Basic Accounting Principles and Concepts Practice Exam Quiz
Which of the following is a fundamental accounting equation?
a) Assets = Liabilities – Equity
b) Assets = Liabilities + Equity
c) Liabilities = Assets – Equity
d) Equity = Assets + Liabilities
What does the matching principle state?
a) Expenses should be recognized when cash is paid.
b) Revenue should be recorded when received.
c) Expenses should be matched to the revenues they help generate.
d) Revenue and expenses must always be equal.
Which principle requires financial statements to be based on factual information?
a) Consistency
b) Objectivity
c) Matching
d) Conservatism
What is the going concern assumption?
a) The business will close after one year.
b) The business will continue to operate indefinitely.
c) The business will liquidate assets to settle debts.
d) The business operations are unpredictable.
The principle that states transactions should be recorded at their original cost is called:
a) Matching principle
b) Historical cost principle
c) Revenue recognition principle
d) Fair value principle
Which of the following is NOT a type of accounting assumption?
a) Economic entity
b) Monetary unit
c) Periodicity
d) Reliability
The principle of conservatism suggests:
a) Overstating revenues and profits.
b) Recognizing potential losses immediately.
c) Ignoring future uncertainties.
d) Reporting transactions based on personal judgment.
Which concept dictates that business transactions are separate from personal transactions of the owners?
a) Going concern
b) Economic entity
c) Accrual basis
d) Conservatism
What is the accrual basis of accounting?
a) Revenue and expenses are recorded when cash is exchanged.
b) Revenue and expenses are recorded when they are incurred, regardless of cash flow.
c) Only revenues are recorded when received.
d) Expenses are recorded when payments are made.
Which accounting principle ensures comparability across different financial periods?
a) Consistency
b) Matching
c) Revenue recognition
d) Objectivity
The monetary unit assumption assumes that:
a) Transactions are expressed in a consistent currency.
b) Only large transactions are recorded.
c) Inflation is considered in financial statements.
d) Financial reports are non-quantitative.
What does the revenue recognition principle state?
a) Revenue is recognized only when cash is received.
b) Revenue is recognized when it is earned and realizable.
c) Revenue is recognized at the end of the fiscal year.
d) Revenue is recognized when expenses are paid.
Which of the following is an example of an intangible asset?
a) Equipment
b) Patent
c) Inventory
d) Cash
What is the periodicity assumption?
a) Financial reports must be prepared at irregular intervals.
b) Financial activities are divided into arbitrary time periods.
c) Financial activities are reported in annual periods only.
d) Financial activities are spread over the lifetime of the business.
Answer: b) Financial activities are divided into arbitrary time periods.
a) Conservatism
b) Matching
c) Consistency
d) Historical cost
a) Accounts Receivable
b) Accounts Payable
c) Retained Earnings
d) Inventory
The term “depreciation” refers to:
a) The decrease in the value of inventory.
b) The allocation of the cost of tangible assets over its useful life.
c) The increase in asset value over time.
d) The expense of intangible assets.
Which of the following is NOT a financial statement?
a) Income Statement
b) Statement of Cash Flows
c) Trial Balance
d) Balance Sheet
What is the primary purpose of the trial balance?
a) Prepare financial statements.
b) Check the mathematical accuracy of debits and credits.
c) Record journal entries.
d) Reconcile bank accounts.
Equity is best defined as:
a) Assets – Liabilities
b) Liabilities – Assets
c) Assets + Liabilities
d) Revenues – Expenses
Which account is NOT an asset?
a) Cash
b) Buildings
c) Accounts Receivable
d) Accounts Payable
Which principle relates to the allocation of costs to the periods they benefit?
a) Matching Principle
b) Conservatism Principle
c) Historical Cost Principle
d) Revenue Recognition Principle
What is the double-entry system of accounting?
a) Every transaction affects one account only.
b) Every transaction affects at least two accounts.
c) Transactions are recorded only when cash is involved.
d) Each transaction affects income and expenses equally.
Which is a current asset?
a) Land
b) Equipment
c) Accounts Receivable
d) Goodwill
What does “chart of accounts” represent?
a) A summary of debits and credits.
b) A listing of all account names and numbers.
c) A financial statement template.
d) A monthly bank statement.
Prepaid insurance is classified as:
a) Revenue
b) Liability
c) Expense
d) Asset
What is goodwill?
a) A tangible asset.
b) An intangible asset arising from reputation and customer loyalty.
c) A liability.
d) An operating expense.
What is the purpose of adjusting entries?
a) To record day-to-day transactions.
b) To ensure accounts reflect accurate balances for a period.
c) To prepare bank reconciliations.
d) To close temporary accounts.
What does the term “current liabilities” refer to?
a) Obligations due within a year.
b) All company liabilities.
c) Liabilities related to non-current assets.
d) Deferred revenue.
