Practice Questions 1

Questions # 1
a. What are the three distinct types of business activity in which companies engage? Assume that you
start your own company to rent bicycles in the summer and skis in the winter. Give an example of at
least one of each of the three types of business activities in which you would engage.

Ans: The types of activities in which companies engage are financing, investing, and operating. To start a
new business, such as renting bicycles and skis, requires initial financing, such as initial contributions by the
owners and loans by a bank. Next, the business would need to invest in the assets it will rent—that is,
bicycles and skis. Once investments in assets are made, the business would earn revenue by renting out
bicycles and skis. The business would also incur various operating expenses, such as wages, advertising,
and taxes.

b. Rogers Corporation starts the year with a Retained Earnings balance of $55,000. Net income for the
year is $27,000. The ending balance in Retained Earnings is $70,000. What was the amount of
dividends for the year?

Ans: If Rogers has $55,000 in Retained Earnings to begin the year and net income for the year of $27,000,
the ending balance in Retained Earnings would be $82,000 if no dividends were paid during the year.
Because the ending balance in Retained Earnings is $70,000, the company must have paid $12,000 in
dividends.

c. Evaluate the following statement: The auditors are in the best position to evaluate a company because
they have prepared the financial statements.

Ans: The auditors may be in an excellent position to evaluate a company, but not
because they have prepared the financial statements. The preparation of the statements is the responsibility
of management. The role of the auditor is to perform
various tests and procedures as a basis for rendering an opinion on the fairness of the presentation of the
statements.

d. What is the relationship between the cost principle and the going concern assumption?

Ans: We assume in the absence of evidence to the contrary that a business will continue indefinitely. This
assumption, known as the going concern assumption, helps to justify the use of historical costs in the
statements. For example, if we knew that a company was in the process of liquidation, it would not be
appropriate to use historical costs in assigning an amount to such assets as land and buildings. Instead, the
current or market values of the assets would be more meaningful to a user of the balance sheet. Because
the normal assumption is that a business will continue indefinitely, the objectivity of historical cost makes
it more attractive as a basis for valuation

e. Why does inflation present a challenge to the accountant? Relate your answer to the monetary unit
assumption.
f. How would you evaluate the following statement: The cash flows to a company are irrelevant to an
investor; all the investor cares about is the potential for receiving dividends on the investment.
g. A key characteristic of useful financial information is understandability. How does this qualitative
characteristic relate to the background of the user of the information?
h. What does relevance mean with regard to the use of accounting information?
i. What is the qualitative characteristic of comparability? Why is it important in preparing financial
statements?
j. What is the difference between comparability and consistency as they relate to the use of accounting
information?
k. How does the concept of materiality relate to the size of a company?
l. How does the concept of the operating cycle relate to the definition of a current asset?
m. How would you evaluate the following statement: A note payable with an original maturity of five
years will be classified on the balance sheet as a long-term liability until it matures.
n. In auditing the financial statements of a company, does the auditor certify that the statements are
totally accurate without errors of any size or variety? Explain.
o. What are four different forms of cash?
p. What is the meaning of the following statement? The choice between historical cost and current value
is a good example of the trade-off in accounting between relevance and reliability.
q. What does the following statement mean? If I want to assess the cash flow prospects for a company
“down the road,” I look at the company’s most recent statement of cash flows. An income statement
prepared under the accrual basis of accounting is useless for this purpose.
r. What is the relationship between the time period assumption and accrual accounting?
s. Is it necessary for an asset to be acquired when revenue is recognized? Explain your answer.
Questions # 2
Three methods of matching costs with revenue were described in the chapter: (a) directly match a specific
form of revenue with a cost incurred in generating that revenue, (b) indirectly match a cost with the
periods during which it will provide benefits or revenue, and (c) immediately recognize a cost incurred as
an expense because no future benefits are expected. For each of the following costs, indicate how it is
normally recognized as expense by indicating either (a), (b), or (c). If you think that more than one
answer is possible for any of the situations, explain why.
1. New office copier
2. Monthly bill from the utility company for electricity
3. Office supplies
4. Biweekly payroll for office employees
5. Commissions earned by salespeople
6. Interest incurred on a six-month loan from the bank
7. Cost of inventory sold during the current period
8. Taxes owed on income earned during current period
9. Cost of three-year insurance policy
Questions # 3
For the following situations, indicate whether each involves a deferred expense (DE), a deferred revenue
(DR), an accrued liability (AL), or an accrued asset (AA).
Example: DE Office supplies purchased in advance of their use
___________ 1. Wages earned by employees but not yet paid
___________ 2. Cash collected from subscriptions in advance of publishing a magazine
___________ 3. Interest earned on a customer loan for which principal and interest have not yet been
collected
___________ 4. One year’s premium on life insurance policy paid in advance
___________ 5. Office building purchased for cash
___________ 6. Rent collected in advance from a tenant
___________ 7. State income taxes owed at the end of the year
___________ 8. Rent owed by a tenant but not yet collected

