Accounting Knowledge practice questions

Financial statements & analysis

30 practice questions on financial statements & analysis, each with the answer and why it is right. From Questiva Consultants' QuickBooks Online skills test.

1. The owner of a landscaping company asks, "How much do we owe everyone as of today, and what do we own?" Which financial statement answers that question?

   1. The profit and loss, because it lists every expense the company has paid
   2. The statement of cash flows, because it shows where the money went
   3. The balance sheet, which reports assets, liabilities and equity at one date
   4. The general ledger, because it lists every transaction in account order by date

   Answer: C) The balance sheet, which reports assets, liabilities and equity at one date. What a company owns and owes is a snapshot of assets and liabilities — the balance sheet, as of a date. The profit and loss covers a period and reports income and expenses, not balances; the cash-flow statement explains where cash went; the general ledger is the record the statements are built from, not a statement — the accounting equation, Assets = Liabilities + Equity.

2. A bakery's profit and loss for June shows: Sales $50,000 Cost of goods sold $30,000 Rent $8,000 Wages $10,000 Interest expense $500 What is the bakery's gross profit for June?

   1. $20,000
   2. $2,000
   3. $1,500
   4. $12,000

   Answer: A) $20,000. Gross profit is sales minus cost of goods sold: 50,000 − 30,000 = 20,000. Subtracting rent and wages as well gives operating income of 2,000; taking interest off that gives net income of 1,500 — each a different line lower on the statement. Gross profit shows what is left to cover operating costs — the P&L structure: gross profit sits above operating expenses.

3. A cabinet shop has been recording the wages of its shop workers as an operating expense. The owner's accountant asks that they be moved to cost of goods sold instead. After the change, what happens to the shop's profit and loss for the year?

   1. Gross profit and net income both fall by the amount of the wages
   2. Gross profit is unchanged and net income falls by the amount
   3. Gross profit rises and net income is unchanged by the move
   4. Gross profit falls and net income is unchanged by the move

   Answer: D) Gross profit falls and net income is unchanged by the move. Moving a cost from operating expenses into cost of goods sold pulls it above the gross-profit line, so gross profit falls by the wages amount. Total expenses are the same, so net income does not move. The reclassification changes what gross margin tells the owner about production cost; it does not make the business more or less profitable — COGS sits above gross profit, operating expenses below.

4. A bookkeeper keeps a small club's books in a spreadsheet. The year-end balance sheet, with this year's net income already in equity, shows: Total assets $120,000 Total liabilities $45,000 Total equity $70,000 What does the $5,000 difference tell you?

   1. It is this year's net income, which has not yet been closed into equity at year end
   2. An entry was posted on one side only. Double-entry books can't do this, so find it
   3. Liabilities are understated by $5,000, so a $5,000 loan is missing and should be added
   4. Equity should be increased by $5,000 so that the statement balances and the books agree

   Answer: B) An entry was posted on one side only. Double-entry books can't do this, so find it. Double-entry books post equal debits and credits, so a balance sheet that does not balance means an error. Net income is already in equity here. Plugging equity or inventing a loan only hides the mistake. Find the one-sided entry.

5. On May 20 the owner of a sole proprietorship transfers $5,000 from the business checking account to her personal account to cover living expenses. How does this affect the May profit and loss?

   1. It has no effect; it reduces cash and owner's equity, not profit
   2. It reduces net income by $5,000 as an owner's salary expense
   3. It reduces revenue by $5,000 because less cash stayed in the business
   4. It increases liabilities by $5,000 because the owner is owed the money

   Answer: A) It has no effect; it reduces cash and owner's equity, not profit. An owner's draw is a distribution of equity, not a cost of running the business, so it never appears on the profit and loss: cash goes down and owner's equity goes down. Recording it as salary understates profit (and a sole proprietor's draw is not a deductible wage); it is neither revenue nor a debt to the owner — expenses versus distributions.

