ch3

ch3Student: ___________________________________________________________________________

1. The operating cycle is the time that elapses between a company's cash payment to suppliers for inventory purchases and the collection of cash from sale of inventory to customers. True False

2. A retail store would likely have a shorter operating cycle than an automotive manufacturer.

True False

3. The time period assumption implies that the life of a business entity can be reported in time periods such as

quarters and years. True False

4. An example of operating revenues would be the revenue created by the sale of an automobile by a car

dealership. True False

5. Revenue is recognized at the time that cash is collected from a customer for services to be provided in the

future. True False

6. Unearned revenues are reported as liabilities on the balance sheet.

True False

7. Interest expense is reported on the income statement as an operating expense.

True False

8. Earnings per share must be either reported on the income statement or disclosed in the notes to the financial

statements. True False

9. Investment income is reported on the income statement as operating revenues and therefore increases

operating income. True False

10. Expenses are decreases in assets or increases in liabilities incurred in order to generate revenues.

True False

11. Salary expense is recognized on the income statement when the salaries are paid rather than when the employee provides the services. True False

12. A gain resulting from the sale of plant and equipment does not create operating income on the income

statement. True False

13. Under accrual accounting, interest expense would be recognized on the income statement when the interest

has accrued with the passage of time even though cash has not been paid. True False

14. Under accrual accounting, revenues are recognized when earned and expenses are recognized when

incurred. True False

15. Application of generally accepted accounting principles requires that the accrual basis of accounting be

used for reporting revenues and expenses on the income statement. True False

16. The matching principle requires expenses to be recorded on the income statement when incurred in

generating revenues. True False

17. The revenue principle recognizes revenue from the sale of goods when ownership passes from the seller to

the buyer regardless of the timing of the cash collection from customers. True False

18. Selling inventory to a customer on account results in an increase in both assets and revenues.

True False

19. Cash collected prior to the providing of the good or service results in an increase in both assets and

liabilities. True False

20. Using cash to purchase office supplies which will be consumed later results in an increase in expenses and

a decrease in assets as of the time of purchase. True False

21. Revenue accounts have credit balances because they result in increases in stockholders' equity.

True False

22. Expense accounts have debit balances because they result in decreases in net income, retained earnings and stockholders' equity. True False

23. Purchasing a six-month insurance policy results in a debit to insurance expense and a credit to cash as of

the date of purchase. True False

24. Recording revenues on the income statement which were previously reported as unearned revenues on

the balance sheet results in a decrease in liabilities and an increase in net income, retained earnings and stockholders' equity. True False

25. When the board of directors declares a cash dividend either retained earnings or the dividends account can

be debited. True False

26. The income statement needs to be prepared prior to preparation of the balance sheet.

True False

27. The statement of stockholders' equity links the income statement to the balance sheet.

True False

28. The statement of cash flows is prepared last and is the only financial statement which shows the cash

inflows and outflows from transactions. True False

29. The total asset turnover ratio is computed by dividing sales revenue by average total assets.

True False

30. The total asset turnover ratio measures sales dollars generated per dollar of assets and is a measure of

efficient management of assets. True False

31. Which of the following best describes the operating cycle?

A. It is the length of the manufacturing process.B. It is the time that elapses from the purchase of inventory on account to the sale of inventory on account.C.

It is the time that elapses from the completion of the manufacturing process to the cash collection from sale of the manufactured goods.

D. It is the time that elapses from the cash payment to suppliers to collection of cash from customers.

32. Which of the following would lengthen the operating cycle? A. Faster collection of accounts receivables.B. Selling inventory in a shorter period of time.C. Increasing the number of customers who paid cash.D. Relaxing credit terms and allowing customers more time to pay.

33. The primary difference between revenues and gains is

A. gains are increases in net assets from peripheral activities while revenues are increases from ongoing

activities.B. revenues increase operating income and gains have no impact on net income.C. revenues cause increases in net assets as a result of peripheral activities and gains cause increases

through ongoing activities.D. gains result in an increase in operating income whereas revenues do not impact operating income.

34. Which of the following best describes the time period assumption?

A. It assumes we value a business as of the end of every month.B. It is the cutoff point for asset and liability recognition.C. It implies that financial statements are prepared at the end of a business entity's operating cycle.D. It assumes we divide the long life of a business into a series of shorter time periods for accounting and

reporting purposes. 35. Which of the following costs is most likely to be the largest expense reported on the income statement of a

merchandiser such as Wal-Mart? A. Salaries expenseB. Cost of goods soldC. Advertising expenseD. Income tax expense

36. Which of the following businesses would most likely not report cost of goods sold on their income

statement? A. A law firmB. An automobile dealershipC. A pizza restaurantD. A computer chip manufacturer

37. Which of the following describes the reporting of interest expense on the income statement?

A. It is reported as an operating expense.B. It is a component of operating income.C. It is deducted from operating income.D. It is added to operating income.

38. Which of the following statements is false?

A. The income statement covers a period of time.B. A loss on the sale of plant and equipment is considered a peripheral activity and is not reported on the

income statement.C. Rent expense is a component of operating income.D. Interest expense isn't a component of operating income.

39. Which of the following is not reported as an operating expense on the income statement? A. Salaries expenseB. Rent expenseC. Interest expenseD. Advertising expense

40. Which of the following statements is correct?

A. Dividend income is a component of operating income.B. Operating income is decreased by the loss from the sale of plant assets.C. A gain on the sale of a stock investment doesn't increase operating income.D. Income before taxes doesn't change when a gain results from the sale of plant assets.

41. Which of the following best describes operating revenues?

A. They are increases in net assets as a result of peripheral transactions.B. They are decreases in net assets as a result of ongoing operations.C. They are increases in net assets as a result of ongoing operations.D. They are decreases in net assets as a result of peripheral transactions.

42. Which of the following transactions will result in an increase in operating income as of the date of the

transaction? A. The sale of plant and equipment at a gain.B. Collection of cash from a customer for services to be provided at a later date.C. Providing a service to a customer on account.D. The receipt of cash dividends from an investment.

43. Which of the following expenses has no impact on operating income?

A. Income tax expenseB. Cost of goods soldC. Depreciation expenseD. Rent expense


A. An expense is a cost incurred to generate revenues.B. Expenses are reported on the income statement as they are incurred.C. Revenues are reported on the income statement as they are earned.D. Revenues result in an increase in net assets, net income, and contributed capital.

45. The following information has been provided by Hable Company: Advertising expense $9,900;Interest expense $3,700;Rent expense $12,000;Loss on sale of plant and equipment $5,700;Cost of goods sold $21,300;Depreciation expense $7,100.How much were Hable's operating expenses? A. $50,300B. $54,000C. $59,700D. $43,200

46. Smith Corporation has provided the following information:

• Cash sales totaled $125,000.• Credit sales totaled $279,000.• Cash collections from customers for services yet to be provided totaled $38,000.• An $11,000 gain from the sale of plant and equipment occurred.• Interest income totaled $7,700.How much were Smith's operating revenues? A. $404,000B. $411,700C. $442,000D. $460,700

47. Lantz Company has provided the following information:

• Cash sales totaled $255,000.• Credit sales totaled $479,000.• Cash collections from customers for services yet to be provided totaled $88,000.• A $22,000 loss from the sale of plant and equipment occurred.• Interest income was $7,700.• Interest expense was $19,900.• Cost of goods sold was $336,000.• Rent expense was $36,000.• Salaries expense was $49,000.• Other operating expenses totaled $79,000.How much was Lantz's operating income? A. $221,800B. $322,000C. $199,800D. $234,000

48. Lantz Company has provided the following information: • Cash sales totaled $255,000.• Credit sales totaled $479,000.• Cash collections from customers for services yet to be provided totaled $88,000.• A $22,000 loss from the sale of plant and equipment occurred.• Interest income was $7,700.• Interest expense was $19,900.• Cost of goods sold was $336,000.• Rent expense was $36,000.• Salaries expense was $49,000.• Other operating expenses totaled $79,000.How much was Lantz's income before income taxes? A. $553,800B. $465,800C. $487,800D. $531,800

49. Which of the following correctly describes the impact of collecting cash from customers for services to be

provided in the future? A. Assets and stockholders' equity increase.B. Assets and revenues increase.C. Assets and liabilities increase.D. Assets and operating income increase.

50. Colby Corporation has provided the following information:

Operating revenues were $199,700.Operating expenses were $111,000.Interest expense was $9,200.Gain from sale of plant and equipment was $3,300.Dividend payments to Colby's stockholders were $7,700.Income tax expense was $36,000.How much was Colby's net income? A. $39,100B. $48,300C. $52,700D. $46,800

51. Which of the following does not correctly describe the cash basis of accounting?

A. It is not accepted for external reporting purposes.B. Revenues are recognized when cash is collected from customers.C. Expenses are recognized when they are paid for.D. Cash payments for long-term assets are recognized as an expense at the time of payment.

