Introduction to Financial Accounting Horngren 11th Edition Test Bank

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Introduction to Financial Accounting Horngren 11th Edition Test Bank

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Introduction to Financial Accounting, 11e (Horngren)
Chapter 4 Accrual Accounting and Financial Statements

Learning Objective 4.1 Questions

1) Which of the following is an example of an accrual?
A) Wages incurred but not yet paid.
B) Payment of insurance 8 months in advance.
C) Purchase of equipment for use in the business.
D) Revenue collected in advance from customer.
E) All of the above.
Answer: A
Diff: 3
Objective: L.O. 4-1

2) Which of the following statements regarding adjusting entries is true?
A) Accountants use adjusting entries to record explicit transactions at the end of each reporting period.
B) Adjusting entries are made on a daily basis as cash is exchanged between parties.
C) Adjusting entries have nothing to do with accrual accounting.
D) Adjusting entries are made at periodic intervals, usually when the financial statements are about to be prepared.
E) The recording of cash receipts from customers is an example of an adjusting entry.
Answer: D
Diff: 1
Objective: L.O. 4-1

3) An example of an explicit transaction is
A) accruing interest payable at the end of the fiscal year.
B) recognizing depreciation expense.
C) cash disbursement for the payment of 3 months rent in advance.
D) accruing wages payable at month end.
E) recognizing rent expense by reducing prepaid rent.
Answer: C
Diff: 2
Objective: L.O. 4-1

4) An example of an explicit transaction is
A) depreciation expense.
B) expiration of prepaid rent.
C) accrual of interest payable.
D) accrual of wages payable.
E) purchasing inventory on account.
Answer: E
Diff: 2
Objective: L.O. 4-1

5) An example of an implicit transaction is
A) a cash sale.
B) a credit purchase of inventory.
C) the receipt of cash in advance of providing services.
D) the expiration of prepaid rent.
E) a credit sale.
Answer: D
Diff: 2
Objective: L.O. 4-1

6) An example of an entry that is not an adjusting entry is
A) reducing Prepaid Rent to record rent expense for the current month.
B) reducing Unearned Revenue to record revenue for services provided during the month.
C) accruing wage expense for labor costs which have been incurred but not yet paid.
D) purchase of land for cash and a note payable.
E) accruing revenue for services that have been provided but not yet billed.
Answer: D
Diff: 2
Objective: L.O. 4-1

7) Which of the following situations does NOT involve an adjusting entry?
A) Recording the expiration of prepaid insurance.
B) Recording depreciation on equipment.
C) Recording wages owed to employees.
D) Recording revenue earned when cash was received in advance.
E) Recognizing sales when they occur.
Answer: E
Diff: 2
Objective: L.O. 4-1

8) Adjusting entries affect
A) neither an income statement account nor a balance sheet account
B) an income statement account and a balance sheet account
C) income statement accounts only
D) balance sheet accounts only
E) a cash account
Answer: B
Diff: 2
Objective: L.O. 4-1

9) Recording an accrual entry involves recording a(n) ________ or ________ at the end of an accounting period even though no explicit transaction occurs.
A) fixed asset; long-term liability
B) intangible asset; long-term liability
C) cash sale; credit sale
D) dividends; retained earnings
E) receivable; payable
Answer: E
Diff: 1
Objective: L.O. 4-1
10) The accountant uses adjusting entries to record implicit transactions at the end of each reporting period.
Answer: TRUE
Diff: 1
Objective: L.O. 4-1

11) Implicit transactions are events such as cash receipts and disbursements that trigger nearly all day-to-day routine entries.
Answer: FALSE
Diff: 1
Objective: L.O. 4-1

12) Some explicit transactions (e.g., the loss of assets due to fire) do not involve actual exchanges of goods and services between parties.
Answer: TRUE
Diff: 1
Objective: L.O. 4-1

13) Every adjusting entry affects one income statement account and one balance sheet account.
Answer: TRUE
Diff: 2
Objective: L.O. 4-1

14) All creditor transactions will result in an adjusting entry.
Answer: FALSE
Diff: 1
Objective: L.O. 4-1

15) Although it does not occur often, the Cash account can be used to record adjusting entries.
Answer: FALSE
Diff: 1
Objective: L.O. 4-1

16) Define the term implicit transaction and explain how these transactions are recorded in the financial records. In addition, list two of the four principal types of adjustments and give an example of each.
Answer: Implicit transactions are events that are temporarily ignored in day-to-day recording procedures and are recognized only at the end of an accounting period. The accountant uses adjusting entries to record implicit transactions at the end of each reporting period. The principal types of adjustments can be classified into four types:
Expiration or consumption of unexpired costs
Realization (earning) of revenues received in advance
Accrual of unrecorded expenses
Accrual of unrecorded revenues

Examples of the expiration of unexpired costs include the recognition of monthly depreciation expense and the write-offs to expense of such assets as Supplies Inventory, Prepaid Insurance, and Prepaid Rent. Examples of the realization of unearned revenues include the reduction of the liability Unearned Rent Revenue at the end of each month or the reduction of the liability Unearned Subscription Revenue each time an issue of a magazine is mailed to the customer. Examples of the accrual of unrecorded expenses are the accrual of wage expense, interest expense, and income tax expense. Examples of unrecorded revenues include unbilled fees generated by attorneys, public accountants, physicians, and advertising agencies.
Diff: 2
Objective: L.O. 4-1

Learning Objective 4.2 Questions

1) The adjusting entry to recognize periodic depreciation expense has what effect on the basic accounting equation?
A) Decrease in assets, decrease in liabilities
B) Decrease in assets, increase in liabilities
C) Decrease in assets, increase in stockholders equity
D) Decrease in assets, decrease in stockholders equity
E) None of these
Answer: D
Diff: 2
Objective: L.O. 4-2

2) An example of an adjusting entry is
A) cash collections from credit customers.
B) payment of the principal and interest on a note.
C) recognizing rent expense by reducing Prepaid Rent.
D) declaring a cash dividend.
E) buying inventory on open account.
Answer: C
Diff: 2
Objective: L.O. 4-2

3) Blockade Consulting Services paid 3 months rent in advance on July 1, at a total cost of $2,400. The rent covers the period from July 1 to September 30. At the time of the payment, prepaid rent was increased by $2,400. What adjusting entry is necessary on July 31?
A) Prepaid rent 800
Rent expense 800
B) Rent expense 800
Prepaid rent 800
C) Prepaid rent 1,600
Rent expense 1,600
D) Rent expense 1,600
Prepaid rent 1,600
E) No adjusting entry is necessary.
Answer: B
Diff: 2
Objective: L.O. 4-2

