Company A purchases office supplies on credit for $500. How does this transaction affect the accounting equation?
Assets increase, Liabilities increase.
✓
Assets increase, Revenue increases.
Assets increase, Equity decreases.
Assets decrease, Liabilities increase.
Correct Answer
Assets increase, Liabilities increase.
Assets (Office Supplies) increase because the company acquired a resource. Liabilities (Accounts Payable) increase because the company now owes money for the purchase. This maintains the accounting equation. Assets increase, Liabilities increase. Assets increase, Equity decreases. Assets decrease, Liabilities increase. Assets increase, Revenue increases.
Question 2
What is the normal balance of an expense account?
Debit.
✓
Varies depending on the specific expense.
Credit.
Debit for assets, credit for liabilities.
Correct Answer
Debit.
Expense accounts reduce equity and are increased by debits, so their normal balance is a debit. Credit is the normal balance for revenue, liabilities, and equity accounts. This option is too general and does not specifically answer for an expense account. Expense accounts always have a normal debit balance, they do not vary in this regard.
Question 3
A business provides $2,000 in services to a client on account. Which of the following journal entries correctly records this transaction?
Debit Service Revenue $2,000, Credit Accounts Receivable $2,000.
Debit Accounts Payable $2,000, Credit Service Revenue $2,000.
Debit Accounts Receivable $2,000, Credit Service Revenue $2,000.
✓
Debit Cash $2,000, Credit Service Revenue $2,000.
Correct Answer
Debit Accounts Receivable $2,000, Credit Service Revenue $2,000.
Since services were provided on account, cash was not received, but a right to collect cash (Accounts Receivable) was created, which is an asset and increased by a debit. Service Revenue is earned, increasing equity, and is increased by a credit. This entry incorrectly assumes cash was received. This entry incorrectly uses Accounts Payable, which is a liability for amounts owed by the company, not amounts owed to the company. This entry reverses the correct debit and credit for an asset and revenue account.
Question 4
Which financial statement reports a company's financial position at a specific point in time?
Income Statement.
Statement of Retained Earnings.
Statement of Cash Flows.
Balance Sheet.
✓
Correct Answer
Balance Sheet.
The Income Statement reports financial performance over a period. The Statement of Cash Flows reports cash inflows and outflows over a period. The Balance Sheet presents assets, liabilities, and equity at a specific date. The Statement of Retained Earnings reports changes in retained earnings over a period.
Question 5
Under the accrual basis of accounting, when is revenue recognized?
When it is earned, regardless of when cash is received.
✓
When cash is received, regardless of when it is earned.
When the service is completed and the customer is billed.
At the end of the accounting period.
Correct Answer
When it is earned, regardless of when cash is received.
This describes the cash basis of accounting, not the accrual basis. Under the accrual basis, revenue is recognized when the company has performed its obligation to the customer, regardless of cash timing. While billing often occurs after a service is completed, the core principle of accrual revenue recognition is when the service is earned. Revenue recognition is not tied to the end of an accounting period, but to the earning process.
Question 6
A company has total assets of $150,000 and total equity of $90,000. What are the total liabilities?
$240,000.
$60,000.
✓
$90,000.
$150,000.
Correct Answer
$60,000.
The accounting equation is Assets = Liabilities + Equity. To find Liabilities, rearrange to Liabilities = Assets - Equity. So, $150,000 - $90,000 = $60,000. This is the result of adding assets and equity, not subtracting. This incorrectly assumes liabilities are equal to total assets. This incorrectly assumes liabilities are equal to equity.
Question 7
A credit balance in which of the following accounts indicates a normal balance?
Equipment.
Cash.
Dividends.
Accounts Payable.
✓
Correct Answer
Accounts Payable.
Cash is an asset, and assets have a normal debit balance. Equipment is an asset, and assets have a normal debit balance. Dividends reduce equity and have a normal debit balance. Accounts Payable is a liability, and liabilities have a normal credit balance.
Question 8
A company pays $800 cash for its monthly utilities bill. Which journal entry correctly records this transaction?
This entry incorrectly reverses the debit and credit; cash is decreasing, not increasing. This entry would be used if the utilities bill was previously recorded as a payable and is now being paid. Utilities Expense is increasing (debit) and Cash is decreasing (credit) to reflect the payment. This entry incorrectly assumes the expense was incurred on account and not paid immediately.
