Chapter 3: The Basics of Record Keeping and Financial Statement
Preparation: Income Statement Key
1. The last step in the accounting record-keeping process is preparing the balance sheet from amounts in the
balance sheet accounts.
2. Current accounting practice takes the viewpoint of shareholders by reporting the amount of net income
available to shareholders after subtracting from revenues all expenses incurred in generating the revenue by
claimants (for example, employees, lenders, governments) other than shareholders.
3. Expenditures on advertising and research must be recognized as expense in the period of expenditure,
regardless of the firm’s expectation of future benefits.
4. Operating risk arises from the asset side of the business, and financing risk arises from debt.
5. Revenues measure the inflow of net assets from operating activities.
6. Expenses provide future benefits, and assets measure the consumption of those benefits.
7. Common terminology, but not definitions in U.S. GAAP and IFRS, often refers to the difference between
sales and cost of sales as gross margin, gross profit, or gross income.
8. Expenses measure the outflow of net assets consumed in the process of generating revenues.
9. Cost is the economic sacrifice made to acquire goods or services.
10. Gains/Losses arise from relatively infrequent transactions, and there can be no assurance that they will recur
in any future period.
11. The beginning balance of the shareholders’ equity account Retained Earnings plus net income from the
income statement less dividends equals the ending balance of Retained Earnings.
12. Retained earnings measures the cumulative excess of net income over dividends for the life of a firm.
Cumulative means that retained earnings aggregates all undistributed earnings.
13. The statement of cash flows begin with revenues; for this reason, analysts often refer to revenue growth as
“top-line” growth.
14. Most firms display the components of cost of sales.
15. The income statement typically provides information about the operating results of business segments.
16. Items classified as operating expenses reflect management’s judgment that the item is a cost of the core
business.
17. Adjusting entries are part of the measurement of net income for the period and financial position at the end
of the period.
18. Adjusting entries may increase or decrease balances in balance sheet accounts and income
statement accounts.
19. If Moore pays a $600 insurance premium for a one-year policy on January 31 for coverage from February 1
of Year1 through January 31 of Year 2, the journal entry to be made at the end of February Year 1 would
include a debit to Insurance Expense for $600.
20. All transactions that increase net assets affect income.
21. When the accountant transfers the balance in each temporary revenue and expense account
to the Retained Earnings account, this procedure is known as the closing of accounts.
22. Once revenue and expense accounts serve their purpose of accumulating specific revenue and expense items
for an accounting period, they have no further purpose for that period.
23. The income statement links the beginning and ending balance sheets.
24. The equation that describes the relationship between the balance sheet and the income statement through the
Retained Earnings account is as follows:
Retained Earnings (beginning) + Net Income – Dividends = Retained Earnings (ending)
25. Recording revenues and expenses directly in the Retained Earnings account suppresses information about
the causes of net income.
26. A T-account is a device or convention for organizing and accumulating the accounting entries of
transactions that affect an individual account. Which of the following is/are true?
27. To record the purchase of equipment that is fully financed by the seller, you would
28. Many firms provide similar types of airline services with similar types of assets. They each received
unqualified opinions from their independent auditors. Yet, Flash Airlines appears to apply its accounting
principles more aggressively in income-enhancing ways relative to its competitors. The choices for Flash
Airlines in applying generally accepted accounting principles under the accrual basis of accounting include(s):
29. The accounting system uses a device called an account. An account
30. A seller of goods can easily associate (or match) the consumption of the benefits of the asset sold with
revenues from its sale. At the time of sale and revenue recognition, the seller
31. U.S. GAAP and IFRS require firms to initially report the results of most income transactions in the
32. The last step in the accounting record-keeping process is:
33. Under accrual accounting, revenue is recognized when
34. The stockholders’ equity of a firm can be defined as
35. Which of the following concepts best characterizes the accrual basis of accounting?
36. The accrual basis of accounting is often contrasted with the cash basis of accounting. Which of the
following is true of the cash basis of accounting?