4) On October 1, Hurt Enterprises paid 4 months insurance in advance for $3,600. At the time of the payment, prepaid insurance was increased by $3,600. What adjusting entry is necessary as of December 31?
A) Prepaid insurance 2,700
Insurance expense 2,700
B) Insurance expense 2,700
Prepaid insurance 2,700
C) Prepaid insurance 900
Insurance expense 900
D) Insurance expense 900
Prepaid insurance 900
E) No adjusting entry is necessary
Answer: B
Diff: 2
Objective: L.O. 4-2

5) The entry to record equipment depreciation when the equipment depreciates $100 per month, the balance in the Accumulated Depreciation, Equipment account is $600 and the balance in the Equipment account is $5,600 is
A) Depreciation expense 100
Accumulated depreciation, Equipment 100
B) Accumulated depreciation, Equipment 100
Depreciation expense 100
C) Equipment 5,500
Depreciation expense 5,500
D) Equipment 5,500
Accumulated depreciation, Equipment 5,500
E) Accumulated depreciation, Equipment 5,500
Equipment 5,500
Answer: A
Diff: 2
Objective: L.O. 4-2
6) On March 31, Getze Family Automotive performed a month-end inventory and counted office supplies valued at $2,100. On March 1, the balance in the Supplies account was $1,200. Assume that $2,900 of purchases for the month was posted to the Supplies account, what adjusting entry would Getze Family Automotive make on March 31?
A) Supplies expense 2,000
Supplies 2,000
B) Supplies 2,000
Supplies expense 2,000
C) Supplies 900
Supplies expense 900
D) Supplies expense 900
Supplies 900
E) Supplies expense 2,900
Supplies 2,900
Answer: A
Diff: 2
Objective: L.O. 4-2

7) During March, Getze Family Automotive installed a new engine with a billed price of $3,500. The company did not bill for the engine until April 1. Ignore the cost of the engine installed. What adjusting entry would Getze Family Automotive make on March 31?
A) Prepaid revenue 3,500
Service revenue 3,500
B) Service revenue 3,500
Unearned revenue 3,500
C) Unearned revenue 3,500
Service revenue 3,500
D) Service revenue 3,500
Prepaid revenue 3,500
E) Accounts receivable 3,500
Service revenue 3,500
Answer: E
Diff: 2
Objective: L.O. 4-2

8) At March 31, Getze Family Automotive owes $5,400 for wages to be paid on April 8. What adjusting entry is necessary on March 31?
A) Wage expense 5,400
Unearned Wages 5,400
B) Wage expense 5,400
Accrued wages payable 5,400
C) Prepaid Wages 5,400
Wage expense 5,400
D) Unearned Wages 5,400
Wage expense 5,400
E) Wage expense 5,400
Prepaid Wages 5,400
Answer: B
Diff: 2
Objective: L.O. 4-2
9) On March 1, Getze Family Automotive received $7,000 cash for services to be rendered in March and April. The company recorded unearned revenue upon receipt of cash. What adjusting entry would Getze Family Automotive make on March 31, assuming that $2,000 of services was performed in March?
A) Unearned revenue 5,000
Service revenue 5,000
B) Accounts receivable 5,000
Service revenue 5,000
C) Unearned revenue 2,000
Service revenue 2,000
D) Service revenue 2,000
Accounts receivable 2,000
E) Accounts receivable 2,000
Unearned revenue 2,000
Answer: C
Diff: 2
Objective: L.O. 4-2

10) Oleke Manufacturing paid $1,800 for 4 months rent in advance on January 1. Assuming only asset accounts were used in the January 1 journal entry, what adjusting entry is necessary on January 31?
A) Prepaid rent 450
Rent expense 450
B) Rent expense 450
Prepaid rent 450
C) Rent expense 450
Rent payable 450
D) Unearned rent 450
Rent expense 450
E) Prepaid rent 450
Rent payable 450
Answer: B
Diff: 2
Objective: L.O. 4-2
11) Oleke Manufacturing received $800 in advance on January 1 from Zinger Company for services to be performed over the next 3 months. If the $800 received from Zinger Company was placed into the Unearned Revenue account, and Oleke had completed 30% of the work as of the end of the month, what adjusting entry would Oleke Manufacturing make on January 31?
A) Prepaid revenue 240
Revenue 240
B) Revenue 240
Unearned revenue 240
C) Unearned revenue 240
Revenue 240
D) Revenue 560
Unearned revenue 560
E) Unearned revenue 560
Revenue 560
Answer: C
Diff: 2
Objective: L.O. 4-2

12) Oleke Manufacturing borrowed $20,000 from Second National Bank on January 1. The note is for 9 months with all interest due at the end of the note. The bank is charging the company 9% interest. What adjusting entry is necessary for Oleke Manufacturing on January 31?
A) Interest expense 150
Accrued interest payable 150
B) Interest expense 150
Notes payable 150
C) Interest expense 200
Accrued interest payable 200
D) Interest expense 200
Notes payable 200
E) Interest expense 1,800
Notes payable 1,800
Answer: A
Diff: 2
Objective: L.O. 4-2

13) Milton Company, a valued customer, placed an order for $1,500 on January 1. Because Milton is experiencing financial difficulties, it has been allowed to pay with a 3-month note receivable. The interest rate on the note is 8%. What adjusting entry is necessary for Oleke Manufacturing on January 31?
A) Notes receivable 10
Interest revenue 10
B) Accrued interest receivable 120
Interest revenue 120
C) Accrued interest receivable 10
Interest revenue 10
D) Notes receivable 120
Interest revenue 120
E) Notes receivable 60
Interest revenue 60
Answer: C
Diff: 2
Objective: L.O. 4-2

14) Oleke Manufacturing performed services for a client during January valued at $5,000. The client was billed on February 9. What adjusting entry would Oleke Manufacturing make on January 31?
A) Accounts receivable 5,000
Revenue 5,000
B) Revenue 5,000
Accounts receivable 5,000
C) Unearned revenue 5,000
Revenue 5,000
D) Revenue 5,000
Unearned revenue 5,000
E) No adjusting entry is necessary on June 30.
Answer: A
Diff: 2
Objective: L.O. 4-2

15) On April 30, Hilte Corporation performed a month-end inventory and counted office supplies valued at $1,425. On April 1, the balance in the Supplies account was $750. Assuming that $2,900 of purchases for the month was posted to the Supplies account, what adjusting entry would Hilte Corporation make on April 30?
A) Supplies expense 2,225
Supplies 2,225
B) Supplies 2,225
Supplies expense 2,225
C) Supplies 675
Supplies expense 675
D) Supplies expense 675
Supplies 675
E) None of the above
Answer: A
Diff: 2
Objective: L.O. 4-2
16) On April 30, Hilte Corporation performed services valued at $3,325. The company did not bill for the services until May 1. What adjusting entry would Hilte Corporation make on April 30?
A) Prepaid revenue 3,325
Revenue 3,325
B) Revenue 3,325
Unearned revenue 3,325
C) Unearned revenue 3,325
Revenue 3,325
D) Revenue 3,325
Prepaid revenue 3,325
E) Accounts Receivable 3,325
Revenue 3,325
Answer: E
Diff: 2
Objective: L.O. 4-2

