the actress appeared on TV, you would have recorded an asset because the TV appearance was expected to bring future economic benefits to your company.
Answer: FALSE
Explanation: This activity is not a transaction because no assets or services were exchanged at the time the actress appeared on television. No asset would be recorded. In addition, recall that an asset is an economic resource presently controlled by the company; has measurable value and is expected to benefit the company by producing cash inflows or reducing cash outflows in the future. This situation does not meet the definition of an asset.
Difficulty: 3 Hard
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Evaluate
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
7) Eagle Company used $50,000,000 of its cash to pay off debt, as a result, Eagle’s stockholders’ equity will decrease $50,000,000.
Answer: FALSE
Explanation: Assets and liabilities would each decrease by $50,000,000; there is no impact on stockholders’ equity.
Difficulty: 2 Medium
Topic: Analyzing Transactions
Learning Objective: 02-02 Apply transaction analysis to accounting transactions.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
8) Puffin, Inc. issues $1,000,000 in new stock for cash. Puffin’s stockholders’ equity does not change because as new shares are sold, the value of its existing shares falls.
Answer: FALSE
Explanation: When new stock is issued for cash, the company has more cash and common stock. Assets and stockholders’ equity both increase.
Difficulty: 2 Medium
Topic: Analyzing Transactions
Learning Objective: 02-02 Apply transaction analysis to accounting transactions.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
9) The record-analyze-summarize process is applied only to daily transactions, month-end adjustments need not be analyzed and summarized.
Answer: FALSE
Explanation: The three-step analyze-record-summarize process is applied to daily transactions, as well as adjustments at the end of each month, before preparing a trial balance and the financial statements.
Difficulty: 2 Medium
Topic: The Debit/Credit Framework
Learning Objective: 02-02 Apply transaction analysis to accounting transactions.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
10) The list of account names and reference numbers that the company will use when accounting for transactions is called the chart of accounts.
Answer: TRUE
Explanation: The chart of accounts is a summary of all account names (and corresponding account numbers) used to record financial results in the accounting system.
Difficulty: 1 Easy
Topic: Analyzing Transactions
Learning Objective: 02-02 Apply transaction analysis to accounting transactions.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
11) A debit may increase or decrease an account, depending on the type of account.
Answer: TRUE
Explanation: Whether a debit or credit increases or decreases an account depends upon the type of account. Debits increase assets, expenses, and dividends, but decrease liabilities, revenues, and equity. Credits increase liabilities, revenue, and equity, but decrease assets, expenses and dividends.
Difficulty: 2 Medium
Topic: The Debit/Credit Framework
Learning Objective: 02-03 Use journal entries and T-accounts to show how transactions affect the balance sheet.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
12) The normal balance of an account is on the same side that decreases the account.
Answer: FALSE
Explanation: The balance in an account is determined by the excess of increases over decreases. It is normal to have more increases in an account than decreases; therefore, the normal balance of an account is on the same side that increases the account.
Difficulty: 1 Easy
Topic: The Debit/Credit Framework
Learning Objective: 02-03 Use journal entries and T-accounts to show how transactions affect the balance sheet.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
13) If the total dollar value of debits to an account exceeds the total dollar value of credits to that account, the ending balance of the account will be a debit balance.
Answer: TRUE
Explanation: If debits exceed credits, the account will have a debit balance.
Difficulty: 1 Easy
Topic: The Debit/Credit Framework
Learning Objective: 02-03 Use journal entries and T-accounts to show how transactions affect the balance sheet.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
14) Every transaction increases at least one account and decreases at least one account.
Answer: FALSE
Explanation: A transaction may have any combination of increases and decreases. For example, a purchase of equipment on account increases both equipment and accounts payable. What is true is that every transaction is recorded with at least one debit and at least one credit.
Difficulty: 2 Medium
Topic: The Debit/Credit Framework
Learning Objective: 02-03 Use journal entries and T-accounts to show how transactions affect the balance sheet.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
15) Accounts increase on the same side as they appear in the accounting equation: A = L + SE.
Answer: TRUE
Explanation: Accounts on the left side of the accounting equation (that is, assets) increase on the left side and accounts on the right side of the equation (that is, liabilities and stockholders’ equity) increase on the right side.
Difficulty: 1 Easy
Topic: The Debit/Credit Framework
Learning Objective: 02-03 Use journal entries and T-accounts to show how transactions affect the balance sheet.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
16) Journal entries show the effects of transactions on the elements of the accounting equation, as well as the account balances.
Answer: FALSE
Explanation: Journal entries are entered into the journal using a debit/credit format. By themselves, journal entries show the effect of transactions, but they do not provide account balances. The entries are “posted” to the ledger accounts, which then show the balance of each of the accounts.
Difficulty: 2 Medium
Topic: The Debit/Credit Framework
Learning Objective: 02-03 Use journal entries and T-accounts to show how transactions affect the balance sheet.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
17) The general ledger is an internal report that lists all the accounts and their balances and is used to check that total debits equals total credits.
Answer: FALSE
Explanation: The trial balance is an internal report that lists all the accounts and their balances and is used to check that total debits equals total credits.
Difficulty: 2 Medium
Topic: Preparing a Trial Balance and Balance Sheet
Learning Objective: 02-04 Prepare a trial balance and a classified balance sheet.