52. A landlord collected $5,000 cash from a tenant for December 2011's rent but the tenant's rent for December

is $8,000. Which of the following is true with respect to the landlord's financial statements? A. $8,000 would be reported on the statement of cash flows.B. $8,000 would appear on the balance sheet as rent receivable.C. $8,000 would appear on the income statement as rent revenue earned.D. $5,000 would appear on the balance sheet as prepaid rent.

53. Which of the following is not criteria pertaining to the revenue principle? A. The goods or services have been delivered.B. The selling price is fixed or determinable.C. Collection is reasonably assured.D. The cash payment has been received.

54. Which of the following statements does not properly describe the accrual basis of accounting?

A. Expenses are recognized when incurred regardless of the timing of cash flows.B. Revenues are recognized when incurred regardless of the timing of cash flows.C. Generally accepted accounting principles require use of the accrual basis.D. It should not be used when providing financial statements to external decision makers.


A. A liability is created when cash is received prior to delivery of the goods or services.B. Revenue is recognized at the time of delivery of the goods or services if cash is received.C. Revenue isn't recognized at the time of delivery of goods and services if cash is received after delivery of

the goods and services.D. Collecting cash after delivery of a good or service does not create revenue on the income statement as of

the date of collection. 56. Which of the following journal entries is prepared when a customer pays cash prior to delivery of the goods

or services?

A. Option AB. Option BC. Option CD. Option D

57. Which of the following journal entries is prepared when a customer pays cash subsequent to delivery of

goods or services?


58. Yelena Company received cash from a customer in advance of providing the service to the customer. Which of the following does not accurately describe the impact on the financial statements when Yelena later provides the service? A. Liabilities are decreased.B. Operating income increases.C. Retained earnings increases.D. Assets are increased.

59. Which of the following best describes the matching principle?

A. It requires expenses to be recorded when they are paid for.B. It requires expenses to be recorded when incurred to generate revenues.C. It requires expenses to be recorded consistent with the cash basis of accounting.D. It does not allow expenses to be recorded if they are incurred prior to being paid for.

60. During 2010, Sigma Company earned service revenues amounting to $700,000, of which $630,000 was

collected in cash; the balance will be collected in January 2011. What amount should the 2010 income statement report for service revenues? A. $630,000B. $700,000C. $70,000D. $570,000

61. A company purchased supplies for cash which will be consumed during future months. Which of the

following correctly describes the impact of the supplies purchase on the financial statements? A. Total assets will remain unchanged.B. Total assets will decrease.C. Operating expenses will increase.D. Operating income will decrease.

62. A company purchased supplies for cash which will be consumed during future months. Which of the

following does not correctly describe the impact on the financial statements when the supplies are used during future months? A. Total assets will remain unchanged.B. Total assets will decrease.C. Operating expenses will increase.D. Operating income will decrease.

63. The revenue principle requires four conditions to be met. Which of the following is one of the four

conditions? A. The customer has paid for the goods or services.B. Delivery of goods or performance of service has occurred or is scheduled to occur.C. The price is fixed or determinable.D. The customer has signed a contract.

64. Which of the following journal entries is correct when a company has incurred interest expense but has not yet paid the interest?


65. McNeil Company owed its employees for services performed and recorded a liability for the wages owed

the employees. Which of the following correctly describes the impact on the financial statements when the employee wages are subsequently paid? A. Operating expenses are increased.B. Retained earnings decreases.C. Operating income does not change.D. Total assets remain the same.

66. Which of the following journal entries correctly records the receipt of a utility bill which will be paid for in

later weeks?


67. Which of the following is not a proper application of the revenue principle?

A. Recording the sale of merchandise on credit as sales revenue.B. Recording rent received in advance as unearned rent revenue.C. Recording interest revenue when cash is collected rather than when earned.D. Reducing the unearned service revenue account for service revenue performed at the end of the

accounting period.

68. Which of the following is an example of revenue or expense to be recognized in the current period's income statement? A. Cash received from a client before the service is provided.B. Inventory being held by a retail store.C. Wages owed to employees who worked during the period.D. Cash collected from an accounts receivable.

69. Which of the following liability accounts is likely to be satisfied without a future cash payment?

A. Wages payableB. Unearned subscriptions revenueC. Accounts payableD. Taxes payable

70. A company receives a $50,000 cash deposit from a customer on October 15 but will not deliver the goods

until November 20. Which of the following statements is true? A. Cash will be reported on the statement of cash flows for the month of November.B. Revenue will be recorded and reported on the income statement for October.C. A liability will be reported on the balance sheet at the end of October.D. A prepaid asset will be reported on the balance sheet at the end of October.

71. A company purchased $20,000 of inventory during February and will pay for it during March. Which of the

following statements is false assuming the inventory was sold during March? A. The company's accounts payable will include the $20,000 on the February month-end balance sheet.B. The statement of cash flows will report an operating cash outflow of $20,000 during March.C. The income statement will report cost of goods sold of $20,000 during February.D. The company's inventory will include the $20,000 on the February month-end balance sheet.

72. Which of the following correctly applies the revenue recognition principle?

A. Recording revenue in December 2009 for units manufactured but not yet sold to customers.B. Recording cash received in advance from customers as revenue when the product is not yet shipped.C. Not recording interest earned in 2009 until the cash is received in 2010.D. Recording revenue in December 2009 for units sold but not yet paid for in full.

73. Which of the following accounts normally have a credit balance?

A. Unearned revenues; Prepaid rent; Revenues.B. Revenues; Expenses; Contributed capital.C. Revenues; Inventory; Unearned revenue.D. Notes payable; Retained earnings; Revenues.

74. During 2010, Sensa Corporation incurred operating expenses amounting to $100,000 of which $75,000 was

paid in cash; the balance will be paid during 2011. Which of the following is correct for the 2010 year-end balance sheet? A. Stockholders' equity decreases $75,000 and assets decrease $75,000.B. Assets decrease $100,000 and stockholders' equity decreases $100,000.C. Assets decrease $100,000, liabilities increase $25,000, and stockholders' equity decreases $100,000.D. Stockholders' equity decreases $100,000, assets decrease $75,000, and liabilities increase $25,000.

75. Which of the following accounts normally have a debit balance? A. Prepaid expenses, wages payable, and dividends.B. Cash, utilities expense, and accounts receivable.C. Retained earnings, cost of goods sold, and wages expense.D. Utilities expense, prepaid expenses, and wages payable.


A. Expense accounts have a debit balance.B. Revenue accounts have a credit balance.C. Gain accounts have a credit balance.D. Loss accounts have a credit balance.


A. Expense accounts result in decreases in net income and stockholders' equity and therefore have credit

balances.B. Revenue accounts result in increases in net income and stockholders' equity and therefore have debit

balances.C. Loss accounts result in decreases in net income and stockholders' equity and therefore have debit

balances.D. Gain accounts result in increases in net income and stockholders' equity and therefore have debit

balances. 78. Which of the following journal entries correctly records a transaction where services were provided to a

customer on account?


79. Which of the following is correct when land costing $20,000 is sold for $29,000? The land was a

component of plant and equipment on the balance sheet. A. Revenues are debited for $29,000.B. Cost of goods sold is credited for $20,000.C. Gain on sale of land is credited for $9,000.D. Operating income increases $29,000.

80. Boone's Cleaning Service performed cleaning services during December, 2010, but had not collected any cash from its customers as of December 31, 2010. What impact did performing these services have on the accounting equation? A. The service increased assets and increased liabilities.B. The service increased assets and increased stockholders' equity.C. The service increased assets and decreased stockholders' equity.D. The service decreased liabilities and decreased stockholders' equity.

81. On December 31, 2010, Avery Corporation paid $10,000 for next year's insurance policy. This transaction

should be recorded as follows by Avery:


82. Mama June Pizza Company sold land costing $39,000 for $51,000 cash. Which of the following statements

concerning the land sale is correct? A. The land account was credited for $51,000.B. The revenue account was debited for $51,000.C. Operating income increased $12,000.D. Income before income taxes increased $12,000.

83. Which of the following statements is false when Mama June Pizza Company paid $47,000 cash on

accounts owed to suppliers? A. The cash account was credited for $47,000.B. Accounts payable was debited for $47,000.C. Supplies expense was increased by $47,000.D. Operating income was not changed by the payment to the suppliers.

84. Which of the following journal entries is correct assuming that Mama June Pizza Company received cash for interest earned on investments?


85. Mama June Pizza Company determined that dough, sauce, cheese and other ingredients costing $8,700

were used to make pizzas during July. Which of the following statements is false with respect to the use of the ingredients? A. Cost of goods sold was debited for $8,700.B. Operating expenses increased $8,700.C. Operating income decreased $8,700.D. Supplies inventory was debited for $8,700.