17) On April 30, Hilte Corporation owes $14,100 for wages to be paid on May 6. What adjusting entry is necessary on April 30?
A) Wage expense 14,100
Unearned wages 14,100
B) Wage expense 14,100
Accrued wages payable 14,100
C) Prepaid wages 14,100
Wage expense 14,100
D) Unearned wages 14,100
Wage expense 14,100
E) Wage expense 14,100
Prepaid wages 14,100
Answer: B
Diff: 2
Objective: L.O. 4-2

18) Failure to adjust for depreciation results in the overstatement of assets and the understatement of net income.
Answer: FALSE
Diff: 3
Objective: L.O. 4-2

19) If the adjusting entry to record the current periods prepaid rent that is expired is omitted, current assets will be overstated.
Answer: TRUE
Diff: 3
Objective: L.O. 4-2

20) The adjusting entry to record $650 of expired insurance would include a debit to Unearned Insurance.
Answer: FALSE
Diff: 1
Objective: L.O. 4-2

21) Examples of adjusting for asset expirations include the write-offs to expense of such assets as Office Supplies and Prepaid Insurance.
Answer: TRUE
Diff: 1
Objective: L.O. 4-2

22) Prepare any necessary adjusting or correcting entries called for by the following situations. Assume that no entries have been made regarding the situation other than those specifically described.
Consider each situation separately.
a. Equipment is repaired and maintained by an outside maintenance company on an annual fee basis, payable in advance. The $2,400 fee was paid in advance on September 1 (for 12 months beginning September 1) and was charged to Repair and Maintenance Expense. What adjustment is necessary on December 31?
b. On January 1, $10,500 of machinery was purchased. $500 cash was paid down and a 3-month, 12% note payable was signed for the balance. The January 1 transaction was properly recorded. Prepare the adjustment for the interest as of January 31.
c. On February 1, $1,200 was paid in advance to the landlord for three months rent. The tenant debited Prepaid Rent for $1,200 on February 1. What adjustment is necessary as of February 28?
Answer:
a. Prepaid repairs and maintenance 2,400
Repair and maintenance expense 2,400
Repairs and maintenance expense 800
Prepaid repairs and maintenance 800
b. Interest expense* 100
Accrued interest payable 100
*($10,000 .12 1/12)
c. Rent expense 400
Prepaid rent 400
Diff: 3
Objective: L.O. 4-2, 4-4

Learning Objective 4.3 Questions

1) Which of the following situations involves a deferral?
A) Recording accrued interest
B) Recording accrued wages
C) Recording revenue earned but not yet received
D) Recording revenue earned that was collected in advance
E) None of the above are deferrals.
Answer: D
Diff: 3
Objective: L.O. 4-3
2) The adjustment for revenue received in advance, which has been earned in the current period, involves a
A) debit to unearned revenue.
B) debit to accrued revenue.
C) credit to accrued revenue.
D) debit to cash.
E) credit to cash.
Answer: A
Diff: 2
Objective: L.O. 4-3

3) The adjustment for revenue received in advance that has now been earned involves a debit to
A) Cash and a credit to Prepaid Revenue.
B) Unearned Revenue and a credit to Revenue.
C) Prepaid Revenue and a credit to Unearned Revenue.
D) Revenue and a credit to Unearned Revenue.
E) Prepaid Revenue and a credit to Cash.
Answer: B
Diff: 2
Objective: L.O. 4-3

4) What effect does the earning of revenue previously collected have on the basic accounting equation? Assume Unearned Revenue had been increased when the cash was collected in advance.
A) Increase in assets, decrease in liabilities
B) Decrease in assets, decrease in liabilities
C) Decrease in liabilities, increase in stockholders equity
D) Decrease in assets, decrease in stockholders equity
E) Increase in assets, increase in stockholders equity
Answer: C
Diff: 3
Objective: L.O. 4-3

5) Scrumptious Donuts sold $2,000 worth of gift certificates in December. As of December 31, $500 worth of the $2,000 gift certificates had been redeemed. All gift certificates sold use the Deferred Revenue account. The balance in the Deferred Revenue account as of December 31 is
A) $2,000
B) $2,500
C) $500
D) $1,500
E) not enough information to answer
Answer: D
Diff: 2
Objective: L.O. 4-3

6) The adjusting entry to record $675 of earned revenue received in advance would include a debit to Unearned Revenue.
Answer: TRUE
Diff: 2
Objective: L.O. 4-3
7) Circle Knitting, Inc. recorded $4,000 of unearned revenue being earned and the collection of $1,500 cash for services previously accrued. The impact of these two entries on total revenue is an increase of $5,500.
Answer: FALSE
Diff: 3
Objective: L.O. 4-3

8) Module Accounting Services receives $8,000 cash for service revenue to be earned in the future. The company credits Service Revenue upon receipt of the cash.
Answer: FALSE
Diff: 3
Objective: L.O. 4-3

9) Auto Detailing, Inc. had the following transactions on August 1:
a. The company sold $2,100 of inventory costing $1,400. The customer will not be billed until September. As of August 31, no entries have been made with respect to the inventory that has been sold or the sale.
b. The company received a $2,000 payment from a customer for services to be performed during August and September. On August 1, the entire $2,000 was placed in the Unearned Revenue account. As of August 31, 40% of the work had been completed.
c. The company paid $7,200 for 4 months rent in advance. The entire amount was placed into Prepaid Rent.
d. The company sold equipment costing $2,400 for $5,400 to a customer in return for a 3-month note. The sale was properly recorded on August 1. Auto Detailing, Inc. is charging 12% interest on the note. The customer will pay the note and all interest after 3 months.

