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Financial Accounting: A Business Process Approach, 3e (Reimers) Chapter 2 Qualities of Accounting Information Learning Objective 2-1 2.1-1) Net income equals ________. A) the gross profit on a sale B) operating income minus cost of goods sold C) the increase in cash for the period D) revenue minus expenses Answer: D Diff: 1 Objective: LO 2-1 2.1-2) Gross profit equals ________. A) sales minus cost of goods sold B) operating income minus cost of goods sold C) the increase in cash for the period D) revenue minus expenses Answer: A Diff: 2 Objective: LO 2-1 2.1-3) Busy Beaver had revenues of $2,000, cost of goods sold of $780, advertising expense of $100, and interest expense of $25. Net income was ________. A) $1,095 B) $1,120 C) $1,195 D) $1,220 Answer: A Diff: 1 Skill: Analytic skills Objective: LO 2-1 2.1-4) Busy Beaver had revenues of $2,000, cost of goods sold of $780, advertising expense of $100, and interest expense of $25. Gross profit was ________. A) $1,095 B) $1,120 C) $1,195 D) $1,220 Answer: D Diff: 2 Skill: Analytic skills Objective: LO 2-1

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2.1-5) Generally accepted accounting principles (GAAP) ________. A) are a set of rules that a U.S. company must follow when preparing its financial statements B) are accounting rules determined by the IRS C) are accounting rules required by the U.S. government for all businesses to follow D) are issued by the International Accounting Standards Board Answer: A Diff: 3 Objective: LO 2-1 2.1-6) The set of rules that a U.S. company must follow when preparing its financial statements is called ________. A) AICPA B) FASB C) GAAP D) SOX Answer: C Diff: 1 Objective: LO 2-1 2.1-7) The set of rules that a U.S. company must follow when preparing its financial statements is called ________. A) generally accepted accounting principles B) internal revenue code C) internal control procedures D) internally accepted accounting principles Answer: A Diff: 1 Objective: LO 2-1 2.1-8) Which of the following statements is TRUE? A) The IASB is the current standards setting body for the U.S. accounting profession. B) The FASB determines U.S. generally accepted accounting principles. C) Applying IFRS will require much less judgment and interpretation than following U.S. GAAP. D) The IRS determines generally accepted accounting principles. Answer: B Diff: 2 Skill: Dynamics of the global economy Objective: LO 2-1

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2.1-9) U.S. generally accepted accounting principles (GAAP) are determined by the ________. A) IFRS B) IASB C) FASB D) U.S. Congress Answer: C Diff: 2 Objective: LO 2-1 2.1-10) It requires more judgment to use ________ than to use ________. A) IFRS; U.S. GAAP B) U.S. GAAP; IFRS C) This is a trick question, since U.S. GAAP and IFRS are the same. D) IGAAP; U.S. GAAP Answer: A Diff: 2 Skill: Dynamics of the global economy Objective: LO 2-1 2.1-11) ________ have more detailed rules than ________. A) IFRS; U.S. GAAP B) U.S. GAAP; IFRS C) This is a trick question, since U.S. GAAP and IFRS are the same. D) IGAAP; U.S. GAAP Answer: B Diff: 2 Skill: Dynamics of the global economy Objective: LO 2-1 2.1-12) ________ are more concept-based than ________. A) IFRS; U.S. GAAP B) U.S. GAAP; IFRS C) This is a trick question, since U.S. GAAP and IFRS are the same. D) IGAAP; U.S. GAAP Answer: A Diff: 2 Skill: Dynamics of the global economy Objective: LO 2-1

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2.1-13) ________ is more rule-based than ________. A) IFRS; U.S. GAAP B) U.S. GAAP; IFRS C) This is a trick question, since U.S. GAAP and IFRS are the same. D) IGAAP; U.S. GAAP Answer: B Diff: 2 Skill: Dynamics of the global economy Objective: LO 2-1 2.1-14) The SEC has ________. A) ordered all U.S. companies to begin using IFRS immediately B) ruled that U.S. companies may never use IFRS for financial reporting C) established a time table for the convergence of U.S. GAAP and IFRS D) established an International Accounting Standards Board to create international accounting rules Answer: C Diff: 2 Skill: Dynamics of the global economy Objective: LO 2-1 2.1-15) The IRS developed GAAP, or generally accepted accounting principles, for the accounting profession. Answer: FALSE Diff: 2 Objective: LO 2-1 2.1-16) The FASB, or Financial Accounting Standards Board, is currently the standards-setting body for rules that U.S. publicly-held companies must use in preparing financial statements. Answer: TRUE Diff: 2 Objective: LO 2-1 2.1-17) GAAP, or generally accepted accounting principles, are the rules for preparing financial statements followed by the accounting profession in the United States. Answer: TRUE Diff: 1 Objective: LO 2-1 2.1-18) Revenue minus expenses equals net income. Answer: TRUE Diff: 1 Objective: LO 2-1

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2.1-19) Revenue minus expenses equals gross profit. Answer: FALSE Diff: 2 Objective: LO 2-1 2.1-20) The Financial Accounting Standards Board sets international financial reporting standards (IFRS). Answer: FALSE Diff: 2 Skill: Dynamics of the global economy Objective: LO 2-1 2.1-21) IFRS and U.S. GAAP are the same in all respects. Answer: FALSE Diff: 1 Skill: Dynamics of the global economy Objective: LO 2-1 2.1-22) IFRS have fewer detailed rules than U.S. GAAP. Answer: TRUE Diff: 2 Skill: Dynamics of the global economy Objective: LO 2-1 2.1-23) What is profit? Answer: Profit is the amount remaining after all the expenses of doing business are deducted from all the revenues for a specific period. Diff: 1 Skill: Communication abilities Objective: LO 2-1 2.1-24) What is the purpose of generally accepted accounting principles (GAAP)? Answer: The purpose of financial reporting is to provide information for decision making. In order for financial information to be useful for evaluating the performance of a business, reporting rules must be uniform and applied in a consistent manner. Generally accepted accounting principles, or GAAP, are the set of rules that accountants and companies must follow when preparing financial statements. Diff: 1 Skill: Communication abilities Objective: LO 2-1

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2.1-25) What are IFRS? How do they compare and contrast with U.S. GAAP? Answer: IFRS are International Financial Reporting Standards, rules that have been set by the International Accounting Standards Board. Many countries have adopted IFRS already. The SEC has set forth a timetable for convergence of U.S. GAAP and IFRS. IFRS and U.S. GAAP have similar general and qualitative characteristics of accounting information. However, U.S. GAAP have more detailed rules, while IFRS are considered to be more concept-based and require more judgment to apply. Diff: 2 Skill: Communication abilities Objective: LO 2-1 Learning Objective 2-2 2.2-1) A financial statement provides information that ________. A) is specific to a business enterprise B) is industry-wide information C) is economy-wide information D) includes the owner's personal financial records Answer: A Diff: 1 Objective: LO 2-2 2.2-2) Characteristics of useful information include ________. A) rationality and reliability B) comparability and consistency C) materiality and conservatism D) comprehensive and complete Answer: B Diff: 2 Objective: LO 2-2 2.2-3) Relevant information ________. A) needs to be current so it can be used to make decisions B) can be verified as accurate and truthful C) allows users to make comparisons across financial statements D) is presented the same way period after period Answer: A Diff: 2 Objective: LO 2-2

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2.2-4) Comparable information ________. A) needs to be current so it can be used to make decisions B) can be verified as accurate and truthful C) allows users to make comparisons across financial statements D) is presented the same way period after period Answer: C Diff: 2 Objective: LO 2-2 2.2-5) Reliable information ________. A) needs to be current so it can be used to make decisions B) can be verified as accurate and truthful C) allows users to make comparisons across financial statements D) is presented the same way period after period Answer: B Diff: 2 Objective: LO 2-2 2.2-6) Consistent information ________. A) needs to be current so it can be used to make decisions B) can be verified as accurate and truthful C) allows users to make comparisons across financial statements D) is presented the same way period after period Answer: D Diff: 2 Objective: LO 2-2 2.2-7) Assets are recorded at their original cost to the company at the time of purchase. This is the ________ principle. A) historical-cost B) full-disclosure C) matching D) revenue recognition Answer: A Diff: 1 Objective: LO 2-2 2.2-8) Expenses are reported on the income statement when the related revenue is recognized. This is the ________ principle. A) historical-cost B) full-disclosure C) matching D) revenue recognition Answer: C Diff: 1 Objective: LO 2-2 7 Copyright Š 2011 Pearson Education, Inc.


