Accounting Knowledge practice questions

The accounting equation, account types & normal balances

30 practice questions on the accounting equation, account types & normal balances, each with the answer and why it is right. From Questiva Consultants' QuickBooks Online skills test.

1. A lawn-care company receives $1,800 on January 2 for six months of weekly service that begins February 1. On the January 31 balance sheet, how is the $1,800 shown?

   1. As Service Income, because the cash was received and is the company's to keep
   2. As Accounts Receivable, because the company has not yet done the work it was paid for
   3. As Unearned Revenue, a liability, because the service is still owed to the customer
   4. As Owner's Equity, because the payment increased what the business is worth

   Answer: C) As Unearned Revenue, a liability, because the service is still owed to the customer. Cash received before the work is done is an obligation, not income: the company must deliver the service or refund the money. It sits in Unearned Revenue (a liability) and moves to income month by month as the service is performed. Recording it as income in January overstates revenue — the revenue recognition principle.

2. Maria is the sole owner of a design studio. On May 15 she moves $2,000 from the business checking account to her personal account to cover her apartment rent. How should the bookkeeper record it?

   1. Debit Owner's Draws 2,000 / Credit Checking 2,000
   2. Debit Salaries Expense 2,000 / Credit Checking 2,000
   3. Debit Checking 2,000 / Credit Owner's Draws 2,000
   4. Debit Rent Expense 2,000 / Credit Checking 2,000

   Answer: A) Debit Owner's Draws 2,000 / Credit Checking 2,000. Money an owner takes for personal use is a draw: it reduces equity and never touches the profit and loss. Calling it salary or rent would overstate business expenses and understate profit. A draw is the owner taking back part of their investment, not a cost of running the business — the business entity principle.

3. A $1,000 monthly payment on the company's equipment loan is made up of $850 principal and $150 interest. After the payment is recorded correctly, what has changed?

   1. Liabilities down 1,000; cash down 1,000; nothing on the profit and loss
   2. Liabilities down 850; interest expense up 150; cash down 1,000
   3. Interest expense up 1,000; cash down 1,000; liabilities unchanged
   4. Liabilities down 150; interest expense up 850; cash down 1,000

   Answer: B) Liabilities down 850; interest expense up 150; cash down 1,000. Only the interest is a cost of doing business; the principal repays what was borrowed and reduces the loan balance on the balance sheet. Posting the whole payment to the loan hides the interest cost; expensing the whole payment overstates expenses and leaves the loan balance too high — the difference between paying down a liability and incurring an expense.

4. While reviewing a trial balance you see four accounts, each showing a credit balance. Which one is correctly a credit balance?

   1. Accounts Receivable
   2. Prepaid Insurance
   3. Cost of Goods Sold
   4. Accumulated Depreciation

   Answer: D) Accumulated Depreciation. Accumulated Depreciation is a contra asset: it sits in the asset section but carries a credit balance that reduces the cost of the equipment it relates to. Receivables, prepaids and cost of goods sold all normally carry debit balances, so a credit there signals an error such as an over-applied payment or a reversed entry — normal balances.

5. On June 9 a company bought $500 of office supplies on account; the bill is unpaid. The bookkeeper recorded Debit Supplies Expense 500 / Credit Checking 500. The entry balances. What is wrong with the June 30 balance sheet?

   1. Nothing — the debits equal the credits, so the statements are correct
   2. Checking and Accounts Payable are each understated by $500
   3. Assets are overstated by $500 and equity is overstated by $500
   4. Accounts Payable is overstated by $500 and Checking is correct

   Answer: B) Checking and Accounts Payable are each understated by $500. A balanced entry can still be wrong. Crediting Checking says cash left the bank, but it did not; the company owes the vendor, so Accounts Payable should have been credited. Cash is $500 too low and liabilities are $500 too low — both sides off by the same amount, which is why the equation still balances. Balancing proves arithmetic, not accuracy.

6. A bakery buys $600 of flour and sugar that go into the cakes it sells, and $120 of cleaning supplies for the kitchen floor. How should the two purchases be classified on the profit and loss?