86. Zeppelin Company received cash during January for services to be provided in February. Which of the

following statements does not accurately describe the impact on the financial statements when Zeppelin provides the services during February? A. Unearned revenues decreased and were debited.B. Revenues increased and were credited.C. Stockholders' equity will increase.D. Total assets will increase.

87. Which of the following describes the transaction resulting in a journal entry with a debit to Salaries payable

and a credit to Cash? A. Salaries expense has been incurred but is unpaid.B. Cash was used to pay for salaries that were previously recorded as an expense.C. Cash was used to pay for salaries that were not previously recorded as an expense.D. Cash was used to prepay employee wages.


A. Recording revenues results in an increase in assets or a decrease in liabilities.B. Recording revenues results in an increase in assets or a decrease in stockholders' equity.C. Recording expenses results in a decrease in assets or a decrease in liabilities.D. Recording expenses results in an increase in assets or an increase in liabilities.


A. The unearned revenue account has a credit balance.B. The revenue account has a credit balance.C. An expense account has a debit balance.D. A prepaid expense account has a credit balance.

90. Which of the following accounts doesn't have a debit balance? A. Prepaid insuranceB. Insurance expenseC. Unearned revenuesD. Salaries expense

91. Which of the following accounts doesn't have a credit balance?

A. Gain on sale of landB. Investment incomeC. Unearned revenuesD. Rent expense

92. On January 1, 2011 Gucci Brothers Inc. had a $500,000 credit balance in retained earnings and $600,000

balance in contributed capital. During 2011, the company earned net income of $100,000, declared a dividend of $15,000, and issued additional stock for $25,000. What is total stockholders' equity on December 31, 2011? A. $1,100,000B. $1,210,000C. $1,225,000D. $1,240,000

93. On January 1, 2010, Denmark Inc., started the year with a $200,000 credit balance in its retained earnings

account. During 2010, the company earned net income of $70,000 and declared and paid dividends of $10,000. Also, the company received cash of $15,000 as an additional investment by its owners. What is the balance in retained earnings on December 31, 2010? A. $200,000B. $270,000C. $245,000D. $260,000

94. Blazon Corporation's retained earnings increased $79,000 during 2011. Blazon declared $19,000 of

dividends and paid $15,000 of the dividends declared during 2011. How much was Blazon's 2011 net income assuming that Blazon's stockholders invested an additional $30,000 during 2011? A. $98,000B. $94,000C. $68,000D. $64,000

95. Beemer Corporation has provided the following information pertaining to the year ended December 31, 2011: • Stockholders' equity as of January 1 was $789,000.• Dividends declared during the year totaled $71,000 of which $60,000 were paid during the year.• Stockholders invested $113,000 cash into the business in exchange for new shares of stock.• Stockholders' equity as of December 31 was $1,030,000.How much was Beemer's 2011 net income? A. $210,000B. $199,000C. $312,000D. $323,000

96. Which of the following transactions would not be reported as cash flow from operations on a cash flow

statement? A. Cash collected from customersB. Cash paid to suppliersC. Cash paid for employee wagesD. Cash paid for dividends

97. Which of the following transactions would be reported as cash flow from operations on a cash flow

statement? A. Cash paid to purchase equipmentB. Cash paid to acquire landC. Cash paid for interestD. Cash paid for rent

98. Garret Company has provided the following selected information for the year ended December 31, 2011:

• Cash collected from customers was $783,000.• Cash received from stockholders in exchange for stock totaled $91,000.• Cash paid to suppliers was $361,000.• Cash paid to employees was $204,000.• Cash to stockholders for dividends was $33,000.• Cash received from sale of a building was $250,000.• Cash paid for rent was $39,000.• Cash received for interest and dividends was $7,000.• Cash paid for income taxes was $55,000.Based on the selected information provided, how much was Garret's cash flow from operations? A. $131,000B. $98,000C. $381,000D. $222,000

99. Which of the following statements is inaccurate with respect to the total asset turnover ratio?

A. It is calculated as sales revenues divided by total assets at year-end.B. It is decreased when additional plant and equipment is purchased.C. A high ratio implies efficient management of assets.D. It is decreased when additional inventory is purchased.

100.Top Company's 2011 sales revenue was $200,000 and 2010 sales revenue was $180,000. Top's total assets as of December 31, 2011 were $150,000 and total assets as of January 1, 2011 were $130,000. What is Top's total asset turnover ratio? A. 1.48B. 1.33C. 1.36D. 1.43

101.What is the operating cycle? Describe a business entity with an operating cycle of less than six months and

a business with an operating cycle of more than one year.

102.Describe the difference between operating revenues and gains from the sale of plant and equipment while

providing examples of each.

103.Describe the difference between operating expenses and losses from the sale of plant and equipment while

providing examples of each.

104.Describe the difference(s) with respect to the cash basis of accounting and the accrual basis of accounting.

105.Why might managers be tempted to violate the revenue principle and the matching principle when preparing an income statement?

106.Describe the debit and credit logic pertaining to items reported on the income statement.

107.Describe transactions which have an impact on the statement of stockholders' equity.

108.Complete the chart below for Monticello Corporation by placing an X in the appropriate boxes to indicate how the transaction should be recorded.

109.Indicate the sequential order of the following steps in the accounting information processing cycle:

Analyzing transactionsPreparing financial statementsDeveloping a trial balanceCollecting original dataPosting to the accountsJournalizing transactions

110.Part A. Perform transaction analysis for Blake Company regarding the following transactions for March. Indicate the account affected by the transaction as well as the increase (+) or decrease (-) to the components of the accounting equation and the amount.

Part B. Determine whether the transactions A-F above affected cash flows during March. If so, determine the type of activity as an operating activity, an investing activity, or a financing activity. If cash is not affected use "no effect." Place an X under the appropriate column for each transaction.

111.For the year ending December 31, 2010, the accounts of Jackson Corporation showed the following balances:

Requirement: Determine the components of stockholders' equity as of December 31, 2010.

112.The following accounts for Carthage Enterprises, Inc. are listed randomly. Enter the number associated

with each transaction to identify the accounts that would be used in the journal entry for each transaction given below.

113.World Services Inc. has provided the following information pertaining to the month ended October 31, 2010:

Prepare an income statement through operating income for the month ended October 31, 2010.

114.The following information has been provided by Flatiron Company for the year ended December 31, 2011:

• Net income was $71,000;• Income tax expense was $47,000;• Dividends declared and paid totaled $7,500;• Interest expense was $8,700;• Loss on sale of plant assets was $15,000;• Operating expenses totaled $91,000;• Cash collected from customers was $220,000.How much was Flatiron's operating income?

115.Describe the transaction which created the following journal entries (amounts omitted):1. CashUnearned revenue2. Utilities expenseUtilities payable3. Accounts receivableSales Revenue4. Salaries expenseCash5. Unearned RevenueSales revenue

116.Explain why the net income reported on the income statement is usually not equal to net cash flows from

operating activities on the statement of cash flows.

117.Describe the operating activities section of the cash flow statement and provide three examples of operating

activities cash flows.

118.Colby Company has provided the following selected information for the year ended December 31, 2011:• Cash collected from customers was $392,000.• Cash received from stockholders in exchange for stock totaled $46,000.• Cash paid to suppliers was $183,000.• Cash paid to employees was $102,000.• Cash received from a long-term bank loan was $75,000.• Cash to stockholders for dividends was $17,000.• Cash received from sale of a building was $125,000.• Cash paid for rent was $19,000.• Cash received for interest and dividends was $4,000.• Cash paid for income taxes was $28,000.Based on the selected information provided, how much was Colby's cash flow from operations?

119.What does the total asset turnover ratio measure and how is it calculated? Give two examples of

transactions that decrease the ratio.

120.The following data is from Gauthier Machine Shop:

Compute Gauthier Machine Shop's total asset turnover ratio for 2011 and 2010.

ch3 Key

1. The operating cycle is the time that elapses between a company's cash payment to suppliers for inventory purchases and the collection of cash from sale of inventory to customers. TRUEThe operating cycle is the time it takes for a company to pay cash to suppliers, sell goods and services to customers, and collect cash from customers.

AACSB: Reflective Thinking

AICPA BB: Critical ThinkingAICPA FN: Reporting

Blooms: RememberDifficulty: Medium

Learning Objective: 03-01 Describe a typical business operating cycle and explain the necessity for the time period assumption.Libby - Chapter 03 #1

Topic Area: How do Business Activities Affect the Income Statement

2. A retail store would likely have a shorter operating cycle than an automotive manufacturer. TRUEThe operating cycle is the time it takes for a company to pay cash to suppliers, sell goods and services to customers, and collect cash from customers. The length of time for completion of the operating cycle depends on the nature of the business. Companies with high volume and lower prices generally have a shorter operating cycle than companies with low volume and higher prices.



Blooms: UnderstandDifficulty: Easy



3. The time period assumption implies that the life of a business entity can be reported in time periods such as quarters and years. TRUEA company's operating cycle repeats itself continuously. The time period assumption indicates that the long life of a company can be reported in shorter time periods.