6. On March 3 a company receives $20,000 from the bank as a five-year term loan and deposits it in checking. Which is the correct effect on the financial statements?

   1. Revenue rises $20,000 on the profit and loss and cash rises $20,000
   2. Cash rises $20,000 and owner's equity rises $20,000 on the balance sheet
   3. Cash rises $20,000 and a $20,000 expense is recorded when it is repaid
   4. Cash rises $20,000 and a $20,000 liability appears on the balance sheet

   Answer: D) Cash rises $20,000 and a $20,000 liability appears on the balance sheet. Borrowed money is not earned, so it is never revenue: the company has more cash and owes the bank the same amount, so a loan payable appears under liabilities. Equity is unchanged because the bank, not the owner, supplied the money. Repayments reduce the liability; only the interest portion is ever an expense — the accounting equation, Assets = Liabilities + Equity.

7. A consulting firm reports net income of $40,000, but its cash fell by $15,000 over the year. Which single change could explain the whole gap?

   1. Depreciation expense of $12,000 was recorded during the year
   2. Accounts payable increased by $20,000 over the year
   3. Accounts receivable grew by $55,000 over the year
   4. Accrued wages payable increased by $9,000 at year end

   Answer: C) Accounts receivable grew by $55,000 over the year. Profit can sit in unpaid invoices. If receivables grew by $55,000, cash from operations is 40,000 − 55,000 = −15,000, which matches the drop in cash. The other three push cash the other way: depreciation is added back, and rising payables or accruals mean expenses not yet paid.

8. A delivery company's net income for the year is $30,000, which includes $6,000 of depreciation on its vans. Receivables, payables and inventory did not change. Using the indirect method, what is cash provided by operating activities?

   1. $24,000
   2. $36,000
   3. $30,000
   4. $6,000

   Answer: B) $36,000. Depreciation reduces net income but no cash leaves the business, so the indirect method adds it back: 30,000 + 6,000 = 36,000. Subtracting it again double-counts a cost that was never paid in cash this year; leaving it alone ignores the adjustment. The cash paid for the vans appears under investing activities in the year they were bought — depreciation is a non-cash expense.

9. A retail store's balance sheet as of June 30 shows: Total current assets $60,000 Total current liabilities $40,000 Long-term loan $30,000 What does this tell the owner about the store's short-term position?

   1. Working capital is $100,000, so the store is in a position to expand
   2. The current ratio is 0.67, so the store cannot meet its obligations
   3. The store earned $20,000 of profit during June, since assets exceed liabilities
   4. The current ratio is 1.5, or $1.50 of current assets per $1 due within a year

   Answer: D) The current ratio is 1.5, or $1.50 of current assets per $1 due within a year. The current ratio is current assets divided by current liabilities: 60,000 ÷ 40,000 = 1.5, and working capital is the difference, 20,000. Both measure short-term liquidity, not profit, and the long-term loan is outside both. Inverting the ratio reads the same numbers as a shortfall; adding the figures produces a number that means nothing — the current ratio as a liquidity measure.

10. A coffee roaster's gross margin was 42% last year and is 35% this year on similar sales. Operating expenses did not change. What should the bookkeeper look at first?

    1. COGS rose against sales, from bean costs, pricing, or expenses miscoded to COGS
    2. Rent and wages grew faster than sales, squeezing the margin over the year
    3. The owner took larger draws from the business this year than last year
    4. Interest on the equipment loan was higher this year than last year

    Answer: A) COGS rose against sales, from bean costs, pricing, or expenses miscoded to COGS. Gross margin is (sales − COGS) ÷ sales, so only sales and COGS can move it. A seven-point drop on flat sales means COGS grew, from input costs, pricing, or purchases posted to COGS that belong in operating expenses. Rent, wages and interest sit below gross profit, and draws are not on the profit and loss.

11. A balance sheet as of September 30 shows: Cash $8,400 Accounts Receivable −$2,300 Inventory $15,000 The company invoices its customers and has written off no bad debt this year. What most likely caused the negative receivable balance?

