FOR INSTRUCTOR USE ONLY
CHAPTER 1
INTRODUCTION TO FINANCIAL STATEMENTS
SUMMARY OF QUESTIONS BY LEARNING OBJECTIVE AND BLOOM’S TAXONOMY
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Multiple Choice Questions
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Brief Exercises
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Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
FOR INSTRUCTOR USE ONLY
1-2
Completion Statements
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Short Answer Essay
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*This topic is dealt with in an Appendix to the chapter.
SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE
Learning Objective 1
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Introduction to Financial Statements
FOR INSTRUCTOR USE ONLY
1-3
Learning Objective 4
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Learning Objective 6
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Note: TF = True-False C = Completion
MC = Multiple Choice Ex = Exercise
Ma = Matching SA = Short Answer Essay
Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
FOR INSTRUCTOR USE ONLY
1-4
CHAPTER LEARNING OBJECTIVES
1. Describe the primary forms of business organization. A sole proprietorship is a business
owned by one person. A partnership is a business owned by two or more people associated
as partners. A corporation is a separate legal entity for which evidence of ownership is
provided by shares of stock.
2. Identify the users and uses of accounting information. Internal users are managers who
need accounting information to plan, organize, and run business operations. The primary
external users are investors and creditors. Investors (stockholders) use accounting
information to help them decide whether to buy, hold, or sell shares of a company’s stock.
Creditors (suppliers and bankers) use accounting information to assess the risk of granting
credit or loaning money to a business. Other groups who have an indirect interest in a
business are taxing authorities, customers, labor unions, and regulatory agencies.
3. Explain the three principal types of business activity. Financing activities involve
collecting the necessary funds to support the business. Investing activities involve acquiring
the resources necessary to run the business. Operating activities involve putting the
resources of the business into action to generate a profit.
4. Describe the content and purpose of each of the financial statements. An income
statement presents the revenues and expenses of a company for a specific period of time. A
retained earnings statement summarizes the changes in retained earnings that have occurred
for a specific period of time. A balance sheet reports the assets, liabilities, and stockholders’
equity of a business at a specific date. A statement of cash flows summarizes information
concerning the cash inflows (receipts) and outflows (payments) for a specific period of time.
5. Explain the meaning of assets, liabilities, and stockholders’ equity, and state the basic
accounting equation. Assets are resources owned by a business. Liabilities are the debts
and obligations of the business. Liabilities represent claims of creditors on the assets of the
business. Stockholders’ equity represents the claims of owners on the assets of the business.
Stockholders’ equity is subdivided into two parts: common stock and retained earnings. The
basic accounting equation is:
Assets = Liabilities + Stockholders’ Equity
6. Describe the components that supplement the financial statements in an annual report.
The management discussion and analysis provides management’s interpretation of the
company’s results and financial position as well as a discussion of plans for the future. Notes
to the financial statements provide additional explanation or detail to make the financial
statements more informative. The auditor’s report expresses an opinion as to whether the
financial statements present fairly the company’s results of operations and financial position.
Introduction to Financial Statements
1-5
TRUE-FALSE STATEMENTS
1. A business organized as a separate legal entity owned by stockholders is a partnership.
2. Corporate stockholders generally pay higher taxes but have no personal liability.
3. The liability of corporate stockholders is limited to the amount of their investment.
4. The majority of U.S. business is transacted by proprietorships.
5. Proprietorships in the United States generate more revenue than the other two forms of
business enterprise.
6. Owners of business firms are the only people who need accounting information.
7. Management of a business enterprise is the major external user of information.
8. External users of accounting information are managers who plan, organize, and run a
business.
9. The information needs and questions of external users vary considerably.
10. Accounting communicates financial information about a business to both internal and
external users.
11. Two primary external users of accounting information are investors and creditors.
12. Financing activities for corporations include borrowing money and selling shares of their
own stock.
13. Investing activities involve collecting the necessary funds to support the business.
Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
1-6
14. The purchase of equipment is an example of a financing activity.
15. Assets are resources owned by a business and provide future services or benefits to the
business.
16. Payments to owners are operating activities.
17. The economic resources that are owned by a business are called stockholders’ equity.
18. Operating activities involve putting the resources of the business into action to generate a
profit.
