Chapter 03 – Measuring Business Income
TRUE/FALSE
1. The intentional preparation of misleading financial statements is referred to as fraudulent financial
reporting.
2. Net income is misleading when revenue is overstated or expenses are understated by significant
amounts.
3. When the estimates involved in earnings management begin moving outside a reasonable range, the
financial statements can become misleading.
4. Accounting periods of greater than a year are called interim periods.
5. If a company is expected to survive, it is considered a going concern.
6. Expenses are often called the cost of doing business or expired costs.
7. When expenses exceed revenues, a net income occurs.
8. When a net loss has been suffered, Retained Earnings will contain a negative balance.
9. Not all increases to cash represent revenues.
10. Revenue is equal to the cash received by a company during an accounting period.
11. All decreases in stockholders’ equity are a result of expenses.
12. Assets become liabilities when they expire.
13. Instead of the word profit, accountants use net income because the latter term can be defined more
precisely.
14. A cash payment that reduces a liability does not result in an expense.
15. Revenue is produced when accounts receivable are collected.
16. A company’s fiscal year need not correspond to the calendar year.
17. Accounting periods should be of equal length to facilitate comparisons between periods.
18. The continuity assumption acknowledges that estimates of net income are still useful.
19. When preparing financial statements, the accountant assumes that the business will continue to operate
indefinitely unless there is evidence to the contrary.
20. The matching rule is most closely related to the cash basis of accounting.
21. The cash basis of accounting is prohibited for income tax purposes.
22. In applying the matching rule, expenses should be recognized in the same accounting period as the
revenues to which they are related. .
23. Assets are converted to revenues as they benefit the company.
24. Direct cause-and-effect relationships between revenues and expenses can be identified easily.
25. When there is no direct connection between revenues and costs, the costs are systematically allocated
among the periods benefited from the costs.
26. One of the applications of accrual accounting is adjusting the accounts.
27. Accrual accounting is an application of the matching rule.
28. The accrual basis of accounting results in a more accurate measurement of net income for the period
than does the cash basis of accounting.
29. Adjusting entries affect only the cash flows of the current period.
30. Revenue should be recognized, even when collectability is not reasonably assured.
31. Revenue cannot be recognized unless delivery of goods has occurred or services have been rendered.
32. Accrual accounting recognizes revenues and expenses at the point that cash changes hands.
33. A deferral is the recognition of an expense that has arisen but not yet recorded.
34. Adjusting entries are useful in apportioning costs among two or more accounting periods.
35. An adjusting entry includes at least one balance sheet account and at least one income statement
account.
36. Recording incurred but unpaid expenses is an example of an accrual.
37. A contra account is an account whose balance is subtracted from an associated account in the financial
statements.
38. Expenses that have been paid for and recorded are called accrued expenses.
39. When an asset’s depreciation is recorded, it’s carrying value increases.
40. Revenue for which the service has been performed but no entry has been made in the accounting
records is accrued revenue.
41. A depreciable asset’s original cost can typically be obtained by referring to the balance sheet.
42. Allowance for depreciation is another term for depreciation expense.
43. Depreciation Expense–Equipment is an example of a contra account.
44. The carrying value of equipment is the estimated dollar amount the equipment could be sold for.
45. The heading of an adjusted trial balance might contain the line “For the Month Ended May 31, 20xx.”
46. The adjusted trial balance facilitates the preparation of the financial statements.
47. An adjusted trial balance must be prepared before the adjusting entries can be recorded.
48. An adjusted trial balance proves the balance of the ledger accounts after the adjusting entries have
been posted.
49. An adjusted trial balance will probably list more accounts than are listed in the trial balance.
50. The dollar amount of Cash on the trial balance and on the adjusted trial balance should be identical.
51. In the accounting cycle, closing entries are prepared before adjusting entries.
52. Closing entries are journal entries made at the beginning of an accounting period.
53. In the accounting cycle, information from source documents is initially recorded in the journal.
54. Financial statements cannot be prepared until the accounts have been adjusted.
55. Nominal account balances are reduced to zero by closing entries.
56. Closing entries deal primarily with the balances of real accounts.
57. The only accounts that are closed are income statement accounts.
58. Closing entries result in the transfer of net income or loss into the Retained Earnings account.
59. After all closing entries have been posted, the balance of the Income Summary account will be zero.
60. Accounts Receivable is a real account.
61. Depreciation Expense–Equipment is a permanent account.
62. Cash is a nominal account.
63. Supplies Expense is a temporary account.
64. A revenue account is closed with a credit to the revenue account and a debit to Income Summary.
65. Net income provides a good measure of a business’s debt-paying ability.
66. Profitability is best determined from cash flow information.
MULTIPLE CHOICE
1. Which of the following transactions results in the recognition of an expense?
a.