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2.2-9) Ace Electronics bought a new factory for $5,000,000. The factory was originally offered for sale for $5,200,000, but Ace successfully negotiated a lower price. Acme, Inc. was also trying to buy the factory and offered to pay $4,900,000. Ace should record the factory on its books at ________. A) $5,200,000 B) $5,000,000 C) $4,500,000 D) $4,900,000 Answer: B Diff: 2 Skill: Analytic skills Objective: LO 2-2 2.2-10) For June, Team Shirts had a beginning balance in its Retained earnings account of $500. Net income for the month was $875. Team Shirts paid dividends of $200. The ending balance in Retained earnings was ________. A) $675 B) $1,575 C) $1,175 D) $1,375 Answer: C Diff: 3 Skill: Analytic skills Objective: LO 2-2 2.2-11) Accounts receivable represents ________. A) amounts owed by the company to suppliers B) amounts owed to the company by customers C) revenue D) shareholders' equity Answer: B Diff: 2 Objective: LO 2-2 2.2-12) Accounts payable represents ________. A) amounts owed by the company to suppliers B) amounts owed to the company by customers C) expenses D) shareholders' equity Answer: A Diff: 2 Objective: LO 2-2

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2.2-13) The monetary-unit assumption refers to ________. A) measuring financial statement items at their cost at the time of the transaction B) an assumption that a company will continue to be in business in the future C) the use of monetary units, such as dollars, to measure the value of financial statement amounts D) the way revenues and expenses are recognized Answer: C Diff: 1 Objective: LO 2-2 2.2-14) The historical-cost principle refers to ________. A) measuring financial statement items at their cost at the time of the transaction B) an assumption that a company will continue to be in business in the future C) using monetary units, such as dollars, to measure the value of financial statement amounts D) the way revenues and expenses are recognized Answer: A Diff: 1 Objective: LO 2-2 2.2-15) The going-concern assumption refers to ________. A) measuring the financial statement items at their cost at the time of the transaction B) an assumption is made that a company will continue to be in business in the future C) the use of monetary units, such as dollars, to measure the value of financial statement amounts D) the way revenues and expenses are recognized Answer: B Diff: 1 Objective: LO 2-2 2.2-16) The accounting rule which requires that only the business transactions of Team Shirts be shown on the balance sheet is the ________. A) separate-entity assumption B) going-concern assumption C) monetary-unit assumption D) historical-cost principle Answer: A Diff: 2 Objective: LO 2-2

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2.2-17) The accounting rule which assumes that Team Shirts is continuing in business for an indefinite period of time is the ________. A) separate-entity assumption B) going-concern assumption C) monetary-unit assumption D) historical-cost principle Answer: B Diff: 2 Objective: LO 2-2 2.2-18) Which of the following is an example of using the materiality concept? A) recording significant purchases as assets even though technically they are considered expenses B) recording insignificant purchases as expenses even though technically they are considered assets C) not recording insignificant purchases at all D) recording insignificant liabilities as assets Answer: B Diff: 3 Objective: LO 2-2 2.2-19) All of Team Shirts' financial statements are presented in U.S. dollars. The accounting rule that applies is the ________. A) separate-entity assumption B) going-concern assumption C) monetary-unit assumption D) historical-cost principle Answer: C Diff: 2 Objective: LO 2-2 2.2-20) The revenue reported on the Team Shirts' income statement has been earned during the accounting period. The accounting rule that applies is the ________. A) going-concern assumption B) historical-cost principle C) revenue-recognition principle D) matching principle Answer: C Diff: 2 Objective: LO 2-2

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2.2-21) Supplies expense on the Team Shirts' income statement represents only supplies that were used to earn revenue during the accounting period. The accounting rule that applies is the ________. A) going-concern assumption B) historical-cost principle C) revenue-recognition principle D) matching principle Answer: D Diff: 2 Objective: LO 2-2 2.2-22) On December 31, 2012, Twisted Pretzel was told by an appraiser that its land, which cost $100,000, was worth $120,000. How should Twisted Pretzel show this information on its financial statements prepared under U.S. GAAP? A) Report a gain of $20,000 on its income statement. B) Report land at $100,000 on its income statement. C) Report land at $120,000 on its income statement. D) Continue showing the land at its cost of $100,000. Answer: D Diff: 2 Skill: Analytic skills Objective: LO 2-2 2.2-23) On December 31, 2012, Twisted Pretzel was told by an appraiser that its land, which cost $100,000, was worth $120,000. Under IFRS, Twisted Pretzel would be allowed to: show the land on its financial statements as ________. A) an expense of $100,000 on the income statement B) an expense of $120,000 on the balance sheet C) an asset of $120,000 on the income statement D) an asset of $120,000 on the balance sheet Answer: D Diff: 3 Skill: Analytic skills, Dynamics of the global economy Objective: LO 2-2 2.2-24) For information to be useful, it must be relevant and reliable. Answer: TRUE Diff: 1 Objective: LO 2-2 2.2-25) The owner of a sole proprietorship should not include personal financial records as part of the financial records and statements of the business. Answer: TRUE Diff: 2 Objective: LO 2-2

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2.2-26) The separate-entity concept means that a company and its owners should keep separate records. Answer: TRUE Diff: 1 Objective: LO 2-2 2.2-27) Two characteristics of useful information are comparability and consistency. Answer: TRUE Diff: 2 Objective: LO 2-2 2.2-28) Comparability means that companies should use the same accounting rules from period to period. Answer: FALSE Diff: 3 Objective: LO 2-2 2.2-29) Reliable information can be verified. Answer: TRUE Diff: 2 Objective: LO 2-2 2.2-30) If a company spends $25 on copy paper, the amount is not material compared with the total office supplies budget of $250,000. Answer: TRUE Diff: 2 Objective: LO 2-2 2.2-31) Information that is relevant is both timely and useful in predicting the future. Answer: TRUE Diff: 1 Objective: LO 2-2 2.2-32) State the most applicable accounting rule for each of the following situations. An accounting rule can be a principle, assumption, constraint, or information characteristic. 1. All purchases and expenses are recorded at the amount paid. 2. South Seas records items imported from Tahiti in U.S. dollars. 3. The owner intends to run South Seas for an indefinite period of time. 4. Jem's Jewelers sold a $5,000 diamond engagement ring on account and recorded it as a sale. 5. Inventory purchased last month and sold this month was deducted as a cost on this month's income statement. Answer: 1. Historical-cost principle; 2. Monetary-unit assumption; 3. Going-concern assumption; 4. Revenue-recognition principle; 5. Matching principle Diff: 2 Objective: LO 2-2 12 Copyright Š 2011 Pearson Education, Inc.


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2.2-33) State the most applicable accounting rule for each of the following situations. Each rule can be used more than once. An accounting rule can be a principle, assumption, constraint, or information characteristic. 1. Maids-R-Us recorded using supplies in the same period the supplies were used instead of expensing them in the period when they were purchased. 2. Clean Sweep cleaned an office building in October and was paid in November. Revenue was reported in October. 3. Team Shirts sends a set of financial statements prepared in accordance with GAAP to First Bank every month. 4. Mary Ellis, owner of Clean Sweep, has a bank account for her business separate from her personal bank account. 5. Jem's Jewelers purchased a three-month insurance policy on its diamond inventory. The cost of the policy was recorded as an asset. Later one-third of the asset was expensed each month over the three-month policy. Answer: 1. Matching principle, 2. Revenue-recognition principle, 3. Consistency, 4. Separate-entity assumption, 5. Matching principle. Diff: 2 Objective: LO 2-2 2.2-34) State the most applicable accounting rule for each of the following situations. An accounting rule can be a principle, assumption, constraint, or information characteristic. 1. A $15 wastebasket was expensed when purchased even though it will be used for more than one year. 2. The owner of the business paid for private school tuition and did not list the amount on the books of his business. 3. Team Shirts prepares financial statements in the same manner each year. 4. South Sea's financial statements are prepared within the first week after the close of each accounting period. 5. An external auditor found receipts documenting the purchase of a computerized information system for Team Shirts. Answer: 1. Materiality; 2. Separate-entity assumption; 3. Consistency; 4. Relevance; 5. Reliability Diff: 2 Objective: LO 2-2

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2.2-35) Busy Beaver, Inc. purchased land ten years ago for $30,000. At December 31, 2012, similar land has been appraised at $50,000. Answer the following questions: 1. At what amount should land be reported on the balance sheet under U.S. GAAP? 2. Which basis is more reliable, historical cost, $30,000, or fair market value, $50,000? 3. Which basis is more relevant, historical cost, $30,000, or fair market value, $50,000? 4. How might the land be reported using IFRS? Answer: 1. $30,000; 2. historical cost; 3. fair market value; 4. IFRS allows (but does not require) the land to be reported at its fair value, $50,000. Diff: 2 Objective: LO 2-2 2.2-36) Explain the objectives of financial reporting. Answer: The most important objective of financial reporting is to provide useful information for decision makers. In order to be useful, the information has to be relevant, reliable, comparable and consistent. Diff: 2 Skill: Communication abilities Objective: LO 2-2 2.2-37) Discuss the qualities of accounting information. Answer: Usefulness is the most important characteristic of accounting information. Useful information is relevant to the decision maker. In other words, it makes a difference in making decisions. Information must be reliable. This means that it must be verifiable or based on some sort of documentation. The information must be accurate and truthful. Useful information must be comparable across different companies. Therefore, accountants and companies follow GAAP reporting rules. When all companies follow the same reporting rules, then information can be compared among companies and industries. Useful information should be consistent. This means that accountants and companies have to follow the same reporting rules across time. Diff: 2 Skill: Communication abilities Objective: LO 2-2

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2.2-38) Match each of the following terms with the appropriate definition. Each term should be used only once. a. b. c. d. e. f. g. h. i. j.

