Topic: Accounting equation
LO: 2, 3
1. On which statement are assets, liabilities and equity reported?
A) Balance sheet
B) Income statement
C) Statement of stockholders’ equity
D) Statement of cash flows
Answer: A
Rationale: A balance sheet reports on investing and financing activities. It lists amounts for
assets, liabilities, and equity at a point in time.
Topic: Qualitative characteristics of accounting information
LO: 6
2. Which one of the following is not a quality of relevant accounting information?
A) Materiality
B) Predictive value
C) Confirmatory value
D) Understandability
Answer: D
Rationale: Accounting information is relevant when it has the ability to make a difference in a
decision. Such information may be useful in making predictions about future performance of a
company or in providing confirmatory feedback to evaluate past events. Accounting information
can still be relevant, even though it may not be understandable to all users.
Topic: Journalizing and posting transactions
LO: 2, 6
3. On January 1, 2021, George Company paid $45,000 in cash for insurance covering the year
2021. Which of the following would be the correct journal entry to record this transaction?
A) Insurance expense 45,000
Cash 45,000
B) Cash 45,000
Insurance expense 45,000
C) Prepaid insurance 45,000
Cash 45,000
D) Cash 45,000
Prepaid insurance 45,000
Answer: C
Rationale: Prepaid insurance is debited and Cash is credited for $45,000.
Topic: Recognition of costs as expense
LO: 3, 4
4. As inventory and PPE assets on the balance sheet are consumed, they are reflected:
A) As a revenue on the income statement
B) As an expense on the income statement
C) As common stock on the balance sheet
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D) Assets are never consumed
Answer: B
Rationale: As assets are consumed (used up), their cost is transferred into the income statement
as an expense.
Topic: Adjusting entries
LO: 3, 4
5. On the last day of December 2021, Coaster Trucks entered into a transaction that resulted in a
receipt of $300,000 cash in advance related to services that will be provided during January
2022. During December of 2021, the company also performed $165,000 of services which were
neither billed nor paid. Prior to December adjustments and before these two transactions were
recorded, the company’s trial balance showed service revenue of $1,425,790 at December 31,
2021. There are no other prepaid services yet to be delivered, and during the month all
outstanding accounts receivable from prior months were collected.
If Coaster Trucks makes the appropriate adjusting entry, how much service revenue will be
reflected on the December 31, 2021 income statement?
A) $1,590,790
B) $1,425,790
C) $1,725,790
D) $1,890,790
Answer: A
Rationale: Service revenue = $1,425,790 + $165,000 = $1,590,790
Topic: Financial statement flows
LO: 6
6. What is a ‘flow’ as it relates to financial statements?
A) An amount that varies over time
B) A change in a level over a period of time
C) An amount depicted on the balance sheet
D) A balance at the end of the period that appears on the income statement
Answer: B
Rationale: The income statement portrays changes in balance sheet levels over time.
Topic: Cash flow activities
LO: 1, 2
7. A firm’s net cash flow from operating activities includes:
A) Cash received from sale of equipment
B) Cash received from issuance of common stock
C) Cash received from sale of merchandise
D) Cash received as payment of loan from a borrower
Answer: C
Rationale: Operating activities are cash in- and outflows from selling goods or rendering
services. Selling equipment is an investing activity. Issuing stock and paying loans are financing
activities.
Topic: Statement of cash flows – Supplemental disclosures
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LO: 4
8. Which of the following is a required separate disclosure for firms using the direct method in
the statement of cash flows?
A) A reconciliation of net income to net cash flows from operating activities
B) A list of all noncash investing and financing transactions
C) The policy for determining which highly liquid, short-term investments are treated as cash
equivalents
D) All of the above
Answer: D
Rationale: All three are required when the direct method is used. Only answer choices B and C
are required with the indirect method.
Topic: Ratios
LO: 3, 4
9. Which one of the following ratios does not involve assets?
A) Account receivable turnover
B) Current ratio
C) Profit margin
D) Inventory turnover
Answer: C
Rationale: Profit margin measures net income against sales revenue, both components of which
are income statement amounts and not assets.
Topic: Horizontal analysis
LO: 1
10. Walker Enterprises reported sales revenue totaling $1,200,000, $1,500,000, and $1,775,000
in the years, 2019, 2020, and 2021, respectively.
