Accounting — Additional Practice — Part 1: 40 MCQs with Explanations

Assets carry a debit balance because every acquisition is entered on the debit side, so the rule is debit what comes in. Liabilities and capital run the other way and carry credit balances.

Liabilities are credited when they arise, which gives them a normal credit balance. The same rule covers capital, which is what the business owes back to its owner.

The incorrect statement is the debit one, because a debit reduces capital. Drawings and losses are debited to capital while profit and fresh capital are credited to it.

An account is the summary record of increases and decreases in one item, not of a single direction of change, so both movements must be captured.

A bank account is an asset to the business. When its credit side exceeds the debit side the account turns negative, which means the bank has lent the business money, that is, an overdraft.

When the debit side of the bank account is heavier, the business holds more at the bank than it has withdrawn, giving the asset balance known as cash at bank.

Goods distributed as charity leave the business without a sale, so purchases are credited to remove them at cost and charity is debited as the expense incurred.

Creditors are amounts owed to suppliers and are therefore liabilities. Cash, equipment and debtors are all resources owned or recoverable by the business, that is, assets.

Cash and cash equivalents are the clearest asset on the list. Creditors, notes payable and a bank loan are all obligations owed to outsiders.

Drawings is the name for any withdrawal of cash or goods by the owner for personal use. It reduces capital and is never treated as a business expense.

A net loss arises when total expenses exceed total income for the period. The excess is transferred to the capital account as a debit.

Nominal accounts record incomes, expenses and losses and are closed at the year end. Rent expense qualifies, while machinery and building are real accounts and creditors is a personal account.

Real accounts survive the accounting period and appear on the balance sheet. Cash is the real account here, since rent expense, rent income and insurance expense are all nominal.

A liability is a present obligation arising from a past event, whose settlement causes an outflow of resources. Resources and future benefits describe assets instead.

Income is defined as the gross inflow of economic benefits during the period, excluding amounts collected on behalf of owners. Expenses are the gross outflow.

Expenses are the gross decrease in economic benefits during the period, other than drawings, and they reduce the capital of the business.

Liabilities must arise from a past event that has already created an obligation. A future event has not yet given the business any duty to pay.

The one characteristic shared by all assets is the ability to produce future economic benefits. Long life, measurable value and physical form do not apply to every asset.

A company is a separate legal person whose total capital is divided into transferable shares. A sole proprietorship and a partnership are not wholly separate from their owners.

An asset must promise future economic benefits for the business. Benefits already consumed are expenses, and an asset need not deliver every kind of advantage.

Auditing is the independent examination of financial statements, whose purpose is to express an opinion on them. Preparing statements and maintaining ledgers are accounting duties, not auditing.

Recording is the first step of the accounting process and means keeping the log of transactions in the books of original entry. Summarising and classifying come afterwards.

Creditors sit outside the business and rely on published statements to judge whether they will be paid. Managers, the chief executive and the controller are all internal users.

Managers use accounting information to run the business and are internal users. Creditors, government agencies and shareholders all depend on statements from outside the firm.

Financial accounting exists to serve external users and must follow prescribed standards, while management accounting is internal, forward-looking and free of such rules.

A source document, such as an invoice or a receipt, is the original evidence that a transaction occurred. Journals and ledgers are the recording that follows it.

Posting a correct amount to the wrong account name is an error of commission. Here the figure is right and the class of account is right, so the trial balance still agrees.

Treating goods sent on approval as a sale records a revenue transaction that has not yet taken place, which is an error of principle because the correct accounting treatment itself has been misunderstood.

Goods still unsold at the reporting date are inventory, an asset carried forward at the lower of cost and net realisable value.

The Institute of Chartered Accountants of Pakistan was established in 1961 under its own Act, and it regulates the accountancy profession in the country.

Withdrawals of cash by the owner for private use are drawings. They reduce capital directly and are not an expense of the business.

Assets with physical existence are tangible assets, such as machinery, furniture and stock. Intangible assets have no physical substance, and current and liquid assets classify assets by convertibility.

Real assets are those with a market value that can be realised, in contrast with fictitious assets such as goodwill written off or preliminary expenses, which carry no resale value.

A contingent asset arises only if some uncertain future event happens. It is disclosed but not recognised until virtually certain, unlike fixed, quick and fictitious assets.

Income earned but not yet received is an outstanding asset, also called accrued income, and is shown on the asset side as a receivable.

Debts payable within the operating cycle or twelve months are current liabilities. Fixed liabilities are repayable over a longer horizon.

Capital is a liability of the business to its owner under the entity concept, because the firm owes back to the owner what the owner introduced.

Cash discount is allowed to encourage prompt payment and is recorded as an expense when allowed or income when received. It differs from a trade discount, which is deducted before entry.

Goods returned to a supplier are purchase returns, also called returns outwards. Sales returns are goods coming back from customers and are called returns inwards.

Working capital is current assets minus current liabilities. Circulating capital refers to the current assets themselves before deducting their liabilities.