    1. Bad debt expense was recorded for $2,300 more than the invoices that were actually open
    2. Customer payments or credits exceed open invoices — an overpayment or a duplicate payment
    3. Sales tax collected on invoices was posted to Accounts Receivable instead of the liability
    4. A credit balance in receivables is normal at the end of a quarter when invoicing is slow

    Answer: B) Customer payments or credits exceed open invoices — an overpayment or a duplicate payment. Receivables carry a debit balance: what customers owe. A credit balance means more has been credited to the account than was invoiced — a customer paid twice or overpaid, a payment was applied to the wrong customer, or a deposit was posted straight to A/R. No bad debt was recorded, and a sales-tax posting error would move the liability, not push A/R negative — normal balances of asset accounts.

12. An owner asks for "total revenue as of June 30." Before running anything, what should the bookkeeper clarify, and why?

    1. Nothing — the balance sheet as of June 30 shows revenue earned to date
    2. Whether to use cash or accrual basis, because revenue only exists on one of them
    3. The period — revenue is measured over a span of time, not as of a date
    4. Which bank account the revenue was deposited into, because revenue is measured by deposits

    Answer: C) The period — revenue is measured over a span of time, not as of a date. Income and expenses are flows, reported for a period (the month, the quarter, the year to date); balances are stocks, reported as of a date. "Revenue as of June 30" needs a start date — June, the quarter, or the year? The balance sheet never shows revenue, both bases measure it, and deposits are not revenue — period versus point-in-time reporting.

13. A corporation began the year with retained earnings of $50,000. During the year it earned net income of $12,000 and paid $3,000 of dividends to shareholders. What is retained earnings at year end?

    1. $62,000
    2. $35,000
    3. $59,000
    4. $47,000

    Answer: C) $59,000. Retained earnings accumulate profit that has not been distributed: 50,000 + 12,000 − 3,000 = 59,000. Dividends are a distribution of equity, not an expense, so they reduce retained earnings directly rather than net income. Forgetting them gives 62,000; subtracting income instead of adding it gives the other figures — the retained-earnings roll-forward.

14. On April 10 a hardware store pays $10,000 cash for inventory it expects to sell over the next two months. How does the purchase affect the April profit and loss?

    1. Cost of goods sold rises by $10,000 in April, which reduces net income
    2. A purchases expense of $10,000 reduces April's net income
    3. Revenue falls by $10,000 because that cash left the business
    4. Not at all: cash became inventory; cost is recognised as goods sell

    Answer: D) Not at all: cash became inventory; cost is recognised as goods sell. Buying inventory swaps cash for another asset, so April's profit and loss is untouched. Cost of goods sold is recorded as each item is sold, matching the cost to the sale it produced. Expensing the whole purchase on delivery overstates April's costs and understates later months — the matching principle; inventory is an asset until sold.

15. A café charges $1,400 of paper goods to the business credit card on March 22 and pays the card balance on April 15. How do the March financial statements show this?

    1. Nothing in March; the expense belongs to April, when the card was actually paid
    2. A $1,400 supplies expense in March and a $1,400 credit card balance in liabilities
    3. A $1,400 supplies expense in March and a $1,400 reduction of cash at March 31
    4. A $1,400 asset in March that becomes an expense in April when the card is paid

    Answer: B) A $1,400 supplies expense in March and a $1,400 credit card balance in liabilities. The expense is incurred when the goods are received, and the unpaid card balance is a current liability at March 31. No cash moves until April 15, so March cash is untouched. Paper goods bought for use are not an asset waiting to be expensed, and waiting for the payment date puts the cost in the wrong month — accrual basis: the expense follows the purchase, not the payment.

16. A cabinet shop ends the year with an $18,000 net loss, yet its checking balance is $60,000 higher than in January. Which event would push cash up in a loss year?

