Practice Questions

Basic Accounting
Solutions
 Basic Accounting Solutions

Answers:

1. Assets increase by $25,000, and liabilities increase by $25,000. Assets go down by $5,000, the
amount of cash paid, and go up by $30,000, the cost of the truck. The net effect is an increase of
$25,000. The loan will increase liabilities by $25,000.

2. A $20,000 decrease in assets and a corresponding decrease of $20,000 in liabilities. When a

company makes a payment on an amount owed to a supplier, the debt decreases. If a debt
decreases, then liabilities decrease, and the cash decreases as a result of the payment. This
means that assets decrease.

3. $150,000. You need to go back to the basic accounting equation: assets = liabilities + owners’
equity. Step one is to determine total owners’ equity, which has two parts — the investment by
owners and the losses that the business experienced during the first year of operations.
Investment by owners is $1,000,000. So, the total owners’ equity is $700,000:

Now you can use the basic accounting equation to calculate total liabilities at the end of the year:

4. profit of $100,000. The starting point to figure this out is the basic accounting equation: assets =
liabilities + owners’ equity. The question provides you with the total assets and total liabilities, but
you need to calculate equity. Equity has two components: capital/investment from owners and
retained earnings, or the profit/loss accumulated since the company’s inception. In this example,
you are given the capital invested but need to calculate the profit/loss. Rewrite the basic equation
in detail:

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5. August 1. Under accrual-basis accounting, revenues are recorded when the goods or services
are delivered to the customer, regardless of whether the customer has paid for them. This
distinguishes accrualbasis accounting from cash-basis accounting, where the revenues are not
recorded until the customer pays for the goods or services. Although the company received an
order for the ice cream on July 31, delivery didn’t happen until August 1.

6. August 10. Cash-basis accounting records revenue when the cash is received from the
customer.

7. none. Under cash-basis accounting, revenue is recorded when the cash is received, which is
August 1 in this situation. No cash is received in September, so no revenue is recorded.

8. The income statement for May will show $759 in utility expense. Accrual-basis accounting
requires all expenses to be recorded when they are incurred (when the obligation is created),
regardless of when they are paid. Because the electricity was used in May, creating an obligation
to pay for it, the expense appears on the May income statement.

9. cash-basis accounting. The company has recorded the entire fuel expense in the month in
which the cash was paid. That is cash-basis accounting. If the company had used accrual-basis
accounting, the $1,000,000 of expense would have been spread out from January 1 to July 1.

10. $750,000. Under cash-basis accounting, revenues are recorded when the customer pays for
the products purchased. In this example, you know that cash receipts from sales were $750,000.
This amount is recorded as revenues when it’s received from customers. None of the other
numbers provided are relevant to cash-basis revenues.

11. $700,000. Under cash-basis accounting, expenses equal the amount of cash paid for products,
services, and other expenses. Therefore, adding cash payments for purchases of products of
$325,000 plus the cash payments for other expenses of $375,000 equals $700,000.

12. $50,000 profit. Under cash-basis accounting, profit is determined as the difference between
the cash inflow and cash outflow. In this case, cash receipts of $750,000 minus the cash payments
of $700,000 gives the cashbasis profit of $50,000.

13. $905,000. Under accrual-basis accounting, revenues are recorded when they are earned.
Revenues include not only the cash collected from customers ($750,000) but also the amount the
customers promise to pay in the form of receivables ($155,000). Thus, in this case, total revenues
under the accrual basis are the sum of the amount collected from customers and the receivables.
(750,000+155,000).

14. $205,000. The cost of goods sold includes the beginning inventory value plus the amount of
cash paid for purchases of products minus the balance of products still unsold at the end of the
year.

(325000-120000)

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15. $825,000. Under accrual-basis accounting, expenses are recorded when they are incurred.
Therefore, they include not only the cash payment of $375,000 but also the liability for unpaid
expenses of $450,000 for a total of $825,000.

16. $125,000 loss. You calculate accrual profit as revenues less cost of goods sold and other
expenses. Accrual-based revenues are equal to the cash received from customers plus the
amounts owed for sales during the year.

750000-155000= 905000

Accrual-based cost of goods sold is equal to the beginning inventory value plus the cash paid for
inventory less the unsold inventory still on hand.

325000-120000=205000

Accrual-based other expenses are equal to the cash paid for those expenses plus any amounts
for expenses incurred but unpaid.

