Question 1

Liquidity refers to how quickly liabilities must be paid.

Accepted Answer

Liquidity is a term applied to a firm's assets. Liabilities are debts owed by the firm.

Question 2

One important source of financing for most small businesses is the owner's savings. If the owner contributes money to the business from his/her personal savings, it will be recorded in the owners' equity account on the balance sheet.

Accepted Answer

Two important sources of financing for businesses are borrowed funds (liabilities) and contributed funds (owners' equity).

Question 3

FIFO is a method of computing net cash flows by subtracting financial inflows from financial outflows.

Accepted Answer

FIFO [first-in, first-out] is an inventory valuation method used for computing the cost of goods sold on an income statement.

Question 4

Net income is simply the difference between revenue and cost of goods sold.

Accepted Answer

Revenues - Cost of goods sold = Gross profit. Net income represents the "bottom line" of the income statement.

Question 5

FIFO is a method of inventory valuation that assumes the items most recently purchased are also the items that are sold first.

Accepted Answer

FIFO [first-in, first-out] assumes that the oldest items in inventory are sold first.

Question 6

Revenue on the income statement represents the dollar amount of what is received for goods sold, services rendered, and/or from other revenue sources.

Accepted Answer

Revenues constitute sales from goods sold and/or services rendered, as well as monies received from other sources such as rent income or interest income from marketable securities.

Question 7

FIFO and LIFO are two common methods used to compute the depreciation of tangible assets.

Accepted Answer

FIFO [first-in, first-out] and LIFO [last-in, first-out] are inventory valuation methods. Depreciation methods include, but are not limited to "straight-line" and "double-declining."

Question 8

The LIFO method of inventory valuation assumes the newest items in inventory are sold first.

Accepted Answer

LIFO [last-in, first-out] assumes that the newest items in inventory are sold first.

Question 9

The cost of goods sold reflects the selling price of the merchandise sold over a period of time.

Accepted Answer

The cost of goods sold reflects the price that a firm paid for merchandise that it plans to resell; or the price of raw materials that a firm paid for in order to produce a good or service for resale. Revenues = Selling price x Volume.

Question 10

When an accountant writes off the cost of a tangible asset over its estimated lifetime, it is called depreciation.

Accepted Answer

Depreciation is the write-off each year of part of an asset over its estimated useful life. The government permits firms to depreciate a fixed asset over its lifetime, rather than deduct the entire expense when the asset is purchased.

Question 11

Although a firm may use different inventory valuation methods, generally accepted accounting principles (GAAP) states that these methods must produce the same dollar value for the cost of goods sold.

Accepted Answer

The accounting treatment of inventory may be different. Depending upon whether the accountant is using FIFO [first-in, first-out] or LIFO [last-in, first-out], the value of cost of goods sold may be different.

Question 12

When valuing items in inventory for financial reporting purposes, generally accepted accounting principles (GAAP) requires firms to value the cost of goods sold by assuming that the items that have been in inventory the longest are the ones that are sold first.

Accepted Answer

GAAP permits businesses to select from a few different methods of inventory valuation, including FIFO (first-in, first-out) and LIFO (last-in, first-out).

Question 13

According to generally accepted accounting principles (GAAP), a firm must use the inventory valuation method that most accurately reflects the actual movement of goods through its inventory.

Accepted Answer

GAAP does not concern itself with the movement of goods through a firm's inventory system. It is concerned with a firm choosing a method of valuation and consistently using that method.

Question 14

The firm's most valuable assets are listed at the top of its balance sheet.

Accepted Answer

Both current and fixed assets are needed and valued by most companies in order to efficiently and effectively run their operations. A firm purchases fixed assets with the intention of using them over an extended period of time-greater than one year. Fixed assets have an estimated useful life.

Question 15

The income statement computes net income by subtracting liabilities from assets.

Accepted Answer

The income statement records revenues and then subtracts all expenses (including taxes) in order to calculate net income.

Question 16

The cash a firm raised from issuing new debt or equity capital would be reported on a statement of cash flows.

Accepted Answer

Cash received or disbursed through financing activities is recorded on the statement of cash flows.

Question 17

Banks are likely to request a firm's balance sheet when determining whether or not to loan money to the firm. However, banks would have little interest in the firm's income statement since it covers a short period of time.

Accepted Answer

Both the income statement and the balance sheet are important in evaluating the financial health of an organization. Specifically, the income statement would show the firm's ability to generate the profits with which to pay back a loan.

Question 18

The best way for a firm to avoid serious cash flow problems is to sustain a rapid growth in sales.

Accepted Answer

Rapid growth can put a serious strain on a company's cash position. For example, a firm may be able to expand its sales rapidly by offering very easy credit, but if customers who buy on credit are late with their payment (or, even worse, default on their payments) the company could have serious problems with its cash flow.

Question 19

Patents and copyrights are examples of intangible assets.

Accepted Answer

Intangible assets do not have physical form, yet they have monetary value for the firm. Sometimes these are referred to as intellectual capital due to their importance as a valuable economic resource.

Question 20

Cash flow difficulties are unlikely for a firm that is profitable.

Accepted Answer

A firm's net income after taxes shows whether the company had a profit or on a loss from operations. However, profits and cash do not mean the same thing. A firm may have the ability to generate revenues and profits, but still have a cash flow shortage. The company should always prepare a statement of cash flows in order to determine its ability to continue to generate cash flow.

Quiz 17: Understanding Accounting and Financial Information