- A company acquired a new warehouse. In exchange, the company issued a 10-year, $500,000 note payable directly to the seller. There was no cash down payment. How did this transaction affect the company's assets, liabilities, and equity?
Answer: Assets increased, liabilities increased, and equity was unchanged.
This is a non-cash transaction. The company receives an asset (warehouse), which increases total assets by $500,000. It simultaneously incurs a long-term debt (note payable), which increases total liabilities by $500,000. Equity is not affected by this exchange of an asset for a liability.
- A custom furniture maker received a $4,000 cash deposit from a customer for a large table that will be built and delivered in the next quarter. How does the receipt of this deposit affect the furniture maker's accounts?
Answer: Increases cash and increases a liability.
The cash received has not yet been earned, so it cannot be recognized as revenue. It represents an obligation to provide a product in the future or to return the money. Therefore, the entry is a debit to Cash (asset increase) and a credit to a liability account such as Customer Deposits or Unearned Revenue.
- On November 1, 20X1, a company borrowed $60,000 by signing a 4-month, 8% note payable. The entire principal and interest are due on March 1, 20X2. The company's fiscal year ends on December 31. What is the effect of the necessary adjusting entry on December 31, 20X1?
Answer: Liabilities increase by $800 and equity decreases by $800.
Interest expense must be accrued for the period it has been incurred. By December 31, interest for two months (November and December) has been incurred. The interest is calculated as: Principal × Rate × Time = $60,000 × 8% × (2/12) = $800. The adjusting entry is to debit Interest Expense for $800 (decreasing equity) and credit Interest Payable for $800 (increasing liabilities).
- On March 15, Stellar Corp. issued a $50,000, 6% promissory note to First Bank as collateral for a loan. The note matures in 180 days. Simultaneously, Stellar received $48,500 cash from the bank (the difference representing a discount). What is the correct transaction analysis for Stellar's books on March 15?
Answer: Increase Cash $48,500; Increase Discount on Notes Payable $1,500; Increase Notes Payable $50,000
When a note is issued at a discount, the full face value is recorded as Notes Payable, the actual cash received increases Cash, and the difference is recorded as Discount on Notes Payable (a contra-liability account that will be amortized over the note's term). Choice A ignores the discount entirely. Choice C incorrectly records the discount as immediate interest expense rather than a contra-liability to be amortized. Choice D incorrectly shows cash received as the face value and misallocates the discount.
- Sterling Company uses the allowance method for uncollectible accounts. The company determines that a specific customer account of $3,000 is uncollectible and writes it off. What is the effect of this write-off on Sterling's total assets and net income?
Answer: Total assets are not affected and net income is not affected.
Under the allowance method, the write-off entry is a debit to Allowance for Doubtful Accounts and a credit to Accounts Receivable. The decrease in the asset (Accounts Receivable) is exactly offset by the decrease in the contra-asset (Allowance for Doubtful Accounts), so there is no change in the net book value of receivables or total assets. The expense (Bad Debt Expense) was recognized in a prior period when the allowance was created, so the write-off itself does not affect net income.
- Velocity Corp. purchased a 2-year insurance policy on January 1 for $24,000 cash. The policy covers the period from January 1 of the current year through December 31 of the following year. On July 31, the end of Velocity's fiscal year, what accounts are affected and by what amounts?
Answer: Increase Insurance Expense $7,000; Decrease Prepaid Insurance $7,000
When you encounter prepaid expenses like insurance policies, you're dealing with the matching principle—expenses should be recorded in the period when they provide benefit, not necessarily when cash is paid.
Velocity paid $24,000 for a 24-month policy (January 1 through December 31 of the following year). To find the monthly expense, divide: 24 months$24,000=$1,000 per month
From January 1 to July 31 is exactly 7 months, so the insurance expense for this period is 7×$1,000=$7,000. The adjusting entry decreases Prepaid Insurance by $7,000 and increases Insurance Expense by $7,000, making answer D correct.