Performing horizontal analysis, what is the percentage change for 2021?
A) 15.49%
B) 18.33%
C) 22.92%
D) 25.00%
Answer: B
Rationale: Change in revenue / Revenue in previous year
= ($1,775,000 - $1,500,000) / $1,500,000 = 18.33%
Topic: Persistent income items
LO: 4, 6
11. Which of the following items can be considered as a persistent income statement item for
analysis purposes?
A) Effects of a strike
B) Gains and losses on the disposal of a business segment
C) Bad debt expense
D) Write-down or write-offs of receivables
Answer: C
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Rationale: Bad debt expense is a persistent (continuing) item. The other three items are all
classified as transitory items, as income (loss) and cash flows from such items are not persistent.
Topic: Revenue recognition subsequent to customer purchase
LO: 1, 2
12. Why must amounts received in advance from customers be deferred?
A) The customer may not pay the entire balance due
B) The company receiving payment has not earned the amount
C) The customer has a right of return
D) All of the above are reasons to defer
Answer: B
Rationale: Revenue recognition requires that amounts be earned and realized, or realizable
before recognizing as revenue.
Topic: Receivable turnover rate
LO: 5
13. If the collection period lengthens compared to historic figures and industry averages, what
might the reason be?
A) Deterioration of collectability of receivables
B) A change in sales mix to longer paying customers
C) A decrease in the amount of sales generated
D) A and B
E) All of the above
Answer: D
Rationale: A lengthened collection period means that receivables turnover slows Answers A and
B are reasons for a slowdown in the receivables turnover.
Topic: Inventory costs for manufacturing companies
LO: 1
14. Which of the following is an inventory account for manufacturing companies?
A) Overhead
B) Finished goods
C) Cost of goods sold
D) Direct labor
Answer: B
Rationale: Answers A and D are manufacturing costs. Answer C is the account used for goods
that are sold. Only amounts reported on the balance sheet are inventory accounts.
Topic: Gross profit under LIFO
LO: 2, 4
15. Wooster Company imports and sells a product produced in Canada. In the summer of 2021, a
natural disaster disrupted production, affecting its supply of product. On January 1, 2021,
Wooster’s inventory records were as follows:
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Year purchased Quantity (units) Cost per unit
2019
5,000
$150
2020
10,000
$200
Total
15,000
Total cost
$ 750,000
2,000,000
$2,750,000
Through mid-December of 2021, purchases were limited to 14,000 units, because the cost had
increased to $300 per unit. Wooster sold 18,000 units during 2021 at a price of $400 per unit,
which significantly depleted its inventory.
Assume that Wooster makes no further purchases during 2021. Wooster uses the LIFO inventory
method. Compute Wooster’s gross profit for 2021.
A) $3,550,000
B) $1,800,000
C) $2,200,000
D) $3,600,000
Answer: C
Rationale: Sales
18,000 x $400
$7,200,000
revenue
Cost of goods sold
(14,000 x $300) +
5,000,000
(4,000 x $200) =
Gross profit
$2,200,000
Topic: Lower of cost of net realizable value
LO: 3
16. The following data refer to Brompton Company’s ending inventory: Item Code
Quantity Unit Cost Unit NRV
Small
100
$250
$246
Medium 400
150
145
Large
600
170
162
Extra-Large 250
265
270
What is the ending inventory balance if the lower of cost or net realizable value rule is applied to
each item of inventory?
A) $248,050
B) $246,050
C) $253,250
D) $252,850
Answer: B
Rationale: (100 x $246) + (400 x $145) + (600 x $162) + (250 x $265) = $246,050
Topic: Capitalization of asset cost
LO: 1, 2, 5
17. Which of the following purchased assets would not be capitalized?
A) Factory machine used to fabricate part for new product to be introduced
B) Building constructed as a warehouse for a company’s inventory
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C) Machine used to test the durability of high tech chair in development for a technology
company. The machine will not be used to test any other products.
D) Building constructed to house management and administrative personnel
Answer: C
Rationale: Items purchased for research and development purposes that have no alternative
future uses are not capitalized and are expensed immediately.
