Question 1

The term liquidity refers to non-current items such as a building.

Accepted Answer

The term liquidity refers to the ability of an asset to be easily converted into cash without a significant loss of value. Non-current items such as a building are typically not considered liquid assets.

Question 2

If deferred revenue has been earned by the end of the current period and no adjustment is recorded, net income for the current period will be understated.

Accepted Answer

If deferred revenue has been earned by the end of the current period but no adjustment is recorded, the revenue and the corresponding expenses will not be recognized in the current period's financial statements. This will result in an understatement of net income for the current period.

Question 3

Accrual accounting is more complex than the cash basis.

Accepted Answer

Accrual accounting records revenue and expenses as they are earned or incurred, regardless of when cash exchanges hands. This requires tracking accounts receivable and payable, adjusting entries, and other complex accounting procedures, making it more complex than the cash basis, which records transactions only when cash is exchanged.

Question 4

The statement of retained earnings is the first financial statement to be prepared, followed by the balance sheet, and then the income statement.

Accepted Answer

The correct order is: 1) Income Statement, 2) Statement of Retained Earnings, and 3) Balance Sheet.

Question 5

Under the revenue recognition principle, businesses should record revenue when it is earned regardless of when payment is received from the customer.

Accepted Answer

The revenue recognition principle requires that revenue be recorded when it is earned, which means that the business has provided goods or services to the customer, and the customer is obligated to pay for them. The timing of payment does not affect when revenue should be recognized.

Question 6

Companies using the cash basis of accounting for their business generally make better decisions.

Accepted Answer

Companies using the cash basis of accounting only record transactions when cash is received or paid out, which can lead to inaccurate financial statements and poor decision-making. Accrual basis accounting provides a better representation of a company's financial position and performance.

Question 7

A multi-step income statement typically includes the calculation of gross profit.

Accepted Answer

A multi-step income statement includes the calculation of gross profit as one of the steps. Other steps may include operating expenses, non-operating income or expenses, and taxes.

Question 8

A low debt ratio is preferable to a high debt ratio, whereas a high current ratio is preferable to a low current ratio.

Accepted Answer

A low debt ratio indicates that the company is not overly reliant on borrowing money, which is generally considered to be less risky. A high current ratio indicates that the company has enough current assets (such as cash, inventory, and accounts receivable) to cover its current liabilities (such as bills and debt payments), which is a sign of financial stability.

Question 9

The closing entry required to reset the dividends account for the next accounting period includes a debit to dividends and a credit to retained earnings.

Accepted Answer

The correct closing entry to reset the dividends account for the next accounting period includes a debit to retained earnings and a credit to dividends, effectively transferring the dividend amount out of retained earnings to close out the dividends account.

Question 10

An adjusted trial balance is prepared without incorporating any end-of-period adjustments.

Accepted Answer

An adjusted trial balance is prepared after incorporating all end-of-period adjustments, such as accruals, deferrals, and depreciation, to reflect the final balances of all accounts before preparing financial statements.

Question 11

Salaries expense is a permanent account, so it is not closed as the end of the period.

Accepted Answer

Salaries expense is a temporary account, which means it is closed at the end of the accounting period to transfer its balance to a permanent account, typically Retained Earnings, to prepare the account for the next period's transactions.

Question 12

Adjusting journal entries recorded at the end of an accounting period update only revenue and expense accounts, and have no effect on either asset or liability accounts.

Accepted Answer

Adjusting journal entries affect both revenue and expense accounts as well as balance sheet accounts such as assets and liabilities. These entries are necessary to update the accounts to reflect the current financial status of the company.

Question 13

If the balance in Retained Earnings on January 1, 2020 was zero, then a credit balance in Retained Earnings on December 31, 2020 (after closing revenue and expense accounts) represents net income for the accounting period providing that no dividends were declared.

Accepted Answer

A credit balance in Retained Earnings indicates that the company has generated net income during the accounting period after deducting all expenses. If no dividends were declared, this credit balance in Retained Earnings represents the amount of net income that has been retained by the company.

Question 14

Retained earnings for the beginning of a period appears on the statement of retained earnings while the ending balance of retained earnings appears on the statement of retained earnings and the balance sheet.

Accepted Answer

Retained earnings for the beginning of a period is part of the calculation for the statement of retained earnings, while the ending balance of retained earnings is reported on both the statement of retained earnings and the balance sheet.

Question 15

To obtain a new customer, a business sells merchandise to the customer for $100. Normally, the merchandise sells for $120. For this sale, the business should record revenue of $100, not $120.

Accepted Answer

The revenue recorded for a sale is the amount received from the customer, which in this case is $100. The fact that the merchandise normally sells for $120 is not relevant to the revenue recorded for this particular sale.

Question 16

An expense that a business has paid for but not yet incurred is an accrued expense.

Accepted Answer

An accrued expense is an expense that a business has incurred but not yet paid for.

Question 17

If prepaid rent has expired during the current period and no adjustment has been made, net income for the current period will be overstated.

Accepted Answer

Prepaid rent is an asset, and when it expires, it becomes an expense that should be recognized in the income statement. Failing to adjust for this expense will result in an overstatement of net income.

Question 18

To close the revenue account a credit is required to retained earnings.

Accepted Answer

Revenue accounts have a natural credit balance, so to close them out, a credit entry is required. This credit entry is usually recorded to retained earnings, which increases the company's equity by the amount of the net income earned during the period.

Question 19

Prepaid expense accounts should appear on the balance sheet.

Accepted Answer

Prepaid expenses represent assets paid for in advance, such as insurance premiums or rent, and are reported on the balance sheet as assets.

Question 20

The cash basis of accounting records the impact of all business transactions as they occur.

Accepted Answer

The cash basis of accounting records transactions only when cash is received or paid, not necessarily when the transactions occur.

Quiz 3: Accrual Accounting and the Financial Statements