Prepare the appropriate journal entries for Auto Detailing, Inc. as of August 31, for each of the above transactions.
Answer:
a. Accounts Receivable 2,100
Sales 2,100
Cost of Goods Sold 1,400
Inventory 1,400
b. Unearned Revenue 800
Revenue 800
c. Rent expense 1,800
Prepaid rent 1,800
d. Accrued interest receivable 54
Interest revenue 54
Diff: 3
Objective: L.O. 4-1, 4-2, 4-3, 4-5
10) Chordall Authors Company circulates a monthly magazine, charging $36 to subscribers for a 12-month subscription. Subscribers are required to forward the entire $36 yearly subscription fee before Chordall Authors Company will furnish the subscriber with the magazine. Chordall Authors Company sold 300 magazine subscriptions in the month of March, while the balance in the Unearned Subscription Revenue account was $20,000 on March 1, 2009. After the necessary adjusting entry for March, the balance in the Unearned Subscription Revenue account was $25,200.
Required:
1. Prepare the appropriate journal entry for Chordall Authors Company as of March 31.
2. How would net income be affected for the month ending March 31 if Chordall Authors Company did not record the above entry?
Answer:
1. Unearned Subscription revenue* 5,600
Subscription revenue 5,600
*(20,000 + (300 $36) 25,200)
2. Net income would be understated by $5,600 if the above entry was not recorded.
Diff: 3
Objective: L.O. 4-3

Learning Objective 4.4 Questions

1) An example of an adjusting entry is
A) the payment of wages that have been accrued.
B) the accruing of interest expense.
C) the return of defective inventory.
D) the payment of rent in advance.
E) collection of an accounts receivable.
Answer: B
Diff: 2
Objective: L.O. 4-4

2) An adjusting entry made to record accrued interest on a note payable involves a credit to
A) interest expense.
B) accrued interest payable.
C) interest revenue.
D) accrued interest receivable.
E) cash.
Answer: B
Diff: 2
Objective: L.O. 4-4

3) The adjusting entry to record accrued salaries has what effect on the basic accounting equation?
A) Increases liabilities, decreases stockholders equity
B) Increases liabilities, increases stockholders equity
C) Decrease assets, decreases stockholders equity
D) Decrease assets, increases stockholders equity
E) Decrease liabilities, decrease assets
Answer: A
Diff: 3
Objective: L.O. 4-4
4) The entry to record the cash payment of salaries that had previously been accrued has what effect on the basic accounting equation?
A) Decrease liabilities, decrease assets
B) Decrease liabilities, decrease stockholders equity
C) Decrease assets, decrease stockholders equity
D) Decrease assets, increase stockholders equity
E) Decrease assets, increase liabilities
Answer: A
Diff: 3
Objective: L.O. 4-4

5) Howard Products has a daily payroll of $2,200, 5 days a week. The employees are paid every Friday for that weeks wages. July 31 was on a Wednesday and the employees were paid $11,000 on August 2. What is the journal entry on August 2, assuming the appropriate month ending adjusting entry was made on July 31?
A) Cash 11,000
Prepaid wages 6,600
Unearned wages 4,400
B) Cash 11,000
Prepaid wages 6,600
Wage expense 4,400
C) Wage expense 11,000
Cash 11,000
D) Prepaid wages 6,600
Wage expense 4,400
Cash 11,000
E) Wage expense 4,400
Accrued wages payable 6,600
Cash 11,000
Answer: E
Diff: 2
Objective: L.O. 4-4

6) Cupling Enterprises borrowed $6,000 from Escada Bank on October 1, 2012. At that time, the company made the appropriate journal entry; however, no other journal entry pertaining to the note has been made. Given that the bank is charging interest at a rate of 9%, what adjusting entry is necessary as of Cupling Enterprises year-end date of December 31, 2012?
A) Interest expense 135
Accrued interest payable 135
B) Interest expense 135
Notes payable 135
C) Interest expense 540
Accrued interest payable 540
D) Interest expense 540
Notes payable 540
E) Notes payable 540
Interest expense 540
Answer: A
Diff: 2
Objective: L.O. 4-4

7) The adjusting entry to record the accrual of interest expense has what effect on the basic accounting equation?
A) Increase assets, increase liabilities
B) Decrease assets, decrease liabilities
C) Increase assets, decrease liabilities
D) Increase liabilities, decrease stockholders equity
E) Decrease liabilities, increase stockholders equity
Answer: D
Diff: 3
Objective: L.O. 4-4

8) What is the effect on the basic accounting equation of the cash payment of accrued interest payable previously accrued?
A) Increase assets, increase liabilities
B) Decrease assets, decrease liabilities
C) Decrease assets, increase liabilities
D) Increase liabilities, decrease stockholders equity
E) Decrease liabilities, increase stockholders equity
Answer: B
Diff: 3
Objective: L.O. 4-4

9) The entry to accrue $2,000 of income tax monthly is
A) Deferred income tax 2,000
Income tax expense 2,000
B) Income tax expense 2,000
Deferred income tax 2,000
C) Income tax expense 2,000
Accrued income tax payable 2,000
D) Accrued income tax payable 2,000
Income tax expense 2,000
E) no entry is needed; taxes are recognized when paid
Answer: C
Diff: 2
Objective: L.O. 4-4

10) Income before income tax is
A) a subtotal before net income on the income statement
B) a subtotal after net income on the income statement
C) included in net income on the income statement
D) included in stockholders equity on the income statement
E) included in stockholders equity on the balance sheet
Answer: A
Diff: 1
Objective: L.O. 4-4

11) The adjusting entry to record accrued salaries earned includes a debit to accrued salaries payable.
Answer: FALSE
Diff: 2
Objective: L.O. 4-4
12) Failure to adjust for an unrecorded expense such as wages expense will overstate net income and stockholders equity for the period.
Answer: TRUE
Diff: 3
Objective: L.O. 4-4

13) Failure to adjust for an unrecorded expense such as interest expense will understate liabilities.
Answer: TRUE
Diff: 3
Objective: L.O. 4-4

14) Recording an unrecorded expense will increase expenses and decrease revenues.
Answer: FALSE
Diff: 2
Objective: L.O. 4-4

15) Stake, Inc., records the payment of $200 cash for a previously accrued expense and the accrual of $625 for another expense. The impact of these two entries is to decrease net income by $825.
Answer: FALSE
Diff: 3
Objective: L.O. 4-4

16) Dell Catering accrues its income taxes quarterly for the sole manufacturing facility located in Brunswick, Florida. Although Dell Catering is not subject to local tax, it is required to pay both state and federal income taxes, which are 12% and 28% of net income, respectively. Second quarter income for Dell Catering amounted to $550,000.
Required:
1. Prepare the appropriate journal entry for Dell Catering as of June 30.
2. Explain how income taxes are shown on a multi-step income statement.
Answer:
1. Income tax expense 220,000
Income tax payable 220,000
2. Income taxes are shown below Income before Income Tax and above Net Income in a multi-step income statement. Income tax Expense of $220,000 will be deducted from Income before Income Tax of $550,000.
Diff: 3
Objective: L.O. 4-4, 4-8

17) Fletcher Products records adjusting entries monthly. The accountant at Fletcher Products is having difficulty figuring out what amount to include as the adjustment. Below are the accounts and amounts from Fletcher Products month-end balances on February 28.