Topic: Depreciation and effects
LO: 3, 4
18. Trainor Corporation purchased equipment at a cost of $500,000. The equipment has an
estimated residual value of $50,000 and an estimated life of 5 years, or 10,000 hours of
operation. The equipment was purchased on January 1, 2020 and was used 2,500 hours in 2020
and 2,100 hours in 2021. On January 1, 2022, the company decided to sell the equipment for
$315,000. Trainor Corporation uses the units-of- production method to account for the
depreciation on the equipment.
Based on this information, the entry to record the sale of the equipment will show a gain of:
A) $45,000
B) $72,000
C) $ 5,000
D) $22,000
Answer: D
Rationale:
Rate = ($500,000 ‒ $50,000) / 10,000 hours = $45 per hour
Expense for 2 years = $45 × 4,600 hours = $207,000
Gain on sale = Selling price ‒ Book value = $315,000 ‒ ($500,000 ‒ $207,000) = $22,000
Topic: Depreciation expense using the double-declining-balance method
LO: 3
19. On January 1, 2020, Danvers Company purchased a copy machine. The machine cost
$800,000, its estimated useful life is 5 years, and its expected salvage value is $50,000. What is
the depreciation expense for 2021 using the double-declining-balance method?
A) $200,000
B) $128,000
C) $150,000
D) $192,000
Answer: D
Rationale: Double-declining-balance rate = 1/5 × 2 = 40%.
Depreciation expense for year 2020 is $800,000 × 40% = $320,000
Depreciation expense for year 2021 is $480,000 × 40% = $192,000
Topic: Current liabilities
LO: 1, 2
20. Which of the following does not affect the current liabilities section of the balance
sheet?
A) Purchase of inventory on credit
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B) Wages owed to employees but not yet paid
C) Insurance bill to be paid next month
D) Sale of goods on credit
E) A probable legal obligation, due within 12 months
Answer: D
Rationale: The sale of goods on credit impacts current assets, accounts receivable. All the other
items are liabilities that the company must pay within the next year, current liabilities.
Topic: Transaction analysis of current liabilities
LO: 1, 2
21. Which of the following transactions that impact current liabilities has a corresponding entry
on the income statement?
A) Purchase inventory on credit from Company XYZ on January 1
B) Payment to XYZ on February 1 for a January 1 purchase
C) Interest accrued on a note payable
D) Payment to employees in March for wages earned in February
Answer: C
Rationale: The purchase of inventory on credit is recorded as an increase in both inventory
(noncash asset) and accounts payable (liability) on the balance sheet. Payment of accounts
payable is recorded as a decrease in cash and accounts payable on the balance sheet. Interest
accrued on a note payable is recorded as an increase in current liabilities (interest payable). An
increase in interest expense is recorded on the income statement. Payment of accrued wages is
recorded as a decrease in both cash and wages payable (liability).
Topic: Debt analysis
LO: 5
22. You have been asked to write a financial analysis report for Companies Y and Z. Company Y
has a debt-to-equity ratio that is much lower than the industry average, with Company Z having a
debt-to-equity ratio much higher than industry average. The times interest earned ratio for
Company Y is much higher than the industry average, and the ratio for Company Z is much
lower.
Which one of the following statements will not be part of your financial analysis report for these
two companies?
A) Company Y is a less leveraged company than Company Z
B) Company Y generates a larger amount of income compared to its obligatory payments to
creditors than Company Z
C) Company Y is a less risky company than Company Z
D) Company Z’s lower times interest earned means that it may experience more difficulties than
Company Y in obtaining attractive financing terms on new borrowings.
Answer: B
Rationale: We don’t have information regarding the amount of income either company makes
compared to its obligatory payments to creditors.
Topic: Book value of common stock
LO: 5
23. What is the net book value of the company that is available to common shareholders
called?
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A) Additional paid-in capital
B) Total contributed capital
C) Book value per share
D) Comprehensive income
Answer: C
Rationale: The book value per share is stockholders’ equity less preferred stock less equity
attributable to noncontrolling interest divided by the number of common shares outstanding.