Questions # 4
Hudson Corp. has extra space in its warehouse and agrees to rent it out to Stillwater Company at the rate
of $2,000 per month. The space was made available to Stillwater beginning on September 1, 2010. Under
the terms of the agreement, Stillwater pays the month’s rent on the fifth day after the end of the month.
Assume that Hudson prepares adjustments at the end of each month.
Required
A. How much revenue should Hudson record in September? How much revenue should Hudson record in
October?
B. Identify and analyze the transactions, including any adjustments, on Hudson’s books during the month
of October.

Questions # 5
Determine whether recording each of the following adjustments will increase (I), decrease (D), or have no
effect (NE) on each of the three elements of the accounting equation.
Assets = Liabilities + Stock. Equity
Example: Wages earned during the period but not yet paid are accrued. NE I
D
1. Prepaid insurance is reduced for the portion of the policy that has
expired during the period. _______ _______ _______
2. Interest incurred during the period but not yet paid is accrued. _______ _______
_______
3. Depreciation for the period is recorded. _______ _______ _______
4. Revenue is recorded for the earned portion of a liability for amounts
collected in advance from customers. _______ _______ _______
5. Rent revenue is recorded for amounts owed by a tenant but not yet
received. _______ _______ _______
6. Income taxes owed but not yet paid are accrued. _______ _______ _______

Questions # 6
Two years ago, Sue Stern opened an audio book rental shop. Sue reports the following accounts on her
income statement:

Sales $84,000
Advertising Expense 10,500
Salaries Expense 12,000
Depreciation on CDs 5,000
Rent Expense 18,000

These amounts represent two years of revenue and expenses. Sue asks you how she can tell how much of
the income is from the first year and how much is from the second year of business. She provides the
following additional data:
a. Sales in the second year are triple those of the fi rst year.
b. Advertising expense is for a $1,500 opening promotion and weekly ads in the newspaper.
c. Salaries represent one employee who was hired eight months ago. No raises have been granted.
d. Rent has not changed since the shop opened.

Required
Prepare income statements for Years 1 and 2.

Questions # 7
Jessie’s Accounting Services was organized on June 1, 2010. The company received a contribution of
$1,000 from each of the two principal owners. During the month, Jessie’s Accounting Services provided
services for cash of $1,400 and services on account for $450, received $250 from customers in payment of
their accounts, purchased supplies on account for $600 and equipment on account for $1,350, received a
utility bill for $250 that will not be paid until July, and paid the full amount due on the equipment.
Determine the company’s Cash balance on June 30, 2010.
Questions # 8
Jane Erving, a newly hired accountant wanting to impress her boss, stayed late one night to analyze the
long-distance calls by area code and time of day placed. She determined the monthly cost for the previous
12 months by hour and area code called.
Required
a. What did Jane think her boss would learn from this information? What action might be taken as a
result of knowing it?
b.Would this information be more relevant if Jane worked for a hardware store or for a real estate
company? Discuss.