Bloom’s: Understand
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
18) A trial balance shows a subtotal for current assets and current liabilities.
Answer: FALSE
Explanation: A classified balance sheet contains subcategories and subtotals for current assets and current liabilities.
Difficulty: 1 Easy
Topic: Preparing a Trial Balance and Balance Sheet
Learning Objective: 02-04 Prepare a trial balance and a classified balance sheet.
Bloom’s: Understand
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
19) When a company prepares a classified balance sheet, liability accounts must be shown in subcategories of current and noncurrent.
Answer: TRUE
Explanation: Assets and liabilities are classified as current and noncurrent. Stockholders’ equity accounts are not classified as current or noncurrent.
Difficulty: 2 Medium
Topic: Preparing a Trial Balance and Balance Sheet
Learning Objective: 02-04 Prepare a trial balance and a classified balance sheet.
Bloom’s: Understand
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
20) The trial balance is a financial statement that reports the assets, liabilities, and equity of a business at a point in time.
Answer: FALSE
Explanation: The trial balance is an internal accounting report that lists the balances in all the ledger accounts at a point in time. It shows whether debit balance accounts equal the credit balance accounts. A balance sheet is a financial statement that reports the assets, liabilities, and equity of a business at a point in time.
Difficulty: 1 Easy
Topic: The Debit/Credit Framework; Preparing a Trial Balance and Balance Sheet
Learning Objective: 02-03 Use journal entries and T-accounts to show how transactions affect the balance sheet.; 02-04 Prepare a trial balance and a classified balance sheet.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
21) The acquisition of inventory in an exchange for a company’s stock would increase the current ratio of the company.
Answer: TRUE
Explanation: The current ratio is current assets divided by current liabilities. Inventory is classified as a current asset and since it increases in this transaction, it would increase the current ratio.
Difficulty: 2 Medium
Topic: Assessing the Ability to Pay
Learning Objective: 02-05 Interpret the balance sheet using the current ratio and an understanding of related concepts.
Bloom’s: Analyze
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
22) The current ratio can be used to evaluate a company’s ability to pay liabilities in the short term, and in general, a higher ratio means better ability to pay.
Answer: TRUE
Explanation: The current ratio is current assets divided by current liabilities. A higher ratio means better ability to pay.
Difficulty: 2 Medium
Topic: Assessing the Ability to Pay
Learning Objective: 02-05 Interpret the balance sheet using the current ratio and an understanding of related concepts.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
23) Owners of a company:
- A) hold promissory notes as evidence of their ownership claim.
- B) are entitled to repayment of their investment.
- C) have a claim that is secondary to creditor’s claims.
- D) have a claim equal to the amount of liabilities a company owes.
Answer: C
Explanation: Owners have a claim on company assets that is secondary to creditor’s claims. Promissory notes are the legal documents that describe the details of a loan; stock certificates are evidence of ownership claims. A business is obligated to repay debt financing, but is not obligated to repay equity financing. Creditors have a claim on company assets equal to the amount of liabilities that the company owes.
Difficulty: 3 Hard
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
24) If a company borrows money from a bank and signs an agreement to repay the loan several years from now, in which account would the company report the amount borrowed?
- A) Common Stock
- B) Accounts Payable
- C) Notes Payable (long-term)
- D) Retained Earnings
Answer: C
Explanation: Debt financing refers to money obtained through loans. A formal loan with the bank is reported as Notes Payable (long-term).
Difficulty: 2 Medium
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
25) The Sweet Smell of Success Fragrance Company borrowed $60,000 from the bank to be paid back in five years and used all of the money to purchase land for a new store. Sweet Smell’s balance sheet would show this as:
- A) $60,000 under Land and $60,000 under Notes Payable (long-term).
- B) $60,000 under Depreciation Expense and $60,000 under Notes Payable (long-term).
- C) $60,000 under Land and $60,000 under Notes Receivable (long-term).
- D) $60,000 under Other Assets and $60,000 under Other Liabilities.
Answer: A
Explanation: The purchase of land is recorded in the Land account and a noncurrent bank loan is recorded as Notes Payable (long-term).
Difficulty: 2 Medium
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
26) Typical steps needed before a business can start selling goods and/or services to customers include:
- A) financing and investing activities.
- B) only financing activities.
- C) only investing activities.
- D) only operating activities.
Answer: A
Explanation: After obtaining initial financing, a company will start investing in assets that will be used after the business opens.
Difficulty: 1 Easy
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
27) Who has first claim to a business’s assets should the company go out of business?
- A) Creditors
- B) Stockholders
- C) Customers
- D) Management
Answer: A
Explanation: Creditors have a claim to a company’s assets equal to the amount of liabilities that the company owes.
Difficulty: 1 Easy
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
28) The creditors’ claims to a company’s resources are represented by:
- A) common stock.
- B) total stockholder’s equity.
- C) total liabilities.
- D) retained earnings.
Answer: C
Explanation: Creditors have a claim to a company’s assets equal to the amount of liabilities that the company owes.
Difficulty: 1 Easy
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
29) A difference between debt financing and equity financing is that:
- A) debt financing must be repaid, while repayment of equity financing is not required.
- B) equity financing must be repaid, while repayment of debt financing is not required.
- C) only debt financing can be used to purchase assets.
- D) only equity financing can be used to purchase assets.