Blooms: RememberDifficulty: Easy



4. An example of operating revenues would be the revenue created by the sale of an automobile by a car dealership. TRUEOperating revenues result from an entity's sale of goods or services.




Learning Objective: 03-02 Explain how business activities affect the elements of the income statement.Libby - Chapter 03 #4

Topic Area: Elements on the Income Statement

5. Revenue is recognized at the time that cash is collected from a customer for services to be provided in the future. FALSERevenue is recognized when earned, usually at the time the company provides the promised goods or services to its customer.






6. Unearned revenues are reported as liabilities on the balance sheet. TRUEUnearned revenues are payments provided to a company before the goods or services are provided. Unearned revenues are liabilities reported on the balance sheet.






7. Interest expense is reported on the income statement as an operating expense. FALSEInterest expense results from the cost of borrowing money. Borrowing money is a financing activity; thus the expenses resulting from this are not classified as operating expenses.






8. Earnings per share must be either reported on the income statement or disclosed in the notes to the financial statements. TRUEEarnings per share is a ratio widely used in evaluating a company's operating performance. This ratio is required to be reported on the income statement or in the notes to the financial statements.






9. Investment income is reported on the income statement as operating revenues and therefore increases operating income. FALSEInvestment income (or revenue) is a result from investing activities. Investing activities are not considered part of central operations; therefore any income generated is not part of operating revenues.






10. Expenses are decreases in assets or increases in liabilities incurred in order to generate revenues. TRUEExpenses are defined as decreases in assets or increases in liabilities from ongoing operations incurred to generate revenues during the period.






11. Salary expense is recognized on the income statement when the salaries are paid rather than when the employee provides the services. FALSEExpenses are recognized when incurred.



Blooms: UnderstandDifficulty: Medium



12. A gain resulting from the sale of plant and equipment does not create operating income on the income statement. TRUEGains resulting from the sale of assets are peripheral activities that do not create operating income.






13. Under accrual accounting, interest expense would be recognized on the income statement when the interest has accrued with the passage of time even though cash has not been paid. TRUEIn accrual accounting expenses are recognized when they are incurred.




Learning Objective: 03-03 Explain the accrual basis of accounting and apply the revenue and matching principles to measure income.Libby - Chapter 03 #13

Topic Area: How are Operating Activities Recognized and Measured

14. Under accrual accounting, revenues are recognized when earned and expenses are recognized when incurred. TRUEIn accrual basis accounting, revenues and expenses are recognized when the transaction that causes them occurs.






15. Application of generally accepted accounting principles requires that the accrual basis of accounting be used for reporting revenues and expenses on the income statement. TRUEFinancial statements issued under cash basis accounting are not very useful to external users, therefore GAAP requires accrual basis accounting for financial reporting purposes.






16. The matching principle requires expenses to be recorded on the income statement when incurred in generating revenues. TRUEThe matching principle requires that expenses incurred to generate revenues be recognized in the same period.






17. The revenue principle recognizes revenue from the sale of goods when ownership passes from the seller to the buyer regardless of the timing of the cash collection from customers. TRUEUnder the accrual accounting basis the revenue principle states that revenues are recognized when earned, which usually occurs at the time goods or services are delivered.






18. Selling inventory to a customer on account results in an increase in both assets and revenues. TRUEInventory sold on account increases accounts receivable, an asset, and sales revenue.






19. Cash collected prior to the providing of the good or service results in an increase in both assets and liabilities. TRUECollecting cash increases assets, and if it is done before services are provided, a liability titled unearned revenue is recorded.






20. Using cash to purchase office supplies which will be consumed later results in an increase in expenses and a decrease in assets as of the time of purchase. FALSETotal assets remain unchanged from this transaction and no expense is recorded. The supplies are to be used later, thus the asset account of cash decreases by the same amount that the asset account of supplies increases. An expense is recorded as the supplies are consumed.






21. Revenue accounts have credit balances because they result in increases in stockholders' equity. TRUERevenues increase stockholders' equity through the account retained earnings and therefore have credit balances.




Learning Objective: 03-04 Apply transaction analysis to examine and record the effects of operating activities on the financial statements.Libby - Chapter 03 #21

Topic Area: The Expanded Transaction Analysis Model

22. Expense accounts have debit balances because they result in decreases in net income, retained earnings and stockholders' equity. TRUEExpenses decrease net income, thus decreasing retained earnings and stockholders' equity. Therefore, they have debit balances.






23. Purchasing a six-month insurance policy results in a debit to insurance expense and a credit to cash as of the date of purchase. FALSEAt the date of purchase a six month insurance policy does not result in a debit to insurance expense, but a debit to prepaid insurance, an asset account.






24. Recording revenues on the income statement which were previously reported as unearned revenues on the balance sheet results in a decrease in liabilities and an increase in net income, retained earnings and stockholders' equity. TRUERecording revenues increases net income which flows through the financial statements to increase retained earnings and stockholders' equity. When unearned revenue is earned, the liability account decreases.






25. When the board of directors declares a cash dividend either retained earnings or the dividends account can be debited. FALSEThe account that is debited when a cash dividend is declared is retained earnings.






26. The income statement needs to be prepared prior to preparation of the balance sheet. TRUEBecause net income is a component of retained earnings on the balance sheet, it is necessary to compute net income first by preparing the income statement.




Learning Objective: 03-05 Prepare financial statements.Libby - Chapter 03 #26

Topic Area: How are Financial Statements Prepared and Analyzed

27. The statement of stockholders' equity links the income statement to the balance sheet. TRUENet income is recorded on the statement of stockholders' equity as an increase in retained earnings. The ending retained earnings balance is reported on the balance sheet.






28. The statement of cash flows is prepared last and is the only financial statement which shows the cash inflows and outflows from transactions. TRUEAny transaction involving cash will be reflected in the statement of cash flows, which is the fourth and final statement prepared.






29. The total asset turnover ratio is computed by dividing sales revenue by average total assets. TRUETotal Asset Turnover = Sales (or Operating) Revenues ÷ Average Total Assets


AICPA BB: Critical ThinkingAICPA FN: Measurement


Learning Objective: 03-06 Compute and interpret the total asset turnover ratio.Libby - Chapter 03 #29

Topic Area: Total Asset Turnover Ratio

30. The total asset turnover ratio measures sales dollars generated per dollar of assets and is a measure of efficient management of assets. TRUETotal Asset Turnover = Sales (or Operating) Revenues ÷ Average Total Assets. This ratio is often used to assess managers' use of all company's assets to improve earnings.






31. Which of the following best describes the operating cycle? A. It is the length of the manufacturing process.B. It is the time that elapses from the purchase of inventory on account to the sale of inventory on

account.C. It is the time that elapses from the completion of the manufacturing process to the cash collection

from sale of the manufactured goods.D. It is the time that elapses from the cash payment to suppliers to collection of cash from customers.

The operating cycle can be described as cash-to-cash. It is the time it takes for a company to pay cash to suppliers, sell goods and services to customers, and collect cash from customers.






32. Which of the following would lengthen the operating cycle? A. Faster collection of accounts receivables.B. Selling inventory in a shorter period of time.C. Increasing the number of customers who paid cash.D. Relaxing credit terms and allowing customers more time to pay.

The operating cycle can be described as cash-to-cash. Allowing customers more time to pay increases the time it takes to collect cash and finish the operating cycle.






33. The primary difference between revenues and gains is A. gains are increases in net assets from peripheral activities while revenues are increases from ongoing

activities.B. revenues increase operating income and gains have no impact on net income.C. revenues cause increases in net assets as a result of peripheral activities and gains cause increases

through ongoing activities.D. gains result in an increase in operating income whereas revenues do not impact operating income.

Revenues are defined as increases in assets or settlements of liabilities from ongoing operations. Gains are a result of an increase in assets or decrease in liabilities from peripheral activities.






34. Which of the following best describes the time period assumption? A. It assumes we value a business as of the end of every month.B. It is the cutoff point for asset and liability recognition.C. It implies that financial statements are prepared at the end of a business entity's operating cycle.D. It assumes we divide the long life of a business into a series of shorter time periods for accounting

and reporting purposes.

The time period assumption indicates that the long life of a company can be reported in shorter time periods such as months, quarters, and years.






35. Which of the following costs is most likely to be the largest expense reported on the income statement of a merchandiser such as Wal-Mart? A. Salaries expenseB. Cost of goods soldC. Advertising expenseD. Income tax expense

In companies with a merchandising focus, cost of goods sold, is usually the most significant expense on the income statement.






36. Which of the following businesses would most likely not report cost of goods sold on their income statement? A. A law firmB. An automobile dealershipC. A pizza restaurantD. A computer chip manufacturer

In purely service-oriented companies in which no products are produced or sold, the cost of using employees to generate revenue is usually the largest expense. This is recorded as a salaries expense.






