Financial Accounting, 10e (Libby)
Chapter 3 Operating Decisions and the Accounting System
1) The operating cycle is the time that elapses between a company’s cash payment to suppliers
for inventory purchases and the collection of cash from sale of inventory to customers.
2) A retail store would likely have a shorter operating cycle than an automobile manufacturer.
3) The time period assumption implies that the life of a business entity can be reported in time
periods such as quarters and years.
4) An example of operating revenue would be the revenue created by the sale of an automobile
by a car dealership.
5) According to the revenue recognition principle, revenue is recognized at the time that cash is
collected from a customer for services to be provided in the future.
6) Unearned revenues are reported as liabilities on the balance sheet.
7) Interest expense is reported on the income statement as an operating expense.
8) Earnings per share must be either reported on the income statement or disclosed in the notes to
the financial statements.
9) Interest revenue is reported as operating revenue and therefore increases operating income.
10) Expenses are the result of decreases in assets or increases in liabilities incurred in order to
generate revenues.
11) According to the expense recognition principle, wages expense is recognized on the income
statement when the wages are paid rather than when the employee provides the work.
12) A gain resulting from the sale of buildings and equipment is not reported as operating
income on the income statement.
13) Under accrual accounting, rent expense for February 2019 would be recognized on the
income statement in February 2019 even though it had been paid for in January of 2019.
14) Under accrual basis accounting, revenues are recognized when goods or services are
transferred to customers, and expenses are recognized when incurred to generate that revenue.
15) Application of generally accepted accounting principles requires that the accrual basis of
accounting be used for reporting revenues and expenses on the income statement.
16) The expense recognition principle requires expenses to be recorded on the income statement
in the same period they are incurred in generating revenues.
17) The revenue recognition principle recognizes revenue when the goods or services are
transferred to customers, regardless of the timing of the cash collection from customers.
18) Selling inventory to a customer on account results in an increase in an asset and an increase
in revenues.
19) Cash received prior to the providing of the goods or services results in an increase in both
assets and liabilities.
20) Using cash to purchase office supplies, which will be consumed later, results in an increase
in expenses and a decrease in assets at the time of purchase.
21) Revenue accounts have credit balances because they increase stockholders’ equity.
22) Expense accounts have debit balances because they decrease net income, retained earnings,
and stockholders’ equity.
23) Purchasing a six-month insurance policy results in a debit to insurance expense and a credit
to cash at the date of purchase.
24) Reporting revenues on the income statement that were previously reported as unearned
revenues on the balance sheet results in a decrease in liabilities and an increase in net income,
retained earnings, and stockholders’ equity.
25) When the board of directors declares a cash dividend, the retained earnings account is
debited.
26) The trial balance needs to be prepared prior to preparation of the income statement.
27) Dividends declared decrease net income.
28) An income statement that is categorized into operating and peripheral activities is called a
consolidated income statement.
29) Collections from customers are cash flows from operating activities.
30) Cash paid to suppliers for inventory is an investing activity.
31) The net profit margin ratio is calculated by dividing net sales by net income.
32) The net profit margin ratio is a measure of how much profit was created per sales dollar.
33) Which of the following best describes the operating cycle?
A) It is the length of the manufacturing process.
B) It is the time that elapses from the purchase of inventory on account to the sale of inventory
on account.
C) It is the time that elapses from the completion of the manufacturing process to the cash
collection from sale of the manufactured goods.
D) It is the time that elapses from the cash payment to suppliers to collection of cash from
customers.
34) Which of the following would lengthen the operating cycle?
A) Faster collection of accounts receivables.
B) Selling inventory in a shorter period of time.
C) Increasing the number of customers who pay cash
D) Relaxing credit terms and allowing customers more time to pay.
35) The primary difference between revenues and gains is:
A) Gains are increases in net assets from periodically selling assets (other than inventory), while
revenues are increases from major or central ongoing operations of a business.
B) Revenues increase operating income and gains have no impact on net income.
C) Revenues cause increases in net assets as a result of infrequent activities and gains cause
increases through ongoing activities.