Answer: A
Explanation: Two sources of financing are available to businesses: equity and debt. Equity refers to financing a business through owners’ contributions and reinvestments of profit. Debt refers to financing the business through loans. A business is obligated to repay debt financing, but it is not obligated to repay its equity financing.
Difficulty: 1 Easy
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
30) Debt financing is financing obtained from:
- A) stockholders.
- B) creditors.
- C) selling goods or services on credit.
- D) both creditors and stockholders.
Answer: B
Explanation: Two sources of financing are available to businesses: equity and debt. Equity refers to financing a business through owners’ contributions and reinvestments of profit. Debt refers to financing the business through loans. A business is obligated to repay debt financing, but it is not obligated to repay its equity financing.
Difficulty: 1 Easy
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
31) Equity financing is financing obtained from:
- A) creditors.
- B) stockholders.
- C) selling goods or services on credit.
- D) both creditors and stockholders.
Answer: B
Explanation: Two sources of financing are available to businesses: equity and debt. Equity refers to financing a business through owners’ contributions and reinvestments of profit. Debt refers to financing the business through loans. A business is obligated to repay debt financing, but it is not obligated to repay its equity financing.
Difficulty: 1 Easy
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
32) The cost principle is used:
- A) to refer to the two sources of financing available to businesses.
- B) to measure the amount used to record assets on the date of the transaction.
- C) by small businesses, but not by large businesses.
- D) to measure internal events, but not external exchanges.
Answer: B
Explanation: The cost principle states that assets and liabilities should be initially recorded at their original cost to the company.
Difficulty: 1 Easy
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
33) Transactions include which two types of events?
- A) Direct events, indirect events
- B) Monetary events, production events
- C) External exchanges, internal events
- D) Past events, future events
Answer: C
Explanation: Transactions include two types of events: external exchanges and internal events.
Difficulty: 1 Easy
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
34) Which of the following is an accounting transaction?
- A) A manager hires an employee.
- B) A manager orders supplies.
- C) A manager signs a promissory note and receives cash.
- D) A manager agrees to deliver their product in three weeks.
Answer: C
Explanation: An accounting transaction occurs when there is an exchange involving assets, liabilities and/or stockholders’ equity. An exchange of a promissory note for cash qualifies as an exchange. An exchange of only promises is not an accounting transaction.
Difficulty: 2 Medium
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
35) Your company places an order for inventory with suppliers for delivery in two weeks.
- A) This is an internal event and it does not affect the balance sheet.
- B) This is an activity that does not affect the balance sheet.
- C) This is an internal event that affects the balance sheet.
- D) This is an external exchange and it affects the balance sheet.
Answer: B
Explanation: External exchanges are exchanges involving assets, liabilities, and/or stockholders’ equity between the company and someone else. An order has been placed; but the promise to pay will not occur until the supplies are delivered. An exchange of only promises is not an accounting transaction. Since no exchange has occurred, this activity would not be recorded as a transaction.
Difficulty: 2 Medium
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
36) The characteristic shared by all liabilities is that they:
- A) provide a future economic benefit.
- B) result in an inflow of resources to the company.
- C) always end in the word “payable.”
- D) obligate the company to do something in the future.
Answer: D
Explanation: Liabilities are debts and other obligations that must be paid or settled in the future. Not all liabilities have the word “payable” in their names.
Difficulty: 2 Medium
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
37) Which of the following is a financing activity?
- A) The business receives land and gives a check for $1,000.
- B) The business receives $1,000 cash and in exchange gives a promissory note.
- C) The business promises to hire an employee on the 15thof the month.
- D) The business orders supplies and promises to pay for them at the end of the month.
Answer: B
Explanation: Financing activities involve debt transactions with lenders (e.g., Notes Payable) or equity transactions with investors (e.g., Common Stock). Receiving cash in exchange for a promissory note is a financing activity.
Difficulty: 2 Medium
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
38) Which of the following would not be recorded as an accounting transaction?
- A) Issuing stock to owners in exchange for cash
- B) Ordering supplies to be delivered next month
- C) Selling inventory to customers in exchange for cash to be received next month
- D) Paying the bank for a portion of a note payable
Answer: B
Explanation: A transaction is an event or activity that has a direct and measurable financial effect on the assets, liabilities, or stockholders’ equity of a business. Ordering supplies is an activity that is not a transaction because no assets or services were exchanged at the time the order was placed.
Difficulty: 2 Medium
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
39) The Flynn Company started business by obtaining financing through debt financing and equity financing. Which of the following statements is not correct?
- A) Equity financing refers to the money obtained through owners’ contributions and reinvestments of profit.
- B) Debt financing refers to the money obtained through loans.
- C) The business is obligated to repay debt financing.
- D) The business is obligated to repay equity financing.
Answer: D
Explanation: Equity refers to financing a business through owners’ contributions and reinvestments of profit. Debt refers to financing the business through loans. A business is obligated to repay debt financing, but it is not obligated to repay its equity financing.
Difficulty: 1 Easy
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
40) Which of the following is an asset?
- A) Common Stock
- B) Retained Earnings
- C) Notes Receivable
- D) Notes Payable
Answer: C
Explanation: Assets are resources presently owned by a business that generate future economic benefits. Notes Receivable is an example of an asset. Common Stock and Retained Earnings are examples of equity accounts, and Notes Payable is a liability.