Generally Accepted Accounting Principles (GAAP) Financial Accounting Standards Board (FASB) Separate-entity assumption Time-period assumption Usefulness Relevant Consistency Materiality Accounts payable On account

_____ 1. Amounts that a company owes its vendors _____ 2. The significance of an amount or item on the financial statements _____ 3. The rules set by the SEC and FASB for preparing financial statements _____ 4. The most important characteristic of accounting information and the objective of financial reporting _____ 5. A qualitative characteristic of accounting information that requires that information be fresh and allows users to evaluate a firm's past performance to predict where a firm is going _____ 6. Term used to signify either buying or selling on credit _____ 7. A qualitative characteristic of accounting information that requires that firms use the same accounting rules from period to period _____ 8. The current standards setting body for the U.S. accounting profession _____ 9. The assumption that the life of the company can be separated into accounting periods of equal length _____ 10. The requirement that a company and its owners keep separate financial records Answer: i, h, a, e, f, j, g, b, d, c Diff: 2 Objective: LO 2-1 & LO 2-2

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2.2-39) From the list of concepts, principles, and assumptions, choose the letter which best matches each item below. Use each term only once. a. Accrual accounting b. Consistency c. Comparability d. Going-concern assumption e. Historical-cost principle f. Matching principle

g. Materiality h. Monetary-unit assumption i. Relevance j. Reliability k. Revenue-recognition principle l. Separate-entity assumption

1. Items purchased for less than $25 are expensed even though they will last longer than a year. 2. Land is valued on the balance sheet at the amount paid for it even though it is worth more. 3. Revenues are recorded when the goods are delivered even if the cash was not collected. 4. Supplies are expensed in the period they are used to help generate revenue. 5. Cost of goods sold is presented in dollars, not units, on the income statement. 6. The same methods of measuring items on the financials should be used from period to period. 7. Assumes companies are going to stay in business indefinitely. 8. The owner's personal expenses should not be included in the company's records. 9. Accounting information is provided in a timely fashion so that the information is still useful. 10. Revenues are recorded when earned and expenses are recorded when incurred regardless of when the related cash changes hands. 11. The items on the financial statements should be accurate and truthful. 12. Comparing financial statements of different companies is more meaningful when the statements are prepared in accordance with GAAP. Answer: 1. g, 2. e, 3. k, 4. f, 5. h, 6. b, 7. d, 8. l, 9. i, 10. a, 11. j, 12. c Diff: 2 Objective: LO 2-2

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2.2-40) Match the accounting principle or assumption that is most applicable to each of the following. Each term should be used only once. a. b. c. d. e.

monetary-unit assumption historical-cost principle going-concern assumption revenue-recognition principle matching principle

_____ 1. Team Shirts reports assets valued at the original transaction price. _____ 2. The expenses incurred by Team Shirts in March were subtracted from March revenues to calculate the profit for March. _____ 3. Team Shirts reports the amounts on its financial statements in dollars. _____ 4. Team Shirts reports amounts earned even though cash has not yet been collected. _____ 5. Tom has plans to run Team Shirts indefinitely. Answer: b, e, a, d, c Diff: 2 Objective: LO 2-2 Learning Objective 2-3 2.3-1) Team Shirts purchased six months' worth of insurance for $900. The insurance would initially be recorded as ________. A) an account receivable B) an account payable C) prepaid insurance D) insurance expense Answer: C Diff: 2 Objective: LO 2-3 2.3-2) Team Shirts has $200 in its Prepaid insurance account on June 30. This amount is for insurance for July and August. It represents a ________. A) current asset B) long-term asset C) current liability D) long-term liability Answer: A Diff: 2 Objective: LO 2-3

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2.3-3) On May 31, Team Shirts pays a $600 dividend to its shareholders. The dividend ________. A) increases assets by $600 B) reduces retained earnings by $600 C) is classified as dividend expense of $600 D) increases net income by $600 Answer: B Diff: 2 Skill: Analytic skills Objective: LO 2-3 2.3-4) On July 1, Team Shirts paid $600 for three months' worth of advertising beginning on July 1. What is the balance in the Prepaid advertising account at July 31? A) $0 B) $200 C) $400 D) $600 Answer: C Diff: 2 Skill: Analytic skills Objective: LO 2-3 2.3-5) On July 1, Team Shirts paid $600 for three months' worth of advertising beginning on July 1. What is the balance in the Prepaid advertising account at August 31? A) $0 B) $200 C) $400 D) $600 Answer: B Diff: 3 Skill: Analytic skills Objective: LO 2-3 2.3-6) On July 1, Team Shirts paid $600 for three months' worth of advertising beginning on July 1. What is Advertising expense for the MONTH ended August 31? A) $0 B) $200 C) $400 D) $600 Answer: B Diff: 3 Skill: Analytic skills Objective: LO 2-3

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2.3-7) Team Shirts sold $125 worth of T-shirts to a customer on credit. This transaction includes ________. A) an account receivable B) an account payable C) a prepaid sale D) T-shirt expense Answer: A Diff: 3 Skill: Analytic skills Objective: LO 2-3 2.3-8) On January 1, Team Shirts paid $600 for three months' worth of advertising beginning on February 1. What should the balance be in the Prepaid advertising account on April 1? A) $0 B) $100 C) $200 D) $300 Answer: C Diff: 3 Skill: Analytic skills Objective: LO 2-3 2.3-9) Adjusting the books is done ________. A) every time a sale is made B) every time an asset is purchased C) as expenses are used up D) at the end of every accounting period Answer: D Diff: 2 Objective: LO 2-3 2.3-10) The first financial statement to be prepared at the end of each accounting period is the ________. A) balance sheet B) income statement C) statement of changes in shareholders' equity D) statement of cash flows Answer: B Diff: 2 Objective: LO 2-3

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2.3-11) The economic resources of a company resulting from past transactions are called ________. A) assets B) revenues C) retained earnings D) contributed capital Answer: A Diff: 2 Objective: LO 2-3 2.3-12) Liabilities are ________. A) amounts that the business owes B) amounts that the business owns C) Shareholder claims on the assets of the business D) matched with revenues to calculate income Answer: A Diff: 2 Objective: LO 2-3 2.3-13) Financial statements may be prepared ________. A) weekly B) monthly C) quarterly D) All of these are correct. Answer: D Diff: 1 Objective: LO 2-3 2.3-14) During its first year of business, Mega, Inc. earned revenues of $400,000, of which it collected only $310,000 in cash. Which of the following statements is CORRECT? A) The income statement will show Cash collected from customers of $310,000. B) The balance sheet will show Accounts receivable of $310,000. C) The income statement will show Revenues of $310,000. D) The income statement will show Revenues of $400,000. Answer: D Diff: 2 Objective: LO 2-3

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2.3-15) The four basic financial statements are the ________. A) income statement, balance sheet, statement of changes in shareholders' equity, and cash budget B) income statement, balance sheet, cash budget, and statement of cash flows C) income statement, balance sheet, statement of changes in shareholders' equity, and statement of cash flows D) balance sheet, shareholders' equity, statement of cash flows, and cash budget Answer: C Diff: 2 Objective: LO 2-3 2.3-16) In June, Team Shirts collected $2,250 from customers, paid $600 for T-shirts, and paid $500 for rent. Net cash from operations was ________. A) $1,950 B) $1,650 C) $1,150 D) $2,250 Answer: C Diff: 2 Objective: LO 2-3 2.3-17) Accounts receivable are classified as ________. A) current assets B) current liabilities C) noncurrent assets D) noncurrent liabilities Answer: A Diff: 1 Objective: LO 2-3 2.3-18) Accounts payable are classified as ________. A) current assets B) current liabilities C) noncurrent assets D) noncurrent liabilities Answer: B Diff: 1 Objective: LO 2-3 2.3-19) Equity ________. A) represents shareholders' claims to the assets of a business B) represents capital contributions to the business by lenders C) represents capital owed by customers D) is equal to assets plus liabilities Answer: A Diff: 1 Objective: LO 2-3 21 Copyright Š 2011 Pearson Education, Inc.