February 28, 2009
Current assets
Cash 45,100
Accounts Receivable 98,500
Office Supplies 2,700
Prepaid Rent 3,000
Long-term assets
Equipment 10,000
Accumulated Depreciation 917
Current liabilities
Accounts Payable 55,700
Interest Payable 400
Long-term liabilities
Notes Payable 10,000

Additional Information:
Office supplies of $250 were purchased in the month of March. On March 31, office supplies are $1,900.
Fletcher Products committed to a one-year rental agreement on February 28, 2009 and paid $3,000 for the 12 month period starting March 1, 2009. This is the only rental agreement for Fletcher Products.
A stamping machine is the only piece of equipment owned by Fletcher Products. It was purchased on April 1, 2008 for $10,000 and the company estimates a zero salvage value on it. Fletcher Products uses the straight line method of depreciation. The machine has a useful life of 10 years.
Fletcher Products signed a 1-year, 24% note on January 1, 2009. The company recognizes interest on a monthly basis and is required to pay the entire amount of interest and principal upon the maturity date of December 31, 2009.
Required:
Prepare any necessary adjusting entries on March 31 based on the above information. Assume that no adjusting entries have been made for the month ending March 31.
Answer:
a. Office Supplies Expense 1,050*
Office Supplies 1,050
*(2,700 + 250 1,900)
b. Rent Expense 250
Prepaid Rent 250
c. Depreciation Expense 83
Accumulated Depreciation, Equipment 83
d. Interest Expense 200
Accrued interest Payable 200
Diff: 3
Objective: L.O. 4-2, 4-4

Learning Objective 4.5 Questions

1) If Company A has an accrual of interest to be received on a note receivable, then the company should debit
A) Interest expense.
B) Accrued interest payable.
C) Accrued interest receivable.
D) Interest revenue.
E) Cash.
Answer: C
Diff: 2
Objective: L.O. 4-5

2) Which of the following is an example of an accrual of unrecorded revenues?
A) Interest accrues each month, but is paid quarterly.
B) Office supplies are purchased each month, but the account is not adjusted until the end of the month.
C) Wages have been earned, but have not been paid at the end of the month.
D) An attorney has performed work for a client, but has not billed the client yet.
E) Equipment purchased will be beneficial for several years.
Answer: D
Diff: 2
Objective: L.O. 4-5

3) Which one of the following adjustments will increase revenues?
A) Fees were not billed for services already performed.
B) Depreciation is recorded.
C) Supplies were used, but not recorded.
D) Interest is incurred on borrowed money, but not yet paid to the bank.
E) Wages have accrued, but will not be paid until next month.
Answer: A
Diff: 2
Objective: L.O. 4-5

4) Small Business Bank loaned $9,000 to Weidenhammer Company on May 1, 2012, accepting a 2-year, 8% note. The bank recorded the transaction properly on May 1. No other journal entry pertaining to the note has been made since May 1. As of year-end on December 31, 2012, what adjusting entry will the bank make with respect to this note?
A) Accrued interest receivable 480
Interest revenue 480
B) Notes receivable 480
Interest revenue 480
C) Accrued interest receivable 720
Interest revenue 720
D) Notes receivable 720
Interest revenue 720
E) Unearned interest 720
Interest revenue 720
Answer: A
Diff: 2
Objective: L.O. 4-5
5) The adjusting entry to record accrued interest receivable has what effect on the basic accounting equation?
A) Increase assets, increase liabilities
B) Decrease assets, decrease liabilities
C) Increase assets, increase stockholders equity
D) Increase assets, decrease stockholders equity
E) Decrease liabilities, increase stockholders equity
Answer: C
Diff: 3
Objective: L.O. 4-5

6) The collection in cash of interest receivable previously accrued has what effect on the basic accounting equation?
A) Increase assets, increase liabilities
B) Decrease assets, decrease liabilities
C) Increase assets, decrease liabilities
D) Increase liabilities, decrease stockholders equity
E) It has no effect as one asset increases while another asset decreases.
Answer: E
Diff: 3
Objective: L.O. 4-5

7) Recording revenue in 2012 that is actually earned in 2013 will result in:
A) overstatement of net income in 2012
B) overstatement of net income in 2013
C) understatement of net income in 2013
D) an overstatement of net income in 2012 and an understatement in net income in 2013
E) an overstatement of net income in 2013 and an understatement in net income in 2012
Answer: D
Diff: 2
Objective: L.O. 4-5

8) The adjusting entry to record accrued interest revenue includes a debit to interest payable.
Answer: FALSE
Diff: 2
Objective: L.O. 4-5

9) The adjusting entry to record revenue earned during the current period when cash was received in the last accounting period includes a credit to Unearned Revenue.
Answer: FALSE
Diff: 3
Objective: L.O. 4-5

10) Failure to adjust for accrued revenue will understate stockholders equity.
Answer: TRUE
Diff: 3
Objective: L.O. 4-5
11) Journalizing amounts for unearned revenue can cause ethical dilemmas for many accountants since estimates are often used when exact completion amounts are uncertain. Discuss potential problems that this may cause for financial statement users. How does the concept of conservatism affect an accountants recognition of revenue of a particular project? How would underestimating revenue of a project affect net income?
Answer: Users of financial statements rely on unbiased information and because completion of a particular project or contract is often not entirely known, debates may occur as to how much revenue to recognize. If an organization is attempting to pay less taxes, for example, in a given year, that company may lean toward a more conservative estimate of the amount of the project that is completed.
Conservatism is the concept that accountants select estimates and methods of measurement that anticipate expenses and liabilities and defer recognition of revenues and assets. Because accountants apply conservatism to their practice, there is the possibility that revenues can be understated enough to bias financial statement information.
If an accountant underestimates the percentage of a project completed, revenue would be lower than it should be, thus decreasing net income as well.
Diff: 2
Objective: L.O. 4-5

12) The following transactions occurred in August, 2012 for Applegate Consulting:

August 1, 2012 Applegate loaned $2,000 to an employee with a 9% interest rate. The loan stipulates that principal and interest be paid back on August 1, 2013.
August 31, 2012 Applegate Consulting performed $3,200 worth of services for Midatlantic Corp. The billing department at Applegate Consulting was unable to bill Midatlantic on August 31, 2012 because the companys computers were malfunctioning and awaiting service.
What adjusting entries should Applegate Consulting make on August 31, 2012?
Answer:
Accrued interest receivable 15
Interest revenue 15
Accounts receivable 3,200
Service revenue 3,200
Diff: 2
Objective: L.O. 4-5

Learning Objective 4.6 Questions

1) The order of the steps in the recording process has
A) the adjusted trial balance after preparing the financial statements.
B) the journalization and posting of adjustments before the ledger.
C) the adjusted trial balance before the ledger.
D) journalization after the adjusted trial balance.
E) the unadjusted trial balance after the ledger.
Answer: E
Diff: 1
Objective: L.O. 4-6
2) Which of the following is the correct order in the recording process?
A) Journalize and post adjustments, unadjusted trial balance, adjusted trial balance, ledger, financial statements
B) Ledger, journalize and post adjustments, unadjusted trial balance, adjusted trial balance, financial statements
C) Ledger, unadjusted trial balance, journalize and post adjustments, adjusted trial balance, and financial statements
D) Unadjusted trial balance, journalize and post adjustments, ledger, adjusted trial balance, financial statements
E) Journalize and post adjustments, adjusted trial balance, ledger, unadjusted trial balance, financial statements
Answer: C
Diff: 1
Objective: L.O. 4-6

