Mya Walker

Financial Accounting
Chapters 3-4 Questions
Chapter 3
1. Why do businesses produce financial statements?
Businesses produce financial statements because they are legally required to do so but they also do it to
provide financial information to decision makers such as investors, creditors, and potential employees.

2. What are the four financial statements typically produced by a company?

The four financial statements produced by a company include the income statement, statement of
retained earnings, balance sheet, and statement of cash flow.

3. On which financial statement would one find revenues and expenses?

Revenues and expenses are reported on the income statement.
4. What is a gain?
A gain is an increase in the net assets of a company that comes from the sale of something that is not
related to the company’s primary product or services offered.

5. How does a gain differ from a revenue?

Both Revenue and gain are increases in net assets but the difference is that revenue is generated from
the products or services that a company offer but gain is unrelated to sales of the primary products or
services offered.

6. What is a loss?
A loss is a decrease in net assets not related to the sale of the primary product or service offered by a
company.

7. How does a loss differ from an expense?

Expenses are incurred in an effort to generated revenue through sales. A loss is incurred by anything not
related to sales.

8. Why are revenues and expenses reported separately from gains and losses?
Revenues and expenses are reported separately from gains and losses because separating them gives
interested parties a better idea of what occurred during the reporting period. They can distinguish
between what was related to sales and what was not.

9. What three items are typically listed at the top of a financial statement?
The company name, the name of the statement and the date year are the three items typically listed at
the top of a financial statement.

10. Define “cost of goods sold.”

The cost of goods sold is how much the business paid to produce the product or service they provide.

11. Define “gross profit.”

Gross profit is the difference how much a business paid to produce a good or service and how much
they sold it for.

12. How do companies determine if a cost is an expense or an asset?

Companies must determine if the cost helped generate revenue in the past or the future and that makes
the distinction between expense and asset
 Mya Walker
Financial Accounting
Chapters 3-4 Questions
13. Define “conservatism.”
Conservativism is the preference that accountants have to downplay an outcome instead of making the
organization look to good to be true in an attempt to avoid misleading decision makers.

14. Explain why dividends are not reported on the income statement.
Dividends are not reported on the income statement because they are not expenses. They do reduce the
net assets of a company but are not related to generating revenue.

15. What are retained earnings?

Retained earnings are the profits left in a business since it started with all of the dividends paid for the
reported time period subtracted from it.

16. Define “capital stock.”

Capital stock is the money investors pay to become part owners of a company.

17. On which statement would assets and liabilities be reported?

Assets and liabilities are reported on the balance sheet.

18. What differentiates a current asset from a noncurrent asset?

The timeframe in which an asset will yield benefit is the difference between current and noncurrent
assets. If a benefit will be paid out within a year’s time, it is a current asset. If the benefit will not be paid
out for more than a year, the asset is considered noncurrent.

19. Give the accounting equation and explain why it is true.

Assets = liabilities + capital stock + retained earnings

The reason this equation is always true is because all assets must come from somewhere. As long as you
can identify the source of each asset, the equation will balance.

20. What are the three categories of cash flows on the cash flow statement?
The three categories of cash flows on the cash flow statement are cash flows from operating activities,
cash flows from investing activities, and cash flows from financing activities.

21. How do operating, investing and financing cash flows differ from one another?
Operating cash flows comes from the business’s primary function and daily operations. Investing cash
flows comes from something separate from daily operations and involve the sale of an asset like land or
equipment. Financing cash flows stem from loans, shareholder dividends and issuing stock to new
owners.

True or False?
1. __F__ The income statement gives company’s revenues and expenses for one particular day of the
year.
2. __F__ An increase in net assets of a business due to the sale of its inventory is a gain.
3. __F__ Retained earnings represents amounts contributed to the business by its owners.
4. __T__ Assets and liabilities can be broken down into the categories of current and noncurrent.
5. __T__ Income tax expense is typically reported separately from other expenses.
6. __F__ Conservatism helps companies look better to potential investors.
 Mya Walker
Financial Accounting
Chapters 3-4 Questions
7. __F__ Dividends paid are reported on the balance sheet.
8. __T__ Companies receive money each time their stock is sold on a stock exchange.
9. __T__ A balance sheet should always balance.
10. _T___ The statement of cash flows is broken up into operating, investing, and financing activities.
11. _T___ Notes are considered part of a complete set of financial statements.
12. _T___ Sales revenue less cost of goods sold is referred to as net income.
13. _F___ A gain is the amount of net income earned by a company over its life less any dividends it
has paid.
14. _T__ The purpose of the balance sheet is to report the assets and liabilities of a company on a
specific date.

