Fundamentals of Financial Accounting Fred Phillips 6th Edition-Test Bank
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Sample Test
Fundamentals of Financial Accounting, 6e (Phillips)
Chapter 3 The Income Statement
1) The period of time between buying assets to be sold to
customers and collecting cash from customers is the operating cycle.
Answer: TRUE
Explanation: The time between buying assets to be sold to
customers and collecting cash from customers is the operating cycle of the
business.
Difficulty: 1 Easy
Topic: Operating Activities
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
2) Expenses are the costs of operating a business that are paid
for in the period covered by the income statement.
Answer: FALSE
Explanation: Expenses are costs of operating the business,
incurred to generate revenues in the period covered by the income statement.
Basically, whenever a business uses up its resources to generate revenues
during the period, it reports an expense, regardless of when the company pays
for the resources.
Difficulty: 1 Easy
Topic: Income Statement Accounts
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
3) If a company decides to record an expenditure made this
period as an expense, when it should have been recorded as an asset, net income
will be overstated in the current period as a result.
Answer: FALSE
Explanation: Erroneously recording an asset as an expense
would overstate total expenses, which would understate net income.
Difficulty: 3 Hard
Topic: Income Statement Accounts
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
4) If revenues are not growing faster than expenses, then net
income will decrease.
Answer: TRUE
Explanation: If revenues are increasing, but expenses are
increasing even faster, then the amount of Net Income (Revenues − Expenses)
will decrease.
Difficulty: 2 Medium
Topic: Income Statement Accounts
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
5) When revenues exceed expenses in a period, stockholders’
equity will increase.
Answer: TRUE
Explanation: When revenues exceed expenses, net income
results. Net income increases stockholders’ equity.
Difficulty: 2 Medium
Topic: Income Statement Accounts
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
6) Dividing up the continuing life of a company into shorter
periods is called the time period assumption.
Answer: TRUE
Explanation: The ongoing life of a company is divided up
into shorter periods according to the time period assumption so that financial
reports can be issued for specific periods of time and at a specific point in
time.
Difficulty: 1 Easy
Topic: Income Statement Accounts
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
7) GAAP does not allow cash basis accounting to be used in
external financial reports.
Answer: TRUE
Explanation: According to GAAP, the accrual basis is the
only acceptable method for external reporting of income. The cash basis can be
used internally by some small companies, but GAAP does not allow it for
external reporting.
Difficulty: 1 Easy
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue and
expense recognition principles.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
8) Deferred Revenue is reported on the balance sheet as a
liability.
Answer: TRUE
Explanation: Deferred Revenue is a liability representing
a company’s obligation to provide goods or services to customers in the future.
Liability accounts are reported on the balance sheet.
Difficulty: 1 Easy
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue and
expense recognition principles.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
9) In the fifth step of the revenue recognition model, “when”
refers to “over a period of time” (e.g., monthly) whereas “as” refers to “a
point in time” (e.g., at delivery).
Answer: FALSE
Explanation: In the fifth step of the revenue recognition
model, “as” refers to “over a period of time” (e.g., monthly) whereas “when”
refers to “a point in time” (e.g., at delivery).
Difficulty: 2 Medium
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
10) A performance obligation is any agreement between a seller
and a customer that creates legal rights and obligations.
Answer: FALSE
Explanation: A performance obligation is the work the
seller promises to do for the customer. A contract is any agreement between a
seller and a customer that creates legal rights and obligations.
Difficulty: 1 Easy
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
11) A company does not need to record the receipt of a bill for
utilities used during this year if the company will not pay the bill until next
year.
Answer: FALSE
Explanation: The expense recognition principle states that
expenses should be recorded in the same period as the revenues they generate,
not necessarily the period in which cash is paid for them. As such, an expense
would be recorded this year since the utilities were used this year.
Difficulty: 2 Medium
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
12) Under the five-step revenue recognition model, a contract
can be written, verbal, or implied.
Answer: TRUE
Explanation: A contract does not require legal paperwork,
or any paperwork at all. Starbucks establishes a contract when it agrees to
sell you a Frappuccino.
Difficulty: 3 Hard
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
13) If the total of debits equals the total of credits on the
trial balance, the accounting records may still contain errors.
Answer: TRUE
Explanation: Even if debits equal credits on the trial
balance, it is still possible that the wrong account was used, an entry was
omitted or recorded twice, and/or the wrong amount was entered as both a debit
and a credit.
Difficulty: 1 Easy
Topic: Unadjusted Trial Balance
Learning Objective: 03-04 Prepare an unadjusted trial
balance.
