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Introduction:
To test your financial statement linking knowledge effectively, consider focusing on understanding the interconnections between the balance sheet, income statement, and cash flow statement. These three primary financial statements are linked through various accounts and transactions:
Balance Sheet: Reflects the company's assets, liabilities, and shareholders' equity at a specific point in time. Changes in these items over time are reflected in the income statement and cash flow statement.
Income Statement: Shows revenues, expenses, gains, and losses over a period of time, leading to net income or loss. Net income increases retained earnings on the balance sheet, affecting shareholders' equity.
Cash Flow Statement: Breaks down how changes in balance sheet accounts affect cash and cash equivalents, categorizing activities into operating, investing, and financing activities. It reconciles the ending cash balance with the beginning balance shown on the balance sheet.
Understanding how transactions impact these statements collectively helps in analyzing a company's overall financial health and performance. For example, a sale recorded as revenue on the income statement might increase cash (an asset) on the balance sheet and be reflected as cash from operating activities on the cash flow statement.
Test your financial statement Linking knowledge with 3 multiple-choice questions. Get detailed answers and explanations to improve your financial knowledge.
Questions-
Theory-Based Questions
Which financial statement shows a company's financial performance over a specific period?
A. Balance Sheet
B. Income Statement
C. Cash Flow Statement
D. Statement of Retained Earnings Income Statement Line Items In Detail
Which financial statement provides information about a company's assets, liabilities, and equity at a specific point in time?
A. Income Statement
B. Cash Flow Statement
C. Balance Sheet
D. Statement of Shareholders' Equity The Balance Sheet In Detail
Net income from the income statement flows into which section of the balance sheet?
A. Current Assets
B. Current Liabilities
C. Retained Earnings
D. Long-term Debt The Financial Statement In Detail
Depreciation expense appears on which financial statement?
A. Balance Sheet
B. Cash Flow Statement
C. Income Statement
D. Both Income Statement and Cash Flow Statement
The cash flow from operating activities is derived from which financial statement?
A. Income Statement
B. Balance Sheet
C. Statement of Retained Earnings
D. Both Income Statement and Balance Sheet Stockholder Equity Line Items In Detail
Which financial statement shows how cash is generated and used during a specific period?
A. Balance Sheet
B. Income Statement
C. Cash Flow Statement
D. Statement of Changes in Equity Cash Flow Statement In Detail
How is the ending balance of cash calculated on the cash flow statement?
A. Starting Cash Balance + Net Income
B. Starting Cash Balance + Operating Cash Flows + Investing Cash Flows + Financing Cash Flows
C. Total Revenue - Total Expenses
D. Assets - Liabilities
Which section of the cash flow statement adjusts for changes in working capital?
A. Operating Activities
B. Investing Activities
C. Financing Activities
D. Supplemental Information
In which financial statement would you find information about dividends paid?
A. Income Statement
B. Balance Sheet
C. Cash Flow Statement
D. Statement of Retained Earnings
How does the sale of equipment appear in the financial statements?
A. As revenue in the Income Statement
B. As a gain or loss in the Income Statement and as cash inflow in the Cash Flow Statement
C. Only in the Balance Sheet under Assets
D. Only in the Cash Flow Statement under Investing Activities
Practical-Based Questions
If a company reports a net income of $50,000 and depreciation expense of $5,000, what is the impact on the cash flow from operating activities?
A. Increase by $55,000
B. Increase by $50,000
C. Increase by $5,000
D. No impact
A company issues $10,000 in new common stock. Where would this appear in the cash flow statement?
A. Operating Activities
B. Investing Activities
C. Financing Activities
D. It would not appear in the cash flow statement
If accounts receivable increase by $3,000, how does this affect the cash flow from operating activities?
A. Increases by $3,000
B. Decreases by $3,000
C. No effect
D. It depends on the method of accounting
A company has a beginning cash balance of $20,000. During the year, it reports net cash provided by operating activities of $15,000, net cash used in investing activities of $5,000, and net cash used in financing activities of $10,000. What is the ending cash balance?
