Midterm Question 1

Question:

How would you see the purchase of an automobile with cash in our three accounting documents?

a) As an expense, equal to the purchase price, on the income statement.
b) On the cash-flow statement as a negative entry in investments.
c) On the income statement
d) On the balance sheet as a decrease in total assets.

Answer:

b) On the cash-flow statement as a negative entry in investments.

Balance Sheet:
A car purchased with cash would show up as a decrease in current assets and an increase in fixed assets; please note that there is no net change in total assets. Therefore option d) does not work.
The car would not show up in the liabilities section since there was no loan taken out to finance the car and it is owned clear and outright.
The car would not show up in the owner equity section of the balance sheet; the car is not a current liability (something which must be paid in the near future).

Income Statement:
Nothing would show up on the income statement since the car is not considered an expense and the cash would not be considered as revenue; thus options a) and c) do not work.

Cash-Flow Statement:
The purchase of a car would show up as a negative entry in the investment section (option b), showing that cash was flowing out of the business. However, the cash used to purchase the car would not show up as a positive number in the finance section (since no loan was taken to purchase the car). Please note that there would be a net change in cash demonstrated on the cash-flow statement.

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