Question 9
What is the correct order of financial statement preparation?
Income Statement, Balance Sheet, Statement of Retained Earnings.
Statement of Retained Earnings, Income Statement, Balance Sheet.
Income Statement, Statement of Retained Earnings, Balance Sheet.
✓
Balance Sheet, Income Statement, Statement of Retained Earnings.
Correct Answer
Income Statement, Statement of Retained Earnings, Balance Sheet.
The Balance Sheet cannot be prepared first because it requires the ending balance of retained earnings, which comes from the Statement of Retained Earnings. The Statement of Retained Earnings cannot be prepared after the Balance Sheet because its ending balance is needed for the Balance Sheet. The Statement of Retained Earnings cannot be prepared first because it requires net income from the Income Statement. Net income from the Income Statement is needed for the Statement of Retained Earnings, and the ending retained earnings balance is needed for the Balance Sheet.
Question 10
A company receives a bill for $300 for advertising services rendered in December, but pays it in January. Under accrual accounting, when should the advertising expense be recognized?
January.
December.
✓
When the bill is received.
Never, until the service generates revenue.
Correct Answer
December.
This describes recognition under the cash basis, not accrual. Under accrual accounting, expenses are recognized when incurred, not when the bill is merely received. Under accrual accounting, expenses are recognized in the period they are incurred, regardless of when cash is paid. The matching principle requires expenses to be recognized when incurred, not contingent on future revenue generation.
Question 11
An owner invests $10,000 cash into the business. How does this transaction affect the accounting equation?
Assets increase, Equity increases.
✓
Equity increases, Revenue increases.
Assets decrease, Equity increases.
Assets increase, Liabilities increase.
Correct Answer
Assets increase, Equity increases.
An owner's investment increases the company's cash (an asset) and increases owner's equity. This incorrectly assumes the investment is a liability (debt) to the business. This incorrectly states that assets decrease; cash, an asset, is increasing. An owner's investment is not considered revenue; it is a direct increase to equity.
Question 12
To increase a revenue account, a company would:
Debit for cash revenue, credit for credit revenue.
Credit the account.
✓
Debit the account.
Credit for cash revenue, debit for credit revenue.
Correct Answer
Credit the account.
Revenue accounts increase equity and are increased by credits. Debiting a revenue account would decrease it. The method of payment (cash or credit) does not change the rule that revenue accounts increase with a credit. The method of payment (cash or credit) does not change the rule that revenue accounts increase with a credit, nor would debits increase revenue.
Question 13
A company received $1,200 in advance for 3 months of services on December 1. By December 31, one month of service has been earned. What adjusting entry is needed on December 31?
Debit Unearned Revenue $1,200, Credit Service Revenue $1,200.
Debit Cash $400, Credit Service Revenue $400.
Debit Service Revenue $400, Credit Unearned Revenue $400.
Debit Unearned Revenue $400, Credit Service Revenue $400.
✓
Correct Answer
Debit Unearned Revenue $400, Credit Service Revenue $400.
Cash was received on December 1, so this is not an adjusting entry for earned revenue. This entry incorrectly reverses the debit and credit; revenue should be credited to increase it, and the liability (Unearned Revenue) should be debited to decrease it. One month's service (1/3 of $1,200 = $400) has been earned, so Unearned Revenue (a liability) is debited to decrease it, and Service Revenue (equity) is credited to increase it. This entry recognizes all $1,200 as earned, but only $400 was earned by December 31.
Question 14
Beginning Retained Earnings were $50,000. Net Income for the period was $20,000. Dividends paid were $5,000. What is the ending balance of Retained Earnings?
$65,000.
✓
$75,000.
$60,000.
$45,000.
Correct Answer
$65,000.
This calculation incorrectly omits the subtraction of dividends. This calculation incorrectly subtracts net income instead of adding it. This calculation incorrectly subtracts both net income and dividends. Ending Retained Earnings = Beginning Retained Earnings + Net Income - Dividends. So, $50,000 + $20,000 - $5,000 = $65,000.
Question 15
Which accounting basis is required by Generally Accepted Accounting Principles (GAAP) for external financial reporting?
Modified cash basis.
Cash basis.
Accrual basis.
✓
Hybrid basis.
Correct Answer
Accrual basis.
