COMMERCE 1AA3 Study Guide - Quiz Guide: Cash Flow Statement, Accrual, Retained EarningsExam
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Question 1: Briefly explain the difference between the cash basis of accounting and the
accrual basis of accounting. Are adjusting entries necessary under both methods?
The cash basis of accounting recognizes revenues and expenses only when cash is received or paid. There
is no need for receivable or payable accounts since no accruals are made. This eliminates the need for
adjustments at the end of the period.
Under the accrual basis of accounting, the accountant recognizes the impact of a business transaction on
an entity when the transaction occurs, whether or not cash is received or paid. The accountant will record
revenue when it is earned and expenses when they are incurred, regardless of when cash is received or
paid. Adjustments are usually necessary at the end of the period to update certain asset and liability
accounts and to recognize revenues that have been earned but not collected and expenses that have been
incurred but not paid.
Question 2: What are the three forms of business organizations? How do they differ?
A proprietorship has a single, or sole, owner who is responsible for the business and its operations. A
partnership has two or more individuals who operate together as co-owners of the business. In both of
these forms of organization, the owners are individually liable for the debts of the business. A corporation
is a business owned by shareholders, who may or may not have a part in the day-to-day operations of the
business. The shareholders of a corporation are not legally liable for the debts of the business.
It is easier to sell one's ownership of a corporation, since the ownership is evidenced by shares of stock,
which can be traded. There are legal rules to be considered when a partner wishes to sell his or her
interest in a partnership. Such rules make it more difficult to sell a partnership interest. A sole proprietor
who sells his or her business may encounter difficulty since the business owner may be the business itself
(such as a consultant or other independent contractor).
There are also tax advantages associated with corporations that are not available to proprietorships and
partnerships; namely the ability to defer a large portion of taxes until the point in time the profits are
taken out in the form of dividends.
Question 3: Four financial statements were covered in depth in class. Name these four
financial statements and indicate on which of these financial statements retained earnings
These financial statements are: 1) balance sheet; 2) income statement; 3) statement of retained earnings;
and 4) cash flow statement. Retained earnings appear on the balance sheet and the statement of retained
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