Chapter 7
Operating Transactions – Revenues, Expenses, and Working Capital
MULTIPLE CHOICE QUESTIONS
1. Which one of the following events is an operating transaction?
a. Purchase of equipment
b. Payment for equipment rental
c. Purchase of land
d. Issuing bonds for cash
2. Which one of the following events is an operating transaction?
a. Payment of office supplies
b. Change in depreciation accounting principle
c. Purchase of another company for stock
d. Disposal of a business segment
3. On the income statement, the result of changing from double-declining-balance to
straight-line depreciation is found in
a. operating revenues and expenses.
b. other revenues or expenses.
c. extraordinary gains or losses.
d. cumulative effects of changes in accounting methods.
4. Which one of the following events is NOT an operating transaction related to a
company’s primary activity?
a. Disposal of a business segment
b. Purchase of equipment
c. Payment for equipment maintenance
d. Purchase of inventory
7-2 Test Bank – Chapter 7 – Operating Transactions –Revenes, Expenses, and Working Capital
5. All of the following are termed considered to be operating revenues or expenses that are
usual and frequent except
a. the sale of furniture by a furniture company.
b. interest expense related to financing with bonds.
c. depreciation expense on machinery.
d. delivery cost of goods .
6. Which one of the following is a nonoperating event that must be reported on the income
statement?
a. Acquisition of a plant asset to be used in operations
b. Extraordinary items
c. Recognition of inventory expense
d. Consumption of office supplies
7. Non-operating items are found in the
a. asset section of the balance sheet.
b. liability section of the balance sheet.
c. cash flows from operations section of the cash flow statement.
d. income statement.
8. On the income statement, interest revenue is found in
a. operating revenues and expenses.
b. other revenues or expenses.
c. the disposal of a business segment section.
d. the extraordinary gains or losses section.
e. the cumulative effects section.
9. On the income statement, the loss from selling an independent business component of
the company is reported as a(n)
a. operating revenue or expense.
b. other revenue or expense.
c. disposal of a business segment.
d. extraordinary gain or loss.
e. cumulative effect of a change in accounting principle.
Test Bank – Chapter 7 – Operating Transactions – Revenues, Expenses, and Working Capital 7-3
10. Which one of the following should be NOT reported net of income taxes?
a. Loss from damages sustained by an earthquake
b. Cumulative adjustments resulting from a change in depreciation methods
c. Bad debt expense associated with a bankrupt customer
d. Gains or loss from discontinuing the operations of a major segment of a business
11. Martin Corporation reported a cumulative effect of the change in accounting (net of tax)
in the amount of $30,000 in its income statement for 2009. Martin’s income tax rate is
25%. The gross amount of the effect of the change in accounting was
a. $30,000.
b. $37,500.
c. $40,000.
d. $120,000.
12. Le Casa Corporation reported net income before extraordinary items and taxes of
$200,000 for the year 2009. During 2009, the average number of common shares
outstanding was 35,000. Basic net earnings per share for 2009 are reported to be only
$2.00. Le Casa’s income tax rate is 30%. How much was Le Casa’s extraordinary gain
or loss (before tax) from a major theft that was perpetrated by Le Casa’s payroll clerk?
The theft loss was the only item that was reported net of tax in the income statement for
2009.
a. $70,000.
b. $100,000.
c. $130,000.
d. none of the above
13. How will a company classify money paid to suppliers on its statement of cash flows?
a. Cash provided from operations
b. Cash used in operations
c. Cash provided from investing activities
d. Cash used in financing activities
14. How will a company classify money paid for inventory acquisitions on its statement of
cash flows?
a. Cash provided from operations
b. Cash used in operations
c. Cash provided from investing activities
d. Cash used for investing activities
7-4 Test Bank – Chapter 7 – Operating Transactions –Revenes, Expenses, and Working Capital
15. How will a company classify money received from selling equipment no longer used in
operations on its statement of cash flows?
a. Cash provided from operations
b. Cash provided from financing activities
c. Cash provided from investing activities
d. Cash used for investing activities
16. A company uses the indirect method of preparing the statement of cash flows. Current
year depreciation expense can be found on the
a. income statement and statement of cash flows.
b. balance sheet and income statement.
c. statement of cash flows and balance sheet.
d. income statement and statement of comprehensive income.