The cash basis is generally not permitted under GAAP for most businesses because it does not accurately match revenues and expenses. Modified cash basis is a variation that is not a standard GAAP-compliant method. Hybrid basis refers to a mix of cash and accrual, which is not a standard GAAP-compliant method. GAAP requires the accrual basis of accounting to ensure that revenues and expenses are recognized in the proper period, regardless of cash flows.
Question 16
A company incurs and pays $700 for rent expense. How does this transaction affect the accounting equation?
Assets decrease, Revenue decreases.
Assets decrease, Assets increase.
Assets decrease, Equity decreases.
✓
Assets decrease, Liabilities decrease.
Correct Answer
Assets decrease, Equity decreases.
Paying an expense reduces cash (an asset), but it does not reduce a liability unless it was previously recorded as a payable. Paying an expense reduces cash (an asset) and reduces equity, but it does not directly reduce revenue. This option suggests an exchange of assets, but paying an expense reduces an asset (cash) and reduces equity. Paying an expense reduces cash (an asset) and reduces equity, as expenses reduce net income which in turn reduces retained earnings, a component of equity.
Question 17
A company purchases new equipment for $10,000 by signing a note payable. Which journal entry correctly records this transaction?
This entry incorrectly assumes cash was paid for the equipment, but a note payable was signed. Equipment, an asset, increases with a debit. Notes Payable, a liability, increases with a credit. This entry incorrectly reverses the debit and credit; Notes Payable should be credited to increase it, and Equipment should be debited. This entry incorrectly uses Accounts Payable, which is typically for short-term trade credit, not a formal note payable.
Question 18
A company sells goods for $1,500 on credit. Which journal entry correctly records this transaction?
This entry incorrectly assumes cash was received, but the sale was on credit. This entry incorrectly reverses the debit and credit; Sales Revenue should be credited to increase it, and Accounts Receivable should be debited. When goods are sold on credit, Accounts Receivable (an asset) increases with a debit, and Sales Revenue (equity) increases with a credit. This entry incorrectly uses Accounts Payable, which is a liability for amounts owed by the company, not amounts owed to the company.
Question 19
The primary purpose of the Income Statement is to report:
A company's financial position at a point in time.
A company's financial performance over a period of time.
✓
A company's cash inflows and outflows over a period.
Changes in a company's retained earnings over a period.
Correct Answer
A company's financial performance over a period of time.
This describes the purpose of the Balance Sheet. This describes the purpose of the Statement of Cash Flows. This describes the purpose of the Statement of Retained Earnings. The Income Statement reports revenues and expenses to show a company's profitability (financial performance) over a specific accounting period.
Question 20
A company collected $5,000 cash for services to be performed next month and paid $1,000 cash for this month's rent. Under the cash basis of accounting, what is the net income for the current month?
($1,000).
$0.
$5,000.
$4,000.
✓
Correct Answer
$4,000.
This option only considers the expense and ignores the cash collected, or incorrectly assumes no revenue under cash basis. Under the cash basis, revenue is recognized when cash is received, and expenses are recognized when cash is paid. So, $5,000 (cash collected) - $1,000 (cash paid) = $4,000. Under the cash basis, the $5,000 collected is revenue immediately, regardless of when services are performed. This option only considers the cash collected as revenue and ignores the cash payment for rent.
Question 21
Which of the following accounts typically has its balance increased by a debit?
Notes Payable.
Dividends.
✓
Retained Earnings.
Service Revenue.
Correct Answer
Dividends.
Retained Earnings is an equity account, which increases with a credit and decreases with a debit. Service Revenue is a revenue account, which increases with a credit. Notes Payable is a liability account, which increases with a credit. Dividends are a contra-equity account that reduce retained earnings, and thus are increased by debits.
Question 22
On October 1, a company paid $3,600 for a one-year insurance policy. What adjusting entry is required on December 31 to record the insurance expense?
This entry records the initial cash payment for the policy, not the adjusting entry for expense recognition. This entry incorrectly reverses the debit and credit; Insurance Expense should be debited to increase it, and Prepaid Insurance should be credited to decrease it. Three months of insurance (October, November, December) have expired. The monthly expense is $3,600 / 12 months = $300. So, 3 months * $300/month = $900. Insurance Expense increases (debit), and Prepaid Insurance (an asset) decreases (credit). This entry only recognizes one month of expense, but three months have passed by December 31.