    1. The company drew $90,000 on an equipment loan during the year
    2. Depreciation of $12,000 was recorded on the shop's machinery
    3. The company paid down $30,000 of its accounts payable balance
    4. $40,000 of the year's sales are still sitting in accounts receivable

    Answer: A) The company drew $90,000 on an equipment loan during the year. Cash can rise in a loss year when it comes from somewhere other than operations. A loan draw is a financing inflow, and $90,000 easily outruns an $18,000 loss. Depreciation moves no cash, and sales still in receivables never reached the bank.

17. A restaurant group compares its two locations for the year: Downtown: sales $600,000, wages $150,000 Riverside: sales $1,200,000, wages $240,000 The owner says Riverside has the payroll problem because it spends $90,000 more on wages. How should the bookkeeper answer?

    1. Riverside is the problem. $240,000 is plainly the larger payroll of the two
    2. The two cannot be compared until both locations reach the same sales volume
    3. As a share of sales, Downtown spends 25% on wages and Riverside 20%
    4. Compare each location's wages with its net income, not with its sales

    Answer: C) As a share of sales, Downtown spends 25% on wages and Riverside 20%. Compare wages as a percentage of sales. Downtown spends 150,000 ÷ 600,000 = 25% and Riverside 240,000 ÷ 1,200,000 = 20%, so Downtown carries the heavier payroll. Dollar totals do not compare locations of different size.

18. A print shop sells a delivery van on August 14 for $9,000 cash. The van cost $32,000 and has $26,000 of accumulated depreciation, so its book value is $6,000. How does the sale appear on the profit and loss?

    1. Sales revenue of $9,000, with the van's $6,000 book value charged to cost of goods sold
    2. A $3,000 gain reported below operating income; the $9,000 is not sales revenue
    3. A $3,000 gain included in sales revenue, since the shop sold something for cash
    4. Nothing at all. The sale only swaps one asset for another on the balance sheet

    Answer: B) A $3,000 gain reported below operating income; the $9,000 is not sales revenue. Proceeds less book value is the gain: 9,000 − 6,000 = 3,000. It goes below operating income as other income, so sales keep showing only the shop's printing. Running the $9,000 through revenue would inflate sales and gross margin.

19. An owner gets a profit and loss for the year and a balance sheet as of December 31. Which relationship shows the two came from the same books?

    1. Cash on the balance sheet equals net income for the year on the profit and loss
    2. Total equity on the balance sheet equals the year's net income on the profit and loss
    3. Beginning equity plus net income, less draws, equals ending equity on the balance sheet
    4. Accounts receivable on the balance sheet equals the year's total sales on the profit and loss

    Answer: C) Beginning equity plus net income, less draws, equals ending equity on the balance sheet. Net income is closed into equity, so equity changes by the profit less what the owner took out. Cash moves with collections and payments, not profit. Equity also holds earlier years' profits and contributions, and receivables show only what customers still owe.

20. On December 31 a bakery owes $60,000 on a five-year equipment loan. The amortization schedule shows $11,000 of principal falling due during the coming year. How should the loan appear on the December 31 balance sheet?

    1. $60,000 under long-term liabilities, since the loan has five years to run
    2. $60,000 under current liabilities, since the whole balance is owed to the bank
    3. $11,000 under current liabilities and $60,000 under long-term liabilities
    4. $11,000 under current liabilities and $49,000 under long-term liabilities

    Answer: D) $11,000 under current liabilities and $49,000 under long-term liabilities. The principal due within twelve months is a current liability; the rest stays long-term: 11,000 current and 60,000 − 11,000 = 49,000 long-term. Leaving the whole $60,000 long-term flatters working capital and the current ratio, calling it all current understates them, and showing $11,000 beside the full $60,000 counts the same principal twice — the current portion of long-term debt.

21. A furniture store's December 31 balance sheet shows current assets of $240,000 — $180,000 of it inventory that has been slow to move, the remaining $60,000 cash and receivables — against current liabilities of $100,000. The current ratio is 2.4, yet the store could not make its January payroll. Which measure would have shown the risk?