3) Cash flows
A) always follow the adjusting entries.
B) always precede the adjusting entries.
C) may precede or follow the adjusting entries.
D) always follow the unadjusted trial balance.
E) always precede the closing entries.
Answer: C
Diff: 2
Objective: L.O. 4-6

4) After the accrual of unrecorded expenses, ________ are decreased by later cash payments.
A) assets
B) equity
C) expenses
D) revenues
E) liabilities
Answer: E
Diff: 2
Objective: L.O. 4-6

5) Entries for the accrual of unrecorded expenses and the accrual of unrecorded revenues are made prior to the associated cash flows.
Answer: TRUE
Diff: 3
Objective: L.O. 4-6

6) Adjusting entries are journalized after the financial statements are prepared.
Answer: FALSE
Diff: 1
Objective: L.O. 4-6

7) Advance cash payments for future services to be received create noncash assets in the balance sheet.
Answer: TRUE
Diff: 1
Objective: L.O. 4-6
Learning Objective 4.7 Questions

1) A classified balance sheet
A) can only be viewed by upper management.
B) classifies assets as current if possessed at the end of the current month and as deferred if they are expected to be owned at the end of the following month.
C) classifies accounts as either assets, liabilities, or owners equity.
D) groups accounts into subcategories to help readers quickly gain a perspective on the companys financial position.
E) is always used when making organizational strategic decisions.
Answer: D
Diff: 2
Objective: L.O. 4-7

2) An example of a current asset is
A) paid-in capital.
B) equipment.
C) accounts receivable.
D) retained earnings.
E) accounts payable.
Answer: C
Diff: 1
Objective: L.O. 4-7

3) An example of a current liability is
A) unearned revenue.
B) accumulated depreciation.
C) long-term note payable.
D) interest expense.
E) retained earnings.
Answer: A
Diff: 1
Objective: L.O. 4-7

4) Working capital is defined as
A) the difference between paid-in capital and retained earnings.
B) the difference between current assets and current liabilities.
C) the difference between cash and retained earnings.
D) the difference between sales and cost of goods sold.
E) the difference between total assets and total liabilities.
Answer: B
Diff: 1
Objective: L.O. 4-7
5) Clokgel Inc. likes to maintain a current ratio near 1.4; however, the CFO for Clokgel, Inc. has noticed a decline in previous months. The current ratio for April, 2012 produced a ratio of 0.6. What would be the CFOs major concern with a declining current ratio?
A) The company has not sold enough products on credit, thus distorting the accounts receivable balance and the current ratio.
B) The company may have difficulty meeting its short-term obligations.
C) The company has not purchased enough inventory to meet current demand.
D) Long-term obligations such as notes payable may need to be deferred, causing potential investor concerns.
E) The company has excessive holdings of current assets.
Answer: B
Diff: 2
Objective: L.O. 4-7

6) Which of the following statements regarding the current ratio is true?
A) The current ratio is calculated as the difference between current assets and current liabilities.
B) Other things being equal, the lower the current ratio, the more assurance creditors have about being paid in full and on time.
C) The current ratio is widely used to evaluate liquidity.
D) The main components of the current ratio are cash and property, plant, and equipment.
E) The comparison of a companys current ratio to the industry average is meaningless.
Answer: C
Diff: 2
Objective: L.O. 4-7

7) Using the account format to prepare a balance sheet is
A) as acceptable as using a report format.
B) an unacceptable method under GAAP rules.
C) permitted as long as the company has $1 million or less in total assets.
D) permitted as long as the company has $1 million or less in total revenues.
E) used primarily by companies following IFRS.
Answer: A
Diff: 1
Objective: L.O. 4-7

8) Liquidity is an entitys ability
A) to meet its dividend obligations with cash and near-cash assets as those obligations become due.
B) to pay its employees a bonus at year-end based on the success of the organization.
C) to meet its near-term financial obligations with cash and near-cash assets as those obligations become due.
D) to liquidate its assets should a company decide to terminate operations.
E) to purchase fixed assets at a reduced loan percentage based on credit ratings.
Answer: C
Diff: 1
Objective: L.O. 4-7
9) In times of economic stress and instability, companies typically have
A) higher operating expenses.
B) lower gross profits.
C) stable revenues.
D) higher current ratios.
E) lower current ratios.
Answer: D
Diff: 2
Objective: L.O. 4-7

10) The quick ratio provides
A) a better indicator than the current ratio of potential growth.
B) a ratio of revenues to net income.
C) a more restrictive view of a companys liquidity compared to the current ratio.
D) more incentive for a company to invest in non-liquid assets.
E) a company with liquidity levels compared to investment levels.
Answer: C
Diff: 1
Objective: L.O. 4-7

11) Prepaid expenses are listed as current assets on the balance sheet.
Answer: TRUE
Diff: 1
Objective: L.O. 4-7

12) Current assets must be greater than current liabilities.
Answer: FALSE
Diff: 1
Objective: L.O. 4-7

13) Current assets are cash plus those assets that are expected to be converted to cash or sold or consumed during the next 12 months or within the normal operating cycle if longer than a year.
Answer: TRUE
Diff: 2
Objective: L.O. 4-7

14) The excess of cash over current liabilities is known as working capital.
Answer: FALSE
Diff: 1
Objective: L.O. 4-7

15) Working capital is the difference between total assets and total liabilities.
Answer: FALSE
Diff: 1
Objective: L.O. 4-7

16) The current ratio can help users of financial statements assess a business entitys liquidity.
Answer: TRUE
Diff: 2
Objective: L.O. 4-7
17) A high current ratio means that a company is highly profitable.
Answer: FALSE
Diff: 2
Objective: L.O. 4-7

18) The account format of the balance sheet reports assets at the top of the statement.
Answer: FALSE
Diff: 1
Objective: L.O. 4-7

19) An entitys ability to meet its immediate financial obligations as they become due is known as profitability.
Answer: FALSE
Diff: 2
Objective: L.O. 4-7

20) Current assets on the balance sheet are listed in descending order of monetary amount.
Answer: FALSE
Diff: 2
Objective: L.O. 4-7

21) A balance sheet that groups the accounts into subcategories to help users gain a perspective on the companys financial position is referred to as a single-step balance sheet.
Answer: FALSE
Diff: 1
Objective: L.O. 4-7

22) Prepare a classified balance sheet dated December 31, 2012 given the following account balances of Helder Company.