Bloom’s: Understand
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
14) A net profit margin of 18.2% means that the company used
81.8 cents of each sales dollar to cover costs and expenses.
Answer: TRUE
Explanation: A net profit margin of 18.2% means that the
company earned 18.2 cents of net income for each dollar of revenue, which means
that 81.8 cents (or $1.00 − $.182) went to cover costs and expenses.
Difficulty: 3 Hard
Topic: Net Profit Margin
Learning Objective: 03-05 Evaluate net profit margin, but
beware of income statement limitations.
Bloom’s: Evaluate
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
15) In general, the lower a company’s net profit margin, the
better the performance of the company.
Answer: FALSE
Explanation: Net profit margin measures how much profit is
generated from each dollar of revenue; therefore, a higher ratio means better
performance.
Difficulty: 2 Medium
Topic: Net Profit Margin
Learning Objective: 03-05 Evaluate net profit margin, but
beware of income statement limitations.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
16) When accrual basis accounting is used, net income equals the
amount of cash generated by the business.
Answer: FALSE
Explanation: Accrual basis net income is the excess of
revenues earned over expenses incurred. Revenues do not necessarily equal cash
receipts and expenses that do not necessarily equal cash disbursements.
Difficulty: 1 Easy
Topic: Income Statement Limitations
Learning Objective: 03-05 Evaluate net profit margin, but
beware of income statement limitations.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
17) It is possible for a company to be profitable, yet not have
enough cash to pay its bills.
Answer: TRUE
Explanation: Accrual basis net income is the excess of
revenues earned over expenses incurred. Revenues do not necessarily equal cash
receipts and expenses that do not necessarily equal cash disbursements. A
profitable company may not be able to pay its bills if it does not collect cash
from customers quickly enough.
Difficulty: 3 Hard
Topic: Income Statement Limitations
Learning Objective: 03-05 Evaluate net profit margin, but
beware of income statement limitations.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
18) Net income is based on estimates.
Answer: TRUE
Explanation: Proper counting is critical to income
measurement, but estimation also plays a role. For example, equipment will not
last forever. Instead, it will be “used up” over time to generate the company’s
revenue. It should therefore be expensed over the period in which it is used.
Doing so requires an estimate of the period over which each category of
equipment will be used.
Difficulty: 1 Easy
Topic: Income Statement Limitations
Learning Objective: 03-05 Evaluate net profit margin, but
beware of income statement limitations.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
19) Which of the following would not be considered an operating
activity?
1. A)
Pay employees for work completed
2. B)
Purchase supplies on account
3. C)
Purchase equipment for cash
4. D)
Sell goods to customers
Answer: C
Explanation: Paying employees, purchasing supplies, and
selling goods to customers are all operating activities. The purchase of
equipment is an investing activity.
Difficulty: 1 Easy
Topic: Operating Activities
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
20) Which of the following is an operating activity?
1. A)
Billing customers for services rendered but not yet paid for
2. B)
Paying off a loan to the bank
3. C)
Purchasing equipment for cash
4. D)
Receiving cash investments from owners
Answer: A
Explanation: Paying off loans, purchasing equipment for
cash, and receiving cash investments from owners are investing or financing
activities. Billing customers for services rendered is an operating activity.
Difficulty: 1 Easy
Topic: Operating Activities
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
21) Which of the following is an operating activity?
1. A)
Repaying a bank loan
2. B)
Paying a dividend to owners
3. C)
Purchasing a new building
4. D)
Purchasing goods to be offered for sale
Answer: D
Explanation: Operating transactions include the purchase
of inventory (that is, goods to be sold to customers). Repaying a bank loan and
paying dividends are financing activities. Purchasing a new building is an
investing activity.
Difficulty: 1 Easy
Topic: Operating Activities
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
22) Which activity is not part of the operating cycle?
1. A)
Repaying a bank loan used to purchase manufacturing equipment
2. B)
Purchasing goods from suppliers for resale to customers
3. C)
Paying employees for hours worked
4. D)
Collecting cash from sales on account made last month
Answer: A
Explanation: Operating activities are the day-to-day
functions involved in running a business. Operating activities include buying
goods and services from suppliers, paying employees, and selling goods and
services to customers and collecting cash from them. Repayment of a bank loan
is a financing activity.
Difficulty: 1 Easy
Topic: Operating Activities
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
23) The primary source of revenues and expenses comes from:
1. A)
financing activities.
2. B)
investing activities.
3. C)
operating activities.
4. D)
other activities.
Answer: C
Explanation: Operating activities are the day-to-day
functions involved in running a business. Operating activities include buying
goods and services from suppliers, paying employees, and selling goods and
services to customers and collecting cash from them.