    1. Gross margin, which shows how much of each sale is left to cover the payroll
    2. The quick ratio, cash and receivables over current liabilities: 60,000 ÷ 100,000 = 0.6
    3. Working capital, the $140,000 by which current assets exceed current liabilities
    4. Debt to equity, which weighs what the store owes against what the owner has in it

    Answer: B) The quick ratio, cash and receivables over current liabilities: 60,000 ÷ 100,000 = 0.6. The current ratio treats inventory as though it were nearly cash. The quick ratio strips it out: 60,000 of quick assets against 100,000 due, or 60 cents per dollar. Working capital leans on the same inflated $240,000, gross margin measures profit per sale, and debt to equity is a solvency measure, not a payroll one — liquidity ratios.

22. A supply company sells only on account, on terms of net 30. Sales for the year were $730,000 and the December 31 Accounts Receivable balance is $120,000. What does that say about collections?

    1. Receivables average about 60 days of sales, roughly twice the 30 days allowed
    2. Receivables are 16% of sales, which is normal for a company on net 30
    3. Collections are on schedule, since a net-30 company carries about one month of sales
    4. $120,000 of the year's revenue is not yet earned and belongs off the profit and loss

    Answer: A) Receivables average about 60 days of sales, roughly twice the 30 days allowed. Sales of 730,000 are about 2,000 a day, so a 120,000 balance is 60 days of sales. Customers are taking twice the terms. One month of sales here would be about 60,000, and an invoiced sale is earned whether or not it has been collected.

23. A landscaping company's statement of cash flows for the year shows: Operating activities $40,000 Investing activities −$95,000 Financing activities $70,000 Cash on January 1 was $22,000. What must the December 31 balance sheet show for cash?

    1. $15,000, the net of the three sections of the statement
    2. $110,000, the operating and financing inflows added together
    3. $37,000, the opening balance plus the net change of the three sections
    4. $132,000, the opening balance plus the inflows the company took in

    Answer: C) $37,000, the opening balance plus the net change of the three sections. The three sections net to 40,000 − 95,000 + 70,000 = 15,000. Add that change to the opening balance: 22,000 + 15,000 = 37,000, which is what the balance sheet shows. The $15,000 is the change, not the balance, and the larger figures ignore the $95,000 of investing outflow.

24. A print shop pays its landlord a $4,500 security deposit in March. The lease runs four more years, and the deposit is refundable when the shop moves out. Where does the $4,500 belong on the balance sheet?

    1. In current assets as prepaid rent, since it was paid to the landlord in advance
    2. Nowhere; it is rent expense in March, when the money left the checking account
    3. In current assets as a receivable, since the landlord will hand the money back
    4. In other assets, below current assets, as it is not coming back within a year

    Answer: D) In other assets, below current assets, as it is not coming back within a year. The deposit is an asset — money the landlord is holding — but it will not turn into cash for four years, so it sits outside current assets. It is not prepaid rent, because it buys no occupancy; it is not a current receivable, because nothing is collectible this year; and expensing it writes off money the shop still owns — current versus non-current classification.

25. A banker reviewing a loan application asks whether the business generates enough cash from its day-to-day operations to cover a new monthly payment. Which statement answers that question most directly?

    1. The profit and loss, because net income is what the business has available to pay
    2. The statement of cash flows, and in particular its operating activities section
    3. The balance sheet, because the cash line shows what is on hand to make payments
    4. The accounts receivable aging, because it shows the cash that is due to come in

    Answer: B) The statement of cash flows, and in particular its operating activities section. Only the cash-flow statement separates cash produced by operations from cash raised by borrowing or spent on equipment, which is the banker's question. Net income can be earned and uncollected; the balance-sheet cash line is one moment's balance; an aging lists what customers owe, not what the business generates each month — the operating section of the statement of cash flows.

