D774 Introduction to Business Accounting - Set 3 - Part 3

Correct Answer: The cash line on the balance sheet

The ending cash on the statement of cash flows must equal the cash line on the balance sheet. The cash-flow statement reconciles to, or explains the change in, that balance-sheet cash, so the two figures tie out exactly. Option a is incorrect because net income comes from the income statement and feeds the equity statement, not the cash balance. Profit and cash differ under accrual accounting, so net income is not the figure that must match ending cash. Option b is incorrect because total equity is the owners' residual stake, reconciled by the equity statement, not by cash flows. Equity links the equity statement to the balance sheet, but it is not what ending cash must equal. Option c is incorrect because retained earnings tracks accumulated profit kept in the business, flowing from the equity statement. It is part of the equity section and unrelated to the cash balance, so it does not match ending cash.

Correct Answer: It overstates equity, then the balance sheet

Overstated revenue inflates net income, which flows into the equity statement and overstates ending equity. That equity then carries onto the balance sheet, so the single error ripples forward, leaving the whole set internally inconsistent. Option a is incorrect because the statements are wired together, so an error cannot simply disappear. Overstated revenue raises net income, which feeds the equity statement and the balance sheet, carrying the mistake forward rather than ending it. Option b is incorrect because the cash-flow operating section reflects actual cash, which overstated, uncollected revenue does not increase. The error instead travels through net income into equity and the balance sheet, not into the cash totals. Option d is incorrect because overstating revenue does not reduce liabilities. It inflates net income and equity, and to keep the balance sheet balanced an asset would typically be overstated, so liabilities are not what the error lowers.

Correct Answer: Beginning inventory plus purchases minus ending inventory

Cost of goods sold starts with beginning inventory, adds purchases to get goods available for sale, then subtracts the ending inventory still on hand. What remains is the cost of the goods that actually sold during the period. Option b is incorrect because beginning inventory should be added, not subtracted, and sales revenue is not part of a cost calculation. Mixing sales into a cost figure confuses what was earned with what was sold. Option c is incorrect because ending inventory is subtracted at the end, not added at the start, and sales do not belong in the formula. Starting from ending inventory and removing sales scrambles both the order and the inputs. Option d is incorrect because purchases must be added to reflect goods bought, and ending inventory must be subtracted, not added. Adding ending inventory and removing purchases reverses two of the three steps, giving a meaningless result.

Correct Answer: First-in-first-out, expensing cheaper costs

Under rising prices, first-in-first-out expenses the oldest, cheapest inventory, producing a lower cost figure and therefore higher net income. Last-in-first-out expenses the newer, costlier inventory, giving a lower reported income. Option a is incorrect because expensing newer, pricier inventory raises the cost charged against sales and lowers net income, which is the last-in-first-out outcome. So that method reports lower, not higher, income during rising prices. Option c is incorrect because the two methods diverge precisely when prices change. During inflation they assign different costs to goods sold, so reported income differs rather than coming out identical, which is the whole point of choosing one. Option d is incorrect because the inventory method directly shapes which costs flow to expense and therefore net income when prices move. Claiming neither affects income ignores how the cost-flow assumption changes the bottom line under inflation.

Correct Answer: Whether current assets cover current debts

The current ratio compares current assets to current liabilities, signaling liquidity, whether the business can pay near-term bills with near-term assets. A reading above one means a cushion; below one can warn of trouble meeting short-term obligations. Option a is incorrect because profit per sales dollar is measured by net profit margin, not the current ratio. The current ratio addresses liquidity by weighing short-term assets against short-term debts, not profit per sale. Option b is incorrect because reliance on debt is captured by the debt-to-equity ratio, which compares total liabilities to equity. The current ratio focuses on short-term solvency, not on the overall mix of borrowed versus owners' money. Option d is incorrect because the current ratio deals with short-term items, not long-term ones. Long-term equipment is a noncurrent asset excluded from the calculation, so the ratio ignores long-lived productive assets.