Difficulty: 1 Easy
Topic: Operating Activities
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
24) Which of the following will result in an increase in
revenue?
1. A)
Borrowing $10,000 from a bank
2. B)
Stockholders investing $10,000 in a company
3. C)
Selling concert tickets for $10,000 four months before the performance
4. D)
Selling $10,000 of groceries to customers
Answer: D
Explanation: Revenues are increases in a company’s
resources created by providing goods or services to customers during the
accounting period. Therefore, selling $10,000 of groceries results in an
increase in revenue. When a company borrows money or stockholders invest in the
company, the company is not providing goods or services so no revenue is
recorded. The “sales” of concert tickets for a performance four months in
advance is not revenue, but a liability since services (the concert) will be
provided in the future.
Difficulty: 2 Medium
Topic: Income Statement Accounts
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
25) Which of the following items is reported on the income
statement as an expense?
1. A)
This month’s cash sales
2. B)
The purchase of supplies
3. C)
This month’s utility bill
4. D)
The purchase of land
Answer: C
Explanation: An expense is recorded in the same period as
the revenues to which it relates or, if it cannot be directly associated with
revenues, it is recorded in the period that the underlying business activity
occurs. Payment of this month’s utility bill would be shown on the income
statement as an expense since the underlying business activity occurred during
this time. Cash sales are reported as revenues. Purchases of land or supplies
would be reported on the balance sheet as increases in assets.
Difficulty: 2 Medium
Topic: Income Statement Accounts
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
26) Which of the following September transactions would impact
the September income statement?
1. A)
Collecting cash related to an account receivable
2. B)
Providing services to new customers
3. C)
Purchasing supplies
4. D)
Issuing stock to new shareholders
Answer: B
Explanation: Providing services in the current period is
reflected in the income statement, which captures activity for the current
period.
Difficulty: 2 Medium
Topic: Income Statement Accounts
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
27) Which of the following represents an account rather than a
subtotal?
1. A)
Net Income
2. B)
Total Revenues
3. C)
Total Expenses
4. D)
Service Revenue
Answer: D
Explanation: Total Revenues, Total Expenses and Net Income
are subtotals reported on the income statement. Service Revenue is an account
representing amounts a business charges its customers.
Difficulty: 1 Easy
Topic: Income Statement Accounts
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
28) Which of the following items is not a specific account in a
company’s chart of accounts?
1. A)
Income Tax Expense
2. B)
Sales Revenue
3. C)
Deferred Revenue
4. D)
Net Income
Answer: D
Explanation: Net income is not an account; it is the final
amount shown on the income statement when revenues are greater than expenses.
Difficulty: 1 Easy
Topic: Income Statement Accounts
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
29) Which of the following line items appear on an income
statement?
1. A)
Inventory
2. B)
Revenues
3. C)
Accounts Receivable
4. D)
Salaries and Wages Payable
Answer: B
Explanation: Revenues appear on the income statement. The
other accounts listed appear on the balance sheet, which reports assets,
liabilities, and stockholders equity.
Difficulty: 1 Easy
Topic: Income Statement Accounts
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
30) Income Tax Expense appears on the ________, while Income Tax
Payable is a(n):
1. A)
income statement; liability on the balance sheet.
2. B)
balance sheet; liability on the income statement.
3. C)
income statement; expense on the income statement.
4. D)
balance sheet; expense on the balance sheet.
Answer: A
Explanation: Income Tax Expense is reported on the income
statement, while Income Tax Payable, a liability, is reported on the balance
sheet.
Difficulty: 1 Easy
Topic: Income Statement Accounts
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
31) The financial statement that reports revenues and expenses
is the:
1. A)
statement of retained earnings.
2. B)
income statement.
3. C)
balance sheet.
4. D)
statement of cash flows.
Answer: B
Explanation: The income statement reports revenues and
expenses.
Difficulty: 1 Easy
Topic: Income Statement Accounts
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
32) Which of the following line items appear on an income
statement?
1. A)
Accounts Payable
2. B)
Equipment
3. C)
Utilities Expense
4. D)
Retained Earnings
Answer: C
Explanation: The income statement reports revenues and
expenses. The other accounts listed appear on the balance sheet, which reports
assets, liabilities, and stockholders’ equity.
Difficulty: 1 Easy
Topic: Income Statement Accounts
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
33) If a company incorrectly records cash received for services
to be provided in the future with a debit to Cash and credit to Sales Revenue,
how will this error affect net income for the current period?
1. A)
Net income will be too high.
2. B)
Net income will be too low.