What is retained earnings?
a) Total revenues minus expenses.
b) Net income kept in the business after dividends.
c) The difference between assets and liabilities.
d) Owner’s withdrawals.
What is the purpose of the balance sheet?
a) To show the company’s profitability
b) To summarize revenues and expenses
c) To present the financial position of a company at a specific date
d) To record daily transactions
Which of the following is NOT classified as a current asset?
a) Inventory
b) Accounts Receivable
c) Prepaid Rent
d) Land
Which concept ensures that only relevant and material information is included in financial statements?
a) Materiality principle
b) Cost principle
c) Revenue recognition principle
d) Consistency principle
What type of account is retained earnings?
a) Asset
b) Liability
c) Equity
d) Revenue
The concept that requires expenses to be reported in the same period as the revenues they generate is:
a) Periodicity assumption
b) Matching principle
c) Revenue recognition principle
d) Full disclosure principle
What is the purpose of closing entries?
a) To transfer temporary account balances to permanent accounts
b) To prepare the trial balance
c) To adjust financial statements for errors
d) To reconcile bank statements
Which of the following is NOT a type of financial statement?
a) Statement of Retained Earnings
b) Statement of Changes in Working Capital
c) Statement of Cash Flows
d) Income Statement
What does the term “liquidity” refer to in accounting?
a) The profitability of a company
b) The ability of a company to pay off short-term obligations
c) The growth rate of a company’s earnings
d) The value of a company’s intangible assets
Which of the following is an example of a contra-asset account?
a) Accounts Receivable
b) Accumulated Depreciation
c) Notes Payable
d) Retained Earnings
Revenues are recorded when:
a) Cash is received
b) The service is performed or goods are delivered
c) Expenses are incurred
d) The balance sheet is prepared
The dual-aspect concept is best summarized by:
a) Each transaction affects at least two accounts.
b) Each financial period is separate.
c) Assets are recorded at cost.
d) Only cash transactions are recorded.
An example of an adjusting entry is:
a) Recording the purchase of equipment
b) Recognizing accrued wages
c) Paying accounts payable
d) Issuing shares
What is a deferred revenue?
a) Revenue recognized before it is earned
b) Revenue earned but not yet received
c) Payment received for goods or services not yet provided
d) Revenue that has been written off as a bad debt
Which financial statement shows the net income of a company?
a) Balance Sheet
b) Statement of Cash Flows
c) Income Statement
d) Retained Earnings Statement
The revenue recognition principle is based on the idea that revenue is recognized when:
a) Cash is collected
b) Revenue is earned
c) Financial statements are finalized
d) Expenses are incurred
Which of the following is NOT an intangible asset?
a) Trademark
b) Copyright
c) Accounts Payable
d) Goodwill
What type of account is Unearned Revenue?
a) Asset
b) Liability
c) Equity
d) Expense
What is the primary goal of financial accounting?
a) To ensure compliance with tax regulations
b) To provide useful information to external users
c) To aid in internal management decision-making
d) To assess employee performance
Which of the following is a non-current liability?
a) Accounts Payable
b) Accrued Expenses
c) Bonds Payable
d) Unearned Revenue
The principle of consistency ensures that:
a) Companies use the same accounting methods over time.
b) Financial statements are free of material errors.
c) Revenues match expenses.
d) All transactions are recorded in the same currency.
What does GAAP stand for?
a) General Accepted Auditing Policies
b) Generally Approved Accounting Practices
c) Generally Accepted Accounting Principles
d) General Accounting and Auditing Procedures
What is an accrued expense?
a) An expense paid in advance
b) An expense incurred but not yet paid
c) A liability that has been written off
d) A prepayment for goods or services
The term “posting” in accounting refers to:
a) Recording journal entries
b) Transferring journal entries to the ledger
c) Preparing the trial balance
d) Reconciling accounts
Which of the following is NOT a characteristic of accounting information?
a) Relevance
b) Reliability
c) Timeliness
d) Obsolescence
What does the term “amortization” refer to?
a) Allocation of the cost of tangible assets
b) Allocation of the cost of intangible assets over their useful lives
c) Depreciation of long-term liabilities
d) Writing off bad debts
What is the normal balance of a revenue account?
a) Debit
b) Credit
c) Either debit or credit
d) Zero
Which account increases with a debit?
a) Revenue
b) Liability
c) Expense
d) Equity
Which principle ensures that all relevant information is disclosed in financial statements?
a) Conservatism Principle
b) Full Disclosure Principle
c) Matching Principle
d) Objectivity Principle
Which concept assumes that a business operates separately from its owners?
a) Business entity concept
b) Periodicity assumption
c) Going concern assumption
d) Dual aspect concept
What type of account is dividends?
a) Asset
b) Liability
c) Equity
d) Contra-equity
What is the accounting equation?