Correct Answer: The net profit margin

Net profit margin compares net income to sales, showing how many cents of each sales dollar survive as profit after all expenses. Higher is better, and it answers exactly the owner's question about profit per sales dollar. Option a is incorrect because the current ratio measures liquidity by comparing short-term assets to short-term liabilities. It indicates whether near-term bills can be paid, not how much of each sales dollar remains as profit after expenses. Option b is incorrect because debt-to-equity gauges leverage, the reliance on borrowed money versus owners' funds. It compares liabilities to equity and reveals nothing about the share of each sales dollar that ends up as profit. Option c is incorrect because gross profit alone, sales minus the cost of goods sold, ignores operating and other expenses. The owner wants profit after all costs, which is net profit margin, so a gross figure overstates what truly remains.

Correct Answer: Greater reliance on borrowing, more risk

The debt-to-equity ratio compares total liabilities to equity, so a higher reading means more debt relative to owners' money, signaling greater reliance on lenders and more risk. A lower reading means owners fund more of the business. Option b is incorrect because paying short-term bills is what the current ratio measures, comparing near-term assets to near-term liabilities. Debt-to-equity weighs total borrowing against owners' money, so it reflects leverage, not short-term liquidity. Option c is incorrect because profit kept from each sale is net profit margin, built from net income and sales. Debt-to-equity says nothing about profitability, only about how much the business leans on borrowing versus the owners' stake. Option d is incorrect because the ratio compares liabilities to equity, not the level of cash on hand. A high reading reflects heavy borrowing relative to owners' funds, which is unrelated to how much idle cash sits in the account.

Correct Answer: The gross-based margin is usually higher

The gross-based margin uses gross profit, sales minus the cost of goods sold, before operating expenses, while net profit margin subtracts all expenses. For a profitable company the gross figure is normally higher, since fewer costs have been removed. Option a is incorrect because the two margins use different numerators, gross profit versus net income, so they rarely match. Operating and other expenses separate them, making them equal only in the unusual case where those expenses are zero. Option b is incorrect because net profit margin subtracts every expense, leaving a smaller numerator than the gross-based margin. So the net figure is normally the lower of the two for a profitable company, not the higher one. Option c is incorrect because both margins come straight from income-statement figures. Gross profit and net income are both reported there relative to sales, so each margin can readily be calculated, making this claim simply false.

Correct Answer: The change in inventory on hand

Purchases is everything bought; the cost of goods sold is only what sold. They differ by the change in inventory: if stock grew, fewer goods were sold than bought, so the inventory shift on the shelf explains the gap. Option a is incorrect because sales revenue measures what was earned, not the cost of goods that left the shelf. The gap here comes from inventory changing, a cost-side quantity unrelated to the revenue side of the business. Option c is incorrect because dividends are a distribution of profit to owners, far removed from inventory accounting. They never enter the cost-of-goods calculation, so they cannot explain why the two figures differ. Option d is incorrect because depreciation allocates the cost of long-term equipment, not inventory. It belongs to fixed assets, so it plays no role in the gap between what was purchased and what was sold from inventory.

Correct Answer: Income flows to equity; cash ties out

Net income flows from the income statement into the equity statement, ending equity carries onto the balance sheet, and the balance sheet's cash must equal the ending cash on the cash-flow statement. That chain is articulation. Option a is incorrect because net income is produced by the income statement and flows outward into equity, not fed by cash. Cash does not generate profit, and net income does not directly set liabilities, so this misroutes the links. Option b is incorrect because liabilities do not drive equity, and equity does not set the cash balance. The genuine chain runs from net income through equity to the balance sheet, with cash tying to the cash-flow statement. Option c is incorrect because expenses feed into net income on the income statement rather than flowing straight into cash, and cash does not set retained earnings. Retained earnings grows from net income through the equity statement instead.