Questions # 9
You are controller for an architectural firm whose accounting year ends on December 31. As part of the
management team, you receive a year-end bonus directly related to the firm’s earnings for the year. One
of your duties is to review the transactions recorded by the bookkeepers. A new bookkeeper recorded the
receipt of $10,000 in cash as an increase in cash and an increase in service revenue. The $10,000 is a
deposit, and the bookkeeper explains to you that the firm plans to provide the services to the client in
March of the following year.
Required
a. Did the bookkeeper correctly record the client’s deposit? Explain your answer.
b.What would you do as controller for the firm? Do you have a responsibility to do anything to correct
the books? Explain your answer.
Questions # 10
As assistant controller for a small consulting fi rm, you are responsible for recording and posting the
daily cash receipts and disbursements to the ledger accounts. After you have posted the entries, your boss,
the controller, prepares a trial balance and the financial statements. You make the following entries on
June 30, 2010:
2010
June 30 Cash 1,430
Accounts Receivable 1,950
Service Revenue 3,380
To record daily cash receipts.
June 30 Advertising Expense 12,500
Utilities Expense 22,600
Rent Expense 24,000
Salary and Wage Expense 17,400
Cash 76,500
To record daily cash disbursements.

The daily cash disbursements are much larger on June 30 than on any other day because many of the
company’s major bills are paid on the last day of the month. After you have recorded these two
transactions and before you have posted them to the ledger accounts, your boss comes to you with the
following request:

As you are aware, the first half of the year has been a tough one for the consulting industry and for our
business in particular. With first-half bonuses based on net income, I am wondering whether you or I will
get a bonus this time around. However, I have a suggestion that should allow us to receive something for
our hard work and at the same time not hurt anyone. Go ahead and post the June 30 cash receipts to the
ledger, but don’t bother to post that day’s cash disbursements. Even though the treasurer writes the
checks on the last day of the month and you normally journalize the transaction on the same day, it is silly
to bother posting the entry to the ledger since it takes at least a week for the checks to clear the bank.

Required
a. Explain why the controller’s request will result in an increase in net income.
b.Do you agree with the controller that the omission of the entry on June 30 “will not hurt anyone”?
Whom could it hurt? Does omitting the entry provide information that is free from bias? Explain your
answer.
c. What would you do if the controller told you to do this? To whom should you talk about this issue? Is
this situation an ethical issue? Why or why not?

Questions # 11
Fill in the blank with the qualitative characteristic for each of the following descriptions.
_________________ 1. Information that users can depend on to represent the events that it purports to
represent
_________________ 2. Information that has the capacity to make a difference in a decision
_________________ 3. Information that is valid, that indicates an agreement between the underlying data
and the events represented
_________________ 4. Information that allows for comparisons to be made from one accounting period to
the next
_________________ 5. Information that is free from error
_________________ 6. Information that is meaningful to those who are willing to learn to use it properly
_________________ 7. Information that is not slanted to portray a company’s position any better or
worse than the circumstances warrant
_________________ 8. Information that allows for comparisons to be made between or among companies

Questions # 12
For each of the following cases, fill in the blank with the appropriate dollar amount.

Sara’s Amy’s Jane’s

Coffee Shop Deli Bagels
Net sales 35,000 ________ 78,000
Cost of goods sold 45,000 ______0000 0_---_____
Gross profit 7,000 18,000 00 _________ __000 0
Selling expenses 3,000 ______ 9,000
General and administrative expenses 1,500 2,800 00000 0______
Total operating expenses ______ 8,800 13,600
Net income 2,500 9,200 25,400

Questions # 13
Potential stockholders and lenders are interested in a company’s financial statements. Identify the
statement—balance sheet (BS), income statement (IS), or retained earnings statement (RE)—on which
each of the following items would appear.

________ 1. Accounts payable

________ 2. Accounts receivable
________ 3. Advertising expense
________ 4. Bad debt expense
________ 5. Bonds payable
________ 6. Buildings
________ 7. Cash
________ 8. Common stock
________ 9. Depreciation expense
________ 10. Dividends
________ 11. Land held for future expansion
________ 12. Loan payable
________ 13. Office supplies
________ 14. Patent
________ 15. Patent amortization expense
________ 16. Prepaid insurance
________ 17. Retained earnings
________ 18. Sales
________ 19. Utilities expense
________ 20. Wages payable

Questions # 14
Roberto is the plant superintendent of a small manufacturing company that is owned by a large
corporation. The corporation has a policy that any expenditure over $1,000 must be approved by the
chief financial officer in the corporate headquarters. The approval process takes a minimum of three
weeks. Roberto would like to order a new labeling machine that is expected to reduce costs and pay for
itself in six months. The machine costs $2,200, but Roberto can buy the sales rep’s demo for $1,800.
Roberto has asked the sales rep to send two separate bills for $900 each.