a) Assets = Liabilities + Revenues
b) Assets = Liabilities + Expenses
c) Assets = Liabilities + Equity
d) Assets = Liabilities – Equity
Which principle states that accountants should not overstate or understate financial data?
a) Matching principle
b) Conservatism principle
c) Objectivity principle
d) Consistency principle
In a double-entry accounting system, each transaction:
a) Affects only one account
b) Affects at least two accounts
c) Requires a debit only
d) Requires a credit only
Which of the following accounts normally has a debit balance?
a) Revenue
b) Accounts Payable
c) Expense
d) Retained Earnings
Which concept dictates that financial statements are prepared periodically?
a) Matching principle
b) Cost principle
c) Periodicity assumption
d) Consistency principle
Which of the following best describes accrued revenue?
a) Revenue that has been earned and received in cash
b) Revenue that has been earned but not yet received
c) Revenue that has been collected but not yet earned
d) Revenue that is recognized at the point of sale
What is the primary purpose of the statement of cash flows?
a) To report the company’s net income
b) To show changes in financial position
c) To summarize the company’s cash inflows and outflows
d) To report owner’s equity
Which account type is closed at the end of each accounting period?
a) Asset accounts
b) Liability accounts
c) Equity accounts
d) Temporary accounts
Which of the following is considered an adjusting entry?
a) Recording equipment purchases
b) Recognizing accrued interest expense
c) Paying rent
d) Issuing common stock
Which principle requires recording assets at their original cost?
a) Matching principle
b) Historical cost principle
c) Revenue recognition principle
d) Full disclosure principle
What is depreciation?
a) Writing off bad debts
b) Allocation of a fixed asset’s cost over its useful life
c) A reduction in net income
d) Loss of value due to market conditions
What does the going concern assumption mean?
a) A company is likely to continue operations in the foreseeable future.
b) A company plans to close operations.
c) A company reports all gains and losses.
d) A company will recognize expenses before revenues.
What does the term “chart of accounts” refer to?
a) A listing of all the financial statements
b) A detailed list of a company’s ledger accounts
c) A summary of all financial transactions
d) A document used to reconcile accounts
Which of the following is NOT an element of the income statement?
a) Revenues
b) Liabilities
c) Expenses
d) Net Income
Which financial statement shows the changes in a company’s retained earnings?
a) Balance Sheet
b) Statement of Cash Flows
c) Statement of Retained Earnings
d) Income Statement
What is the purpose of a trial balance?
a) To prepare journal entries
b) To ensure that total debits equal total credits
c) To calculate net income
d) To close temporary accounts
Which concept allows accountants to ignore insignificant details?
a) Prudence concept
b) Materiality concept
c) Matching concept
d) Full disclosure principle
The accrual basis of accounting recognizes revenues and expenses:
a) Only when cash is received or paid
b) When revenues are earned and expenses are incurred
c) At the end of the accounting period
d) When preparing the balance sheet
Prepaid expenses are initially recorded as:
a) Assets
b) Liabilities
c) Expenses
d) Revenue
Which of the following is classified as a financing activity on the statement of cash flows?
a) Issuing common stock
b) Purchasing equipment
c) Collecting accounts receivable
d) Paying wages
Which account is debited when the owner withdraws cash for personal use?
a) Retained Earnings
b) Drawings
c) Cash
d) Revenue
What is the main objective of the matching principle?
a) To ensure assets are recorded at historical cost
b) To report revenues and expenses in the same period
c) To prepare accurate balance sheets
d) To record cash transactions
What is the purpose of adjusting entries?
a) To close accounts at the end of the period
b) To correct errors in previous entries
c) To allocate revenues and expenses to the correct accounting period
d) To finalize cash transactions
The term “equity” refers to:
a) Total assets of a company
b) Owner’s interest in the company
c) Current liabilities of a company
d) Revenue generated by the company
What type of account is accumulated depreciation?
a) Asset
b) Contra-asset
c) Liability
d) Equity
Which account is NOT included in the trial balance?
a) Cash
b) Depreciation Expense
c) Unearned Revenue
d) Income Tax Payable
Revenue is recognized under the accrual basis when:
a) Cash is received
b) Goods are delivered or services are provided
c) The fiscal year ends
d) Payment is confirmed
Which of the following is an example of a current liability?
a) Notes Payable (due in 2 years)
b) Accounts Payable
c) Bonds Payable
d) Retained Earnings
Which account increases with a credit?
a) Prepaid Expenses
b) Service Revenue
c) Salaries Expense
d) Inventory
Which statement is correct about liabilities?
a) Liabilities represent future obligations.
b) Liabilities increase with a debit entry.
c) Liabilities are not shown on the balance sheet.
d) Liabilities are considered a part of equity.
Essay Questions and Answers for Study Guide
Explain the accrual basis of accounting and how it differs from the cash basis of accounting.