37. Over sufficiently long time periods, the amount of net income equals
38. The _____ convention, links the timing of some expenses with revenue recognition.
39. Which of the following is/are false?
40. Which of the following is/are true?
41. Which of the following is/are true?
42. Prepaid assets are valued on the balance sheet at
43. Which of the following is an example of a contra account?
44. Which equation is correct?
45. The firm recognizes an expense when the following condition(s) hold(s):
46. What criterion or criteria must sales transactions meet in order for the seller to recognize revenues before
collecting cash?
47. The matching convention assigns _____ to the related _____.
48. _____ are part of the ongoing central operations of the firm, so they are relatively persistent and
sustainable.
49. When assets and income from operations that a firm has decided to discontinue (and dispose of or abandon),
separating the two income components allows users to form better predictions of
50. _____ arise from relatively infrequent transactions, and there can be no assurance that they will recur in any
future period.
51. The income statement is not also called the statement of
52. _____ present an ordered list, grouped by broad categories of revenues and expenses. They begin with
revenues followed by a list of expenses.
53. Common terminology, but not definitions in U.S. GAAP and IFRS, often refers to the difference between
sales and cost of sales as gross
54. Which of the following is/are true?
55. Subtraction of total operating expenses from sales yields:
56. Other (nonoperating) items follow operating expenses or the subtotal for operating profit. Most firms
reporting under U.S. GAAP separately report financing costs, such as
57. A firms decision to sell its headquarters building at a gain
58. Subtracting nonoperating expenses from operating income yields:
59. U.S. GAAP and IFRS require separate income statement display of income from continuing operations and
_____earnings that will not continue because the firm either sold, or made a decision to sell, a portion of its
business). Such a requirement aids users of the income statement in predicting future earnings.
60. A firm sells its headquarters building at a gain. This means that at the time of sale
61. As a general principle, under the accrual basis of accounting, the firm recognizes revenue when the
62. Manufacturing overhead include(s):
63. For manufacturing firms, the cost of completed products remains on the balance sheet as __________ assets
until the firm sells the products; upon sale, the cost of the assets becomes a cost of goods sold expense.
64. Which of the following is not an example of a period expense?
65. Which of the following is not a period expense?
66. A manufacturing firm has manufacturing costs which become product costs. These manufacturing costs do
not include:
67. Which of the following is not true?
68. Which financial statement reports operating performance for a specific period of time?
69. Revenue and expense accounts
70. Recognition of revenue usually occurs when
71. Dividends
72. Which of the following is correct?
73. At the end of the third year of operation, Forgione Corporation has total assets equal to $100,000, liabilities
totaling $90,000, and contributed capital of $30,000. What is the balance in retained earnings?
74. Revenues from marketable securities and investments in securities, interest expense on borrowings, and
gains and losses from peripheral activities appear as _____. The firm expects these sources of earnings to
continue.
75. Which section includes income derived from a firm’s primary business activities as well as from activities
peripherally related to operations? (Assume the firm expects these sources of earnings to continue.)
76. Shareholders of Augusta Corporation have received $35,000 in dividends in the current year. At year end
the corporation has total assets of $500,000, total liabilities equal to $300,000, and contributed capital totaling
$100,000. If retained earnings at the beginning of the year was $80,000, what was Augusta’s net income for the
current year?
77. The following balances have been excerpted from Bain balance sheets:
December 31, 2014
December 31, 2013
Prepaid Insurance ……………………………..
$ 6,000
$ 7,500
Interest Receivable …………………………...
3,700
14,500
Salaries Payable ……………………………….
61,500
53,000
Bain Company paid or collected during 2014 the following items:
Insurance premiums paid …………………….
$ 41,500
Interest collected ………………………………
123,500
Salaries paid ..……………………………….….