Long-term Note Payable $ 11,000
Accounts Receivable 4,400
Accounts Payable 6,300
Additional Paid-in Capital 12,500
Prepaid Insurance 900
Wages Payable 2,600
Accumulated Depreciation, Equipment 9,100
Capital Stock 3,700
Inventory 8,200
Interest Payable 3,700
Retained Earnings 24,000
Equipment 55,200
Cash 4,200
Answer: Helder Company
Balance Sheet
December 31, 2012

Current Assets:
Cash $ 4,200
Accounts Receivable 4,400
Inventory 8,200
Prepaid Insurance 900
Total Current Assets $17,700
Long-term Assets:
Equipment 55,200
Less: Accumulated Depreciation (9,100)
Total Long-term Assets 46,100
Total Assets $63,800

Current Liabilities:
Accounts Payable $ 6,300
Interest Payable 3,700
Wages Payable 2,600
Total Current Liabilities $ 12,600
Long-term Liabilities:
Notes Payable 11,000
Total Liabilities 23,600
Stockholders Equity:
Capital Stock 3,700
Additional Paid-in Capital 12,500
Retained Earnings 24,000
Total Stockholders Equity 40,200
Total Liabilities & Stockholders Equity $63,800
Diff: 2
Objective: L.O. 4-7
23) Given the following year-end balances, prepare a classified balance sheet for Briggs Manufacturing dated December 31, 2012. (Hint: Compute net income first.)

Interest Expense $ 2,000
Beginning Retained Earnings 13,100
Depreciation Expense 5,200
Cash 26,900
Accounts Payable 3,300
Rent Expense 7,200
Accumulated Depreciation, Equipment 13,500
Wage Expense 59,200
Prepaid Rent 1,400
Paid-in Capital 9,000
Accounts Receivable 13,600
Wages Payable 3,200
Equipment 63,000
Sales 249,600
Inventory 14,400
Long-term Note Payable 20,000
Income tax Expense 24,500
Dividends Declared 21,000
Cost of Goods Sold 94,300
Dividends Payable 21,000
Answer: Briggs Manufacturing
Balance Sheet
December 31, 2012

Current Assets:
Cash $26,900
Accounts Receivable 13,600
Inventory 14,400
Prepaid Rent 1,400
Total Current Assets $56,300
Long-term Assets:
Equipment $63,000
Less: Accumulated Depreciation (13,500) 49,500
Total Assets $105,800

Current Liabilities:
Accounts Payable $ 3,300
Dividends Payable 21,000
Wages Payable 3,200
Total Current Liabilities $27,500
Long-term Liabilities:
Note Payable 20,000
Total liabilities 47,500
Stockholders Equity:
Paid-in Capital 9,000
Retained Earnings 49,300
Total Stockholders Equity 58,300
Total Liabilities and Stockholders Equity $105,800
Diff: 3
Objective: L.O. 4-7

24) A classified balance sheet groups assets and liabilities into two categories. Identify and define those two categories for both assets and liabilities. Why is this categorization made? Finally, two measures of liquidity can be generated using these two categories. What are the two measures of liquidity and how are they calculated?
Answer: A classified balance sheet groups assets and liabilities into two categories: current and long-term.
Current assets are cash plus assets that are expected to be converted to cash or sold or consumed during the next 12 months or within the normal operating cycle if longer than a year. Similarly, current liabilities are those liabilities that fall due within the coming year or within the normal operating cycle if longer than a year. The distinction between short-term and long-term accounts is useful in assessing a companys ability to meet obligations as they become due.
A classified balance sheet groups the accounts into subcategories to help readers quickly gain a perspective on the companys financial position and to draw attention to certain accounts or groups of accounts. The two measures of liquidity generated using the categories of current and long-term are working capital and current ratio. Working capital is the excess of current assets over current liabilities while the current ratio is calculated by dividing current assets by current liabilities.
Diff: 2
Objective: L.O. 4-7

25) Logell Paper Products
Balance Sheet
December 31, 2012

Assets:
Current Assets:
Cash $ 25,000
Accounts Receivable 62,500
Inventory 66,500
Prepaid Rent 4,800
Total Current Assets $158,800
Long-Term Assets:
Fixed Assets $ 135,900
Less: Accumulated Depreciation (51,900) 84,000
Total Assets $242,800

Liabilities:
Current Liabilities:
Accounts Payable $31,000
Wages Payable 8,500
Income Taxes Payable 6,400
Interest Payable 4,500
Total Current Liabilities 50,400
Long-Term Liabilities:
Note Payable, long-term 71,600
Total Liabilities $122,000
Stockholders Equity:
Capital Stock ($10 par) 15,000
Additional Paid-in Capital 45,000
Retained Earnings 60,800
Total Stockholders Equity 120,800
Total Liabilities & Stockholders Equity $242,800

Logell Paper Products
Income Statement
For the Year Ended December 31, 2012

Sales $973,700
Less: Cost of Goods Sold 706,750
Gross Profit 266,950
Less: Operating Expenses:
Wages Expense $170,000
Depreciation Expense 10,150
Rent Expense 27,350
Total Operating Expenses 207,500
Operating Income 59,450
Less: Other Expenses:
Interest Expense 15,350
Income Before Taxes 44,100
Less: Income Tax Expense 17,600
Net Income $ 26,500

Required:
1. What is the current ratio?
2. What is the working capital?
3. What is the return on sales?
4. If the beginning stockholders equity balance for Logell Paper Products was $85,000, then what is the return on stockholders equity?
Answer:
1. 3.15
2. $108,400
3. 2.7%
4. 25.8%
Diff: 2
Objective: L.O. 4-7, 4-9

Learning Objective 4.8 Questions

1) Gross profit appears on a
A) single-step income statement.
B) classified balance sheet.
C) multiple-step balance sheet.
D) multiple-step income statement.
E) single-step balance sheet.
Answer: D
Diff: 1
Objective: L.O. 4-8

2) Which account is usually a separate line item on the multiple-step income statement?
A) Cash
B) Dividends
C) Paid-in capital
D) Retained earnings
E) Income taxes
Answer: E
Diff: 1
Objective: L.O. 4-8

3) Gross profit is defined as
A) net income before the effect of income taxes.
B) the income generated by the company after subtracting all operating expenses.
C) the difference between total assets and total liabilities.
D) net income less the dividends declared during the period.
E) sales minus cost of goods sold.
Answer: E
Diff: 1
Objective: L.O. 4-8
4) The multiple-step income statement is
A) used by most U.S. companies.
B) used when total revenues exceed $1 million.
C) used to segregate current assets from non-current assets.
D) used for income tax purposes.
E) used in order to incorporate the current ratio into the statement.
Answer: A
Diff: 1
Objective: L.O. 4-8

5) An income statement without any intermediate subtotals is referred to as a multiple-step income statement.
Answer: FALSE
Diff: 1
Objective: L.O. 4-8

6) On a multiple-step income statement, operating expenses are deducted from cost of goods sold to obtain operating income.
Answer: FALSE
Diff: 2
Objective: L.O. 4-8

7) Gross profit equals sales minus operating expenses.
Answer: FALSE
Diff: 1
Objective: L.O. 4-8

8) The following single-step income statement for Balm Butters and Jellies needs to be converted into a multiple-step income statement for the year ended December 31, 2012.

