Question 1

Total assets always equal total liabilities plus total equity.

Accepted Answer

This is known as the accounting equation and it must always balance in a properly maintained set of financial records.

Question 2

The recognition principle states that the activities of an entity should be kept separate from those of its owner.

Accepted Answer

The recognition principle refers to the criteria for recognizing revenue and expenses in financial statements, not the separation of entity and owner activities. The concept of keeping an entity's activities separate from its owner is known as the economic entity assumption.

Question 3

Limited liability means that owners of a business are only liable for the debts of the business up to the amounts they can afford.

Accepted Answer

Limited liability means that owners of a business are only liable for the debts of the business up to the amount of their investment or ownership stake. They are not personally liable for the full extent of the business's debt.

Question 4

The practice of showing assets on the balance sheet at their cost rather than at their current market value is explained in part by the fact that cost is supported by objective evidence that can be verified by independent experts.

Accepted Answer

The statement is true. Showing assets on the balance sheet at their cost is supported by objective evidence that can be verified by independent experts. The cost is based on past transactions or events, while current market value may fluctuate, making it difficult to determine a reliable value for reporting purposes.

Question 5

A business entity is regarded as separate from the personal activities of its owners whether it is a sole proprietorship, a partnership, or a corporation.

Accepted Answer

This is known as the principle of separate legal personality, which means that the business entity has its own legal rights, responsibilities, and obligations that are separate from those of its owners.

Question 6

The collection of an account receivable will cause total assets to decrease.

Accepted Answer

The collection of an account receivable converts one asset (accounts receivable) into another asset (cash), keeping the total assets unchanged.

Question 7

The going concern principle assumes that the business will continue indefinitely.

Accepted Answer

The going concern principle assumes that the business will continue indefinitely and is an underlying assumption in financial reporting. This means that the financial statements are prepared with the belief that the business will be able to continue operating in the foreseeable future without the need to liquidate or severely alter its operations.

Question 8

Assets need not always have physical characteristics such as buildings, machinery or inventory.

Accepted Answer

Assets can also include intangible assets such as patents, trademarks, copyrights, and goodwill. These assets may not have physical substance but have value and can be owned and used by a company.

Question 9

Any business event that might affect the future profitability of a business should be reported in its balance sheet.

Accepted Answer

The balance sheet is a snapshot of a business's financial position at a specific point in time and as such, it only reflects the financial position of the business at that moment. Events that may affect future profitability, such as changes in market conditions or new competitors entering the market, are not reflected in the balance sheet. These events are typically reported in a company's financial statements or management discussion and analysis.

Question 10

In a business organized as a corporation, it is not necessary to list the equity of each shareholder on the balance sheet.

Accepted Answer

In a corporation, the equity of each shareholder is not reported on the balance sheet. Instead, the total equity of the corporation is reported as one line item on the balance sheet. Shareholders' equity can be found in the corporation's financial statements, but not on the balance sheet.

Question 11

The accounting equation may be stated as "assets minus liabilities equals equity."

Accepted Answer

This is the correct statement of the accounting equation, where assets (what a company owns) are equal to the sum of liabilities (what a company owes) and equity (the residual interest in the assets after liabilities are deducted).

Question 12

Notes payable and accounts payable are written promises to pay an amount owed by a certain date. Notes payable generally have interest but accounts payable generally do not.

Accepted Answer

Notes payable and accounts payable are both types of liabilities, but notes payable include interest while accounts payable do not.

Question 13

The sale of additional shares of share capital will cause treasury shares to increase.

Accepted Answer

The sale of additional shares of share capital will not cause treasury shares to increase. Treasury shares are shares that a company has bought back from its investors and are held in the company's treasury. The sale of additional shares would increase the number of outstanding shares, but would have no effect on the number of treasury shares.

Question 14

Articulation between the financial statements means that they relate closely to each other.

Accepted Answer

Articulation between the financial statements is essential as each statement provides information that is linked to the other statements. For instance, the net income on the income statement flows into the retained earnings on the statement of changes in shareholder equity, which then flows into the balance sheet. Therefore, the financial statements must be accurate and consistent to demonstrate a strong correlation between them.

Question 15

The payment of a liability causes an increase in equity.

Accepted Answer

The payment of a liability reduces the amount of the liability owed, but does not directly impact equity. It may indirectly impact equity if the liability was used to purchase assets which generate income or if the payment of the liability reduces interest expenses, thereby increasing net income and retained earnings.

Question 16

A transaction that causes an increase in an asset may also cause a decrease in another asset, an increase in a liability, or an increase in equity.

Accepted Answer

This statement is true. Every transaction in accounting has a dual effect, meaning that at least two accounts are affected. An increase in one asset may be matched with a decrease in another asset or with an increase in a liability or equity account.

Question 17

Total assets plus total liabilities equals total equity.

Accepted Answer

The correct equation is: Total Assets = Total Liabilities + Total Equity. This is known as the accounting equation.

Question 18

The entity principle states that the affairs of the owners are not part of the financial operations of a business entity and should be separated.

Accepted Answer

The entity principle is a fundamental accounting principle that states that the business entity is separate from its owners or shareholders. This means that the financial transactions and operations of the business should be recorded and reported separately from the personal affairs of the owners. This principle allows for accurate and reliable financial reporting that reflects the true financial position of the business.

Question 19

A profit results from having more revenues than liabilities.

Accepted Answer

A profit results from having more revenues than expenses, not liabilities. Liabilities are obligations or debts, not costs.

Question 20

A cash flow statement reports revenue and expense activities for a specific time period such as one month or one year.

Accepted Answer

A cash flow statement reports the inflows and outflows of cash, not revenue and expenses, for a specific period.

Quiz 2: Basic Financial Statements