37. Which of the following describes the reporting of interest expense on the income statement? A. It is reported as an operating expense.B. It is a component of operating income.C. It is deducted from operating income.D. It is added to operating income.

Interest expense is a cost resulting from financing activities, not operating activities, and thus a reduction from operating income.






38. Which of the following statements is false? A. The income statement covers a period of time.B. A loss on the sale of plant and equipment is considered a peripheral activity and is not reported on the

income statement.C. Rent expense is a component of operating income.D. Interest expense isn't a component of operating income.

Peripheral activities include gains or losses on the sale of assets, and are reported on the income statement.






39. Which of the following is not reported as an operating expense on the income statement? A. Salaries expenseB. Rent expenseC. Interest expenseD. Advertising expense

Interest expense is the result of financing activities, not operating activities, therefore it is not listed as an operating expense.






40. Which of the following statements is correct? A. Dividend income is a component of operating income.B. Operating income is decreased by the loss from the sale of plant assets.C. A gain on the sale of a stock investment doesn't increase operating income.D. Income before taxes doesn't change when a gain results from the sale of plant assets.

Gain or losses from the sale of investments are not the central focus of the business and do not increase operating income.






41. Which of the following best describes operating revenues? A. They are increases in net assets as a result of peripheral transactions.B. They are decreases in net assets as a result of ongoing operations.C. They are increases in net assets as a result of ongoing operations.D. They are decreases in net assets as a result of peripheral transactions.

Operating revenues are increases in assets or settlements of liabilities from ongoing operations.






42. Which of the following transactions will result in an increase in operating income as of the date of the transaction? A. The sale of plant and equipment at a gain.B. Collection of cash from a customer for services to be provided at a later date.C. Providing a service to a customer on account.D. The receipt of cash dividends from an investment.

Operating income is increased by operating revenue. Operating revenues result from the sale of goods or services to a customer.






43. Which of the following expenses has no impact on operating income? A. Income tax expenseB. Cost of goods soldC. Depreciation expenseD. Rent expense

Income tax expense is not classified as an operating expense and is deducted below the calculation of operating income.






44. Which of the following statements is false? A. An expense is a cost incurred to generate revenues.B. Expenses are reported on the income statement as they are incurred.C. Revenues are reported on the income statement as they are earned.D. Revenues result in an increase in net assets, net income, and contributed capital.

Revenues result in an increase in net assets, net income, and retained earnings. There is no impact on contributed capital from revenue.






45. The following information has been provided by Hable Company: Advertising expense $9,900;Interest expense $3,700;Rent expense $12,000;Loss on sale of plant and equipment $5,700;Cost of goods sold $21,300;Depreciation expense $7,100.How much were Hable's operating expenses? A. $50,300B. $54,000C. $59,700D. $43,200

Operating expenses = $50,300 = $9,900 + $12,000 + 21,300 + $7,100

AACSB: Analytic

AICPA BB: Critical ThinkingAICPA FN: Reporting, Measurement

Blooms: ApplyDifficulty: Medium



46. Smith Corporation has provided the following information: • Cash sales totaled $125,000.• Credit sales totaled $279,000.• Cash collections from customers for services yet to be provided totaled $38,000.• An $11,000 gain from the sale of plant and equipment occurred.• Interest income totaled $7,700.How much were Smith's operating revenues? A. $404,000B. $411,700C. $442,000D. $460,700

Operating revenues = $404,000 = $125,000 + $279,000

AACSB: Analytic





47. Lantz Company has provided the following information: • Cash sales totaled $255,000.• Credit sales totaled $479,000.• Cash collections from customers for services yet to be provided totaled $88,000.• A $22,000 loss from the sale of plant and equipment occurred.• Interest income was $7,700.• Interest expense was $19,900.• Cost of goods sold was $336,000.• Rent expense was $36,000.• Salaries expense was $49,000.• Other operating expenses totaled $79,000.How much was Lantz's operating income? A. $221,800B. $322,000C. $199,800D. $234,000


AACSB: Analytic


Blooms: ApplyDifficulty: Hard



48. Lantz Company has provided the following information: • Cash sales totaled $255,000.• Credit sales totaled $479,000.• Cash collections from customers for services yet to be provided totaled $88,000.• A $22,000 loss from the sale of plant and equipment occurred.• Interest income was $7,700.• Interest expense was $19,900.• Cost of goods sold was $336,000.• Rent expense was $36,000.• Salaries expense was $49,000.• Other operating expenses totaled $79,000.How much was Lantz's income before income taxes? A. $553,800B. $465,800C. $487,800D. $531,800


AACSB: Analytic





49. Which of the following correctly describes the impact of collecting cash from customers for services to be provided in the future? A. Assets and stockholders' equity increase.B. Assets and revenues increase.C. Assets and liabilities increase.D. Assets and operating income increase.

Collecting cash from customers increases assets. For services to be provided in the future, an increase in the unearned revenue (a liability) account is also recorded.






50. Colby Corporation has provided the following information: Operating revenues were $199,700.Operating expenses were $111,000.Interest expense was $9,200.Gain from sale of plant and equipment was $3,300.Dividend payments to Colby's stockholders were $7,700.Income tax expense was $36,000.How much was Colby's net income? A. $39,100B. $48,300C. $52,700D. $46,800

Net income = $46,800 = $199,700 - $111,000 - $9,200 + $3,300 - $36,000

AACSB: Analytic





51. Which of the following does not correctly describe the cash basis of accounting? A. It is not accepted for external reporting purposes.B. Revenues are recognized when cash is collected from customers.C. Expenses are recognized when they are paid for.D. Cash payments for long-term assets are recognized as an expense at the time of payment.

Cash basis accounting results in revenues being recorded when cash is received and expenses are recorded when cash is paid. This method is not acceptable for external reporting purposes. Cash payments for long-term assets result in assets being reported on the balance sheet; there isn't immediate expense recognition.






52. A landlord collected $5,000 cash from a tenant for December 2011's rent but the tenant's rent for December is $8,000. Which of the following is true with respect to the landlord's financial statements? A. $8,000 would be reported on the statement of cash flows.B. $8,000 would appear on the balance sheet as rent receivable.C. $8,000 would appear on the income statement as rent revenue earned.D. $5,000 would appear on the balance sheet as prepaid rent.

Revenue is recognized on the income statement once it has been earned.

AACSB: Analytic





53. Which of the following is not criteria pertaining to the revenue principle? A. The goods or services have been delivered.B. The selling price is fixed or determinable.C. Collection is reasonably assured.D. The cash payment has been received.

Under accrual accounting, the revenue principle states that revenues are recognized when goods or services are delivered, there is persuasive evidence of an arrangement for customer payment, the price is fixed or determinable, and collection is reasonably assured.






54. Which of the following statements does not properly describe the accrual basis of accounting? A. Expenses are recognized when incurred regardless of the timing of cash flows.B. Revenues are recognized when incurred regardless of the timing of cash flows.C. Generally accepted accounting principles require use of the accrual basis.D. It should not be used when providing financial statements to external decision makers.

Accrual basis accounting is required by GAAP for use when providing financial statements to external decision makers.






55. Which of the following statements is false? A. A liability is created when cash is received prior to delivery of the goods or services.B. Revenue is recognized at the time of delivery of the goods or services if cash is received.C. Revenue isn't recognized at the time of delivery of goods and services if cash is received after

delivery of the goods and services.D. Collecting cash after delivery of a good or service does not create revenue on the income statement as

of the date of collection.

Revenue is recognized at the time of delivery of goods and services regardless of when the cash is received.






56. Which of the following journal entries is prepared when a customer pays cash prior to delivery of the goods or services?


When cash is received before goods or services have been provided, cash is debited and unearned revenue (a liability account) is credited.






57. Which of the following journal entries is prepared when a customer pays cash subsequent to delivery of goods or services?


When goods are sold to a customer on account, an accounts receivable (an asset) is created at the time of sale. At the time of collection from the customer, cash is debited and accounts receivable is credited.






58. Yelena Company received cash from a customer in advance of providing the service to the customer. Which of the following does not accurately describe the impact on the financial statements when Yelena later provides the service? A. Liabilities are decreased.B. Operating income increases.C. Retained earnings increases.D. Assets are increased.

When Yelena provides the service revenue is recognized and the unearned revenue account is reduced, neither increases assets.






59. Which of the following best describes the matching principle? A. It requires expenses to be recorded when they are paid for.B. It requires expenses to be recorded when incurred to generate revenues.C. It requires expenses to be recorded consistent with the cash basis of accounting.D. It does not allow expenses to be recorded if they are incurred prior to being paid for.

The matching principle requires that expenses be recorded when incurred in earning revenue.






60. During 2010, Sigma Company earned service revenues amounting to $700,000, of which $630,000 was collected in cash; the balance will be collected in January 2011. What amount should the 2010 income statement report for service revenues? A. $630,000B. $700,000C. $70,000D. $570,000

$700,000 of service revenue was earned during 2010; therefore that amount should be recorded on the income statement.