26. A contractor's December 31 balance sheet shows liabilities of $260,000 and equity of $65,000. A supplier weighing credit terms asks what those figures say about how the company is financed. What should the bookkeeper tell him?

    1. Creditors have put in about $4 for every $1 the owner has in the business
    2. The company is insolvent, because liabilities are larger than the owner's equity
    3. The company holds $195,000 of assets, being the difference between the figures
    4. Nothing, until the profit and loss for the year is read alongside the balance sheet

    Answer: A) Creditors have put in about $4 for every $1 the owner has in the business. Debt to equity is 260,000 ÷ 65,000 = 4, so outside money funds four times what the owner has at risk. That is highly leveraged but not insolvent, which means unable to pay debts as they come due. Assets are the sum, $325,000, not the difference.

27. A hardware store's December 31 balance sheet carries $22,000 of discontinued fittings that have not sold in three years, still at original cost. The owner expects to scrap them. What is the effect on the statements until the inventory is written down?

    1. Only the balance sheet is affected; profit is untouched because nothing was sold
    2. Cost of goods sold is overstated by $22,000 and the year's profit is understated
    3. Total assets are overstated by $22,000, and so is the profit reported to date
    4. There is no effect; inventory stays at cost until it is sold or physically scrapped

    Answer: C) Total assets are overstated by $22,000, and so is the profit reported to date. Goods that will never sell are not worth their cost. The write-down moves $22,000 from inventory to expense, so until it is made, assets and cumulative profit are both too high by that amount. Cost of goods sold is understated, not overstated.

28. A gift shop has sales of $480,000, cost of goods sold of $288,000, operating expenses of $168,000 and net income of $24,000. The owner says the shop "keeps 40 cents of every dollar." What should the bookkeeper point out?

    1. 40% is the gross margin; after operating expenses the shop keeps 5% of each dollar
    2. 40% is the net margin, and the gross margin is 5% once the cost of goods is taken
    3. The claim holds, since 480,000 − 288,000 leaves $192,000 for the owner to keep
    4. Net margin is 24,000 ÷ 168,000, or 14 cents for every dollar the shop spends

    Answer: A) 40% is the gross margin; after operating expenses the shop keeps 5% of each dollar. Gross margin is (480,000 − 288,000) ÷ 480,000 = 40%. Net margin is 24,000 ÷ 480,000 = 5%. The owner quoted gross margin but meant what is left after everything. The $192,000 of gross profit still has to cover $168,000 of operating costs.

29. An owner points at her balance sheet and says it is wrong: the building she bought for $300,000 eight years ago would sell today for $500,000, but the statement still shows the $300,000 less depreciation. How should the bookkeeper answer?

    1. She is right, and the building should be written up to $500,000 with equity raised
    2. She is right, but only a licensed appraiser may change the figure on the books
    3. The building belongs at $500,000, with the $200,000 difference reported as income
    4. Assets are carried at what was paid for them, less depreciation, not at market value

    Answer: D) Assets are carried at what was paid for them, less depreciation, not at market value. Under the cost principle an asset stays on the books at what the company paid, reduced by depreciation. An unrealised rise in market value is not recorded and is certainly not income, whoever estimates it. That is why a balance sheet is not a valuation of the business; a buyer or a lender applies market values separately, outside the books — the historical cost principle.

30. A bookkeeper is sorting this year's cash movements into the financing section of the statement of cash flows. Which two items belong there? Choose two.

    1. The $50,000 the owner put in from her personal savings in April
    2. The $18,000 paid in June for a used forklift the warehouse will keep for years
    3. The $9,000 of principal repaid on the equipment loan during the year
    4. The $31,000 collected in November on invoices issued in September

    Answer: A) The $50,000 the owner put in from her personal savings in April; C) The $9,000 of principal repaid on the equipment loan during the year. Financing covers cash moving between the business and its owners or lenders: money put in, money drawn out, loan proceeds and principal repaid. The forklift is investing, and collecting customer invoices is operating. The interest part of a loan payment is also operating.