3. C)
Net income will not be affected by this error.
4. D)
Net income will be too high in the following period.
Answer: A
Explanation: This transaction includes an obligation to
provide services in the future. This obligation is a liability called Deferred
Revenue. Service Revenue will be reported later, when the services are
provided. Because the company recorded the revenue now instead of later, it
overstated its revenues and, as a result, overstated its net income.
Difficulty: 2 Medium
Topic: Income Statement Accounts
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
34) During the year, Sand, Inc. had $120,000 in revenues, $48,000
in expenses, and paid $3,600 in dividends. Net income equals:
600.
A) $75,600.
601.
B) $68,400.
602.
C) $120,000.
603.
D) $72,000.
Answer: D
Explanation: Net income = Revenues − Expenses
= $120,000 − $48,000 = $72,000
Dividend payments do not affect net income.
Difficulty: 3 Hard
Topic: Income Statement Accounts
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Apply
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
35) If a company incorrectly records a payment as an asset
instead of an expense, how will this error affect net income in the current
period?
1. A)
Net income will be too high.
2. B)
Net income will be too low.
3. C)
Net income will not be affected by this error in the current period, but will
be too low in a later period.
4. D)
Net income will never be affected by this error because assets are reported on
the balance sheet.
Answer: A
Explanation: Because the company recorded an asset instead
of an expense, it understated its expenses and, as a result, overstated its net
income.
Difficulty: 2 Medium
Topic: Income Statement Accounts
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
36) Cobalt Co.’s income statement shows Service Revenue of
$64,000, Salaries and Wages Expense of $40,000 and net income of $1,600. The
other expenses on Cobalt’s income statement must equal:
400.
A) $22,400.
401.
B) $24,000.
402.
C) $105,600.
403.
D) $25,600.
Answer: A
Explanation: Net Income = Revenues − Expenses
Expenses = Revenues − Net Income
= $64,000 − $1,600 = $62,400
Total Expenses = Salaries and Wages Expense + Other expenses
Other expenses = Total Expenses − Salaries and Wages Expense
= $62,400 − $40,000 = $22,400
Difficulty: 3 Hard
Topic: Income Statement Accounts
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Apply
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
37) A net loss results when:
1. A)
assets are greater than liabilities.
2. B)
revenues are less than expenses.
3. C)
revenues are greater than expenses.
4. D)
cash paid is less than cash received.
Answer: B
Explanation: It is called a net loss if expenses are
greater than revenues (or net income if revenues are greater than expenses).
Difficulty: 1 Easy
Topic: Income Statement Accounts
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
38) Dividing the long life of a company into shorter periods
such as months, quarters, or years for reporting purposes is called the:
1. A)
time period assumption.
2. B)
expense recognition principle (“matching”).
3. C)
revenue recognition principle.
4. D)
separation principle.
Answer: A
Explanation: The time period assumption states that the long
life of a company can be divided into shorter periods, such as months,
quarters, and years.
Difficulty: 1 Easy
Topic: Income Statement Accounts
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
39) Which of the following statements about the income statement
and income statement accounts is correct?
1. A)
The income statement reports the financial position of a company at a point in
time.
2. B)
Income statement accounts are permanent accounts, while balance sheet accounts
are temporary accounts.
3. C)
Income statement accounts are temporary accounts, while balance sheet accounts
are permanent accounts.
4. D)
The income statement reports the cash received and paid during the period.
Answer: C
Explanation: Balance sheet accounts are considered
permanent, whereas income statement accounts are considered temporary. Another
way people describe this difference is that the balance sheet takes stock of
what exists at a point in time whereas the income statement depicts a flow of
what happened over a period of time. The balance sheet (rather than the income
statement) reports the financial position of a company at a point in time. The
income statement (rather than the balance sheet) reports financial activities
only for the current accounting period. The income statement reports revenues
earned and expenses incurred (rather than the cash received and paid) during the
period.
Difficulty: 2 Medium
Topic: Income Statement Accounts
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
40) The ________ takes stock of what exists at a point in time
whereas the ________ depicts a flow of what happened over a period of time.
1. A)
income statement; balance sheet
2. B)
balance sheet; income statement
3. C)
statement of cash flows; balance sheet
4. D)
statement of retained earnings; income statement
Answer: B
Explanation: The balance sheet reports the financial
position of a company at a point in time. The income statement covers a period
of time.
Difficulty: 1 Easy
Topic: Income Statement Accounts
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Remember
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
41) Which of the following would not be reported on the income
statement?
1. A)
Utilities expense in the amount of a bill received for utilities used during
the current period but unpaid as of the end of the period.