17. A company uses the direct method of preparing the statement of cash flows. Current
year depreciation expense can be found on the
a. balance sheet and income statement.
b. income statement and statement of cash flows.
c. statement of cash flows and balance sheet.
d. income statement only.
e. statement of cash flows only.
18. An investor is interested in assessing the effectiveness of a company’s cash
management. Where will the investor look to evaluate this?
a. Statement of cash flows
b. Income statement
c. Balance sheet
d. Company’s bank statements
19. What is reported on the statement of cash flows?
a. Operating, investing, and financing activities of an entity for a period of time
b. All revenues and expense listed by operating, financing, and operating actitivity
c. Operating, investing, and financing activities of an entity at the balance sheet date
d. A detail of all incoming and outgoing cash flows of a business
Test Bank – Chapter 7 – Operating Transactions – Revenues, Expenses, and Working Capital 7-5
20. Which statement is true with respect to the preparation of the cash flows from operating
activities’ section?
a. It can be calculated by using the direct or indirect methods.
b. Cash flows are calculated as the difference between revenues and expenses.
c. It is always equal to accrual accounting income.
d. Cash payments for depreciation and dividends are reported in the operating activites
sections.
21. A company uses straight-line instead of the units of production method of depreciation.
Assuming a tax rate of zero, which statement is true as a result of its choice of
depreciation methods?
a. Cash flows from operations will be less than under the straight-line method
b. Cash flows from operations will be more than under the straight-line method
c. Cash used for investing activities will be more than under the straight-line method
d. Cash used for investing activities will be less than under the straight-line method.
e. Cash flows are the same as if the straight-line method had been used.
22. Which one of the following is consistent with a company recording a large operating loss
but still having healthy cash flows from operations?
a. A large amount of depreciation and/or amortization expense
b. An increase in accounts receivable and inventory
c. A decrease in accounts payable
d. All sales are on a cash basis.
23. Which one of the following is consistent with a company recording a large operating
income but having a net cash outflow from operations?
a. A great amount of depreciation expense
b. An increase in accounts receivable and inventory
c. An increase in accounts payable
d. Acquisition of new plant assets for cash
24. Which one of the following is added to net income in determining cash flows from
operations?
a. Amortization of intangibles
b. Decrease in accounts payable
c. Increase in accounts receivable
d. A gain on the sale of plant assets
7-6 Test Bank – Chapter 7 – Operating Transactions –Revenes, Expenses, and Working Capital
25. A company’s operating cycle may be described as
a. the period of time that is typically required for a company to convert cash into
inventory and inventory into cash.
b. the period of time from the beginning of operations until a company liquidates all of
its assets.
c. always a one-year time period.
d. a cycle that is distinguished at the discretion of the Board of Directors on a daily
basis.
26. The allowance for doubtful accounts is
a. an ‘other revenue’ account.
b. a contra accounts receivable account.
c. an ‘other expense’ account.
d. a contra expense.
27. The net realizable value of receivables is calculated as the face value of the receivables
less adjustments for
a. sales returns and sales discounts.
b. actual uncollected amounts adjusted for purchase discounts.
c. bad debts already written off.
d. sales returns, cash discounts, and estimated uncollectible accounts..
28. Under the allowance method of accounting for bad debts, the recognition of bad debts
expense
a. increases current assets and decreases net income.
b. decreases current assets and increases net income.
c. increases current assets and net income.
d. decreases current assets and net income.
29. Under the allowance method of accounting for bad debts, the write-off of an account
receivable determined to be uncollectible
a. decreases the current ratio.
b. increases the current ratio.
c. has no effect on the current ratio.
d. decreases working capital.
Test Bank – Chapter 7 – Operating Transactions – Revenues, Expenses, and Working Capital 7-7
30. Under the allowance method of accounting for bad debts, the actual write-off of an
account receivable determined to be uncollectible
a. decreases current assets.
b. has no effect on current assets.
c. increases current assets.
d. occurs in the same accounting period as the sale.
31. Trent Company uses the allowance method of accounting for bad debts. Trent:
a. is violating the matching principle.
b. will record bad debt expense only when an account is determined to be uncollectible.
c. will not sell to customers on account anymore.
d. will report accounts receivable in the balance sheet at their net realizable value.
