True/False questions
__ 1. Adjusting entries affect only expense and asset accounts.
__ 2. During inflationary periods, the use of the LIFO method of costing inventory will result in a greater amount of net income than would result from the use of the FIFO method.
__ 3. The amount representing the difference between Accounts Receivable and its contra asset account is known as the net realizable value.
__ 4. The customers subsidiary ledger is controlled by the general ledger account entitled Accounts Payable.
__ 5. When using a perpetual inventory system, anytime a customer returns a prior sale, the Merchandise Inventory account will need to be increased for the returned goods.
__ 6. When an account receivable that has been written-off is then subsequently collected, the account receivable needs to be reinstated.
__ 7. If the balance in Cash Short and Over at the end of a period is a credit, it indicates that cash shortages have exceeded cash overages for the period.
__ 8. Receivables not currently collectible (within the next 12 months) are reported in the Investments section of the balance sheet.
__ 9. In preparing a bank reconciliation, the amount of outstanding checks is added to the balance per bank statement.
__ 10. If net income for a business was $175,000, withdrawals were $40,000 in cash, and the owner made no investment, the owner’s equity increased $215,000.
The correct answer and explanation is :
Answers to True/False Questions:
- False – Adjusting entries affect not only expense and asset accounts but also revenue, liability, and equity accounts.
- False – During inflationary periods, the LIFO method results in lower net income compared to FIFO because it assigns higher costs to the cost of goods sold.
- True – Net realizable value (NRV) is the amount expected to be collected from accounts receivable after deducting the allowance for doubtful accounts.
- False – The customers’ subsidiary ledger is controlled by the Accounts Receivable account, not Accounts Payable.
- True – In a perpetual inventory system, merchandise inventory is updated immediately, so returns increase the inventory account.
- True – If an account previously written off is later collected, it must first be reinstated before recording the cash receipt.
- False – A credit balance in Cash Short and Over indicates that cash overages exceeded shortages.
- True – Long-term receivables (not collectible within 12 months) are reported in the Investments section of the balance sheet.
- False – Outstanding checks are subtracted from the balance per bank statement during reconciliation.
- False – The correct increase in owner’s equity should be $135,000 ($175,000 net income – $40,000 withdrawals).
Explanation
Understanding these accounting principles is essential in financial reporting. Adjusting entries ensure accurate financial statements by recognizing expenses and revenues in the correct period. Inventory valuation methods like FIFO and LIFO impact financial results, particularly during inflation. The net realizable value of receivables represents the actual expected cash inflow. Subsidiary ledgers help track individual accounts, such as customers (Accounts Receivable) and suppliers (Accounts Payable).
A perpetual inventory system continuously updates inventory balances, meaning returned goods are promptly recorded. Writing off bad debts does not necessarily mean the receivable is lost; reinstating it when collected is standard practice. The Cash Short and Over account reflects errors in cash handling, and a credit balance means more cash was found than lost.
For bank reconciliations, outstanding checks reduce the bank balance, not increase it. Owner’s equity changes based on net income, investments, and withdrawals. In the final question, the increase should be $135,000 because owner’s withdrawals reduce total equity, contradicting the incorrect answer of $215,000.
Here is the conceptual illustration of key accounting principles, including a balance sheet with net realizable value, bank reconciliation adjustments, LIFO vs. FIFO comparisons, and changes in owner’s equity.