The Review and Practice section provides opportunities for students to review key

concepts and terms as well as complete multiple-choice questions, exercises, and a Review and Practice 27
comprehensive problem. Detailed solutions are also included.

REVIEW AND PRACTICE

11 Identify the activities and users associated with account- The expanded accounting equation is:
ing. Accounting is an information system that identifies,
records, and communicates the economic events of an Assets 5 Liabilities 1 Owner’s Capital 2 Owner’s
organization to interested users. The major users and Drawings 1 Revenues 2 Expenses
uses of accounting are as follows. (a) Management uses
accounting information to plan, organize, and run the Owner’s capital is assets the owner puts into the busi-
business. (b) Investors (owners) decide whether to buy, ness. Owner’s drawings are the assets the owner with-
hold, or sell their financial interests on the basis of draws for personal use. Revenues are increases in
accounting data. (c) Creditors (suppliers and bankers) assets resulting from income-earning activities.
evaluate the risks of granting credit or lending money on Expenses are the costs of assets consumed or services
the basis of accounting information. Other groups that used in the process of earning revenue.
use accounting information are taxing authorities, regu-
latory agencies, customers, and labor unions. 4 Analyze the effects of business transactions on the
accounting equation. Each business transaction must
2 Explain the building blocks of accounting: ethics, prin- have a dual effect on the accounting equation. For
ciples, and assumptions. Ethics are the standards example, if an individual asset increases, there must
of conduct by which actions are judged as right or be a corresponding (1) decrease in another asset,
wrong. Effective financial reporting depends on (2) increase in a specific liability, or (3) increase in
sound ethical behavior. owner’s equity.
Generally accepted accounting principles are a
common set of standards used by accountants. The 5 Describe the four financial statements and how they
primary accounting standard-setting body in the are prepared. An income statement presents the reve-
United States is the Financial Accounting Standards nues and expenses, and resulting net income or net
Board. The monetary unit assumption requires that loss, for a specific period of time. An owner’s equity
companies include in the accounting records only trans- statement summarizes the changes in owner’s equity
action data that can be expressed in terms of money. for a specific period of time. A balance sheet reports
The economic entity assumption requires that the activ- the assets, liabilities, and owner’s equity at a specific
ities of each economic entity be kept separate from the date. A statement of cash flows summarizes informa-
activities of its owner(s) and other economic entities. tion about the cash inflows (receipts) and outflows
(payments) for a specific period of time.
3 State the accounting equation, and define its compo-
nents. The basic accounting equation is: * 6 Explain the career opportunities in accounting.
Accounting offers many different jobs in fields such
Assets 5 Liabilities 1 Owner’s Equity
as public and private accounting, governmental, and
Assets are resources a business owns. Liabilities are forensic accounting. Accounting is a popular major
creditorship claims on total assets. Owner’s equity is because there are many different types of jobs, with
the ownership claim on total assets. unlimited potential for career advancement.

GLOSSARY REVIEW

Accounting The information system that identifies, Bookkeeping A part of the accounting process that
records, and communicates the economic events of an involves only the recording of economic events. (p. 5).
organization to interested users. (p. 4). Convergence The process of reducing the differences
Assets Resources a business owns. (p. 12). between U.S. GAAP and IFRS. (p. 9).
*Auditing The examination of financial statements by a Corporation A business organized as a separate legal
certified public accountant in order to express an opin- entity under state corporation law, having ownership
ion as to the fairness of presentation. (p. 25). divided into transferable shares of stock. (p. 10).
Balance sheet A financial statement that reports the Drawings Withdrawal of cash or other assets from an
assets, liabilities, and owner’s equity at a specific unincorporated business for the personal use of the
date. (p. 2). owner(s). (p. 13).
Basic accounting equation Assets 5 Liabilities 1 Owner’s Economic entity assumption An assumption that
equity. (p. 21). requires that the activities of the entity be kept separate
 28 1 Accounting in Action