32. Trevor, Inc. uses the allowance method to account for bad debts. The entry to record the
write-off of a customer’s account balance decreases
a. assets and owners’ equity.
b. assets and decreases liabilities.
c. owners’ equity and revenues.
d. none of these answers is correct.
33. If a company uses the allowance method to account for bad debts, the company’s
owners’ equity will decrease
a. at the end of the accounting period when an adjusting entry to estimate bad debts is
recorded.
b. on the date a customer’s account is determined to be uncollectible.
c. when the accounts receivable amount becomes past due.
d. on the date a customer’s account is written off.
34. Which of the following would be separately reported as restricted cash in the balance
sheet or footnotes to the financial statement?
a. $8,000 in the savings account at First Bank
b. $200 in a petty cash drawer
c. $10,000 cash in an escrow account at Guarantee Bank
d. $4,000 in a checking account at Second Rate Bank
7-8 Test Bank – Chapter 7 – Operating Transactions –Revenes, Expenses, and Working Capital
35. The procedures designed to ensure that the cash account on the balance sheet reflects
the actual amount of cash in the company’s possession are referred to as
a. compensating balances.
b. record controls.
c. physical controls.
d. cash budgeting.
36, Tyson Corp. uses the aging method to estimate bad debts. The bookkeeper provided the
following schedule as of March 30th, 2010:
Account Age
Balance
Noncollection Probability
Current
$50,000
2%
1 — 30 days past due
40,000
4%
31 — 60 days past due
10,000
8%
Over 60 days past due
5,000
17%
What is the amount of receivables deemed uncollectible?
a. $1,650
b. $4,250
c. $3,400
d. $105,000
37. Which one of the following expenditures should not be included in the cost of inventory?
a. Transportation-out
b. Purchase cost
c. Packaging cost
d. Transportation-in
e. Storage cost
AICPA BB: Critical Thinking AICPA FN: Reporting
38. Elliot Books purchased 200 books, paying $10 each. Elliot paid the $30 shipping costs
and $20 binding repair fees so that those books could be sold. How much is the cost of
inventory?
a. $2,000
b. $2,030
c. $2,020
d. $2,050
Test Bank – Chapter 7 – Operating Transactions – Revenues, Expenses, and Working Capital 7-9
39. A company deliberately and inappropriately included interest costs on its December 31
inventory. Which one of the following statements is true for the company’s December 31
financial statements?
a. Earnings per share is understated.
b. Inventory turnover ratio is understated.
c. The current ratio is understated.
d. Cost of goods sold is overstated.
40. Ursula Clothing has cost of goods sold of $12,000 with beginning and ending inventories
of $4,000 and $2,000, respectively. Purchases during the period are
a. $ 8,000.
b. $ 9,000.
c. $10,000.
d. $11,000.
e. $12,000.
41. Beginning inventory is valued at $7,000, purchases are $15,000 and ending inventory is
valued at $8,000. Cost of goods sold is
a. $23,000.
b. $16,000.
c. $30,000.
d. $14,000.
e. $16,000.
42. During a year of rising prices and increasing inventory, which cost flow assumption
would yield the greatest current ratio?
a. Averaging
b. LIFO
c. FIFO
d. Both a and c are correct.
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43. Unusually high income resulted when Vicente Inc. cut back its inventory levels. This
effect is
a. backed by the LIFO elimination rule.
b. expected in most industries.
c. achieved through using the lower-of-cost-or-market rule.
d. called LIFO liquidation.
44. During a period of rising prices and increasing inventory, which cost flow assumption
used on both federal income tax returns and financial reports would provide a company
with the greatest cash position?
a. FIFO
b. LIFO
c. Averaging
d. TIFO
45. If a company uses the LIFO cost flow assumption on its federal income tax return in
order to minimize its tax payment, then it
a. must use LIFO on its financial statements.
b. must use FIFO on its financial statements.
c. may use any cost flow assumption permitted by GAAP on its financial statements.
d. must correct the error at the beginning of the next accounting period.
46. An unacceptably low inventory turnover ratio may reveal that
a. customers are delaying their payments on account.
b. the selling price of inventory is too high.
c. sales returns have decreased significantly.
d. the company is selling too much inventory.