What would you do if you were the sales rep? Do you agree or disagree with Roberto’s actions? What do
you think about the corporate policy?

Questions # 15
Financial statements are the means by which accountants communicate to external users. Recent financial
reporting scandals have focused attention on the accounting profession and its role in the preparation of
these statements and the audits performed on the statements.

Required
a. Who is responsible for the preparation of the financial statements that are included in a company’s
annual report?
b.Why is it important for those who are responsible for an audit of the financial statements to be
independent of those who prepare the statements? Explain your answer.

Questions # 16
Millie Abrams opened a ceramic studio in leased retail space, paying the fi rst month’s rent of $300 and a
$1,000 security deposit with a check on her personal account. She took molds and paint, worth about
$7,500, from her home to the studio. She also bought a new fi ring kiln to start the business. The new kiln
had a list price of $5,000, but Millie was able to trade in her old kiln, worth $500 at the time of trade, on
the new kiln. Therefore, she paid only $4,500 cash. She wrote a check on her personal account. Millie’s fi
rst customers paid a total of $1,400 to attend classes for the next two months. Millie opened a checking
account in the company’s name with the $1,400. She has conducted classes for one month and has sold
$3,000 of unfinished ceramic pieces called greenware. All greenware sales are cash. Millie incurred $1,000
of personal cost in making the greenware. At the end of the fi rst month, Millie prepared the following
balance sheet and income statement:

Millie’s Ceramic Studio

Balance Sheet
July 31, 2010
Cash $1,400
Kiln 5,000 Equity $6,400
Total $6,400 Total $6,400
 Millie’s Ceramic Studio
Income Statement
For the Month Ended July 31, 2010
Sales $4,400
Rent $300
Supplies 600 900
Net income $3,500

Millie needs to earn at least $3,000 each month for the business to be worth her time. She is pleased with
the results.

Required
Identify the assumptions that Millie has violated and explain how each event should have been handled.
Prepare a corrected balance sheet and income statement.

Questions # 17
For each of the following cases, fill in the blank with the appropriate dollar amount.

Case 1 Case 2 Case 3 Case 4

Total assets, end of period $40,000 $ $75,000 $50,000
Total liabilities, end of period 00000 15,000 25,000 10,000
Capital stock, end of period 10,000 5,000 20,000 15,000
Retained earnings, beginning of period 15,000 8,000 10,000
20,000
Net income for the period 8,000 7,000 0 0000 9,000
Dividends for the period 2,000 1,000 3,000 0 00000

Questions # 18
Classify each of the following items according to (1) whether it belongs on the income statement (IS) or
balance sheet (BS) and (2) whether it is a revenue (R), expense (E), asset (A), liability (L), or stockholders’
equity (SE) item.
Item Appears on the Classified as
Example: Cash BS A
1. Salaries expense ___________ ___________
2. Equipment ___________ ___________
3. Accounts payable ___________ ___________
4. Membership fees earned ___________ ___________
5. Capital stock ___________ ___________
6. Accounts receivable ___________ ___________
7. Buildings ___________ ___________
8. Advertising expense ___________ ___________
9. Retained earnings ___________ ___________
Question#19
1. Which of the following would contain the total value of all inventory owned by an organization?
a. Source document
b. General ledger
c. Cash budget
2. How does the chart of account list general ledger accounts?
a. Alphabetical order
b. Chronological order
c. Size order
d. The order in which they appear in the financial statements
 3. Recording and processing information about a transaction at the time it takes place is referred to
as which of the following?
a. Batch processing
b. Online, real time processing
c. Captured transaction processing
d. Chart of account processing
4. Which of the following is the most useful for projecting the need for short term borrowing?
a. Income statement
b. Performance report
c. Cash budget
d. Balance sheet
Question#20
Lakeside Slammers Inc. is a minor league baseball organization that has just completed its fi rst season.
You and three other investors organized the corporation; each put up $10,000 in cash for shares of capital
stock. Because you live out of state, you have not been actively involved in the daily affairs of the club.
However, you are thrilled to receive a dividend check for $10,000 at the end of the season—an amount
equal to your original investment. Included with the check are the following financial statements, along
with supporting explanations:
LS Ltd
Income Statement
For the Year Ended December 31, 2010
Amount Amount
Revenues:
Single-game ticket revenue 420,000
Season ticket revenue 140,000
Concessions revenue 280,000
Advertising revenue 100,000 940,000
Expenses:
Cost of concessions sold 110,000
Salary expense—players 225,000
Salary and wage expense—staff 150,000
Rent expense 210,000 695,000
Net Income 245,000