and distinct from the activities of its owner and all systems to support services for marketing projects and
other economic entities. (p. 10). merger and acquisition activities. (p. 25).
Ethics The standards of conduct by which actions are Managerial accounting The field of accounting that
judged as right or wrong, honest or dishonest, fair or provides internal reports to help users make decisions
not fair. (p. 7). about their companies. (p. 5).
Expanded accounting equation Assets 5 Liabilities 1 Monetary unit assumption An assumption stating that
Owner’s capital 2 Owner’s drawings 1 Revenues 2 companies include in the accounting records only
Expenses. (p. 13). transaction data that can be expressed in terms of
Expenses The cost of assets consumed or services used money. (p. 9).
in the process of earning revenue. (p. 13). Net income The amount by which revenues exceed
Fair value principle An accounting principle stating expenses. (p. 21).
that assets and liabilities should be reported at fair Net loss The amount by which expenses exceed reve-
value (the price received to sell an asset or settle a nues. (p. 21).
liability). (p. 9). Owner’s equity The ownership claim on total assets.
Faithful representation Numbers and descriptions (p. 13).
match what really existed or happened—they are Owner’s equity statement A financial statement that
factual. (p. 9). summarizes the changes in owner’s equity for a specific
Financial accounting The field of accounting that pro- period of time. (p. 21).
vides economic and financial information for investors, Partnership A business owned by two or more persons
creditors, and other external users. (p. 6). associated as partners. (p. 10).
Financial Accounting Standards Board (FASB) A pri- *Private (or managerial) accounting An area of
vate organization that establishes generally accepted accounting within a company that involves such activ-
accounting principles in the United States (GAAP). ities as cost accounting, budgeting, design and support
(p. 9). of accounting information systems, and tax planning
*Forensic accounting An area of accounting that uses and preparation. (p. 26).
accounting, auditing, and investigative skills to con- Proprietorship A business owned by one person. (p. 10).
duct investigations into theft and fraud. (p. 26). *Public accounting An area of accounting in which the
Generally accepted accounting principles (GAAP) accountant offers expert service to the general public.
Common standards that indicate how to report eco- (p. 25).
nomic events. (p. 8). Relevance Financial information that is capable of mak-
Historical cost principle An accounting principle that ing a difference in a decision. (p. 9).
states that companies should record assets at their Revenues The gross increase in owner’s equity resulting
cost. (p. 9). from business activities entered into for the purpose of
Income statement A financial statement that presents earning income. (p. 13).
the revenues and expenses and resulting net income or Sarbanes-Oxley Act (SOX) Law passed by Congress
net loss of a company for a specific period of time. intended to reduce unethical corporate behavior. (p. 7).
(p. 21).
Securities and Exchange Commission (SEC) A gov-
International Accounting Standards Board (IASB) An ernmental agency that oversees U.S. financial markets
accounting standard-setting body that issues standards and accounting standard-setting bodies. (p. 9).
adopted by many countries outside of the United
Statement of cash flows A financial statement that
States. (p. 9).
summarizes information about the cash inflows
International Financial Reporting Standards (IFRS) (receipts) and cash outflows (payments) for a specific
International accounting standards set by the Interna- period of time. (p. 21).
tional Accounting Standards Board (IASB). (p. 9).
*Taxation An area of public accounting involving tax
Investments by owner The assets an owner puts into advice, tax planning, preparing tax returns, and repre-
the business. (p. 13). senting clients before governmental agencies. (p. 25).
Liabilities Creditor claims against total assets. (p. 12). Transactions The economic events of a business that are
*Management consulting An area of public accounting recorded by accountants. (p. 14).
ranging from development of accounting and computer

PRACTICE MULTIPLE-CHOICE QUESTIONS

(LO 1) 1. Which of the following is not a step in the accounting 2. Which of the following statements about users of (LO 1)
process? accounting information is incorrect?
(a) Identification. (c) Recording. (a) Management is an internal user.
(b) Economic entity. (d) Communication. (b) Taxing authorities are external users.
(a) identification is the first step in the accounting process, (c) recording is the second step in the
accounting process, and (d) communication is the third and final step in the accounting process.
 Practice Multiple-Choice Questions 29