Difficulty: 1 Easy
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
41) Which of the following transactions for Bill’s Fish ‘n Chips restaurant would be treated as an accounting transaction?
- A) Bill distributed coupons to local hotels for 10% off and requested that the coupons be distributed to hotel guests.
- B) Bill spoke to a local high school about the rewards and challenges of being an entrepreneur.
- C) Bill signed an agreement with a local fisherman to purchase 20 pounds of halibut each month.
- D) Bill purchased a fryer and a dishwasher, which will be paid for next month.
Answer: D
Explanation: A transaction is an event or activity that has a direct and measurable financial effect on the assets, liabilities, or stockholders’ equity of a business. A liability (Bill’s promise to pay) was exchanged for assets (fryer and dishwasher) and, so, the purchase is a transaction. No exchange took place with regards to the coupons, the speech, or the agreement with the fisherman.
Difficulty: 2 Medium
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
42) ________ are of special importance because they are the only activities that enter the financial accounting system.
- A) External exchanges
- B) Internal events
- C) Documents
- D) Transactions
Answer: D
Explanation: Business activities that affect the basic accounting equation (A = L + SE) are called transactions. Transactions are of special importance because they are the only activities that enter the financial accounting system.
Difficulty: 2 Medium
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
43) Which account is affected by recording the buying of goods on credit?
- A) Cash
- B) Retained Earnings
- C) Common Stock
- D) Accounts Payable
Answer: D
Explanation: A businesses typically buy goods or services from others on credit, by promising to pay within 30 days of the purchase. Accounts Payable represents the amount owed to suppliers for prior credit purchases (on account).
Difficulty: 2 Medium
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
44) Which of the following is not true regarding the double-entry system?
- A) Transactions must be recorded twice to ensure accuracy.
- B) Debits must equal credits.
- C) Assets must equal liabilities plus stockholders’ equity.
- D) Both what is received and what is given in exchange must be recorded.
Answer: A
Explanation: Because the accounting system captures both what is received and what is given, it is often referred to as a “double-entry” system. The double-entry system requires that debits = credits and that A = L + SE
Difficulty: 1 Easy
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
45) Every transaction involves a(n):
- A) receiving and giving something of value.
- B) increase in assets.
- C) increase in stockholder’s equity.
- D) exchange of promises.
Answer: A
Explanation: The company always receives something and gives something. This is a basic feature of all business activities. A business enters into an exchange either to earn a profit immediately or to obtain resources that will allow it to earn a profit later. This is the fundamental idea of business: to create value through exchange. Any exchange that affects the company’s assets, liabilities, or stockholders’ equity must be captured in and reported by the accounting system.
Difficulty: 2 Medium
Topic: Building a Balance Sheet from Business Activities
Learning Objective: 02-01 Identify financial effects of common business activities that affect the balance sheet.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
Fundamentals of Financial Accounting, 6e (Phillips)
Chapter 4 Adjustments, Financial Statements, and Financial Results
1) The purpose of adjusting entries is to transfer net income and dividends to Retained Earnings.
Answer: FALSE
Explanation: Adjustments need to be made at the end of an accounting period to: (1) update amounts already recorded in the accounting records and (2) include events that occurred but had not yet been recorded.
Difficulty: 1 Easy
Topic: Why Adjustments are Needed
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
2) A deferral adjustment may involve one asset and one liability account.
Answer: FALSE
Explanation: Deferrals commonly involve (1) an asset and an expense or (2) a liability and a revenue.
Difficulty: 1 Easy
Topic: Why Adjustments are Needed
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Understand
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
3) When a company pays its rent in advance, an asset is reported on the balance sheet.
Answer: TRUE
Explanation: When a company pays its rent in advance, the expense is initially deferred as an asset on the balance sheet (in an account called Prepaid Rent).
Difficulty: 1 Easy
Topic: Why Adjustments are Needed
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
4) As a company uses supplies, an adjustment should be made to decrease an expense account and increase an asset account.
Answer: FALSE
Explanation: When a company purchases supplies, the expense is initially deferred as an asset on the balance sheet (in an account called Supplies). The adjustment part comes later when the supplies are used. The adjustment to record supplies used decreases the Supplies account and increases the Supplies Expense account.
Difficulty: 2 Medium
Topic: Making Required Adjustments
Learning Objective: 04-02 Prepare adjustments needed at the end of the period.
Bloom’s: Analyze
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
5) A contra-account is added to the account it offsets.
Answer: FALSE
Explanation: A contra-account is an account that is an offset to, or reduction of, another account.
Difficulty: 1 Easy
Topic: Making Required Adjustments
Learning Objective: 04-02 Prepare adjustments needed at the end of the period.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
6) Depreciation is a measure of the decline in market value of an asset.
Answer: FALSE
Explanation: Depreciation is the process of allocating the cost of buildings, vehicles, and equipment to the accounting periods in which they are used.
Difficulty: 2 Medium
Topic: Making Required Adjustments
Learning Objective: 04-02 Prepare adjustments needed at the end of the period.
Bloom’s: Understand
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
7) The carrying value of an asset is an approximation of the asset’s market value.
Answer: FALSE
Explanation: Carrying value is simply the amount at which an asset or liability is reported (“carried”) in the financial statements.