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2.3-20) A classified balance sheet shows subtotals for ________. A) revenues and expenses B) current assets, long-term assets, current liabilities, long-term liabilities and shareholders' equity C) operating activities, investing activities and financing activities D) retained earnings, net income, and dividends Answer: B Diff: 2 Objective: LO 2-3 2.3-21) Contributed capital is also called ________. A) paid-in capital B) retained earnings C) investments D) non-current liabilities Answer: A Diff: 2 Objective: LO 2-3 2.3-22) Cash is ________. A) part of retained earnings B) found on the income statement C) equal to net income on the income statement D) found on the balance sheet Answer: D Diff: 2 Objective: LO 2-3 2.3-23) Team Shirts purchased $2,000 worth of T-shirts from a company in Guatemala. Team Shirts recorded the value of the transaction in U.S. dollars. Which accounting rule applies to this situation? A) monetary-unit assumption B) consistency C) relevance D) full-disclosure principle Answer: A Diff: 2 Skill: Analytic skills, Dynamics of the global economy Objective: LO 2-3

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2.3-24) The three basic elements of the balance sheet are ________. A) operating activities, investing activities, and financing activities. B) assets, liabilities, and shareholders' equity C) revenues, expenses, and net income or loss D) retained earnings, net income, and dividends Answer: B Diff: 1 Objective: LO 2-3 2.3-25) The three basic elements of the statement of cash flows are ________. A) operating activities, investing activities, and financing activities B) assets, liabilities, and shareholders' equity C) revenues, expenses, and net income or loss D) retained earnings, net income, and dividends Answer: A Diff: 1 Objective: LO 2-3 2.3-26) The three basic elements of the income statement are ________. A) operating activities, investing activities, and financing activities B) assets, liabilities, and shareholders' equity C) revenues, expenses, and net income or loss D) retained earnings, net income, and dividends Answer: C Diff: 1 Objective: LO 2-3 2.3-27) South Seas reported the following items on its financial statements. Determine the amount of the missing operating expenses. Net income Sales Cost of goods sold

$ 50,000 250,000 80,000

Answer: $250,000 - 50,000 - 80,000 = $120,000 Diff: 2 Skill: Analytic skills Objective: LO 2-3

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2.3-28) South Seas reported the following items on its financial statements. Determine the amount of cost of goods sold. Net income Sales Operating expenses

$ 50,000 250,000 120,000

Answer: $250,000 - 50,000 - 120,000 = $80,000 Diff: 1 Skill: Analytic skills Objective: LO 2-3 2.3-29) South Seas reported the following items on its financial statements. Determine the amount of net income. Then calculate the ending balance for retained earnings. Sales $ 300,000 Cost of goods sold 180,000 Operating expenses 40,000 Net income ?? Dividends 2,000 Beginning retained earnings 30,500 Answer: $300,000 — 180,000 —40,000 = $80,000 net income Beginning retained earnings $ 30,500 Net income 80,000 Dividends (2,000) Ending retained earnings $108,500 Diff: 2 Skill: Analytic skills Objective: LO 2-3

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2.3-30) Jem's Jewelers reported the following items on its financial statements. Determine the amount of net income. Then calculate the ending balance for retained earnings. Sales $ 250,000 Cost of goods sold 57,500 Operating expenses 25,000 Net income ?? Dividends 4,000 Beginning retained earnings 55,500 Answer: $250,000 — 57,500 — 25,000 = $167,500 net income Beginning retained earnings $ 55,500 Net income 167,500 Dividends (4,000) Ending retained earnings $219,000 Diff: 2 Skill: Analytic skills Objective: LO 2-3 2.3-31) Analyze each of the following transactions and determine the effect on the accounting equation. 1. Purchased three months' worth of prepaid advertising for $300. 2. Paid $500 cash on an account payable. 3. Paid $100 for supplies. 4. Performed $4,000 of services on account. Answer: 1. Increased assets $300 and decreased assets $300 (or no change). 2. Decreased assets $500 and decreased Accounts payable $500. 3. Increased assets $100 and decreased assets $100 (or no change). 4. Increased assets $4,000 and increased shareholders' equity $4,000. Diff: 1 Skill: Analytic skills Objective: LO 2-3

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2.3-32) River Runners, Inc. reported the following information in its financials for the year ended December 31, 2012: Dividends Net Income Total expenses Retained earnings - beginning balance Jan. 1, 2012 Accounts receivable

$ 3,000 45,000 50,000 30,000 20,000

1. What were the company's revenues? 2. How much of the past profits have been kept by the company as of December 31? 3. How much do customers owe River Runners as of December 31, 2012? Answer: 1. $95,000 revenue = $45,000 + 50,000 2. $122,000 = $30,000 + 95,000 — 3,000 3. $20,000 Diff: 2 Skill: Analytic skills Objective: LO 2-3 2.3-33) Why is it necessary to adjust the books? Answer: Adjusting the books is the process of bringing the accounts up to date at the end of an accounting period and before the financial statements are prepared. It is necessary because some account items change during the accounting period. For example, a company can purchase a sixmonth vehicle insurance policy. After one month, one month's insurance has been used up. This is an expense. An adjusting entry must be made in order to record the insurance expense and the reduction in the prepaid insurance (asset) account. Once this is done, the accounting records will accurately reflect the true picture of a company. Diff: 3 Skill: Communication abilities Objective: LO 2-3

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2.3-34) Beta Company reported the following information in its year ended December 31, 2012 financials: Net income Sales revenue Retained earnings - beginning balance Dividends

$ 15,000 75,000 16,000 4,000

1. What were the company's total expenses? 2. How much of the company's profits have been kept by the company as of 1/1/12? 3. What is the balance of retained earnings at December 31, 2012? Answer: 1. $60,000 = $75,000 - 15,000 2. $16,000 3. $27,000 = $16,000 + 15,000 - 4,000 Diff: 2 Skill: Analytic skills Objective: LO 2-3 2.3-35) Use the following information for DeltaCo for the year ended December 31, 2011 to answer the questions below. Assume no new common stock was issued during the year. Expenses for the year Net income Retained earnings, December 31, 2010 Retained earnings, December 31, 2011 Total shareholders' equity at December 31,2010 Total assets at December 31, 2010 Total assets at December 31, 2011

$ 700 200 600 500 900 1,200 1,300

1. What were the total revenues for the year? 2. What was the dividend during the year? 3. What were the total liabilities on the balance sheet at December 31, 2011? 4. How much is contributed capital at December 31, 2011? Answer: 1. $900 = $700 + 200 2. $300 = $600 + 200 - 500 3. $400 = $1,300 - 900 4. $400 = $900 - 500 Diff: 2 Skill: Analytic skills Objective: LO 2-3

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2.3-36) Match each of the accounts listed below with the appropriate balance sheet classification. a. Assets b. Liabilities c. Shareholders' equity _____ 1. Accounts receivable _____ 2. Retained earnings _____ 3. Accounts payable _____ 4. Cash _____ 5. Contributed capital _____ 6. Notes payable _____ 7. Inventory _____ 8. Common stock Answer: a, c, b, a, c, b, a, c Diff: 2 Objective: LO 2-3

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2.3-37) Indicate with an “X" whether each item is an asset, liability or shareholders' equity account. There is only one correct answer for each. Item: 1. Dividends 2. Accounts receivable 3. Contributed capital 4. Note payable 5. Wages expense 6. Wages payable 7. Prepaid insurance 8. Insurance expense 9. Accounts payable 10. Retained earnings Answer: Item: 1. Dividends 2. Accounts receivable 3. Contributed capital 4. Note payable 5. Wages expense 6. Wages payable 7. Prepaid insurance 8. Insurance expense 9. Accounts payable 10. Retained earnings

Asset Liability Shareholders' equity

Asset Liability Shareholders' equity X X X X X X X X X X

Diff: 2 Objective: LO 2-3

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2.3-38) Identify the appropriate financial statement for each of the items listed below. Some items may be found on more than one financial statement. a. b. c. d.

Balance sheet Income statement Statement of changes in shareholders' equity Statement of cash flows

_____ 1. Cash paid for supplies _____ 2. Net income _____ 3. Sales revenue _____ 4. Rent expense _____ 5. Inventory _____ 6. Retained earnings _____ 7. Cash received from customers _____ 8. Cash Answer: d, b and c, b, b, a, a and c, d, a and d Diff: 2 Objective: LO 2-3

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2.3-39) Match each of the following terms with the appropriate definitions. Use each term only once. a. b. c. d. e. f. g. h. i. j. k.

prepaid insurance accounts receivable accounts payable assets current assets liabilities current liabilities classified balance sheet shareholders' equity contributed capital adjusting the books

_____ 1. Name for the owners' claims to the assets of the business which includes both contributed capital and retained earnings _____ 2. The economic resources of a company resulting from past transactions _____ 3. Amounts customers owe a company for goods or services purchased on credit _____ 4. Obligations the company has incurred to obtain the assets it owns _____ 5. Insurance a business has purchased, but not yet used _____ 6. Assets the company plans to turn into cash or use to generate revenue in the next fiscal year _____ 7. The amount the owners have put into their business _____ 8. The process of making changes in the accounting records, at the end of an accounting period to make sure that the amounts reflect the financial condition of a company as of that date _____ 9. Financial statement which shows subtotals for current assets and current liabilities _____ 10. Liabilities the company will pay off within the next fiscal year _____ 11. Amounts the company owes its vendors Answer: i, d, b, f, a, e, j, k, h, g, c Diff: 2 Objective: LO 2-3

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2.3-40) Indicate with an "X" the one financial statement where you would expect to find each line item: Statement Income of Cash Balance Statement Flows Sheet 1. Cash paid for insurance 2. Prepaid insurance 3. Insurance expense 4. Wages paid to employees 5. Wages payable 6. Wages expense 7. Accounts payable 8. Cost of goods sold 9. Inventory 10. Cash paid to vendors Answer:

Statement Income of Cash Balance Statement Flows Sheet 1. Cash paid for insurance X 2. Prepaid insurance X 3. Insurance expense X 4. Wages paid to employees X 5. Wages payable X 6. Wages expense X 7. Accounts payable X 8. Cost of goods sold X 9. Inventory X 10. Cash paid to vendors X Diff: 2 Objective: LO 2-3