375000+450000=825000

Revenue minus cost of goods sold minus other expenses equals the profit or loss for the year. A
negative result indicates a loss

905000-205000-825000= -125000

17. loss on the sale of equipment. An income statement summarizes all revenues, expenses,
gains, and losses of a business during a period of time, and it calculates the net income or loss for
that period. Deferred revenue is a liability and appears on the balance sheet.

18. $27,000. You calculate gross margin (also known as gross profit) by subtracting the cost of
goods sold from sales revenues. (47000-20000)

19. $10,000. Operating income/earnings includes all operating revenues and expenses but
excludes the interest revenue and income tax expense.

47000-20000-14000-3000 = 10,000

20. $11,200. Income tax expense is presented as a separate line item on the income statement,
and the line just before that expense is called ―income before income taxes.‖ It includes all
revenues, gains, expenses, and losses except tax expense.

47000-20000-14000-3000+1200=11,200

21. $2,600,000. You calculate gross profit as the difference between sales revenues and cost of
goods sold.

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22. $1,150,000. You calculate operating earnings as gross profit less selling, general, and
administrative expenses. You calculate gross profit as sales revenues less the cost of goods sold.
Then deduct selling, general, and administrative expenses from cost of goods sold to calculate
operating earnings.

23. $750,000. To calculate earnings before income taxes, all non-income tax expenses are
deducted from all revenues.

15000000-12400000-1450000-125000-275000=750000

24. $550,000. The formula to calculate net income is to subtract all expenses from all revenues.

15000000-12400000-1450000-125000-275000-200000=550,000

25. $240,000. Net income is the final number on the income statement. You calculate it by
subtracting income taxes from earnings before income taxes. However, in this example, you need
to determine the amount of the income tax expense. Because earnings before income taxes and
net income are provided, your formula should be earnings before the income tax of $420,000
minus the unknown tax expense equals net income of $180,000.

26. $6,000,000. Gross margin is equal to the difference between sales revenue and cost of goods
sold

27. $1,350,000. You calculate selling, general, and administrative expenses as the difference
between gross margin and operating earnings.

28. $230,000. Interest expense is presented on the income statement after operating earnings and
before earnings before income taxes. Thus, you calculate it as the difference between operating
income and earnings before income taxes.

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29. $275,000. Assets include cash, amounts owed by customers (accounts receivable), and cost of
unsold product (inventory).

110000+75000+90000=275000

30. $155,000. Liabilities include amounts owed for unpaid purchases and expenses (accounts
payable), notes payable to the bank, and unearned revenues.

72000+73000+10000=155000

31. $120,000. The basic accounting equation is assets = liabilities + owners’ equity. You can
calculate equity from this equation by subtracting liabilities from assets. Assets include cash,
amounts owed by customers (accounts receivable), and cost of unsold product (inventory).

110000+75000+90000=275000

Liabilities include amounts owed for unpaid purchases and expenses (accounts payable), notes
payable to the bank, and unearned revenues.

72000+73000+10000=155000

32. cash flows from investing activities. The statement of cash flows classifies the purchase of
fixed assets as investing activities.

33. as a financing activity. Paying off loans is a financing activity.

34. as a cash inflow of $30,000. Proceeds from sales of operating assets are an investing activity
on the statement of cash flows. The cash inflow is measured as the amount of cash received.

35. increase of $20,000. You calculate the net increase in cash as the sum of cash flow from
operating, investing, and financing activities.

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36. ($115,000). You calculate the net increase in cash as the sum of cash flow from operating,
investing, and financing activities. However, in this example, you are given the net decrease in
cash and need to calculate the cash flow from investing activities

37. $12,000. You calculate the net increase in cash as the sum of cash flow from operating,
investing, and financing activities. However, in this example, you are given the net increase in cash
and need to calculate the cash flow from financing activities.

38. $110,000. You calculate the net increase in cash as the sum of cash flow from operating,
investing, and financing activities. However, in this example, you are given the beginning and
ending cash balance and must calculate the change. Then, you use that number to determine cash
flows from operating activities. Cash increased by $100,000.

370000-270000=100,000

Now, the sum of the cash flows from operating, investing, and financing activities must equal
100,000.

39. net cash outflow of $85,000. Investing activities include investments in financial markets and
investments in capital assets. In the example, investing activities include the cash received from
the sale of old equipment and the cash paid to purchase the new equipment.