2. B)
Rent expense in the amount of rent paid during the period for use of a storage
facility in the current period.
3. C)
Revenue for services provided to customers who promise to pay in the next
period.
4. D)
Cost of land purchased with cash for future use.
Answer: D
Explanation: The purchase of land is an investing activity
(rather than an operating activity) and, as such, it would not be reported on
the income statement.
Difficulty: 1 Easy
Topic: Operating Activities; Accrual Basis of Accounting
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.; 03-02
Explain and apply the revenue and expense recognition principles.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
42) Which of the following statements about the income statement
of a company that was formed 10 years ago is correct?
1. A)
Reports a Net Loss for the year if expenses are more than revenues.
2. B)
Reports the financial effects of activities that have occurred since the
company’s inception.
3. C) Reports
the amount of the increase in stockholders’ equity this year as a result of the
company’s operations.
4. D)
Reports Net Income, which is an account in the ledger.
Answer: A
Explanation: The income statement reports the results of
operations for a period of time, not since the inception of the company. If
revenues are less than expenses then the net income is a negative amount and is
called net loss. Stockholders’ equity increases by the amount of net income or
decreases by the amount of net loss for a period.
Difficulty: 2 Medium
Topic: Income Statement Accounts
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
43) During 2018, a company provided services for cash of $33,600
and services on credit of $24,000. The company collected accounts receivable of
$12,800 and incurred operating expenses of $36,320, $22,400 of which were paid
during the year. The amount of net income (loss) for the year is:
280.
A) $21,280.
281.
B) $2,720.
282.
C) $36,320.
283.
D) $10,080.
Answer: A
Explanation: Net Income = Revenues (Services performed for
cash + Services performed on account) − Expenses
= ($33,600 + $24,000) − $36,320 = $21,280
Difficulty: 2 Medium
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Apply
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44) Which of the following statements about accrual basis
accounting is correct?
1. A) If
a company uses accrual basis accounting, the company should not record revenue
until payments are actually received.
2. B) If
a company uses accrual basis accounting, the company should record expenses in
the same period as the revenues they generate.
3. C)
IFRS does not allow accrual basis accounting for external reporting of income.
4. D)
The items reported on the income statement continue to have an impact beyond
the current period, whereas the items reported on the balance sheet impact just
the current period.
Answer: B
Explanation: The expense recognition principle
(“matching”) requires the recording of expenses in the same period as the
revenues they generate, not necessarily the period in which cash is paid for
them. According to GAAP and IFRS, the accrual basis is the only acceptable
method for external reporting of income. The revenue recognition principle
requires a seller to record revenue when the seller provides the goods or
services to customers, in the amount the seller expects to be entitled to
receive. Items reported on the balance sheet items (rather income statement
items) continue to have an impact beyond the current period; whereas items reported
on the income statement (rather than balance sheet items) impact just the
current period.
Difficulty: 2 Medium
Topic: Income Statement Accounts; Accrual Basis of
Accounting
Learning Objective: 03-01 Describe common operating
transactions and select appropriate income statement account titles.; 03-02
Explain and apply the revenue and expense recognition principles.
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45) Which of the following identifies, in the correct order,
steps in the five-step model for reporting revenue?
1. A)
Determine the transaction price; identify the seller’s performance
obligation(s); identify the contract.
2. B)
Allocate the transaction price to the performance obligation(s); determine the
transaction price; recognize revenue when (or as) each performance obligation
is satisfied.
3. C)
Identify the contract; determine the transaction price; identify the seller’s
performance obligation(s).
4. D)
Identify the seller’s performance obligation(s); determine the transaction
price; recognize revenue when (or as) each performance obligation is satisfied.
Answer: D
Explanation: The steps in the five-step model for
reporting revenue are (1) identify the contract; (2) identify the seller’s performance
obligation(s); (3) determine the transaction price; (4) allocation the
transaction price to the performance obligation(s); (5) recognize revenue when
(or as) each performance obligation is satisfied.
Difficulty: 1 Easy
Topic: Cash Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Remember
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46) The fact that any problems a seller has in collecting
amounts due from customers is accounted for separately is implied in the
language of:
1. A)
step 3 “entitled to.”
2. B)
step 5 “when (or as) each performance obligation is satisfied.”
3. C)
step 1 “it can be written, verbal, or merely implied.”
4. D)
step 2 “transferring control of goods or services to a customer.”
Answer: A
Explanation: The words “entitled to” in step 3 of the
model imply any problems in later collecting amounts due from customers are
accounted for separately.