Balm Butters and Jellies
Income Statement
For the year ended December 31, 2012

Revenues:
Sales $840,000
Interest Revenue 3,000
$843,000
Expenses:
Cost of Goods Sold 434,800
Depreciation Expense 4,200
Income tax Expense 59,300
Insurance Expense 8,100
Interest Expense 3,700
Rent Expense 14,800
Wage Expense 103,700
Total Expenses: 628,600
Net Income $ 214,400
Answer: Balm Butters and Jellies
Income Statement
For the year ended December 31, 2012

Sales $840,000
Cost of Goods Sold 434,800
Gross Profit $405,200
Operating Expenses:
Wage Expense 103,700
Depreciation Expense 4,200
Rent Expense 14,800
Insurance Expense 8,100 130,800
Operating Income 274,400
Add (Less) Other Revenues and Expenses:
Interest Revenue 3,000
Interest Expense (3,700) (700)
Income Before Taxes 273,700
Income Tax Expense 59,300
Net Income $ 214,400
Diff: 2
Objective: L.O. 4-8

9) Two companies have the following balance sheets as of December 31, 2012:

Reef Company
Cash $ 25,000 10% Note Payable, $ 50,000
Other Assets 75,000 Stockholders Equity 50,000
Total Liabilities And
Total Assets $100,000 Stockholders Equity $100,000

Score Company
Cash $ 25,000
Other Assets 75,000

Total Assets $100,000 Stockholders Equity $100,000

In 2012, each company had sales of $225,000 and expenses (excluding interest) of $200,000. Ignore income taxes. Assume Reefs 10% Note Payable is outstanding the entire year.
Required:
a. Calculate net income for both Reef and Score.
b. Calculate operating income for both Reef and Score.
Answer:
a. Reef Company Score Company
Income Statement Income Statement

Sales $225,000 Sales $225,000
Less: expenses (200,000) Less: expenses (200,000)
Operating income 25,000
Less: interest expense 5,000
Net Income $ 20,000 Net Income $ 25,000

Net income for Reef = $20,000
Net income for Score= $25,000

b. Operating income for Reef = $25,000
Operating income for Score= $25,000

Both companies earned the same operating income of $25,000. Reef Companys net income, however, was $5,000 lower due to interest charges on the note payable.
Diff: 2
Objective: L.O. 4-8

10) Briefly explain the difference between operating income and net income. Why do companies calculate both?
Answer: Operating income is the income that remains after cost of goods sold and other operating expenses are deducted from sales revenue. Operating expenses are recurring expenses that pertain to the firms routine, ongoing operations. Operating income less other nonoperating revenues and expenses (including interest expense) and income tax expense gives net income. Companies calculate both operating income and net income because the two numbers provide different information.
Diff: 2
Objective: L.O. 4-8
11) Name and define the subtotals that appear on a multiple-step income statement and not on a single-step income statement. Explain why income tax expense is usually the final deduction on both single-step and multiple-step income statements.
Answer:
The subtotals that appear on a multiple-step income statement are as follows:
Gross profit, the excess of sales revenue over the cost of goods sold
Operating income, gross profit less all operating expenses
Income before income taxes, operating income plus nonoperating revenues and less nonoperating expenses (i.e., those not directly related to the mainstream of a firms operations)
The amount of income tax expense is based on the income before income taxes. As such, most companies prefer to present these two items at the end of their income statements to emphasize this relationship.
Diff: 2
Objective: L.O. 4-8

Learning Objective 4.9 Questions

1) Which of the following statements is true with respect to the gross profit percentage?
A) The gross profit percentage shows the relationship of net income to sales revenue.
B) The gross profit percentage is widely regarded as the ultimate measure of overall accomplishment.
C) Retailers have high gross profit percentages because product costs are their main expense.
D) The gross profit percentage is useful to retailers in choosing a pricing strategy and in judging its results.
E) Gross profit percentages vary very little across industries.
Answer: D
Diff: 2
Objective: L.O. 4-9

2) Which of the following statements is NOT true?
A) Companies where product costs represent a high percentage of total costs would be expected to have a low gross profit percentage.
B) It is appropriate to compare a companys current financial ratio with the same financial ratio for (1) that company in prior years and/or (2) the ratio for the industry in which the company operates.
C) Return on sales ratios are useful in choosing a pricing strategy for a companys products.
D) Profitability evaluation ratios have a higher power than liquidity ratios for predicting a companys liquidity.
E) Return on assets equals net income divided by average total assets.
Answer: D
Diff: 3
Objective: L.O. 4-9
3) The return on assets ratio measures
A) how effectively assets generate profits.
B) how effectively assets generate stockholders equity.
C) the relationship of total assets to current assets.
D) the relationship of total assets to total liabilities.
E) a companys ability to generate sales.
Answer: A
Diff: 1
Objective: L.O. 4-9

4) Ratios such as the return on sales ratio allow readers to assess whether or not a company will provide them with a particular rate of return on their investment.
Answer: TRUE
Diff: 2
Objective: L.O. 4-9

5) Analysts will compare a companys financial ratios from the current year with those of past years in order to make judgments about a companys financial status, but comparison to other companies ratios is usually not performed.
Answer: FALSE
Diff: 2
Objective: L.O. 4-9

6) The gross profit percentage is calculated as sales divided by gross profit.
Answer: FALSE
Diff: 1
Objective: L.O. 4-9

7) The income statement of Bearwald Company is shown below.

Bearwald Corporation
Condensed Income Statement
Year Ended December 31, 2012

Sales $350,000
Cost of goods sold 217,000
Gross profit $ 133,000
Operating expenses
Wages $45,000
Depreciation 2,000
Rent 8,000 55,000
Operating income $ 78,000
Other revenues and expenses
Rent revenue $ 800
Interest revenue 200
Total other revenue $ 1,000
Deduct: interest expense 500
Income before income taxes $ 78,500
Income taxes 19,625
Net Income $ 58,875
Required:
1. Calculate the gross profit percentage.
2. Calculate the return on sales.
3. What term is often used in place of sales or sales revenue? Which organizations typically use this term?
Answer:
1. 38% ($133,000 /$ 350,000)
2. 16.8% ($58,875 / $350,000)
3. Turnover is often used in place of sales or sales revenue typically in organizations utilizing IFRS.
Diff: 3
Objective: L.O. 4-8, 4-9

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