LS Ltd
Balance Sheet
December 31, 2010
Assets Amount Liabilities & Shareholders’ equity Amount
Cash 5,000 Notes payable 50,000
Accounts receivable Capital stock 40,000
Season tickets 140,000 Additional owners’ capital 80,000
Advertisers 100,000 Parent club’s equity 125,000
Auxiliary assets 80,000 Retained earnings 205,000
Equipment 50,000
Player contracts 125,00

Total assets 500,000 Total liabilities and stockholders’ 500,000

equity

Additional information:
a. Single-game tickets sold for $4 per game. The team averaged 1,500 fans per game. With 70 home
games x $4 per game x 1,500 fans, single-game ticket revenue amounted to $420,000.
b. No season tickets were sold during the first season. During the last three months of 2010, however, an
aggressive sales campaign resulted in the sale of 500 season tickets for the 2011 season. Therefore, the
controller (who is also one of the owners) chose to record an Account Receivable—Season Tickets and
corresponding revenue for 500 ticketsx$4 per gamex70 games, or $140,000.
c. Advertising revenue of $100,000 resulted from the sale of the 40 signs on the outfield wall at $2,500
each for the season. However, none of the advertisers have paid their bills yet (thus, an account
receivable of $100,000 on the balance sheet) because the contract with the Company required
payment only if the team averaged 2,000 fans per game during the 2010 season. The controller
believes that the advertisers will be sympathetic to the difficulties of starting a new franchise and will
be willing to overlook the slight deficiency in the attendance requirement.
d. The Company has a working agreement with one of the major league franchises. The minor league
team is required to pay $5,000 every year to the major league team for each of the 25 players on its
roster. The controller believes that each of the players is an asset to the organization and has
therefore recorded $5,000x25, or $125,000, as an asset called Player Contracts. The item on the right
side of the balance sheet entitled Parent Club’s Equity is the amount owed to the major league team
by February 1, 2011, as payment for the players for the 2010 season.
e. In addition to the cost described in item (d), the Company directly pays each of its 25 players a $9,000
salary for the season. This amount—$225,000—has already been paid for the 2010 season and is
reported on the income statement.
f. The items on the balance sheet entitled Auxiliary Assets on the left side and Additional Owners’
Capital on the right side represent the value of the controller’s personal residence. She has a
mortgage with the bank for the full value of the house.
g. The $50,000 note payable resulted from a loan that was taken out at the beginning of the year to
finance the purchase of bats, balls, uniforms, lawn mowers, and other miscellaneous supplies needed
to operate the team. (Equipment is reported as an asset for the same amount.) The loan, with interest,
is due on April 15, 2011. Even though the team had a very successful first year, the Company is a little
short of cash at the end of 2010 and has asked the bank for a three-month extension of the loan. The
controller reasons, “By the due date of April 15, 2011, the cash due from the new season ticket holders
will be available, things will be cleared up with the advertisers, and the loan can be easily repaid.”
Required
1. Identify any errors you think the controller has made in preparing the financial statements.
2. On the basis of your answer in part (1), prepare a revised income statement, statement of retained
earnings, and balance sheet.
3. On the basis of your revised fi nancial statements, identify any ethical dilemma you now face. Does the
information regarding the season ticket revenue provide reliable information to an outsider? Does the
$100,000 advertising revenue on the income statement represent the underlying economic reality of the
transaction? Do you have a responsibility to share these revisions with the other three owners? What
is your responsibility to the bank?
4. Using Exhibit 1-9 and the related text as your guide, analyze the key elements in the situation and
answer the following questions. Support your answers by explaining your reasoning.
a. Who may benefit or be harmed?
b. How are they likely to benefit or be harmed?
c. What rights or claims may be violated?
d. What specific interests are in conflict?
e. What are your responsibilities and obligations?
f. Do you believe the information provided by the organization is relevant, is reliable, accurately
represents what it claims to report, and is unbiased?