481,000
The salary expense on the income statement for 2014 was
78. Which of the following is not presented in an income statement?
79. Which of the following is/are true?
80. Which of the following is not a period expense?
81. If the firm measures an asset at acquisition cost on the balance sheet, it measures expenses based on the
_____ of the asset consumed.
82. Which of the following is/are true?
83. Under the accrual method, the timing of revenue recognition is influenced by
84. Which of the following are not an example of adjusting entries?
85. Llama Company signed a new $36,000 three-year lease beginning October 1, Year 1, for a storage facility
for holding merchandise inventory. On October 1, Year 1, Llama Company recorded the first year’s payment of
$12,000 in the Prepaid Rent account. There was no balance in the Prepaid Rent account prior to this entry.
Llama Company records adjustments only at the calendar year end. At December 31, Year 1, the adjusting entry
needed to accurately reflect the correct balances in the Prepaid Rent and Rent Expense accounts would be to
debit:
86. Roseland Company uses the periodic method of accounting for inventory. Unfortunately, the sales manager
of Roseland Company failed to record a valid sale on account of merchandise that had been shipped to a
customer prior to the end of the current year. However, he did exclude the merchandise from inventory at the
end of the current year. As a result of this error, Roseland Company’s
87. Columbia Manufacturing Corp. purchased a new lathe machine for its baseball bat manufacturing plant on
January 1. The machine cost $12,000 and is expected to be used in production for 4 years at which time its
estimated salvage value will be $2,000. The yearly straight-line depreciation for this asset would be
88. On April 1, Year 1, Seaside Bookstore bought an insurance policy costing $48,000 that would insure the
retail building for two years against fire loss. What asset account and what amount are recorded on the balance
sheet at December 31, Year 1?
89. On November 1, Year 1, Dorian Collections Agency accepted a $100,000, 3-month note from a customer.
The note earns 9% interest per year. What is the amount of interest receivable recorded by Dorian Collections
Agency at December 31, Year 1? (Assume no other entries to record interest have been made.)
90. If a firm detects an error at the end of the year, where property taxes on the headquarters buildings was
recorded as a debit to Cost of Goods Sold instead of Selling and Administrative Expenses, which of the
following entries would they make?
91. Which of the following is not an example of an adjusting entry?
92. Malcolm Corporation purchased an insurance policy for three years beginning January 1, Year 2, and
recorded the $6,000 premium in the Prepaid Insurance account. What adjusting entry is required to reflect the
proper balances, in the insurance-related accounts at year-end, on December 31, Year 2?
93. Gross Company purchased $50,000 worth of office supplies on January 1. Gross expects to use 60 percent
of the supplies in the first year and the remainder in the second year. After adjusting entries (and before closing
entries), how much should Gross show in its Supplies Expense account?
94. Andrews Corporation’s liability account balances at June 30, 2013, included a 10 percent note payable. The
note is dated October 1, 2011, and carried an original principal amount of $600,000. The note is payable in
three equal annual payments of $200,000 plus interest. The first interest and principal payment was made on
October 1, 2012. In Andrews’ June 30, 2013, balance sheet, what amount should be reported as Interest Payable
for this note?
95. Magic Corp. purchased new equipment during the year but neglected to record depreciation. What is the
effect of this omission on each of the named accounts?
Accumulated Retained Depreciation
Depreciation Earnings Expense
96. Failure to record the expired amount of prepaid rent expense would not
97. If an expense has been incurred but not yet recorded, then the end-of-period adjusting entry would involve
98. Failure to record depreciation expense at the end of an accounting period results in
99. An adjusting entry will not take the format of which one of the following entries?
100. The Supplies account balance at the beginning of the period was $6,600. Supplies totaling $12,825 were
purchased during the period and debited to Supplies . A physical count shows $3,825 of Supplies at the end of
the period. The proper journal entry at the end of the period
101. The result of closing entries is that balances in all temporary accounts
102. The result of closing entries is that balances in all temporary accounts
103. The closing process involve(s):
104. Before preparing the balance sheet and income statement, an accountant would use what accounting record
105. Which of the following accounts would not appear on a post-closing trial balance?