Expiration of the usefulness of equipment during the accounting period
b.
Payment on an account payable
c.
Declaration and payment of a dividend
d.
Payment on the principal portion of a loan
2. Which of the following actions can distort company records and result in fraudulent financial
reporting?
a.
Prepaying an expense and recording it as an asset
b.
Collecting revenue in advance of earning it
c.
Recording income that has not yet been earned
d.
Recording an expense that has been incurred but has not yet been paid
3. The manipulation of revenues and expenses to achieve a specific outcome is called
a.
earnings management.
b.
the matching rule.
c.
adjusting entries.
d.
revenue recognition.
4. When a credit sale takes place,
a.
revenue account will increase.
b.
liabilities will increase.
c.
one asset account will increase and another will decrease.
d.
assets will be unaffected.
5. A net loss results in a decrease in
a.
expenses.
b.
liabilities.
c.
stockholders’ equity.
d.
assets.
6. Net income results in a(n)
a.
increase in stockholders’ equity.
b.
increase in revenues.
c.
decrease in expenses.
d.
decrease in liabilities.
7. Which of the following transactions results in an increase in expenses?
a.
Payment on accounts payable
b.
Usage of utilities
c.
Repayment of principal of bank loan
d.
Purchase of office equipment on credit
8. Which of the following transactions results in an increase in revenues?
a.
Sale of a service on credit
b.
Receipt of cash from bank loan
c.
Sale of land at cost for cash
d.
Collection of cash on account
9. Which of the following transactions will not result in an increase in revenues?
a.
Sale of goods on credit
b.
Sale of services for cash
c.
Accumulation of interest in bank account
d.
Sale of stock to investors for cash
10. Which of the following transactions will not result in the recognition of an expense?
a.
Interest accrued on a bank loan
b.
Declaration and payment of a dividend
c.
Use of machinery during the period
d.
Expiration of prepaid insurance
11. The recording of an expense could result in a corresponding increase in
a.
stockholders’ equity.
b.
revenue.
c.
a liability.
d.
an asset.
12. When expenses exceed revenues,
a.
a net income will result.
b.
a net loss occurs.
c.
stockholders’ equity increases.
d.
a liability is created.
13. Expenses are incurred
a.
to generate revenue.
b.
to produce liabilities.
c.
only during the adjustment process.
d.
to produce assets.
14. The cost of doing business is also known as
a.
a liability.
b.
an expense.
c.
revenue.
d.
an asset.
15. A customer’s promise to pay for goods or services
a.
decreases the company’s liabilities.
b.
increases the company’s Cash account.
c.
creates a liability for the company.
d.
increases the assets of the company.
16. As the usefulness of a plant asset expires,
a.
an amount is transferred from one asset account to another.
b.
a related expense account is reduced.
c.
a liability is created.
d.
the cost of the asset is allocated to an expense account.
17. The periodicity assumption recognizes that
a.
the company may continue indefinitely.
b.
all financial statements should cover a fiscal year.
c.
it is useful to estimate the business’s net income in terms of accounting periods.
d.
the value of an asset may vary from month to month.
18. Retailers often end their fiscal year that ends
a.
during a slack season.
b.
during the peak of the busy season.
c.
at different times each year, depending on the tax consequences.
d.
on September 30.
19. Which of the following is the most difficult to assign to specific time periods?
a.
The incurrence of wages expense
b.
The accrual of interest
c.
The use of equipment
d.
The expiration of insurance
20. Financial statement time periods should be of equal length
a.
and should end during the peak season.
b.
to make comparison easier.
c.
and should correspond to the calendar year.
d.
to comply with income tax regulations.
21. The going concern assumption is not applied to
a.
companies that have sustained losses for the previous two years.
b.
companies about to file for bankruptcy.
c.
the partnership form of business.
d.
companies that have been in existence for less than a year.
22. The going concern assumption helps solve the
a.
matching issue.
b.
accounting period issue.
c.
revenue recognition issue.
d.
continuity issue.
23. Equipment might be depreciated over 20 years because
a.
it will lose most of its market value in 20 years.
b.
it will be paid for in 20 years.
c.
it will help to generate revenue for the company over 20 years.
d.
income tax provisions require depreciation over 20 years.
24. When a direct cause-and-effect relationship cannot be established between revenues and costs, the
costs are
a.
not expensed and remain as assets on the balance sheet.
b.
expensed among the accounting periods that benefit from the costs.
c.
expensed immediately in their entirety.
d.
expensed equally each year.
25. The matching rule relates the least to
a.
systematic and rational allocation.
b.
the cash basis of accounting.
c.
revenues and expenses.
d.
cause-and-effect relationships.