Difficulty: 1 Easy
Topic: Cash Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Understand
AACSB: Analytical Thinking
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47) The Fastbank Motorcycle Service Company wins a $10 million
bid to provide the repair services for a recall on a popular brand of
motorcycles. No money is exchanged. The repair services are expected to be
performed early next year. Which of the steps of the five-step model for
revenue recognition is not yet complete?
1. A) Determine
the transaction price.
2. B)
Identify the seller’s performance obligation(s).
3. C)
Identify the contract.
4. D)
Recognize revenue when (or as) each performance obligation is satisfied.
Answer: D
Explanation: No services have yet been provided, revenue
will only be recognized when goods are delivered or services provided.
Difficulty: 2 Medium
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Understand
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48) The Rainbow House Painting Company has been contracted to
paint a house for $3,600. One-half of that amount will be paid up front; the
rest will be paid upon satisfactory completion. Rainbow should recognize the
revenue when:
1. A)
the performance obligation is identified.
2. B)
the first payment is received.
3. C)
the contract is identified.
4. D)
the performance obligation is satisfied.
Answer: D
Explanation: Under the five-step model for revenue recognition,
revenue is recognized when (or as) each performance obligation is satisfied.
Difficulty: 3 Hard
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Remember
AACSB: Analytical Thinking
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49) Which of the following statements about cash basis
accounting and accrual basis accounting is correct?
1. A)
Net income is always larger under accrual basis accounting than cash basis accounting.
2. B)
GAAP does not require the use of accrual basis accounting for external
reporting.
3. C)
Accrual basis accounting and cash basis accounting will always produce the same
amount of net income.
4. D)
Accrual basis accounting provides a better measure of operating performance
than cash basis accounting.
Answer: D
Explanation: Accrual basis accounting reports revenues
when they are earned and expenses when they are incurred, regardless of the
timing of cash receipts or payments. Accrual basis accounting produces a better
measure of the profits arising from the company’s activities. It is required
for external reporting under GAAP. Since cash basis accounting records revenues
and expenses when cash is received and paid and accrual basis accounting reports
revenues when they are earned and expenses when they are incurred, differences
in net income reported under the two methods cannot be predicted.
Difficulty: 2 Medium
Topic: Accrual Basis of Accounting; Cash Basis of
Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Understand
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50) A company’s revenue recognition policy:
1. A)
affects the income statement but not the balance sheet.
2. B)
defines when its revenue should be collected.
3. C) is
usually described in the notes to a company’s financial statements.
4. D)
states that revenues should not be recorded until payments are received from
customers.
Answer: C
Explanation: Every company reports its revenue recognition
policy in the notes to the financial statements.
Difficulty: 2 Medium
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Remember
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51) During June, the Grass Is Greener Company mows 100 lawns a
week; the company bills customers and full payment is due by July 15. The
company uses the accrual basis of accounting. How will these events affect the
company’s financial statements?
1. A) In
June, an asset and a liability account will both increase.
2. B) In
June, an asset and a revenue account will both increase.
3. C) In
July, an asset account will increase and a liability account will decrease.
4. D) In
July, a liability account will decrease and a revenue account will increase.
Answer: B
Explanation: When a sale occurs or a service is provided
before cash is received, an asset account (Accounts Receivable) increases and a
revenue account (Service Revenue) increases at the time the sale occurs or the
service is provided. At a later date, when cash is received, an asset account
(Cash) will increase and another asset account (Accounts Receivable) will
decrease.
Difficulty: 2 Medium
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Understand
AACSB: Analytical Thinking
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52) If an apartment leasing company receives the rent for
January 2018 from a tenant in December 2017, this will be reported by the
leasing company as:
2017.
A) revenue in 2017.
2018.
B) an expense in 2017.
2019.
C) a liability in 2017.
2020.
D) stockholders’ equity in 2017.
Answer: C
Explanation: When the rent check is received in December
2017, the leasing company will debit Cash and credit Deferred Revenue, a
liability. That liability will be reported on the balance sheet at the end of
December 2017. The requirement under accrual basis accounting is to record
revenues when the performance obligation is satisfied. Since the performance
obligation will be satisfied in January, rent revenue will be recorded on the
income statement during January 2018.
Difficulty: 2 Medium
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Understand
AACSB: Analytical Thinking
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53) Which of the following situations results in deferred revenue?
1. A)
Collected $100 from a customer who purchased goods a month ago.
2. B)
Received an order from a customer who will purchase and pay for goods in two
weeks.
3. C)
Sold goods for $100 today with payment due from the customer in 30 days.
4. D)
Received $100 cash from a customer for an order of goods to be shipped next
month.
