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2.5 End-of-Chapter Exercises


  1. Why is the information reported by financial accounting not necessarily correct or accurate?
  2. What is a misstatement?
  3. In reference to a misstatement, what is meant by materiality?
  4. How is materiality determined?
  5. When is a misstatement considered fraud?
  6. Provide several examples of uncertainties faced by businesses that can impact the financial reporting process.
  7. Why is financial accounting compared to the painting of a portrait?
  8. Why is financial accounting compared to a language?
  9. What is U.S. GAAP and how has U.S. GAAP developed over the years?
  10. Why is U.S. GAAP so important to the capital market system in the United States?
  11. Why is there a push to accept International Financial Reporting Standards (IFRS) as the universal standards for financial accounting?
  12. Define “asset” and give several examples.
  13. Define “liability” and give several examples.
  14. What is meant by the term “net assets?”
  15. Define “revenue.”
  16. Define “expense.”

True or False

  1. ____ Most countries require companies that operate within their borders to follow U.S. GAAP in preparing their financial statements.
  2. ____ Companies face many uncertainties when preparing their financial statements.
  3. ____ If a company reports equipment costing $122,756,255, that is the amount that it actually did cost.
  4. ____ A liability is defined as a probable future economic benefit that an organization owns or controls.
  5. ____ Creation of U.S. GAAP is primarily done by the U.S. government.
  6. ____ IFRS has been in wide use in many countries since 1976.
  7. ____ In order for investors to properly evaluate the financial information of a business or other organization, it is vital that the financial information be exact.
  8. ____ A corporation reports sales of $33,453,750 when the actual figure was $33,453,843. This information contained a misstatement.
  9. ____ Materiality depends on the size of the organization.
  10. ____ A material misstatement that is made in a set of financial statements is acceptable as long as there is only one.
  11. ____ A misstatement has to be caused by fraud.
  12. ____ The reporting of a pending lawsuit is relatively simple.
  13. ____ One business has a misstatement of $10,000 that is caused by fraud. It also has another misstatement of $10,000 that is caused by error. If one of these misstatements is material, then they both are.
  14. ____ Only accountants need to understand the terminology that is found in accounting.
  15. ____ For a business or other organization, an employee is an example of an asset.
  16. ____ A sales transaction is normally considered revenue even if cash is not collected until the following year.
  17. ____ The purchase of a building for $2.4 million is recorded as an expense.

Multiple Choice

  1. Which of the following is not an example of an uncertainty that companies often face in their financial reporting?

    1. Sales that have not yet been collected in cash
    2. Warranties
    3. A loan due to a bank
    4. A lawsuit that has been filed against the company
  2. Which of the following is true about U.S. GAAP?

    1. U.S. GAAP has been developed over the past ten years.
    2. U.S. GAAP allows financial statement users to compare the financial information of companies around the world.
    3. U.S. GAAP helps accountants achieve an exact presentation of a company’s financial results.
    4. U.S. GAAP helps investors and creditors evaluate the financial health of a business.

    Questions 3, 4, and 5 are based on the following:

    Mike Gomez owns a music store called Mike’s Music and More. The store has inventory for sale that includes pianos, guitars, and other musical instruments. Mike rents the building in which his store is located, but owns the equipment and fixtures inside it. Last week, Mike’s Music made sales of $3,000. Some of the sales were made in cash. Some were made to customers who have an account with Mike’s Music and are billed at the end of the month. Last month, Mike’s Music borrowed $10,000 from a local bank to expand the amount of inventory being sold.

  3. Which of the following is not an asset owned by Mike’s Music?

    1. The inventory of musical instruments
    2. The building in which the store is located
    3. The amount owed to Mike’s Music by its customers
    4. The equipment and fixtures in the store
  4. Which of the following is a liability to Mike’s Music?

    1. The loan amount that must be repaid to the bank
    2. The amount owed to Mike’s Music by its customers
    3. The sales Mike’s Music made last week
    4. The cash collected from customers on the sales made last week
  5. Which of the following statements is true?

    1. Mike’s Music is too small for any outside party to care about its financial information.
    2. The sales Mike’s Music made last week are considered revenue.
    3. The intent of Mike’s Music to expand is an asset.
    4. The sales Mike’s Music made on credit last week is viewed as a liability.
  6. The Acme Company reports financial information to potential investors. The information is said to be “presented fairly according to U.S. GAAP.” What does that mean?

    1. The information contains no material misstatements according to the rules and standards of U.S. GAAP.
    2. The information is correct and follows the rules of U.S. GAAP.
    3. The information contains neither errors nor fraudulent numbers as specified by U.S. GAAP.
    4. The information is comparable to that reported by other companies around the world.
  7. Which of the following statements is true?

    1. Accounting rules referred to as IFRS are more complex than those existing within U.S. GAAP.
    2. Accounting rules referred to as IFRS have been developed for as long a period of time as the rules that make up U.S. GAAP.
    3. Accounting rules referred to as IFRS have become dominant in the world of accounting outside of the United States.
    4. Accounting rules referred to as IFRS will become mandatory in the United States in 2014.
  8. The Remingshire Corporation paid $2,000 at the end of the week to employees who worked for the business during that week. The corporation also paid another $3,000 at the end of the week for rent on the retail space that was occupied that week. Which of the following statements is true?