19. A business is usually involved in two types of activity—financing and investing.
20. Net income for the period is determined by subtracting total expenses and dividends from
revenues.
21. A different set of financial statements usually is prepared for each user.
22. The heading for the income statement might include the line “As of December 31, 20xx.”
23. Net income is another term for revenue.
24. Cash is another term for stockholders’ equity.
25. The primary purpose of the statement of cash flows is to provide information about the
cash receipts and cash payments of a company for a specific period of time.
26. The balance sheet reports assets and claims to those assets at a specific point in time.
Introduction to Financial Statements
1-7
27. The basic accounting equation states that Assets = Liabilities.
28. One way of stating the accounting equation is: Assets + Liabilities = Stockholders’ Equity.
29. The accounting equation can be expressed as Assets – Stockholders’ Equity = Liabilities.
30. The accounting equation can be expressed as Assets – Liabilities = Stockholders’ Equity.
31. If the assets owned by a business total $150,000 and liabilities total $105,000,
stockholders’ equity totals $45,000.
32. If the assets owned by a business total $100,000 and liabilities total $65,000,
stockholders’ equity totals $25,000.
33. Claims of creditors and owners on the assets of a business are called liabilities.
34. Creditors’ rights to assets supersede owners’ rights to the assets.
35. All publicly traded U.S. companies must provide their stockholders with an annual report
each year.
36. Information in the notes to the financial statements has to be quantifiable (numeric).
37. An auditor is an accounting professional who conducts an independent examination of the
accounting data presented by a company.
38. The management discussion and analysis (MD & A) section of an annual report covers
various financial aspects of a company.
39. Explanatory notes and supporting schedules are an optional part of an annual report.
Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
1-8
40. Examples of notes are descriptions of the significant accounting policies and methods
used in preparing the statements, explanations of contingencies, and various statistics.
Answers to True-False Statements
MULTIPLE CHOICE QUESTIONS
41. The proprietorship form of business organization
a. must have at least two owners in most states.
b. generally receives favorable tax treatment relative to a corporation.
c. combines the records of the business with the personal records of the owner.
d. is classified as a separate legal entity.
42. A business organized as a corporation
a. is not a separate legal entity in most states.
b. requires that stockholders be personally liable for the debts of the business.
c. is owned by its stockholders.
d. has tax advantages over a proprietorship or partnership.
43. The partnership form of business organization
a. is a separate legal entity.
b. is a common form of organization for service-type businesses.
c. enjoys an unlimited life.
d. has limited liability.
44. Which of the following is not one of the three forms of business organization?
a. Corporations
b. Partnerships
c. Proprietorships
d. Investors
Introduction to Financial Statements
1-9
45. Most business enterprises in the United States are
a. proprietorships and partnerships.
b. partnerships.
c. corporations.
d. government units.
46. A business organized as a separate legal entity is a
a. corporation.
b. proprietor.
c. government unit.
d. partnership.
47. Which of the following is not an advantage of the corporate form of business
organization?
a. No personal liability
b. Easy to transfer ownership
c. Favorable tax treatment
d. Easy to raise funds
48. An advantage of the corporate form of business is that
a. it has limited life.
b. its owner’s personal resources are at stake.
c. its ownership is easily transferable via the sale of shares of stock.
d. it is simple to establish.
49. Which of the following is an advantage of corporations relative to partnerships and sole
proprietorships?
a. Reduced legal liability for investors
b. Harder to transfer ownership
c. Lower taxes
d. Most common form of organization
50. A corporation has which of the following set of characteristics?
a. Shared control, tax advantages, increased skills and resources
b. Simple to set up and maintains control with founder
c. Easier to transfer ownership and raise funds, no personal liability
d. Harder to raise funds and gives owner control
Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
1-10
51. A small neighborhood barber shop that is operated by its owner would likely be organized
as a
a. joint venture.
b. partnership.
c. corporation.
d. proprietorship.