A. $10,000
B. $20,000
C. $15,000
D. $30,000
If a company purchases equipment for $25,000 in cash, how is this reflected in the financial statements?
A. Increase in assets on the Balance Sheet
B. Decrease in cash flow from operating activities
C. Decrease in cash flow from investing activities
D. Increase in expenses on the Income Statement
How does an increase in inventory affect the cash flow statement?
A. Increases cash flow from operating activities
B. Decreases cash flow from operating activities
C. Increases cash flow from investing activities
D. No effect on the cash flow statement
If a company repays a $5,000 loan, how is this transaction reported in the cash flow statement?
A. Operating Activities
B. Investing Activities
C. Financing Activities
D. Not reported in the cash flow statement
A company declares and pays dividends of $8,000. How does this impact the financial statements?
A. Reduces net income on the Income Statement
B. Increases liabilities on the Balance Sheet
C. Decreases cash flow from financing activities
D. Increases cash flow from operating activities
If a company sells a piece of equipment for $10,000, and the book value of the equipment is $7,000, how is the gain reported?
A. As a $10,000 revenue in the Income Statement
B. As a $3,000 gain in the Income Statement and $10,000 cash inflow in the Cash Flow Statement
C. As a $7,000 gain in the Income Statement and $3,000 cash inflow in the Cash Flow Statement
D. As a $10,000 cash inflow in the Cash Flow Statement only
If a company receives $5,000 from a customer for services to be provided next year, how is this reported?
A. As revenue in the Income Statement
B. As cash inflow from operating activities and a liability on the Balance Sheet
C. As cash inflow from financing activities and an asset on the Balance Sheet
D. As cash inflow from investing activities and revenue in the Income Statement
Answers
Theory-Based Questions
Which financial statement shows a company's financial performance over a specific period?
Correct Answer: B. Income Statement
Explanation: The income statement provides a summary of a company's revenues and expenses over a specific period, indicating how the business performed financially.
Explanation Why Other Options Are Incorrect:
A. Balance Sheet: Shows financial position at a point in time.
C. Cash Flow Statement: Shows cash inflows and outflows over a period.
D. Statement of Retained Earnings: Shows changes in retained earnings over a period.
Which financial statement provides information about a company's assets, liabilities, and equity at a specific point in time?
Correct Answer: C. Balance Sheet
Explanation: The balance sheet provides a snapshot of a company’s financial position at a particular date, listing assets, liabilities, and shareholders' equity.
Explanation Why Other Options Are Incorrect:
A. Income Statement: Covers performance over time, not a snapshot.
B. Cash Flow Statement: Details cash movements, not financial position.
D. Statement of Shareholders' Equity: Focuses on equity changes, not full financial position.
Net income from the income statement flows into which section of the balance sheet?
Correct Answer: C. Retained Earnings
Explanation: Net income increases retained earnings on the balance sheet, reflecting accumulated profits.
Explanation Why Other Options Are Incorrect:
A. Current Assets: Represents assets expected to be converted to cash within a year.
B. Current Liabilities: Represents obligations due within a year.
D. Long-term Debt: Represents liabilities due beyond one year.
Depreciation expense appears on which financial statement?
Correct Answer: D. Both Income Statement and Cash Flow Statement
Explanation: Depreciation expense is listed on the income statement as an expense and added back to net income in the operating section of the cash flow statement since it’s a non-cash charge.
Explanation Why Other Options Are Incorrect:
A. Balance Sheet: Shows accumulated depreciation, not expense.
B. Cash Flow Statement: Yes, but also needs Income Statement.
C. Income Statement: Yes, but also needs Cash Flow Statement.
The cash flow from operating activities is derived from which financial statement?
Correct Answer: D. Both Income Statement and Balance Sheet
Explanation: The cash flow from operating activities adjusts net income (from the income statement) for changes in working capital (from the balance sheet).
