Question

i) A Business owner takes money out of his business in the form of a loan and gives the business a long-term promissory note. Which of the following would be the most conservative approach to treating this transaction from the point of view of a lender?

A) Decrease assets and decrease equity by the amount of the note receivable.

B) Decrease assets and decrease liabilities by the amount of the note receivable

C) Increase liabilities and decrease equity by the amount of the note receivable.

D) Decrease liabilities and increase equity by the amount of the note receivable.

ii)Which of the following is a primary purpose for using common-size financial statement?

A) To determine whether business borrowers are following the same accounting practices in preparing financial statements.

B) To evaluate trends in the relationship of expenses to sales and of individual assets to total assets.

C) To determine the effect of common accounting methods used in recognizing revenue and valuing assets.

D) To ensure that business borrowers provide a standard amount of information in their financial statements.   

Answer 1

1) Taking out loan from the business by owner would decrease equity and also decrease cash which would decrease the asset.

So correct answer is A) Decrease assets and decrease equity by the amount of the note receivable.

2) Common size financial statements help in analysing expenses as % of sales or each component of assets as % of total assets. So correct answer is :B) To evaluate trends in the relationship of expenses to sales and of individual assets to total assets.