chapter 5 liability Flashcards
According to the balance sheet equation, which of the following statements is TRUE?
- Liabilities may be greater than the difference between assets and owner’s equity.
- The total of a firm’s liabilities and owner’s equity may exceed its total assets.
- The total assets of a company must be equal to its sources of capital.
- Owner’s equity cannot exceed current and non-current liabilities.
Correct Answer: 3
The balance sheet equation states:
ASSETS = LIABILITIES + OWNER’S EQUITY
Option (3) is correct because it is a true statement: the two sources of financing are the creditors (liabilities) and owners (owner’s equity). Therefore, total assets must be equal to these sources of capital.
Options (1) and (2) are incorrect because liabilities and owner’s equity must be equal to total assets as shown in the equation above. Option (4) is incorrect because according to the balance sheet equation, owner’s equity may be greater than current and non-current liabilities.
Which of the following statements regarding forms of business organizations is TRUE?
- A limited partnership (LP) is a variation of a general partnership where all partners are actively involved in management and are jointly and severally liable.
- A limited liability partnership (LLP) requires that limited partners are passive investors only, who cannot be involved in the management of the firm.
- A corporation can never cease to exist.
- A corporation has the ability to defer income taxes for the owners by keeping profits in the form of retained earnings.
Correct Answer: 4
Option (4) is correct because when a corporation earns profits, the directors can choose to distribute the income to the shareholders in the form of dividends or choose to keep the profits invested in the company in the form of retained earnings.
Option (1) is incorrect because limited partnerships (LPs) are not a form of general partnership in that they include both passive and active partners, with their risk of liability defined by their involvement within the partnership.
Option (2) is incorrect because a limited liability partnership (LLP) allows each limited partner to be active and to be involved in managerial decision making. Only limited partners in a limited partnership (LP) are required to be passive investors.
Option (3) is incorrect because a company can cease to exist if it is terminated by the shareholders.
DOODLEBUGGY COMPANY LTD.
BALANCE SHEET
As at December 31, 20XX
ASSETS
Current Assets:
Cash
?
Accounts Receivable
$72,000
Merchandise Inventory
$57,000
Total Current Assets
$173,000
Non-Current Assets:
Land
$422,000
Machinery
?
Accumulated Depreciation
($95,000)
Total Non-Current Assets
?
TOTAL ASSETS
$992,000
LIABILITIES AND
SHAREHOLDERS’ EQUITY
Current Liabilities:
Accounts Payable – Merchandise
$82,000
Accounts Payable – Office Supplies
$14,000
Salaries Payable
$47,000
Total Current Liabilities
$143,000
Non-Current Liabilities:
Bonds Payable
$400,000
Total Liabilities
$543,000
Shareholders’ Equity:
Share Capital ($15 par value)
?
Retained Earnings
$149,000
Total Shareholders’ Equity
?
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
?
Based on the balance sheet provided, what is the value of Doodlebuggy Company’s cash, machinery, and total non-current assets?
- Cash = $44,000, machinery = $422,000, total non-current assets = $992,000
- Cash = $44,000, machinery = $492,000, total non-current assets = $819,000
- Cash = $173,000, machinery = $492,000, total non-current assets = $422,000
- Cash = $992,000, machinery = $95,000, total non-current assets = $173,000
Correct Answer: 2
Option (2) is correct because the value is Doodlebuggy Company’s cash is $44,000, the value of its machinery is $492,000, and its total non-current assets are $819,000.
Cash is calculated as follows:
Cash = total current assets − merchandise inventory − accounts receivable
Cash = $173,000 − $57,000 − $72,000
Cash = $44,000
Machinery is calculated as follows:
Machinery = total non-current assets – accumulated depreciation – land
Machinery = $819,000 + $95,000 – $422,000
Machinery = $492,000
Total non-current assets is calculated as follows:
Total non-current assets = total assets − total current assets
Total non-current assets = $992,000 − $173,000
Total non-current assets = $819,000
Option (1) is incorrect because the stated amounts for machinery and total non-current assets are incorrect.
Option (3) is incorrect because the stated amounts for cash and total non-current assets are incorrect.
Option (4) is incorrect because the stated amounts for cash, machinery, and total non-current assets are incorrect.
DOODLEBUGGY COMPANY LTD.
BALANCE SHEET
As at December 31, 20XX
ASSETS
Current Assets:
Cash
?
Accounts Receivable
$72,000
Merchandise Inventory
$57,000
Total Current Assets
$173,000
Non-Current Assets:
Land
$422,000
Machinery
?
Accumulated Depreciation
($95,000)
Total Non-Current Assets
?
TOTAL ASSETS
$992,000
LIABILITIES AND
SHAREHOLDERS’ EQUITY
Current Liabilities:
Accounts Payable – Merchandise
$82,000
Accounts Payable – Office Supplies
$14,000
Salaries Payable
$47,000
Total Current Liabilities
$143,000
Non-Current Liabilities:
Bonds Payable
$400,000
Total Liabilities
$543,000
Shareholders’ Equity:
Share Capital ($15 par value)
?
Retained Earnings
$149,000
Total Shareholders’ Equity
?
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
?
Based on the balance sheet provided, what is the value of Doodlebuggy Company’s share capital, total shareholders’ equity, and total liabilities and shareholders’ equity?
- Share capital = $300,000, total shareholders’ equity = $449,000, total liabilities and shareholders’ equity = $543,000
- Share capital = $235,000, total shareholders’ equity = $308,000, total liabilities and shareholders’ equity = $543,000
- Share capital = $300,000, total shareholders’ equity = $449,000, total liabilities and shareholders’ equity = $992,000
- Share capital = $260,000, total shareholders’ equity = $570,000, total liabilities and shareholders’ equity = $992,000
Correct Answer: 3
Option (3) is correct because the value of Doodlebuggy Company’s share capital is $300,000, its total shareholders’ equity is $449,000, and its total liability and shareholders’ equity is $992,000.
Share capital is calculated as follows:
Share capital = total shareholders’ equity – retained earnings
Share capital = $449,000 – $149,000
Share capital = $300,000
Total shareholders’ equity is calculated as follows:
Total shareholders’ equity = total liabilities and shareholders’ equity – total liabilities
Total shareholders’ equity = $992,000 – $543,000
Total shareholders’ equity = $449,000
Total liabilities and shareholders’ equity is calculated as follows:
Total liabilities and shareholders’ equity = total assets
Total liabilities and shareholders’ equity = $992,000
Option (1) is incorrect because total liabilities and shareholders’ equity is incorrectly stated.
Option (2) is incorrect because share capital, total shareholders’ equity, and total liabilities and shareholders’ equity are incorrectly stated.
Option (4) is incorrect because share capital and total shareholders’ equity are incorrectly statement.