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2.3-41) Classify each of the items below according to the section of a firm's financial statements where it would be reported. Some sections may be used more than once. Others may not be used at all. a. Current asset c. Current liability f. Revenue b. Long-term asset d. Long-term liability g. Expense e. Shareholders' equity _____ 1. Common stock _____ 2. Notes payable (due in 2 years) _____ 3. Prepaid insurance (2 months remaining) _____ 4. Sales _____ 5. Cost of goods sold Answer: e, d, a, f, g, c, b, a, f, a Diff: 2 Objective: LO 2-3

_____ 6. Accounts payable _____ 7. Land _____ 8. Inventory _____ 9. Service fees earned _____10. Accounts receivable

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2.3-42) Indicate with an "X" the one financial statement where you would expect to find each line item: Statement Income of Cash Balance Statement Flows Sheet 1. Interest payable 2. Interest expense 3. Notes payable 4. Cash paid for interest 5. Rent payable 6. Prepaid rent 7. Rent expense 8. Cash paid for rent 9. Sales revenue 10. Cash collected from customers 11. Accounts receivable

Answer: 1. Interest payable 2. Interest expense 3. Notes payable 4. Cash paid for interest 5. Rent payable 6. Prepaid rent 7. Rent expense 8. Cash paid for rent 9. Sales revenue 10. Cash collected from customers 11. Accounts receivable

Statement Income of Cash Balance Statement Flows Sheet X X X X X X X X X X X

Diff: 2 Objective: LO 2-3

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2.3-43) For each description, identify with an “X" whether the item is either an asset (A), liability (L) or shareholders' equity (SE) account on the balance sheet or a revenue (R) or expense (E) on the income statement. There is only one correct answer for each description. Income Balance Sheet Statement Description: A L SE R E 1. Resources available for future use 2. Accounts payable 3. Amounts not yet collected from customers 4. Cost of goods sold 5. Prepaid insurance 6. Past profits kept by the company Answer:

Income Balance Sheet

1. 2. 3. 4. 5. 6.

A X

L

SE

Statement

R

E

X X X X X

Diff: 2 Objective: LO 2-3 Learning Objective 2-4 2.4-1) Team Shirts purchased T-shirts in July. The T-shirts were sold to customers in August. Team Shirts received the final cash payments in September. According to the revenuerecognition principle, when should revenue be recorded? A) July B) August C) September D) both August and September Answer: B Diff: 3 Skill: Analytic skills Objective: LO 2-4

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2.4-2) Team Shirts ordered T-shirts from its supplier in June. The T-shirts were delivered in July. Team Shirts paid the bill in August and sold the T-shirts in September. When should Team Shirts recognize an expense using accrual accounting? A) June B) September C) August D) July Answer: B Diff: 3 Skill: Analytic skills Objective: LO 2-4 2.4-3) Accrual accounting is an accounting system in which ________. A) measurement of income is NOT based on cash receipts and cash disbursements B) measurement of income is based on cash receipts and cash disbursements C) all businesses prepare reports required by the FASB D) there are no timing differences Answer: A Diff: 3 Objective: LO 2-4 2.4-4) Clean Sweep performed cleaning services and billed the customer for $900. This transaction includes ________. A) revenue and an account payable B) revenue and an account receivable C) revenue and cash D) revenue and retained earnings Answer: B Diff: 3 Skill: Analytic skills Objective: LO 2-4 2.4-5) During the year, Mega, Inc. had revenues of $400,000 of which $310,000 was collected from customers. It also had expenses of $360,000 of which $280,000 was paid. The shareholders were paid $20,000 in dividends. Net income for the year equals ________. A) $10,000 B) $30,000 C) $40,000 D) $20,000 Answer: C Diff: 3 Skill: Analytic skills Objective: LO 2-4

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2.4-6) Team Shirts ordered T-shirts from its supplier in June. The T-shirts were delivered in July. Team Shirts paid the bill in August and sold the T-shirts in September. When should Team Shirts recognize an expense using cash-basis accounting? A) June B) September C) August D) July Answer: C Diff: 3 Skill: Analytic skills Objective: LO 2-4 2.4-7) During May, Team Shirts spent $4,000 to buy 800 T-shirts and sold 300 of them for $15 each. Team Shirts should recognize ________ as expense for May. A) $4,500 B) $1,500 C) $3,750 D) $4,000 Answer: B Diff: 3 Skill: Analytic skills Objective: LO 2-4 2.4-8) During May, Team Shirts spent $4,000 to buy 800 T-shirts. In May, Team Shirts sold 300 of them for $15 each. The rest were sold for cash of $12 each in June. Net income for May and June was ________. A) $4,500 in May and $6,000 in June B) $3,000 in May and $3,500 in June C) $1,500 in May and $2,500 in June D) $500 in May and $6,000 in June Answer: B Diff: 3 Skill: Analytic skills Objective: LO 2-4 2.4-9) An accrual transaction is one in which ________. A) the action comes before the cash B) cash comes before the action C) a company postpones recognizing cash transactions D) the exchange of cash coincides with the economic substance of a transaction Answer: A Diff: 2 Objective: LO 2-4

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2.4-10) A deferral transaction is one in which ________. A) the action comes before the cash B) cash comes before the action C) a company postpones recognizing cash transactions D) the exchange of cash coincides with the economic substance of a transaction Answer: B Diff: 2 Objective: LO 2-4 2.4-11) An account receivable is ________. A) an accrual B) a deferral C) a cash sale to a customer D) cash collected from a customer Answer: A Diff: 2 Objective: LO 2-4 2.4-12) Prepaid insurance is ________. A) an accrual B) a deferral C) insurance expense D) a liability Answer: B Diff: 2 Objective: LO 2-4 2.4-13) An accrual transaction is one in which revenue is earned before cash is received. Answer: TRUE Diff: 3 Objective: LO 2-4 2.4-14) Cash-basis accounting is the preferred method of accounting according to the FASB. Answer: FALSE Diff: 2 Objective: LO 2-4 2.4-15) On April 25, Team Shirts paid $1,000 for advertising for May and June. This transaction is a deferral. Answer: TRUE Diff: 3 Objective: LO 2-4

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2.4-16) Accrual accounting is an accounting system in which the measurement of income is based on cash receipts and cash disbursements. Answer: FALSE Diff: 3 Objective: LO 2-4 2.4-17) Financial statements should be prepared using accrual accounting. Answer: TRUE Diff: 1 Objective: LO 2-4 2.4-18) Nikki Okuma is going over the transactions for May. She is having fun running South Seas and is eager to learn more about the accounting aspects of her business. Review the following transactions and explain to Nikki the accounting rules that apply to each situation. 1. South Seas imports items from several Pacific island countries. All of them have different currencies. 2. South Seas imported $10,000 worth of inventory in May and sold $3,000 of it in May. 3. Three customers paid $400 in advance deposits for some carvings to be ordered from Tahiti. 4. Nikki has a personal collection of Balinese puppets which is displayed in her store. Answer: 1. The monetary-unit assumption requires that all of the financial statements should be reported in U.S. dollars. 2. The matching principle requires that items sold in May be recognized as cost of goods sold in May. 3. The revenue-recognition principle applies to accrual accounting. South Seas cannot recognize revenue even though customers have paid $400 in cash. The money will not be earned until the carvings are delivered. 4. Nikki cannot include her personal collection of Balinese puppets as part of the assets of the business. The separate-entity assumption requires that personal assets be kept separate from business assets. Diff: 3 Skill: Communication abilities, Dynamics of the global economy Objective: LO 2-4 2.4-19) Baby Boutique had $150 worth of supplies on hand at the beginning of June. During June, the store paid $600 for more supplies. At the end of the month, a physical count showed $475 of supplies left. How much supplies expense did Baby Boutique have during June? Answer: $150 + 600 - 475 = $275 Diff: 3 Skill: Analytic skills Objective: LO 2-3 & LO 2-4

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2.4-20) Baby Boutique had $250 worth of supplies on hand at the beginning of July. During July, the store paid $460 for more supplies. At the end of the month, a physical count showed $240 of supplies left. How much supplies expense did Baby Boutique have during July? Answer: $250 + 460 - 240 = $470 Diff: 3 Skill: Analytic skills Objective: LO 2-3 & LO 2-4 2.4-21) Both Company A and Company B use accrual accounting. Both have $80,000 in sales revenues and $50,000 in expenses for their first month of business. Company A allows cash sales only. Company B sells to its customers on account and as of the end of the month its customers owe $30,000. Show how Company A's and B's four financial statements compare by putting an X under either the Same or Different column for each of the statements. Same

Different

Same X X

Different

1. Income Statement 2. Statement of Changes in Shareholders' Equity 3. Statement of Cash Flows 4. Balance Sheet Answer:

1. Income Statement 2. Statement of Changes in Shareholders' Equity 3. Statement of Cash Flows 4. Balance Sheet

X X

Diff: 3 Skill: Analytic skills Objective: LO 2-3 & LO 2-4 2.4-22) Clean Sweep contracted to clean an office building in May for $2,000. The work was completed in May and Clean Sweep received a payment of $1,800. The second payment was received in June. How were these events reported on the May 31 financial statements? Answer: The May income statement will report revenue of $2,000; the statement of cash flows will report cash collected from customers of $1,800; and the balance sheet will report accounts receivable of $200. Diff: 3 Skill: Analytic skills Objective: LO 2-3 & LO 2-4