(c) Present creditors are external users. (c) A cash investment is made into the business.
(d) Regulatory authorities are internal users. (d) The owner withdraws cash for personal use.
(LO 2) 3. The historical cost principle states that: 10. During 2017, Bruske Company’s assets decreased (LO 4)
(a) assets should be initially recorded at cost and $50,000 and its liabilities decreased $50,000. Its own-
adjusted when the fair value changes. er’s equity therefore:
(b) activities of an entity are to be kept separate and (a) increased $50,000. (c) decreased $100,000.
distinct from its owner. (b) decreased $50,000. (d) did not change.
(c) assets should be recorded at their cost. 11. Payment of an account payable affects the compo- (LO 4)
(d) only transaction data capable of being expressed nents of the accounting equation in the following
in terms of money be included in the accounting way.
records. (a) Decreases owner’s equity and decreases liabilities.
(LO 2) 4. Which of the following statements about basic assump- (b) Increases assets and decreases liabilities.
tions is correct? (c) Decreases assets and increases owner’s equity.
(a) Basic assumptions are the same as accounting (d) Decreases assets and decreases liabilities.
principles. 12. Which of the following statements is false? (LO 5)
(b) The economic entity assumption states that there (a) A statement of cash flows summarizes informa-
should be a particular unit of accountability. tion about the cash inflows (receipts) and out-
(c) The monetary unit assumption enables account- flows (payments) for a specific period of time.
ing to measure employee morale. events (b) A balance sheet reports the assets, liabilities, and
(d) Partnerships are not economic entities. owner’s equity at a specific date.
(LO 2) 5. The three types of business entities are: (c) An income statement presents the revenues,
(a) proprietorships, small businesses, and partner- expenses, changes in owner’s equity, and resulting
ships. net income or net loss for a specific period of
(b) proprietorships, partnerships, and corporations. time.
(c) proprietorships, partnerships, and large busi- (d) An owner’s equity statement summarizes the
nesses. changes in owner’s equity for a specific period of
(d) financial, manufacturing, and service companies. time.
(LO 3) 6. Net income will result during a time period when: 13. On the last day of the period, Alan Cesska Company (LO 5)
(a) assets exceed liabilities. buys a $900 machine on credit. This transaction will
(b) assets exceed revenues. affect the:
Dr. Machine $900
(c) expenses exceed revenues. (a) income statement only. Cr. Account payable $900
(d) revenues exceed expenses. (b) balance sheet only.
(LO 3) 7. As of December 31, 2017, Kent Company has assets of (c) income statement and owner’s equity statement
$3,500 and owner’s equity of $2,000. What are the lia- only.
bilities for Kent Company as of December 31, 2017? (d) income statement, owner’s equity statement, and
(a) $1,500. (c) $2,500. balance sheet.
(b) $1,000. (d) $2,000. 14. The financial statement that reports assets, liabilities, (LO 5)
(LO 4) 8. Performing services on account will have the follow- and owner’s equity is the:
ing effects on the components of the basic accounting (a) income statement.
equation: (b) owner’s equity statement.
(a) increase assets and decrease owner’s equity. (c) balance sheet.
(b) increase assets and increase owner’s equity. (d) statement of cash flows.
(c) increase assets and increase liabilities. *15. Services performed by a public accountant include: (LO 6)
(d) increase liabilities and increase owner’s equity. (a) auditing, taxation, and management consulting.
(LO 4) 9. Which of the following events is not recorded in the (b) auditing, budgeting, and management consulting.
accounting records? (c) auditing, budgeting, and cost accounting.
(a) Equipment is purchased on account. (d) auditing, budgeting, and management consulting.
(b) An employee is terminated.

Solutions

1. (b) Economic entity is not one of the steps in the accounting process. The other choices are true because (a) identification is the
first step in the accounting process, (c) recording is the second step in the accounting process, and (d) communication is the third
and final step in the accounting process.
2. (d) Regulatory authorities are external, not internal, users of accounting information. The other choices are true state-
ments.
3. (c) The historical cost principle states that assets should be recorded at their cost. The other choices are incorrect because
(a) the historical cost principle does not say that assets should be adjusted for changes in fair value, (b) describes the economic
entity assumption, and (d) describes the monetary unit assumption.
4. (b) The economic entity assumption states that there should be a particular unit of accountability. The other choices are incor-
rect because (a) basic assumptions are not the same as accounting principles, (c) the monetary unit assumption allows accounting
to measure economic events, and (d) partnerships are economic entities.
30 1 Accounting in Action