Answer:
The accrual basis of accounting is a method where revenues are recorded when they are earned, and expenses are recorded when they are incurred, regardless of when cash is received or paid. This approach adheres to the matching principle, which ensures that revenues and related expenses are recognized in the same accounting period.
In contrast, the cash basis of accounting records revenues only when cash is received and expenses only when cash is paid. While simpler, the cash basis does not accurately reflect a company’s financial position or performance over a period since it ignores accounts receivable and payable.
For example, under the accrual basis, a company delivering goods in December but receiving payment in January would record the revenue in December. However, under the cash basis, this revenue would not be recorded until January. Accrual accounting provides a more comprehensive view of financial activities, making it the preferred method under generally accepted accounting principles (GAAP).
Discuss the significance of the historical cost principle in financial accounting.
Answer:
The historical cost principle dictates that assets should be recorded at their original purchase price, rather than their current market value. This principle provides consistency and reliability in financial reporting, as the purchase price is verifiable and not subject to fluctuations in market value.
For instance, if a company purchases a building for $500,000, it will record the asset on its balance sheet at $500,000, even if its market value increases to $700,000 later. By using historical cost, financial statements remain comparable over time, aiding stakeholders in making informed decisions.
However, the historical cost principle has limitations, particularly in periods of inflation or when asset values significantly differ from their purchase price. Despite this, it remains a cornerstone of accounting because of its objectivity and simplicity.
Why is the matching principle important in accounting, and how does it impact financial reporting?
Answer:
The matching principle is critical in accounting as it ensures that expenses are recognized in the same period as the revenues they help generate. This principle aligns with the accrual basis of accounting and enhances the accuracy of financial statements by providing a clearer picture of a company’s profitability.
For example, if a company incurs advertising expenses in November to boost sales in December, the matching principle requires these expenses to be recorded in December when the associated revenue is realized. This prevents misleading financial reports that either overstate profits in one period or understate them in another.
The matching principle improves comparability and transparency, aiding stakeholders in evaluating a company’s operational efficiency and financial health. Without it, financial reports would lack uniformity and misrepresent a company’s performance.
What is the role of the consistency principle in accounting, and why is it essential?
Answer:
The consistency principle requires that a company uses the same accounting methods and procedures across accounting periods. This principle enhances the comparability of financial statements, allowing stakeholders to analyze trends and make informed decisions.
For instance, if a company chooses the straight-line method for depreciation, it should continue using this method in subsequent periods. Switching frequently between methods, such as moving to the declining balance method without a valid reason, could distort financial results and erode stakeholder trust.
Consistency is essential for maintaining transparency and ensuring that financial statements present a true and fair view of a company’s performance. However, if a change in accounting method is necessary, the reasons must be disclosed in the financial statements to maintain integrity and transparency.
Describe the importance of the going concern assumption in accounting.
Answer:
The going concern assumption assumes that a business will continue its operations for the foreseeable future and has no intention or need to liquidate. This assumption underpins the preparation of financial statements, as it allows for the deferral of expenses and the recognition of assets over their useful lives.
For example, the cost of a piece of machinery is allocated over its expected lifespan through depreciation, reflecting the assumption that the business will remain operational to use the machinery fully. If the going concern assumption is not valid, the company must report its assets at liquidation values, significantly altering financial statements.
The going concern assumption is critical for stakeholders, as it reassures them about the company’s stability and long-term viability. However, if there are substantial doubts about a company’s ability to continue, this must be disclosed in the financial statements to ensure transparency.
What is the dual aspect concept, and how does it shape the accounting equation?
Answer:
The dual aspect concept is the foundation of double-entry accounting, which states that every financial transaction has two equal and opposite effects on the accounting equation: Assets = Liabilities + Equity.
For instance, when a company borrows $10,000 from a bank, its assets (cash) increase by $10,000, and its liabilities (loan payable) also increase by $10,000. This ensures that the accounting equation remains balanced.
The dual aspect concept ensures accuracy and completeness in financial records. It highlights the interconnected nature of financial transactions, providing a comprehensive view of how resources are sourced and utilized. This concept also simplifies the preparation of financial statements by maintaining the balance between assets, liabilities, and equity.
How does the conservatism principle influence accounting decisions?
Answer:
The conservatism principle advises accountants to exercise caution in financial reporting by recognizing expenses and liabilities as soon as they are probable, while revenues and assets are recorded only when they are certain. This principle helps prevent overstatement of financial health and ensures that financial statements present a realistic picture.
For example, if a company anticipates a potential lawsuit loss, it records a liability even before the case concludes. Conversely, it does not recognize a gain from an ongoing lawsuit until the case is resolved in its favor.
The conservatism principle protects stakeholders from over-optimistic projections that could lead to poor decision-making. However, excessive conservatism can understate a company’s financial performance, so it must be applied judiciously.