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40. net cash inflow of $45,000. Financing activities are activities that raise capital and repay
investors. After reviewing the information provided in the example, you should note that financing
activities include the proceeds from the new debt and proceeds from the issuance of stock less the
amount paid for dividends.

41. $11,300. Net cash increase/decrease is the sum of all cash inflows and outflows or the sum of
cash flows from financing, investing, and operating activities. Cash flows from financing activities
include the sale of stock, the payment of dividends, and the proceeds from the new loan.

Cash flows from investing activities include the cash paid for new equipment and the proceeds
from the sale of old equipment.

The net change in cash for the year combines the cash flows from financing, investing, and
operating activities.

The cash balance increased by $5,000 during the year

42. $90,000. Total liabilities and owners’ equity decreased by $95,000 if the company had that
amount in expenses. On the asset side, the depreciation expense decreased assets by $5,000.
The remaining $90,000 must have been expenses paid in cash, which reduces total assets

43. $130,100. Total expenses are $141,000. Depreciation expense is a non-cash item. The
increase in accounts payable means that $2,400 of the expense was posted to a liability account,
not paid in cash. Cash payments are $141,000 – $8,500 – $2,400 = $130,100.

44. $7,000. The difference between sales and cost of goods sold is gross profit, also called gross
margin (10000-3000).

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45. Gross margin is $5,100,978. The difference between sales and cost of goods sold is gross
profit, sometimes called gross margin (7632614-2531636=5100978.)

Operating profit is $669,967. Sales revenue less all variable costs and fixed costs equals operating
profit. Variable costs include cost of goods sold. (7632614-2531636-3631011-80000= 669,967)

46. 14%. You determine rate of return on equity by comparing income before taxes to total owners’
equity. Income before taxes is equal to operating profit minus interest expense.

47. 60%. You determine rate of return on equity by comparing income before taxes to total owners’
equity. Income before taxes is equal to operating profit minus interest expense.

48. 10.1%. You determine rate of return on equity by comparing income before taxes to total
owners’ equity. Income before taxes is equal to operating profit minus interest expense

49. 4.8 years. The rule of 72 gives a rough idea of how long it will take for an investment to double
in value given a stable rate of return. Divide 72 by the rate to get the number of years

50. current ratio Liquidity ratios are used to evaluate a company’s ability to pay current obligations.
The current ratio is the only liquidity ratio in the list.

51. return on equity, return on assets, and earnings per share All three of these ratios compare
income to some other element that measures the profitability for the year.

52. A supplier is trying to determine whether a customer is creditworthy. Liquidity ratios are used to
evaluate a company’s ability to pay current obligations. Before extending credit, the supplier will
want to analyze the customer’s ability to pay.

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53. 5.6. The current ratio is equal to current assets divided by current liabilities. Cash, accounts
receivable, and inventory are the current assets. Accounts payable is the only current liability

54. 6.92. You calculate accounts receivable turnover by dividing net credit sales by average
accounts receivable. To get net credit sales, you deduct returns from the credit sales for the year.

55. 18%. ROE is a measure of a company’s profitability. Analysts look at the trend over time and
compare the company’s ratio to the industry average to determine the profitability of the company.
ROE is equal to net income divided by common stockholders’ equity. Common stockholders’
equity is equal to the sum of contributed capital and retained earnings if there is no preferred stock.

970/5364 = 0.18

56. 97¢. Earnings per share measures the earnings available to common shareholders. The
numerator of the ratio is net income reduced by the amount of preferred dividends paid during the
year. The denominator is the average number of shares outstanding during the year.
(970/1,000=0.97)

57. 13% Return on assets is a profitability measure. You calculate it by dividing net income by
average assets during the year.

58. 1.97. Asset turnover is a profitability measure that indicates how well the assets of the
company produce sales. You calculate it as net sales divided by average assets.

59. 23. You calculate the price-earnings ratio by dividing the stock price per share by the earnings
per share. You calculate earnings per share by comparing earnings available to common
shareholders divided by the average number of shares of common stock outstanding during the
year. The numerator of the ratio is net income reduced by the amount of preferred dividends paid
during the year. The denominator is the average number of shares outstanding during the year.

970/1000 = 0.97 is the EPS for 2015.

Therefore P-E Ratio = 22.31/.97 = 23.

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