47. Under generally accepted accounting principles, a company can choose a cost flow
assumption for valuing cost of goods sold that can result in different income
measurement. However, it cannot frequently change the cost flow assumption adopted
in order to measure the highest income possible because of the
a. conservative principle.
b. going concern principle.
c. stable-dollar principle.
d. consistency principle.
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48. Which one of the following companies would likely carry the largest percentage of
inventory as compared to its other assets?
a. Ernst & Young, CPAs
b. Merrill Lynch Investment Brokers
c. The Magic Kingdom at Disney World
d. Jim’s Ford Dealership
49. An employee of Shim Inc. failed two drug tests. The employee has sued and Shim Inc.’s.
lawyers appropriately believe that, at best, it is only reasonably probable that Shim Inc.
will lose the court case. The proper accounting treatment of the lawsuit will
a. increase earnings per share.
b. increase the debt/asset ratio.
c. decrease the current ratio.
d. not affect the debt/equity ratio.
50. One of Villager Corp’s employees invented a revolutionary coffee lid that cools coffee as
you drink it in order to prevent burns. Two children ordered coffee and burned their
mouths after failing to properly secure the lids. The children’s parents sued. Villager
Corp’s. lawyers believe that it is highly probable that judgment will be rendered against
Villager Corp and it is likely a payment in excess of $2 million will be incurred. The
proper accounting treatment of the lawsuit will
a. decrease total liabilities.
b. increase total liabilities.
c. increase the current ratio.
d. require accountants to wait until the suit is settled to account for the event.
51. Collecting sales taxes from customers
a. decreases net income.
b. increases the debt/equity ratio.
c. increases the current ratio.
d. decreases net worth.
52. Dividends payable typically arise because
a. creditors want a return on funds loaned to a company.
b. cash is paid for dividends previously declared in another accounting period.
c. the board of directors declare a dividend that will be paid at a later date.
d. bond investors demand a return.
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53. If a loss contingency related to a lawsuit against a firm is deemed to have a reasonable
probability of requiring ultimate payment, then the proper accounting treatment of the
loss contingency will
a. require note disclosure.
b. decrease the debt/asset ratio.
c. increase the accounts payable/sales ratio.
d. decrease the debt/equity ratio.
54. Unearned revenue typically arises because
a. cash is received as security that will be paid back in the future.
b. cash is received from customers prior to the rendering of services or delivery of
products.
c. a company temporarily requires cash for operations.
d. merchandise is sold to customers prior to payment.
55. Accruing warranty expense will
a. increase the debt/equity ratio.
b. increase the current ratio.
c. reduce uncollectible accounts during the period.
d. increase inventory turnover.
56. If a loss contingency related to a lawsuit against a firm is deemed to have a remote
probability of requiring ultimate payment, then the proper accounting treatment of the
loss contingency will
a. increase the debt/equity ratio.
b. increase the debt/asset ratio.
c. have no effect on earnings per share.
d. increase the quick ratio.
57. Contingent liabilities whose ultimate payment is highly probable and can be reasonably
estimated must be
a. ignored until actual payment is made.
b. disclosed only in the footnotes to the financial statements.
c. recorded in the body of the balance sheet.
d. disclosed in the auditor’s report.
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58. Contingent liabilities whose ultimate payment is remote should be
a. recorded in the body of the balance sheet.
b. disclosed in the footnotes to the financial statements.
c. disclosed in the auditor’s report.
d. ignored.
59. Which one of the following is a current liability?
a. Portions of notes payable due beyond the next accounting period
b. Sales taxes paid on new equipment acquired
c. Estimated costs of hurricanes which might develop in the Caribbean during next
hurricane season
d. Football tickets sold to customers for games in the coming season
60. Liabilities are
a. sometimes credit and other times debit balances.
b. deferred amounts which will be recognized on the balance sheet when the actual
due date arrives.
c. obligations arising from past transactions and payable in assets or services in the
future.
d. obligations to transfer ownership of one company to other entities.
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MATCHING QUESTIONS
1. Given below are several items (1 through 4) that will be reported on a company’s financial
statements. Select the letter of the proper financial statement reporting section listed as a
through f. You may use each letter more than once or not at all.