52. A local retail shop has been operating as a sole proprietorship. The business is growing
and now the owner wants to incorporate. Which of the following is not a reason for this
owner to incorporate?
a. Ability to raise capital for expansion
b. Desire to limit the owner’s personal liability
c. The prestige of operating as a corporation
d. The ease in transferring shares of the corporation’s stock
53. All of the following are advantages for choosing a proprietorship for a business except
a. a proprietorship is a simple form of business to set up.
b. a proprietorship gives the owner control of the business.
c. proprietorship receive more favorable tax treatment.
d. transfer of ownership is easily achieved through stock sales.
54. Jack and Jill form a partnership. Jack runs the business in New York, while Jill vacations
in Hawaii. During the time Jill is away from the business, Jack increases the debts of the
business by $20,000. Which of the following statements is true regarding this debt?
a. Only Jack is personally liable for the debt, since he has been the managing partner
during that time.
b. Only Jill is personally liable for the debt of the business, since Jack has been working
and she has not.
c. Both Jack and Jill are personally liable for the business debt.
d. Neither Jack nor Jill is personally liable for the business debt, since the partnership is
a separate legal entity.
55. Which one of the following questions is most likely asked by an internal human resources
director for the company?
a. Which product line is most profitable?
b. What price for our product will maximize the company income?
c. What average pay raise is affordable for employees this year?
d. Should any product lines be eliminated?
Introduction to Financial Statements
1-11
56. Which of the following are internal reports that accounting provides to internal users?
a. Forecasts of cash needs for next year.
b. Financial comparisons of operating activity alternatives.
c. Both forecasts of cash needs and financial comparisons are internal reports.
d. Neither forecasts of cash needs or financial comparisons is an internal report.
57. Which of the following is the best definition of an internal user of accounting information?
a. Investors who use accounting information to decide whether to buy or sell stock.
b. Creditors like banks that use accounting information to evaluate the risk of lending
money.
c. Labor unions who use accounting information to examine the ability of the company to
pay increased wages and benefits.
d. Managers who use accounting information to plan, organize, and run a business.
58. External users of accounting information, like the Internal Revenue Service, are most
commonly known as
a. taxing authorities.
b. labor unions.
c. customers.
d. regulatory agencies.
59. Which of the following statements is not true regarding the Sarbanes-Oxley Act (SOX)?
a. The Act calls for increased oversight responsibilities for boards of directors.
b. The Act has resulted in increased penalties for financial fraud by top management.
c. The Act calls for decreased independence of outside auditors reviewing corporate
financial statements.
d. The Act is meant to decrease the likelihood of unethical corporate behavior.
60. Which of the following is not a step for solving an ethical dilemma?
a. Identifying the alternatives and weighing the impact of each alternative on various
stakeholders.
b. Certifying the ethical accuracy of the financial information.
c. Identifying and analyzing the principal elements in the situation.
d. Recognizing the ethical situation and issues involved.
61. Which of the following is the most appropriate and modern definition of accounting?
a. The information system that identifies, records, and communicates the economic
events of an organization to interested users.
b. A means of collecting information.
c. The interconnected network of subsystems necessary to operate a business.
d. Electronic collection, organization, and communication of vast amounts of information.
Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
1-12
62. Which of the following would not be considered an internal user of accounting data for the
Xanadu Company?
a. President of the company
b. Production manager
c. Merchandise inventory clerk
d. President of the employees’ labor union
63. Which of the following groups uses accounting information primarily to insure the entity is
operating within prescribed rules?
a. Taxing authorities
b. Regulatory agencies
c. Labor Unions
d. Management
64. The group of users of accounting information charged with achieving the goals of the
business is its
a. auditors.
b. investors.
c. managers.
d. creditors.
65. Which of the following groups uses accounting information to determine whether the
company can pay its obligations?
a. Investors in common stock
b. Marketing managers
c. Creditors
d. Chief Financial Officer
66. Which of the following groups uses accounting information to determine whether the
company’s net income will result in a stock price increase?
a. Investors in common stock
b. Marketing managers
c. Creditors
d. Chief Financial Officer
67. Which of the following groups uses accounting information to determine whether a
marketing proposal will be cost effective?
a. Investors in common stock
b. Marketing managers
c. Creditors
d. Chief Financial Officer
Introduction to Financial Statements
1-13
68. Which of the following would not be considered an external user of accounting data for
the Julian Company?