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2.4-23) Clean Sweep contracted to clean an office building in July for $1,500. The work was contracted in July. The building was completely cleaned in August and Clean Sweep received a payment of $500. The remaining payment of $1,000 was received in September. Discuss how this event would be reported in the monthly financial statements for July, August and September. Answer: The financial records were not affected in July because there was no completed transaction. For the month ended August 31, the income statement would report revenue of $1,500; the statement of cash flows would report cash collected from customers of $500; and the balance sheet at August 31 would report an account receivable of $1,000. In September, the income statement would report no revenue; the statement of cash flows would report cash collected from customers of $1,000; and the balance sheet would show no account receivable. Diff: 3 Skill: Analytic skills Objective: LO 2-3 & LO 2-4 2.4-24) Clean Sweep agreed to clean an office building on a weekly basis for $1,000 per week. The contract began on August 15, and Clean Sweep cleaned the building twice during August. Clean Sweep received $1,000 cash in August. During August, Clean Sweep spent $400 on wages for the workers who cleaned the building, $90 for the cleaning supplies used, and $4,000 to purchase specialized cleaning equipment. How much revenue should Clean Sweep recognize in August using accrual accounting? Answer: Revenue = $2,000 Diff: 3 Skill: Analytic skills Objective: LO 2-4 2.4-25) Clean Sweep agreed to clean an office building on a weekly basis for $1,000 per week. The contract began on August 15, and Clean Sweep cleaned the building twice during August. Clean Sweep received $1,000 cash in August. During August, Clean Sweep spent $400 on wages for the workers who cleaned the building, $90 for the cleaning supplies used, and $4,000 to purchase specialized cleaning equipment. How much revenue should Clean Sweep recognize in August using cash-basis accounting? Answer: Revenue = $1,000 Diff: 3 Skill: Analytic skills Objective: LO 2-4 2.4-26) Explain the differences between accruals and deferrals. Answer: An accrual is a transaction in which the revenue is earned, or the expense is incurred, before the exchange of cash. An example would be a sale on account. The account receivable is an accrual. A deferral is a transaction in which the exchange of cash takes place before the revenue is earned, or the expense is incurred. An example would be prepaid rent. Diff: 3 Skill: Communication abilities Objective: LO 2-4

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2.4-27) Explain the differences between cash-basis and accrual accounting. Answer: Cash-basis accounting is a system based on the exchange of cash. In this system, revenue is recognized only when cash is collected, and an expense is recognized only when cash is disbursed. Cash-basis accounting is not an acceptable method under GAAP. Accrual accounting is the required method of reporting under GAAP. Under accrual accounting, revenues are recognized when earned, and expenses are recognized when incurred. The recognition of revenues and expenses does not always occur in the same accounting period as the related cash receipts and cash disbursements. Diff: 3 Skill: Communication abilities Objective: LO 2-4

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2.4-28) Max is having a problem understanding the financial statements. He believes that his administrative assistant has made some errors in preparing the income statement. Evaluate the following transactions and the income statement prepared by the administrative assistant. Prepare a corrected income statement using U.S. GAAP. a. Max's Catering earned $10,000 in catering business during June. b. Customers paid $2,500 in deposits for parties to be catered in July. c. The business paid $500 for June rent. d. The business paid the chef $5,000 in wages for June. e. The business spent $3,300 on food, spices, and other ingredients, and used $1,500 of them during June. Max's Catering Income Statement At June 2012 Revenues Expenses Rent Wages Supplies Total expenses Net income

$12,500 $ 500 5,000 3,300 $(8,800) $ 3,700

Answer: Max's administrative assistant has prepared a cash basis income statement instead of an accrual income statement. The assistant also made other mistakes. Max's Catering Income Statement At June 2012 Revenues Expenses Rent $ 500 Wages 5,000 Supplies 1,300 Total expenses Net income Diff: 3 Skill: Analytic skills Objective: LO 2-3 & LO 2-4

$10,000

$(7,000) $ 3,000

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2.4-29) Clean Sweep agreed to clean an office building on a weekly basis for $1,000 per week. The contract began on August 15, and Clean Sweep cleaned the building twice during August. Clean Sweep received $2,000 cash in September for the cleaning performed in August. How much revenue should Clean Sweep recognize in August using accrual accounting? Answer: Clean Sweep should recognize two weeks, or $2,000, of revenue. Diff: 3 Skill: Analytic skills Objective: LO 2-4 2.4-30) Clean Sweep agreed to clean an office building on a weekly basis for $1,000 per week. The contract began on August 15, and Clean Sweep cleaned the building twice during August. Clean Sweep received $2,000 cash in September for the cleaning performed in August. How much revenue should Clean Sweep recognize in August using cash-basis accounting? Answer: Since Clean Sweep received $0 from its customer; it would recognize $0 in revenue. Diff: 3 Skill: Analytic skills Objective: LO 2-4 2.4-31) Identify each of the following items as either an accrual or deferral. a. Accrual b. Deferral _____ 1. Account receivable _____ 2. Account payable _____ 3. Prepaid insurance _____ 4. Interest receivable _____ 5. Prepaid advertising Answer: a, a, b, a, b Diff: 2 Objective: LO 2-4

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2.4-32) Team Instructions: Divide the class into teams of three or four people. Each team member should work the following problem separately outside of class. Then give the students time in class to compare answers with their teammates and put together a final correct copy of the problem. Each team should turn in only one copy of the problem for grading. All team members will receive the same grade. First do Parts A through C on your own. Then get together with your team and prepare a team solution to hand in. Part A: Record Icon Consultant's transactions below by filling in the amount and the account title from the list of accounts below (use the abbreviations given): Account - abbreviation Accounts receivable - AR Cash Common stock - CS Dividends - Div

Account - abbreviation Insurance expense - Ins exp Operating expenses - Oper exp Other payables - OP Prepaid insurance - PI

Account - abbreviation Service revenue - Rev Supplies - Sup Supplies expense - Sup exp

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Part B: Using Part A, fill in the missing information on the following financial statements for the year ended December 31, 2012.

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Part C:

Answer: Part A:

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Part B:

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Part C:

Diff: 3 Skill: Analytic skills, Team Objective: LO 2-3 & LO 2-4 Learning Objective 2-5 2.5-1) The current ratio measures the ________. A) amount of revenue recognized in the current accounting period B) liquidity of a company C) profitability of a company D) financial risk of a company Answer: B Diff: 1 Objective: LO 2-5 2.5-2) Liquidity ________. A) represents the amount of financial risk a company assumes B) measures how easily a company can turn its long-term assets into cash C) measures how easily a company can pay its debts as they come due D) is always higher for large companies than for small companies Answer: C Diff: 2 Objective: LO 2-5

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2.5-3) Team Shirts had current assets of $2,500, long-term assets of $3,850, current liabilities of $1,450, long-term liabilities of $2,000, and shareholder's equity of $2,900. The current ratio (rounded) is ________. A) 0.72 B) 1.84 C) 4.38 D) 1.72 Answer: D Diff: 2 Skill: Analytic skills Objective: LO 2-5 2.5-4) Team Shirts had current assets of $500 and total assets of $2,300. Long-term liabilities were $700 and total liabilities were $1,430. The current ratio (rounded) is ________. A) 0.68 B) 1.61 C) 0.35 D) 0.71 Answer: A Diff: 3 Skill: Analytic skills Objective: LO 2-5 2.5-5) Maids-R-Us had current assets of $1,160 and total assets of $2,640. It had $650 in accounts payable and a note payable for $1,500 due in two years. The current ratio (rounded) was ________. A) 1.23 B) 1.78 C) 0.54 D) 0.81 Answer: B Diff: 2 Skill: Analytic skills Objective: LO 2-5 2.5-6) Clean Sweep had current assets of $650 and long-term assets of $1,350. It had current liabilities of $500 and a note payable of $600 due in three years. Its current ratio (rounded) was ________. A) 1.30 B) 1.82 C) 4.00 D) 0.59 Answer: A Diff: 1 Skill: Analytic skills Objective: LO 2-5 50 Copyright Š 2011 Pearson Education, Inc.