26. The matching rule is applied
a.
because it is required by the Internal Revenue Code.
b.
by expensing certain items immediately and in their entirety.
c.
to help make the bookkeeper’s job easier.
d.
to help produce an accurate measurement of a company’s performance.
27. Which of the following accounts probably would need to be adjusted at year end?
a.
Notes Payable
b.
Land
c.
Supplies
d.
Dividends
28. Which of the following is not an application of accrual accounting?
a.
Recognizing revenues when earned and expenses when incurred
b.
Applying the matching rule
c.
Adjusting the accounts
d.
Recording on the basis of actual receipt and payment of cash
29. Which of the following is not an application of accrual accounting?
a.
Recording advertising fees earned at the time the work is done
b.
Adjusting unearned advertising fees to the proper balance at the end of the month
c.
Recording advertising fees earned at the time the cash payment is received
d.
Recording telephone expense in the accounting period covered by the monthly bill
30. Which of the following transactions is most likely not to result in an adjusting entry at the end of the
period?
a.
Performance of a service for which payment was received in advance
b.
Payment of this month’s rent
c.
Purchase of office equipment
d.
Purchase of a two-year insurance policy
31. Which of the following is an application of accrual accounting?
a.
Depreciating a building as quickly as allowed by income tax regulations
b.
Recording utilities expense in the accounting period covered by the monthly bill
c.
Expensing a machine in its entirety when purchased
d.
Recording revenue at the time payment is received
32. Which of the following accounts need not be adjusted at year end?
a.
Prepaid Advertising
b.
Land
c.
Office Supplies
d.
Unearned Revenue
33. Which of the following conditions is not a requirement by the SEC for the recognition of revenue?
a.
Delivery has occurred or services have been rendered.
b.
Collectability is reasonably certain.
c.
A written agreement has been signed.
d.
The seller’s price to the buyer is fixed or determinable.
34. Which of the following is not a condition required by the SEC for the recognition of revenue?
a.
Delivery of goods or rendering of services
b.
Transfer of cash from the buyer to the seller
c.
Fixed or determinable price
d.
Existence of an arrangement
35. Which of the following is a condition required by the SEC for the recognition of revenue?
a.
Completion of goods manufactured
b.
Execution of a promissory note
c.
Price in excess of $100
d.
Reasonable assurance of collection
36. Which of the following accounts could increase as a result of adjusting entries?
a.
Prepaid Insurance
b.
Accounts Receivable
c.
Unearned Fees
d.
Office Equipment
37. Which of the following accounts could decrease as a result of adjusting entries?
a.
Office Supplies
b.
Accumulated Depreciation–Buildings
c.
Wages Expense
d.
Revenue from Services
38. Which of the following is an example of a deferral?
a.
Interest expense incurred but not yet paid
b.
A commission collected in advance
c.
Estimated income taxes for the year
d.
Medical fees earned but not yet collected
39. Which of the following is an example of an accrual?
a.
Bookkeeping fees collected but not yet earned
b.
Six months’ rent paid in advance
c.
Interest earned but not yet received
d.
Equipment purchased for use in the business
40. Which of the following is an example of an accrual?
a.
Debit Office Supplies Expense, credit Office Supplies
b.
Debit Wages Expense, credit Wages Payable
c.
Debit Rent Expense, credit Prepaid Rent
d.
Debit Unearned Revenue, credit Revenue from Services
41. Which of the following is an example of a deferral?
a.
Debit Interest Expense, credit Interest Payable
b.
Debit Accounts Receivable, credit Legal Fees Earned
c.
Debit Property Taxes Expense, credit Property Taxes Payable
d.
Debit Depreciation Expense–Truck, credit Accumulated Depreciation–Truck
42. An adjusting entry would not include which of the following accounts?
a.
Income Taxes Payable
b.
Unearned Revenue
c.
Interest Receivable
d.
Cash
43. An adjusting entry cannot include a debit to a(n)
a.
expense and a credit to an asset.
b.
asset and a credit to a revenue.
c.
liability and a credit to a revenue.
d.
asset and a credit to a liability.
44. Which of the following is an example of a deferral?
a.
Income taxes recorded but not yet paid
b.
The purchase of a company vehicle
c.
Legal fees earned but not yet collected
d.
The accumulation of interest in a bank account
45. Which of the following is an example of an accrual?
a.
The purchase of office supplies
b.
Wages expense incurred but not yet paid
c.
Tuition revenue collected in advance
d.
Payment of two years’ insurance in advance
46. An adjusting entry can include a debit to a(n)
a.
asset and a credit to a liability.
b.
liability and a credit to a revenue.
c.
revenue and a credit to an asset.
d.
expense and a credit to a revenue.