   1. Classify both purchases as Cost of Goods Sold, since both were used in the kitchen
   2. Flour and sugar as Cost of Goods Sold; cleaning supplies as an operating expense
   3. Classify both purchases as operating expenses, since the bakery does not track inventory
   4. Flour and sugar as an operating expense; cleaning supplies as Cost of Goods Sold

   Answer: B) Flour and sugar as Cost of Goods Sold; cleaning supplies as an operating expense. Cost of Goods Sold holds the direct cost of what is sold — the ingredients that become the product. Cleaning supplies keep the shop running but are not part of any cake, so they are an operating expense below gross profit. Putting the cleaning supplies in COGS understates gross margin — the direct-cost definition of cost of goods sold.

7. On March 3 a consultant finishes a project and invoices the client $3,000, due in 30 days. No cash has been received. What happens to the accounting equation on March 3?

   1. Assets increase $3,000 and equity increases $3,000
   2. Assets increase $3,000 and liabilities increase $3,000
   3. Nothing changes until the client actually pays the invoice
   4. Equity increases $3,000 and liabilities decrease $3,000

   Answer: A) Assets increase $3,000 and equity increases $3,000. The invoice creates a receivable (an asset) and income, and income increases equity. Waiting for cash is cash-basis thinking; under accrual accounting the sale is recorded when earned. The client's unpaid balance is the business's asset, not its liability — the accounting equation, Assets = Liabilities + Equity.

8. The Accounts Payable T-account for May shows: Debits: 5/12 $2,400 · 5/27 $1,100 Credits: 5/1 opening balance $3,000 · 5/8 $2,400 · 5/20 $1,900 What is the May 31 balance, and what does it tell you?

   1. $800 credit — bills received this month exceeded bills paid by $800
   2. $3,800 debit — vendors owe the company $3,800 at month end
   3. $7,300 credit — the total of every bill the company has received
   4. $3,800 credit — the company owes its vendors $3,800 at month end

   Answer: D) $3,800 credit — the company owes its vendors $3,800 at month end. Credits (3,000 + 2,400 + 1,900 = 7,300) less debits (2,400 + 1,100 = 3,500) leave a $3,800 credit balance, the normal side for a liability: that is what the company still owes. The $800 answer ignores the opening balance; a debit balance would mean vendors owe the company, which is not what Accounts Payable measures — reading a T-account.

9. The balance sheet shows Equipment $40,000 (debit) and Accumulated Depreciation $12,000 (credit). How should you read these two lines?

   1. The equipment is worth $52,000 in total, and $12,000 of it was bought during the current year
   2. The equipment cost $40,000 and the company still owes $12,000 of the purchase price
   3. The equipment cost $40,000 and, after $12,000 of depreciation to date, carries at $28,000
   4. The equipment cost $40,000 and the $12,000 is this year's depreciation expense only

   Answer: C) The equipment cost $40,000 and, after $12,000 of depreciation to date, carries at $28,000. Accumulated Depreciation is a contra asset: it collects every year's depreciation since purchase and is subtracted from cost to give the carrying (book) value, here $28,000. It is not a debt and not this year's expense alone — the current-year charge is on the profit and loss as Depreciation Expense. Carrying value, not market value — the cost principle.

10. On October 1 the company pays $2,400 for a 12-month liability insurance policy. Immediately after the payment is recorded, and before any month-end adjustment, what does the balance sheet show?

    1. Prepaid Insurance (an asset) up $2,400 and Checking down $2,400
    2. Insurance Expense up $2,400 and Checking down $2,400
    3. Insurance Payable (a liability) up $2,400 and Checking down $2,400
    4. Owner's Equity down $2,400 and Checking down $2,400

    Answer: A) Prepaid Insurance (an asset) up $2,400 and Checking down $2,400. Paying a year in advance buys a right to coverage the business has not used yet, which is an asset. Each month $200 moves from Prepaid Insurance to Insurance Expense. Expensing the whole $2,400 in October would overstate that month's costs by $2,200 and understate the next eleven — the matching principle.