a. Internal Revenue Service agent
b. Management
c. Creditors
d. Customers
69. Which of the following would not be considered an internal user of accounting data for a
company?
a. The president of a company
b. The controller of a company
c. Creditor of a company
d. Salesperson of a company
70. Which of the following is a primary user of accounting information with a direct financial
interest in the business?
a. Taxing authority
b. Creditor
c. Regulatory agency
d. Labor union
71. Which of the following is a user of accounting information with an indirect financial interest
in a business?
a. A financial adviser
b. Management
c. Investor
d. Creditor
72. Which type of corporate information is readily available to investors?
a. Financial comparison of operating alternatives
b. Marketing strategies for a product that will be introduced in eighteen months
c. Forecasts of cash needs for the upcoming year
d. Amount of net income retained in the business
73. Which of the following statements concerning users of accounting information is incorrect?
a. Management is considered an internal user.
b. Present creditors are considered external users.
c. Regulatory authorities are considered internal users.
d. Taxing authorities are considered external users.
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74. External users want answers to all of the following questions except
a. Is the company earning satisfactory income?
b. Will the company be able to pay its debts as they come due?
c. Will the company be able to afford employee pay raises this year?
d. How does the company compare in profitability with competitors?
75. Which type of corporate information is not available to investors?
a. Dividend history
b. Forecast of cash needs for the upcoming year
c. Cash provided by investing activities
d. Beginning cash balance
76. The liability created by a business when it purchases coffee beans and coffee cups on
credit from suppliers is termed a(n)
a. account payable.
b. account receivable.
c. revenue.
d. expense.
77. The right to receive money in the future is called a(n)
a. account payable.
b. account receivable.
c. liability.
d. revenue.
78. Which of the following is not a principal type of business activity?
a. Operating
b. Investing
c. Financing
d. Delivering
79. Borrowing money is an example of a(n)
a. delivering activity.
b. financing activity.
c. investing activity.
d. operating activity.
Introduction to Financial Statements
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80. Issuing shares of stock in exchange for cash is an example of a(n)
a. delivering activity.
b. investing activity.
c. financing activity.
d. operating activity.
81. Debt securities sold to investors that must be repaid at a particular date some years in the
future are called
a. accounts payable.
b. notes receivable.
c. taxes payable.
d. bonds payable.
82. Which of the following activities involves collecting the necessary funds to support the
business?
a. Operating
b. Investing
c. Financing
d. Delivering
83. Buying assets needed to operate a business is an example of a(n)
a. delivering activity.
b. financing activity.
c. investing activity.
d. operating activity.
84. Which activities involve acquiring the resources to run the business?
a. Delivering
b. Financing
c. Investing
d. Operating
85. Which activities involve putting the resources of the business into action to generate a
profit?
a. Delivering
b. Financing
c. Investing
d. Operating
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86. The statement of cash flows would disclose the payment of a dividend
a. nowhere on the statement.
b. in the operating activities section.
c. in the investing activities section.
d. in the financing activities section.
87 Buying and selling products are examples of
a. operating activities.
b. investing activities.
c. financing activities.
d. delivering activities.
88. The common characteristic possessed by all assets is
a. long life.
b. great monetary value.
c. tangible nature.
d. future economic benefit.
89. Expenses are incurred
a. only on rare occasions.
b. to produce assets.
c. to produce liabilities.
d. to generate revenues.
90. The cost of assets consumed or services used is also known as
a. a revenue.
b. an expense.
c. a liability.
d. an asset.
91. Resources owned by a business are referred to as
a. stockholders’ equity.
b. liabilities.
c. assets.
d. revenues.
92. The best definition of assets is the
a. cash owned by the company.
b. collections of resources belonging to the company and the claims on these resources.
c. owners’ investment in the business.
d. resources belonging to a company that have future benefit to the company.
Introduction to Financial Statements
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93. Debts and obligations of a business are referred to as
a. assets.
b. equities.
c. liabilities.
d. expenses.
94. Jackson Company recorded the following cash transactions for the year:
Paid $135,000 for salaries.
Paid $60,000 to purchase office equipment.
Paid $15,000 for utilities.
Paid $6,000 in dividends.