Answer A incorrectly assumes 12 months of expense should be recorded by July 31, but the fiscal year is only 7 months long (January through July). Answer B uses 17 months, which might represent the remaining coverage period but isn't relevant for calculating the current year's expense. Answer C records the entire $24,000 as expense, which violates the matching principle by expensing the full two-year policy in just 7 months.
Remember this pattern: for prepaid expenses, always calculate the monthly rate first, then multiply by the actual number of months in the accounting period. Don't assume a full 12-month year—pay attention to the specific fiscal year dates given in the problem. The key is matching the expense to the period that receives the benefit. - Phoenix Corp. factored $120,000 of accounts receivable to a finance company. The finance company charged a 3% factoring fee and retained 10% of the receivables as a security deposit (to be returned after collection). Phoenix surrendered control of the receivables, and the finance company assumed all credit risks. How should Phoenix record this transaction?
Answer: Increase Cash $104,400; Increase Factoring Fee Expense $3,600; Increase Due from Factor $12,000; Decrease Accounts Receivable $120,000
Phoenix receives cash of $104,400 (87% of $120,000), recognizes factoring fee expense of $3,600 (3% of $120,000), records a receivable from the factor for the 10% security deposit ($12,000), and removes the full accounts receivable balance ($120,000). This is a sale since Phoenix surrendered control and the factor assumed credit risks. Choice B treats the security deposit as an additional expense. Choice C miscalculates the cash received and factoring fee. Choice D ignores the security deposit retention.
- Quantum Industries purchased equipment for $75,000 cash and also assumed a $25,000 liability for unpaid property taxes on the equipment from the previous owner. The seller had originally paid $90,000 for the equipment and recorded $40,000 in accumulated depreciation. What accounts are affected on Quantum's books, and in what amounts?
Answer: Increase Equipment $100,000; Decrease Cash $75,000; Increase Property Tax Payable $25,000
Quantum records the equipment at its total acquisition cost, which includes both the cash paid ($75,000) and the liability assumed ($25,000), totaling $100,000. The seller's original cost and accumulated depreciation are irrelevant to Quantum's recording. Choice A incorrectly uses the seller's historical records. Choice C uses the seller's net book value ($90,000 - $40,000). Choice D only considers the cash portion of the cost.
- Titan Corp. traded in old machinery with a book value of $45,000 (cost $80,000, accumulated depreciation $35,000) for new machinery. Titan paid an additional $95,000 cash. The fair value of the old machinery was $38,000, and the new machinery had a fair value of $133,000. This exchange has commercial substance. What is the correct recording of this transaction?
Answer: Increase Equipment $133,000; Increase Accumulated Depreciation $35,000; Increase Loss on Disposal $7,000; Decrease Equipment $80,000; Decrease Cash $95,000
Since the exchange has commercial substance, the new equipment is recorded at fair value ($133,000). The old equipment is removed at cost ($80,000) with its accumulated depreciation ($35,000). A loss of $7,000 is recognized (book value $45,000 minus fair value $38,000). Cash decreases by the amount paid ($95,000). Choice B uses cost basis ($140,000 = $45,000 + $95,000) instead of fair value. Choice C doesn't recognize the loss and miscalculates cash. Choice D uses net amounts and doesn't properly remove the old equipment's cost and accumulated depreciation.
- The owner of a small business, operating as a sole proprietorship, contributed a personal computer to the business. The computer originally cost the owner $2,000 and had a current fair market value of $800. How should this transaction be recorded in the business's accounting records?
Answer: Increase Equipment by $800 and increase Owner's Capital by $800.
When a non-cash asset is contributed to a business by its owner, it must be recorded at its fair market value on the date of contribution. The owner's original cost is irrelevant to the business's financial records. The transaction increases an asset (Equipment) and increases the owner's equity (Owner's Capital).
- On October 15, the board of directors of Quantum Inc. declared a cash dividend of $0.50 per share on its 100,000 outstanding shares of common stock. The dividend is payable on November 15 to shareholders of record on November 1. What is the impact on Quantum's accounting equation on October 15?
Answer: Liabilities increase and equity decreases.