11. A hardware store sells $500 of goods to a walk-in customer and collects 8% sales tax, receiving $540 in cash. How is the $540 recorded?

    1. Sales Income $540, since that is what the customer paid
    2. Sales Income $500 and Sales Tax Expense $40, a cost of making the sale
    3. Sales Income $540 now, with a $40 expense when the tax is remitted to the state
    4. Sales Income $500 and Sales Tax Payable $40, a liability owed to the state

    Answer: D) Sales Income $500 and Sales Tax Payable $40, a liability owed to the state. The $40 was never the store's money; it was collected on behalf of the state and must be paid over, so it is a liability from the moment it is collected. Booking it as income overstates sales and then needs an expense to fix it; it is not an expense of the store at all — the definition of a liability.

12. The owner puts $10,000 of personal savings into the business checking account. The bookkeeper debits Checking and credits Loan Payable – Owner for 10,000, but the owner says it never has to be repaid. What should change?

    1. Nothing. Money that comes from an owner is always recorded as a loan to the business
    2. The credit should go to Sales Income, because the business can spend the money
    3. The credit should go to Owner's Capital, because a contribution that need not be repaid is equity
    4. The credit should go to Owner's Draws, because that account tracks everything the owner moves in or out

    Answer: C) The credit should go to Owner's Capital, because a contribution that need not be repaid is equity. Owner money is a liability only if it must be repaid. A contribution with no repayment obligation is Owner's Capital. Leaving it as a loan overstates liabilities and understates equity, and it is not income because nothing was sold.

13. A new bookkeeper is building a chart of accounts and must place each of these in the right section. Which two belong in the Assets section? Choose two.

    1. Accounts Receivable
    2. Accounts Payable
    3. Inventory
    4. Retained Earnings

    Answer: A) Accounts Receivable; C) Inventory. Receivables (money customers owe) and inventory (goods held for sale) are resources the business controls, so they are assets. Accounts Payable is what the business owes vendors — a liability — and Retained Earnings is accumulated profit kept in the business — equity. Mixing these up puts whole balance sheet sections out of order — account classification.

14. At December 31 total assets are $85,000 and total liabilities are $32,000. During the year the owner contributed $5,000, took draws of $18,000, and the business earned net income of $26,000. What was owner's equity on January 1?

    1. $53,000
    2. $56,000
    3. $66,000
    4. $40,000

    Answer: D) $40,000. Closing equity is assets less liabilities: $85,000 − $32,000 = $53,000. Work the year backwards: $53,000 − $5,000 contributed + $18,000 draws − $26,000 income = $40,000 opening equity. $53,000 is the ending figure, not the start; the other answers get a sign wrong on draws or contributions — the statement of owner's equity roll-forward.

15. A June 30 general ledger entry reads Debit Equipment 3,000 / Credit Repairs Expense 3,000, memo 'reclass new compressor'. The $3,000 compressor was bought in June and will be used for several years; the purchase was first posted to Repairs Expense. Was the reclass correct?

    1. Yes — a multi-year asset was expensed in error, and the reclass puts it on the balance sheet
    2. No — equipment should be expensed in full in the month it is paid for, like any other purchase
    3. No — the credit should have gone to Checking, because that is where the $3,000 came from
    4. Yes, but the debit should have gone to Accumulated Depreciation rather than to Equipment

    Answer: A) Yes — a multi-year asset was expensed in error, and the reclass puts it on the balance sheet. A purchase that will serve the business for years is capitalised as an asset and expensed gradually through depreciation, not charged to one month. The original entry already credited Checking when the compressor was paid for; the reclass only moves the debit from expense to asset. Accumulated Depreciation is credited later as the asset is used — the matching principle.

16. In April the electric company refunds $200 because it overcharged on the March bill, which was already recorded as Utilities Expense and paid. The refund check is deposited. How should the deposit be recorded?