Explanation Why Other Options Are Incorrect:
A. Income Statement: Only provides net income, not full cash flow details.
B. Balance Sheet: Provides working capital changes but not net income.
C. Statement of Retained Earnings: Focuses on changes in retained earnings, not cash flow.
Which financial statement shows how cash is generated and used during a specific period?
Correct Answer: C. Cash Flow Statement
Explanation: The cash flow statement details cash inflows and outflows from operating, investing, and financing activities over a period.
Explanation Why Other Options Are Incorrect:
A. Balance Sheet: Provides a snapshot, not cash movements.
B. Income Statement: Shows revenues and expenses, not cash flows.
D. Statement of Changes in Equity: Shows changes in equity, not cash flows.
How is the ending balance of cash calculated on the cash flow statement?
Correct Answer: B. Starting Cash Balance + Operating Cash Flows + Investing Cash Flows + Financing Cash Flows
Explanation: This formula accounts for all cash activities to arrive at the ending cash balance.
Explanation Why Other Options Are Incorrect:
A. Starting Cash Balance + Net Income: Ignores cash specifics of net income.
C. Total Revenue - Total Expenses: Relates to net income, not cash flow.
D. Assets - Liabilities: Reflects equity, not cash.
Which section of the cash flow statement adjusts for changes in working capital?
Correct Answer: A. Operating Activities
Explanation: Changes in current assets and liabilities are adjusted in the operating activities section to convert net income to cash flow from operations.
Explanation Why Other Options Are Incorrect:
B. Investing Activities: Relates to investments, not working capital.
C. Financing Activities: Relates to financing sources and uses, not working capital.
D. Supplemental Information: Provides additional details, not adjustments.
In which financial statement would you find information about dividends paid?
Correct Answer: C. Cash Flow Statement
Explanation: Dividends paid are listed in the financing activities section of the cash flow statement.
Explanation Why Other Options Are Incorrect:
A. Income Statement: Shows expenses and revenues, not dividends paid.
B. Balance Sheet: Shows retained earnings reduction, but not direct cash flow.
D. Statement of Retained Earnings: Shows dividends declared, but not paid.
How does the sale of equipment appear in the financial statements?
Correct Answer: B. As a gain or loss in the Income Statement and as cash inflow in the Cash Flow Statement
Explanation: The gain or loss from the sale appears in the income statement, while the cash received appears in the investing activities section of the cash flow statement.
Explanation Why Other Options Are Incorrect:
A. As revenue in the Income Statement: Only the gain or loss is included.
C. Only in the Balance Sheet under Assets: Equipment sale also impacts income and cash flow statements.
D. Only in the Cash Flow Statement under Investing Activities: Also affects the income statement.
Practical-Based Questions
If a company reports a net income of $50,000 and depreciation expense of $5,000, what is the impact on the cash flow from operating activities?
Correct Answer: A. Increase by $55,000
Explanation: Net income of $50,000 plus non-cash depreciation expense of $5,000 is added back to arrive at cash flow from operating activities.
Explanation Why Other Options Are Incorrect:
B. Increase by $50,000: Misses adding back depreciation.
C. Increase by $5,000: Only considers depreciation, not net income.
D. No impact: Both net income and depreciation impact cash flow.
A company issues $10,000 in new common stock. Where would this appear in the cash flow statement?
Correct Answer: C. Financing Activities
Explanation: Issuing common stock generates cash inflow recorded under financing activities.
Explanation Why Other Options Are Incorrect:
A. Operating Activities: Relates to core business operations, not financing.
B. Investing Activities: Relates to investment in assets, not stock issuance.
D. It would not appear in the cash flow statement: Stock issuance affects cash flow.
If accounts receivable increase by $3,000, how does this affect the cash flow from operating activities?
Correct Answer: B. Decreases by $3,000
Explanation: An increase in accounts receivable means cash not yet received, thus reducing operating cash flow.