Answer: D
Explanation: Deferred revenue is a liability representing
a company’s obligation to provide goods or services to customers in the future.
Accordingly, the receipt of $100 cash from a customer for an order of goods to
be shipped next month is deferred revenue.
Difficulty: 2 Medium
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Understand
AACSB: Analytical Thinking
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54) In its first year of business, Declan Industries earned
$175,000 of revenues of which $140,000 was collected. It also incurred $157,500
in expenses for which $140,000 was paid. Which of the following statements are
correct?
1. A)
Declan should use cash basis accounting for external reporting purposes as
required under GAAP and IFRS.
2. B)
Declan should report net income of $17,500 for external reporting purposes.
3. C)
Declan should report $0 net income for external reporting purposes.
4. D)
Declan should report net income of $35,000 for external reporting purposes.
Answer: B
Explanation: Using the accrual basis, which is required by
GAAP and IFRS for external reporting purposes:
Net income = Revenues − Expenses
= $175,000 − $157,500 = $17,500
Difficulty: 3 Hard
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Apply
AACSB: Analytical Thinking
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55) Reporting revenues when they are earned and expenses when
they are incurred is called ________ basis accounting.
1. A)
accrual
2. B)
cash
3. C)
expense recognition
4. D)
cost
Answer: A
Explanation: Accrual basis accounting reports revenues
when they are earned and expenses when they are incurred, regardless of the
timing of cash receipts or payments.
Difficulty: 1 Easy
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Remember
AACSB: Analytical Thinking
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56) Revenues are recognized when:
1. A) a
contract is identified.
2. B) a
seller’s performance obligations are identified.
3. C) a
seller’s performance obligations are satisfied.
4. D) a
transaction price has been determined and allocated.
Answer: C
Explanation: The five-step model for recognizing revenue
calls for revenue to be recognized when (or as) each performance obligation is
satisfied.
Difficulty: 1 Easy
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Remember
AACSB: Analytical Thinking
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57) If more than one performance obligation exists, the total
contract price:
1. A) is
split by referring to the stand-alone price of each part sold separately.
2. B) is
recognized as revenue once one of the performance obligations is satisfied.
3. C) is
recognized as Deferred Revenue and later recognized as Revenue when the
performance obligations are satisfied.
4. D) is
allocated by contract, first to written contracts, then to verbal contracts,
and finally to implied contracts.
Answer: A
Explanation: If more than one performance obligation
exists, the total contract price is split between the performance obligations
by referring to their stand-alone prices.
Difficulty: 1 Easy
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Remember
AACSB: Analytical Thinking
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58) During September, By the Book Co. collected $1,800 cash from
a customer for services to be provided during November. Which of the following
statements about this transaction is correct?
1. A)
$1,800 of revenue should be recorded in September.
2. B)
$900 of revenue should be recorded in September and $900 in November.
3. C)
$1,800 of revenue should be recorded in November.
4. D) No
revenue should be recorded for these events because they relate only to the
balance sheet.
Answer: C
Explanation: The revenue recognition principle is the
requirement under accrual basis accounting to record revenues when the
performance obligations are satisfied, not necessarily when cash is received
for them. The company should record the $1,800 of revenue in November when the
services are performed.
Difficulty: 2 Medium
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Understand
AACSB: Analytical Thinking
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59) During February, Blake Building Co. billed a customer $4,500
for services performed during February. During March, Blake collected the
$4,500. Which of the following statements about this transaction is correct?
1. A)
$4,500 of revenue should be recorded in February.
2. B)
$2,250 of revenue should be recorded in February and $2,250 in March.
3. C)
$4,500 of revenue should be recorded in March.
4. D) No
revenue should be recorded for these events because they relate only to the
balance sheet.
Answer: A
Explanation: The revenue recognition principle is the
requirement under accrual basis accounting to record revenues when the performance
obligations are satisfied, not necessarily when cash is received for them. The
company should record the $4,500 of revenue in February when the services are
performed.
Difficulty: 2 Medium
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Understand
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60) When cash is received in advance of a performance obligation
being satisfied, a(n) ________ called ________ is recorded.
1. A)
liability; Deferred Revenue
2. B)
asset; Deferred Revenue
3. C)
liability; Accounts Receivable
4. D)
asset; Accounts Receivable
Answer: A
Explanation: Deferred Revenue is a liability representing
a company’s obligation to provide goods or services to customers in the future.
Difficulty: 1 Easy
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Remember
AACSB: Analytical Thinking
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61) Deferred Revenue is a(n):
1. A)
expense.
2. B)
asset.
3. C)
revenue.
4. D)
liability.