    1. Debit Checking 200 / Credit Other Income 200
    2. Debit Checking 200 / Credit Accounts Payable 200
    3. Debit Checking 200 / Credit Utilities Expense 200
    4. Debit Utilities Expense 200 / Credit Checking 200

    Answer: C) Debit Checking 200 / Credit Utilities Expense 200. The refund reverses part of a cost already recorded, so it reduces Utilities Expense — a credit to an expense account lowers it. Recording it as income overstates both revenue and expenses by $200; there is no payable, because nothing is owed to the utility. Expenses show the net cost of what was actually consumed — the expense recognition principle.

17. Riverbend Cleaning charges $420 of cleaning supplies to the company credit card on July 8 and the crew uses them on jobs that same week. The card statement is paid from checking on August 5. On the July 31 accrual-basis statements, how does the July 8 purchase appear?

    1. Nothing in July — the purchase is recorded on August 5, when the card is paid and cash leaves the bank
    2. Supplies Expense up $420 and the credit card liability up $420, with cash untouched
    3. Supplies Expense up $420 and Checking down $420, because the card is a business payment method
    4. Prepaid Supplies, an asset, up $420 and the credit card liability up $420 until the card is paid

    Answer: B) Supplies Expense up $420 and the credit card liability up $420, with cash untouched. A company credit card is a liability account, not a bank account. Charging it records the expense — the supplies were used in July — and increases what the company owes the issuer; no cash moves until August, and that payment reduces the liability, not expenses. Waiting for the statement pushes July costs into August — the matching principle.

18. Four things happened at a print shop during July. Which one left total assets unchanged?

    1. Paid $4,000 from checking for a used laminator delivered the same day
    2. Paid a $1,500 vendor bill that was already sitting in Accounts Payable
    3. Bought $900 of paper stock on account from the shop's paper supplier
    4. Recorded $700 of depreciation on the shop's three-year-old delivery van

    Answer: A) Paid $4,000 from checking for a used laminator delivered the same day. Buying equipment with cash swaps one asset for another: checking down $4,000, equipment up $4,000. Paying a bill lowers assets and liabilities, buying on account raises both, and depreciation lowers assets and equity.

19. Two employees worked December 26 through December 31 and earned $2,600, which will be paid in the January 3 payroll run. The company is on the accrual basis. What belongs on the December 31 books?

    1. Nothing — the wages belong to January, because that is when the payroll is processed and paid
    2. Wages Expense $2,600 in December and Prepaid Wages, an asset, of $2,600 until payday
    3. Wages Expense $2,600 in December and Wages Payable, a liability, of $2,600
    4. Wages Payable $2,600 in December, with the expense recorded in January when the wages are paid

    Answer: C) Wages Expense $2,600 in December and Wages Payable, a liability, of $2,600. The work was done in December, so December carries the cost, and the money is still owed, which makes it a liability until payday. Leaving it out understates December expenses and overstates profit. Nothing has been paid, so it is not prepaid, and an expense cannot sit in a later month than the work that caused it — the matching principle.

20. On March 1 a business signs a shop lease and pays $3,600: $1,800 for March rent and a $1,800 security deposit that the landlord returns at the end of the lease. How is the payment recorded?

    1. Rent Expense $3,600, because the whole payment went to the landlord under the lease
    2. Rent Expense $1,800 and Prepaid Rent $1,800, since the deposit covers the final month
    3. Prepaid Rent $3,600, with $1,800 moved to Rent Expense at the end of March
    4. Rent Expense $1,800 and a $1,800 security deposit asset held until the lease ends

    Answer: D) Rent Expense $1,800 and a $1,800 security deposit asset held until the lease ends. The deposit is refundable, so the business still has a claim on it. That makes it an asset until the landlord returns it, not a cost. Only March rent is an expense. Calling the deposit prepaid rent assumes it offsets rent, which this lease does not promise.

21. Kestrel Supply's December trial balance shows Sales $80,000 credit and Sales Returns and Allowances $2,400 debit, both in the income section. The owner says the $2,400 must be a posting error because income accounts carry credits. How should the $2,400 be read?