5. (b) Proprietorships, partnerships, and corporations are the three types of business entities. Choices (a) and (c) are incorrect
because small and large businesses only denote the sizes of businesses. Choice (d) is incorrect because financial, manufacturing,
and service companies are types of businesses, not business entities.
6. (d) Net income results when revenues exceed expenses. The other choices are incorrect because (a) assets and liabilities are not
used in the computation of net income; (b) revenues, not assets, are included in the computation of net income; and (c) when
expenses exceed revenues, a net loss results.
7. (a) Using a variation of the basic accounting equation, Assets 2 Owner’s equity 5 Liabilities, $3,500 2 $2,000 5 $1,500. There-
fore, choices (b) $1,000, (c) $2,500, and (d) $2,000 are incorrect.
8. (b) When services are performed on account, assets are increased and owner’s equity is increased. The other choices are incor-
rect because when services are performed on account (a) owner’s equity is increased, not decreased; (c) liabilities are not affected;
and (d) owner’s equity is increased and liabilities are not affected.
9. (b) If an employee is terminated, this represents an activity of a company, not a business transaction. Assets, liabilities, and
owner’s equity are not affected. Thus, there is no effect on the accounting equation. The other choices are incorrect because they
are all recorded: (a) when equipment is purchased on account, both assets and liabilities increase; (c) when a cash investment is
made into a business, both assets and owner’s equity increase; and (d) when an owner withdraws cash for personal use, both assets
and owner’s equity decrease.
10. (d) In this situation, owner’s equity does not change because only assets and liabilities decreased $50,000. Therefore, the other
choices are incorrect.
11. (d) Payment of an account payable results in an equal decrease of assets (cash) and liabilities (accounts payable). The other
choices are incorrect because payment of an account payable (a) does not affect owner’s equity, (b) does not increase assets, and
(c) does not affect owner’s equity.
12. (c) An income statement represents the revenues, expenses, and the resulting net income or net loss for a specific period of time
but not the changes in owner’s equity. The other choices are true statements.
13. (b) This transaction will cause assets to increase by $900 and liabilities to increase by $900. The other choices are incorrect
because this transaction (a) will have no effect on the income statement, (c) will have no effect on the income statement or the
owner’s equity statement, and (d) will affect the balance sheet but not the income statement or the owner’s equity statement.
14. (c) The balance sheet is the statement that reports assets, liabilities and owner’s equity. The other choices are incorrect because
(a) the income statement reports revenues and expenses, (b) the owner’s equity statement reports details about owner’s equity, and
(d) the statement of cash flows reports inflows and outflows of cash.
*15. (a) Auditing, taxation, and management consulting are all services performed by public accountants. The other choices are
incorrect because public accountants do not perform budgeting or cost accounting.

PRACTICE EXERCISES

Analyze the effect of 1. Selected transactions for Fabulous Flora Company are listed below.
transactions.
1. Made cash investment to start business.
(LO 3, 4)
2. Purchased equipment on account.
3. Paid salaries.
4. Billed customers for services performed.
5. Received cash from customers billed in (4).
6. Withdrew cash for owner’s personal use.
7. Incurred advertising expense on account.
8. Purchased additional equipment for cash.
9. Received cash from customers when service was performed.

Instructions
List the numbers of the above transactions and describe the effect of each transaction on
assets, liabilities, and owner’s equity. For example, the first answer is: (1) Increase in assets
and increase in owner’s equity.

Solution
1. 1. Increase in assets and increase in owner’s equity.
2. Increase in assets and increase in liabilities.
3. Decrease in assets and decrease in owner’s equity.
4. Increase in assets and increase in owner’s equity.
 Practice Problem 31

5. Increase in assets and decrease in assets.

2. Alma’s Payroll Services Company entered into the following transactions during May Analyze the effect of
2017. transactions on assets,
liabilities, and owner’s equity.
1. Purchased computers for $15,000 from Bytes of Data on account.
(LO 3, 4)
2. Paid $3,000 cash for May rent on storage space.
3. Received $12,000 cash from customers for contracts billed in April.
4. Performed payroll services for Magic Construction Company for $2,500 cash.
5. Paid Northern Ohio Power Co. $7,000 cash for energy usage in May.
6. Alma invested an additional $25,000 in the business.
7. Paid Bytes of Data for the computers purchased in (1) above.
8. Incurred advertising expense for May of $900 on account.

Instructions
Indicate with the appropriate letter whether each of the transactions above results in:
(a) an increase in assets and a decrease in assets.
(b) an increase in assets and an increase in owner’s equity.
(c) an increase in assets and an increase in liabilities.
(d) a decrease in assets and a decrease in owner’s equity.
(e) a decrease in assets and a decrease in liabilities.
(f) an increase in liabilities and a decrease in owner’s equity.
(g) an increase in owner’s equity and a decrease in liabilities.

Solution
2. 1. (c) 3. (a) 5. (d) 7. (e)
2. (d) 4. (b) 6. (b) 8. (f)

PRACTICE PROBLEM

Joan Robinson opens her own law office on July 1, 2017. During the first month of opera- Prepare a tabular presentation
tions, the following transactions occurred. and financial statements.
1. Joan invested $11,000 in cash in the law practice. (LO 4, 5)
2. Paid $800 for July rent on office space.
3. Purchased equipment on account $3,000.
4. Performed legal services to clients for cash $1,500.
5. Borrowed $700 cash from a bank on a note payable.
6. Performed legal services for client on account $2,000.
7. Paid monthly expenses: salaries and wages $500, utilities $300, and advertising $100.
8. Joan withdrew $1,000 cash for personal use.

Instructions
(a) Prepare a tabular summary of the transactions.
(b) Prepare the income statement, owner’s equity statement, and balance sheet at July 31,
2017, for Joan Robinson, Attorney.
 => understated

16,000 - 5,000