AACSB: Analytic


Blooms: ApplyDifficulty: Easy



61. A company purchased supplies for cash which will be consumed during future months. Which of the following correctly describes the impact of the supplies purchase on the financial statements? A. Total assets will remain unchanged.B. Total assets will decrease.C. Operating expenses will increase.D. Operating income will decrease.

Cash decreases by the same amount supplies increase, both are asset accounts and therefore total assets remain unchanged.






62. A company purchased supplies for cash which will be consumed during future months. Which of the following does not correctly describe the impact on the financial statements when the supplies are used during future months? A. Total assets will remain unchanged.B. Total assets will decrease.C. Operating expenses will increase.D. Operating income will decrease.

When supplies are consumed during the course of business, supplies expense is recognized and the supplies account is reduced; thus increasing expenses and reducing assets.






63. The revenue principle requires four conditions to be met. Which of the following is one of the four conditions? A. The customer has paid for the goods or services.B. Delivery of goods or performance of service has occurred or is scheduled to occur.C. The price is fixed or determinable.D. The customer has signed a contract.

The four conditions for revenue to be recognized according to the revenue principle are: 1) goods or services are delivered 2) there is persuasive evidence of an arrangement for customer payment 3) the price is fixed or determinable and 4) collection is reasonably assured.






64. Which of the following journal entries is correct when a company has incurred interest expense but has not yet paid the interest?


Expenses are recorded (with a debit entry) when incurred. When they have been incurred and not paid, the interest payable account needs to be increased with a credit entry.






65. McNeil Company owed its employees for services performed and recorded a liability for the wages owed the employees. Which of the following correctly describes the impact on the financial statements when the employee wages are subsequently paid? A. Operating expenses are increased.B. Retained earnings decreases.C. Operating income does not change.D. Total assets remain the same.

When the wages are paid, the liability account is reduced as is the cash account. Neither has an impact on operating income.






66. Which of the following journal entries correctly records the receipt of a utility bill which will be paid for in later weeks?


The utility expense account needs to be increased with a debit, and because the bill will be paid at a later date, the utility payable account needs to be increased with a credit. An expense is recognized and a liability is recorded.






67. Which of the following is not a proper application of the revenue principle? A. Recording the sale of merchandise on credit as sales revenue.B. Recording rent received in advance as unearned rent revenue.C. Recording interest revenue when cash is collected rather than when earned.D. Reducing the unearned service revenue account for service revenue performed at the end of the

accounting period.

Revenue is recorded when earned, not upon the collection of cash.






68. Which of the following is an example of revenue or expense to be recognized in the current period's income statement? A. Cash received from a client before the service is provided.B. Inventory being held by a retail store.C. Wages owed to employees who worked during the period.D. Cash collected from an accounts receivable.

Expenses are recorded when incurred and revenues are recorded when earned. Wages owed to employees for work during a period need to be recorded as an expense during that period.






69. Which of the following liability accounts is likely to be satisfied without a future cash payment? A. Wages payableB. Unearned subscriptions revenueC. Accounts payableD. Taxes payable

Reduction of the liability account, unearned revenue, occurs once goods or services have been provided and does not require a cash payment.






70. A company receives a $50,000 cash deposit from a customer on October 15 but will not deliver the goods until November 20. Which of the following statements is true? A. Cash will be reported on the statement of cash flows for the month of November.B. Revenue will be recorded and reported on the income statement for October.C. A liability will be reported on the balance sheet at the end of October.D. A prepaid asset will be reported on the balance sheet at the end of October.

Upon the receipt of the cash deposit, a liability (unearned revenue) must be reported on the balance sheet. This liability exists until the goods have been delivered, in this case until November 20.






71. A company purchased $20,000 of inventory during February and will pay for it during March. Which of the following statements is false assuming the inventory was sold during March? A. The company's accounts payable will include the $20,000 on the February month-end balance sheet.B. The statement of cash flows will report an operating cash outflow of $20,000 during March.C. The income statement will report cost of goods sold of $20,000 during February.D. The company's inventory will include the $20,000 on the February month-end balance sheet.

The matching principle requires that expenses be recorded when incurred in earning revenue. Cost of goods sold should be recorded when the inventory is sold, which in this case is during March.






72. Which of the following correctly applies the revenue recognition principle? A. Recording revenue in December 2009 for units manufactured but not yet sold to customers.B. Recording cash received in advance from customers as revenue when the product is not yet shipped.C. Not recording interest earned in 2009 until the cash is received in 2010.D. Recording revenue in December 2009 for units sold but not yet paid for in full.

The revenue recognition principle requires that revenue be recorded once goods have been sold.






73. Which of the following accounts normally have a credit balance? A. Unearned revenues; Prepaid rent; Revenues.B. Revenues; Expenses; Contributed capital.C. Revenues; Inventory; Unearned revenue.D. Notes payable; Retained earnings; Revenues.

Liability, retained earnings, and revenue accounts are all on the right side of the accounting equation, are all increased with a credit, and thus have a normal credit balance.






74. During 2010, Sensa Corporation incurred operating expenses amounting to $100,000 of which $75,000 was paid in cash; the balance will be paid during 2011. Which of the following is correct for the 2010 year-end balance sheet? A. Stockholders' equity decreases $75,000 and assets decrease $75,000.B. Assets decrease $100,000 and stockholders' equity decreases $100,000.C. Assets decrease $100,000, liabilities increase $25,000, and stockholders' equity decreases $100,000.D. Stockholders' equity decreases $100,000, assets decrease $75,000, and liabilities increase $25,000.

The full operating expense amount reduces net income, which reduces stockholders' equity through the retained earnings account. The portion paid in cash reduces assets and the unpaid portion of the expense must be recognized as an increase to liabilities.

AACSB: Analytic





75. Which of the following accounts normally have a debit balance? A. Prepaid expenses, wages payable, and dividends.B. Cash, utilities expense, and accounts receivable.C. Retained earnings, cost of goods sold, and wages expense.D. Utilities expense, prepaid expenses, and wages payable.

Assets and expenses have normal debit balances. Cash, utilities expense, and accounts receivable are all classified as either assets or expenses.






76. Which of the following statements is false? A. Expense accounts have a debit balance.B. Revenue accounts have a credit balance.C. Gain accounts have a credit balance.D. Loss accounts have a credit balance.

Losses reduce stockholders' equity and therefore have a debit balance.






77. Which of the following statements is correct? A. Expense accounts result in decreases in net income and stockholders' equity and therefore have credit

balances.B. Revenue accounts result in increases in net income and stockholders' equity and therefore have debit

balances.C. Loss accounts result in decreases in net income and stockholders' equity and therefore have debit

balances.D. Gain accounts result in increases in net income and stockholders' equity and therefore have debit

balances.

Losses reduce net income and stockholders' equity and therefore have a debit balance.






78. Which of the following journal entries correctly records a transaction where services were provided to a customer on account?


When services are provided to a customer on account, a debit to accounts receivable is required. The services have been provided so it is appropriate to credit revenue.






79. Which of the following is correct when land costing $20,000 is sold for $29,000? The land was a component of plant and equipment on the balance sheet. A. Revenues are debited for $29,000.B. Cost of goods sold is credited for $20,000.C. Gain on sale of land is credited for $9,000.D. Operating income increases $29,000.

When an asset is sold for more than it cost, a gain on the sale is reported. This is done by crediting the gain on sale of land account for the amount the sales price exceeded cost.

AACSB: Analytic





80. Boone's Cleaning Service performed cleaning services during December, 2010, but had not collected any cash from its customers as of December 31, 2010. What impact did performing these services have on the accounting equation? A. The service increased assets and increased liabilities.B. The service increased assets and increased stockholders' equity.C. The service increased assets and decreased stockholders' equity.D. The service decreased liabilities and decreased stockholders' equity.

Performing the services generated revenue, increasing net income and stockholders' equity. Even though cash was not collected, assets increased (through an account receivable) because the services have been performed.






81. On December 31, 2010, Avery Corporation paid $10,000 for next year's insurance policy. This transaction should be recorded as follows by Avery:


The insurance is for future periods, so it is considered prepaid insurance, an asset account increased with a debit. This is paid for with cash resulting in a cash outflow, recorded with a credit to the cash account.






82. Mama June Pizza Company sold land costing $39,000 for $51,000 cash. Which of the following statements concerning the land sale is correct? A. The land account was credited for $51,000.B. The revenue account was debited for $51,000.C. Operating income increased $12,000.D. Income before income taxes increased $12,000.

The excess cash received over the cost of the land is recognized as a gain on sale of land. This is recorded as a peripheral income activity before income taxes.

AACSB: Analytic



Learning Objective: 03-02 Explain how business activities affect the elements of the income statement.Learning Objective: 03-04 Apply transaction analysis to examine and record the effects of operating activities on the financial statements.