    1. The $2,000 is an expense for this period, but the $3,000 is not.
    2. The $3,000 is an expense for this period, but the $2,000 is not.
    3. Neither the $2,000 nor the $3,000 is an expense for this period.
    4. Both the $2,000 and the $3,000 are expenses for this period.
  9. Officials for the Boston Company have just borrowed $25,000 on a three-year loan from a bank. Which of the following is true?

    1. The company has an expense as a result of this transaction.
    2. The company’s net assets have gone down as a result of this transaction.
    3. The company’s net asserts have gone up as a result of this transaction.
    4. No change took place in this company’s net assets as a result of this transaction.

Video Problems

Professor Joe Hoyle discusses the answers to these two problems at the links that are indicated. After formulating your answers, watch each video to see how Professor Hoyle answers these questions.

  1. Your roommate is an English major. The roommate knows that you are taking a course in financial accounting. The roommate has never once considered taking a class in business and is interested in what you are learning. One evening, while listening to some music on the Internet, you mention that financial accounting is a type of language. The roommate is completely baffled by this assertion and wants to know how anything in accounting could possibly resemble a language such as English. How would you respond?

  2. Your uncle has worked for a large office supply business for the past twenty years. He is responsible for a small team of employees who do the interior design work for each of the company’s stores located around the country. One day he sends you the following e-mail:. “As a reward for twenty years of service, my company has offered to sell me one thousand shares of their capital stock for $23 per share. That’s $23,000, and that is a lot of money. I’ve never been interested in this aspect of business, but I don’t want to make a dumb decision. The company furnished me with a set of financial statements that are just full of numbers and odd terms. At one point, I found a statement that this information was presented fairly in conformity with U.S. Generally Accepted Accounting Principles. I understand you are taking a financial accounting course in college. What is meant by ‘presented fairly’? What is meant by ‘U.S. Generally Accepted Accounting Principles’? Most important, why is this important to me as I look through financial statements in hopes of making a good decision?”


  1. Mark each of the following with an (A) to indicate it is an asset, an (L) to indicate it is a liability, an (R) to indicate it is revenue, or an (E) to indicate it is an expense.

    1. ____ Cash
    2. ____ Building
    3. ____ Loan due to the bank
    4. ____ Inventory
    5. ____ Salary expense
    6. ____ Rent expense
    7. ____ Amounts owed to employees for work done
    8. ____ Equipment
    9. ____ Amounts owed to suppliers
    10. ____ Sales
  2. For each of the following, indicate at least one area of uncertainty that would impact the financial reporting of the balance.

    1. Inventory
    2. Receivable from a customer
    3. Equipment
    4. Income taxes payable
    5. Liability from lawsuit
  3. The Winslow Corporation operates a jewelry store in Topeka, Kansas. The business has recently issued a set of financial statements. One asset, inventory, was reported at $1.5 million. Later, it was determined that this balance was misstated. Describe several reasons why this misstatement might have happened.
  4. For each of the following events, indicate whether the net assets of the reporting company increase, decrease, or remain the same.

    1. The company owes $1,000 for some purchases made last month and pays that amount now.
    2. The company borrows $220,000 from a bank on a loan.
    3. The company sells a service to a customer for $30,000 with payment made immediately.
    4. The company sells a service to a customer for $40,000, but payment will not be made for several months.
    5. The company pays $8,000 in cash for several pieces of equipment.
    6. The company rented a large truck for one day for $500, which it paid at the end of the work day.

Research Assignments

  1. Go to At the McDonald’s Web site, click on “Investors” at the left of the page. Click on “Annual Reports” on the right of the next screen. Finally, click on “2010 Annual Report” to download. Answer the following questions:

    1. On page 26 of the 2010 annual report for McDonald’s, you will see a list of revenues and expenses. What is the largest revenue and what is the amount? What is the largest expense and what is the amount?
    2. On page 27 of the 2010 annual report for McDonald’s, you will see a list of assets and liabilities. What is the largest asset and what is the amount? What is the largest liability and what is the amount?
  2. IBM Corporation provides information about accounting to help decision makers understand the financial statements that the business provides. Go to the following URL and read the sections presented on “Assets” and on “Liabilities.”

    For the coverage of assets, and then also for liabilities, list two pieces of information that you already knew based on the coverage here in Chapter 2 "What Should Decision Makers Know in Order to Make Good Decisions about an Organization?". Next, list one piece of information about both assets and liabilities that you learned from the IBM essay.

  3. Go to In the box labeled “Get quotes,” enter “Johnson & Johnson.” On the page that appears, scroll down and find “Investor Relations” on the right side. Click on that link and then click on “Annual Reports” on the left side of the next page. Click on “2010 Annual Report” in the middle of the next page that appears. After the annual report downloads, scroll to page 41. You should find a listing of the company’s assets and liabilities.

    1. What is the total amount reported for the company’s assets?
    2. What is the total amount reported for the company’s liabilities?
    3. Determine the net assets for Johnson & Johnson.