Chapter 02 Basic Financial Statements

Chapter 02 Basic Financial Statements 1) The sale of additional shares of capital stock will cause retained earnings to increase.

• True
• False

2) A business entity is regarded as separate from the personal activities of its owners whether it is a sole proprietorship, a partnership, or a corporation.

• True
• False

3) Assets need not always have physical characteristics as do buildings, machinery, or inventory.

• True
• False

4) The going concern principle assumes that the business will continue indefinitely.

• True
• False

5) Notes payable and accounts payable both require a company to pay an amount owed by a certain date.Notes payable generally have interest, while accounts payable generally do not.

• True
• False

6) Any business event that might affect the future profitability of a business should be reported in its balance sheet.

• True
• False

7) The practice of showing assets on the balance sheet at their cost, rather than at their current market value is explained, in part, by the fact that cost is supported by objective evidence that can be verified by independent experts.

• True
• False

8) Liabilities are usually listed in order of magnitude, from smallest dollar amount to largest dollar amount.

• True
• False

9) The entity principle states that the affairs of the owners are not part of the financial operations of a business entity and should be separated.

• True
• False

10) The accounting equation may be stated as "assets minus liabilities equals owners' equity."

• True
• False

11) Total assets plus total liabilities must equal total owners' equity.

• True

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• False

12) A transaction that causes an increase in an asset may also cause a decrease in another asset, an increase in a liability, or an increase in owners' equity.

• True
• False

13) The collection of an account receivable will cause total assets to decrease.

• True
• False

14) The payment of a liability causes an increase in owners' equity.

• True
• False

15) When a business borrows money from a bank, the immediate effect is an increase in total assets and a decrease in liabilities or owners' equity.

• True
• False

16) The purchase of an asset, such as office equipment, for cash will cause owners' equity to decrease.

• True
• False

17) Total assets must always equal total liabilities plus total owners' equity.

• True
• False

18) If a company purchases equipment with cash, its total assets will increase.

• True
• False

19) If a company purchases equipment by issuing a note payable, its total assets will not change.

• True
• False

20) The balance sheet shows assets, liabilities, and equity, as an extension of the accounting equation.

• True
• False

21) A net profit results from having more revenues than liabilities.

• True
• False

22) A statement of cash flows reports revenue and expense activities for a specific time period such as one month or one year.

• True
• False

23) It is not unusual for an entity to report a significant increase in cash from operating activities, but a decrease in the total amount of cash.

• True
• False

24) The statement of cash flows provides a link between two balance sheets by showing how net income (or loss) has changed owners' equity from one balance sheet date to the next.

• True
• False

25) Articulation between the financial statements means that they relate closely to each other on the basis of the same underlying transaction information.

• True
• False

26) Limited liability means that owners of a business are only liable for the debts of the business up to the amounts they can afford.

• True
• False

27) In a business organized as a corporation, it is not necessary to list the equity of each stockholder on the balance sheet.

• True
• False

28) The owner of a sole proprietorship is personally liable for the debts of the business, whereas the stockholders of a corporation are not personally liable for the debts of the business.

• True
• False

29) Window dressing occurs when management attempts to make a company look financially stronger than it actually is.

• True
• False

30) Decision makers outside the organization base their credit decisions on weekly, or even daily, financial statements.

• True
• False

31) The major outgrowth from business failures and allegations of fraudulent financial reporting during the 1990s was the passage of the Securities and Exchange Act.

• True
• False

32) Which of the following is the primary objective of an income statement?

• Providing managers with detailed information about where the enterprise stands at a specific date.
• Providing users outside the business organization with information about the company's operating results

for a period of time.

• Reporting to the Internal Revenue Service the company's taxable income.
• Indicating to investors in a particular company the current market values of their investments.

33) Which of the following describes the proper form of a balance sheet?

• Owners' equity is always the first section listed because it is the most important to external users.
• Cash is always the first asset listed, followed by permanent assets (such as land and buildings), and

finally by assets such as receivables and supplies.

• Liabilities are listed before owners' equity.
• A subtotal for total assets plus total liabilities is shown.

34) A balance sheet is designed to show:

• How much a business is worth.
• The profitability of the business during the current year.
• The assets, liabilities, and owners' equity of a business as of a particular date.
• The cost of replacing the assets and of paying off the liabilities at December 31.

35) Blue Wholesale Shirt Co. sold shirts to Pink Retail Shoppe. The owner of Pink Retail said she would pay Blue at a later date, which Blue Wholesale agreed to. Blue Wholesale Shirt Co. is considered to be a:

• borrower. B) liability. C) creditor. D) debtor.

36) Which of the following best defines an asset?

• Something with physical form that is valued at cost in the accounting records.
• An economic resource owned by a business and expected to benefit future operations.
• An economic resource representing cash or the right to receive cash in the near future.
• Something owned by a business that has a ready market value.

37) From an accounting viewpoint, when is a business considered as an entity separate from its owner(s)?

• Only when organized as a sole proprietorship.
• Only when organized as a partnership.
• Only when organized as a corporation.
• A business is always considered as an accounting entity separate from the activities of the owner(s).

38) The accounting principle that assumes that a company will operate in the foreseeable future is:

• Going concern. B) Objectivity.C) Liquidity. D) Disclosure.

39) The valuation of assets in the balance sheet is based primarily upon:

• What it would cost to replace the assets.
• Cost, because cost is usually factual and verifiable.
• Current fair market value as established by independent appraisers.
• Cost, because in the event of liquidation, the assets would be sold at an amount equal to their original

cost.40) Which of the following is not a generally accepted accounting principle relating to the valuation of assets?

• The cost principle - in general, assets are valued at cost, rather than at estimated market values.
• The objectivity principle - accountants prefer to use objective, rather than subjective, information as the

basis for accounting information.

• The safety principle - assets are valued at no more than the value for which they are insured.
• The going-concern assumption - one reason for valuing assets such as buildings and equipment at cost

rather than at their current market values is the assumption that the business will use these assets rather than sell them.41) Each year, the accountant for Southern Real Estate Company adjusts the recorded value of each asset to its market value. Using these market value figures on the balance sheet violates:

• The accounting equation. B) The stable-dollar assumption.