Intro to Financial Statements
Self Test
Introduction to Accounting
Introduction to Financial Statements
Self Test
Click the “Check Your Answer” box below each problem to reveal the correct answer and explanation.
1. If net income after tax is $42,000, the tax rate is 30%, and total expenses not including tax expense are $126,000, revenues must be:
a. $78,000
b. $60,000
c. $186,000
d. $200,000
Answer
1st- divide net income by 70% get income before of 60,000
2nd- add the income before tax expenses together to get revenues
Revenues 186,000 plug, work up from bottom
– Expenses (126,000)
= Income before tax 60,000
– Tax expense (18,000)
= Net income 42,000
2. The financial statement that reports what the company owns and what the company owes is the
a. statement of owner’s equity
b. income statement
c. balance sheet
d. cash flow statement
Answer
C. What the company owns/has is called assets and what the company owes is called liabilities. Assets, liabilities, and owner’s equity are presented on the balance sheet. The income statement reports revenues and expenses. The cash flow statement reports sources and uses of cash. The statement of owner’s equity reports transactions that change owner’s equity accounts.
3. What is supposed to “balance” on the balance sheet?
a. revenues = expenses
b. assets = liabilities + owner’s equity
c. liabilities = owner’s equity
d. cash flow in = cash flow out
Answer
B. Assets, liabilities, and owner’s equity are presented on the balance sheet. What you have, you either owe for or you own. Assets must equal liabilities plus owner’s equity.
4. Which of the following is for the specific purpose of reporting cash flows?
a. statement of assets
b. income statement
c. cash flow statement
d. statement of changes in cash
Answer
C. The cash flow statement reports sources and uses of cash flows. It shows where cash comes from and what cash is used for. There is no such thing as a statement of assets. The income statement reports what is earned for this period. Earnings are not the same as change in cash. There is no statement called statement of changes in cash.
5. The purpose of financial accounting is to provide
a. financial information to internal users
b. financial information to external users
c. operational information to external users
d. operational information to internal users
Answer
B. Financial accounting is the recording and reporting of financial information to external users (outside the company). This information may also be used by internal management but it is generated for external users. It provides financial information and not operational information.
6. Which statement provides information on goods and services provided to customers?
a. statement of owner’s equity
b. income statement
c. balance sheet
d. cash flow statement
Answer
B. Providing goods and services to customers is revenue. Revenue is stated on the income statement. It is not stated on any other financial statement.
7. The accounting equation is
a. assets = liabilities – equity
b. liabilities = assets + equity
c. assets = liabilities + equity
d. revenues + expenses = income
Answer
C. Assets = Liabilities + Owner’s equity is the accounting equation that must stay in balance. When you have something, you either own it outright or you owe for it.
8. Liabilities are
a. increases in assets from profits
b. obligations resulting from past transactions
c. services provided to customers
d. equal to increases in equity
Answer
B. A liability is something that a company owes (is obligated to pay) because the company was provided a good or service. Projected liabilities are not recorded. Services provided to customers are revenues. Equity increases with profits (revenues less expenses). Revenues generate an increase in profits and assets, not liabilities.
9. Which financial statement provides information related to the financial performance of a company during a specific period?
a. statement of owner’s equity
b. income statement
c. balance sheet
d. cash flow statement
Answer
B. The income statement reports earning for a company during a specific time period. It is normally for the period of a month, quarter, or year. The balance sheet reports what the company has and owes at a specific point in time. The cash flow statement shows what occurs with cash only. The statement of owner’s equity reports only transactions that change owner’s equity.
10. Prepaid expenses is an asset because
a. the company owns it
b. the company has paid ahead and therefore has future benefit
c. a past transaction has occurred
d. all of the above
Answer
D. An asset is a probable future economic benefit; something that will be used in the future to generate cash. It is also owned or controlled. The past transaction is the previous payment. The right to receive the service in the future is a future benefit. Prepaid expenses meet all of the requirements of an asset.
