CHAPTER 1: Accounting in Action

Which of the following is not a step in the accounting process?

• Identification.

• Economic entity.

• Recording

• Communication

Answer explanation

Economic entity is not one of the steps in the accounting pro- cess. 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.

Which of the following statements about users of account-

ing information is incorrect?

• Management is an internal user.

• Taxing authorities are external users.

• Present creditors are external users.

• Regulatory authorities are internal users.

Answer explanation

Regulatory authorities are external, not internal, users of accounting information. The other choices are true statements.

The historical cost principle states that:

• assets should be initially recorded at cost and adjusted when

  the fair value changes.

• activities of an entity are to be kept separate and distinct from its owner.

• assets should be recorded at their cost.

• only transaction data capable of being expressed in terms of

  money be included in the accounting records.

Answer explanation

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.

Which of the following statements about basic assump-

tions is correct?

• Basic assumptions are the same as accounting principles.

• The economic entity assumption states that there should be a particular unit of accountability.

• The monetary unit assumption enables accounting to mea- sure employee morale.

• Partnerships are not economic entities.

Answer explanation

The economic entity assumption states that there should be a particular unit of accountability. The other choices are incorrect because (a) basic assumptions are not the same as accounting princi- ples, (c) the monetary unit assumption allows accounting to measure economic events, and (d) partnerships are economic entities.

The three types of business entities are:

• proprietorships, small businesses, and partnerships.

• proprietorships, partnerships, and corporations.

• proprietorships, partnerships, and large businesses.

• financial, manufacturing, and service companies.

Answer explanation

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.

Net income will result during a time period when:

• assets exceed liabilities.

• assets exceed revenues.

• expenses exceed revenues.

• revenues exceed expenses.

Answer explanation

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 rev- enues, a net loss results.

As of December 31, 2020, Stoneland AG has assets of €3,500 and equity of €2,000. What are the liabilities for Stoneland AG as of December 31, 2020?

• €1,500.

• €1,000.

• €2,500.

• €2,000.

Answer explanation

Using a variation of the basic accounting equation, Assets − Equity = Liabilities, €3,500 − €2,000 = €1,500. The other choices are therefore incorrect.

Performing services on account will have the following

effects on the components of the basic accounting equation:

• increase assets and decrease equity.

• increase assets and increase equity.

• increase assets and increase liabilities.

• increase liabilities and increase equity.

Answer explanation

When services are performed on account, assets are increased and equity is increased. The other choices are incorrect because when services are performed on account (a) equity is increased, not decreased; (c) liabilities are not affected; and (d) equity is increased and liabilities are not affected.

Which of the following events is not recorded in the account-

ing records?

• Equipment is purchased on account.

• An employee is terminated.

• A cash investment is made into the business.

• The company pays a cash dividend.

Answer explanation

If an employee is terminated, this represents an activity of a company, not a business transaction. Assets, liabilities, and equity are not affected. Thus, there is no effect on the accounting equa- tion. The other choices are incorrect because they are all recorded: (a) when equipment is purchased on account, both assets and liabili- ties increase; (c) when a cash investment is made into a business, both assets and equity increase; and (d) when a dividend is paid, both assets and equity decrease.

During 2020, Xia Lin Company’s assets decreased ¥500,000 and its liabilities decreased ¥900,000. Its equity therefore:

• increased ¥400,000.

• decreased ¥1,400,000.

• decreased ¥400,000.

• increased ¥1,400,000.

Answer explanation

Using the basic accounting equation, Assets = Liabilities + Equity, −¥500,000 = −¥900,000 + Equity, so equity increased ¥400,000, not (b) decreased ¥1,400,000, (c) decreased ¥400,000, or (d) increased ¥1,400,000.