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2.5-7) Before lending money to Brokah, Inc., you should calculate Brokah's current ratio to measure its ________. A) liquidity, i.e., its ability to pay its current debts as they come due B) ability to turn its noncurrent liabilities into current liabilities C) profitability D) ability to turn its noncurrent assets into current assets Answer: A Diff: 2 Skill: Analytic skills Objective: LO 2-5 2.5-8) The current ratio measures a company's ability to pay its bills. Answer: TRUE Diff: 2 Objective: LO 2-5 2.5-9) Team Shirts has $189,000 in total current assets and $165,000 in total current liabilities. Calculate the current ratio for Team Shirts. Round your answer to one decimal place. Answer: $189,000/$165,000 = 1.1 Diff: 1 Skill: Analytic skills Objective: LO 2-5 2.5-10) Team Shirts has $240,000 in total current assets and $190,000 in total current liabilities. Calculate the current ratio for Team Shirts. Round your answer to one decimal place. Answer: $240,000/$190,000 = 1.3 Diff: 1 Skill: Analytic skills Objective: LO 2-5 2.5-11) Team Shirts has $233,000 in total current assets and $141,500 in total current liabilities. 1. Calculate the current ratio (rounded to one decimal place) for Team Shirts. 2. Is this a more favorable ratio than 0.9 to 1? Answer: 1. $233,000/$141,500 = 1.6 to 1, 2. Yes, it is more favorable Diff: 2 Skill: Analytic skills Objective: LO 2-5

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2.5-12) Evaluate the following information for Team Shirts. Part A: Calculate the current ratio for Team Shirts (round to two decimal places). Part B: Is the ratio acceptable or unacceptable? Why? Part C: Advise Team Shirts how to improve the ratio. Assets Cash Accounts receivable Supplies Prepaid insurance Equipment Building

Liabilities and shareholders' equity

$ 10,000 2,030 180 2,000 25,000 110,000

Accounts payable Wages payable Notes payable (due in 2 years) Common stock Retained earnings

$ 20,750 1, 220 8,000 100,000 19,240

Answer: Part A. Total current assets = $10,000 + 2,030 + 180 + 2,000 = $14,210 Current liabilities = $20,750 + 1,220 = $21,970 Current ratio: $14,210/$21,970 = 0.65 Part B. This is an unacceptable ratio. There are not nearly enough current assets to cover the current liabilities Part C. If Team Shirts wants to improve this ratio, it could pay off some of the accounts payable and/or increase the amount of cash by borrowing long-term. Diff: 3 Skill: Analytic skills Objective: LO 2-5 2.5-13) Ima Knerd is happy with the progress of her computer repair business. She has made a profit in each of the past six months. However, her accountant is worried because the current ratio for the business is 0.80. Explain to Ima why this is a concern. Answer: A current ratio of 0.80 means that for every $1 of current liabilities, Ima's business has only $0.80 available in current assets. She has borrowed too much money and will not be able to pay the debts with her current assets. She must rely on current cash flows to cover her debt payments. Ima should concentrate on paying her debts. At the same time, she should try to increase the amount of her current assets, particularly cash. Diff: 3 Skill: Communication abilities Objective: LO 2-5

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2.5-14) Evaluate the following information for Team Shirts: Part A: Calculate the current ratio for Team Shirts (round to two decimal places). Part B: Is the ratio acceptable or unacceptable? Why? Part C: Advise Team Shirts how to improve the ratio. Assets Cash Accounts receivable Supplies Prepaid insurance

Liabilities and shareholders' equity $ 9,000 4,430 2,690 3,000

Accounts payable Wages payable Common stock Retained earnings

$ 10,750 250 6,000 2,120

Answer: Part A. Total current assets = $9,000 + 4,430 + 2,690 + 3,000 = $19,120 Total current liabilities = $10,750 + 250 = $11,000 Current ratio: $19,120/$11,000 = 1.74 Part B. This is an acceptable ratio because all of the current liabilities are covered by current assets. Part C. If Team Shirts wants to improve this ratio, it could pay off some of the accounts payable and/or increase the amount of cash by borrowing on a long-term note. Diff: 3 Skill: Analytic skills Objective: LO 2-5

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2.5-15) Evaluate the following information for Team Shirts. Part A: Calculate the current ratio for Team Shirts. (Round to two decimal places.) Part B: Is the ratio acceptable or unacceptable? Part C: Advise Team Shirts how to improve the ratio. Assets Cash Accounts receivable Supplies Prepaid insurance Equipment Building

Liabilities and shareholders' equity

$ 8,000 7,030 980 3,000 35,000 120,000

Accounts payable Wages payable Notes payable (due in 2 years) Common stock Retained earnings

$ 13,750 3, 220 20,000 120,000 17,040

Answer: Part A. Total current assets = $8,000 + 7,030 + 980 + 3,000 = $19,010 Current liabilities = $13,750 + 3,220 = $16,970 Current ratio: $19,010/$16,970 = 1.12 Part B. This is an acceptable ratio because all of the current liabilities are covered by current assets. Part C. Team Shirts could pay off some of the accounts payable and/or increase cash by borrowing on a long-term note. Diff: 3 Skill: Analytic skills Objective: LO 2-5

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2.5-16) Team Instructions: Divide the class into teams of three or four people. Each team member should work the following problem separately outside of class. Then give the students time in class to compare answers with their teammates and put together a final correct copy of the problem. Each team should turn in only one copy of the problem for grading. All team members will receive the same grade. Provide students with copies of real merchandising companies' annual reports, or give students the Web addresses of real merchandising companies and ask them to print out the annual reports. All team members should work with the same company's annual report. Answer the following questions using the annual report assigned to your team. Turn in your annual report along with your answers.

1 2 3 4 5 6 7 8 9

What is the name of your company? Does the company use accrual or cash basis accounting? How can you tell which basis of accounting it uses? Do the property values represent cost or market values? Name one asset that is not a current asset. What is the amount of current assets at the most recent yearend? $ Name one liability that is not a current liability. Name one liability that is a current liability. What is the amount of current liabilities at the most recent yearend? $ 10 Calculate the current ratio for the most recent year. 11 Does the company have the ability to pay its bills when they come due? 12 Is the current or prior year's current ratio more favorable? Answer: 1 2

Company name Accrual Because the balance sheet has accounts receivable, accounts 3 payable, and other accrual type balance sheet accounts. 4. Cost 5 Property 6 7 Long-term debt 8 Accounts payable 9 10 11 Yes 12 Diff: 2 Skill: Analytic skills, Team Objective: LO 2-3, LO 2-4, & LO 2-5 55 Copyright Š 2011 Pearson Education, Inc.


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2.5-17) Team Instructions: Divide the class into teams of three or four people. Each team member should work the following problem separately outside of class. Then give the students time in class to compare answers with their teammates and put together a final correct copy of the problem. Each team should turn in only one copy of the problem for grading. All team members will receive the same grade. Part A: Record the transactions below by filling in the amount and the account title from the list of accounts below (use the abbreviations given): Account - abbreviation Accounts payable - AP Accounts receivable - AR Cash Common stock - CS

Account - abbreviation Cost of goods sold - COGS Dividends - Div Inventory - Inv Insurance expense - Ins exp

Account - abbreviation Net income - NI Prepaid insurance - PI Rent expense - Rent exp Sales revenue - Sales

1. February 1 Tim's Tams paid $800 for February's rent of a booth. 2. February 1 Tim's Tams paid $600 cash for three months of insurance coverage that begins February 1. 3. February 2 Tim's Tams purchased 800 baseball caps that cost $6.00 each on account. 4. February 12 Tim's Tams sold 600 baseball caps @ $10.00 each on account. Record both a)the sale and b) the cost of the sale. 5. February 20 Tim's Tams paid for $500 of the caps purchased on February 2. 6. February 28 Tim's Tams declared and paid a $100 cash dividend to its shareholder. 7. February 28 Adjusted for insurance used during the month.

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Parts B, C, D and E: Complete the four financial statements: Part B:

Part C:

Part D:

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Part E:

Part F: For each description, write in the amount and show on which of the February financial statements this information is found.

Part G: Using the financial statements above, answer the following:

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Answer: Part A:

Part B:

Part C:

Part D:

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Part E:

Part F:

Part G:

Skill: Analytic skills, Team Objective: LO 2-3, LO 2-4, & LO 2-5

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Learning Objective 2-6 2.6-1) Internal controls are ________. A) laws and regulations imposed by the IRS and SEC to ensure the accuracy of financial statements B) accounting procedures required by the FASB to ensure the accuracy and reliability of firms’ accounting records C) policies and procedures the managers of a firm use to protect a firm’s assets and the accuracy of its accounting records D) rules required by creditors to ensure repayment of liabilities Answer: C Diff: 2 Objective: LO 2-6 2.6-2) Preventive controls include ________. A) having the company’s accountant review the accounting records and make corrections each month B) limiting access to assets C) bank reconciliations (comparing the company’s accounting records for cash to its bank statement) D) counting the money in the cash register and comparing it with the total sales entered in the register Answer: B Diff: 3 Objective: LO 2-6 2.6-3) Detective controls include ________. A) separating the duties of cash collection from the duties of recording cash transactions in the books B) bank reconciliations (comparing the company’s accounting records for cash to its bank statement) C) limiting access to assets D) requiring passwords to access the computerized accounting records Answer: B Diff: 2 Objective: LO 2-6 2.6-4) Corrective controls include ________. A) requiring authorization for certain transactions B) limiting access to assets C) requiring passwords to access the computerized accounting records D) procedures for handling any errors that are detected Answer: D Diff: 2 Objective: LO 2-6

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2.6-5) Preventive controls are ________. A) designed to monitor business risks B) designed to identify when an error or irregularity has occurred C) designed to stop a problem before it starts D) directed at recovering from an error Answer: C Diff: 1 Objective: LO 2-6 2.6-6) Detective controls are ________. A) designed to monitor business risks B) designed to identify when an error or irregularity has occurred C) designed to stop a problem before it starts D) directed at recovering from an error Answer: B Diff: 1 Objective: LO 2-6 2.6-7) Corrective controls are ________. A) designed to monitor business risks B) designed to identify when an error or irregularity has occurred C) designed to stop a problem before it starts D) directed at recovering from an error Answer: D Diff: 1 Objective: LO 2-6 2.6-8) Denying future credit to customers who are slow to pay their accounts is called a ________. A) business control B) detective control C) corrective control D) preventative control Answer: C Diff: 2 Objective: LO 2-6 2.6-9) An accountant discovered a bank error while reviewing the bank statement, and called the bank to correct the mistake. This call is an example of a ________. A) business control B) detective control C) corrective control D) preventive control Answer: C Diff: 2 Objective: LO 2-6 62 Copyright Š 2011 Pearson Education, Inc.