Topic: Dividends and stock prices
LO: 2, 4
24. If a company feels that its shares are undervalued and it wants to send a signal to the market,
the company may:
A) Issue more stock (as allowed under its charter)
B) Decrease regular cash dividends in an attempt to increase share price
C) Repurchase shares
D) Do nothing and wait - the market will realize the undervaluation
Answer: C
Rationale: One reason a company may repurchase shares is if it feels that the market undervalues
them. The logic is that the repurchase sends a “signal” to the market and the company is able to
realize a subsequent “gain” on resale of the shares. However, these gains are never reflected on
the income statement. Instead, the excess of the resale price over the original repurchase price is
credited to additional paid-in capital.
Topic: Earned Capital
LO: 1, 3
25. Where is accumulated other comprehensive income generally listed in the balance
sheet?
A) In the liabilities section below unearned income
B) In the shareholders’ equity section before common stock
C) In the asset section before prepaid expenses
D) In the shareholders’ equity section below retained earnings
Answer: D
Rationale: Earned capital also includes the positive or negative effects of accumulated other
comprehensive income. It is generally listed below retained earnings in the shareholders’ equity
section of the balance sheet.
26.
The purpose of financial accounting is
To help the internal management of a firm make operating decisions
To ensure accountability of managers to investors and provide information for pricing of
the firm’s securities
C) To help customers determine if the price charged by the firm is fair or not
D) To ensure that the employees of the firm have the right information in negotiating with
the management.
Answer: B
A)
B)
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Internal management of the firm is covered in Management Accounting. Financial accounting is
meant to serve the investors, not customers and employees. If you got this question wrong, you
should go over the pre-course video that I put in canvas – why should I study accounting?
The following is for questions 27-30.
Consider the following balance sheet accounts for Dec. 31, 2019 and Dec. 31, 2020 for Joey Inc.
Dec. 31, 2019
Dec. 31, 2020
Cash
200,000
250,000
Marketable securities 150,000
200,000
Accounts Rec.
800,000
700,000
Prepaid expenses
500,000
400,000
Other operating assets 1200,000
1000,000
------------------------Total assets
2850,000
2550,000
Accounts payable
Taxes payable
Short term debt
Other operating liab
Total liabilities
100,000
50,000
250,000
200,000
-------------600,000
200,000
40,000
150,000
250,000
-----------640,000
27. The operating assets for Dec. 31, 2019 is
a. 2850,000
b. 2250,000
c. 2350,000
d. 2700,000
Answer: D
In the balance sheet, Cash, accounts receivable, prepaid expenses and other operating
assets are operating assets whereas marketable securities is not. Marketable securities
are not used in the generation of revenue for the business. The definition of operating
assets is the assets that are used by the business in its operations to generate revenue.
28. The net operating assets for Dec. 31, 2019 is
a. 2850,000
b. 2250,000
c. 2350,000
d. 2700,000
Answer: C
Net operating assets = Operating Assets – Operating Liabilities.
Operating assets = 2700,000 (from the previous question)
Operating liabilities include accounts payable, taxes payable and other operating liabilities.
It does not include short term debt which is a financing liability. Therefore, operating
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liabilities = 350,000
Net operating assets = 2700,000 – 350,000 = 2350,000
29. The average net operating assets for the year 2020 is
a. 2055,000
b. 2650,000
c. 2030,000
d. 2105,000
Answer: D
Average net operating assets for 2020 = Average of the operating assets as on Dec. 31,
2019 and that on Dec. 31, 2020.
Net Operating assets as on Dec. 31, 2019 = 2350,000 (from the answer to 28)
Using the same logic as in 27, the operating assets as on Dec. 31, 2020 = 2350,000490,000 = 1860,000
The average of the above two numbers = 2105,000
30. The Net Average Profit After Tax is defined as Net Income – (Nonoperating revenue –
Nonoperating expense)*(1-Tax rate). If the net income for 2020 for Joey Inc. is $45,000 but
it includes interest expense of 10,000. There are no other nonoperating items. Assume a tax
rate of 20%. What is Net Operating Profit After Tax?
a. 55,000
b. 35,000
c. 53,000
d. 37,000
Answer:C
Net operating profit after tax = Net income + (1-tax rate)* (Non-operating expenses – Nonoperating revenue), i.e., you need to add back the tax-adjusted net non-operating expense that
you have subtracted in the income statement to compute the Net Income.
The interest expense is the only non-operating expense. The tax rate is 20%.
Therefore, NOPAT = 45000 + (1-0.2)*10,000 = $53,000
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