On the date of declaration (October 15), the company incurs a legal obligation to pay the dividend. This creates a liability, Dividends Payable, for $50,000 (100,000 shares * $0.50). This declaration reduces Retained Earnings (an equity account) by the same amount. Therefore, liabilities increase and equity decreases. The payment of the dividend on November 15 will decrease assets and liabilities.
- A company sold a machine for $55,000 cash. The machine was originally purchased for $120,000 and had accumulated depreciation of $70,000 at the time of sale. Which of the following statements accurately describes the effects of this sale transaction?
Answer: Assets increase by $5,000 and equity increases by $5,000.
First, calculate the machine's book value: Cost ($120,000) - Accumulated Depreciation ($70,000) = $50,000. Next, calculate the gain or loss: Cash proceeds ($55,000) - Book Value ($50,000) = $5,000 Gain. A gain increases equity. For assets, cash increases by $55,000, while the net book value of the machine ($50,000) is removed from assets. The net increase in total assets is $55,000 - $50,000 = $5,000.
- Nexus Company borrowed $200,000 on July 1 by issuing a 9% note payable. Interest and principal are due in one year. On September 30, the end of Nexus's fiscal year, what adjusting entry is required?
Answer: Increase Interest Expense $4,500; Increase Interest Payable $4,500
When you encounter accrued interest problems, you're dealing with the matching principle—expenses must be recorded in the period they're incurred, regardless of when cash is paid.
Nexus borrowed $200,000 at 9% annual interest on July 1, with payment due in one year. By September 30 (their fiscal year-end), three months have passed since the borrowing. You need to calculate how much interest expense has accumulated: $200,000×9%×123=$4,500
Since this interest hasn't been paid yet, you must record both the expense (to match it with the current period) and the liability (since the company owes this amount). This requires increasing Interest Expense by $4,500 and increasing Interest Payable by $4,500.
Answer A calculates the full year's interest ($200,000 × 9% = $18,000) instead of just the three months that have elapsed. Answer B uses six months ($200,000 × 9% × 6/12 = $6,000), perhaps confusing the calculation period. Answer C correctly calculates the three-month interest amount but incorrectly decreases Cash—no cash payment has been made yet, so this creates an impossible scenario where interest is paid but no liability is recorded.
Remember this pattern: accrued expenses always create two effects—an increase in expense (affecting the income statement) and an increase in payable (affecting the balance sheet). Never decrease Cash for accrued items since "accrued" specifically means the expense is recognized before cash payment occurs. - Cosmos Inc. declared and distributed a 10% stock dividend when it had 50,000 shares of $5 par value common stock outstanding. The market price per share on the declaration date was $24. What is the correct transaction analysis for the declaration of this stock dividend?
Answer: Increase Common Stock Dividends Distributable $25,000; Increase Additional Paid-in Capital $95,000; Decrease Retained Earnings $120,000
When you encounter stock dividend questions, you need to understand that stock dividends under 25% are considered "small" and recorded at market value, while the accounting involves three key components: par value, additional paid-in capital, and retained earnings.
For this 10% stock dividend, you'll distribute 5,000 new shares (50,000 × 10%). The total market value is $120,000 (5,000 shares × $24 market price). Here's the correct accounting: decrease Retained Earnings by the full market value ($120,000), increase Common Stock Dividends Distributable by the par value of new shares (5,000 × $5 = $25,000), and increase Additional Paid-in Capital for the difference ($120,000 - $25,000 = $95,000). This matches answer C.
Answer A incorrectly puts the entire $120,000 into Common Stock Dividends Distributable, ignoring the need to separate par value from the excess. Answer B makes the critical error of immediately crediting Common Stock instead of using the temporary "Dividends Distributable" account—remember, the stock isn't actually issued until the distribution date, not the declaration date. Answer D uses only par value ($25,000) instead of market value, which violates the accounting principle for small stock dividends.
The key pattern to remember: small stock dividends (under 25%) always use market value for the total charge to retained earnings, always use a "Dividends Distributable" account (not Common Stock directly) on declaration, and always split between par value and additional paid-in capital components.