Multiple Choice

1. You are the CEO of Fisher Corporation. You are very concerned with presenting the best financial
picture possible to the owners of your company. Unfortunately, Fisher has a lawsuit pending at the
end of the year, which could result in the company having to pay a large sum of money. On the bright
side, Fisher also has business deal that might go through, which could result in the company making
a large gain. The principle of conservatism would say that which of the following is true?

C. FISHER SHOULD REPORT THE POTENTIAL LIABILITY IT HAS RELATED TO THE LAWSUIT.

2. Henderson Inc. reports the following: assets of $500,000, liabilities of $350,000 and capital stock of
$100,000. What is the balance in retained earnings?

C. $250,000

3. Giles Corporation borrowed money from Midwest Bank during the year. Where would this event be
reported on Giles’s statement of cash flows?

C. FINANCING ACTIVITIES

4. You are considering investing in the stock of Mogul Corporation. On which of the following
statements would you find information about what a company has to help it generate revenue in the
future and what the company owes to others?

C. BALANCE SHEET

5. Which of the following is not a correct representation of the accounting equation?

D. ASSETS + LIABILITIES = OWNERS’ EQUITY

 Mya Walker
Financial Accounting
Chapters 3-4 Questions
Chapter 4

Questions
1. What is a transaction?
A transaction is any event that affects a company financially.

2. Where was the accounting system developed that is still used by businesses today?
Venice, Italy

3. What is this system called?

Double-entry bookkeeping

4. What are the four steps followed by accounting systems?

Analyze, record, adjust, report

5. By what is financial information accumulated?

accounts

6. Define “T-account.”
A T- account is the venetian model for accumulating financial information that allows room for recording
both credits and debits on each account. Credits go on the right and debit go on the left.

7. Which accounts are increased with a debit?

Expenses and losses, assets, and dividends paid are the accounts that can increase with debits.

8. Which accounts are increased with a credit?

Liabilities, capital stock, revenue and gains, and retained earnings are all accounts that can increase with
credits.

9. What is a journal in the accounting sense?

A journal is the financial history of a company that records the events as they occur and the impact each
transaction has on the company.

10. What is a trial balance?

A trial balance is a current listing of all a company’s individual balances on their various accounts.

11. Accrual accounting is composed of which two principles? Define each.

Accrual accounting is composed of the revenue realization principle and the matching principle. The
revenue realization principle gives accountants guidelines on the correcting timing to include revenue in
a report. The matching principle gives accountants guidelines on how and when to report expenses.

12. Define “unearned revenue.”

Unearned revenue is when payment is received prior to services or goods being rendered.
 Mya Walker
Financial Accounting
Chapters 3-4 Questions
True or False

1. _T___ Debits and credits must equal for every transaction.

2. _F___ A list of all recorded journal entries is maintained in the ledger.

3. _F__ Revenue may not be recorded until cash is collected.
4. _T___ A transaction is any event that has a financial impact on a company.
5. _T__ An expense account is increased with a credit.
6. _T___ Examples of accrued expenses include salary, rent, and interest.
7. _F___ Posting refers to process of recording journal entries.
8. _F___ A company must recognize an accrued expense as incurred.
9. _T___ The matching principle states that expenses should be recognized in the same period as the
revenues they help generate.
10. _F__ Unearned revenue is a type of revenue account.

Multiple Choice

1. Which of the following is not true about double-entry bookkeeping?

D. AN ENTRY CAN HAVE NO MORE THAN ONE CREDIT AND ONE DEBIT.

2. Which of the following entries could Yeats Company not make when they perform a service for a
client?

C. FIGURE 4.22

3. Which of the following is a transaction for Tyler Corporation?

B. TYLER CONSIDERS RENTING OFFICE SPACE THAT WILL COST $1,500 PER MONTH.

4. Elenor Company sells 400 units of inventory for $40 each. The inventory originally cost Elenor $26
each. What is Elenor’s gross profit on this transaction?

C. $ 5,600

5. Which of the following increases with a debit?

C. INVENTORY

6. In January, Rollins Company is paid $500 by a client for work that Rollins will not begin until
February. Which of the following is the correct journal entry for Rollins to make when the $500 is
received?

A. FIGURE 4.24