CHAPTER 3

1. What are the basic financial statements provided in an annual report?

a. Statement of financial position and income statement.
b. Statement of financial earnings and statement of equity.
c. Statement of financial position, income statement, and cash flow statement.
d. Statement of financial position, income statement, cash flow statement, and statement
of changes in equity.

2. What is the function of each cash flow statement?

a. To provide information about cash receipts and payments during an accounting
period.
b. To provide information about the operating, investing, and financing activities for an
accounting period.
c. To reconcile the beginning and ending balance of all equity accounts.
d. Both (a) and (b).

3. What items are included in the notes to the financial statements?

a. Summary of accounting policies.
b. Changes in accounting policies, if any.
c. Detail about particular accounts.
d. All of the above.

4. What does unqualified auditors report indicate?

a. The financial statements unfairly and inaccurately present the companys financial
position for the accounting period.
b. The financial statements present fairly the financial position, the results of operations,
and the changes in cash flows for the company.
c. There are certain factors that might impair the firms ability to continue as a going
concern.
d. Certain managers within the firm are unqualified and as such, are not fairly or
adequately representing the interests of the shareholders.

5. Who hires the auditor?

a. The firm which is audited.
b. The auditors accounting firm.
c. The Financial Reporting Standards Council.
d. The Securities and Exchange Commission.

6. What is the allocation of the cost of fixed assets called?

a. Fixed cost allocation.
b. Depreciation.
c. Salvage value.
d. Matching revenues and expenses.
7. Why could depreciation expense be considered a discretionary item?
a. Management must estimate the useful life of the asset.
b. A salvage value must be estimated.
c. Management must select a method of depreciation.
d. All of the above.

8. What do the choices and estimates relating to depreciation affect?

a. Gross fixed assets on the statement of financial position and depreciation expense on
the income statement.
b. Accumulated depreciation on the income statement and depreciation expense on the
statement of financial position.
c. Net fixed assets on the statement of financial position and depreciation expense on
the income statement.
d. Only net fixed assets on the statement of financial position.

9. Which of the following statements is true?

a. Published financial statements are prepared according to the cash basis of accounting.
b. Published financial statements are prepared according to the accrual basis of
accounting.
c. Published financial statements may be prepared according to either the accrual or
cash basis of accounting.
d. Published financial statements must be prepared according to both the accrual and
cash basis.

10. Why do some firms present two figures for earnings per share-basic and diluted?
a. The auditor may feel that as a result of poor management, future earnings potential
has been diluted and therefore the firms should adjust current earnings per share to
reflect this.
b. The financial statements contain many accounting changes which affect income in the
current year but not future earnings potential or cash flow.
c. The firm has a complex capital structure with convertible securities, stock options,
and warrants, which may represent potential dilution of earnings per share.
d. The firm expects to issue more stock within the next year which will lower earnings
per share.

11. Which statement of financial position account is used to reconcile the differences that
arise because of temporarily differences in tax actually paid to the BIR and income tax
expense reported in the income statement?
a. Taxes payable
b. Deferred taxes
c. Taxes receivable
d. Tax adjustment liability
12. Why might the use of accelerated depreciation rather than straight-line depreciation
produce earnings of higher quality?
a. Accelerated depreciation more accurately reflects financial reality because higher
depreciation expense would be taken in the early years of an assets productive
period.
b. During inflationary periods, rising prices increase replacement costs of most assets,
resulting in an understatement of depreciation based on historical cost.
c. Both (a) and (b).
d. None of the above.

13. Which of the following are methods by which management can manipulate earnings and
possibly lower the quality of reported earnings?
a. Changing an accounting policy to increase earnings.
b. Refusing to take a loss on inventory in an accounting period when the inventory is
known to be obsolete.
c. Decreasing discretionary expenses.
d. All of the above.

14. Which of these statements is true during the periods of inflation?

a. Depreciation expense tends to be understated.
b. Depreciation expense tends to be overstated.
c. The firm should change the method they use to account for depreciation.
d. Gross fixed assets are overstated.

15. Which section or pieces of information can be ignored when analyzing financial
statements?
a. Auditors report.
b. Management discussion and analysis.
c. The cash flow statement.
d. None of the above.

16. What does the statement of financial position summarize for a business?
a. Financial position at a point in time.
b. Operating results for a period.
c. Financing and investment activities for a period.
d. Profit or loss at a point in time.

