MAB1033 Phillips Chapter 2 Balance Sheet

If a company borrows money from a bank and signs an agreement to repay the loan several years from now, in which account would the company report the amount borrowed?

• Common Stock

• Accounts Payable

• Notes Payable (long-term)

• Retained Earnings

Answer explanation

Debt financing refers to money obtained through loans. A formal loan with the bank is reported as Notes Payable (long-term).

Typical steps needed before a business can start selling goods and/or services to customers include:

• financing and investing activities.

• only financing activities.

• only investing activities.

• only operating activities.

Answer explanation

After obtaining initial financing, a company will start investing in assets that will be used after the business opens.

Who has first claim to a business's assets should the company go out of business?

• Creditors

• Stockholders

• Customers

• Management

Answer explanation

Creditors have a claim to a company's assets equal to the amount of liabilities that the company owes.

A difference between debt financing and equity financing is that:

• debt financing must be repaid, while repayment of equity financing is not required.

• equity financing must be repaid, while repayment of debt financing is not required.

• only debt financing can be used to purchase assets.

• only equity financing can be used to purchase assets.

Answer explanation

Two sources of financing are available to businesses: equity and debt. Equity refers to financing a business through owners' contributions and reinvestments of profit. Debt refers to financing the business through loans. A business is obligated to repay debt financing, but it is not obligated to repay its equity financing.

The cost principle is used:

• to refer to the two sources of financing available to businesses.

• to measure the amount used to record assets on the date of the transaction.

• by small businesses, but not by large businesses.

• to measure internal events, but not external exchanges.

Answer explanation

The cost principle states that assets and liabilities should be initially recorded at their original cost to the company.

Which of the following is an accounting transaction?

• A manager hires an employee.

• A manager orders supplies.

• A manager signs a promissory note and receives cash.

• A manager agrees to deliver their product in three weeks.

Answer explanation

An accounting transaction occurs when there is an exchange involving assets, liabilities and/or stockholders' equity. An exchange of a promissory note for cash qualifies as an exchange. An exchange of only promises is not an accounting transaction.

Your company places an order for inventory with suppliers for delivery in two weeks.

• This is an internal event and it does not affect the balance sheet.

• This is an activity that does not affect the balance sheet.

• This is an internal event that affects the balance sheet.

• This is an external exchange and it affects the balance sheet.

Answer explanation

External exchanges are exchanges involving assets, liabilities, and/or stockholders' equity between the company and someone else. An order has been placed; but the promise to pay will not occur until the supplies are delivered. An exchange of only promises is not an accounting transaction. Since no exchange has occurred, this activity would not be recorded as a transaction.

Which of the following is a financing activity?

• The business receives land and gives a check for $1,000.

• The business receives $1,000 cash and in exchange gives a promissory note.

• The business promises to hire an employee on the 15th of the month.

• The business orders supplies and promises to pay for them at the end of the month.

Answer explanation

Financing activities involve debt transactions with lenders (e.g., Notes Payable) or equity transactions with investors (e.g., Common Stock). Receiving cash in exchange for a promissory note is a financing activity.

Which of the following would not be recorded as an accounting transaction?

• Issuing stock to owners in exchange for cash

• Ordering supplies to be delivered next month

• Selling inventory to customers in exchange for cash to be received next month

• Paying the bank for a portion of a note payable

Answer explanation

A transaction is an event or activity that has a direct and measurable financial effect on the assets, liabilities, or stockholders' equity of a business. Ordering supplies is an activity that is not a transaction because no assets or services were exchanged at the time the order was placed.

Which of the following is an asset?

• Common Stock

• Retained Earnings

• Notes Receivable

• Notes Payable

Answer explanation

Assets are resources presently owned by a business that generate future economic benefits. Notes Receivable is an example of an asset. Common Stock and Retained Earnings are examples of equity accounts, and Notes Payable is a liability.