Explanation Why Other Options Are Incorrect:
A. Increases by $3,000: Incorrect, since cash is not received.
C. No effect: Incorrect, as it affects working capital.
D. It depends on the method of accounting: Always affects cash flow from operations.
A company has a beginning cash balance of $20,000. During the year, it reports net cash provided by operating activities of $15,000, net cash used in investing activities of $5,000, and net cash used in financing activities of $10,000. What is the ending cash balance?
Correct Answer: A. $10,000
Explanation: Starting cash $20,000 + $15,000 (operating) - $5,000 (investing) - $10,000 (financing) = $10,000.
Explanation Why Other Options Are Incorrect:
B. $20,000: Ignores cash flows.
C. $15,000: Miscalculates the impact of all cash flows.
D. $30,000: Adds instead of correctly applying net changes.
If a company purchases equipment for $25,000 in cash, how is this reflected in the financial statements?
Correct Answer: C. Decrease in cash flow from investing activities
Explanation: Cash outflow for equipment purchase is recorded under investing activities.
Explanation Why Other Options Are Incorrect:
A. Increase in assets on the Balance Sheet: Correct, but question asks for cash flow impact.
B. Decrease in cash flow from operating activities: Investing, not operating.
D. Increase in expenses on the Income Statement: Equipment purchase capitalized, not expensed.
How does an increase in inventory affect the cash flow statement?
Correct Answer: B. Decreases cash flow from operating activities
Explanation: Cash used to purchase additional inventory decreases cash flow from operations.
Explanation Why Other Options Are Incorrect:
A. Increases cash flow from operating activities: Incorrect, as it uses cash.
C. Increases cash flow from investing activities: Inventory purchase is an operating activity.
D. No effect on the cash flow statement: Incorrect, as it affects working capital.
If a company repays a $5,000 loan, how is this transaction reported in the cash flow statement?
Correct Answer: C. Financing Activities
Explanation: Loan repayment is recorded as a cash outflow under financing activities.
Explanation Why Other Options Are Incorrect:
A. Operating Activities: Loan transactions are financing activities.
B. Investing Activities: Loan transactions are not related to investments.
D. Not reported in the cash flow statement: Incorrect, it impacts cash flow.
A company declares and pays dividends of $8,000. How does this impact the financial statements?
Correct Answer: C. Decreases cash flow from financing activities
Explanation: Dividends paid are a cash outflow recorded under financing activities.
Explanation Why Other Options Are Incorrect:
A. Reduces net income on the Income Statement: Dividends are not expenses, not affecting net income.
B. Increases liabilities on the Balance Sheet: Dividends paid reduce cash, not increase liabilities.
D. Increases cash flow from operating activities: Incorrect, it affects financing activities.
If a company sells a piece of equipment for $10,000, and the book value of the equipment is $7,000, how is the gain reported?
Correct Answer: B. As a $3,000 gain in the Income Statement and $10,000 cash inflow in the Cash Flow Statement
Explanation: The gain is the difference between selling price and book value ($3,000) reported on the income statement, and the cash received ($10,000) is reported under investing activities.
Explanation Why Other Options Are Incorrect:
A. As a $10,000 revenue in the Income Statement: Only gain, not total proceeds, is recorded.
C. As a $7,000 gain in the Income Statement and $3,000 cash inflow in the Cash Flow Statement: Incorrect calculation of gain and cash flow.
D. As a $10,000 cash inflow in the Cash Flow Statement only: Also affects income statement with gain.
If a company receives $5,000 from a customer for services to be provided next year, how is this reported?
Correct Answer: B. As cash inflow from operating activities and a liability on the Balance Sheet
Explanation: The cash received increases cash flow from operations, and the obligation to provide services creates a liability (unearned revenue).
Explanation Why Other Options Are Incorrect:
A. As revenue in the Income Statement: Revenue is not recognized until services are provided.
C. As cash inflow from financing activities and an asset on the Balance Sheet: Incorrect, it’s an operating activity and a liability.
D. As cash inflow from investing activities and revenue in the Income Statement: Incorrect, relates to operating and not yet revenue.
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