11. A company reports net income when
a. earnings from all periods are higher than all dividends paid
b. services provided are greater than the cost to provide the services
c. it has more than it owes
d. the balance in cash has increased
Answer
B. Revenues less expenses = net income, which is the same thing as saying services provided less the cost to provide services equals net income. Dividends are a payment back to shareholders and do not meet the definition of an expense. Dividends are not included in net income. Assets (own) and liabilities (owe) are not part of net income. Revenues are reported when earned and expenses are reported when incurred, which may or may not be the same period the cash is received or paid.
12. Economic resources is the technical term for
a. assets
b. liabilities
c. owner’s equity
d. expenses
Answer
A. An economic resource is an asset. A use of a future economic resource is a liability. Owner’s equity is resources less the obligated future use of the resource. An expense occurs when the economic resource is used up.
13. Which of the following is considered an expense?
a. prepaid expense
b. cost of goods sold
c. sales
d. building
Answer
B. Expenses are using an asset or being provided a goods/service that must be paid for. Cost of goods sold is using an asset to generate revenue; the inventory, the asset is provided to the customer and used up. Sales are a revenue. Prepaid expenses is an asset because it is a future benefit paid ahead of time. Building is an asset that is owned.
14. An examination of accounting records to determine if the records and reports are in accordance with generally accepted accounting standards is called
a. a fiscal examination
b. an acceptable presentation of financial information
c. a validation of accounts
d. an audit
Answer
D. This is the technical definition of an audit. The audit opinion states whether or not the financial statements are materially stated in accordance with GAAP. It does not state that the financial statements are 100% accurate.
15. The government agency with legal authority over financial reporting of U.S. public companies is called
a. financial accounting standards board (FASB)
b. international accounting standards board (IASB)
c. federal trade commission (SEC)
d. securities exchange commission (SEC)
Answer
D. The SEC has legal authority over public companies accounting and reporting. FASB provides accounting guidance and has no legal authority. The IASB provides guidance for other countries and has no legal authority (similar to FASB) The federal trade commission does not provide accounting guidance or regulate financial reporting.
16. What increases retained earnings?
a. revenues
b. assets
c. dividends paid
d. liabilities
Answer
A. Retained earnings is increased by net income. Net income occurs when revenues are greater than expenses. Revenues increase retained earnings. Dividends paid directly reduce retained earnings. Liabilities and assets do not change retained earnings.
17. Which financial statement reports dividends paid to shareholders?
a. statement of owner’s equity
b. income statement
c. balance sheet
d. statement of net assets
Answer
A. Dividends are payments to owners and the statement of owner’s equity reports transactions that affect owners. Dividend paid is not an expense and is not reported on the income statement. Dividends paid are a reduction to retained earnings. Dividends are not reported separately on the balance sheet, it is already netted into retained earnings. Statement of net assets is not one of the four primary financial statements.
18. Which financial statement reports what the company owes suppliers?
a. statement of owner’s equity
b. income statement
c. balance sheet
d. cash flow statement
Answer
C. What the company owes suppliers is accounts payable, a liability. Liabilities are reported on the balance sheet only. The income statement reports revenues and expenses and gains and losses.
19. Assets typically include
a. accounts receivable and accounts payable
b. sales and prepaid expenses
c. inventory and cost of goods sold
d. accounts receivable and equipment
Answer
D. Accounts receivable and equipment are both assets. Accounts payable is a liability. Sales is a revenue. Cost of goods sold is an expense.
20. Which of the following is not a liability?
a. unearned revenues
b. accounts payable
c. taxes payable
d. sales
Answer
D. Sales is a revenue reported on the income statement. Sales occur when goods or services are provided to the customer. Unearned revenues is a cash received from the customer before the goods or services are provided and the company owes the customer the good or service. Taxes payable are owed to the government. Accounts payable are owed to suppliers for inventory and other services that are purchased repeatedly.