    1. An error — returned merchandise belongs in Cost of Goods Sold, where the goods were charged out
    2. Correct — a contra revenue account subtracted from Sales, giving net sales of $77,600
    3. An error — the $2,400 belongs in Bad Debt Expense, because that revenue was never collected
    4. Correct, but it is a cost of making sales and belongs with the operating expenses

    Answer: B) Correct — a contra revenue account subtracted from Sales, giving net sales of $77,600. Sales Returns and Allowances collects credits given back to customers and carries a debit balance on purpose, the mirror of the Sales account it offsets: $80,000 less $2,400 is $77,600 of net sales. A return is revenue given back, not an expense and not a bad debt — the customer returned goods rather than failing to pay — contra accounts.

22. A client's June 30 balance sheet shows Vehicle Loan Payable with a $4,500 debit balance. The company bought a $28,000 truck in January with dealer financing and has made five $900 payments from checking. What is the most likely cause?

    1. The truck loan was paid off early, and the $4,500 debit is what the lender now owes back
    2. Each payment was posted twice, and reversing one set of five entries clears the balance
    3. Interest inside each payment went to the loan account instead of Interest Expense
    4. The financing was never entered as a liability, so the five payments hit an account that started at zero

    Answer: D) The financing was never entered as a liability, so the five payments hit an account that started at zero. Five $900 payments debited to a liability that was never credited when the truck was financed leave a $4,500 debit, the opposite of a liability's normal balance. Entering the truck as an asset against a $28,000 note fixes it. Doubled payments would still leave a credit.

23. At December 31 a bakery owes $30,000 on a five-year equipment loan. The amortization schedule shows $6,000 of principal falling due during the coming twelve months. How should the loan appear on the December 31 balance sheet?

    1. $30,000 in long-term liabilities, because the loan does not mature for five years
    2. $30,000 in current liabilities, because a payment comes due within the next month
    3. $6,000 in current liabilities and $24,000 in long-term liabilities
    4. $6,000 in current liabilities and $24,000 netted against the cost of the equipment

    Answer: C) $6,000 in current liabilities and $24,000 in long-term liabilities. A balance sheet sorts debt by when it comes due: the next twelve months of principal is current, the remainder is long-term. That split is what makes working capital and the current ratio mean anything. Leaving the whole loan long-term flatters liquidity, calling it all current does the opposite, and debt is never netted against the asset it bought.

24. On February 6 a landscaper buys a $9,000 trailer, paying $2,000 from checking and signing a $7,000 note with the dealer for the balance. What is the effect on the accounting equation that day?

    1. Assets up $7,000 net of the cash paid, and liabilities up $7,000
    2. Assets up $9,000 and liabilities up $9,000, the trailer's full price
    3. Assets down $2,000 and equity down $2,000, with the note recorded as it is paid
    4. Assets up $2,000, liabilities up $7,000 and equity down $5,000

    Answer: A) Assets up $7,000 net of the cash paid, and liabilities up $7,000. The trailer adds $9,000 of assets while checking falls $2,000, a net increase of $7,000, matched by the $7,000 note. The equation stays in balance. Buying an asset on credit is not an expense, so equity does not move, and the note is a liability from the day it is signed rather than when the first payment is made — Assets = Liabilities + Equity.

25. A garden center owner takes six patio chairs home for her own deck. They cost the business $540 and are tagged at $900. The business uses perpetual inventory. How is this recorded?

    1. Debit Owner's Draws 900 / Credit Sales Income 900, at the price a customer would have paid
    2. Debit Owner's Draws 540 / Credit Inventory 540, at what the business paid for the chairs
    3. Debit Cost of Goods Sold 540 / Credit Inventory 540, since the chairs left the sales floor
    4. No entry. Nothing was sold, so the books stay as they are until the next inventory count

    Answer: B) Debit Owner's Draws 540 / Credit Inventory 540, at what the business paid for the chairs. The owner took an asset out of the business, so inventory falls and equity falls through draws, at cost: $540. No customer bought anything, so there is no revenue and no cost of goods sold. With no entry, inventory stays overstated until the next count.

26. On December 20 a corporation's board declares a $15,000 dividend payable January 10. The company is on the accrual basis with a December 31 year end. What do the December 31 statements show?