Answer: D
Explanation: Deferred Revenue is a liability representing
a company’s obligation to provide goods or services to customers in the future.
Difficulty: 1 Easy
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Remember
AACSB: Analytical Thinking
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62) What type of account is Accounts Receivable?
1. A)
Asset
2. B)
Liability
3. C)
Expense
4. D)
Revenue
Answer: A
Explanation: Selling on account means that the company
provides goods or services to a customer not for cash, but instead for the
right to collect cash in the future. This right is an asset called Accounts
Receivable, an asset.
Difficulty: 1 Easy
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Remember
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63) Which of the following will have no effect on total assets?
1. A)
Billing a customer for work performed during the current month
2. B)
Receiving cash from a customer to pay for a previously recorded account receivable
3. C)
Receiving cash from a customer for work to be performed next month
4. D)
Receiving cash from a customer for work performed today
Answer: B
Explanation: When a company receives payment on a
previously recorded account receivable, the company will increase its Cash
account and decrease its Accounts Receivable account. One asset increases while
another asset decreases, thus there is no effect on total assets.
Difficulty: 2 Medium
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Understand
AACSB: Analytical Thinking
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64) Under the accrual basis of accounting, the ________
recognition (“matching”) principle requires that expenses be recognized in the
same period as the related revenues.
1. A)
expense
2. B)
revenue
3. C)
cost
4. D)
separate
Answer: A
Explanation: The expense recognition principle
(“matching”) is the practice under accrual basis accounting to record expenses
in the same period as the revenues they generate, not necessarily the period in
which cash is paid for them.
Difficulty: 1 Easy
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Remember
AACSB: Analytical Thinking
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65) The expense recognition principle (“matching”) dictates:
1. A)
where on the income statement expenses should be presented.
2. B)
when revenues are recognized on the income statement.
3. C)
the ordering of current assets and current liabilities on the balance sheet.
4. D)
when costs are recognized as expenses on the income statement.
Answer: D
Explanation: The expense recognition principle
(“matching”) is the practice under accrual basis accounting to record expenses
in the same period as the revenues they generate, not necessarily the period in
which cash is paid for them.
Difficulty: 1 Easy
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Remember
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66) In accordance with the expense recognition principle,
expenses are recorded in the period when the:
1. A)
related revenues are recorded.
2. B)
cash is paid.
3. C)
related assets are recorded.
4. D)
contract and performance obligations are identified.
Answer: A
Explanation: The expense recognition principle
(“matching”) is the practice under accrual basis accounting to record expenses
in the same period as the revenues they generate, not necessarily the period in
which cash is paid for them.
Difficulty: 1 Easy
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Remember
AACSB: Analytical Thinking
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67) Murphy, Inc. paid $9,600 cash for insurance in June that
provides coverage for six months, from July through December. How much expense
should be recognized in June to be in accordance with generally accepted
accounting principles?
1. A) No
expense should be recognized in June.
2. B)
$9,600
3. C)
$1,600 ($9,600 × 1/6 for the month of June)
4. D)
$4,800
Answer: A
Explanation: The expense recognition principle (“matching”)
is the practice under accrual basis accounting to record expenses in the same
period as the revenues they generate, not necessarily the period in which cash
is paid for them. Since the payment in June covers the period from July through
December, no expense should be recognized in June.
Difficulty: 2 Medium
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Understand
AACSB: Analytical Thinking
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68) In its first year of operations, Jetway Airlines incurred
and paid Salaries Expense of $40 million. On December 31, it accrued an
additional Salaries Expense of $2 million. What should Jetway report in the
income statement and balance sheet for its first year ended December 31?
1. A)
Income statement: Salaries and Wages Expense $42 million; Balance sheet:
Salaries and Wages Payable $2 million
2. B)
Income statement: Salaries and Wages Expense $40 million; Balance sheet:
Salaries and Wages Payable $2 million
3. C)
Income statement: Salaries and Wages Expense $40 million; Balance sheet:
Salaries and Wages Payable $0
4. D)
Income statement: Salaries and Wages Payable $2 million; Balance sheet:
Salaries and Wages Expense $42 million
Answer: A
Explanation: The expense recognition principle
(“matching”) is the practice under accrual basis accounting to record expenses
in the same period as the revenues they generate, not necessarily the period in
which cash is paid for them. Salaries and Wages Expense equals $42 million
which includes the $40 million paid and the $2 million owed to employees.
Difficulty: 2 Medium
Topic: Accrual Basis of Accounting
Learning Objective: 03-02 Explain and apply the revenue
and expense recognition principles.
Bloom’s: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
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