Libby - Chapter 03 #82Topic Area: Elements on the Income Statement, The Expanded Transaction Analysis Model

83. Which of the following statements is false when Mama June Pizza Company paid $47,000 cash on accounts owed to suppliers? A. The cash account was credited for $47,000.B. Accounts payable was debited for $47,000.C. Supplies expense was increased by $47,000.D. Operating income was not changed by the payment to the suppliers.

Paying suppliers cash owed on account do not result in an incurred expense but a reduction in assets (cash) and liabilities (accounts payable).

AACSB: Analytic





84. Which of the following journal entries is correct assuming that Mama June Pizza Company received cash for interest earned on investments?


The cash account is increase with a debit, because cash is received. Interest earned on investments is synonymous with investment income, an account increased with a credit.






85. Mama June Pizza Company determined that dough, sauce, cheese and other ingredients costing $8,700 were used to make pizzas during July. Which of the following statements is false with respect to the use of the ingredients? A. Cost of goods sold was debited for $8,700.B. Operating expenses increased $8,700.C. Operating income decreased $8,700.D. Supplies inventory was debited for $8,700.

Supplies inventory is an asset account reduced with a credit for $8,700.






86. Zeppelin Company received cash during January for services to be provided in February. Which of the following statements does not accurately describe the impact on the financial statements when Zeppelin provides the services during February? A. Unearned revenues decreased and were debited.B. Revenues increased and were credited.C. Stockholders' equity will increase.D. Total assets will increase.

In February, the unearned revenue account is reduced with a debit and revenue is increased with a credit. Neither of these transactions increases total assets.






87. Which of the following describes the transaction resulting in a journal entry with a debit to Salaries payable and a credit to Cash? A. Salaries expense has been incurred but is unpaid.B. Cash was used to pay for salaries that were previously recorded as an expense.C. Cash was used to pay for salaries that were not previously recorded as an expense.D. Cash was used to prepay employee wages.

Salaries payable is recorded when a salaries expense has been incurred but not yet paid. The credit to cash indicates these salaries have been paid and to reduce the payable a debit is required.






88. Which of the following statements is correct? A. Recording revenues results in an increase in assets or a decrease in liabilities.B. Recording revenues results in an increase in assets or a decrease in stockholders' equity.C. Recording expenses results in a decrease in assets or a decrease in liabilities.D. Recording expenses results in an increase in assets or an increase in liabilities.

Recording revenues results in an increase in either cash or accounts receivable (both asset accounts) or the reduction of unearned revenue (a liability account).






89. Which of the following statements is false? A. The unearned revenue account has a credit balance.B. The revenue account has a credit balance.C. An expense account has a debit balance.D. A prepaid expense account has a credit balance.

A prepaid expense is an asset account with a debit balance.






90. Which of the following accounts doesn't have a debit balance? A. Prepaid insuranceB. Insurance expenseC. Unearned revenuesD. Salaries expense

Unearned revenues are liability accounts with a credit balance.






91. Which of the following accounts doesn't have a credit balance? A. Gain on sale of landB. Investment incomeC. Unearned revenuesD. Rent expense

Expense accounts decrease net income, retained earnings, and stockholders' equity and thus have debit balances.






92. On January 1, 2011 Gucci Brothers Inc. had a $500,000 credit balance in retained earnings and $600,000 balance in contributed capital. During 2011, the company earned net income of $100,000, declared a dividend of $15,000, and issued additional stock for $25,000. What is total stockholders' equity on December 31, 2011? A. $1,100,000B. $1,210,000C. $1,225,000D. $1,240,000

Stockholders' equity on December 31, 2011 = $1,210,000 = $500,000 + $600,000 + $100,000 - $15,000 + $25,000

AACSB: Analytic





93. On January 1, 2010, Denmark Inc., started the year with a $200,000 credit balance in its retained earnings account. During 2010, the company earned net income of $70,000 and declared and paid dividends of $10,000. Also, the company received cash of $15,000 as an additional investment by its owners. What is the balance in retained earnings on December 31, 2010? A. $200,000B. $270,000C. $245,000D. $260,000

Retained earnings on December 31, 2010 = $260,000 = $200,000 + $70,000 - $10,000

AACSB: Analytic





94. Blazon Corporation's retained earnings increased $79,000 during 2011. Blazon declared $19,000 of dividends and paid $15,000 of the dividends declared during 2011. How much was Blazon's 2011 net income assuming that Blazon's stockholders invested an additional $30,000 during 2011? A. $98,000B. $94,000C. $68,000D. $64,000

2011 net income = $98,000 = $79,000 + $19,000 The change in retained earnings equals net income ($98,000) minus dividends declared ($19,000).

AACSB: Analytic





95. Beemer Corporation has provided the following information pertaining to the year ended December 31, 2011: • Stockholders' equity as of January 1 was $789,000.• Dividends declared during the year totaled $71,000 of which $60,000 were paid during the year.• Stockholders invested $113,000 cash into the business in exchange for new shares of stock.• Stockholders' equity as of December 31 was $1,030,000.How much was Beemer's 2011 net income? A. $210,000B. $199,000C. $312,000D. $323,000

Beginning stockholders' equity ($789,000) + net income - dividends declared ($71,000) + stockholder investments ($113,000) = Ending Stockholders equity ($1,030,000).

AACSB: Analytic





96. Which of the following transactions would not be reported as cash flow from operations on a cash flow statement? A. Cash collected from customersB. Cash paid to suppliersC. Cash paid for employee wagesD. Cash paid for dividends

Cash paid for dividends is a cash flow from financing activities, not operating activities.






97. Which of the following transactions would be reported as cash flow from operations on a cash flow statement? A. Cash paid to purchase equipmentB. Cash paid to acquire landC. Cash paid for interestD. Cash paid for rent

Operations cash flows are that result from operations, rent is included in this category.






98. Garret Company has provided the following selected information for the year ended December 31, 2011: • Cash collected from customers was $783,000.• Cash received from stockholders in exchange for stock totaled $91,000.• Cash paid to suppliers was $361,000.• Cash paid to employees was $204,000.• Cash to stockholders for dividends was $33,000.• Cash received from sale of a building was $250,000.• Cash paid for rent was $39,000.• Cash received for interest and dividends was $7,000.• Cash paid for income taxes was $55,000.Based on the selected information provided, how much was Garret's cash flow from operations? A. $131,000B. $98,000C. $381,000D. $222,000

Cash flow from operations = $131,000 = $783,000 - $361,000 - $204,000 - $39,000 + $7,000 - $55,000

AACSB: Analytic





99. Which of the following statements is inaccurate with respect to the total asset turnover ratio? A. It is calculated as sales revenues divided by total assets at year-end.B. It is decreased when additional plant and equipment is purchased.C. A high ratio implies efficient management of assets.D. It is decreased when additional inventory is purchased.

Total Asset Turnover = Sales (or Operating) Revenues/Average Total Assets






100. Top Company's 2011 sales revenue was $200,000 and 2010 sales revenue was $180,000. Top's total assets as of December 31, 2011 were $150,000 and total assets as of January 1, 2011 were $130,000. What is Top's total asset turnover ratio? A. 1.48B. 1.33C. 1.36D. 1.43

Average total assets = $140,000 = ($150,000 + $130,000) ÷ 2 Total asset turnover ratio = 1.43 = $200,000 ÷ $140,000

AACSB: Analytic





101. What is the operating cycle? Describe a business entity with an operating cycle of less than six months and a business with an operating cycle of more than one year. Answers will varyFeedback: The operating cycle is the time that elapses from the cash payment for inventory to the cash collection form customers from sale of the inventory. A restaurant and a grocery store would be examples of businesses with operating cycles of less than six months. An airplane manufacturer and a winery would be examples of businesses with operating cycles of more than one year.






102. Describe the difference between operating revenues and gains from the sale of plant and equipment while providing examples of each. Answers will varyFeedback: Operating revenues result from ongoing operations and are an element of operating income. An accountant providing consulting services and an automobile dealer selling a car are both examples of operating revenues. A gain from the sale of plant and equipment are peripheral activities and are not an element of operating income. Selling a building or land for more than cost are examples of gains from the sale of plant and equipment.






103. Describe the difference between operating expenses and losses from the sale of plant and equipment while providing examples of each. Answers will varyFeedback: Operating expenses result from ongoing operations, are an element of operating income and are incurred to generate revenues. Rent expense, cost of goods sold and salaries expense are examples of operating expenses. A loss from the sale of plant and equipment are peripheral activities and are not an element of operating income. Selling a building, land or equipment for less than cost are examples of losses from the sale of plant and equipment.






104. Describe the difference(s) with respect to the cash basis of accounting and the accrual basis of accounting. Answers will varyFeedback: The cash basis of accounting recognizes revenues and expenses on the income statement when the associated cash flows occur. The accrual basis of accounting recognizes revenues on the income statement when earned regardless of the timing of cash collection and recognizes expenses on the income statement when they are incurred regardless of the timing of cash payments. The accrual basis of accounting is the only acceptable method for external reporting purposes according to generally accepted accounting principles.