47. Which of the following situations involves a deferral?
a.
Recording accrued interest
b.
Recording depreciation
c.
Recording unrecorded wages
d.
Recording unrecorded revenue
48. Which of the following situations is an example of an accrual?
a.
Recording supplies consumed
b.
Recording unrecorded, earned revenues
c.
Recording depreciation
d.
Recording the portion of prepaid rent that has expired
49. What is the adjustment entry for that portion of revenue received in advance which has now been
earned?
a.
Unearned Revenue – Debit; Cash – Credit.
b.
Unearned Revenue – Debit; Revenue from Services – Credit.
c.
Revenue from Services – Debit; Unearned Revenue – Credit.
d.
Cash – Debit; Unearned Revenue – Credit.
50. An adjusting entry made to record accrued interest on a note payable due next year consists of
a.
Interest Expense – Debit; Cash – Credit.
b.
Interest Receivable – Debit; Interest Income – Credit.
c.
Interest Expense – Debit; Notes Payable – Credit.
d.
Interest Expense – Debit; Interest Payable – Credit.
51. In accounting, depreciation refers to the
a.
allocation of asset cost.
b.
wearing away of an asset.
c.
decline in value of an asset.
d.
obsolescence of an asset.
52. Which of the following assets is not subject to depreciation?
a.
Store fixtures
b.
Art equipment
c.
Land
d.
Computers
53. Which of the following accounts is a contra account?
a.
Accumulated Depreciation–Office Furniture
b.
Interest Payable
c.
Depreciation Expense–Office Furniture
d.
Unearned Revenue
54. The carrying value of a depreciable asset equals
a.
original cost minus depreciation expense for the current period.
b.
original cost minus accumulated depreciation.
c.
the estimated cost to replace the asset.
d.
the estimated amount that the asset could be sold for.
55. Which of the following pairs of accounts could not possibly appear in the same adjusting entry?
a.
Interest Income and Interest Payable
b.
Revenue from Services and Accounts Receivable
c.
Revenue from Services and Unearned Revenue
d.
Rent Expense and Rent Payable
56. Failure to adjust for accrued wages at year end will result in an
a.
overstatement of liabilities.
b.
understatement of assets.
c.
understatement of stockholders’ equity.
d.
overstatement of net income.
57. Failure to record depreciation at year end will result in an
a.
understatement of total liabilities.
b.
overstatement of total assets.
c.
understatement of net income.
d.
overstatement of total liabilities.
58. The principal difference between depreciation expense and most other types of expenses is that
depreciation
a.
can be avoided if the asset is in as good condition as when it was purchased.
b.
does not require an immediate cash outlay.
c.
is not deductible if it will cause a net loss.
d.
is subject to more precise measurement.
59. Use this information to answer the following question.
The trial balance for Tsung Corporation appears as follows:
Tsung Corporation
Trial Balance
December 31, 2010
Cash
$ 200
Accounts Receivable
500
Prepaid Insurance
50
Supplies
150
Office Equipment
400
Accumulated Depreciation–Office Equipment
$ 200
Accounts Payable
300
Common Stock
600
Service Revenue Earned
500
Salaries Expense
100
Rent Expense
200
______
$1,600
$1,600
If on December 31, 2010, supplies on hand were $20, the adjusting entry would contain a
a.
credit to Supplies for $20.
b.
credit to Supplies Expense for $130.
c.
debit to Supplies Expense for $130.
d.
debit to Supplies for $20.
60. Use this information to answer the following question.
The trial balance for Tsung Corporation appears as follows:
Tsung Corporation
Trial Balance
December 31, 2010
$ 200
500
50
150
400
$ 200
300
600
500
100
200
______
$1,600
$1,600
If on December 31, 2010, the insurance still unexpired amounted to $20, the adjusting entry would
contain a
a.
debit to Prepaid Insurance for $30.
b.
credit to Prepaid Insurance for $30.
c.
debit to Insurance Expense for $20.
d.
credit to Prepaid Insurance for $20.
61. Use this information to answer the following question.
The trial balance for Tsung Corporation appears as follows:
Tsung Corporation
Trial Balance
December 31, 2010
$ 200
500
50
150
400
$ 200
300
600
500
100
200
______
$1,600
$1,600
If the estimated depreciation for office equipment were $200, the adjusting entry would contain a
a.
debit to Accumulated Depreciation, Office Equipment for $200.
b.
credit to Office Equipment for $200.
c.
credit to Accumulated Depreciation, Office Equipment for $200.
d.
credit to Depreciation Expense, Office Equipment for $200.
62. Use this information to answer the following question.
The trial balance for Tsung Corporation appears as follows:
Tsung Corporation
Trial Balance