    1. Nothing yet. A dividend reaches the books on January 10, when the cash actually goes out
    2. Dividend Expense of $15,000 on the December profit and loss, reducing the year's net income
    3. Dividends Payable, a current liability, of $15,000 and equity lower by the same amount
    4. Retained Earnings down $15,000 and cash down $15,000, with the transfer clearing in January

    Answer: C) Dividends Payable, a current liability, of $15,000 and equity lower by the same amount. Declaring a dividend creates a legal obligation, so December 31 shows a $15,000 current liability and $15,000 less equity. Cash stays in the bank until January 10. A dividend distributes profit already earned, so it is not an expense and net income does not change.

27. On August 12 the owner of a small consultancy buys $340 of software for the business on her personal credit card and tells the bookkeeper she does not want to be reimbursed. How should it be recorded?

    1. Debit Software Expense 340 / Credit Owner's Capital 340, an owner contribution
    2. No entry — the business never paid anything, so nothing belongs in its books
    3. Debit Software Expense 340 / Credit Checking 340, to keep the cost in the month of purchase
    4. Debit Software Expense 340 / Credit Accounts Payable 340, leaving the owner as a vendor to pay

    Answer: A) Debit Software Expense 340 / Credit Owner's Capital 340, an owner contribution. The business received the software, so it carries the expense; the money came from the owner personally with no repayment expected, which makes it a contribution to equity. Skipping the entry understates costs and overstates profit. Crediting checking claims cash left an account it never left, and a payable records a debt the owner has already waived — the business entity principle.

28. A bookkeeper is typing a manual journal entry for an unpaid $500 rent bill, which must increase Accounts Payable by $500 and increase Rent Expense by $500. Which sides does the entry use?

    1. Debit Accounts Payable and debit Rent Expense
    2. Credit Accounts Payable and credit Rent Expense
    3. Debit Accounts Payable and credit Rent Expense
    4. Credit Accounts Payable and debit Rent Expense

    Answer: D) Credit Accounts Payable and debit Rent Expense. Liabilities increase on the credit side and expenses increase on the debit side, so an unpaid bill debits the expense and credits the payable. Debiting the payable and crediting the expense is the mirror image — the pair of moves that records paying a bill off, not receiving one — and two debits or two credits cannot balance — the rules of debit and credit.

29. A bookkeeper is sorting a December 31 balance sheet into current and long-term sections. Which of these accounts belongs in Current Assets?

    1. The delivery van, which the company expects to keep driving for another four years
    2. Prepaid Insurance, covering the eight months of coverage left on the policy
    3. Accumulated Depreciation on the building, which grows a little larger every month
    4. Owner's Capital, on the grounds that the owner could withdraw the balance at any time

    Answer: B) Prepaid Insurance, covering the eight months of coverage left on the policy. Current assets are resources that will be used up or turned into cash within twelve months, and eight months of unexpired coverage qualifies. The van is used over four years, so it is long-term. Accumulated Depreciation is a contra asset that reduces the building it belongs to, and Owner's Capital is equity, not something the business owns — the current and long-term split.

30. A delivery van that cost $24,000 and carries $24,000 of accumulated depreciation is hauled away for scrap in May. The scrap yard pays nothing for it. What does the disposal require?

    1. Debit Accumulated Depreciation 24,000 / Credit Vehicles 24,000, with no gain or loss
    2. Debit Loss on Disposal 24,000 / Credit Vehicles 24,000, writing off the van's cost
    3. No entry — a fully depreciated van has already dropped off the balance sheet
    4. Debit Depreciation Expense 24,000 / Credit Vehicles 24,000, finishing the van off in May

    Answer: A) Debit Accumulated Depreciation 24,000 / Credit Vehicles 24,000, with no gain or loss. Cost less accumulated depreciation makes the van's carrying value zero, so clearing both lines removes it and touches nothing on the profit and loss. There is no loss, because nothing of value was given up, and no further depreciation, because the $24,000 was expensed over earlier years. Both accounts stay on the books until disposal is recorded — carrying value on disposal.