Financial Statement Reporting Sections
a. Income from continuing operations section of the income statement
b. Discontinued operations section of the income statement
c. Extraordinary items section of the income statement
d. Cumulative effect of a change in accounting principle section of the income statement
e. A separate comprehensive income item
f. Not reported on the income statement or comprehensive income statement
_____1. A loss incurred by Maranda Corporation due to a strike by employees of the
company
_____2. A large loss of inventory incurred by a meat-packing factory due to a government
FDA inspection which found dangerously high levels of bacteria; no previous
situations in the company’s history
_____3. Manufacturing circuits were determined obsolete and had to be written down to a
nominal scrap value due to an improved manufacturing process
_____4. A loss due to a decline in market value on an available-for-sale investment
_____5. Losses due to hurricane damage
_____6. Financial impacts of the adoption of a new FASB standard on goodwill.
_____7. The financial effects of outsourcing the company’s industrial product division
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2. For each transaction provided in items 1 through 5, select the proper section of the
statement of cash flows in which it should be reported using the indirect method from the
reporting categories provided in a through h below. If the item is not required to be
reported on the statement of cash flows, place an ‘X’ in the space provided.
Reporting Categories
1. Retired long-term debt before its maturity date
2. Cash paid for income taxes
3. Recognized loss on the sale of equipment
4. Declared cash dividends
5. Amortization of patent
3. For each item numbered 1 through 5 below, identify the letter of the best description by
selecting from items a through e below. You may use each letter more than once or not
at all.
Descriptions
a. Intention is to convert into cash within one year
b. Current assets/current liabilities
c. Current assets – current liabilities
Must pay within one year
e. (Cash + marketable securities + accounts receivable) divided by current liabilities
____ 1. Current liabilities
____ 2. Current assets
____ 3. Quick ratio
____ 4. Working capital
____ 5. Current ratio
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4. For each item listed in 1 through 7, place the letter (a through e) of the accounting effect
in the space provided. You may use each letter more than once or not at all.
Accounting Effects
a. Assets and net income increase
b. Assets and net income decrease
c. Assets decrease and net income increases
d. Assets increase and net income decreases
e. Assets and net income are not affected
____ 1. During a period of increasing inventory and rising prices, a company decides to
use FIFO instead of LIFO.
____ 2. During a period of increasing inventory and rising prices, a company decides to
use averaging instead of FIFO.
____ 3. During a period of increasing inventory and increasing prices, a company uses
the LIFO method, which creates the largest cost of goods sold.
____ 4. A company applies lower-of-cost-or-market for valuing ending inventory when
market price is less than cost.
____ 5. A company applies lower-of-cost-or-market for valuing ending inventory when
cost is less than market price.
____ 6. Transportation-in is properly expensed instead of being added to the cost of
ending inventory.
____ 7. During an extended period of constant prices, a company adopts LIFO instead
of FIFO.
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5. For each item numbered 1 through 16 below, select the appropriate effect on liabilities
listed in a through e that each transaction describes. You may use each letter more than
once or not at all. In some cases, two effects are correct.
Effects on Liabilities
a.
Decrease current liabilities
b.
Increase current liabilities
c.
No effect on recorded current liabilities
d.
Accrued contingent liability
e.
Contingent liability disclosed in the notes only
____ 1. Purchased supplies on account.
____ 2. Paid accounts payable.
____ 3. Issued a $1,000 short-term note payable for $970.
____ 4. Amortized the discount of the short-term note payable.
____ 5. A portion of long-term debt is due next year.
____ 6. Declared cash dividends to holders of stock.
____ 7. Paid the cash dividend previously declared.
____ 8. Received money from customers prior to delivery of the product to the
customer.
____ 9. Delivered products to a customer who previously paid for that product.
____ 10. Collected sales tax on behalf of the state government.
____ 11. Accrued payroll taxes that the firm has to pay to the federal government
within three months.
____ 12. Accrued a bonus amounting to 5% on reported income to the CEO.
____ 13. In a lawsuit filed against the firm, counsel indicates that the potential $10,000
loss is remote.
____ 14. In a lawsuit filed against the firm, counsel indicates that the potential $10,000
loss is reasonably possible.
____ 15. In a lawsuit filed against the firm, counsel indicates that the potential $10,000
loss is highly probable.
____ 16. Accrued warranty expense.