Difficulty: 2 Medium
Topic: Making Required Adjustments
Learning Objective: 04-02 Prepare adjustments needed at the end of the period.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
8) The amount charged for a good or service provided to a customer on account is recorded as revenue only after the payment is received.
Answer: FALSE
Explanation: The amount charged for a good or service provided to a customer on account is debited to Accounts Receivable and credited to the related revenue account at the time the good or service is provided.
Difficulty: 2 Medium
Topic: Making Required Adjustments
Learning Objective: 04-02 Prepare adjustments needed at the end of the period.
Bloom’s: Understand
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
9) The adjustment for corporate income taxes is generally the first adjustment prepared.
Answer: FALSE
Explanation: Income tax is calculated by multiplying the company’s adjusted income (before income tax expense) by the company’s tax rate. Therefore, the adjustment for income taxes cannot be calculated until all other adjustments are made.
Difficulty: 2 Medium
Topic: Making Required Adjustments
Learning Objective: 04-02 Prepare adjustments needed at the end of the period.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
10) Adjusting entries often involve cash.
Answer: FALSE
Explanation: Adjusting entries never involve the Cash account. Transactions involving cash are recorded as regular journal entries.
Difficulty: 1 Easy
Topic: Making Required Adjustments
Learning Objective: 04-02 Prepare adjustments needed at the end of the period.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
11) If a contra-account of $20,000 is mistakenly included in the same column of the trial balance as the account it offsets, the error will cause the debit and credit column totals to differ by $40,000.
Answer: TRUE
Explanation: A contra-account is an account that is an offset to, or reduction of, another account. Including a contra-account in the same column as the account it offsets will make the columns differ by twice the amount of the contra-account balance.
Difficulty: 2 Medium
Topic: Making Required Adjustments; Preparing an Adjusted Trial Balance
Learning Objective: 04-02 Prepare adjustments needed at the end of the period.; 04-03 Prepare an adjusted trial balance.
Bloom’s: Analyze
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
12) An adjusted trial balance is completed to check that debits still equal credits after the income statement is prepared.
Answer: FALSE
Explanation: An adjusted trial balance is prepared before the financial statements are prepared, and after the adjusting entries are made.
Difficulty: 1 Easy
Topic: Adjusted Trial Balance
Learning Objective: 04-03 Prepare an adjusted trial balance.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
13) The amounts of all the accounts reported on the balance sheet can be taken from the adjusted trial balance.
Answer: FALSE
Explanation: The adjusted trial balance includes the beginning balance for the Retained Earnings account; the balance sheet reports the ending balance of Retained Earnings. The ending balance of Retained Earnings comes from the statement of retained earnings.
Difficulty: 3 Hard
Topic: Preparing the Financial Statements
Learning Objective: 04-04 Prepare financial statements.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
14) One of the purposes of the closing entries is to bring the balances in all asset, liability, revenue, and expense accounts down to zero to start the next accounting period.
Answer: FALSE
Explanation: At the end of each year, after all transactions and adjustments are recorded, all revenue, expense, and dividends accounts are closed by moving their balances to their permanent home in Retained Earnings. Asset and liability accounts are not closed.
Difficulty: 1 Easy
Topic: The Closing Process
Learning Objective: 04-05 Explain the closing process.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
15) The asset, liability, and stockholders’ equity accounts are referred to as permanent accounts.
Answer: TRUE
Explanation: The permanent accounts are the accounts that track financial results from year to year by carrying their ending balances into the next year. The permanent accounts include all asset, liability, and stockholders’ equity accounts.
Difficulty: 1 Easy
Topic: The Closing Process
Learning Objective: 04-05 Explain the closing process.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
16) If the Retained Earnings account is credited for $3,600 in the closing process, the company had a net income of $3,600.
Answer: TRUE
Explanation: The closing entries include a debit to each revenue account for the amount of its credit balance, a credit to each expense account for the amount of its debit balance, and record the difference in Retained Earnings. The amount credited to Retained Earnings should equal Net Income on the Income Statement. (If the company has a net loss, Retained Earnings will be debited.)
Difficulty: 2 Medium
Topic: The Closing Process
Learning Objective: 04-05 Explain the closing process.
Bloom’s: Analyze
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
17) The closing process includes a transfer of the Dividends account balance to the Retained Earnings account.
Answer: TRUE
Explanation: At the end of each year, after all the year’s transactions and adjustments are recorded, the Dividends account is closed by transferring its balance to its permanent home in Retained Earnings.
Difficulty: 1 Easy
Topic: The Closing Process
Learning Objective: 04-05 Explain the closing process.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
18) The temporary accounts will have zero balances in a post-closing trial balance.
Answer: TRUE
Explanation: All temporary accounts are reduced to zero in the closing process, which means they would have zero balances in the post-closing trial balance.
Difficulty: 1 Easy
Topic: The Closing Process
Learning Objective: 04-05 Explain the closing process.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
19) If a company forgot to record depreciation on equipment for a period, Total Assets would be overstated and Total Stockholders’ Equity would be overstated on the balance sheet.
Answer: TRUE
Explanation: If the adjusting entry to record depreciation for the period is not made, the Accumulated Depreciation account will be understated, which means that Total Assets will be overstated. Depreciation Expense would also be understated, which means that expenses would be understated and net income will be overstated. This overstatement of net income causes stockholders’ equity to be overstated.