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2.6-10) The accountant called the bank after noticing that a $200 deposit made on July 21 did not appear on the July 31 bank statement. This call is an example of a ________. A) business control B) detective control C) corrective control D) preventive control Answer: C Diff: 2 Objective: LO 2-6 2.6-11) Internal controls are the policies and procedures managers of a firm use to protect the firm’s assets and to ensure the accuracy and reliability of the firm’s accounting records. Answer: TRUE Diff: 1 Objective: LO 2-6 2.6-12) An example of a preventive control is requiring that all purchases over $1,000 be authorized by upper management. Answer: TRUE Diff: 2 Objective: LO 2-6 2.6-13) An example of a detective control is requiring that the cash drawer be compared with the sales recorded by the register. Answer: TRUE Diff: 2 Objective: LO 2-6 2.6-14) An example of a corrective control is requiring that on a regular basis management must follow up on all errors and irregularities identified. Answer: TRUE Diff: 2 Objective: LO 2-6 2.6-15) Preventive controls are designed to prevent an error or irregularity. Answer: TRUE Diff: 1 Objective: LO 2-6 2.6-16) An example of a preventive control is to require passwords in order to limit access to the information system. Answer: TRUE Diff: 2 Skill: Use of information technology Objective: LO 2-6

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2.6-17) For each of the following situations discuss whether the accounting treatment is proper and, if not proper, what accounting principle is violated. Discuss the ethical and financial statement implications of each of the improper treatments. A. A service company records revenue when cash is collected in advance of performing the service. B. The owner used the cash received from a company bank loan to buy a car for his own personal use. The car was recorded as a company asset. C. A company records revenue when earned even when the cash has not yet been received. D. Land purchased ten years ago for $20,000 is reported on the balance sheet at its current value of $30,000. The company follows U.S. GAAP in preparing financial statements. E. Inventory purchased last month and sold this month was deducted as an expense on this month’s income statement. Answer: A. This violates the revenue-recognition principle and is considered unethical because recording revenue prior to performing the service would overstate revenue and net income (and understate liabilities.) B. This violates the separate-entity assumption and is considered unethical because owners should not include their personal affairs with their companies’ affairs. The company’s notes payable and assets will be overstated, which is unethical since these are not the company’s but the owner’s obligation and asset. C. This is proper treatment. D. This violates the cost principle. Land is to be reported at its cost and not its current value. It is unethical to increase the value of land under U.S. GAAP because it is thought that the current values are not reliable. However, this is an acceptable accounting treatment under IFRS. E. This is proper treatment. Diff: 2 Skill: Analytic skills, Dynamics of the global economy, Ethical understanding and reasoning abilities Objective: LO 2-2 & LO 2-6 2.6-18) Vestige, Inc. needs another loan from a bank in order to pay its bills. In order to improve its chances of getting another loan, it reports its ten-month note payable as a long-term liability. Discuss the treatment of this note payable including the financial statement presentation and the effect on the current ratio. Discuss the ethical issue with Vestige’s treatment of this note payable. Answer: Vestige, Inc. is unethical in misrepresenting its financial position. The note is a current liability, not a long-term liability, because it is due within one year. Since its current liabilities are understated, the current ratio will look more favorable than it should. A potential creditor will be misled and may decide to lend the money only to find out later that the company does not have the ability to pay back its loans when due. Diff: 2 Skill: Communication abilities, Ethical understanding and reasoning abilities Objective: LO 2-3, LO 2-5, & LO 2-6

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2.6-19) Name one type of preventive control that would be useful in a computerized information system. Answer: Preventive controls include the use of passwords and limiting access to certain computer files and programs. Computer programs could include calculations and reasonableness checks and limits to flag and correct errors. Diff: 2 Skill: Use of information technology Objective: LO 2-6 2.6-20) Name one type of detective control that would be useful in a computerized information system. Answer: A detective control includes using computerized reports that list any unusual amounts or activity. Diff: 2 Skill: Use of information technology Objective: LO 2-6 2.6-21) On July 1, the bank said it may lend money to Funny Books, Inc., but only after it prepares an income statement for the month of July. Since the bank did not specify, Funny Books, Inc. did not follow generally accepted accounting principles (GAAP). It reported net income of $12,000 for the month ended July 31. The revenue included $4,000 of cash collected in advance from customers for services to be performed in August. The revenue also included a $3,000 increase in the value of its land. The expenses excluded $2,000 Funny Books owed for July services it received. Part A: List the GAAP that were violated by Funny Books, Inc. and explain what the proper accounting treatment would be. Part B: Net income in accordance with GAAP should have been $________. Part C: Do you think the management of Funny Books, Inc. was acting unethically? Why or why not? Answer: Part A: Funny Books, Inc. violated the revenue-recognition principle by recording revenue in advance of performing the services. It also violated the cost principle because land should not be increased to reflect its fair market value. Lastly, the matching principle was violated because it should have reported the July services received as expenses in the period it received the services regardless of the fact that cash had not changed hands. Part B: Net income = $3,000 = $12,000 — 4,000 — 3,000 — 2,000 Part C: Management should put ethical behavior above trying to make the company look better financially. Management should have been forthright with the bank and clarified whether the income statement was to be prepared in accordance with GAAP. It should have followed the full disclosure requirement and specified how it accounted for its transactions. Diff: 3 Skill: Analytic skills, Ethical understanding and reasoning abilities Objective: LO 2-2 & LO 2-6

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2.6-22) Describe internal controls and discuss why internal controls are necessary for a business. Answer: Internal controls are the policies and procedures used by a business to protect the assets of a business and to ensure the accuracy and reliability of the accounting records. Business owners and managers use these controls to minimize the risk of the loss of assets and to maintain control over the operations of a business. Internal controls can be organized into three categories: preventive, detective, and corrective controls. Preventive controls are designed to prevent an error or irregularity. An example would be keeping cash in locked cash drawers or in a safe. Detective controls are designed to identify when an error or irregularity has occurred. A cash (bank) reconciliation is an example of a detective control. Corrective controls are designed to fix errors. For example, denying credit to a customer who has not paid an account would be a corrective control. Diff: 2 Skill: Communication abilities Objective: LO 2-6 2.6-23) Lisa Vogle has been running the Bird’s Nest Inn since the death of her husband. Common sense tells Lisa that she should take some action to protect the assets of the business and the financial records. Explain the basic concepts of internal control to Lisa. Answer: Internal controls are the policies and procedures used by a business to protect the assets of a business and to ensure the accuracy and reliability of the accounting records. Business owners and managers use these controls to minimize risk and to maintain control over the operations of a business. Internal controls can be organized into three categories: preventive, detective, and corrective controls. Preventive controls are designed to prevent an error or irregularity. An example would be keeping cash in locked cash drawers or in a safe. Detective controls are designed to identify when an error or irregularity has occurred. A cash (bank) reconciliation is an example of a detective control. Corrective controls are designed to fix errors. For example, denying credit to a customer who has not paid an account would be a corrective control. Diff: 2 Skill: Communication abilities Objective: LO 2-6

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2.6-24) Match each of the following terms with the appropriate definition. Use each term only once. a. b. c. d e. f. g. h. i. j. k. l.

monetary-unit assumption historical-cost principle going-concern assumption revenue-recognition principle matching principle accrual accounting accruals deferrals cash-basis accounting detective controls corrective controls preventive controls

_____ 1. Procedures to find errors _____ 2. Transactions in which the revenue is earned or the expense is incurred before the exchange of cash _____ 3. An accounting principle which requires that revenue should be recognized when it is earned _____ 4. An accounting assumption which requires that financial statement items be measured in monetary units _____ 5. An accounting method in which revenues are recognized when earned and expenses recognized when incurred _____ 6. Transactions in which the exchange of cash takes place before the revenue is earned or the expense incurred. _____ 7. An accounting principle which requires that financial statement items should be reported at their costs at the time of the transaction _____ 8. An accounting method in which revenues are recognized when cash is collected and expenses are recognized when cash is disbursed _____ 9. An accounting principle which requires that expenses should be recognized in the same period as the revenue they helped generate _____ 10. An accounting assumption which assumes that a company will continue to be in business in the future _____ 11. Controls designed to fix errors _____ 12. Controls designed to prevent an error or irregularity Answer: j, g, d, a, f, h, b, i, e, c, k, l Diff: 3 Objective: LO 2-2, LO 2-3, & LO 2-6

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