- A corporation had $1,000,000 of convertible bonds outstanding with a carrying value equal to face value. Bondholders exercised their option to convert all the bonds into 50,000 shares of the company's $10 par value common stock. What is the overall effect of this conversion on the corporation's accounting equation?
Answer: Liabilities decrease and equity increases.
The conversion of bonds to stock extinguishes a debt and creates equity. The Bonds Payable liability account is decreased by $1,000,000. Stockholders' Equity is increased by $1,000,000, allocated between Common Stock (50,000 shares × $10 par = $500,000) and Additional Paid-in Capital ($500,000). The net effect is a decrease in total liabilities and an increase in total equity by the same amount. Total assets are unaffected.
- On November 1, a magazine publisher receives $240 in cash from a customer for a two-year subscription. The publisher credits Unearned Subscription Revenue. What is the effect of the adjusting entry that must be made on December 31 of that same year?
Answer: A decrease in liabilities and an increase in equity.
By December 31, two months of the 24-month subscription have been earned. The monthly revenue is $240 / 24 = $10. The revenue earned for two months is $20. The required adjusting entry is to debit Unearned Subscription Revenue (a liability) for $20 and credit Subscription Revenue (an equity account) for $20. This results in a decrease in total liabilities and an increase in total equity.
- Meridian Inc. received a $30,000 cash advance from a customer on October 1 for services to be performed over the next six months. On December 31, Meridian's year-end, three months of services have been completed. What adjusting entries are needed on December 31?
Answer: Decrease Unearned Revenue $15,000; Increase Service Revenue $15,000
By December 31, three of the six months have passed, so 50% ($15,000) of the services have been performed. The adjusting entry transfers this amount from the liability account (Unearned Revenue) to the revenue account (Service Revenue). Choice B incorrectly recognizes all revenue despite only half being earned. Choice C creates a receivable when cash was already collected. Choice D incorrectly decreases cash and doesn't recognize the earned revenue.
- On June 10, a company paid $1,200 for June's rent. The bookkeeper mistakenly debited Office Supplies and credited Cash for $1,200. The error was discovered on June 30, before financial statements were prepared. What is the effect of the correcting entry?
Answer: It increases Rent Expense and decreases Office Supplies.
The incorrect entry was Dr. Office Supplies, Cr. Cash. The correct entry should have been Dr. Rent Expense, Cr. Cash. To fix the error, the incorrect debit to Office Supplies must be removed and the correct debit to Rent Expense must be made. The correcting entry is: Dr. Rent Expense $1,200, Cr. Office Supplies $1,200. This entry increases an expense account and decreases an asset account. Cash is not part of the correcting entry itself.
- Zenith Corp. issued 1,000 shares of its $5 par value common stock in exchange for a piece of land. On the date of issuance, Zenith's stock was actively trading at $22 per share. The land was recently appraised at $23,000. Which of the following correctly describes the effect of this transaction?
Answer: Assets increase by $22,000, and equity increases by $22,000.
When issuing stock for a non-cash asset, the transaction is recorded at the fair value of the stock issued or the fair value of the asset received, whichever is more clearly determinable. The market price of an actively traded stock ($22 per share) is a more objective measure than an appraisal. Therefore, the transaction is valued at 1,000 shares * $22/share = $22,000. Assets (Land) increase by $22,000, and Equity (Common Stock at par + Additional Paid-in Capital) increases by a total of $22,000.
- Apex Industries purchased a new delivery truck for $60,000. The company paid $15,000 in cash and signed a three-year note payable for the remaining balance. Which of the following correctly describes the effect of this transaction on Apex's accounting equation?
Answer: Total assets increase by $45,000 and total liabilities increase by $45,000.
The transaction increases the Equipment asset by $60,000 and decreases the Cash asset by $15,000, resulting in a net increase in total assets of $45,000. A Note Payable is created, which increases total liabilities by $45,000. Equity is unaffected. Thus, the accounting equation remains in balance (Assets +$45,000 = Liabilities +$45,000).