Difficulty: 3 Hard
Topic: Making Required Adjustments; Adjusted Financial Results
Learning Objective: 04-02 Prepare adjustments needed at the end of the period.; 04-06 Explain how adjustments affect financial results.
Bloom’s: Evaluate
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
20) If a company forgot to prepare an adjusting entry to record salaries and wages incurred but unpaid at the end of the period, Total Liabilities would be understated and Retained Earnings would be understated on the Balance Sheet.
Answer: FALSE
Explanation: If the adjusting entry to accrue unpaid salaries and wages is not made (Salaries and Wages Payable) a liability account will be understated, which means that Total Liabilities will be understated. Salaries and Wages Expense would also be understated, which means that expenses would be understated and net income will be overstated. This overstatement of net income would cause Retained Earnings to be overstated.
Difficulty: 3 Hard
Topic: Making Required Adjustments; Adjusted Financial Results
Learning Objective: 04-02 Prepare adjustments needed at the end of the period.; 04-06 Explain how adjustments affect financial results.
Bloom’s: Evaluate
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
21) Which of the following statements about the need for adjustments is not correct?
- A) Without adjustments, the financial statements present an incomplete and misleading picture of the company.
- B) Adjusting entries are intended to change the operating results to reflect management’s objectives for operating performance.
- C) Adjustments help the financial statements present the best picture of whether the company’s activities were profitable for the period.
- D) Adjustments help the financial statements present the economic resources that the company owns and owes at the end of the period.
Answer: B
Explanation: Adjustments need to be made at the end of an accounting period to (1) update amounts already recorded in the accounting records and (2) include events that occurred but had not yet been recorded. Without these adjustments, the financial statements present an incomplete and misleading picture of the company’s financial performance.
Difficulty: 3 Hard
Topic: Why Adjustments are Needed
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Understand
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
22) One of the major advantages of making adjustments in order to improve the quality of financial statements is that they:
- A) ensure that revenues and expenses are recognized during the period they are earned and incurred.
- B) ensure that all estimates of future activities are eliminated from consideration.
- C) ensure that revenues and expenses are recognized conservatively during the period in which they are paid.
- D) provide an opportunity to manipulate the numbers to the best advantage of the reporting company.
Answer: A
Explanation: Adjustments need to be made at the end of an accounting period to (1) update amounts already recorded in the accounting records and (2) include events that occurred but had not yet been recorded. Without these adjustments, the financial statements present an incomplete and misleading picture of the company’s financial performance. Proper counting is critical to income measurement, but estimation also plays a role.
Difficulty: 2 Medium
Topic: Why Adjustments are Needed
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Understand
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
23) Adjusting entries are typically prepared:
- A) at the beginning of the accounting period.
- B) at the end of the accounting period.
- C) on a daily basis.
- D) on a weekly basis.
Answer: B
Explanation: Companies wait until the end of the accounting period to adjust their accounts because daily adjustments would be costly and time-consuming.
Difficulty: 1 Easy
Topic: Why Adjustments are Needed
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
24) If certain assets are partially used up during the accounting period, then:
- A) nothing is recorded on the financial statements until they are completely used up.
- B) a liability account is decreased and an expense is recorded.
- C) an asset account is decreased and an expense is recorded.
- D) nothing is recorded on the financial statements until they are replaced or replenished.
Answer: C
Explanation: When the company pays cash before incurring the expense, the prepayment is recorded in an asset account on the balance sheet. When an asset is partially used up during the accounting period, the expense is incurred and recorded with a debit and the asset account is decreased with a credit.
Difficulty: 2 Medium
Topic: Why Adjustments are Needed
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Understand
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
25) The company uses up $5,000 of an existing asset and the company adjusts its accounts accordingly. This is an example of a(n):
- A) accrual adjustment.
- B) closing adjustment.
- C) deferral adjustment.
- D) unethical adjustment.
Answer: C
Explanation: When the company pays cash before incurring the expense, the prepayment is recorded in an asset account on the balance sheet. A deferral adjustment occurs when the asset is partially used up during the accounting period. The expense is incurred and recorded and the asset account is decreased.
Difficulty: 2 Medium
Topic: Why Adjustments are Needed
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Understand
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
26) A company makes a deferral adjustment that increased a revenue account. This must mean that a(n):
- A) expense account was decreased by the same amount.
- B) expense account was increased by the same amount.
- C) liability account was decreased by the same amount.
- D) asset account was decreased by the same amount.
Answer: C
Explanation: Previously deferred amounts exist on the balance sheet because the company paid cash before incurring the expense or received cash before earning revenue. When a company receives cash from customers before delivering the goods or services, this revenue is initially deferred as a liability on the balance sheet (in an account called Deferred Revenue). Later, when the company delivers the goods or services, thereby meeting its obligation and earning the revenue, a deferral adjustment is made to decrease the liability and increase the related revenue account.
Difficulty: 3 Hard
Topic: Why Adjustments are Needed
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Understand
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
27) When existing assets are used up in the ordinary course of business:
- A) an expense is recorded.
- B) Deferred revenue is recorded.
- C) an accrual is recorded.
- D) a prepaid expense is recorded.
Answer: A
Explanation: When the company pays cash before incurring the expense, the prepayment is recorded in an asset account on the balance sheet. A deferral adjustment occurs when the asset is partially used up during the accounting period. The expense is incurred and recorded and the asset account is decreased.