Collected $245,000 from customers.
What was Jackson’s net cash provided by operating activities?
a. $95,000
b. $35,000
c. $110,000
d. $89,000
95. Gibson Company recorded the following cash transactions for the year:
Paid $180,000 for salaries.
Paid $80,000 to purchase office equipment.
Paid $20,000 for utilities.
Paid $8,000 in dividends.
Collected $310,000 from customers.
What was Gibson’s net cash provided by operating activities?
a. $110,000
b. $30,000
c. $130,000
d. $102,000
96. When expenses exceed revenues, which of the following is true?
a. a net loss results
b. a net income results
c. assets equal liabilities
d. assets are increased
97. Which of the following is an asset?
a. Mortgage payable
b. Investments
c. Common stock
d. Retained earnings
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98. Which of the following is not a liability?
a. Unearned Service Revenue
b. Accounts Payable
c. Accounts Receivable
d. Interest Payable
99. Which of the following financial statements is divided into major categories of operating,
investing, and financing activities?
a. The income statement.
b. The balance sheet.
c. The retained earnings statement.
d. The statement of cash flows.
100. The retained earnings statement shows all of the following except
a. the amounts of changes in retained earnings during the period.
b. the causes of changes in retained earnings during the period.
c. the time period following the one shown for the income statement.
d. beginning retained earnings on the first line of the statement.
101. Ending retained earnings for a period is equal to beginning
a. Retained earnings + Net income + Dividends
b. Retained earnings – Net income – Dividends
c. Retained earnings + Net income – Dividends
d. Retained earnings – Net income + Dividends
102. Which of the following statements is true?
a. Amounts received from issuing stock are revenues.
b. Amounts paid out as dividends are not expenses.
c. Amounts paid out as dividends are reported on the income statement.
d. Amounts received from issued stock are reported on the income statement.
103. Dividends are reported on the
a. income statement.
b. retained earnings statement.
c. balance sheet.
d. income statement and balance sheet.
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104. Dividends paid
a. increase assets.
b. increase expenses.
c. decrease revenues.
d. decrease retained earnings.
105. The financial statement that summarizes the changes in retained earnings for a specific
period of time is the
a. balance sheet.
b. income statement.
c. statement of cash flows.
d. retained earnings statement.
106. To show how successfully your business performed during a period of time, you would
report its revenues and expenses in the
a. balance sheet.
b. income statement.
c. statement of cash flows.
d. retained earnings statement.
107. Net income results when
a. Assets > Liabilities.
b. Revenues = Expenses.
c. Revenues > Expenses.
d. Revenues < Expenses.
108. Net income will result during a time period when
a. assets exceed liabilities.
b. assets exceed revenues.
c. expenses exceed revenues.
d. revenues exceed expenses.
109. Retained earnings at the end of the period is equal to
a. retained earnings at the beginning of the period plus net income minus liabilities.
b. retained earnings at the beginning of the period plus net income minus dividends.
c. net income.
d. assets plus liabilities.
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110. Which of the following financial statements is concerned with the company at a point in
time?
a. Balance sheet
b. Income statement
c. Retained earnings statement
d. Statement of cash flows
111. The company’s policy toward dividends and growth could best be determined by
examining the
a. balance sheet.
b. income statement.
c. retained earnings statement.
d. statement of cash flows.
112. An income statement
a. summarizes the changes in retained earnings for a specific period of time.
b. reports the changes in assets, liabilities, and stockholders’ equity over a period of
time.
c. reports the assets, liabilities, and stockholders’ equity at a specific date.
d. presents the revenues and expenses for a specific period of time.
113. If the retained earnings account increases from the beginning of the year to the end of the
year, then
a. net income is less than dividends.
b. a net loss is less than dividends.
c. additional investments are less than net losses.
d. net income is greater than dividends.
114. The retained earnings statement would not show
a. the retained earnings beginning balance.
b. revenues and expenses.
c. dividends.
d. the ending retained earning balance.
115. If the retained earnings account decreases from the beginning of the year to the end of
the year, then
a. net income is less than dividends.
b. there was a net income and no dividends.
c. additional investments are less than net losses.
d. net income is greater than dividends.