D) Gains result in an increase in operating income whereas revenues do not impact operating
income.
36) Which of the following best describes the time period assumption?
A) It assumes we value a business as of the end of every month.
B) It is the cutoff point for asset and liability recognition.
C) It implies that financial statements are prepared at the end of a business entity’s operating
cycle.
D) It assumes we divide the long life of a business into a series of shorter time periods for
accounting and reporting purposes.
37) Which of the following costs is most likely to be the largest expense reported on the income
statement of a merchandiser, such as Walmart Stores, Inc.?
A) Utilities expense.
B) Cost of goods sold.
C) Advertising expense.
D) Income tax expense.
38) Which of the following businesses would most likely not report cost of goods sold on its
income statement?
A) A law firm.
B) An automobile dealership.
C) A pizza restaurant.
D) A computer chip manufacturer.
39) Which of the following describes the reporting of interest expense on the income statement?
A) It is reported as an operating expense.
B) It is a component of operating income.
C) It is deducted from operating income.
D) It is added to operating income.
40) Which of the following statements is false?
A) The income statement covers a period of time.
B) A loss on the sale of plant and equipment is considered a peripheral activity and is not
reported on the income statement.
C) Rent expense is a component of operating income.
D) Interest expense is not a component of operating income.
41) Which of the following is not reported as an operating expense on the income statement?
A) Wages expense.
B) Rent expense.
C) Interest expense.
D) Cost of goods sold.
42) Which of the following statements is correct?
A) Dividend revenue is a component of Income from Operations.
B) Income from Operations is decreased by a loss from the sale of plant assets.
C) A gain on the sale of a stock investment increases Income from Operations.
D) Income before taxes occurs before Other Items on the income statement.
43) Trend Decorations Company provides decorating services for store displays. Trend sold
equipment that it had been using to create decorations. Of the following choices, which will
Trend report on its income statement when it sells the equipment?
A) Operating revenue: Sales revenue
B) Operating expenses: Loss on disposal of equipment
C) Other items: Loss on sale of equipment
D) General and administrative expenses: Sale of decorating equipment
44) Which of the following best describes operating revenues?
A) They are increases in assets or increases in liabilities as a result of peripheral transactions.
B) They are decreases in assets or decreases in liabilities as a result of central ongoing
operations.
C) They are increases in assets or decreases in liabilities as a result of central ongoing operations.
D) They are decreases in assets or increases in liabilities as a result of peripheral transactions.
45) Which of the following transactions will result in an increase in operating income as of the
date of the transaction?
A) The sale of investments at a gain.
B) Collection of cash from a customer for services to be provided at a later date.
C) Providing a service to a customer on account.
D) The receipt of cash dividends from an investment.
46) Which of the following expenses does not affect the reporting of operating income?
A) Income tax expense.
B) Cost of goods sold.
C) Depreciation expense.
D) Rent expense.
47) Which of the following statements is false?
A) An expense is a cost incurred to generate revenues.
B) Selling assets at a gain does not result in earning revenue.
C) Revenues are reported on the income statement as they are earned.
D) Revenues result in an increase in net income and additional paid-in capital.
48) The following information has been provided by Hable Company:
• Advertising expense $9,900
• Interest expense $3,700
• Rent expense for store $12,000
• Loss on sale of property and equipment $5,700
• Cost of goods sold $21,300
• Depreciation expense $7,100
• Prepaid insurance $1,000
How much were Hable’s total expenses in calculating operating income?
A) $50,300.
B) $54,000.
C) $56,000.
D) $43,200.
49) The following information has been provided by Hable Company:
• Advertising expense $9,900
• Interest expense $3,700
• Rent expense for store $12,000
• Loss on sale of property and equipment $5,700
• Cost of goods sold $21,300
• Depreciation expense $7,100
• Prepaid insurance $1,000
What is the amount included in the Other Items section of Hable’s income statement?
A) $19,300.
B) $9,400.
C) $3,700.
D) $13,800.