Difficulty: 2 Medium
Topic: Why Adjustments are Needed
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Understand
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
28) When a deferral adjustment is made to a liability account, that liability becomes a(n):
- A) asset.
- B) other liability.
- C) expense.
- D) revenue.
Answer: D
Explanation: Deferral adjustments are used to update amounts that have been previously deferred on the balance sheet. When a company receives cash from customers before delivering the goods or services, this revenue is initially deferred as a liability on the balance sheet (in an account called Deferred Revenue). Later, when the company delivers the goods or services, thereby meeting its obligation and earning the revenue, a deferral adjustment is made to decrease the liability and increase the related revenue account.
Difficulty: 1 Easy
Topic: Why Adjustments are Needed
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
29) The term deferral best describes a situation in which:
- A) cash is paid in advance of recognizing an expense.
- B) an expense is recognized before it is paid for with cash.
- C) an expense is recognized after cash has been received.
- D) a liability is established at the time an expense is recognized.
Answer: A
Explanation: The term defer means to postpone until later. In accounting, we say an expense or revenue has been deferred if we have postponed reporting it on the income statement until a later period. A deferral exists when cash is paid in advance of recognizing an expense or when cash is received in advance of recognizing revenue.
Difficulty: 1 Easy
Topic: Why Adjustments are Needed
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
30) At the end of the year, accrual adjustments could include a:
- A) debit to an expense and a credit to an asset.
- B) credit to revenue and a debit to an expense.
- C) debit to cash and a credit to Common Stock.
- D) debit to an asset and a credit to a revenue.
Answer: D
Explanation: Accrual adjustments are needed when a company has earned revenue or incurred an expense in the current period but has not yet recorded it because the related cash will not be received or paid until a later period. As a result, accrual adjustments would include a debit to an expense account and a credit to a liability account or a debit to an asset account and a credit to a revenue account.
Difficulty: 2 Medium
Topic: Making Required Adjustments
Learning Objective: 04-02 Prepare adjustments needed at the end of the period.
Bloom’s: Analyze
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
31) Accrual adjustments involve increasing:
- A) assets and revenues or increasing liabilities and expenses.
- B) assets and expenses or increasing liabilities and revenues.
- C) assets and decreasing revenues or increasing liabilities and decreasing expenses.
- D) assets and decreasing expenses or increasing liabilities and decreasing revenues.
Answer: A
Explanation: Accrual adjustments are needed when a company has earned revenue or incurred an expense in the current period but has not yet recorded it because the related cash will not be received or paid until a later period. As a result, accrual adjustments would include a debit to increase an expense account and a credit to increase a liability account or a debit to increase an asset account and a credit to increase a revenue account.
Difficulty: 2 Medium
Topic: Why Adjustments are Needed
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Analyze
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
32) Accrued revenues recorded at the end of the current year:
- A) often result in cash receipts from customers in the next period.
- B) often result in cash payments in the next period.
- C) are also called Deferred Revenues.
- D) are recorded in the current year when cash is received.
Answer: A
Explanation: An accrual adjustment is needed when a company has earned revenue in the current period but has not yet received the related cash. Cash will not be received until a later period.
Difficulty: 2 Medium
Topic: Why Adjustments are Needed
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Understand
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
33) An example of an account that could be included in an accrual adjustment for revenue is:
- A) Rent Receivable.
- B) Interest Payable.
- C) Deferred Revenue.
- D) Cash.
Answer: A
Explanation: An accrual adjustment is needed when a company has earned revenue in the current period but has not yet received the related cash. Cash will not be received until a later period. As a result, the asset involved usually has the word “Receivable” in the account name. If Rent Revenue is earned this month but not received in cash until a later month, an accrual adjustment is needed at the end of the current month to record increases in the company’s Rent Revenue and Rent Receivable accounts.
Difficulty: 2 Medium
Topic: Why Adjustments are Needed
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Understand
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
34) A company owes rent at a rate of $6,000 per month. The company pays the rent owed on the tenth of each month for the previous month. At the end of each month, what kind of adjustment is required?
- A) An accrual adjustment.
- B) A closing adjustment.
- C) A deferral adjustment.
- D) No adjustment.
Answer: A
Explanation: Accrual adjustments are needed when a company has earned revenue or incurred an expense in the current period but has not yet received or paid the related cash. The related cash will not be received or paid until a later period. In this case, at the end of each month, rent expense has been incurred but is not paid until the tenth of the following month.
Difficulty: 2 Medium
Topic: Why Adjustments are Needed
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Analyze
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
35) An example of an account that could be included in an accrual adjustment for expense is:
- A) Accounts Receivable.
- B) Income Tax Payable.
- C) Prepaid Insurance.
- D) Accumulated Depreciation.
Answer: B
Explanation: An accrual adjustment is needed when a company has incurred an expense in the current period but has not yet received or paid the related cash. The related cash will not be paid until a later period. As a result, the liability involved usually has the word “Payable” in the account name. If income tax is owed but not paid in cash until later, an accrual adjustment is needed at the end of the current month to record increases in the company’s Income Tax Expense and Income Tax Payable accounts.
Difficulty: 2 Medium
Topic: Why Adjustments are Needed
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
36) If an expense has been incurred but will be paid later, then:
- A) nothing is recorded on the financial statements.