17. Which group of items would most likely be included in the other assets account on the
statement of financial position?
a. Land held for investment, start-up costs, long-term prepayments.
b. Inventories, marketable securities, bonds.
c. One-year pre-paid insurance policy, stock investments, copyrights.
d. Inventories, franchises, patents.
18. What is the difference between notes payable- banks and current maturities of long-term
debt?
a. There is no difference.
b. Notes payable-banks are short-term obligations, while current maturities of long-term
are the portion of long-term debt are the portion of long-term debt that will be repaid
during the upcoming year.
c. Notes payable-banks are usually included under current liabilities, and current
maturities of long-term debt are included under long-term debt.
d. Notes payable-banks are long-term liabilities, and current maturities of long-term
debt are current liabilities.

19. Companies A, B and C:

A___ B C

Inventory P 90,000 P120,000 P180,000

Property, Plant and Equipment P 75,000 P 30,000 P 45,000

Total Assets P300,000 P300,000 P300,000

Which company is most likely a retailer? A wholesaler? A manufacturer?

Company A Company B Company C

a. Wholesaler Manufacturer Retailer
b. Retailer Wholesaler Manufacturer
c. Manufacturer Wholesaler Retailer
d. Manufacturer Retailer Wholesaler

20. Which of the following items could cause the recognition of accrued liabilities?

a. Sales, taxes, interest income.

b. Sales, interest expense, rent.
c. Salaries, rent, insurance.
d. Salaries, interest expense, interest income.

21. Which of the items below need not be disclosed separately in the income
statement?

a. Selling a major business segment.

b. Salary expense.
c. Extraordinary transactions.
d. Cumulative effect of changes in accounting principles.

22. What does the income statement measure for a firm?

a. The financing and investment activities for a period.

b. The changes in assets and liabilities that occurred during a period.
c. The results of operations for a period.
d. The financial position of a firm for a period.

23. Which two financial statements are frequently combined for presentations
purposes?

a. The income and retained earnings statements.

b. The statement of financial position and the balance sheet.
c. The statement of cash flows and the retained earnings statement.
d. The statement of financial position and the income statement.

24. What are three profit measures calculated from the income statement?

a. Gross profit margin , cost of goods sold percentage, EBIT.

b. Gross profit margin, operating profit margin, net profit margin.
c. Operating profit margin, net profit margin, repairs and maintenance to fixed assets.
d. None of the above.

25. Why is the figure for operating profit important?

a. The figure for operating profit provides a basis for assessing the success of a
company apart from its financing and investment activities and separate from its
tax status.
b. This is the figure used for calculating federal income tax expense.
c. The operating profit figure includes all operating revenues and expenses as well as
interest and taxes related to operations.
d. The figure for operating profit provides a basis for assessing the wealth of a firm.

26. The Statement of Cash Flows segregates cash inflows and outflows by:

a. Operating and financing activities.

b. Financing and investing activities.
c. Operating and investing activities.
d. Operating, financing, and investing activities.

27. How would short-term investment in marketable securities be classified?

a. Operating activities.
b. Cash
c. Financing activities.
d. Investing activities.

28. How would payments for taxes be classified?

a. Operating inflow.
b. Operating outflow.
c. Investing outflow.
d. Financing outflow.

29. How would the repayment of debt principal be classified?

a. Operating inflow.
b. Operating outflow.
c. Investing outflow.
d. Financing outflow.

30. What type of accounts are notes payable and current maturities of long-term debt?

a. Operating accounts.
b. Cash accounts.
c. Financing accounts.
d. Investing accounts.

31. What type of firm generally has the highest proportion of inventory to total
assets?

a. Wholesalers.
b. Retailers.
c. Manufactures.
d. Serving-oriented firms.

32. Which of the following assets will not be depreciated over its service life?

a. Furniture
b. Buildings
c. Equipment
d. Land

33. Which of the following cause a change in the retained earnings account balance?

a. Payment of dividends.
b. Prior period adjustment.
c. Net profit or loss.
d. All of the above.

34. What is the largest expense item for most firms?

a. Depreciation.
b. Gross profit.
c. Operating expense.
d. Cost of goods sold.

35. What does the cash account include?

a. Cash in bank accounts.

b. Cash awaiting deposit.
c. Both a and b.
d. None of the above.

36. Which statement is false?

a. Deferred taxes arise from the use of the same method of depreciation for tax and
reporting purposes.
b. Deferred taxes are the product of temporary differences in the recognition of
revenue and expense for taxable income relative to reported income.
c. Deferred taxes arise when taxes actually paid are less than tax expense reported in
the financial statements.
d. Temporary differences causing the recognition of deferred taxes may arise from the
methods used to account for items such as depreciation, installment sales, leases, and
pensions.

37. How would revenue from sales of goods and services be classified?

a. Operating inflow.
b. Operating outflow.
c. Investing inflow.
d. Financing inflow.

38. How would the sale of a building be classified?

a. Operating inflow.
b. Operating outflow.
c. Investing inflow.
d. Financing inflow.