105. Why might managers be tempted to violate the revenue principle and the matching principle when preparing an income statement? Answers will varyFeedback: Managers want their companies to appear successful when financial statements are issued. When revenues are as high as possible and expenses as low as possible, net income will be maximized. Managers might be tempted to report revenues even though the earnings process is not complete. Also, if some expenses can be put off until a later time, net income will appear larger. Many times manager bonuses are calculated based on net income. In addition, earnings expectations in the marketplace create tremendous pressures for those expectations to be met. Lower net income could cause an adverse reaction in the market place regarding stock prices.

AACSB: Ethics, Reflective Thinking





106. Describe the debit and credit logic pertaining to items reported on the income statement. Answers will varyFeedback: Revenue and gain accounts have credit balances because they both result in increases in retained earnings. Expense and loss accounts have debit balances because they both result in decreases in retained earnings.






107. Describe transactions which have an impact on the statement of stockholders' equity. Answers will varyFeedback: Additional stock issues result in an increase in both contributed capital and stockholders' equity. Net income results in an increase in both retained earnings and stockholders' equity. Dividends declared and a net loss both decrease retained earnings and stockholders' equity.






108. Complete the chart below for Monticello Corporation by placing an X in the appropriate boxes to indicate how the transaction should be recorded.

Answers will vary

Feedback:






109. Indicate the sequential order of the following steps in the accounting information processing cycle:Analyzing transactionsPreparing financial statementsDeveloping a trial balanceCollecting original dataPosting to the accountsJournalizing transactions Answers will varyFeedback: Collecting original dataAnalyzing transactionsJournalizing transactionsPosting to the accountsPreparing financial statements






110. Part A. Perform transaction analysis for Blake Company regarding the following transactions for March. Indicate the account affected by the transaction as well as the increase (+) or decrease (-) to the components of the accounting equation and the amount.

Part B. Determine whether the transactions A-F above affected cash flows during March. If so, determine the type of activity as an operating activity, an investing activity, or a financing activity. If cash is not affected use "no effect." Place an X under the appropriate column for each transaction.

Answers will vary

Feedback: A.

B.




Learning Objective: 03-02 Explain how business activities affect the elements of the income statement.Learning Objective: 03-05 Prepare financial statements.

Libby - Chapter 03 #110Topic Area: Elements on the Income Statement, How are Financial Statements Prepared and Analyzed

111. For the year ending December 31, 2010, the accounts of Jackson Corporation showed the following balances:

Requirement: Determine the components of stockholders' equity as of December 31, 2010. Answers will varyFeedback: Contributed Capital: $550,000 = $500,000 + $50,000Retained earnings: $150,000 = $100,000 + $150,000 - $90,000 - $10,000

AACSB: Analytic


Blooms: ApplyDifficulty: Easy



112. The following accounts for Carthage Enterprises, Inc. are listed randomly. Enter the number associated with each transaction to identify the accounts that would be used in the journal entry for each transaction given below.

Answers will vary

Feedback:






113. World Services Inc. has provided the following information pertaining to the month ended October 31, 2010:

Prepare an income statement through operating income for the month ended October 31, 2010. Answers will vary

Feedback:

AACSB: Analytic





114. The following information has been provided by Flatiron Company for the year ended December 31, 2011:• Net income was $71,000;• Income tax expense was $47,000;• Dividends declared and paid totaled $7,500;• Interest expense was $8,700;• Loss on sale of plant assets was $15,000;• Operating expenses totaled $91,000;• Cash collected from customers was $220,000.How much was Flatiron's operating income? Answers will varyFeedback: Step 1: Net income ($71,000) + Income tax expense ($47,000) = Income before taxes ($118,000)Step 2: Income before taxes ($118,000) + Interest expense ($8,700) + Loss on sale of plant assets ($15,000) = Operating income ($141,700)

AACSB: Analytic





115. Describe the transaction which created the following journal entries (amounts omitted):1. CashUnearned revenue2. Utilities expenseUtilities payable3. Accounts receivableSales Revenue4. Salaries expenseCash5. Unearned RevenueSales revenue Answers will varyFeedback: 1. Cash was received from a customer in advance of providing the good or service.2. A utility bill was received but not yet paid.3. A sale was made to a customer on account.4. Employee wages were paid using cash.5. Goods or services were provided to customers that previously paid in advance.






116. Explain why the net income reported on the income statement is usually not equal to net cash flows from operating activities on the statement of cash flows. Answers will varyFeedback: Net income on the income statement is an application of the accrual basis of accounting; revenues are reported when earned and expenses incurred are matched to those earned revenues. The net cash flows from operating activities on the statement of cash flows are reported on the cash basis of accounting. That is, amounts received from customers and amounts paid for expenses are on the statement of cash flows. Therefore, the difference in net income and net cash from operating activities is a timing issue.




Learning Objective: 03-03 Explain the accrual basis of accounting and apply the revenue and matching principles to measure income.Learning Objective: 03-05 Prepare financial statements.

Libby - Chapter 03 #116Topic Area: How are Operating Activities Recognized and Measured, How are Financial Statements Prepared and Analyzed

117. Describe the operating activities section of the cash flow statement and provide three examples of operating activities cash flows. Answers will varyFeedback: The operating activities section of the cash flow statement provides cash flow information pertaining to an entity's normal recurring profit seeking activities. Examples include cash collected from customers, cash collected from interest and dividends, cash paid to suppliers, cash paid to employees and cash paid for any other operating expense.






118. Colby Company has provided the following selected information for the year ended December 31, 2011:• Cash collected from customers was $392,000.• Cash received from stockholders in exchange for stock totaled $46,000.• Cash paid to suppliers was $183,000.• Cash paid to employees was $102,000.• Cash received from a long-term bank loan was $75,000.• Cash to stockholders for dividends was $17,000.• Cash received from sale of a building was $125,000.• Cash paid for rent was $19,000.• Cash received for interest and dividends was $4,000.• Cash paid for income taxes was $28,000.Based on the selected information provided, how much was Colby's cash flow from operations? Answers will varyFeedback: Cash flow from operations = $64,000 = $392,000 - $183,000 - $102,000 - $19,000 + $4,000 - $28,000

AACSB: Analytic





119. What does the total asset turnover ratio measure and how is it calculated? Give two examples of transactions that decrease the ratio. Answers will varyFeedback: The total asset turnover ratio measures a company's use of all company assets to generate sales dollars; it measures the efficiency of asset use to generate sales dollars. The total asset turnover ratio is sales divided by average total assets. The ratio will decrease if additional assets are purchased on a credit basis and by decreasing sales commissions which would most likely reduce sales.






120. The following data is from Gauthier Machine Shop:

Compute Gauthier Machine Shop's total asset turnover ratio for 2011 and 2010. Answers will varyFeedback: 2011 total asset turnover ratio = 2.05 = $1,000,000 ÷ {($500,000 + $475,000) ÷ 2}2010 total asset turnover ratio = 1.95 = $900,000 ÷ {($475,000 + $450,000) ÷ 2}

AACSB: Analytic





ch3 Summary

Category # of Questions

AACSB: Analytic 22

AACSB: Ethics, Reflective Thinking 1

AACSB: Reflective Thinking 97

AICPA BB: Critical Thinking 120

AICPA FN: Measurement 5

AICPA FN: Reporting 95

AICPA FN: Reporting, Measurement 20

Blooms: Apply 22

Blooms: Remember 49

Blooms: Understand 49

Difficulty: Easy 51

Difficulty: Hard 5

Difficulty: Medium 64

Learning Objective: 03-01 Describe a typical business operating cycle and explain the necessity for the time period assumption.

7

Learning Objective: 03-02 Explain how business activities affect the elements of the income statement. 36

Learning Objective: 03-03 Explain the accrual basis of accounting and apply the revenue and matching principles to measure income.

33

Learning Objective: 03-04 Apply transaction analysis to examine and record the effects of operating activities on the financial statements.

27

Learning Objective: 03-05 Prepare financial statements. 18

Learning Objective: 03-06 Compute and interpret the total asset turnover ratio. 6

Libby - Chapter 03 120

Topic Area: Elements on the Income Statement 30

Topic Area: Elements on the Income Statement, How are Financial Statements Prepared and Analyzed 3

Topic Area: Elements on the Income Statement, The Expanded Transaction Analysis Model 3

Topic Area: How are Financial Statements Prepared and Analyzed 14

Topic Area: How are Operating Activities Recognized and Measured 32

Topic Area: How are Operating Activities Recognized and Measured, How are Financial Statements Prepared and Analyzed

1

Topic Area: How do Business Activities Affect the Income Statement 7

Topic Area: The Expanded Transaction Analysis Model 24

Topic Area: Total Asset Turnover Ratio 6