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15. A company receives a payment of $10,000 on 1 December, for rent on a property for December and January. On receipt, they correctly record it as cash and unearned revenue. If at 31 December, their year-end, they failed to make an adjusting entry related to this payment, ignoring taxes, what is the effect on the financial statements for the year?

A. Assets are overstated by $5,000 and Liabilities are overstated by $5,000

B. Assets are overstated by $5,000 and Owner’s equity is overstated by $5,000

C. Liabilities are overstated by $5,000 and Owners’ equity is understated by $5,000

  
   
Ans: C.

The company should have made an adjusting entry to reduce the Unearned revenue account (a liability) by $5,000 and increase Revenue, (and hence net income and retained earnings) by $5,000.

Unearned revenue   5,000

    Revenue                   5,000

As the company failed to make the adjusting entry the liabilities are overstated and owners’ equity is understated.

cityboy

14. The following information is from a company’s 2008 financial statements ($millions): Balances as of the year ended 31 December 2008 2007 Retained earnings 140 120 Accounts receivable 43 38 Inventory 48 45 Accounts payable 29 36 In 2008 the company declared and paid cash dividends of $5 million and recorded depreciation expense in the amount of $25 million. The company’s 2008 cash flow from operations ($ millions) is closest to: A. 25. B. 30. C. 35.

Ans: C. Operating activities:   NI +depreciation and other noncash expenses -gain on sales of long-term assets & investments +decrease in current asset (- increase in current assets) +increase in current liabilities (+ decrease in current liabilities) +increase in deferred tax liabilities (-decrease in DTL) =CFO The change in retained earnings is $20 and dividends are paid from retained earnings. 2008 net income equals the change in retained earnings plus any dividends paid during 2008. Depreciation expense is added to net income and the changes in balance sheet accounts are also considered to determine cash flow from operations. $20 + 5 (dividends) + 25 (depreciation) – 5 (increase in receivables) – 3 (increase in inventory) – 7 (decrease in payables) = $35 million.

cityboy

13. Which of the following is least likely to be classified as a financial statement element?
A. Asset.

B. Revenue.

C. Net income.

  
   
Ans: C.

Net income is not an element of the financial statements, but the net result of revenues less expenses. The elements are: assets, liabilities, owners’ equity, revenue and expenses.

cityboy

12. The following information is available for a company: December 31, 2009: Total Assets $100,000 Net income for the year $4,000 Dividends paid $0 Assets are equally financed with debt and equity 50% of the equity comes from contributed capital December 31, 2010: Total Assets $92,000 Net loss for the year $3,000 No new debt or equity issued or repurchased In 2010, the company most likely: A. paid a dividend of $1,000 B. paid a dividend of $5,000 C. did not pay a dividend because they incurred a loss.

Ans: B. 2009 ($) 2010 ($) Total Assets (given) 100,000 92,000 Total Debt (50% in 2009, no change in 2010) 50,000 50,000 Total Equity (Total assets – total debt) 50,000 42,000 Equity Components Contributed Capital (50% of Equity in 2009, no change in 2010) 25,000 25,000 Retained Earnings (solved for) (Total Equity – Contributed Capital) 25,000 17,000 Retained earnings = opening RE + net income – dividends 2010 Retained Earnings = 17,000 = 25,000 - 3,000 - Dividends Dividends = 5,000

cityboy

11. Under IFRS, which of the following financial statement elements most accurately represents inflows of economic resources to a company?

A. Assets.

B. Equity.

C. Revenues.

  
   
Ans: C.

The financial statement elements under International Financial Reporting Standards (IFRS) are: Assets, Liabilities, Owners’ Equity, Revenue, and Expenses. Revenues are inflows of economic resources.

  

A is incorrect. Assets are the firm’s economic resources.

  

C is incorrect. Equity is the owners’ residual claim of a firm’s resources, which is the amount by which assets exceed liabilities.

cityboy

10. Which of the following statements best describes a trial balance? A trial balance is a document or computer file that:

A. shows all business transactions by account.

B. lists account balances at a particular point in time.

C. contains business transactions recorded in the order in which they occur.

  
   
Ans. B.

A trial balance is a document that lists account balances at a particular point in time.

At the end of the accounting period, an initial trial balance is prepared that shows the balances in each account. If any adjusting entries are needed, they will be recorded and reflected in an adjusted trial balance.

  

A is incorrect. Journal entries show all business transactions by account.

  

C is incorrect. A listing of all the journal entries in order of their dates is called the general journal.

cityboy

9. At the start of a month, a retailer paid $5,000 in cash for different types of candies. He sold candies costing $2,000 for $3,000 during the month. The most likely effect of these transactions on the retailer’s accounting equation for the month is that assets will:

A. be unchanged.

B. increase by $1,000.

C. decrease by $2,000.

  
   
Ans: B.

Buying $5,000 of candies will decrease cash by $5,000 and increase inventory by $5,000. Selling $2,000 of candies for $3,000 will decrease inventory by $2,000, and increase either cash (if cash collected in the same accounting period) or accounts receivable (if sold on credit) by $3,000. The combined effect is an increase of $1,000 in assets.

cityboy

8. Which of the following statements is most accurate?

A. Accrued revenue arises when a company receives cash prior to earning the revenue.

B. A valuation adjustment for an asset converts its historical cost to its depreciated value.

C. Accrued expenses arise when a company incurs expenses that have not yet been paid as of the end of the accounting period.

  
   
Ans: C.

The principle of accrual accounting requires that revenue is recorded when the firm earns it and expenses are recorded as the firm incurs them, regardless of whether cash has actually been paid.

Accrued expense—the firm owes cash for expenses it has incurred. Expense increase and a liability for accrued expenses increases as well. The liability decreases when the firm pays cash to satisfy it.

  

A is incorrect. Accrued revenue arises when a company receives cash before it provides a good or service to customers.

  

B is incorrect. A valuation adjustment for an asset converts its historical cost to current market value.

cityboy

7. What is the most likely effect on the accounting equation when a company purchases office equipment with cash?

A. Assets increase, and liabilities increase.

B. There is no effect on the accounting equation.

C. Assets decrease, and owners’ equity decreases.

  
   
Ans: B.

There would be no effect on the accounting equation because the company has exchanged one asset for another. Cash has decreased, and office equipment, a capital asset, has increased.

cityboy

6. The least likely reason that a security analyst needs to understand the accounting process is to:

A. prevent earnings manipulation by management.

B. make adjustments to reflect items not reported in the financial statements.

C. aid in the assessment of management’s judgment in accruals and valuations.

  
   
Ans: A.

Understanding the accounting process may assist an analyst in identifying earnings manipulation, but it will not prevent the manipulation of earnings by management. It is important for analysts to understand the accounting process so they can make adjustments for items not reported and to aid in the assessment of management’s judgment of accruals and valuations.