- B) a liability account is created or increased and an expense is recorded.
- C) an asset account is decreased or eliminated and an expense is recorded.
- D) a revenue and an expense are accrued.
Answer: B
Explanation: An accrual adjustment is needed when a company has incurred an expense in the current period but has not yet paid the related cash. The related cash will not be paid until a later period. The accrual adjustment record increases in an expense account and a liability account.
Difficulty: 2 Medium
Topic: Why Adjustments are Needed
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Understand
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
37) Which of the following best describes when an accrual adjustment is required?
- A) An expense has been incurred and paid in cash.
- B) An expense has been incurred but not yet paid in cash.
- C) An expense has not been incurred, but cash has been paid.
- D) An expense has not been incurred nor has it been paid in cash.
Answer: B
Explanation: Accrual adjustments are needed when a company has earned revenue or incurred an expense in the current period but has not yet received or paid the related cash. The related cash will not be received or paid until a later period.
Difficulty: 1 Easy
Topic: Why Adjustments are Needed
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
38) Which of the following statements about adjustments is correct?
- A) An accrual adjustment that increases an asset will include an increase in an expense.
- B) A deferral adjustment that decreases an asset will include an increase in an expense.
- C) An accrual adjustment that increases an expense will include an increase in assets.
- D) A deferral adjustment that increases a contra-account will include an increase in an asset.
Answer: B
Explanation: Each deferral adjustment involves one asset and one expense account, or one liability and one revenue account. Each accrual adjustment involves one asset and one revenue account, or one liability and one expense account.
Difficulty: 2 Medium
Topic: Why Adjustments are Needed
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Analyze
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
39) What is the main difference between accrual and deferral adjustments?
- A) Deferral adjustments are required to update previously recorded items whereas accrual adjustments are required to include items not previously recorded.
- B) Deferral adjustments are required under the cash basis of accounting whereas accrual adjustments are required under the accrual basis of accounting.
- C) Deferral adjustments are required to include items not previously recorded whereas accrual adjustments are required to update previously recorded items.
- D) Deferral adjustments are used for expenses whereas accrual adjustments are used for revenues.
Answer: A
Explanation: Deferral adjustments are needed when an asset (or liability) has already been recorded and it needs to be updated to show that some of its benefits have been used up (or its obligations have been fulfilled). Accrual adjustments are needed when revenue has been earned (but not yet recorded) or expenses have been incurred (but not yet recorded).
Difficulty: 2 Medium
Topic: Why Adjustments are Needed
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
40) One major difference between deferral and accrual adjustments is that deferral adjustments:
- A) involve previously recorded assets and liabilities, and accrual adjustments involve previously unrecorded assets and liabilities.
- B) are made after financial statements are prepared, and accrual adjustments are made before financial statements are prepared.
- C) are made annually, and accrual adjustments are made monthly.
- D) are influenced by estimates of future events, and accrual adjustments are not.
Answer: A
Explanation: Adjustments need to be made at the end of an accounting period to (1) update amounts already recorded in the accounting records and (2) include events that occurred but had not yet been recorded. The first type includes deferral adjustments and the second type includes accrual adjustments. Both types of adjustments may be influenced by estimates of future events and are made before financial statements are prepared.
Difficulty: 2 Medium
Topic: Why Adjustments are Needed
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Understand
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
41) One major difference between deferral and accrual adjustments is that:
- A) accrual adjustments affect income statement accounts, and deferral adjustments affect balance sheet accounts.
- B) deferral adjustments increase net income, and accrual adjustments decrease net income.
- C) deferral adjustments are made under the cash basis of accounting, and accrual adjustments are made under the accrual basis of accounting.
- D) accounts affected by an accrual adjustment always go in the same direction (i.e., both accounts are increased or both accounts are decreased), and accounts affected by a deferral adjustment always go in opposite directions (one account is increased and one account is decreased).
Answer: D
Explanation: Accrual adjustment increase balance sheet accounts and increase corresponding income statement accounts. Deferral adjustments are used to decrease balance sheet accounts and increase corresponding income statement accounts.
Difficulty: 3 Hard
Topic: Why Adjustments are Needed
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Understand
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
42) Adjusting entries affect:
- A) only balance sheet accounts.
- B) only income statement accounts.
- C) only statement of cash flow accounts.
- D) both income statement and balance sheet accounts.
Answer: D
Explanation: Adjusting entries always include one balance sheet account and one income statement account.
Difficulty: 1 Easy
Topic: Making Required Adjustments
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
43) Adjustments help to ensure that all ________ are recorded in the period in which they are earned.
- A) revenues
- B) cash transactions
- C) closing entries
- D) journal entries
Answer: A
Explanation: Adjustments, which are journal entries, ensure that all revenues are recorded in the period earned.
Difficulty: 1 Easy
Topic: Why Adjustments are Needed
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
44) Adjustments ensure that ________ balances are reported at amounts representing the economic benefits used during the period.
- A) expense
- B) revenue
- C) asset
- D) account
Answer: A
Explanation: Asset accounts are reported at amounts representing economic benefits that remain at the end of the period. Revenues represent amounts earned during the period. Expenses represent the economic benefits used during the period.
Difficulty: 1 Easy
Topic: Why Adjustments are Needed
Learning Objective: 04-01 Explain why adjustments are needed.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
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